Last updated: 2/1/01
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Some Ideas About Economics
Common terms:
- Markets
- A place or a space (e.g. in the want-ads or on the web) where people come together to
exchange things of value. It is much more efficient for exchanging things than the
alternative, which is to wander around and hope you bump into somebody else who also wants
to do this. Since it is more efficient, it leads to a higher level of activity, that is,
more things being bought and sold. It became worthwhile, or at least more worthwhile, to
make more than you needed.
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- Money
- A medium for exchanging things of value. Before the rise of money (it really became
common in Industrial society), barter was the method of exchanging things of value. If you
had an ax and wanted a chicken, you had to find someone with a chicken who wanted an ax.
No easy job, even in a market. With money, you only had to find someone with a chicken who
wanted anything else, so you gave that person the chicken and you got their
money, and then you had to find someone with an ax who wanted anything else, and
you ended up with their ax in exchange for the money. Since this was easier and faster (in
economic terms, more efficient), it led to a higher level of activity, and the other
consequences resulting from the rise of the market. An industrial society, producing all
the food that an agricultural society did (and probably more - agricultural societies have
more frequent famines, and only rarely have obesity problems) and approximately ten times
more of non-agricultural goods and services in addition. If an agricultural society was a
bicycle, an industrial society was a race car. Will the productivity of Third Wave
societies also be ten times greater than that of industrial societies?
Although it may seem that money has intrinsic value, this is not really the case. Suppose
that everything that is worth money today - chickens, axes, work, and so forth - suddenly
were worth half as much money, in all national currencies, and the national currencies did
not change their relative values either. Would anything else change besides the money that
something was worth? Would any human activity or level of activity change? Would the
structure of the economy or the structure of society change?
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- Market allocation (of goods and services)
- Any society needs a method of sorting people into different economic categories, such as
farmers, financiers, workers, etc. How many cars should we make, how many corn flakes, how
many Bachelor's degrees, how many paintbrushes? How many people should work making
paintbrushes, and how much should they be paid? A market or capitalist society makes these
allocations by paying more or less for work, and charging more or less for goods. The
result is a society that is pretty good at, and perhaps the best at producing what people
really value (which is often different from what they will say they value, if
asked, and can even be different from what people think they want), and so has a
high level of activity, or standard of living. Some complain that this is materialism; the
abandonment of spiritual or social values, but this is only true if people do not really
value those. Now, this adjustment of profit, effort, production and consumption is done in
myriads of daily detailed transactions, that no statistician and no government can fully
measure - there are just too many negotiations of price, quantity and wages to keep track
of. I went to Radio Shack on January 28, 2001 to buy a rechargeable flashlight. They were
$20 or so, much more than I wanted to pay. The clerk asked me, "What would it
take" to make you buy it? I didn't know what to say. What's going on here - barter in
suburban Detroit? But the point I want to make here is, what government statistician, or
even what Radio Shack executive, will ever learn about this negotiation? Thus, Adam Smith
wrote about "the invisible hand of the market."
One of the mechanisms of this allocation is profit. If people are willing to pay more for
something than it costs to supply it, then there will be a supply, and if the profit is
high enough, then the supply will increase. Theoretically, it would be possible to make
this allocation without profit, and achieve even higher levels of production and
consumption; that is, a higher standard of living. This gave rise to several varieties of
"centrally planned" economies, most notably the USSR. Of course, as we know now,
the central planning failed. For a variety of reasons, the central government did not make
good allocation decisions, and it was probably impossible for the central government to
make good allocation decisions. The standard of living fell, or at least fell far behind
that of market economies. This was the case even though the USSR did not engage in
"non-productive" activities such as environmental protection and political
freedom. Perhaps China and the surviving Communist countries can do better. China, in
particular, is choosing market allocation of the economy, but central control of other
aspects of society, such as politics. Can people be freed economically but controlled
politically, spiritually and otherwise? My bet is "no," but we will see how this
goes.
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- Competition
- In a market system, competition means that if one company is charging too much, or
delivering too little, or has unacceptably low quality, that another provider of those
goods and/or services can increase its production, or even start up from "ground
zero" and lure the customers away from the first company. In a competitive market,
all such weakness are constantly being probed. There are several crucial conditions for
ensuring a competitive market:
- Customers must have full and accurate knowledge about price, quality and so forth. This
includes investors, a special class of customers.
- Companies can not be allowed to seem to be independent, but in reality be making deals
in "constraint of trade," for example by keeping prices high.
- It must be possible for competitors to actually increase production, and ideally for new
producers to come into being.
- The US has laws to enforce these conditions. It is interesting to note that the field
upon which competition plays out is changing. For example, where before, movies, telephone
service, cable TV, radio and Internet service were all separate areas of the economy, they
are now in the process of merging into an information sector that can provide all of these
services. Whereas before we might need so many telephone companies, so many cable TV
companies and so forth, the same level of competition can be maintained with fewer total
companies. If there are strong foreign competitors, the supposition is that we need fewer
domestic competitors.
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- Creative Destruction
- This term, which seems to contradict itself, was coined by Joseph Schumpeter in Capitalism,
Socialism and Democracy, first published in (I think) 1942. Schumpeter analyzed market
or capitalist economies and later compared them socialist economies. He criticized earlier
analyses of capitalist economies. These earlier analyses, according to Schumpeter, were
flawed because they viewed market economies as static, by which he meant that in these
analyses, the corporations, customers, goods and other components of the economy were
unchanging, or changing only slowly, driven by forces that were also unchanging, and the
relationships between these economies were also unchanging. Viewing the large corporations
of the day, and the stability that we believed them to have even ten years ago, and that
they often attributed to themselves, we can see how this impression could arise.
Schumpeter claimed that, in reality, if you talked to the the heads of companies large or
small, they were always worried about being beaten out in the marketplace, and were always
trying to adjust to and even anticipate a myriad of real and perceived threats. It was not
only the direct competitors that kept them awake at night, but the ever-present
possibility that an entirely new product or service would arise and make an end run around
them. Consequently, the economy was never static, but always making itself more efficient.
There was, Schumpeter wrote, "a perpetual gale of creative destruction" blowing
through the economy. Existing methods and units were continuously being torn apart. That
is the "destruction" part. The "creative" part is that, out of the
debris of the destruction (machines, buildings, people, money and so forth), new and more
efficient units were created, either through competition or through fear of competition.
Socialist or centrally planned economies could not compete with capitalist economies
by taking aim at a fixed target, they had to aim at targets that were moving, and always
finding new ways to move faster. Interestingly, Schumpeter claimed that this constant
upheaval would (a) find internal limitations or "decreasing returns" and more
importantly (b) turn the citizens subjected to this constant upheaval against the system.
(Indeed, during the 1970's and 1980's, there was a lot of publicly expressed resentment at
the conditions of industrial work - Take This Job and Shove It being merely one of
the more spirited.) Socialism, according to Schumpeter, would triumph over capitalism. It
was, instead, the citizens of the most advanced socialist economies that turned against
that form of government. But the term "creative destruction" survives, and more
importantly the creative destruction itself survives. Today, the destruction part makes
the headlines (layoffs, business failures etc.) but the creative part just happens
invisibly. And, as Schumpeter said, the new units are better not just because they are
planned better, but because the people in them have improved also. The people learn and
continue, but the organizations are gone. With unemployment insurance, job retraining
programs and many of the "Great Society" programs, we have learned how to help
people survive and improve themselves (in economic terms). If we were better at making the
"destruction" part less destructive to the people, could we become more
competitive? If we go too far in this direction, do we risk helping those people to make
the wrong decisions?
Another reason for the survival of capitalism (funny - I still feel that has some
pejorative connotations, so Marx is still with us) is the middle class, which often does
not exist in agricultural societies - there is the elite at the top and the peasants on
the bottom, with precious little in between. The existence of a middle class does at least
two things: (a) it "pacifies" a large fraction of those not in the elite, and
(b) it provides role models for small and therefore practical upward movement. If you are
a peasant, it is very hard to conjure up how to become the king, but if you want to
increase your middle-class income by several thousand dollars a year, say, there are lots
of examples all around you - take your pick. Get a second job, suck up to the Supervisor,
get overtime, get some training, sell door-to-door, and many, many more. This conviction
that we can all improve our economic lot in life simply does not exist in agricultural
societies.
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- Corporate planning, change, and the relationship between employers and employees
- Companies used to make elaborate projections of their business five or even ten years
into the future. The problem with these projections is that they of necessity make untold
assumptions about what is called "the business environment" - roughly, the
competition and the customers. The business environment (society, really) is now changing
so fast, and so fundamentally, that this planning activity is now in decline. In many
cases, companies now assume that six months is as far ahead as they can see with any
accuracy. In six months, things will have changed so drastically, that the business will
be fundamentally different. There is only one speed, and that is full speed. If you try to
be first in your market, you may be lucky and end up in third place. If you try to be
third, you will not survive. In this environment, increasingly, management's understanding
is that, if they construct a plant or an office building, it is starting to go out of date
on the day it is finished. What resource can help them change? People are the only
resource that can change, and even then they often need help in changing, or they can't
change fast enough. In the old employee-employer relationship, the employee was more or
less guaranteed a job if s/he did as told. Now, the employees are often aware of the
changes in the market before the management is, and it takes too long for that information
to travel up the hierarchy and back down. And who believes in long-term guaranteed
employment in any case? Schumpeter's "gale" is gathering speed daily. No
employee believes that management decisions are made to benefit the employee. So what is
the new relationship? One part has to be that, if the employee keeps skill up-to-date and
is flexible, and takes more responsibility for producing things that customers actually
want even though that keeps changing, that they have a job. In return, the company should
support employees in keeping their skills current, to benefit the company and to make the
employee employable in the event of layoffs. This, of course is a double-edged sword -
employees may leave anyway. The most self-consciously future-oriented companies, for
example Anderson Consulting (which recently changed it's name to include characters not on
the standard keyboard) go further. They say, "We are going to work together for
awhile. We will help you become valuable in the marketplace, and expose you to other
companies where you will become invaluable. they will hire you away. There will be a
network of former Anderson employees and Anderson Consulting itself. The former employees
will be able to call upon Anderson, and Anderson will use the network to find new business
opportunities." Network security, instead of stand-alone security.
Money circulation and the level of activity. "The economy
game," a two-person imaginary economy. This illustrates the importance of developing
a product (or a service) that people want, so they will pay money for it, and of consumer
confidence, as manifested by the willingness to spend that money (especially important for
expensive products that will be paid for in the future).
It is very clear that the next part is important, but I am not 100% clear about why.
But, the more people that play in this game of exchanging things of value, the better it
is for everybody. There are a couple of reasons for this that I do understand. These are:
- If everybody is in this game, the transactions do not simply go around in a circle
("serial") but form a dense network ("parallel"). If one person, or
one category of the economy, slows down, in a serial economy the whole economy slows down
and can even stop. If new people or groups participate, and they make and/or like slightly
different things than other people or groups, then in a network economy, when one person
or group slows down, the others can keep up a high rate of exchange. the economy is better
able to keep operating at a high rate, which is good economic news for everybody, even
those who are (temporarily, we hope) having a harder time. This is a basic characteristic
of networks, and not just computer networks; the denser the network connections are, the
more robust the network is.
- If there are people or groups who do not fully participate in the economy, they do not
just simply shrivel up and blow away. By whatever means necessary, they find ways to
satisfy their basic needs. But they are of course not as confident or perhaps even adept,
at keeping the game moving quickly, and so act as a brake on the economy.
So, an economy that involves everyone, that has "the invisible hand" working
to learn what its participants want, that has a good set of laws and people to enforce
open competition, that has good systems in place to help those caught up in the
destruction of business units but does not do too much, and that can move money really,
really quickly (Don't wait until you actually have the money! Borrow it and spend now!
Just whip that card out and lay it down on the counter and walk out with... whatever you
want, whatever you want.), will be very good at providing large amounts of what its
citizens value most. Can it provide too much? For example, obesity is on the rise, causing
health problems such as heart disease and diabetes. That can be a problem, but medicines,
exercise programs, healthy foods and similar goods will be produced, if those are real
problems for the populace. Winston Churchill said about democracy, but it applies equally
to capitalism, "democracy is the worst possible form of government, except for all
the others."
Financing, interest rates and stocks
The "creative" part of Schumpeter's excellent phrase is where (economic)
improvements happen. But companies, or companies just getting started, need funds to
operate. It is important to realize that companies need money even to "run in
place," to replace machinery and other equipment as it wears out. One possibility is
self-funding, from earnings or savings, but the amount available here is often
insufficient. There is more available by borrowing from a bank. The Federal Reserve Board,
which maintains and controls the US system for moving money and supplying credit, can open
or close the money faucet by raising or lowering interest rates here. But more money can
be raised if the company sells ownership of itself - stock, since this promises a higher
rate of return - a share of the profits - than lending does. Each step, from
self-financing to bank financing, to stock market financing, makes possible a higher level
of activity. Once a company sells stock in itself, buying and selling of the stock, and
changes in the stock price do not directly help or hurt the company any more, unless it
wants to sell more stock in itself to raise more money. The stock price does not directly
affect the company, but it does matter to the stock holders. In the not-too-distant past,
stockholders were passive enough that company management often had effective ownership.
These days, stockholders are much more active, at least partially because they can
communicate with each other much more easily, and management watches the stock price
carefully, unless it really wants to find other work.
But wait! Even as borrowing seems to be on the decline in January 2001, companies may
be financing expansion and upgrading with internal funds (National Public Radio, 2/1/01).
With so many options, if one slows down, there are others ready to take its place. A
robust network economy has many ways to stay active even if some methods rise and fall.
Be careful with that economy!
We rely upon "the invisible hand" for much of the management our economy, and
there is much we do not understand about why or how our economy works. Witness the
dramatic shifts in foreign aid and development goals:
- In the 1950's, the conviction was that natural resources were key to economic
development. Africa has lots of natural resources, so African development activities were
to locate and extract ores and gems. Nowadays we might bring up Japan as a counterexample,
a country with virtually no natural resources and yet a substantially modern economy. But
success in developing natural resources did not make the African economies take off.
- In the 1980's the idea was that infrastructure was the key; roads, bridges, energy,
telephones and so forth. African governments were advised to and did borrow a lot of money
to build infrastructure, but that didn't work either. I think that those loans are now the
debt that third-world countries are now asking to be forgiven.
- In the 1990's the idea was that "the rule of (economic) law",
"transparency" and market rules were the key. Give people the means to own
businesses and property, to make enforceable contracts, and to trust that courts and
agencies fulfill their charters and not the whims of the king or dictator, and the
citizens would figure out for themselves how to start businesses and move up in the world.
- A new suggestion is that cultural differences are key; citizens need to think like
consumers and entrepreneurs before they can act like them.
The point is not that the West intentionally misled Africa and other third-world
countries. the advice was given with the best of intentions, and in some cases, it
actually worked. Why are the economies in Poland and the Czech Republic take off, while
Slovakia, which neighbors the Czech Republic and even used to be part of the same country,
still has trouble getting started? Slovakia was even the active party in the split,
because it felt is was being dragged down by the Czechs! The point is: we do not
understand our own economy, what it is that makes us so prosperous, even the poorest
of us. This lack of understanding is of course what makes the stock market so exciting. It
goes up, it goes down, what's going on? The stock market involves guessing about what a
company's worth will be at some time in the future, perhaps in six months to two years or
so. Just last year, investors seemed to be willing to gamble five to ten years in the
future for Internet companies, but now they are being treated in much more traditional
terms.
If we do not understand how the economy works, then perhaps we should be cautious in
trying to regulate or steer it. Two examples:
- President Jimmy Carter tried to control energy supplies: we were in an energy crisis.
That is even the platform he ran and was elected on. Under regulation, energy demand rose
but supplies fell slightly, and prices skyrocketed. (Energy demand is known to be
"inelastic", meaning that we will pay a lot more if it gets just a little scarce
relative to demand.) Interest rates also spiked. Mortgage rates, for example, reached
almost twenty percent. The economy contracted as both spending and investment decreased.
Well, that was it for energy conservation! Have we learned? The same thing, with slightly
different details, is happening in California right now. Will it spread from California?
Everyone has an opinion on this, but who is right? If it will be confined to California,
there is an excuse for no or limited action at the Federal level. If it will spread, then
either the Federal government takes action or we all get unhappy, and we just don't
appreciate doing with less like we used to.
- With the more stringent environmental regulations of the 1970's and 1980's, there were
widespread predictions of economic problems, as companies would have to spend more to
comply, and therefore raise prices, decreasing demand, and so forth. What actually
happened was that companies found less expensive ways to comply, they reduced their
dependence on polluting activities, they found that compliance often led to lower costs
(the best way to clean up emissions is not to waste the chemicals in the first place), and
new companies - a new industry - started; assisting in conservation. The US today uses
less energy per unit of economic output than at any time in its past.
I am not meaning to imply here that methods that worked in the past will work the same
way when applied today. Some environmentalists, for example, assume that society can place
any demands at all upon industry, and since we prospered the last time we did this, we
will prosper this time also. But I see, for example, that automotive engineers simply do
not know whether or not they will be able to meet the newest round of California
environmental regulations. But even if the regulations are met, will customers be as eager
to buy those cars if they are more expensive or if they turn out not to drive as well or
to be as much fun? If they don't buy as many, could automobile sales decline so much that
the economy as a whole will suffer? I do understand that California has real environmental
problems that they need to solve. For example, the brown haze that used to always visible
when flying into Los Angeles is now not there all of the time, or so I have read.
Another sign that we do not know how a market economy really works is that we often do
not trust markets, and are very quick to abandon market-based explanations. With energy
prices rising in California during its current electricity (and perhaps natural gas)
crisis, people are complaining that the utility companies are "gouging," and
taking plants out of service, seemingly to repair them, but, or so the theory goes, really
as part of a conspiracy to make electricity scarce and raise the price. A conspiracy is a
necessary part of this scenario, because without it, the company taking the generator out
of service will simply loose revenue as other companies step in to fill the shortfall. Can
the conspiracy be informal, that is without concrete documents and explicit agreements? It
is really difficult to set up a good conspiracy - not impossible, but if widespread
knowledge within the company is necessary (for example, in the California case, the
maintenance crews would have to know that maintenance wasn't really necessary but shut it
down anyway), then it becomes hard to contain within the company and secret from, say, the
government or the media. A conspiracy was proven last year for some over-the-counter drug
prices, but in that case only a few people in top management in each company had to know
to control the prices, and only those people did know. These people in the various
companies still had to meet with each other to coordinate prices. Another factor making
conspiracies difficult to start up and maintain is conspiricists often tend not to trust
each other, perhaps because they themselves are untrustworthy. And to top it all off, it
is illegal in the US and people can end up paying large fines and going to jail. And yet,
people are still very ready to assume the existence of conspiracies, without any other
pretext than that the prices have gone up, even when there are numerous market forces that
would drive the prices up without the existence of a conspiracy.
Again, the point of this discussion is that, even in the leader among market-based
economies, we do not know how our economy works, and are often ready to abandon what we do
know.
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