"I live in a Society, not an Economy"

Many voters and pundits have been making the case against President Obama’s reelection because he, as President, should have fixed the economic climate. The economy is only slightly better than that of four years ago, and four years ago was a pretty low point to compare to. The reluctance is understandable. However, it misses some really important points about how economics works.

Economics is not a science, however much people would like to believe. You can’t “test” economic theories the way you can in other fields. While we have anecdotal data and see real world applications of economic ideas, there are too many confounding factors (like, everything that happens in the world) to take any economic “experiment” seriously. Economics is a system of very many moving parts between very many parties; even so-called isolated economies, like that of North Korea, don’t “prove” anything since they’re impacted by events outside of their countries (international politics, populations, environmental factors, and so forth). Even the weather can have profound implications on economic situations: consider a drought or a hurricane.

Neither are markets and economics synonymous. The market is shorthand for the general state of buying and selling things. The economy is a collection of markets, policies, finances, politics, and other external factors. Markets, however, are a good measure of the health and confidence in the economy– when the economy is good, more people feel confident in trading, money moves around, and new things to trade are made. The economy’s response is to print more money so that it doesn’t get concentrated and stuck anywhere– with more money, people buy and sell more. Markets, and hence the economy, are dependent primarily on consumer trust and consumer wealth, not policy. In short, you visit a market; you manage an economy.

Markets move relatively independent to policy… every five to ten years, the state of the market will swing from good to bad, and vice versa. First a rise in buying and selling, then a fall in both; Sometimes more buying, sometimes more selling. The volume of the market is always increasing simply because we are always creating more stuff and hence can and do trade more. New things create new markets, and new markets create new things. This trend is relatively independent of whether America’s presidents were Republican or Democrat.

For example: the chart below color codes market performance (re: DowJones yearly averages) to whether presidents were Republican or Democrat:

You can see that the markets performed better under Clinton than Reagan. You can also point out that Obama has been pretty good for the markets, because you can see a similar slope of growth (albeit rockier), and he’s steadily restored the market to its high before the 2008 crash. While the policies Presidents put forward will affect the economy, the market itself is self-perpetuating, and bends to more than mere Presidential policy. People want to be successful, regardless of whether they are democratic or republican– the American pursuit of wealth continues regardless of economic policy, and the markets attest to that. Economic policy, at its best, seeks to regulate inflation/deflation, to regulate risk/volatility in the market, and to make sure everyone plays by the same rules in the market.

The labels “Republican” and “Democrat” have historically switched back and forth, relative to policy, both fiscal and social.

But, to paraphrase the tweet I opened with, “We live in a political economy, not a market.” You can have a lot of unemployed people and still have a growing market (Under President Obama, the market has performed well, in spite of a historically high unemployment rate). This is especially true for countries with a very high level of wage inequality. America is a perfect example of this: we have high income inequality and yet our markets grow and perform well. Why?

When Money Goes on Vacation

A popular theory called “trickle-down economics” argues that making rich people richer will make everyone else better off too. These folks will purchase more services and goods, which will in turn trickle their money down to everyone else to purchase more goods with as well.

The inequality of opportunity (and increased marginalization therefrom) is one of the reasons for affirmative action and social programs in this country.

To debunk that argument in very few words, rich people can go on trading amongst themselves and everyone else will barely feel a difference. The market we’ve described doesn’t care about who is trading, just how much trading is going on. In fact, you see an inverse reaction with trickle-down economics: when the financially upper class folks get wealthier without having the rest of the population wealthier at the same time, the upper class becomes even more socially and economically isolated from the rest of society, due to the ability to enjoy tax havens, international investments, the spread of wealth across different countries, and so forth… In a deregulated market, as trickle down economics argues for, access to opportunity is correlated with your wealth, and that perpetuates more inequality.

Globalization and deregulation has been kind to the rich; meanwhile, the poor have become even more locked in, immobile even within their strata. Forget social mobility when you can barely pay for gas! Forget economic mobility when you can’t leave your town because you don’t know if you’ll find a job elsewhere!

In fact, minimizing risk is ‘bought.’ Medium to low income people can only cannot make investments with ‘value added costs.’ Which is to say, they cannot afford extra insurance or more attention. Yes, attention is bought.

But rich people do invest their money, like the theory predicts. What the theory doesn’t take into account that is that folks with lots of money make investments in “safe” markets or trust funds where there is potential for growth over the long term with minimal risk.

Outsourcing is another variation: investing in third-world countries lets a company provide services at a lower human and regulatory cost when compared to investing in America. After all, why open up a manufacturing business in the US, when you can do it in China? The famous Chinese lack of environmental oversight, lower wages, and lower social-security payments make operating costs a fraction of what they are in the States.

China benefited greatly from foreign investment when it opened its borders to Western companies, but now it’s seeing things slow down because it is no longer the cheapest country to do business in. In a global economy, trickle-down economics help only the marginal countries, because as soon as those countries really benefit from any local profit, the social/political demand a higher standard of living (ie: not slavery), which means companies need to find a new market to move to.

Those same economists argue that the rich folks’ “trickle” will come in the form of investment. The problem is that there is no consideration of when the literal cost of doing business grows to the point where you need the rich people’s investments to keep your doors open. For example, in one of today’s fastest growing and most accessible fields, technology, you need millions of dollars to settle broad patent lawsuits as soon as you create any product. The patent is used as a sword, as a recent New York Times article argued. Small businesses in developed markets are at the mercy of monopolies, both commercial and intellectual. Research depends on loans, scholarships, and grants from large organizations that can afford it. Entrepreneurship is great, but when you have no assets to use as collateral for a loan, the legal and economic costs of starting a small project become astronomical, making you literally dependent on the super-rich angel investor to fund your product, company, and thereby, your future. That’s a perverse amount of power to give to a relatively small group of people!

The recent Vice-Presidential debate made this very clear: Romney is a great guy. He helped a family suffering during the recession by offering to pay for their college education. Except, we don’t all benefit from that sort of patronage. Self-taxation, the idea that the rich should choose where their money goes, is a fundamentally flawed argument: according to that, we’d have much more ballet and opera houses than working roads or public infrastructure! I agree the arts are great, but self-taxation doesn’t work as a means of economic support. Charity and endowment, while important financial choices, are no substitute for the role of taxes in making a country run.

Another problem is that advances in technology also mean that a lot of our industrial jobs which once fueled the economic growth are no longer necessary. Computers have taken over for data entry and basic clerical work, and machines do the job of industrial workers, putting things together or packing them. Even logistics, the art of organizing things, has seen a tremendous hop forward due to technology. AI and computer algorithms are disrupting even our best “business consultants” with big data. This all means that the same stuff can keep getting made, but with fewer human jobs. In a global economy, you can also sell to anyone in the world, not just your local markets. Thus: a good market, yet still high local unemployment.

Besides that, we have a cognitive and media bias for entrepreneurship… It’s the great American myth of rags-to-riches. We see and hear about people starting businesses every day, folks making it big, but the actual percentage of those people (as compared to the rest of the population) is tiny. Even worse is the “2 year” curse, where most small businesses don’t actually survive for too long or make much money: in a global economy, you’re competing with not just your neighbors, but effectively with the whole world. When a local restaurant competes with a global brand, the global brand has name recognition and industrial-scale supply chains to cut costs and profit over the competition. If you compete with McDonald’s, you compete with the world.

The Market’s Dirty Fingers

When the economy is bad, people don’t buy stuff. No one wants to/can invest in a new house or a new car (or really, any big-ticket item) because they’re not sure about the future. If you don’t know if you’ll have a job a year from now, it’s really frightening to put a lot of money into something that won’t bring you any money back, directly. Can you pay your car or house loan if you lose your job? In a recession, people spend less and buy less. In turn, this means that production cut back as well, for lack of profits. This cutting back in turn leads to fewer jobs, and again less spending. It’s a feedback loop.

Investors want to put money where they will profit. They’d rather put money into a factory in China than in America because China can make things at a lower cost, human-rights-be-damned. America is simply no longer competitive in making nuts and bolts (and cars and toilet paper), the core drivers of our industrial revolution-era growth. Again: China and India can do it cheaper. The quality-of-life regulations that America has, such as minimum wage, workers’ compensation, pollution controls… these also drive up the cost of doing business.

The fiscal and auto bailouts were thus purely political and economic, not market driven: Politics works on image, and so their goal was to save American industrial dignity, save jobs in the immediate term, and mitigate the immediate costs of the recession by letting those companies collapse slowly, instead of all-at-once. For example, Lehman Brothers is still around, but its sole objective is to make enough money to repay everyone it owes so that it can finally close its doors. The real American industry today is, as always, in high technology and precision manufacturing, not cars. Those are doing fine.

How to Invest Your Money

There are two simple ways of getting out of an economic slump: war, and creating new markets. That’s pretty much it. Anything else and you’ll regress to zero economic growth, which in turn will lead to more recession. The call is always: more new stuff to buy, sell, and invest in.

War is, at best, a temporary fix. Wars get rid of a huge population of employable people and send them elsewhere. That means, less competition for jobs. Wars also mobilize previously stagnant industries and create new work (i.e., making stuff for soldiers to use). In turn, that creates more jobs. Together, more jobs + less people to work = really great employment numbers!

Though to be fair, with the way America conducts wars with drones, hopefully we won’t need to send any soldiers overseas. Not sure if this is better or worse, economically and politically speaking.

But when the war ends, when soldiers come home, and when war-time industries stop, you get an even worse economic climate that you had before. More people + fewer jobs + more unskilled workers = shitty employment numbers. You don’t need to be an economist to understand that one.

Instead, you create new markets, in either of two ways: investment in infrastructure, or through research and technology, which leads to new investment. This is a tricky one, because infrastructure investment usually forces government to lead in the markets, a those same economists hate. Economically speaking, these are loss-leading projects, which mean that you lose a lot of money on one thing to make a lot of money on something else. You bet against one product to create profit on another… the original arbitrage: buy low, sell high.

A good example of this can be found in the relationship between public transportation and real estate, an anecdote from early San Francisco: a company created an extremely cheap tram system, charging riders literally pennies to use it, operating at a loss. They did this because it allowed inner city residents to travel cheaply to real estate on the outer limits of the city. The same company which lost a lot of money in creating the trams made a lot of money back when it then sold houses in places people couldn’t get to before. Viola! The loss on the trams was negligible compared to the profit on real estate.

America did a similar thing after World War II, to counter the economic effects of returning soldiers. When the interstate highway system was built, it was a bunch of highways to nowhere, but as the highway system grew, new communities sprouted up alongside wherever it went. New businesses for transient workers led to new towns, which led to more new businesses, new trade routes, new jobs, and so forth. But without such a radical government intervention, “the market” wouldn’t have done such a thing itself– there was no profit to be made on new highways themselves. The government literally created a new market with the Interstate Highway Act, just like the trams created a new real estate market. It wasn’t inherently obvious at the time that such innovation would work as planned either. Some bridges, as Alaska is fond of, are literally “bridges to nowhere.”

Most companies can’t undertake this sort of structural loss leading endeavor. They’re either too small, don’t have enough money to make any significant impact, or they have responsibilities to public shareholders, which are focused on immediate returns. It’s hard to keep your bottom line in the black and do any meaningful long-term investing. That’s why governments are normally the lead investors in this sort of work. I’d even argue that this is one of Government’s most important roles: developing new markets through informed foresight.

Research and technology work similar to infrastructure development. New technology allows new markets to flourish. TV and radio created huge new markets, thereby economic growth, in the same way that smart phones created huge new swathes of businesses we couldn’t have even imagined before, as well as invigorating existing markets. This was made possible by investment in the research and technology of computer science. New research in biology, chemistry, and psychology has created huge new pharmaceutical markets and jobs, in turn spurring more research, development, and growth.

Are You a Government or a Company?

It’s good to remember the dynamic between private companies and governments here. They are fundamentally connected. Government, as a loss leader, develops many new technologies for competitive purposes (though their competition is mostly military and national-security based). Mechanical computers were developed out of code-breaking necessity during World War II. Highway and modern energy infrastructure were (and are still) being developed due to cold-war and energy-independence/national security mentalities. The internet was developed as an information sharing system for national security interests (DARPA). The space program and satellites and GPS were developed in response to cold-war national security demands.

Today, all of these industries are dominated by private companies. Entrepreneurs realized that the technology behind these research-oriented projects had commercial potential and jumped on them. Many of these projects have since become non-government businesses. Where the government created the internet, private companies monetized it. Where the government created space programs, private companies monetized them. Same with energy. The government, unaccountable to markets, was able to realize and create these technologies sans profit, and usually at large losses. Short term loss for a long term profit. Nevertheless, these new markets paid themselves back through new companies, and profits for the government to draw revenue from by means of taxation (not charitable giving).

As Obama said in a widely ridiculed quote, “You didn’t build that.” The markets took over after government had made the initial investment. The government had to run up a deficit to make it back on new markets, and as the saying goes, “you need to spend money to make money.” The economy is where tax money is spent to create new markets and new taxes, and to keep market growth going. The takeaway is that both government and markets were necessary, and neither could have worked without the other. The economy did not “trickle” down—a waterfall was built.

Investing in education, research, public works, and national infrastructure are all things which companies are hesitant to do. Our roads fall into disrepair because they aren’t pretty or marketable. They don’t give a good direct return either. But without these necessities, new markets to invest in can’t really be created, and growth stagnates. Wealth is invested overseas because that’s where governments are building infrastructure for companies to take advantage of.

Thing is, when we don’t have new goods to trade and invest in, growth becomes manipulative: instead of structural innovation like I’ve been talking about here, we’ve had financial innovation: derivatives and high frequency trading. Instead of trading tangible things, we’re trading bets and loans and other intangible things. Financial innovation of that sort creates an artificial addition the market; sure, the market volume goes up . But these financial innovations aren’t real things, they’re like specters tacked on to existing commodities to create the illusion of growth (albeit real profit). That’s why, when you have a rise in the market due to financial innovation, the rise becomes exponential; likewise, a fall in the market becomes much more dramatic—if the commodities fall, so does their economic shadow, and the castles built upon them. Financial innovation is no substitute for real innovation—it’s a bubble of questionably relevant information tacked on to the original value of the commodity—also known as “real value” and “nominal value.” That’s what we saw in 2008 (and will probably see again and again). It’s simply money made out of air, and it doesn’t really trickle anywhere. And when our politics does not allow the government to invest in structural innovation, we leave the market no choice but to create financial innovation to create the deformed specter of growth.

The government plays an additional role, one outside the market proper. It regulates the market, and fills in where the market fails. That’s the government’s social and regulatory responsibility. For example: health. There is no profit in covering unhealthy people with preexisting conditions. Nonetheless, you need a healthy workforce to do business. The government regulates in two ways: first, by making sure that the businesses, by way of food or pharmaceutical or environmental factors, don’t contribute to making the workforce unhealthy. Second, by ensuring people that are sick can get the healthcare that the market is unwilling to provide. Both of these have huge costs: regulation costs money because it isn’t just laws… its cost comes from enforcement and compliance and prosecution (whether by the FBI or FDA or IRS). Providing a service that the market is unwilling to provide also costs money, and this cost isn’t really recuperated. After all, where is the benefit of providing end-of-life care? Let them die, the market whispers. They’re a strain on society. They cost a lot of money and give nothing back… never mind that these end-of-life folks have worked upwards of 50 years in the economy, buying stuff and working for companies, contributing the entire time, and even now towards the end, to this economy.

When Hurricane Sandy Visited the Economy

Hurricane Sandy shifted the debate. You had NYC Mayor Bloomberg endorsing President Obama, New Jersey’s Governor Christie (once Romney’s mouthpiece) telling the world how great Obama has been, and New York’s Governor Cuomo calling climate change not political, but fact.

Climate change, national energy, and the environment are all related to the sort of infrastructural investment advocated for here. Energy is the core unit of our modern life. If it goes out for a week, as many experienced during Hurricane Sandy, we see our world fall apart and businesses fail. And yet, the disasters the Hurricane Irene and Hurricane Sandy have caused are predicted to be coming more often than not. Similarly, if Middle East oil is embargoed, like during the 1970s, we fall into the same sort of recession. Energy independence is a national security issue, and is is also a point of structural innovation on which many small companies can innovate on. Energy is used on every scale, from small homes and toys to large businesses and states. Disaster mitigation, regarding both energy being reliable and our environment being safer, is an area of opportunity for growth. It’s something that we should take advantage of, improving both our country, our future, and our current quality of life at the same time.

To come full circle, if you’re voting, vote on the future. Vote on investment. You want education, research, technology, social welfare, and public infrastructure. A healthy, safe, and consistent workforce with a safety net will live longer and be more likely to try new things, which in turn create new markets. Governments need income too, whether from taxes or new projects, and letting the invisible hand of the market take over won’t give you the sort of growth that the country needs. Reading this, you should be informed enough to make your own choice. Researching each candidate’s policies is your responsibility as a citizen. Don’t argue that both sides suck equally. If you don’t like it, change it. After all, we elect the officials, and democracies take time to change. And if you really don’t like the way the government runs, then it’s your job to run for office.

About the Author

Roman Kudryashov is the founding editor of What Are These Ideas. Educated in design and political philosophy, he often writes about the intersection of language, society, and technology. He currently lives in New York.

Contact:

Email: roman@whataretheseideas.com //
Twitter: @SharedPhysics //
Web: Required Thinking //

It's Just Basic Developmental Economics, Silly!


By Roman Kudryashov //
April 11, 2012 //
3800 Words
Essay



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