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First World Macroeconomics in less than 2,500 words, part 2

Week of 9 Feb 2009

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Last week we left our first world economy flying along in their airplanes, one seat per person. This resulted in the 2nd to Nth derivative businesses being out of work for the slope of the curve of the flight of our economy was zero, being steady-state.

However, in modern societies, we have come to expect an ever-improving standard-of-living. Just moving along in our standard airplane does not sound like an improving standard-of-living.

Standard-of-living improvements require an improvement in productivity. Productivity improvements result from using less human input per unit of output. The source of such improvements are working smarter, using less manual labor, or other matters such as material substitution (same performance with lower costs materials).

Let's say our airplanes experience an 8% increase in productivity. Perhaps this came about from reducing the cabin staff by one person due to putting in automatic, self serve beverage trays. We'll take that 8% and split it up as follows: The remaining crew gets a 4% raise, the airline gets a 2% increase in profits, and they lower ticket prices by 2% (this is, of course, inexact math, which we can freely use in an allegory). The airline crew is happy, for they have more money and their own tickets are cheaper, the stockholders are happy because profits went up. The general public is flying at less cost, too. The only unhappy person is the one whose job was eliminated--in fact if something doesn't happen for them, they become a Luddite immediately. How do we keep them engaged in the economy? The economy has to grow enough (in our case more planes are needed) so we can keep them employed on another plane. It is key: in order to maintain steady (not even growing) employment while improving the standard-of-living, we need to have a positive slope to the basic economy, in other words, the basic economy has to be continuously growing. And guess what, this will take care of our 2nd to Nth derivative businesses that were shut down, too, for we constantly need more planes in a growing economy.

Last week, we said we could grow the economy by one of three methods: innovation, exports, and growth in population.

In developed countries, innovation has been on the wane for decades. Why? Innovation involves risks, and financial markets hate risks. Public companies that innovate (unless they have an extremely strong track record of success, such as 3M or Procter & Gamble, for instance) are brutally punished in the financial markets for innovative efforts. This is why it is often said most jobs are created in small businesses. Entrepreneurs innovate (with a horrific record of failure, but with private money) and provide the majority of innovation we have. As soon as one tries to organize innovation, it is stifled, resulting in a failure rate probably somewhere around 95%. The way I describe this is as follows--you can't fly with one foot on the ground. Organized innovation is often stifled innovation.

We mentioned last week that exports carry a quid pro quo--one has to allow imports. The current world economic conditions are causing governments to consider protectionist moves, that is the barring or discouragement of imports. Read the history books--in the United States, at least, this posture has always been a disaster, starting with the Tariff of 1828 which imposed a 50% duty on imported goods. The McKinley Tariff of 1890 caused home produced goods to soar in price due to the lack of foreign competition (the argument for its imposition was to ensure full employment for US workers; it did this but in short they could not afford to buy the goods they made due to the relatively high profits their non-competitive employers could realize). At the beginning of the Great Depression, the Smoot-Hawley Tariff Act of 1930 was supposed to, once again, protect US workers. It resulted in reciprocal high tariffs and a near shut down of exports. Some economists suggest it prolonged the Great Depression and was perhaps even a contributor to the conditions creating World War II.

What causes imported foreign goods to be lower costs? The importer:

1. employs better technology in manufacturing their goods (lower material costs; higher productivity).
2. is not encumbered by artificial work rules.
3. is not encumbered by the same environmental or labor standards such as child labor prohibitions.
4. hires employees that are willing to work for less.
5. enjoys an artificially low currency exchange rate.

There is only one long term response to these (one can accomplish anything in the short term, but with disastrous long term results), and it is as follows:

a. Find ways to compete with 1, 2, and 4.
b. Don't accept goods made with 3.
c. Don't worry about 5--it will blow up sooner or later on its own.

It is not worth the risk to fight imports with tariffs, for one will surely kill their own exports by doing so, and we can see from our allegory what happens when we reduce the possibility of expanding our markets. By the way, regarding currency exchange rates, "The Economist" has developed a great index to gauge a currency's valuation: The Big Mac Index. You can find it at [Click here].

The third way to grow the economy, growth in population, seems to be out of favor almost everywhere. Different regions of the world are at various stages in implementing this policy. One can get a glimpse of its coming disastrous consequences in the aging populations of France, Germany and Japan. The common wisdom is the world is becoming over populated, a position I don't support on the macro level. I'll remind you of the clever little riddle which shows everyone on earth can fit in Jacksonville, Florida--each will have a space slightly less than four square feet (0.37 square meters).

The only other ways to grow the economy, not previously mentioned, are through entertainment and its subset, novelty. My view of entertainment is everything, and I mean everything, that is not basic food, shelter, and clothing. The Bernie Madoff case, for instance, a $50 billion ponzi scheme, is entertainment under my definition. For not one of the players in this case, including Mr. Madoff, is going to be without basic food, shelter and clothing.

Novelty is temporary entertainment. These phenomenon appear out of nowhere and as quickly disappear. The first one of these I can remember was hoola-hoops. "Beanie Babies" and "Pokeman" fit in this category. Novelties cause a quick bump in the economy and then rapidly fade away. Cigar bars are an adult version.

Some of you will argue all I have said here can be manipulated by modern governments. I will agree these matters can be manipulated for a while--but such manipulations will eventually become top heavy and collapse, as they are doing world-wide right now. The only way a government can create money in the long run is tax our descendants or crank up inflation--it is a zero-sum game. The basic macroeconomic forces outlined here are as real as gravity, and, over time, will always win as they always have.

We haven't covered price setting, a subject that begins to slide over into microeconomics. However, let's just say, again in the long run, any given product can not defy the rules of a supply/demand equation set. The last time the United States tried to do this was with President Nixon's price controls in the early 1970's. By 1980 we had double digit inflation with interest rates at 21%. Nixon’s price controls were a major contributor.

Finally, even in a totalitarian regime, you can not force people to buy goods and services they do not want. The only thing governments can do is force people to pay taxes, which they enforce with the threat of fines and prison. Mandate the production of goods and services people do not want and you'll find they just won't buy. Again, Nixon's administration tried this with starter interlocked seatbelts on automobiles in 1974 (you could not start the car without putting on the seatbelt). Congress dumped them before the model year was over.

Adding this week's 1,361 words to last week's 1,138, we come in at 2,499: 1 to spare. It’s always good to be economical.

Safety is as real as the forces of economics, too. You can't fake it, you can't ignore it. Be real about your safety actions this week.

Be safe and we will talk next week.

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