John Phipps: Econ 101 is Broken

02:59PM Nov 15, 2019
John Phipps
It was elegant in its simplicity. The graceful curves, the sturdy crossed supply and demand lines, and the intuitively believable narratives.
( AgWeb )

It was elegant in its simplicity. The graceful curves, the sturdy crossed supply and demand lines, and the intuitively believable narratives. I loved Economics 101 and its follow-on models and explanations. But like the earth-centered cosmology of centuries ago, tiny problems are revealing it at best an imperfect description for how economies work; at worst, a delusion that impairs our ability to plan any future.

The first hint was the inflation that didn’t bark in the night. Scarred by double-digit annual price increases, my generation stood vigilantly at the ramparts scanning for any hint of rising prices. With the exceptions of extreme political incompetence (Venezuela) or utter corruption (Zimbabwe), we have wasted our time. Through good, mediocre, and recessionary periods, inflation has failed to meet our economic predictions. 

Meanwhile, governments are issuing enormous amounts of debt to boost slogging economies. The US ran a federal deficit of exactly a trillion last fiscal year. Nobody cares – and why should they, it seems? Not only is inflation dormant, more than a few economists are concerned the real enemy is deflation. We’ve been staring in the wrong direction, so to speak.

Inflation is just one of the awkward facts that doesn’t fit our traditional economic understanding. The trusty Phillips Curve, which logically suggests that low unemployment will exert inflationary pressure has stopped working as well. To be sure it had been under heavy criticism for years, but for opposite reasons: periods of high unemployment with high inflation.

 

Phillips Curve

 

With record low unemployment, we should be seeing wage increases as labor takes advantage of shortages to demand higher pay. Not happening.

Lower interest rates for savers should be prompting savers to spend instead. That’s why central banks have traditionally cut rates – to boost consumer spending, which is about 70% of our GDP. It’s not working either, for several possible reasons. There could be generational consumption pattern changes, for one. The Boomer appetite for consumer goods may have been unique to our cohort. Younger citizens have fewer homes to furnish and clutter up, prefer to blow money on activities than stuff, and may be using these different values to delineate themselves from us oldsters. Still, you have to admire the perseverance of central bankers as over one-quarter of the mountain of sovereign debt is now trading at negative yields.

More to the point, as returns to all investments drop, financial advisers and reasonable individuals realize the need to save more to make sure retirement goals are met. Thus, the lower rates go, the more we save. No wonder the previously absurd idea of negative rates has been adopted in several countries.

Our current lengthy expansion lacks both fireworks and effectiveness.  The modest GDP gains go mostly to the wealthiest. Given that the rich invest, more than consume, it would explain why asset prices (stocks, real estate, bonds, etc.) are rising briskly while wages sputter. Income and wealth inequality messes with Adam Smith’s plausible stories.

Finally, labor mismatches and new balance with capital undo many old mechanisms that made Econ 101 a useful tool. Between automation and trade reduction, workers feel little confidence in pressing the case for higher wages. Most value job security far more. At the same time, as our service sector now comprises 80% of our economy, our focus on manufacturing jobs has too few new workers pointed toward the right type of jobs.

All these factors contribute to the confusion surrounding policy debates. If you don’t know how something works it’s harder to fix it. Agriculture has always been mish-mash of economic models, mixing government intervention (subsidies, mandates, etc.) with market forces. It’s even more confounding to try to understand how these new trends will affect our economic future.

Economists are not taking this lying down. Intense scrutiny on the now multiple forms of capitalism in the world are beginning to show why the old rules must be modified to fit reality. Some point to Modern Monetary Theory (MMT) as a better roadmap, but nobody can really explain it, let alone encourage consensus. This work, like all economic research will struggle to arrive in time to be useful. It’s good thing economic textbooks are increasing digital. We need Econ 201 as soon as possible.

John Phipps, a farmer from Chrisman, Ill., is the on-farm “U.S. Farm Report” commentator.