Macro, continued

Patrick had a couple interesting comments on my micro/macro post that I’d like to respond to. This started as a comment but grew a bit long for that, so I’m just adding a new post here.

I think my framing could be improved. I wrote the original after reading something talking about micro and macro. I framed my piece as such, but what I really did was highlighted one understanding of the macroeconomy. Mine was based on viewing the economy as a system of patterns of specialization and trade. Other understandings include the Keynesian Aggregate Demand/Aggregate Supply, or the equilibrium-based economies of neoclassical models. My main point is that thinking of “the economy” isn’t really helpful, whereas thinking of the economy as patterns of specialization and trade can be useful. It was more a point about thinking about things rather than actually applying them. That said, here are a few points.

1. Kling’s view is very general. My specific example was not, but the view isn’t applicable to just capitalist economies. Viewing the USSR’s economy as consisting of patterns of specialization and trade is just as viable. You work at the tank factory, and in exchange you get bread in the breadline. The government has more control over the direction of specialization and trade–“you all go to this school, learn how to do this skill, and we will pay you to produce these goods”–but the economy as a whole can still be viewed as patterns of specialization and trade. The point that, in hindsight, these particular patterns were unsustainable in the long-run doesn’t negate that.

Or socialist France: you work and get paid as you wish, but also the government is going to provide certain goods at free or reduced cost in exchange for taxing your income and your consumption at a relatively high rate. This model has proved to be much more sustainable than the USSR, and every bit as sustainable as the US. Exploring the differences between the US and France in terms of these patterns sounds like an interesting approach, actually. But my main point: this understanding can be applied to all sorts of types of economies. In fact, I plan to do so in future posts, although in a slightly different direction than I do here. So, Kling is not restating Schumpeter, but rather Schumpeter’s view fits within Kling’s framework.

2. Capitalism is nothing more than a system of organizing production and distribution in the face of scarcity using the price mechanism to sort goods and services. Things that it does well include revealing the preferences of individuals (based on what they choose to buy), creating redundant but differentiated means of obtaining necessities (and I mean “redundant” in a good way here–you go to the grocery store and they don’t have what you need, well, you’ll go to another grocery store. There isn’t just the one) and providing incentives for entrepreneurs to come up with new ideas for innovations–be they new products, new ways of creating the same products, or other types. Like Patrick said: capitalism is able to get silk socks for the workers (should they be interested) because it allows entrepreneurs pursuing profits to attempt to find a way to produce and distribute silk socks in a way that workers can afford. An autocratic monarchy would be perhaps somewhat less likely to see this as a worthwhile initiative.

So, anyway, besides innovation, here is a model: imagine a world with two goods. Maybe they are cheese and wine, but they can be anything. In some years, people prefer a lot of cheese but not as much wine, and some years more wine and less cheese. People’s tastes shift at random from one year to the next. A centrally planned economy would have a tough time accommodating people’s actual desires, no matter how benevolent the rulers. In a capitalist economy, however, as soon as the store shelves are running low on cheese and overflowing with wine, the stores will call up their cheese distributors, who will call up the farmers, and tell them to produce more cheese. The farmers of course already know, because they have been to the store. So they are pumping cheese out as quickly as they can. In the meantime, the store manager puts wine on sale, while raising the price of cheese by a couple dollars a pound. People would prefer cheese, but with the good deals on wine–how could they resist? So they don’t. The farmers produce the extra cheese, but because they’ve had to work overtime, and stress out their cows, they charge a bit extra for it. Of course, the stores are willing to pay a bit extra, because <i>they</i> are charging a bit extra, too. So: capitalism has managed to alleviate the mismatch of actual production and desired consumption by adjusting prices. The people who really really wanted cheese got it anyway. The people who were more indifferent got a good deal on wine.

What, on the other hand, would a centrally planned economy do in the face of cheese shortages? History suggests that they would ration: only one pound of cheese per person per week. But who does this benefit, relative to the capitalist solution? The farmers don’t get the extra income, the store managers don’t get the extra income, the people who would have been okay with more wine and less cheese aren’t better off, and the people who really really wanted more cheese have to make do with less. Now obviously, this model is a gross simplification, but it highlights the general ability of the price mechanism to create the right incentives to solve problems of shortages and gluts–and the challenges faced by centrally planned economies doing the same. I think the point of the socks example is not that capitalism produces new and more stuff all the time. It’s that capitalism allows workers to tell producers what they want, and for producers to give it to them—without any role for the queen.

That said, capitalism has drawbacks, too. The chief problem is that capitalism allocates goods according not only to willingness to pay for them (i.e., people who really like cheese are more willing to pay for it), but according to ability to pay: poor people aren’t able to buy things, even if they’d be willing consumers at a different price point. So capitalism is pretty good at producing things effectively, but not guaranteeing that everyone is able to consume the things they want. Additionally, capitalism is dependent on a social contract (and/or government enforcement) for things like property rights. Property rights are at the root of things like pollution: firms feel free to pollute when nobody’s property rights are being infringed upon, thus you see a lot more pollution into public water systems than into private reservoirs. Because “public” places are owned collectively, there needs to be a mechanism for the collective whole to express its interests and defend its rights. So, capitalism does not effectively curb pollution in the absence of such a mechanism. There are other problems, but these distributional ones seem to be the focus of other bloggers here, so that’s a good place to stop for now.

3. More on the idea of creative destruction. At any given time, any economic framework will produce relative winners and losers, and capitalism is no different. The first entrepreneur into a new sector or a new market is sometimes able to solidify her position into one of monopoly power. Even without this advantage, market incumbents can try to use the political process to prevent challenges to their position. So what “creative destruction” refers to is entrepreneurs coming up with new ways (creative) of competing with the incumbents and reducing their monopoly power (destruction).

4. Finally, my aim wasn’t to delineate what “is micro” and what “is macro”. Patrick makes some good points about transnational organizations, etc, and how those can be tougher to fit into one box or the other. My point is that, when thinking about “the economy”, a useful starting point is viewing it as patterns of specialization and trade. “Macroeconomics” is the study of the phenomena that emerge from these patterns. So when thinking about what can be done to “improve the economy”, thinking about the effects on these patterns is key: does legislation reinforce an unsustainable status quo, or does it enable new patterns to emerge that lead to an improved status quo next year? Patrick’s point about looking at political actions is a good one: the current patterns clearly benefit energy companies that produce fossil fuels. These companies also pour money into the political system in order to maintain this status quo. I think these ideas are completely compatible with thinking about the economy as a system of patterns of specialization and trade—and not only compatible, but this view of the economy encourages a slightly different viewpoint of politics, too. But I’ve already written enough here, so maybe that will be developed more fully later.

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One thought on “Macro, continued

  1. Just a few off the cuff remarks:

    Capitalism is nothing more than a system of organizing production and distribution in the face of scarcity using the price mechanism to sort goods and services.

    I think it’s not quite just that. It’s also about who gets what. It’s also about what’s scarce or isn’t for whom. For example: food. We produce enough of it and have for a long time. But famines happen all the time. Capitalism, though, is a way to distribute without really having to think about it much.

    It’s also not just about producing what people want because “wants” are not individual desires alone, but are formed via societal interactions.

    I’m interested where profits and exploitation (we’ll just stick to the substantive sense here, not the moral) work into the specialization and trade and then creative destruction. It’s exploitation that create profits so that capitalism can continue and, in fact, dictate that it has to continue for if one doesn’t you’re buried by the other guy who invests his capital first. That brings us to…

    Another aspect of what capitalism is: it’s dependent on the fact that there have to be losers. Losers in trade (historically this has proved to be very contentious–think Africa, North America, or, well, anywhere Europeans have gone). “Trade” doesn’t happen in a vacuum. And the destruction also refers to losers: people who will often lose everything because they don’t keep up with the system that no one really has on a leash. Of course, all of this depends on how who policies are set up to benefit more or less at any given time. Direct colonialism is different from neo-colonialism, etc. etc.

    I do think I see how Schumpeter would fit into Klink’s model (that’s explained very well), though I wonder if it could also stand on its own, but I’d have to review the book since it’s been a while. And I just don’t have time right now.

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