Psst

by Russ Roberts on February 10, 2011

in Complexity & Emergence, Creative destruction, Prices

The latest EconTalk is Arnold Kling on what he calls PSST, Patterns of Sustainable Specialization and Trade. It’s a conversation about how to think about macroeconomics.

Here is an example of applying Arnold’s concept that we discuss briefly in the podcast. Suppose there is an increase in the desire to stay home and cook more rather than eating out. Arnold thinks of this as an increase in non-market activity and a decrease in specialization–I’m cooking more for myself–some restaurants that specialized in cooking for others will now go out of business. A whole set of adjustments take place throughout the economy. Arnold is contrasting this with the Keynesian idea that this will lead to  a reduction in aggregate demand. So Arnold sees the challenge of this change in behavior as being one where people who were once in the restaurant business now have to find something else to specialize in–they have to become part of a new pattern of specialization and trade.

But it is not just that there is less specialization. In fact in some sense there is just as much market activity but its nature has changed. So there will be fewer restaurants but more pots and pans sold, more cookbooks published, more cooking shows on TV, a wider array of ingredients in the grocery.

These kinds of changes take place all the time, without major disruption. It’s creative destruction. Hayek sees the price system as the mechanism that allows these changes to take place with relative seamlessness. Here is how I described it (slightly edited) in my book, The Price of Everything (which is only $8.99 (whoo-hoo!) at Amazon right now):

Just to take one example, million of Americans now try to lead healthier lives than they did in the past. They decide to exercise more and eat better. Think of the enormous range of things that have to happen and that do happen to let those plans and dreams come to reality. New kinds of food in the grocery store. New kinds of grocery stores. New kinds of running shoes and racquetball shoes and walking shoes. New kinds of clothes made of new materials that make sweating more pleasant. New kinds of exercise machines. Videos to go with them.

New kinds of bikes. More tennis rackets. New kinds of tennis rackets. People to make all those things and work in all those places making and selling and explaining to people about the new choices that are available. An enormous army of workers and creators springs into action. The plans of all the people who want to eat better and exercise more got matched with the plans of all the entrepreneurs who strove to make money meeting those desires.

Who made sure that those dreams and desires, those plans and actions didn’t conflict with each other or with the thousands of other dreams and plans underway at the same time?

All the resources—the workers and the raw materials—that had to be mobilized to make sure that life elsewhere in the economy wasn’t hopelessly disrupted? Who settled those disputes over how much land would be devoted to organic food and how much to junk food? Because there’s more and better junk food, too. What a world we live in. You can get organic milk and four kinds of mesquite flavored potato chips! The dreams of a healthier America didn’t shut down the dreams of those who wanted to be couch potatoes playing video games. Some biochemists even figured out ways to reduce the cholesterol of the coach potatoes so they wouldn’t pay too high a price for not exercising. Who made sure there were enough biochemists and enough engineers working on the lasers? Who made sure that Nike would find all the rubber and fabric and workers it needed to cushion the feet of all those runners while other shoemakers were looking for materials and workers because a TV show made higher heels all the rage?

Who weaves together all the plans to make sure that they work in parallel  rather than producing conflict? Who is the planner in charge?

There isn’t one. Each of us takes the unique strands of our hopes and dreams and adds them to everyone else’s. Yet, somehow they all fit together and the tapestry of our lives just gets more interesting and varied and human.

But how do our choices manage to fit together without a weaver of dreams? How is that some of us can become vegetarians or exercise fanatics or couch potatoes or take up the guitar or become gardeners or engineers or teachers and all the products and tools we need are out there waiting for us without us having to let anyone know what we’re going to choose? How is that 100 million Chinese can leave the countryside and their kids start using pencils and bicycles but there’s still graphite for tennis rackets? Who sends out the memo to put all the effort into motion to make sure all the dreams can coexist so peacefully? What is the glue that holds everything together on its own without anyone being in charge.

The prices. Our choices fit together because the price of everything can adjust and steer resources and knowledge throughout the economy. We only see our own little corner of the tapestry. No one can see the whole thing. But the genius of the system is that our little corner is all we need to see. No one has to know the price of everything even though the price of everything is always adjusting in response to all the changes going on in our incredibly dynamic economy. The graphite owner can focus on the price of graphite and spend the rest of the time learning about how to find cheaper ways of getting graphite out of the ground. And because no one has to know the price of everything, our knowledge grows, our world get better and no one has to master all the dreams going all at once to make sure they somehow fit together.

So why all of a sudden is there so much disharmony, so much unemployment? Why don’t the pieces fit together any more? Is it because the prices aren’t doing their job? Why not? Or is it because a non-organic change–an artificially induced increase in the demand for houses–causes a different set of actions and reactions? Or is it because the increase in demand for houses was so sharp and the increase in demand (and wages) for carpenters and electricians was so sharp, that they’re having trouble dealing with the fact that those $100,000 a year jobs are gone for at least five to ten years and maybe never coming back. So they have to figure out the best use of the skills that they have (what Arnold calls figuring out their comparative advantage) and this isn’t easy to do. It might mean moving or retraining. But it most likely means facing a new reality you rather not face where you earn a lot less than you did just yesterday. Who is eager to validate that change? So you wait a while before committing to being in a different part of the economic tapestry.

Thinking about the micro of macro like this may help us understand the jobless recoveries of recent recessions. Could it be that it is not the recovery that is so different but the boom and bust that preceded it? Certainly in the last two recessions, this one and the one in 2001, sectors of the economy boomed with great wage increases and then busted–suddenly a lot of jobs that once paid a lot of money (tech sector in 2001, housing in this one), are very scarce. And when times are good, they are very good for some sectors but not others. And when they are bad, they are mostly bad for some sectors and not others. Could there be more heterogeneity in the expansions and contractions that makes it harder for people to figure out and decide where they should work next?

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