Thursday, December 22, 2016

We are being lied to! (oh, boy, are we!)

Let’s begin giving credit where credit is due, with the proverbial image that is worth a thousand words:

For those that arrived yesterday from an entirely different planet, too distant to ever have received the most cursory communication from Earth, the gentleman depicted above is Jim Wendler, the author of one of the finest methods for getting insanely strong ever devised by any human being (5/3/1, which I’ve been using in any of its multiple variants, for years and years). I hope you’ve noticed the sentence I’ve taken as title of this post is a more encompassing version of the one originally penned by him seen in the photograph (which you can buy nicely emblazoned on a T-shirt or a hoodie in his web site, btw). Mr. Wendler probably refers mainly to the habits of training and eating peddled by the so-called “fitness industry”, which are oriented mainly towards the enrichment of the trainers and the peddlers, and not so much to the overall health and well-being (and even less to the strength and general “awesomeness”) of the unsuspecting consumers of their pabulum.

But the concept could very well be applied to the whole cultural industry, which in turn is but the conveyor belt that society uses to transmit the ideas, values and opinions that the majority needs to embrace to keep it in working condition. I’ve contended a number of times that most of those ideas, values and opinions are not just false, but noxious. They do indeed keep the society working and reproducing itself, but at what a price! At the price of making its members miserable, of pushing them to live lives of quiet (or not so quiet) desperation. Lives that are literally not worth living (and people, consciously or unconsciously recognize such worthlessness, and react the only way left to them: by voting with their gonads not to reproduce such insanity, not to keep the system going for a single generation more).

Not a nice state of affairs. And the fight against it starts with denouncing the lies we collectively tell ourselves to keep it going, with exposing them and invalidating them and pointing their inconsistencies, showing how they seem plausible only because they are repeated so many times. But their plausibility does not derive from being so relentlessly drilled, but rather from benefitting some few at the expense of the majority (one of the many funny aspects of a dominant reason is that those few benefited by them are not even aware of the untruth on which their worldview rests; they do not even have to actively and consciously push the falsities on which their dominance depends).

So let’s do our part today by reviewing a somewhat schematic and summarized list of the lies we are almost daily being told:

Lie # 1: thanks to our social system (capitalism) we are growing richer every day

That one seems almost like a cinch, doesn’t it? If there is a stablished truth, almost written in stone, is how lucky we are to have inherited such a fantastic social system that has allowed us to enjoy more wealth than any previous generation in the whole history of the human race.
For example, here is what one of the most widely used textbooks on economics (Samuelson & Nordhaus) present us with right in the first page of their treatise:

Pretty impressive, uh? Focusing just on the last 45 years (since 1970) the national product has grown from about six times what we produced at the beginning of the XX century to an astounding thirty times, a more than fivefold increase. If you are interested in the raw data, the US of A went from collectively exchanging goods and services valued at about 1.076 trillion of 2015 dollars in 1970 to 18.037 trillion of equivalent dollars in (you guessed it) 2015.

Part of that improvement was caused by the raw increase in population (more people producing goods and providing services), that grew from roughly 200 million souls in 1970 to 321 million in 2015. However, the image of per capita  GDP growth is similarly impressive, from roughly 5,500 dollars/year (again, in 2015 dollars) in 1970 to a tad above 56,000 dollars/ year today:

So is it a closed case? Can we accept that, after a (relatively minor, seen in perspective) bump after the 2008 recession, the system is indeed creating untold amounts of wealth for everybody? Should we rest contented being the luckiest humans being that have ever lived? Nope, unless you have  very warped understanding of who “we” are (or you are damn lucky), as if we look not at how average per capita GDP has grown, but at how median income has, the picture looks quite different:

So what is it? How is it possible that the average GDP per capita has grown 1,000 % (is ten times bigger what it was in 1970) but median income has barely budged (has grown a paltry 12%, from around 50,000 USD to 56,000 USD)? What kind of statistical trickery is this?
Let’s explain it with an easy-to-understand slide (which has taken quite a few hours to prepare, btw), assuming a simplified economy where all income is in the form of cooked chickens, which allows us to compare how we are faring today with how we fared almost half a century ago:

So in 1970 I (I’m standing here for the whole 20% of the population with a higher income, or 80% quintile) the average income was 1 chicken per person, I did a bit better (earning one chicken and a half), you did about as well as the people around you (your brother in law and that annoying neighbor that kept throwing noisy stoner parties, all of which stood in the three central quintiles), which in turn did significantly better than the lower quintile.

But fast forward 45 years, and see what has happened: the lower quintile has improved substantially, so they now earn practically as much as yourself. You are still earning what you did back then, as is your in-law and the annoying neighbor (that somehow has survived through all his drug use). But the average income has skyrocketed to an astounding ten chickens per person! How come? Simply put, me and the likes of me have hoarded almost all the gains, and now make a whooping 45 chickens.

At a global level, the phenomenon was recently identified by Branko Milanovic (which has an excellent blog I recently added to the right side of my own) in a much commented and discussed graph charting the changing fortunes of different income groups aggregated for the whole world (thus going beyond the national analyses we were used to):
So it’s not surprising all of you are pretty pissed off! Of course you are voting for Trump, Brexit, against Italy’s constitutional reform, for the Law& Order party or the Front National! Not only have you not reaped any benefit at all from globalization, the supposed economic growth and whatnot, but you are seeing some people (me) making it royally, and the meager consolation you had (there are those “other people” that are in much worse shape than you) is slowly disappearing. Not that it was a strongly defensible (from a moral point of view) consolation but hey! You take what you can and try to make the most from the hand you’ve been given.

In summary, we can safely dispel with the myth that the system works because the economy grows and we are in a Paretian paradise where everybody is either better of or as well off as they were, and nobody is worse off. Because the bunch that has seen no significant improvement in almost fifty years is indeed considerably worse off. Worse off because they see the distance between themselves and the top quintile increasing beyond any limit. Worse off because to maintain the lifestyle they were accustomed to (the one their fathers enjoyed) they have to work significantly more hours (thanks to the incorporation of women to the labor market, as let’s not forget their forebears enjoyed a very similar income level with almost half of the paid effort, as typically only the husband worked outside the home). Worse off because their parents, in addition to amass almost the same amount of wealth than them also managed to reproduce and put in place a generation to pay for their retirement, something the current generation is failing to do…

I already identified as one of the sources of the current malaise the realization by a growing number of workers than they are indeed not living any better than their parents did, a realization recently shared by none other than my very admired newspaper of record (The American dream seems pretty moribund):

So a system built on the premise (and the promise) of never ending material improvement is showing itself to be more and more incapable to fulfill such expectation… expect people to be more and more angry as they realize what they would get in exchange for hard work and endless sacrifice is a life of never improving drudgery.

Lie # 2: thanks to the spread of innovations, technology will solve all of our problems

Nope again, not only innovations are more and more circumscribed to a somewhat collateral domain (software development, which creates programs of less and less impact on people lives), but even in that restricted domain they are slowing down

Lie # 3: thanks to our superior knowledge, we are healthier and will soon live over a thousand years

Nope, doesn’t matter if you put your hopes on knowing more how genes work, knowing more how aging works, or knowing more how nanomachines could interact with every single cell of our bodies, you will still die (irreversibly, finally, ultimately, in a “that’s all folks”-y way) before your 100th birthday.

OK, obviously I’m running late and didn’t have the time to properly develop the last two lies, probably will make it in subsequent posts. An awful way to stop for today, but remember nobody’s payin’ me for this

Wednesday, December 14, 2016

The shortcomings of Economics II (interlude)

In my last post I argued basically that Economics (the discipline shaped and practiced by university professors, students, uncountable employees and executives distributed in tens of thousands of private and public enterprises along the world, as well as in government positions and as consultants and accountants and occasional entrepreneurs) is a sham. A con job. An ideological construct (in the old Marxist sense) without an atom of empirically verifiable truth within it.  

At the core of such accusation was the idea that economics offers only the skeleton of a theory in the form of equations that are not really equations. So in any Econ101 text you will find that demand (number of units demanded) is a function of the price: D = f(p), and is a monotonically decreasing function at that (so its derivate must be negative): df/dp < 0. Similarly we are told that supply (amount of units supplied) is a function of price, and labor (total number of hours offered by employees) is a function of wages (which is but another name for the price of hours worked in exchange for a salary), etc.

Which sounds “mathematicky” and “scienty”, but is really either a tautology (a statement that, being always true, tells us nothing new about the world) or empty verbiage with very little explanatory power. Putting seemingly common sense ideas (“the law of diminishing returns”, “the equalization of marginal costs and marginal utilities”) in a mathematical formalism apparently allows to understand them better and explore better their implications. It’s called “building a model”, it is understood that the “equations” are not really tools for providing testable predictions of how the real world works, but simplified representations that can indeed help us, in practice… predict how the world works.

According to this line of defense, the shadow of an equation is the second best thing (I guess after a “real” equation) to understand the infinitely complex realities of economic interactions, and not that different from what we encounter in physics or chemistry. When we read that the gravitational attraction between two bodies is directly proportional to the product of their masses and inversely proportional to the square of their distance (F = G x m1 x m2 / d2) that is also an approximation (we can only know G, the gravitational constant, up to a certain level of exactitude, which could mask that the formula is not as precise as it sounds, but an approximation that masks the contribution of additional factors, not to mention that it is valid, even approximately valid, for non-relativistic conditions -when both bodies are relatively stationary or move at speeds much below that of light). Although the engineering part of me feels strongly tempted to dismiss such argument as ludicrous, wooly-headed and downright idiotic, I’m going to give it some unmerited credit and expose its tomfoolery by devoting the remainder of today’s post to highlight the difference between what the knowledge of “economic laws” allow us to predict of how the world behaves and what the knowledge of good ol’ plain physical laws allow by imagining a world where the later are as well known as the former.

Thus, let’s imagine a world where all we know about how the natural world behaves is that it follows “pseudo-equations” of whose real content we know nothing at all. We don’t know what variables underlie the exhibited properties of any system, and what the variation of those variables may cause in the observed output we may choose to measure. All we know is there are “relationships”, and we may have some (not very reliable) inklings about the monotonicity of such relationships. To make it more understandable, I’ll illustrate such a world by the interaction between two characters, a Young Engineer called YE that has just started to work in an engineering company, and an old hand (unimaginatively called OH) that has to teach him the tricks of the trade:

YE: Good morning, Mr. Oh, I was told to ask you for some help in my new assignment

OH: Well, good morning, kid. Pleased to meet you. You’ve come to the right place, yes you have, as I am well known in our company for being not only very knowledgeable, but also kind and patient with young guns wanting to prove their mettle and find their way around. What is it that you have to do?

YE: Well, I have to calculate the diameter and the thickness of the pipes that go into the boiler of a new combined cycle power plant that we are designing.

OH: Now that’s a honorable and exciting task, isn’t it? And a serious one to boot! Make the pipes too big and thick and they will be too expensive, and difficult to support for the metallic structure that is being designed at the same time. Make ‘em too small or thin and they may crack or, even worse, blow up when their valves are closed, and seriously damage the plant. What input data have they given you?

YE: I know the height of the boiler intakes, and the water flow it needs (in gallons per minute) under different operational modes. I also have the performance curve for the pumps that have been selected to be at the base of the boiler and that will push the water

OH: Good, good, so the first thing you have to know is that the pressure loss the pumps will need to overcome is a function of the diameter of the pipes, and of the total flow that goes through them: TDH = f(D,F)

YE (smugly): Yep, I already know that, they teach that to us in engineering school

OH: Oh, that’s great, isn’t it? You’ve got a lot of  the bases covered, then. The other thing you need to know is that the loss of pressure grows with the flow of water, and decreases with the diameter of the pipe: df/dD < 0 and df/dF > 0

YE (a whiff of impatience starts showing in his voice): yep, I also knew that already

OH: well, my boy, then this is the final thing you have to know: WE DON’T HAVE THE DARNEDEST IDEA OF ANYTHING ELSE ABOUT WHAT THE RELATIONSHIP BETWEEN TDH, D AND F IS.

YE: What?

OH: You heard me right. Just no clue.

YE: What do you mean no clue?

OH: what you just heard. There are lots of theories, of course. A bunch of people call themselves “pipe neokeynesians” and maintain that after reaching some maximum the pressure loss may start increasing with an increase in the diameter of the pipe. Another lot (“pipe monetarists”) say that when the flow diminishes beyond certain point (“zero boundary”) it doesn’t matter what you do any more because the pressure loss remains constant. Nobody has been able to prove one or the other, and of course they don’t know either what those conditions may be beyond which the behavior of the water in the pipe changes

YE: But, but… couldn’t this things be, I don’t know, like, be tested? Couldn’t some experiments be run and so those “equations” be a bit more fleshed out, so for example we could determine the coefficients and the relationships between the variables. To arrive at something of the form, I don’t know, v x v/2+ gz + p/d = K (and then determine the value of K for different fluids and different materials of the pipe)???? So I could know the pressure of the fluid, and then see how that pressure affected the section of the pipe at each point?

OH: No, no, nonononononono… that’s a rookie’s mistake, thinking that such relationships can be teased out. You have to realize that nature is really complex, and that this field of research is the most complicated you can imagine. You really would have to take many, many more things into account than the fluid and condition of the inner surface of the pipe: what about the fluid temperature? How viscous it is because of impurities? The air temperature? The possible vibrations due to wind? The noise of the turbine nearby? Lingering effects of past earthquakes? The position of the moon and the stars? Any attempt to try to define anything more precise than TDH = f(D,F) is doomed to fail once and again, to be thoroughly disproved, to throw the whole field of hydrodynamics into disrepute and to reveal more exceptions than rules and to sow more confusion than clarity

YE: But… again, even if we can’t find a detailed relationship to define the pressure within the pipe, and the diameter to limit the internal speed of the fluid, and matrix of forces at each point of the pipe (depending on the thickness), can’t we at least plot the main variables and thus go to such graphic and find the values I need so I can solve the problem I’ve been given

OH: Well, we could do some nice graphs, sure, but they could not have any units on them, so they wouldn0t be of much use

YE: Why is that?

OH: At the beginning of time that method was attempted, and essentially found wanting. Depending on who drew the graphs the units were different, but for some unknown reason the shape was always the same. Thus they lost all credibility. Furthermore, used by different people they predicted wildly different values: where one engineer understood that a 25 inch stainless steel pipe two inches thick was needed, another concluded that a 2 inch PVC pipe 2/16 inches thick would be more than enough, and there was no way on Earth to make them agree. If you asked for the opinion of a third engineer with more experience, he would proffer a third combination, and the ensuing discussion could last for months, so no projects could ever be completed. So the profession decided it was best not even to attempt to reach numerically precise values

YE: So, how should I answer my supervisor? How can a respond to her request for a numerically precise value?

OH (speaking very, very softly): well, kid, this is the dirty little secret of our trade I’m about to tell you. Do as we all end up doing: go to the archive, find a previous project we have already design, take whatever number we used there, and use those

YE: But what if she asks me to justify those numbers?

OH: Again, do as we all do. Invent any contorted justification, make it as confusing and difficult to follow as possible, and the defend it so vehemently that nobody can reasonably judge it may conceivably be worth the effort to contradict you

If nothing better could be said, I’m pretty sure Ye would leave somewhat dejected and disappointed, but would in the end follow Oh’s advice, and in the end being as self-assured and confident in his engineering abilities as you could dream of.

Of course, in such a world power plants would be either outrageously expensive (but as in our world, that would greatly depend on what you compared them with…not that they would have a labor theory of value to explain in crystal clear terms why things cost what they cost) or dramatically unreliable. Just to be clear, that’s NOT the world we live in. We are clueless about what effect a raise in the interest rate may have. We are clueless about what may happen if the minimum wage is raised (heck, it is not as clear as I thought it was that the overall level of employment will fall, as that happens ceteris paribus… but all the rest never stays the same). But we do know pretty well how big and thick the pipes going into the boilers should be. And how much fuel (or gas, or coal) those boilers should burn to send a certain amount of steam to the turbine. And how many megawatts the turbine will in turn allow the generator attached to its shaft to pour in the electrical grid.

Now for how those megawatts should be priced, that is an entirely different story… 

Wednesday, December 7, 2016

The shortcomings of Economics (and yes, it is once more about Trump…)

It will come as a surprise to exactly none of my regular readers (all two or three of them) that I am not especially fond of the discipline (I refuse to refer to it with the more exalted adjective of “science”) of Economics. After finishing my MsC in industrial engineering I halfheartedly pursued a degree in Business Administration for three years, but the sheer lack of structure and outright irrationality of the field (and the growing demands of my day job, it has to be said) finally made me to give up and shift my attention to other interests (although more than ten years would pass before I came back to academia, this time to pursue a PhD in philosophy which only this year I completed). It may be argued that trying to obtain a degree in a “social science” (a hodgepodge of some tidbits of knowledge successfully hidden within tons upon tons of half-baked opinion and crass ideology with no regard whatsoever for any semblance of “objective truth”, to the point that the very same concept of truth is utterly discredited and suspect) after getting one in engineering is like trying to bang a 10 $/hour hooker after successfully dating Giselle Bündchen (not that I especially fancy Ms. Bündchen, but I hope you get the idea). Be it as it may, I pride myself of being an intellectually curious guy and to follow whatever train of thought may help me to better understand the universe we inhabit, wherever such pursuit may lead me (I was also a victim of the dominant narrative, originated in Marx’s thought no less, that holds economic relations are somehow the “real” explanation behind how the world works).

As anyone who has ever held an unpopular opinion may readily concede (I hope a position most of my readers have experienced sometimes), being subjected to a constant barrage of dissent can make even the staunchest and sternest believer waver in his beliefs, so after more than a decade hearing from every reputable opinion maker how Economics is the “queen” of the social disciplines; how its epistemic status is undisputed and any other discipline aspires to reach its lofty position; how elections should be decided by the economic content of the platforms (“it’s the economy, stupid!”); how the more or less economic literacy of a candidate (or his/her advisers) should be the most important factor to consider when deciding who to vote for; how the economic impact of any election (most markedly in recent times in the cases of Brexit and the Colombian peace deal between the government and the FARC) should be the first aspect in people’s minds; I hope I can be excused if I say I felt gently pushed (or, more accurately, almost bludgeoned to death) to reconsider my initial distrust and even open scorn for the field and  give it a fresh new look.

Now, when I say “a new look” I don’t mean “let’s read a couple Wikipedia articles, peruse some issues of The Economist and weekly glance at the salmon press somewhat nonchalantly”. May be the way Economics was taught in the University I attended was just not good, maybe I was missing the real deal, and was just for all practical purposes unschooled, and thus my distrust was just a product of my ignorance. So, having made a firm decision to remedy such potential source of error, I went back to The Wealth of Nations (I had read it as moral philosophy, and wanted to check on the labor theory of value as seeming quite foundational for the whole field of Economics), to Ricardo’s Principles of Political Economy and Taxation and to Stuart Mill’s Principles of Political Economy (yup, the good ol’ Classical economists were not the most original of men when it came to giving titles to their works). Wow, wow, wow, you may say, that’s really old stuff! Nothing to do with how Economics has evolved and how it is taught in modern schools! I know, I know, just bear with me for a little longer. I just wanted to have a better grasp of how this kind of thing started, so I also read Steuart’s Enquiry into the Principles of Political Economy, Hume’s Essays having to do with economic issues (“of Money”, “of Interest”, “of the Balance of Trade” and “of Commerce”) and (more recently) the Tableau Économique by Quesnay. I’ll get into more detail about what I learned and what I think of such foundational works (short summary: mostly a befuddling mix of tautologies and wishful thinking), but let’s continue with what I did to ensure I was not judging the august body of knowledge unfairly: I then moved on to the neoclassical thinkers, reading Marshall’s Principles of Economics (interesting that the “political” part had been dropped), Jevons’ The Principles of Economics (that charming originality when it comes to titles, again) and Pigou’s The Economics of Welfare. All of them served as an appetizer for Keynes’ The General Theory of Employment, Interest and Money (with the Essays on Persuasion thrown in the mix just for fun). 

Still old news, and not much used to shape the economic thinking of contemporary students! Yup, I know, so after having gone through those mostly forgotten texts I went right away to Samuelson and Nordhaus’ Economics (not the latest edition, it was the eighteenth, printed in 2007, so it may have been updated -indeed, some of its final policy endorsements and criticism of fiscal policy vs. monetary seems way outdated), Friedman A Monetary History of the United States, 1867-1960, Becker’s The Economic Approach to Human Behavior (which, btw, I’ve repeatedly said is literally the worst book I’ve ever read) and then mostly papers and articles (of note was Coase’s The Nature of the Firm, from which I’ve profited nicely in my current line of work), as I couldn’t find any more books of similar standing to convey a good, comprehensive overview of the discipline.

There may be some picky reader that would object that my understanding of the field of Economics is still incomplete or not up to date enough (please feel free to leave your suggestions of what else I may read to correct such deficiency in the comments section or, not to put it too politely, STFU), I may only add that in sixteen years as management consultant(followed by five years as a C-Level executive in a multinational firm) I’ve been exposed to what a wide array of companies (mostly big corporations, with an oversized impact in their countries’ GDP) do to maximize their benefit and decide what to produce, how to distribute it and how to report it to the (mostly unsuspecting and hapless) public, so I honestly don’t feel like any professor may school me substantially in how a modern economy actually works.

Hoping to have stablished good enough bona fides for what is about to be said, let’s review a short selection of the problems I see with how the field of inquiry has been shaped from its inception:

The shape of Demands to come

The basic unit of analysis for Economics is supposedly what people “want”. When they get what they want they derive satisfaction from it, and such satisfaction is also known as “utility”. Thus, the maximization of utility is posited as the main goal of any rational being, and the means for such maximization are the consumption (or rather the acquisition) of the mix of goods that would yield the maximum utility. Such understanding of humanity is hopelessly flawed, and based on a purely circular logic (note that utility lends itself admirably well to maximization by being an unmeasurable quantity that just happens to be expressed as a function of what we consume) that leaves no space for things like being in a stable, fulfilling relationship, enjoying a clean environment, being in good health (rather the opposite, good natural and spontaneous health is a source of disutility, as it prevents us from spending in medicines) or enjoying a good book or music from the local library (which has costed us nothing).

But let’s leave aside for a moment the essential incompleteness of the economic understanding of men’s motives, and try to delve a bit deeper in how such understanding can at least be useful to model (and thus predict) at least some elements of people’s behaviors. According to economists (in their neoclassical, or marginalist, interpretation) the utility that people derive from the acquisition of a particular good is a function of how many items of that same good it has already acquired, so the value that a person would assign to adding one more item to its existing stock (hence what he would be willing to pay for it) can be calculated by just knowing the amount he already has. To be more precise, in the majority of cases it will be a decreasing function, as additional units will be less enjoyable, less useful (or producing less pleasure), thus less valuable. In the arch-famous representation devised by Marshall, the “demand curve” has a downward slope:
Seems intuitive enough, right? Unfortunately, a cursory reflection shows that this is not, by a long shot, how people think of most of the things they do, let alone about the things they buy. First, although it may make some sense for commodities (those items that are interchangeable, exactly alike) like loaves of bread or gallons of tap water, it doesn’t work so well for the growing percentage of purchases in a knowledge economy that are not commodities, like information or unique experiences (what is the value of purchasing a book you have just read or a song you have just downloaded and copied? It may very well be zero; what about a travel to a unique location? Ditto, after being there and ticking it off from your bucket list you may very well not want to return in a number of years… the demand curve would then be a single step, with a certain value for Q=1 and zero for every other value of Q). If you are a collector, the additional items of a certain category that you acquire to complete certain areas of your prized collection may not have a decreasing marginal value to you, but an increasing one. And finally, depending on the moment of the day, of the lifecycle, and the location, exactly the same item may have very different values to the same person, regardless of how many of those he already has (like the proverbial bottle of water after an exhausting workout in the gym that makes your regular bro be willing to pay three times the normal price, regarding of how many more he may have in his home’s fridge). In sum, the demand curve is an invalid construct as it does not “explain” in any meaningful sense neither an individual’s choice (how many money, or effort, he would be willing to forswear to obtain an additional unit of a certain good) nor the collective one (it can not be aggregated to guess how much a whole group would be willing to pay for a certain amount of said good, as it doesn’t accurately reflect the real value for any of the members of the group at any value of Q).

My own experience tends to confirm such uselessness of the model. After having covered the basic concepts of supply and demand in one of the subjects (“economic organization of production”) within the syllabus of my engineering training, I was mildly surprised that none of the companies I worked for had the slightest idea of what the demand curve for their products was (starting with my employer, a consulting firm, ad going through all my clients, be they telecommunication companies, utilities, industrial conglomerates or consumer products manufacturers). They did build predictive models of how variations in the price of their different product lines would affect the amount they would be able to sell, but they all had to resort to a host of additional variables that gave very little (if any at all) weight to the total amount they and their competitors poured in the market (or the amount their clients may already have).

OK, so may be Economics has not been very good at coming with a simple model able to predict the amount of any merchandise that clients may buy, no big deal as such imperfect model may still be useful when combined with the (similarly flawed) one used to predict how much of each merchandise the producers will supply. Fat chance, but that forces us to turn to

Supply and the supplyin’ suppliers

In the neoclassical model, consumption decisions are made by consumers (duh!) of each commodity in accordance with the demand curve. What about the decisions that determine how much of each commodity will be manufactured (and thus offered in the market)? As you may imagine, for symmetry’s sake an elegant model was devised to define how much (how many items) of any merchandise will be produced, based on how much it costs to produce the latest item (that is, the only variable taken into consideration is how many items are produced in total). Since the beginning it was supposed that each additional item would be more costly to produce, as it would require additional units of the different inputs that went into its production that would eventually interfere between them (in what has been considered an almost universal law of nature: the law of diminishing returns), so the equivalent of the demand curve would be a “supply curve” that would slope upwards:
Again, any person that has actually managed a production facility would scratch his head seeing this, as normally the opposite of what it depicts is the case: up to a certain extent (where you have to expand your facilities, incur in additional costs for new plant, machinery and labor and thus give a big boost to costs), the more units you produce the cheaper you can sell them, because you have more units between which to distribute your fixed costs and thus the average cost per unit (which consist in the sum of the variable cost, that tend to be constant per unit within certain range, and the fixed cost divided by the number of units produced) goes down with the increase in units.

As with the demand curve, I’ve seen (and led) complex projects to help my clients set up cost accounting so they could better understand how much it costed them to produce each unit (at the margins or not), and I can tell you that the total amount produced was the smaller of the contributors, dwarfed by the cost of the raw materials, labor, communications and transportation, amortizations (depending on the industry) and other financial costs. Yup, in the long term all of them could be treated as variable, but the production decisions are rarely taken “in the long term”, the problem managers have to solve is how much to produce (and what resources to commit) in the shortest of terms, in the next shift, in the current fiscal year, given the overall business cycle. So unsurprisingly nobody cares a iota for the classical supply curve (heck, nobody would even know what their supply curve, understood as the marginal cost of producing an additional unit based only on the total level of output, is).

So we have a theory which neither does adequately model how people make their purchasing decisions nor fares any better modeling how firms make their production decisions. What could go wrong? Of course, when you put those two together (technically adding every consumer’s decisions to create an “aggregate demand” curve, and doing the same for every producer’s to create the “aggregate supply”) you get the mythical spot where demand equals supply, and which defines the price at which the market “clears”: if the price is a bit higher, being above what consumers would pay for that amount the unsold inventories would pile up and force producers to reduce their output; if the price is a bit lower consumers would snatch up the existences, creating scarcities and inducing manufacturers to produce more. Which I dare to say is a big load of balderdash, and does not reflect what has ever happened in a market in the whole history of the human race (well, that may be too strong a statement, may be the pork bellies futures’ market in Chicago has some time or other seen such miraculous coincidence happen). To a certain extent, even economists recognize the very limited applicability of such model, as they proffer it is only valid to describe the expected behavior of “perfectly competitive markets”, which are again as doubtful of ever having existed (with the aforementioned exception of pork bellies futures) as the tooth fairy or the Easter bunny.

Let’s stop for a minute to take stock of where we stand. We have a theoretical framework that professes to be of some help to decide the “best” use of limited resources that have alternative uses (“best” being the one conductive to a greater sum of individual utility for those involved in the enjoyment of the products of such resources), but such framework is defective when it comes to decide:

·         How to allocate our (limited) consumption budget (i.e. what to consume)

·         How to decide what quantities to produce

·         How prices are set (and thus, if the price level is adequate, fair, conductive to a just distribution of the social effort, etc.)

Such is life. However, that is the realms of microeconomics, which sometimes is compared with the nebulous relationships postulated as much as observed between the evanescent entities of quantum dynamics. It may be similarly said that even though we are not very sure of what it is that we measure and predict when talking about an elementary particle’s spin or mass or momentum, but when we just blindly apply the model and solve the equations what comes out happens to coincide surprisingly well with how the world (at a macroscopic level, amenable to measurement) behaves. Stretching our analogy, when we put together the simple but powerful models of supply and demand and apply them to the goods market, the labor market and the money market we obtain the triple equilibrium (or general equilibrium) that actually describe how a modern economy works…

Balancing the balances (it’s not Karma, it's even better!)

Do not pay attention to the inconvenient fact that almost not a single market works according to the dynamics of classical supply and demand. If there are markets that deviate from such model, they surely are the market for salaried workers (labor market) and the market for means of payment (the money market). Hell, even most goods are either subject to heavy regulations or offered by a very small number of suppliers that can exert an unduly influence both in the amount of merchandise offered for exchange and in its price. But that doesn’t prevent the whole field to have swooned over the stroke of genius of linking together precisely those three types of exchanges:

Just brilliant, now you really understand how the total production of goods and services of an economy (national Gross Domestic Product), the price level, the employment rate (more or less dictated by the total hours worked), the salaries paid, the amount of money in circulation and the interest rate all relate to each other, and by varying one of them you know how all the other variables may vary. Wow! Really something. When I learned about all this I really wondered why there were still cyclical depressions (I learned it in the early 90’s, quite dire times in Europe although the USA were beginning its longest recorded expansionary phase). And do you know what the answer is? Pick at random literally any post by Paul Krugman in the NYT and Ken Rogoff (latest one in the Grauniad: The dark side of Rogoff) and you will soon find out. Keynes may have been a respected genius, but nobody knows how to separate heads from tails regarding his brilliant insights, and none of the models built after them has stood too well the passing of time (the stagnation of the 70’s is widely understood as having driven the proverbial last nail on the coffin of standard Keynesianism, thus what we have today is “neo-Keynesianism”, which battles with neo-Fisherism and neo-monetarism and a bunch of other old novelties for a supremacy that never seems to be attained for long). None of the above presented curves is really known (by any accepted methodology), so really the best prediction of how much a country’s GDP may improve if we raise 1%the interest rate is anybody’s guess. The best prediction of how much we could reduce the rate of unemployment by the same raise? Anybody’s guess. The best prediction of how much inflation we would have if we increased aggregate demand by a certain amount through public purchases, or public investment in infrastructure? You already know the answer: anybody’s guess…

Not surprising, giving that the elementary components used to build the integrated model are, each of them, highly dubious and of questionable validity. Even calling them “models” is a misrepresentation, as all they really are are attempts to pass as a continuous function (represented by an equation, unfortunately one whose terms are never known) what is nothing but a bunch of individual, isolated observations which only seem to share a regression coefficient (something that really we, as observers, impose on the data, and not something we could claim the data present us with).

But what, then about the brilliant mathematical models that the discipline has developed and that have been empirically validated? Every time I hear such comment I tend to ask what models are we talking about, because what I’ve mostly read in the more detailed, supposedly more advanced literature are “ghosts” of functions that are differentiated (and equaled to zero to find their maxima or minima as if that was a highly esoteric, highly respectability-enhancing procedure that could stand for the lack of true understanding of what kind of relationship they were supposedly revealing) but about whose underlying nature very little is actually said or presented as evidence (the worst offender in this area is, as far as I’ve seen, Becker, whose debunking would merit a post of its own). But from a ghost of a function, from the formal structure of what a function would look like (but with very little actual content of what it actually poses) very little can be either predicted or actually measured. No kidding the falsifiability of most economic theories has proved so hard, and all the “neos” I mentioned before have shown such a resilience, regardless of how many economists have come out saying they had been thoroughly disproved.

However, how much of such disproving has actually succeeded will be the subject of a future post, along with how such failure indeed explains in part the success of Trump in the latest USA presidential election.