Week of 2 Feb 2009
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I chose the qualifier "First World" for we will find that in developing countries, the model behaves somewhat differently. By "developed" I mean a society that has modern methods of finance, modern standards of food, shelter and clothing and uses modern energy sources to reduce the labor necessary to sustain these basics--we also call this mature, speaking of either a whole economy or an individual industry. With these ground rules established, we can use an allegory to describe macroeconomics.
The basic model for our macroeconomic system is the passenger airplane. It is not a car, train, bicycle, horse or other form of transportation. The reason we choose an airplane is because it has to be in motion, above a certain stall speed, in order to function, indeed in order to exist (a grounded airplane is merely a wheeled vehicle). A modern, free-market, macroeconomic system has to also be in continuous motion in order to function. If this were not so, you could work one week, obtain a paycheck and that would be it. However, you find you consume this paycheck, on basics or entertainment (entertainment = anything that is not a basic) and then need another, just like our airplane needs to continuously move through the air in order to have lift.
Let's look at what it took to make our airplane possible. First and foremost, it takes free markets. It took innovation (the Wright Brothers will do), factories, tools in factories, raw materials and people to operate all of these systems. We'll assume the Wright Brothers did all of the innovation, so that part is done, we need no more. They are out of work.
However, Mr. Boeing had to conceive and build a factory, equip it, arrange for and procure raw materials and so forth. He asked his friend Mr. Bechtel to build and equip his factory and when it was done, Mr. Bechtel was out of business. Since Mr. Boeing built very good airplanes, when he had built enough to carry our entire economy, he was out of business. He had to shut down.
Then something happened--one day a plane crashed. Now there were not enough planes to carry the economy, so a new business sprang up, one to build replacement planes. And since planes crashed fairly regularly, this replacement plane business had steady but relatively low volume work, a sideline to our economy.
What I have just simplistically described is a calculus problem. If we think of the steady-state airplane scenario, the description of this phenomenon is the basic equation of flight of our economy (please, you highly scientific types, don't take me too literally here). Manufacturing airplanes is the first derivative of this equation, and Mr. Bechtel's business, the building of airplane manufacturing facilities, is the second derivative.
If we have reached a steady state of flight, we need no more airplanes (except for the replacement business) and the slope of the basic equation is zero. Manufacturing more airplanes depends on the slope being positive. What if you are Mr. Bechtel? You are riding the second derivative of the basic equation. For your business to continue, you not only need for there to be an increasing need for airplanes, you need for there to be an increasing need for more airplane factories (or an ever increasing need for airplanes). In other words, the increasing need for airplanes must be increasing. If the first derivative represents the velocity of the basic equation, your factory building business is dependent on the acceleration of the basic equation. And so on and so on.
You can find examples of this throughout free market first world economies. The conundrum is those employed in the 2nd, 3rd... Nth derivatives spend their incomes in the basic economy. So if the person that builds airplane factories has to lay off their employees, they can not afford to ride airplanes and the basic equation experiences a negative slope. It is key: a reduction in the Nth derivative business causes layoffs in that business which affects the basic equation through reduced consumption by those laid off.
Hence, if you build airplane factories, you are highly interested in creating an ever-increasing need for more airplanes.
One way to create this need is through innovation. Creating safer, more luxurious, more fuel efficient airplanes may increase the need for new airplane factories that can build planes in new ways to force obsolescence of the ones already in the air. This will put the final nail in the coffin of the factories that made the old style planes, but that is not Mr. Bechtel's problem--he needs to build new factories in order to sustain his business. Innovation requires creativity (always in short supply) and ever more highly trained workers (oops, we let our kids grow up being used to being entertained, not learning). On top of that, Wall Street has decided they don't want Mr. Boeing spending money on innovation--it is too risky. So no new factories springing from innovation.
Another way is to encourage exports to less developed countries. For until their airplane transportation business is mature, they will need an ever increasing number of planes and we can run the old factories to make them. This is good for Mr. Boeing (first derivative) but not so good for Mr. Bechtel (second derivative). The problem with exports is that we have to do a quid pro quo and allow imports, something very unpopular with certain segments of the population. (Ironically, in real life, Boeing is the largest exporter in the United States).
A third way is to grow the economy through a growth in population. For if we know we need one airplane seat per person, obviously more people will fill more seats and we'll need more planes. There are two problems with this idea. One, we closed Ellis Island (I am being figurative here) and have no systematic way to invite others in large quantities to come to here. Two, with modern birth control, we have reduced family size and slowed the growth of population to near zero. Any business dependent on per capita consumption and a growth in population thus has a problem. Worse than that, from a business point of view, it has become common wisdom to aspire to zero population growth, hence no help likely on this front.
The pulp and paper industry is a "per capita" industry. Any mature markets, like ours, are almost solely dependent on an increase in the consuming population in order to grow. Mature markets are also threatened by innovation in competitive technologies (newsprint being the prime example here). This leaves us with internal innovation and trade as our primary methods of growth. As far as the first, second and beyond derivatives, their world may be bleak indeed (unless they get very creative).
Well, that is 1,138 words. Gives me plenty of room to wrap up next week--and, I promise, we'll end on a positive note.
I am highly concerned these days about our unemployed friends being mentally pre-occupied when driving a car or doing other tasks. No matter what else is going on in your life, you must use a clear head when doing these tasks in order to stay safe.
Be safe and we will talk next week.