Submitted by Shawn Conn on Thu, 10/07/2010 - 13:29

Economics is an interesting science. For me, one of its appeals is its dual nature; it makes use of both sides of the brain. In some ways, it has elements of a hard science, mathematical models, empirical data, etc. However, at its core, it is a social science. We can see an example of this in the concept of value. It can be both intangible and tangible. The value of a human life is subjective. How can you place a value on thoughts, feelings, actions, and impact of a person's life? On the other hand, you can place a value on human life when it comes to things like insurance or wrongful death lawsuits. Economics tends stay focused more on hard data that can measured, but the intangible is unavoidable since it drives a lot of our actions and motivations. In some cases, there are economic terms for intangible value like goodwill.

I think one of the reasons why it's so hard for economists to definitely nail down a cause or effect of an economic problem; there are usually more than one ways at looking at the problem.

Is a company over valued in terms of the price of its stock? There are many different metrics on which to evaluate that answer. Things like P/E and PEG ratios try to analyze the price (or the growth there of) compared to the money it makes in a standardized way so it can be compared with other companies. On the other hand, there's a whole branch of study called Technical Analysis that tries to analyze pricing to charts based on the assumption there's some underlying pattern in how/when people buy/sell securities (think stocks, bonds, and other financial products).

What are the problems with the American economy? There's one way to look at the problems in terms of Macroeconomics. This the perspective that economists, central bankers, & politicians (may) look at. They look at broad data (like GDP and unemployment) and models of the economy to try to analyze the problem and take action upon those models. There's another way at looking at in terms of Microeconomics. This is the discipline of economics that the layman is most familiar with. It looks at things like supply, demand, costs, etc. This is the perspective that most of us look at as consumers and employees of businesses.

Trying to pull in all these economic disciplines and models, one thing is clear to me. They still don't make predicting economic effects or solving economic problems that much easier. Does that make them useless? No, from a historic perspective there's a lot of insight to be gained from economic models that can help us predict how the future may play out. However, no perfect economic model/theory/analysis exists. There's a few reason why.

First is accurately measuring data for the model. As much progress that has been made to accurately record economic metrics like the amount of spending, saving, unemployment, none of this information is 100% accurate; they are based on surveys & records. Sampling data is not the same as having a complete data set, which for something as large as a national economy is next to impossible to have.

Second is modeling decisions. I would argue, consciously or unconsciously, a person makes at least 10 economic decisions a day, and that's probably low considering all the possible unintentional economic decisions (e.g. I didn't take my wallet to the beach thus I didn't buy that bottle of water I wanted). At minimum that makes for 60 billion decisions a day to predict in a model. That's way too much for a model to predict.

Lastly, there's experimentation. The kinds of economic experiments that can happen in a controlled lab environment are limited and very few of those can experiment on the larger real world theories of macroeconomics; in those cases the best economists can do is look at historic economic data which can have various degrees of accuracy which they can then fit into their model.

Even if it you were able to keep track of every bit of economic information, model the decisions of every person accurately, & were able to perform any perfect simulated experiment, you still wouldn't have a perfect model of the economy. Why? Because the model wouldn't be sitting in a vacuum; any information gleaned from this model would be used by others looking to serve their own end. Whether that would be to reduce unemployment or to maximize their own return on the stock market, the model would have effectively changed the economic system it was modeling. Unless your model could model itself within the model, it's predictions would start to fall out of line with reality very quickly. 

At best, you can say economic disciplines and models have provided us a charted some-what-inaccurate map where we've been and what the future could be like based on previous topography we've seen before. This isn't a failing of economics per se. Rather, it's more a statement about the impossibility of trying to predict the future. Some of these impossible-to-predict events can disrupt some of the solid assumptions in economic theories and models.

As I've been reading much about the current economic problems, present and future, two themes stick out at me: Technology and Demography. These two, very disruptive, themes have had an immense impact on the global, national, regional, & local economy, and it looks like they will continue to have such an impact into the not-so-easy-to-predict future. 

Technology has obsoleted many businesses and simplified our lives. It has also had an unintended consequence, sucking many middle class/skill jobs out of the work place altogether. This has been made all the more evident with the recent recession. Phone support has been replaced by IVR or cheap outsourced developing economy labor. Movie rentals no longer need a manned brick and mortar store. Manufacturing has become automated and mechanized to great lengths.

Let's look at the spectrum of employment. On the low end there are many basic jobs that jobs that can't be outsourced, easily automated, or it's just cheaper to hire labor than to automate it. In the middle area, there are many jobs that require some specific education & knowledge but not as much as a professional career. They have either been outsourced to a labor market that's cheaper or they've been automated away from a person. They still exist but not to the same degree when this country was developing. On the high end, there are many jobs that require a long amount of education and are highly focused discipline. Many of these jobs exist but they take a long amount of time to acquire the skills necessary for them. This is a bit of a oversimplification, but in a global, highly technical economy many of middle skill workers in this country have been priced out of their jobs by machines or foreign labor.

Impact of Demography can be summarized by a simple phrase: an aging workforce. This can visualized by looking at population pyramids that represent the age groups. In the past, this has been a nice, ordered pyramid, having a wide base with a narrowing top. As we've progressed into the modern age, 2 effects have changed the distribution of the pyramid; technology and modern medicine has enabled the top of the pyramid to widen out as people live longer; as economy has gone through modernization and birth rates have fallen, the base of the pyramid has shrank.

These are 2 good effects; people get to live their lives easier and longer; populations have naturally slowed their growth preventing some sort of Malthusian catastrophe. However, this has also produced 2 very worrying disruptive effects about the future.

The first hovers around something called the dependency ratio. This can be thought of as the ratio between children and elders compared to middle aged adults. For things like child assistance and social security this number is vital; it represents how many people are paying into a social system versus how many are cashing out. The smaller this number gets the less that can be paid out to the young and old.

The second hovers around something called the replacement rate. This is the fertility rate needed for a static population. This number is around 2.1 for many industrialized countries but varies based on mortality. If the fertility rate is below this number, the population is shrinking. If it is above this number, the population is growing. A growing/shrinking population has many evident effects for economy. All things being equal, an economy should grow/shrink with its population of people. 

Coming back to the population pyramid, we can that these 2 effects have widen the top of the pyramid, and for shrinking populations made it top heavy. Many industrialized countries, including our own, are seeing this effect take place right now. Luckily for us, net immigration helps keep us above the replacement ratio. Many European countries are falling below this ratio. Japan at a rate of 1.3, has been shrinking for a few years. If this continues long enough, it's easy to see how the economy, and more worryingly society, could decay altogether.

Both of these themes put together, spell out trouble times ahead. I think, more than anything else, this has very troubling consequences toward inequality in this economy. Income inequality has been rising for quite some time. A concentration of inequality when it comes to job availability, and between those who are giving versus receiving from social welfare, can only exasperate the trend. Looking at all the data, it can really depress your outlook on the future. 


Submitted by Craig VanEtten (not verified) on Sun, 10/17/2010 - 05:01


Wow what a great piece Shawn. I have a degree in Economics. You are 100% correct economics as a study relies far too much on the tangible. Western policies have worshiped Ricardian Economics to establish the global economy we have today, while ignoring the intangible aspects of these policies. I love that Capitalist societies seek out efficiency in new economies without regard for the effect on their own society, but it can be suicidal. The United States relies on other societies for production of goods and even services at the expense of both societies. (I sound like a crazy hippy) I have no idea how to fix it without some sort of protectionism which is a cardinal sin in Economics.

Submitted by Shawn Conn on Tue, 10/19/2010 - 17:17


Awesome! I'm glad you liked it. Economics has been a pet interest of mine for a few years ever since I got into the stock market. I can't say I know that much outside of reading handful of books, the Economist, & daily information on the stock market.

I think there's a lot of externalities that have yet to come to due as the result of both Wall St's growth fetishism & the government's short-term thinking (i.e. only concerned insofar as the next election cycle). There are some really big issues that need some thoughtful decisive action taken for the next few decades. Meanwhile, the political debate for many people (i.e. what they see on TV) hasn't reached much beyond the intellectual depth of professional wrestling.

As far as solutions, I'm stumped too. Economics seems to be a much better history teacher than problem solver. The big comparisons thrown around are the Great Depression (the effects Smoot–Hawley pretty much puts the final nail in the protectionism coffin) & post-90's-bubble Japan. If I had to pick one, Japan seems the most apt. However, our society is very different from Japan. The world is going through unprecedented times, Economics provides insight but probably won't have any clear answers for awhile.