If you listen to Raj Chetty at Princeton, one implication is that the economy is not well described as a GDP factory. Most of the talk is about heterogeneities in the economy. Affluent consumers behave differently from low-income consumers. Small service businesses were impacted differently from other firms. And above all, the patterns of specialization and trade that were broken are not likely to come back quickly.
As a result, the “stimulus” largely missed its target. In order to be able to see this, Chetty and his collaborators are using new data sources, rather than the standard government statistics that were designed for the Keynesian paradigm.
But to make the most sense of what he finds, it helps to read Economics after the Virus, my latest essay. I had already anticipated most of Chetty’s empirical results when I wrote,
In a typical recession, households reduce spending involuntarily, since they have lost income. In this case, household members have deliberately chosen not to shop or travel or seek entertainment outside their homes, even if they can afford to do so. . .In a typical recession, construction and durable-goods manufacturing experience the sharpest declines, while service industries stay relatively stable. In this case, in-person services have been among the hardest hit sectors of the economy. In a typical recession, nearly every industry can look past the immediate troubles and foresee something close to a return to normal. In this case, retail stores, restaurants, entertainment venues, institutions of higher education, hotels, and the like foresee drastic changes even if the economy were to revive rapidly.
It is one of my most important essays. Academic economists, including Chetty, should be reading it in something like the American Economic Review, in order to have perspective on Chetty’s findings. But the PSST story is too “soft” to sell to an academic journal. George Akerlof explains the methodological bias.
it has become all-but-uncontestable that new theories need to generate testable predictions. This belief may seem innocuous; but, in point of fact, it involves rejecting softer tests of theories, such as those that evaluate models based upon the quality of their assumptions as well as the quality of their conclusions. It especially entails exclusion of evidence from case studies, whose detailed evidence can be highly informative regarding context and motivation. While harder tests with statistical data may be a gold standard, restricting the set of permissible tests reduces—perhaps greatly—the ability to test theories. Hence, bias toward the hard makes us too accepting of existing theory and insufficiently willing to be self-critical as a profession.
Pointer from Tyler Cowen.
“ In this case, retail stores, restaurants, entertainment venues, institutions of higher education, hotels, and the like foresee drastic changes even if the economy were to revive rapidly.”
Could someone point me to arguments why this is the case? I can see it for brick and mortar retail, because it had already been declining, and I can see the habit of ordering things online outlasting social distancing, especially for older folks who hadn’t before done much online ordering. And I can see an ongoing lack of international students impacting higher education, as well as school closures, though if anything I suspect that demand for the in real life experience of a college campus will have increased. Though maybe commuters at directional schools had not yet taken full advantage of online classes.
For the rest, I don’t see the big changes. Are global trade and supply chains a big enough driver of hotel bookings and tickets for entertainment venues that rejiggering supply chains will make a material impact on the industry?
I doubt that remote work changes much, except to drive higher employee turnover. To pit it another way, if you can do your job remotely, you are either some kind of indispensable, very difficult to replace subject matter expert, or a very replaceable cog in the machine whose function is to produce widgets, and not anything more valuable than that. Most people fall into that latter bucket, and should see remote work as the prelude to redundancy, and start looking for a better job ASAP.
Another brilliant article worth pondering at length.
Some initial thoughts.
Your article doesn’t seem to promote your overdraft protection proposal. It might be of interest that the Swiss bailout included something similar:
“the Bund will make available “bridging” loans to small and medium businesses designed to prevent a wave of bankruptcies. These loans are backed by Bund money, and they will be administered by the “house banks” of the borrowers. Banks will bear a portion of the risk (15 percent) for larger loans. To qualify for bridge loans, borrowers must demonstrate their business has been harmed by the pandemic. The interest rate will be set a 0.5 percent. The bridging loan program went into effect immediately, on March 25.”
https://thehill.com/opinion/finance/489970-should-we-follow-the-swiss-in-dealing-with-covid-19
One wonders how much fragility is due to high capital requirement barriers to entry in non-software industries. Looking at the World Bank national rankings for ease of doing business sub-indices, we see for 2019, the USA ranked 4th on ease of getting credit, but 55th on ease of starting a new business, 25th on ease of paying taxes, 64th on getting electricity, 24th on construction permits, 39th on registering property, 17th on enforcing contracts. PSST would be more agile and rapid if these, largely regulatory and legal, were reformed and improved.
You write “all we lack is the will to follow through.” Yes, but how much more will is needed due to our crappy political system and institutions? Still digging around boxes in the attic trying to find my copies of Dahl. I suspect reforms to the polyarchy playing field through a more democratic political system would pay substantial returns on investment in terms of reducing fragility.
There is a saying that a lot of political will is actually “political won’t.”
I think this is what Francis Fukuyama means when he talks about the proliferation of actors with power to veto things in the USA.
So, to return to the general issue, we don’t have the political will to fix things because a lot of interests have fought to get things pretty much as they are.
However you define “we”, there is also a “they,” and “We” don’t want the same things that “they” want.
This is obvious–I’m not saying it like we don’t already know it on one level. But it’s easy to forget periodically.
In terms of a theoretical framework, Mancur Olson’s work is relevant. Every special interest produces friction and a veto. Charles Murray’s take on Mancur Olson is that the only real solution is to lose an all-out war and start again from scratch.
People who are Reagan fans will argue that Reagan halted the growth of special interests for a time. People who like Trump will argue that Trump is trying to do the same. A topic for another post.
The GDP factory model predicts taxable income for Federal government.
We are not a federal government we are a value added chain. The 2008 unemployment lasted because of California which the charts indicate. California is the one which was not sustainable. California is not sustainable because ti is a big unmeasured GDP factory which cannot coordinate with the government value chain. The government value chain is obviously unstable because the recessions are cyclic and predictable, since 1980.
To give you the example, look at the tax battle which was solved on midnight 2010, I hink, just before the mid terms elections. The federal GDP factory model broke down and we had to have last minute alignment of California and Federal tax law. Prior to the Covid we were again headed for the same cycle, the same tax battles up against the election wall again.
The essence of macro economics is to account for most of the measurable GDP factories in economy when doing GDP aggregation. Everyone worries about the federal government and neglects the variety of states, and the state system is here to stay, unfortunately.
Our ignorance is born of the Nixon Shock Syndrome,a traumatic moment for most of finance.
PSST sounds like a simplified version of the Austrian business cycle theory. BTW, many economists think the bank problem in 08 resulted from a recession that caused house prices to fall. “Slapped by the Invisible Hand” saw it as an old fashioned bank run in the midst of a recession, but a run on investment banks instead of commercial.
Meanwhile, with 2 deaths in Ontario and 0 in Québec, life in Canada is returning to normal (two heavily injured in a car crash with a moose). Restaurants and gyms reopening (with safety precautions that unfree but alive Canadians will follow).
The joy of living in a developed civilized country.
The border with the US remains closed.
In (non-confidential parts) of the bilateral discussions about it, the Canadian government not only agreed but requested that the border remain shut to non-essential travel until at least July 7th.
The big worry was that there would be lot of northbound traffic for people wanting to participate in Canada Day festivities around July 1st, and a lot of southbound traffic to do likewise for the Fourth of July, which were thought to create an opportunity for a kind of perfect storm of mass-super-spreader events.
As it happens, someone in my family was scheduled to attend a Canadian event shortly after the holiday weekend, and if the border re-opened immediately thereafter, it would not have been an issue. However, those who issue American legal measures like to use big round numbers, i.e., “one month”, “60 days”, “the remainder of the fiscal year / calendar year”, and so the border closure policy was extended for one week after the event so it would be a one-month extension. Oh well.
The same logic did not quite apply to Mexico, but the same sort of preferences in the issuers like to treat those neighboring countries in a way that is as simple and uniform as possible, and so the same applied to that country.
PSST explains why we ran out of TP for homes but not institutions/businesses. Likewise chicken wings, bananas and other things. Patterns are important in a modern economy and disrupting those patterns causes problems. These are less apparent in other models.
Thanks for the essay, Arnold. As others say, it is worth careful reading and serious contemplation.
You end with an emphasis on “sustainability” in PSST but my conclusion about your framework suggests a new label without it — let sustainability be the metric rather than a component. The framework I see in your analysis would better be called “evolving patterns of specialization and trade” (EPST) or perhaps “fragile patterns” (FPST) or “dynamic patterns” (DPST) or “adjusting patterns” (APST). Your analysis correctly shows that sustainability is a mirage, temporary at best, perpetually shifting like tectonic plates. PSST sounds much more static than what you actually mean.
I realize that you have been pitching PSST for some time now, perhaps leading to deep investment in the acronym, but now might be the moment for a facelift.
I agree that “evolving” patterns of specialization and trade is more accurate. Economies, after all, are just one kind of ecosystem, with living creatures who can be modeled as maximizing something, and a whole host of “abiotic” (non-living) parts, some of which are made by the living creatures. And everyone in biology believes in evolution. If the abiotic parts stay the same, the ecosystem can function without a large amount of variation for a long time.