7 Apr 2009

Over-capitalization and Sustainability

Most of you have noticed that the economy is in "trouble," and many of you wonder what's going to happen next. Although I am a micro-economist, here are a few of my thoughts on the macro-economy:
  1. Our economy is an ecosystem of goods and services, where people buy and sell to each other.
  2. It's size (GDP) indicates the amount of stuff that are moving around.
  3. GDP also grows (or shrinks) at a certain rate, depending on how fast people are consuming.
  4. When things slow down, GDP shrinks as demand falls. Supply will also shrink to reduce over-capacity. When GDP shrinks, fewer resource inputs (oil, water, steel, etc.) are needed.
Now let's expand on this toy model of the economy. Say that we get used to a certain lifestyle. In fact, we get AMBITIOUS and spend as much money on consumption as we make. We may eat at better restaurants, go on bigger vacations, buy more stuff, live in a bigger house, etc.

If the cost of doing that (e.g., cheaper credit AND more income) falls, then we can consume even more. Such consumption will be unsustainable if:
  • We spend more than we make.
  • We use resources in an unsustainable way.
  • We buy more stuff than we consume (put your car in the garage lately?)
When we realize that we are in unsustainable land (hitting the wall wrt credit, resources, greed, etc.), we may decide -- or be forced to face -- that fact, and the cycle of growth will reverse. Here's what happens:
  1. We cut back on consumption: buying less stuff, bargaining over the price of what we pay, and using more of our "excess" capital (gee, I CAN wear out a pair of shoes!)
  2. That hits businesses, and they cut back on operations/jobs/etc.
  3. Businesses ALSO get hit when competitors lower prices and consumers compete by selling excess stuff on the used market (cars, computers, etc.).
    (In fact, I predict that the Dollar stores are going to face tough competition from the Goodwill and other thrift shops. Since they pay NOTHING for their stock, they can charge 50 cents!)
  4. Resource intensity drops (a good thing!) as the bubble deflates and we get back to a "normal" economy.
Now this adjustment period is NOT easy, but it IS necessary. Bubble economies are not good for us, because people get sloppy with their decisions: Bad businesses (pets.com), bad consumption (obesity, anyone?), and bad outcomes (pollution, etc.) go on for far too long.

That's one reason why I am SO pissed off at the "stimulus" package. It's like trying to keep a party going long after the guests have thrown up and passed out. We need a cure -- and it's NOT hair of the dog! (One thing I REALLY hate is the idea of creating "green" jobs through regulation and/or training programs. What if there is no DEMAND for green workers? More wasted tax dollars!)

Note that the people who are hurt the hardest are those who have expectations farthest from reality -- the recent college grad who thinks that breathing a cubicle merits a $50k salary. They will be unemployed until they lower their expectations to the point where they can take a $25k job -- if that job is there for them. Even worse, they took out massive loans with the expectation that they would make that money back quickly. (Talk to lawyers and doctors about THAT great idea.)

Also note that our recovery will NOT begin until bad business are gone (hear that AIG? GM?) and entrepreneurs are ALLOWED to make a profit by exploring and exploiting the opportunities that grow in niches here and there.

Addendum: The Economist discusses changing consumer sentiment.

Bottom Line: A sustainable economy is like a sustainable lifestyle: Minimize your consumption, put something away for a rainy day, and MAKE SURE that you are selling good quality at a good price.
Read more on business cycles, the growth cult, and sustainable economies.

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