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The Important Detail They Never Tell You About in Macroeconomics Class

IN EVERY introductory economics class, it becomes clear from early on that specialization is the source of greater efficiency or productivity; in the division of labor and in free trade, the secret sauce is “specialize.” In other words, everyone should stop doing what they used to do and begin to do only the things they do best. It even works if they only do the things they do least poorly. This sounds great and all the textbooks have nice charts, pictures, and examples of how much we all benefit from this miracle. The books almost insult us for thinking that we might do things any other way.

As a result of the consistent application of these principles over time, a country or an integrated global economy exploits the efficiencies – which usually lower costs—and becomes increasingly complex. Anyone paying attention would realize that this approximates the current status of the global economy as a result of the policies of freer trade and globalization over the last 50 years.

As I consider the worst case scenarios of an epidemic, a war, etc., I think about the world 80 or 100 years ago. Most of our basic needs: energy, food, water, were produced or provided in reasonable proximity to where we lived.

The cost of free trade, however, is almost never mentioned in the textbooks. Free markets are certainly not free, and one of the reasons is evident today. With the outbreak of the coronavirus, we are immediately faced with one specific cost of free trade: systemic risk. This is the same risk that says if you have a modern car with 300 moving parts, there are a lot more things that can go wrong and leave you with a car that will not run. When you have a global economy that is extremely inter-dependent, the failure of one component—one key producer/supplier/transporter—can cause a breakdown in the whole system.

As I consider the worst case scenarios of an epidemic, a war, etc., I think about the world 80 or 100 years ago. Most of our basic needs: energy, food, water, were produced or provided in reasonable proximity to where we lived. The economy of the US was significantly more decentralized. There was very little systemic risk. In other words, many households—mostly rural ones—were nearly self-sufficient. Today we would be immobilized if the internet or the grid went down.

In this day and age, we are so integrated (in so many ways) into a much larger and terrifically more complex system than we were several generations ago, it’s hard not to imagine the effect of a systemic shock that could leave us craving to return to an existence perhaps less efficient, more decentralized, but more independent and less prone to systemic risk– a process I refer to as “dis-integration.” We have already seen some reversals of the processes of globalization and integration. Brexit, Protectionism, Trade Zones are breaking down and longstanding alliances (maybe NATO?) are in danger of losing membership.

And that was before we realized that we were all in this together and that if someone across the world sneezed, we could all catch a cold.

 

WRH

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