Sunday, February 12, 2017

Apples, Haircuts, Growth and Output

What might apples and haircuts - as an imaginary economy with only one service and one product - suggest about equilibrium growth and output potential? A recent post from Nick Rowe, encouraged me to explore the dynamics and make some related connections as well. Here's Rowe's opening paragraph:
An economy produces two goods: apples and haircuts. The production function for apples shifts up or down every year at random, depending on the weather. The production function for haircuts never shifts. The weather causes relative prices to change. When there is good weather, and the apple harvest is large, the price of haircuts in terms of apples rises (the price of apples in terms of haircuts falls). When there is bad weather, and the apple harvest is small, the price of haircuts in terms of apples falls (the price of apples in terms of haircuts rises).
Importantly, weather defines the setting, as it establishes an output range for the initial product. Good weather translates into a good crop in which not only does the abundance of apples cause the price of each apple to fall, the greater abundance of apples overall allows the costs of haircuts to rise. Likewise, bad weather is a smaller crop in which each apple costs more, and there is less apple output in aggregate for the resulting haircut valuations.

The beauty of the one product one service economy, is that it illustrates what I've referred to as primary and secondary market functions of output and growth potential. Apples can be likened to the random resource capacity of primary markets, which provide settings for initial market conditions. Haircuts are the secondary market capacity which represents time based services in general. That said, however, the fact that time based product is dependent on primary markets is obscured at the aggregate level, by the still growing effects of Baumol's cost disease. Consequently, the lower productivity of time based services in its dependent position, instead of creating wealth via its own means, is gradually displacing the resource capacity of primary market functions. In some recent discussions re cost disease, a commenter at Scott Sumner's blog left this useful reference point from William Baumol's book on the subject:
In the long run, wages for all workers throughout a country's economy tend to go up and down together. Otherwise, an activity whose wage rate falls behind will tend to lose its labor force. Auto workers and police officers will see their wage rise at roughly the same rate in the long run, but if productivity on the assembly line advances while productivity in the patrol car does not, then the cost of police protection will rise relative to manufacturing. Over several decades the two sectors differing cost growth will add up, making personal services enormously more expensive than manufactured goods.
If today's time based service products are dependent on primary market formation - in ways that are mostly being papered over via extensive debt, taxation and hidden unemployment - what mechanism created such a massive problem in the first place?

This circumstance can actually be traced to money as representative of all resources and marketplace output - be those resources scarce and finite such as time or land product, or the sum total of all product capacity. Yet one only needs to recall that the value of random resource aggregates continue indefinitely to pull away, from the scarce and finite product of time and land. Nominal income is embedded in the latter, in ways that provide a mirror for the valuation of random resource capacity. Various marketplace participants stake income claims ahead of other would be participants in the economy, simply because they can. Even though the subordinate position of time value has price elasticity which responds normally to output in the above one product one service economy, the sticky wages of a complex equilibrium are reinforced by land values which already mirror local aggregate income levels.

Since time value does not (yet!) have formal representation as a store of value, it doesn't have a specific, economically quantitative template whereby production gains can be generated. Instead, today's time value has little "choice" but to exist in relation to total marketplace output. Even though the prices of haircuts (as a secondary market, i.e. not internally generated) rise and fall with apple output in a simple economy, it's difficult for anyone to determine a "reasonable" time based product value, in relation to the full resource potential of an otherwise productive and complex economy. To add to the confusion, a vast majority of income is ultimately stored in real estate - a process which particularly makes time value resistant to good deflation and production norms.

Again, return to the thought of money as the sole representation of marketplace output as a beginning point. The reason that time value aligns with total resource output, is the fact that it does not (presently) have the option of aligning production capacity in relation to itself. Not only would internal facing of services generation overcome Baumol's disease, this organizational capacity would move into a primary market position that generates new wealth. Over time, time based services as a primary market position, would increase total growth and output. Once tradable sector activity experiences the massive relief of higher labor force participation and a strong customer base, one could even hope that today's political chaos will subside.

There's another problem for money as the sole representation of total output value. Of late, some seek to downplay the role of money in macroeconomic activity - in part because it does suggest hard equilibrium limits beyond the ways in which today's "maker" roles are conceptualized. Indeed, secondary market formation is becoming more self limiting, as the Baumol effect creates more distortion for budgets and debt formation.

Nevertheless, I believe that time value as expressed on formal, primary market economic terms, would be a better approach to long term growth than using debt to sustain an excessive amount of secondary market patterns. Some people think about these things and despair. So it confuses others, when I'm still able to get excited about the potential for a better economic future. Is it still possible to convince anyone that low labour force participation and reduced growth potential can be addressed via a marketplace for time value? I certainly hope so.

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