Could Theoretical Economics Benefit Political Dialogue?

Perhaps a good theoretical discussion is needed: One which takes a closer look, at how today's service sector dominance affects macroeconomic outcomes. After all, the last significant theoretical debates, took place while tradable sector activity was still dominant, and much has changed since then.

For decades, theoretical economics has taken a back seat to empirical economics. While this is understandable in many respects, empirical work lacks the broader framing which could help citizens rediscover a common ground for the challenges of the 21st century. Small wonder that citizens are losing trust in their governmental institutions, as policy makers and others have too much incentive to further polarize their constituents, instead.

Even though economics as a discipline was severely questioned during the Great Recession, little was changed, and no real broader understandings were reached. But if corporate entities and economic thought in general are doing "just fine", why, then, is politics the world over in such turmoil? Why such a dramatic disconnect between political and corporate realities?

In a recent Bloomberg post, Tyler Cowen questioned why so many political problems exist, given the fact corporate America is quite healthy. He reasons that even though politics is weird, the fact that business firms are functioning normally, means there should be little cause for concern. Oddly, his post made me think of numerous posts from Noah Smith, who insists that theoretical economics is no longer important. Nevertheless, monetary policy is one of our best indicators that something is wrong, as central bankers move ever closer to a deflationary era. Without current takes on theoretical thought, we scarcely have means to describe what we are witnessing.

Meanwhile, much of the national discussion is too disjointed, to deal effectively with rapidly changing equilibrium conditions. What's more, the economic dialogue which is more theoretical than empirical, is largely focused on the nature of equilibrium expectations before they became dominated by service sector activity.

To be sure, a similar set of outdated expectations is true of Keynesian thought. Only consider how fiscal stimulus was once more effective, before non tradable sector dominance meant diminishing returns for this approach. When Keynesian thought gained prominence in the twentieth century, tradable sector activity was still dominant, which meant government redistribution had a much greater likelihood of contributing - albeit indirectly - to increased marketplace output. Before non tradabable sector requirements became so extensive, basic living costs left more discretionary income for all income levels.

Hence those 20th century multiplier effects once contributed to thriving Main Streets, even in small towns. Whether or not Baby Boomers "spent too much" in those earlier times - as some now believe - isn't quite the issue. A "good time out" could be had by frugal shoppers, as well. Indeed, most shopping was a minimal expense, compared with the non tradable sector requirements of the present. Little about the "marketplace" of the latter could be considered fun, right now.

How to think about these changes, which have unfortunately meant diminishing returns for fiscal stimulus? Again, consider how distribution patterns for tradable sector product, contrast with those of non tradable sector product. Non only is non tradable sector activity (still) dependent on the direct wealth formation of tradable sector activity, it has limited incentive for marketplace expansion, since its producers and consumers are both time and place dependent. In other words: unlike tradable sector product which is produced and consumed with little regard to time and place restraints, marketplace expansion for non tradable sector product, can mean diluted profits.

Given this instance, higher costs are sometimes understandable. The problem is that when fiscal policy addresses high costs through subsidies for non tradable sector activity, the natural limits of time and place only encourage costs to continue in the same direction. Whereas 20th century government fiscal policies once contributed to tradable sector markets which could ready expand without losses in profits. Consequently, cutting costs was not illogical for tradable sector self preservation.

Wait: If tradable sector activity is being crowded by non tradable sector dominance, why does business activity appears as though normal and flourishing? Tradable sector activity is thriving because of global production and consumption. These firms remain successful in spite of a limited marketplace "at home" in advanced economies, because of growing levels of discretionary income in developing economies, even as discretionary income is still being lost at home.

And even though it is understood that government subsidies can make tradable sectors lose their competitive edge in a global environment, non tradable sectors - with their local customers who may have few other choices - again, don't have the same incentive for innovation. Consequently, low productivity can be seen as both a cause (non tradable sectors), and a result, when tradable sectors are compelled to reduce production at home, due to the income crowding of non tradable sectors.

Protectionism begins at home, and it is the protectionism of non tradable sector activity, which could ultimately affect tradable sector activity across the globe. Hopefully, citizens will gain a better understanding of what is at stake, before the effects of a tight money and protectionist environment, spread too far. Let's take a closer look at economic issues in a broader light.