The Risk of Losing Productive Complexity

So many economic risks exist at a global level, that it can be difficult to discern what needs immediate attention. Nevertheless: among our greatest risks, is the possibility of losing productive economic complexity in the years to come. Without a sufficient response, more nations and governments are likely to double down on mercantile "solutions" to economic uncertainty. Now is the time to make certain, of real economy responses which extend well beyond bringing traditional manufacture "back home". Doubtless, such a protectionist mindset wouldn't have taken hold, had free markets already been strengthened and diversified, so as to allow everyone to take part.

Since free markets in knowledge use and building component definition have been held back, the risks of lost complexity are greater than what existed, prior to the Great Recession. Unfortunately, it's not completely off the mark for bloggers and others to compare the erratic leadership of prominent nations, with the leadership of countries whose economic complexity has hardly been encouraged.

Meanwhile, there's been too many years of "eminently reasonable" leaders, who nonetheless didn't work to promote the forms of productivity which result in greater output without excessive costs. Even the centuries old production standards of housing, means construction workers have scarcely held the job security of traditional manufacturing workers, whose incomes continue to benefit from the increased output of mass manufacture. For instance: why assume "real men" would rather build homes than take on "soft jobs", when building homes without today's added technological benefits, often means not even having sufficient wages to build a home of one's own? Anyone who has personally known construction workers is familiar with this reality.

The most encouraging response to political and economic uncertainty I've heard so far, is that a better understanding of productivity is crucial, to continued progress and prosperity. Hopefully, more individuals in the days ahead, will take this challenge to heart. While highlighting a productivity perspective (in macro) can be confusing at times, this earlier post from yesterday counts among my recent efforts. Before too long I'll put a series of productivity notes into a broader and (hopefully) more clear context. Unfortunately it can be difficult for society to focus on critical issues, when political distractions begin to pile up all too quickly. Plenty of thoughtful posts from multiple quarters may go unnoticed, as the latest atrocities from Washington and elsewhere drown them out. Which is why "calls to action" in the form of applied economic response, need to begin well before the "roof" already has gaping holes which let in the rain.

Again, I have suggested the possibility of alternative equilibrium constructs not as a replacement for general equilibrium conditions, but as a relief valve for too rigid equilibrium conditions. Too many successful groups now have little incentive to evolve, grow, adapt or otherwise make room for those who still seek economic entry. Yet in order for this broad set of economic expectations to remain stable, people have to at least allow growth to continue in ways which do not pose direct threats to existing investments and ways of life.

Eric Beinhocker in "The Origin of Wealth", reminded his readers that there's no such thing as a static equilibrium. When populations try too hard to ensure that everything about their lives remains the same, the consequent loss of dynamism can lead to more entrophy than might otherwise be the case. Even though prominent players on the present "game board" set the rules and dictate how resources are to be utilized, resource availability - and demand - constantly changes just the same.

As Jason Collins noted in a 2012 review of "The Origin of Wealth", Beinhocker didn't take the additional step of bringing complexity economics (as an applied science) to present day settings. In Beinhocker's defense, I can only note that we still need the institutional means which would make it possible to work out potential evolutionary paths such as mutual employment. I'm presently 300 pages in, and this book does offer evolutionary illustrations capable of providing additional perspective at a basic level, while citizens explore the early stages of knowledge use as a free market platform. Even though complexity economics has yet to benefit from an applied approach, there's still hope that its observations can also shed further light on the productivity dilemma of our time.

Secondary Market Limits Can Affect Solow Residual Limits

Specifically, secondary markets for which time value is an important component of final product. Even though this form of organizational capacity continues to generate employment, its methods are less certain - or reliable - than those of primary markets. Whenever primary market and tradable sector activity are dominant, the productivity gains of the Solow Residual are more obvious. Meanwhile, total factor productivity has stalled, as the limits of secondary markets affect total output and capacity. From Wikipedia re the Solow Residual:

The Solow Residual is a number describing empirical productivity growth in an economy from year to year and decade to decade. Robert Solow defined rising productivity as rising output with constant capital and labor input. It is a "residual" because it is the part of growth that cannot be explained through capital accumulation or increased labor...The Solow Residual is procyclical and is sometimes called the rate of growth of total factor productivity.

When secondary market formation is confronted by economic stagnation, one result is a reversal of a previously "virtuous" cycle of increased labor force participation, as contributing to manufacturing demand. So long as economies maintain solid growth trajectories, secondary market formation and primary market formation are able to reinforce one another in this process. What's more, until the Great Recession, many believed that secondary markets would be able to substitute for primary markets, if and when the latter didn't provide sufficient employment.

Now that the organizational capacity of secondary markets is facing limits, a new form of organizational structure is needed, so as to restore first mover market positions for long term growth. Unfortunately, knowledge use as the obvious candidate, is still trapped within a limited framework of secondary market terms of engagement. Consequently, a lack of first mover organizational capacity, means governments increasingly resort to long outdated mercantile strategies, as a response to economic stagnation.

No longer are secondary markets for time based product, the employment panacea they might have appeared, scarcely more than a decade ago. As it turns out, the secondary markets of time based product - as a second mover - have been revenue dependent. Hence when this form of organizational capacity seeks greater efficiency via a Solow Residual process, the result is often lost supply and demand of time based product, instead of the productivity gains which normally accrue to the cumulative labor reductions of (total) tradable sector output.

What isn't always evident is that lost supply and demand for time based product also translates into lost productivity. This is all the more important, given the fact tradable sector consumption has also been limited by falling labor force participation. However, a first mover position for knowledge and time based product, requires a different organizational response than what has transpired thus far - one that reinforces the Solow Residual of tradable sector wealth, instead of detracting from its benefits.

Meanwhile, as Arnold Kling noted in a recent entry for the Concise Encyclopedia of Economics:

For most people, viewing trade as a rivalry is as instinctive as rooting for their national team in Olympic basketball. To economists, Olympic basketball is not an appropriate analogy for international trade. Instead, we see international trade as analogous to a production technique. Opening up to trade is equivalent to adopting a more efficient technology.

What's important now, is a recognition how rivalry for knowledge use has decreased the work availability that many individuals have sought and prepared for, in the marketplace. Otherwise, populations might not be so inclined to disregard centuries of progress, via the mutual gains from international trade.

Consider Arnold Kling's assertion above, that opening up to trade means adopting more efficient technology. Before anyone can remain comfortable with the efficiency of the Solow Residual model for tradable sector productivity, time value needs its own place in the sun as well. Time based product is particularly scarce and finite. Hence it coordinates best with other forms of time based product. Further, mutual cooperation within a continuum of group patterns, would finally allow economic settings in which both parties gain from the process. This is particularly important, given the fact too much economic activity has become reduced to zero sum outcomes, and the protectionism they imply.

The Solow Residual will always be a vital component of economic activity. However, it functions best on the traditional productivity terms of tradable sector activity. Whereas in the time based product of non tradable sector activity, this approach often translates into lost marketplace potential. It's time to build new primary market formation for knowledge use, which is capable of measuring productivity gains as surely as those which the Solow Residual have indicated for tradable sector activity.

Social Contracts and the Choice to "Opt Out"

Since important national budget issues are already being addressed, what is immediately at stake? The social contracts which involve mutual coordination for time based product, aren't just important for citizens, but also national prosperity. One example involves a study which gained attention last November. The researchers highlighted "opting out" which occurs in emergency rooms. From CNBC:

A new study that looked at more than 2 million emergency department visits found that more than 1 in five patients who went to ERs within their health-insurance networks end up being treated by an "out-of-network" doctor - and thus exposed to additional charges not covered by their insurance plan. 

And the average out-of-network bill those patients faces, unless their insurance plan ultimately agreed to cover it, was more than $622...But the bills can be much higher than that, according to the researchers, who pointed out that one patient they were aware of faced a potential balance bill of more than $19,600. 

Still, this is only a limited opt out example, given the fact physicians already have limited participation with either Medicare or Medicaid patients. Often, individuals with chronic illness and/or disability, may go months at a time without a primary care provider, should they lose one. Or when they finally locate another, may need to drive several hours one way, in order to reach appointments. It's not always possible to gain healthcare provision in nearby cities, as physicians who take Medicare and Medicaid tend to have very full schedules.

Traveling long distances for healthcare can be difficult enough for those who still have reliable transportation. But as health declines, one faces additional uncertainties regarding doctor's visits, should their vehicles have some of the same ongoing maintenance issues that a physical body may face. If there's one thing worse than being stranded on the side of the road with no one nearby to call on, it's being stranded on the side of the road in approaching nightfall, with a patient in the car who really should be in the hospital. Yes I've been there, and after circumstance like this, decades of driving confidence can flat out disappear.

Where opt out for the physician is a matter of being able to freely choose patients, opting out for others may simply mean leaving the participation framework that exists. Now, an even larger opting out issue is at stake, as Washington contemplates a partial opting out for Medicaid provisions. While the extent of block grants involved is uncertain, the bigger message is clear: as healthcare gradually reverts to the states, policy makers can finally achieve much needed cost reductions. There's just one problem. As the healthcare marketplace is currently designed, national output is more likely to suffer, as no one really knows the kinds of supply and demand that would exist were there free market conditions for healthcare.

These supply problems originate with the ways in which healthcare became a social contract in the twentieth century - especially in the U.S. Since the opting out process realistically only goes one way (doctors and healthcare providers choose the patients they can serve with their limited time), it is most inefficient and illogical. Even though doctors and healthcare providers are quite reasonable in making the most of their time scarcity, other citizens cannot make good collective use of their time to amend the fact that existing hours on the part of physicians and healthcare providers are severely limited. This lack of citizen options re rights to produce/apply knowledge for healing, is all the more illogical, since there is little if any cultural acceptance for suicide in the U.S.

Ultimately, if democracy is to remain viable, everyone needs realistic opting out and opting in for time based product processes. Citizens with low incomes need the same formal opt out options that healthcare workers have, so they can to take part in local "opt in" system alternatives. Opt in alternatives would mean knowing one's budget need not be devastated after years of resisting healthcare markets designed for higher income, only to need them anyway, in the event of emergency or serious illness.

Knowledge use systems as a new form of social contract, would encourage further development of applied and practical knowledge. Doing so is all the more important, given the fact that block grants for states would run their course long before existing markets are addressed. With the budget cutting in Washington, there's little time to lose, for citizens to gain the kinds of production rights that could secure knowledge use and prosperity, well into the future.

The Wealth That is Missing

Reflecting on yesterday's presidential inauguration, I remembered a long lingering question: is there any context in which "nation first" is as important, as some leaders now believe? Perhaps the answer depends on the form of wealth, which is at stake. Are we referring to the random and mobile resource capacity that is globalization, prosperity and our world marketplace? Or, the fixed resource capacity of time value in our personal lives? After all, the potential of the latter, with its inevitable links to fixed-in-time economic location, has hardly been considered. Consequently, the lack of free markets in today's non tradable sectors, now threatens the prosperity of tradable sector free markets across the globe.

Yet much of the "nation first" rhetoric of late, has little context in which missing wealth can be readily understood. How does one explain the economic dynamism which has been disallowed, when not only is it missing, it might not even get the chance to see the light of day? The only part of economic logic that makes sense in this context re wealth creation, is that new growth doesn't result from forcing manufacture to return to one's shores. No amount of political efforts towards these ends would increase aggregate global wealth, or national wealth for that matter. So why do political constituencies - along with a growing list of others - see protectionism as the only solution to promote long term growth and prosperity at home?

Perhaps it's due to the protectionism which has already taken place. One way to think about this problem, is the fact that protectionism at home continues unabated. Yet even as it reduces both employment potential and national output, home based protectionism occurs in ways not easy to correlate with the vagaries of world trade.

Further, internal protectionism at home (wealth capture) mostly takes place in non tradable sectors. It results in limits on both production and consumption of both time based services and housing, in particular. Even though Adam Smith spoke of the dangers of protectionism centuries earlier, tradable sector activity was the primary economic given of his time. Indeed, tradable sector activity remains central to economic thought, even though U.S. manufacture is now less than 12% of GDP. Hence who has means, for instance, to determine precisely how non tradable sector dominance affects equilibrium conditions and growth capacity? Meanwhile, non tradable sector wealth capture continues to be glossed over, as world leaders reach for the understandable prosperity of tradable sector activity.

If worldwide tradable sector activity was threatened by the crowding out effect (of non tradable sector dominance) before, worldwide or external protectionism, only makes the threat worse. Home based protectionism is also likely to worsen - in spite of calls for greater inclusiveness - should local sources of (international) revenue become less certain. The domestic protectionism which is built into the regulations of knowledge use and (physical) asset formation, is today's missing wealth, in all areas of society. Small wonder that some policy makers have warned their populations of economic stagnation, with no seeming end in sight.

Given this unfortunate reality, an inaugural speech in Washington which aimed to make both Democrats and Republicans uncomfortable, makes a bit more sense - even as people around the world react to a president they are disinclined to trust. If economic prosperity is to remain a viable possibility, the wealth that is missing - that which represents the true finite reality of our time value - will have to be acknowledged and honored. Otherwise, the insidious protectionism which begins at home, will only spill out into the larger world arena for decades to come.

Notes On High Skill Transaction Costs Versus the Baumol Effect

What forms of transaction costs have become most problematic? Often, they involve time based product which requires a great deal of knowledge use preparation and investment beforehand, as these costs ultimately need to be shared throughout a broad range of systems. Even though one hears complaints of Baumol's disease in terms of, say, medium skill work which adjusts income levels via coordination alongside higher skills and more productive work; often it is high skill work, which requires a higher level of compensation for individuals wherever they may live, which poses the more substantial societal costs.

How might one think about these productivity differences, in terms of time based product? For instance: even though citizens of prosperous regions pay more for a wide range of skill levels in their vicinity (some of which cost far less elsewhere such as hairdressers), most citizens are expected to travel to prosperous regions to gain the expertise of professionals, and pay the same costs to those professionals as other local citizens - regardless of existing wide variance in the income levels of their own regions.

Again, think about the difference in aggregate. Medium skill levels which are subject to Baumol's disease, can appear unproductive in relation to nearby high skill and other productive work. Yet since local high income levels can still directly coordinate for many of these skills costs via their own means, medium skill levels don't carry the same (societal) cost burdens as the costs of high skill time based product. Nevertheless: even though medium skill levels tend to command less income in less prosperous areas, most high skill work is presently subject to higher costs (income compensation at a multi institutional level) regardless of where or how social coordination takes place.

These transaction costs, which in the U.S. are shared by consumers, governments, municipal budgets and businesses alike, need to at least be addressed at the margins, in order to maintain system viability in the foreseeable future. Might it be possible for regions which are beginning to falter under these circumstance (bankruptcy, etc.), to adopt a new institutional structure which is capable of reducing these otherwise built in transaction costs?

Firms in recent centuries were able to reduce transaction costs, in part because many divisions of labour were more flexible and required less extensive investment, beforehand. In "Theory of the Firm", Wikipedia notes:

According to Ronald Coase, people begin to organize their production in firms when the transaction cost of coordinating production through the market exchange, given imperfect information, is greater than within the firm.

In the present, the more important concern is not one of further divisions of labour for a non market environment to generate separately existing product, but divisions of labour which would allow individuals to coordinate their time via direct free market terms. Hence the equilibrium corporation would be different from the traditional firm, for it would restore local market platforms to make more complex forms of economic activity possible.

Rather than removing divisions of labour functions from the marketplace, the equilibrium corporation would seek to bring multiple time based functions back to the marketplace - albeit in a somewhat changed form. Whereas the single entrepreneur in the Coase model was responsible for the coordinated activity of large groups - so as to facilitate the complicated production processes of tradable sectors, participants in an equilibrium corporate construct would assume entrepreneurial responsibility for their own time value. What makes it possible to take this approach, is the fact these non tradable service sector settings don't involve the numerous level of production processes that have often been required by tradable sector activity.

There's another important factor for the transaction costs which comprise local coordination of time based services. Once a region becomes more prosperous, it often seeks to control local entry and access, so that only a certain amount of medium skill participation remains possible. Indeed, some economists have recently noted this self limiting Baumol effect. Prosperous municipalities can achieve these limits via control over local real estate values.

Whereas lower income regions don't necessarily have the same ability to control local factors for the skills levels they may seek. Since many professional skill sets include considerable sacrifice and investment, individuals who seek these opportunities, may not have the option of locating where lower income levels are hard pressed to compensate them. Areas with lower incomes could especially benefit from a new institutional structure, which would also build new markets for high skill levels which otherwise might not be locally possible.

Today's Healthcare: A Missed Opportunity For Trade

Has Washington mostly suffered from a naming rights process, when it comes to the basic gist of Obamacare? It's beginning to appear as though the "wrong" party was in power, for enacting a healthcare policy. Never mind what could have been the use of logic and rationality, to sort out particulars. What an expensive game! Much of what is at stake involves the costs of Medicaid, for which Timothy Taylor provides useful perspective in a recent post.

For me, the real story is that healthcare never got the chance to evolve free market options in the twentieth century. At root, the supply for healthcare in terms of knowledge, skill and other resources is far too restricted for anyone to know its true potential. Consequently, it's difficult to imagine, how producer/consumer choice and personal challenge in these areas might play out, were they given the chance. I thought about these missed opportunities for healthcare, after reading about a computer enactment of a basic economy which took place more than twenty years ago.

In "The Origin of Wealth" (2007), Eric Beinhocker describes an experiment called Sugarscape, created by two researchers, Joshua Epstein and Robert Axtell. Was it possible to create an economy from scratch? They began with a fifty-by-fifty computer grid and one resource: sugar. While each square had varying amounts of sugar, there were two mountains in the grid with a range of four sugar units high.

Each person (agent) in the Sugarscape environment could look for sugar, move, eat sugar and also store what they didn't immediately need. Agents were programmed with metabolisms which needed more or less sugar for survival, and not enough would cause an agent to starve or be removed from the game. Some agents were programmed with better vision: they could see up to six squares ahead, while poor vision may only mean being able to see one square ahead. Agents also had randomly assigned lifetimes.

Once 250 agents were dropped on the Sugarscape, some landed on rich sugar mountains, hence born into wealth. Others had bad luck - being born where sugar was scarce. Even though the game appeared chaotic at the start, order soon emerged, and it proved clear how geographic destiny mattered for survival. Many died before they could reach their needed resource. Indeed Sugarscape was efficient, for almost as soon as sugar grew back to capacity, a grazing agent would find it.

Some had real sugar advantages, and distributions of wealth became increasingly skewed. Sure enough, this was an emergent property of the system. It became particularly interesting for me, when Epstein and Axtell introduced a second commodity called spice. From the book:

Each square on the board now had a value for how much sugar it held and a value for how much spice it held. As with sugar, spice was concentrated in two mountains...Epstein and Axtell also tweaked their agents' metabolisms so that they all required some of each commodity to survive. However, some agents needed lots of sugar and only a little spice, while others needed more spice than sugar - again, this was determined by their DNA...

Epstein and Axtell seeded Sugarscape with randomly endowed agents who could now trade, and hit the switch. The agents started to buzz around, and immediately a brisk business in sugar and spice took off. 

Trade made Sugarscape much richer than it had been. They highlighted one extreme case, in which neighboring agents who were close to death came into close proximity with the other which held the resource they needed. Here, trade was the definitive factor in maintaining life. Again, from the book:

Trade has an effect equivalent to increasing the carrying capacity of the landscape, thus making everyone better off.

Of course, I had to wonder: what might have been the effect on output and agent survival, had they programmed a requirement to get permission, before offering or consuming needed resources. How many more agents would die, before they could get to the mountains where "permission givers" lived in sufficient abundance to give the okay for specific resources? Is not healthcare, a missed opportunity for trade?

Poor logic can be involved in the assignment of permission givers, especially if they capture the wealth capacity of what may have been normal life amenities of a given landscape. When societies have little choice but to accept that permission givers are "necessary" for basic economic activities, it becomes more difficult to accept that logic is truly useful, in other areas of daily life, as well. The negating of logic is often a slow process, but finally - like the ripples from a skipping stone - such perceptions spread to the "edge of a pond".

Once, it may have seemed like a good thing, for authorities to assume logic and important decision making "on behalf" of their citizens. But when this process goes on long enough, people can become convinced that logic isn't really necessary after all. In fact, some people become more inclined to dismiss logic at a social level, if the use of logic means a loss of their own degree of control, or has not proven helpful for their peers. Anyone who has lived any length of time where economic complexity is lacking, likely has seen this process firsthand. And should that dismissal of logic and rationality continue, a growing percentage of populations eventually become convinced to elect leaders who also lack faith in the social processes of logic and rationality. Is it still possible to reverse, what is now taking place?

Market Position Matters, for Output Potential

Why is primary and secondary market positioning so important, in terms of output potential? One thing to consider: when more output and product diversity is desired by both producers and consumers, competition is more likely to be encouraged. In particular, tradable sectors already have high incentives for productive competition. After all, many of these institutions are well organized to benefit, if and when it becomes possible to increase aggregate output.

Whereas increased output is not necessarily a plus for some forms of non tradable sector activity, especially when it is organized in a secondary market position which is dependent on external revenue (such as knowledge use). Here, increased market output and/or product diversity may actually translate into revenue dilution, since time and place linked product cannot be replicated by means of the same (identical) time and place. As I have argued in previous posts, new forms of organizational capacity are needed, to generate similar forms of product which expand the marketplace without directly competing with these fixed scarcities. Yet ultimately, no person - or institution - should have to be completely dependent on the fixed scarcity of (one's own) time value or real estate value, as a sole revenue source. Not only does this form of ownership create excessive vulnerability, but also a natural impulse to decrease additional marketplace formation if it "competes" with personal ownership capacity.

Too many people and institutions are now dependent on revenue that is directly linked to the fixed scarcities of time and place, which understandably leads to widespread protection of market definition and share. Since these crucial differences in ownership incentive are not well understood, they are adversely affecting aggregate output, so as to negatively impact tradable sector capacity. Meanwhile, the forms of capitalism which are already well aligned to embrace competition, have become confused with negative "competition", which instead seeks to "crush" those who dare "threaten" the fixed scarcities of time and place.

These differences in ownership incentive are important, at a very basic economic level. Without the organizational capacity that would encourage non tradable sector output and product diversity, future growth potential could be jeopardized. Organizational factors in primary and secondary market positioning matter, for marketplace outcomes. In the meantime, some of today's secondary market patterns will continue to diminish marketplace capacity, due to NIMBY responses re fixed product scarcities as aligned with time and place. Unfortunately, the way institutions now approach these fixed scarcities, also plays psychological havoc with the public psyche.

But how does one know, whether a secondary market position is aligned so as to prompt the suppression of potential aggregate output? It depends on whether ownership is mostly in terms of fixed scarcity product limits (time and place), or if ownership more closely represents product in a related capacity. An apt illustration of the difference, comes from a post by Arnold Kling (re higher education), in which he stated:

The Kling theory of Public Choice is that public policy will always choose to subsidize demand and restrict supply.

Indeed, plenty of examples come to mind, since government economic activity tends to be closely linked to product which includes fixed scarcities - particularly time linked healthcare and place linked real estate/housing. But supply of education isn't exactly limited. What gives? As some of Kling's commenters noted, the subsidy (which increases the cost of access) is mostly a response to the limited platform of participation, as represented by the best educational institutions. In this instance, it's the platform for knowledge use participation, which is the most obvious fixed scarcity, in terms of productive agglomeration at an aggregate level.

Additional options for higher education, are not unlike other secondary marketplace components which exist in abundance - particularly financial activity. Secondary markets such as these can afford to be competitive and expansive in outlook, because they serve as further support for economic access, instead of access as it is actually put to use in the marketplace. And even though financial activities have at times fallen victim to their own excesses, they have nonetheless proven capable of expanding the output of general equilibrium in productive ways. In this sense, they are a positive association for competition that one may not always expect.