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Home > Politics
Invisible Hand Drops Ball & Economics 101
by Bob Powell, 3/24/08
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Jump directly within this page to:
- Main Article on how the Invisible Hand Drops the Ball & Economics 101
- Supply & Demand Regulated by Market Forces ... except when they're Not: on specific mechanisms producing "free market" failures.
- Ignoring Long Wave Dynamics
- The Origin of Our Societal Problems: Mistaken Beliefs in 'Free Trade' and 'Free Market' Policies
- Only Pain and Pleasure Rule ... therefore, Keep Them in Poverty

See the economic devastation "free market", "free trade" policies have wrought: Jobs & 'Trade' Data Update Oct09, 11/19/09.

Added 6/15/09:

In this article I'd concentrated on effects that result in the "free market" not allowing "market forces" to effectively regulate supply and demand. A major issue that deserves more attention is that we are human ... and that we humans are part of the system. Because of that, our beliefs influence our behaviors and our behaviors influence the system. George Soros understands this. See also Mental Models & Beliefs.

From: The credit crunch according to Soros By Chrystia Freeland, The Financial Times, 1/30/09

... His core idea is "reflexivity", which he defines as a "two-way feedback loop, between the participants" views and the actual state of affairs. People base their decisions not on the actual situation that confronts them, but on their perception or interpretation of the situation. Their decisions make an impact on the situation and changes in the situation are liable to change their perceptions."

It is, at its root, a case for frequent re-examination of one's assumptions about the world and for a readiness to spot and exploit moments of cataclysmic change -- those times when our perceptions of events and events themselves are likely to interact most fiercely. It is also at odds with the rational expectations economic school, which has been the prevailing orthodoxy in recent decades. That approach assumed that economic players -- from people buying homes to bankers buying subprime mortgages for their portfolios -- were rational actors making, in aggregate, the best choices for themselves and that free markets were effective mechanisms for balancing supply and demand, setting prices correctly and tending towards equilibrium.

The rational expectations theory has taken a beating over the past 18 months: its intellectual nadir was probably October 23 2008, when Alan Greenspan, the former Federal Reserve chairman, admitted to Congress that there was "a flaw in the model". Soros argues that the "market fundamentalism" of Greenspan and his ilk, especially their assumption that "financial markets are self-correcting", was an important cause of the current crisis. It befuddled policy-makers and was the intellectual basis for the "various synthetic instruments and valuation models" which contributed mightily to the crash.

By contrast, Soros sees the current crisis as a real-life illustration of reflexivity. Markets did not reflect an objective "truth". Rather, the beliefs of market participants -- that house prices would always rise, that an arcane financial instrument based on a subprime mortgage really could merit a triple-A rating -- created a new reality. Ultimately, that "super-bubble" was unsustainable, hence the credit crunch of 2007 and the recession and financial crisis of 2008 and beyond.

... Soros's money has been crucial in enabling him to voice maverick views: "That's what led me to oppose Bush very publicly, because I was in a position that I could afford to do it," he said. But he also believes his fortune and the automatic credibility it gives him in America has drawn the fire of conservative pundits such as Fox's Bill O'Reilly and extremist pamphleteer Lyndon LaRouche. "Given the excessive esteem in which people who make money are held in America, I had to be demonised," he said.

Their attacks worked. So much so that last year, as the Obama bandwagon gained speed and American financiers, along with much of the rest of the country, clamoured to jump on, his earliest heavyweight Wall Street backer kept a low profile. "Obama seeks to be a unifier," Soros said. "And I have been a divisive figure because I've been demonised by the right. I thought my vocal support for him would not necessarily benefit him." ...

__________________________________________

 

Note 6/11/09: On the Thomas Jefferson Hour this last weekend (I think it was show 772), Clay Jenkinson (portraying Jefferson) made several interesting comments something to the effect that:

  • Society and government should be in accord with natural law.
  • Natural law is not created by man, but discovered by man.
  • The most important aspects of natural law are obvious.

I agree with the first and second, but not the third. Many aspects of natural law are not obvious at all.

For example, some guys got the Nobel Prize for "discovering" the "adverse selection" dynamic. If it were all that obvious, it wouldn't have been such a notable discovery. Even so, it remains a veritable secret in that I have never heard any mention of it in debates about what to do relative to heath insurance.

Being in accord with this effect of "natural law" is absolutely necessary for a functional system, so the absence of "adverse selection" from the debate is rather amazing. Is this because of ideological blindness and political correctness that dares not challenge free market fundamentalism? "Market forces" do not operate properly to regulate supply & demand when we ignore natural law.

While a single-payer system is the only workable approach -- other developed countries have adopted it -- we hear it characterized as (gasp) "government-run health care." This is obviously false, because doctors would not work for the government. We also hear the argument that "we don't want government between us and our doctors." But what we've got now are "corporations between us and our doctors," charging high premiums to determine who not to cover, to determine what treatments to not cover, and to pay CEOs exhorbitant amounts (e.g., William McGuire's $1.6 billion stock options). See more examples at The Health Insurance Mafia Deserves a Good Screwing by Bob Cesca 6/10/09.

Turns out, humans are terrible at systems thinking. And many humans, especially those of the libertarian variety, won't recognize systems effects at all. There's a word for those out of touch with reality; they're called "insane."

_____________________________________

Find libertarian objections and responses at I Can Disprove 'Progressive' Anti-think. I originally posted responses to this article here. But they're important enough to deserve a separate article. The objections addressed here are essentially:

  • 3/23/09: Libertarian Objection, 1st try: Government's had a hand in all market failures, so why blame the "free market" and not government?
  • 3/25/09: Libertarian Objection, 2nd try: What's the proof that "conservatism" produces bad results? I can disprove so-called "progressive" anti-think: progressively taxing income is like progressively taxing intelligence & performance ... both produce dysfunctional results.

I've expanded on what's in Wealth Happens to include more on the "path dependence" dynamic, known in systems thinking as the "Success to the Successful" archetype, that makes progressive taxation necessary to avoid extremes of poverty and wealth.

Links to sections of the responses:
Path Dependence
The Rules of the Game
The Universal Human Paradigm and "Winning Strategy"

 

Invisible Hand Drops Ball & Economics 101

Might better read: "Some people refuse to recognize reality ... even AFTER they collide with it." When their "free market" God fails, "conservatives" say, "This isn't a free market.," i.e., the "free market just wasn't free enough."
Excerpt from:
All models are wrong: reflections on becoming a systems scientist
John D. Sterman, Jay Wright Forrester Prize Lecture, 2002
System Dynamics Review, Volume 18, Number 4 Winter 2002

Much of the misery people inflict on others arises from the arrogant belief that only we know the True Path, and the resulting intolerance and fear of any who profess beliefs different than ours. Fundamentalism, whether religious or secular, whether the unquestioning belief in an all-powerful deity, the all-powerful state or the all-powerful free market, breeds persecution, hatred and war.

In a similar vein, Daryll E. Ray, Institute of Agriculture, University of Tennessee, and Director of UT's Agricultural Policy Analysis Center (APAC) wrote on February 27, 2009:

Events of the last year have taught us that blindly believing that markets are unequivocally self-regulating and universally self-correcting does not reflect reality. We are finding that those beliefs, while true under certain theoretical conditions, come up short in the real world.

We have been living in an alternate reality based on compellingly logical arguments coupled with ideological fundamentalism in the absence of shocks of a sufficient size to force financial, economic, and political leaders to confront the difference between the theoretical and the actual behavior of free markets. Events in the housing market, financial markets, and their worldwide repercussions provided that shock. ...

From the Wall Street Journal: On Wall Street, Talk of Trust and Civil War 3/25/09 ... gee, does Soros know anything about markets?

Mr. Soros sought a thorough overhaul of regulation of the markets. "The idea that the markets are self-correcting has been proven false. ... The market, rather than reflecting the underlying reality, is always distorting it."

In this same WSJ article, Arthur Levitt, a former chairman of the Securities and Exchange Commission is quoted:

"This is an issue of 'we' and 'they,'" Mr. Levitt said. "Compensation is a part of it, but a symbolic part of it. We are a centrist nation ... We're now shifting to the left pretty far in terms of business-bashing and it has reached extremes of incivility that are intolerable."

"Centrist nation" in the U.S. means well to the economic right as shown on this chart. What's amazing is that those like Levitt don't see what's happening; there are enormous government and Fed funds going to banks with few if any strings attached, and yet they call it "socialism."  Instead, it's extreme right-wing corporate control of government, confirming that government is way further to the economic right than shown on this chart.

A riddle: "How many libertarians (or economic "conservatives") does it take to change a light bulb?" The answer: "None, they just sit in the dark and wait for the invisible hand to do if for them."

Bill Hawkins of the United States Business and Industry Council noted that "... as the 'invisible hand' turns off the lights in one factory after another in America, the intellectually dishonest [libertarian] has the temerity to deny that it is dark at all."

Ignoring, turning a blind eye toward, or denying the existence of certain economic realities yields harmful results. "Free market" libertarians should just admit that these are the results they want, rather hiding behind the rhetoric of a flawed ideology.

The belief of libertarians and economic "conservatives" in the "free market" is just as blind today as was the belief in bloodletting in 18th century (and earlier) medicine. Bloodletting was common despite contrary evidence that it did not work; belief in its efficacy was so strong that contrary evidence was ignored. They believed that those who got well did so because the treatment worked; those who died ... well, they were just really sick.

Wikipedia on Benjamin Rush

Benjamin Rush (December 24, 1745 – April 19, 1813) was a Founding Father of the United States. Rush lived in the state of Pennsylvania and was a physician, writer, educator, humanitarian and a devout Christian, as well as the founder of Dickinson College in Carlisle, Pennsylvania.

Rush was a signatory of the Declaration of Independence and attended the Continental Congress. Later in life, he became a professor of medical theory and clinical practice at the University of Pennsylvania.

Although anatomy was well understood in Rush's time, the causes of disease remained elusive. Doctors therefore relied on various unscientific treatments. ...

Rush was a proponent of bloodletting and calomel therapy, treatments that were widespread in America at the time. In his report on the Philadelphia yellow fever epidemic, he wrote:

I have found bleeding to be useful, not only in cases where the pulse was full and quick, but where it was slow and tense. I have bled twice in many, and in one acute case four times, with the happiest effect. I consider intrepidity in the use of the lancet, at present, to be necessary, as it is in the use of mercury and jalap, in this insidious and ferocious disease.

Some contemporaries, notably William Cobbett, objected to Rush's extreme use of bloodletting. Cobbett accused Rush of killing more patients than he had saved. Rush sued Cobbett for libel, winning a judgement of $500. ...

Unfortunately, bloodletting doesn't work:

Rush firmly believed that diseases resulted from over- or under-stimulation of the nervous system, to which remedies of depletion or stimulation were to be applied accordingly. Unfortunately for Rush (and for his patients as well), depletion more often than not removed too much blood from the body, ending in death.

Wikipedia on Benjamin Rush and calomel

Mercury(I) chloride is the chemical compound with the formula Hg2Cl2. Also known as calomel (a mineral form, rarely found in nature) or mercurous chloride ...

Mercury became a popular remedy for a variety of physical and mental ailments during the age of "heroic medicine." It was used by doctors in America throughout the 18th century, and during the revolution, to make patients regurgitate and release their body from "impurities". Benjamin Rush, a famed physician in colonial Philadelphia and signer of the Declaration of Independence, was one particular well-known advocate of mercury in medicine and famously used calomel to treat sufferers of Yellow Fever during its outbreak in the city in 1793. Calomel was given to patients as a purgative until they began to salivate. However, it was often administered to patients in such great quantities that their hair and teeth fell out.

Bloodletting likely contributed to his own death:

In the spring of 1813, Rush fell ill with a fever and died five days later in his home in Philadelphia. A firm believer in his therapeutic approach, Rush had himself bled twice during his final illness.

Similarly, policies based on belief in the "free market" and "free trade" are undermining the U.S. economy, but belief is powerful and contrary evidence is readily ignored.

Belief in the "free market" and "free trade" is bolstered by the belief that these are reflections of "natural law" and the hand of God. In this view, attempting to do anything to effect the results is meddling that is doomed to fail. For example, individuals in poverty are solely to blame for their plight and attempting to do anything about it is not just wrong, it's impious.

Here's an excerpt from A World of Ideas -- A Dictionary of Important Theories, Concepts, Beliefs, and Thinkers by Chris Rohmann, 1999

Burke, Edmund (1729 - 1797) Anglo-Irish statesman and political theorist, considered the founder of CONSERVATISM. ... Burke also embraced the LAISSEZ-FAIRE economics of Adam Smith, maintaining that "the laws of commerce ... are the laws of nature, and consequently the laws of God." (Capitalized words indicate other entries in this dictionary.)

Find more on Edmund Burke, an prominent conservative in his time, in The Conservative Mind by Russell Kirk, 1953. Conservatives & libertarians are stuck in "government will only make things worse" 16th century thinking of Machiavelli. This has pervaded their thinking from then to Edmund Burke to David Brooks today (see The Big Test by David Brooks).

 

Supply & Demand Regulated by Market Forces ... except when they're Not: on specific mechanism producing "free market" failures.

Economics 101 (Classical Economics)

The Economics 101 feedback of Supply and Demand regulated via Price is a powerful mechanism. Libertarians and economic "conservatives" understand this, but there's a lot more going on. See The Invisible Hand for more on these feedbacks.

The "Invisible Hand" feedback structure of markets. Figure 5-26 of Business Dynamics.
The diagram shows the feedback loops by which price regulates supply and demand. These are Balancing Loops (negative feedback loops) for which going completely around a loop ends with a change in the opposite direction to oppose the original change. Balancing Loops are regulating feedback loops, like thermostatically-controlled heating and cooling systems.

Reading the Demand Loop: When Price decreases compared to the Price of Substitutes, the Relative Value (Price of Substitutes - Price) of product, commodity or service increases. This increases Demand, which prompts increases in Price. An increase in Price decreases Relative Value. In this case the Price of Substitutes is the counterpart of a thermostat.

Read the Supply Loop in the same manner. See Reading Systems Diagrams for more on this language.

This is the powerful "Invisible Hand" God of Economics 101, but that's not all there is to it.

The World Doesn't Work According to Econ 101

From Business Dynamics: Systems Thinking and Modeling for a Complex World,  (2000), by John Sterman, Director of the MIT System Dynamics Group, p. 174.

5.5.1 Market Failure, Adverse Selection, and the Death Spiral

Many real world markets are imperfect due to limitations of information, costs of entry and exit, and inflexibility of resources. These imperfections create feedbacks that sometimes overwhelm the negative loops normally balancing supply and demand, leading to inefficiency or even the complete failure of the market.

Market failure!!! Gasp. Can this be? Yes. In this text Sterman addresses speculative bubbles, adverse selection, and "policy resistance" (explained at Primacy of the Whole) using a traffic congestion example.

Here are examples of complications ignored by Economics 101 market fundamentalists.

Ignoring: Adverse selection (see Single-Payer Health InsuranceHealth Care Dynamics)
Result: Failing privatized health insurance system with 47 million people (and increasing) without health insurance (with people and children dying because of it). Because of adverse selection, privatized health insurance systems lacking universal coverage are doomed to fail; it's only blind ideology that has left the U.S. as to only major developed country without national health insurance. We have reduced national competitiveness due to increased costs for companies in competition with other developed countries with national health insurance. We have more deaths and higher costs due to poorer health of a large population without adequate health insurance (loss of positive externalities).

Note: When children are caught by this, or have poor or irresponsible parents, tough; they were stupid to pick the wrong parents. Equal opportunity? Forget it. Take responsibility for your choices, kids.

Ignoring: Negative externalities (see portions of Explaining Liberal Principles, Global Warming: An Inconvenient-to-Understand Truth, Growth Facts of Life)
Result: Pollution, global warming and climate change, potholes, traffic jams, congested highways and excessive traffic deaths, and other infrastructure backlogs. Loss of farmland to development because developers are able to externalize costs onto the public and farmers can't ... so more profit can be made from development than for farming. Inadequate workplace safety regulations allow externalizing costs of doing business onto employees in the form of injuries and death (e.g., in coal mines). All result from socializing costs and privatizing profits. Economic "conservatives" love it ... it's their form of socialism ... the redistribution of costs.

Ignoring: Positive externalities (see portions of Explaining Liberal Principles)
Result: Less economic development because of inadequate investment in education. Economic inefficiency due to poorer health of the population.

From Wikipedia: Positive externalities are frequently associated with the free rider problem. For example, individuals who are vaccinated reduce the risk of contracting the relevant disease for all others around them, and at high levels of vaccination, society may receive large health and welfare benefits; but any one individual can refuse vaccination, still avoiding the disease by "free riding" on the costs borne by others.

When we work together, I benefit from your investments in your education ... we're more productive. We benefit when others invest in their health ... less lost time at work and less likelihood of becoming sick. Society at large benefits from individual investments in education & health.

"Free riding" is a major problem. "FreedomWorks" objects to mandatory union dues: "All employees would have to pay union dues whether they want to join the union or not." The rationale is that a democratic union spend funds for things some don't like; of course "FreedomWorks" doesn't want funds going to "liberal" causes. It promotes the idea of optional union dues because it knows that free-riding employees opting out of paying them would lead to the death of the union. The counterpart, that would lead to the death of govenment, would be to make taxes optional. The similar rationale would be: taxes go to pay for some things I don't like (e.g., Bush's illegal invasion and occupation of Iraq).

"Conservatives," however, oppose the idea that shareholders approve corporate political expenditures. See that companies oppose a 'Corporate Political Accountability Act' and see the CA Chamber of Commerce Statement Opposing the 'Corporate Political Accountability Act'. Gee, that would be too burdensome for corporations, but not for unions ... oh, wait .... they want unions to be burdened.

Ignoring: Inelasticities (see Farm Policy Failure)
Result: Because both supply and demand for farm commodities are quite inelastic, the "free market" fails for farming, which is why there is such great pressure for farm subsidies. They're larger now than they were when the Republicans passed the "Freedom to Farm Act" in 1996. This makes farming quite unlike manufacturing and puts a stake in the heart of right-wing claims that manufacturing employment should decline just as farm employment declined.

Ignoring: Delays (see portions of Explaining Liberal Principles)
Result: Extreme Volatility of prices because changes in price have inadequate short-term effects on either supply or demand or both. Example: Oil prices can go very high, but supply cannot quickly increase, because it takes time to develop new wells. Demand cannot quickly fall because of building patterns and a large stock of inadequately efficient cars. There's also inelasticity due to inadequate regulation to prevent oligopoly that allows a limited number of producers to restrict supply (e.g., the five major multinational oil companies with profits exceeding those in the history of the world).

Ignoring: Impact of Net Present Value calculations (see portions of Explaining Liberal Principles)
Result: The value of long-term investment returns are devalued so significantly that capitalism tends to not invest very far into the future. It's generally only government that does such investment. For example, no self-respecting capitalist would ever invest in education, which is why education is heavily-subsidized by government. It takes 20 years to attain higher education; because the Tyranny of NPV calculations determine that future returns are worth zip ... it's just not worth it. Besides, the investment in some persons will not pay off ... it's a very risky investment.

Ignoring: Path Dependence
This dynamic, also called "Success to the Successful", has two major effects.

Result 1. The rich "get richer and the poor get poorer" (see Wealth Happens). This happens even when everyone starts out with equal ability and resources. (See at The Conservative Mind that "conservatives" believe that poverty is part of the "eternal order of things ... which never can be removed by legislation.")

The Rules of the Game feedback structure.
Result 2. Unregulated competition evolves into monopoly and oligopoly. Anyone who's familiar with the game, Monopoly, is familiar with how this works. Those who worship competition also oppose antitrust laws and worship deregulation, which ends in monopoly and destroys competition. This should cause some cognitive dissonance, but it does not. Stronger companies lower prices, control distribution chains and use other anticompetitive practices to drive weaker competitors out of business. This benefits consumers for a time, but when the competitors are gone, the monopolist raises prices to achieve higher profits that would otherwise be possible. Those profits make it possible to influence government to pass laws and further deregulate to further increase their profits; see the Rules of the Game structure above -- example: the Copyright Term Extension Act whereby Disney got major extended-copyright protectionism for Mickey Mouse.

The Fallacy of Composition (described at The Trade Deficit and the Fallacy of Composition)
Result: One major example is the "transfer of the factors of production" (not trade) that provides cheap imports but undermines wages over the long run, runs up a massive "trade" deficit that puts the nation in debt to foreign nations, sells off the nations assets to foreign interests, and undermines our economic and military security.

Note: See at The Death of the Middle Class that, had compensation continued to track productivity, compensation would have been 68% higher in 2004 and we wouldn't need those cheap products from China ... cheap prices that have cost us dearly.

Ignoring: Federal Reserve "command & control" manipulation of the economy. (See There's no 'free market' for Labor.)

Result1: Less demand for those who work for a wage than supply. Chronic low wages and joblessness (that create poverty). Ignoring this Fed manipulation provides political cover for libertarians and economic "conservatives" to complain that unions and a minumum wage interfere in the "free market" for labor (which does not exist).

Result2: This effect similarly results in a low tax base (the "regional wage" counterpart to wages for individuals) that creates infrastructure backlogs. This is because regions must compete with "low taxes" and less "burdensome regulation" for the jobs the Fed does allow to be created.

Note: The Federal Reserve is a private corporation owned and run by private banks; it is not "federal." Economic "conservatives" put this vital economic function, that largely controls the economy, in private hands and then you're allowed to vote on the less-important everything else.

The Fed controls economic "brake" ... when, in it's view, there is too much job demand that might increase wages, it will take actions to slow the economy. It's supposed to give equal weight to promoting full employment. It does not; employment statistics are massively manipulated to understate unemployment (see Unemployment: Official, Effective, Real and #24. Employment & Unemployment with updated graphs). See the Fed's admission that it promotes worker insecurity to hold down inflation.

For a systems diagram illustrating how the Fed works and its effects on the economy, see the section on "The Economic Environment and National Economic Policy" in a Systems Thinking Perspective on Manufacturing Base Restoration.

Ignoring: Speculative Bubbles

Result: Economic Boom & Bust. From Business Dynamics: Systems Thinking and Modeling for a Complex World,  (2000), by John Sterman, Director of the MIT System Dynamics Group, p. 173. He's noting that "locally rational" is not rational for the system (the collective) because the "positive feedbacks" destabilize the system; this is an example of the Fallacy of Composition.

Not all markets consist of negative feedbacks alone. In many markets the locally rational behavior of individual entrepreneurs creates positive feedbacks as they interact with one another and with the physical structure of the system. One common example is the speculative bubble. There have been many dozens of major speculative bubbles in the past few centuries, from the infamous tulip mania of 1636 and South Sea bubble of 1720 to the manias and crashes of the past few decades, including gold, silver, realestate, impressionist paintings, and internet stocks.[2]

[Sterman's footnote: [2] Perhaps the best treatment of speculative bubbles is Charles Kindleberger's (1978) Manias, Panics, and Crashes. See also Galbraith's (1988) The Great Crash on the 1929 stock market crash.]

John Stuart Mill distilled the essence of the dynamics of speculation in the following passage from his famous text Principles of Political Economy, originally published in 1848.

When there is a general impression that the price of some commodity is likely to rise, from an extra demand, a short crop, obstructions to importation, or any other cause, there is a disposition among dealers to increase their stocks, in order to profit by the expected rise. This disposition tends in itself to produce the effect which it looks forward to, a rise of price: and if the rise is considerable and progressive, other speculators are attracted, who, so long as the price has not begun to fall, are willing to believe that it will continue rising. These, by further purchases, produce a further advance: and thus a rise of price for which there were originally some rational grounds, is often heightened by merely speculative purchases, until it greatly exceeds what the original grounds will justify. After a time this begins to be perceived; the price ceases to rise, and the holders, thinking it time to realize their gains, are anxious to sell. Then the price begins to decline: the holders rush into the market to avoid a still greater loss, and few being willing to buy in a falling market, the price falls much more suddenly than it rose.

In other words, individually rational behavior is collectively irrational. As noted, this is another example of the Fallacy of Composition. It's also an example of how considering feedbacks loops in a system is necessary for understanding its behavior.

In addition to the internet stocks, dot-com bubble Sterman mentions, the Fed's abrupt lowering of interest rates following the dot-com collapse produced the housing and the mortgage bubbles, which are now in turn collapsing. Our right-wing government, including the privatized Federal Reserve, believes there should be no interference, no regulation to avoid bubbles (after all, "the market" -- aka, God, to "conservatives -- knows best), but there should be plenty of involvment in having taxpayers assume the risk of bailing out those who have engaged in risky behavior and speculation, e.g., the bailout of Bear Sterns by The Plunge Protection Team and the Savings and Loan bailout.

Ignoring "Long Wave" dynamics

Result: An economy caught in an economic vicious cycle (see the diagram from Sterman's paper referenced just below).

The origin of the "long wave" from a system dynamics perspective is described in the paper by John Sterman of MIT on the Long Wave Decline and the Politics of Depression (pdf, 21.1Mb). There are also excerpts in A Systems Thinking Perspective on Manufacturing & Trade Policy.

See the diagram just below from p.18 of his paper. Balancing loop B1 shows how industry manages capacity. Reading around the loop: More "excess capacity" results in more "downsizing" results in less "industry capacity" and therefore lower "excess capacity". [How to read systems diagrams.]

He notes about feedback loop R2 that "Readers trained in economics will recognize the reinforcing feedback loop just described as the 'Keynesian consumption multiplier.'"

Briefly, an example of the dynamic is that, following WWII, there was pent-up demand for consumer goods. To fill that demand, more capacity to produce goods is needed than would be needed in an equilibrium condition. (Just as, to fill a bathtub, water flowing into a bathtub must exceed water flowing out.) Eventually, that excess-over-equilibrium capacity is capable of producing more goods than are needed (for the U.S. economy, this peak of the long wave was in 1972). After the peak of the long wave excess capacity must be worked off because supply made possible by this capacity exceeds demand.

Considering economic policy: Prior to the peak, investment should be encouraged. Following the peak, demand should be encouraged. Insane, voodoo, "supply-side" economics, encouraging increasing supply, has been followed since 1980 through the Reagan, Bush Sr., Bush Jr. years ... the exact opposite of what was needed. Only during some of the Clinton years did real wages rise to increase demand (see Republican statements on their dire, and wildly incorrect, economic expectations of doom regarding Clinton's tax increase here).

Loop B1 shows that individual companies make rational decisions to downsize to reduce company expenses; this reduces industry and excess capacity. But loop R2 shows the sum of all the downsizing decisions has an overall industry "side-effect" of reducing employment, income, and demand to create even more excess capacity. This economic vicious cycle can lead to overall economic collapse. From Sterman, "The Long Wave Decline and the Politics of Depression."
Ravi Batra describes the economic vicious cycle in Greenspan's Fraud (p. 62) following a section on "Say's law", the foundation of "supply-side economics."

When an illogical idea reigns for long, the end result is catastrophe. That's what happened in 1929 when the lofty stock market crashed and spawned the Great Depression. ... Moved by mass suffering, a brilliant economist named John Maynard Kennes offered an alternative to the classical paradigm. His masterpiece, The General Theory of Employment, Interest, and Money, appeared in 1936. Turning Say's law around, Keynes argued that demand creates its own supply. This made far more sense than the thesis that supply creates its own demand [Say's law], at least in an advanced economy, where the engines of production already exist, because if there is adequate spending or demand, companies come forward to match that demand through supply to earn a profit. It is in their self-interest to do so.

However, if demand is insufficient, businesses are stuck with unsold goods. There is overproduction, and workers are fired. Under these circumstances, according to classical economists, the interest rate falls and employers expand their investment until excess supply disappears in both the product and labor market.

Keynes, however, saw it differently. If the producers have already overinvested, they are in no position to expand capital spending; they may also be reluctant to do so in the wake of inadequate product demand. In this case overproduction will remain a problem for a long time to come. Therefore, because of insufficient demand, the economy will be trapped in a downward spiral of unemployment, poverty, and mass starvation.

This exactly the situation in which we find the US (and world) economy today: massive excess capacity. We are caught in an economic vicious cycle for which Republican policies are the exact opposite of what's needed. No matter how much they cut taxes for corporations and the wealthy, there will be little investment without demand (example: Will less business spending stall growth? 7/31/06).

The Origins of Our Societal Problems:
Mistaken Beliefs in 'Free Trade' and 'Free Market' Policies

Every major societal economic problem has at its root "conservative" ideology: unquestioning belief in the "free market" and "free trade".

In short, because they ignore or deny the dynamics that produce the "free market" failures described above, libertarians and economic "conservatives" want:
- people to be without health insurance and die
- worker injury, sickness, and death
- pollution that fouls water and air
- climate change and global warming
- you stuck in traffic
- you hitting potholes or driving across a bridge that collapses
- farmland to be lost
- inadequate investment in education for economic development
- inadequate health insurance with economic efficiency
- extreme price volatility
- inadequate long term investment
- extremes of wealth and poverty
- low pay for those who work for a wage
- massive federal and "trade" deficits
- a nation sold off to foreign interests
- economic boom and bust from speculation with taxpayer bailouts of banks and other corporations

This is what "conservative" economic policies deliver. They should have the courage to admit this is what they want, because it serves the wealthy few ... i.e., the top 1%, see Data on Income & Tax Distributions. Only by subterfuge can they succeed in getting their policies adopted.

When they say they want "freedom," they mean their limited idea of "economic freedom," not a society that functions for the benefit of all citizens. And certainly not the freedom of one-man, one-vote democracy. True freedom is more than the freedom to take action; it requires the ability to take effective action. See On Freedom.

Here's Joseph Stiglitz: "Our Faith in Markets Blinds Us", 9/15/09, with an illustration of destructive "freedom" of deregulation.

... Economists were pathetic. They gave arguments to those who wanted to deregulate. They bear a large responsibility for what's happened. Not all have plunged into becoming apologists for the self-regulation of markets and the theology of finance. ...

Only Pain and Pleasure Rule ... therefore, Keep Them in Poverty

In Greenspan's Fraud by Ravi Batra, another major facet of "conservative" thought and its impact is described (p. 51). The impact: keep them poor because that's the only reason they will work.

Jeremy Bentham's Influence

Another British writer [besides Adam Smith] who influenced Alan Greenspan as well as classical economists was actually a philosopher named Jeremy Bentham, who believed that human actions are guided purely by pleasure and pain, and nothing else. "Nature," wrote Bentham in oft-quoted words, "has placed mankind under the governance of two sovereign masters, pain and pleasure. It is for them alone to point out what we ought to do, as well as to determine what we shall do. On the one hand the standard of right and wrong, on the other the chain of causes and effects, are fastened to their throne. They govern us in all we do, in all we say, in all we think: every effort we can make to throw off our subjection, will serve but to demonstrate and confirm it."

In his view, no one does anything if it does not bring pleasure, or avoids pain. If people could find no joyful activities or feared no discomfort, they would simply be inert, motionless, and lazy. These are the fundamental emotions that underlie all other emotions. Work or effort is basically tedious, and not itself a source of pleasure. A person's innate desire is for ease or comfort, not labor. In other words, workers are basically lethargic and uninterested in doing anything except under the pressure of hunger or for eschewing pain. "The practical outcome of this doctrine," assert economists Hunt and Sherman, "was the widespread belief at the time that laborers were incurably lazy. Thus only a large reward or the fear of starvation and deprivation could force them to work." In economics jargon, pleasure became utility and pain became disutility. The economists came to believe that everyone tries to maximize utility and minimize disutility.

Such utilitarian beliefs form the psychological basis of classical economics and its policy prescriptions. Smith proved that capitalism or free markets formed an efficient system, so that the economy should be left to itself, because government intervention only creates poverty and stagnation. But the creed that laborers would offer little labor unless goaded by hunger led the latter-day classical economists to oppose labor unions and minimum wage laws. This is because if government or union actions raise wages above the subsistence level, workers would withhold their labor, so output and profit would decline.

Therefore, classical economists believed that wages should be kept as low as possible. This, they argued, would also keep workers fully employed, because low wages induce companies to hire more workers, ensuring a high-employment economy. Of course, profits would then be high, but high profits also serve the social interest. From high profits arises capital accumulation, which in turn promotes new technology, raises labor productivity, and causes further increases in profit. This is a virtuous circle that generates high efficiency, high employment, and high growth.

This despicable ideology is exactly what "conservatives" pursue to this day:

  • Federal Reserve policy that assures more "people who need jobs" than jobs to keep wages at or below subsistence level,
  • taxes on wages are higher than taxes on interest and capital gains ("conservatives" would eliminate the latter two totally, if they could get away with it), and
  • opposition to government intervention in the "free market", and opposition to unions, that might make life better for those who work for a wage.

This is why, in The Conservative Mind from Burke to Eliot by Russell Kirk, 1953 we find the statement below. It's considered the foundational book that inspired the conservative resurgence in America.

Poverty is part of the "eternal order of things ... which never can be removed by legislation."

This thinking rules "conservatives" to this day: Make people comfortable and they won't work. Here's Michelle Malkin saying that people with unemployment benefits, even in the face of current massive job loss, are being given incentives to not work: Michelle Malkin, Cynthia Tucker Spar Over Unemployment Benefits. This "let them starve so they'll work" ideology ignores that thousands line up when even a few jobs are advertised.
_______________________

Find libertarian objections and responses at I Can Disprove 'Progressive' Anti-think.

I originally posted responses to this article here. But they're important enough to deserve a separate article. The objections addressed here are essentially:

  • 3/23/09: Libertarian Objection, 1st try: Government's had a hand in all market failures, so why blame the "free market" and not government?
  • 3/25/09: Libertarian Objection, 2nd try: What's the proof that "conservatism" produces bad results? I can disprove so-called "progressive" anti-think: progressively taxing income is like progressively taxing intelligence & performance ... both produce dysfunctional results.

I've expanded on what's in Wealth Happens to include more on the "path dependence" dynamic, known in systems thinking as the "Success to the Successful" archetype, that makes progressive taxation necessary to avoid extremes of poverty and wealth.

Links to sections of the responses:
Path Dependence
The Rules of the Game
The Universal Human Paradigm and "Winning Strategy"


URL: http://www.exponentialimprovement.com/cms/invhanddrops.shtml

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