We need a new set of solutions for the economic crisis

Summary:  In the past few posts I have discussed a possible solution to this crisis.  Unfortunately, it will not work.  The reasons why are both depressing and technical, so let’s defer them until the next post and instead concentrate on what must be done. A reminder: we can only speculate about these things, as they lie beyond both fact and theory.

Old Recommendations

For a summary see A solution to our financial crisis.  This series of posts took you to the cutting edge of insights about the crisis.  Now we will attempt to go beyond that.

  1. Stabilize the financial system – Being attempted, probably now it’s too late.
  2. Stabilize the economy with monetary stimulus– Rates are comign down and money printed, but probably with relatively little effect.
  3. Stabilize the economy with fiscal stimulus — Just now being considered; will work but slow to implement and slow to have effect.
  4. Arrange long-term financing for steps #1 and #2 with our foreign creditors – Unacceptable to our leaders at this time.

None of these will work, in the sense of having full effect before next Fall.  That does not mean they are not worth attempting (i.e., the Fed and Treasury have programs included in numbers 1 and 2 ).  Or worth doing, to help at a future date (number 3, recently advocated by Pelosi).  Or worth advocating, hoping it will done before disaster strikes (number 4).

However, we must prepare for the possibility that the economy will be in a severe recession — or even depression — when the new President takes office in January.  A depression does not mean like the 1930’s — the Great Depression.  There is a large gap — usually ignored by analysts — between the severe post-WWII recessions (1973-75 and 1980-82) and the horror of the 1930’s.  The frequent depressions of the late 1800’s lie in that gap, and for various technical reasons we may now be experiencing one of those.

The challenge

The new President must be prepared to immediately take action after inauguration.  There is no time for the usual drill:  search for staff, redecorate the Oval Office, have meet-and-greets so the new officials get to know each other, schedule meetings to formulate a plan and build support.  The damage to the economy will be terrible by that time these things are completed, and (worst case) the economy still might be sliding downwards.  Also, any plans will require time for Congressional approval and implementation, and plus lag times until results appear.

Then there is is the bad news.  The conventional solutions which the new Administration could easily put into effect — fiscal and monetary stimuli, plus devaluation of the dollar to stimulate exports — probably will not work (in the sense of sparking a recovery of the economy).  Let’s defer the reasons why until a later post, and consider the implications.  We have two alternatives (not exclusive):

  1. Wait it out.  Rely on conventional mitigation efforts to cushion the downturn until the economy’s natural recovery begins.
  2. Explore the fringes of economics, seeking some smart people who can take us beyond the now-exhausted standard Keynesian theory.  We need new ideas.

New Recommendations for the new President

These are things to do, not arranged in a sequential order.

(1)  Right now start assembling your “shadow cabinet”, and their key assistants.  Get them working together ASAP.  This poses all sorts of operational and marketing problems, plus the risk of conflict with (or undercutting of) the existing guys running the show.  Deal with it.

(2)  Get a small team searching for solutions outside the conventional beltway consensus.  This is America, the brainstorming center of the world.  There are new ideas out there.

(3)  Prepare a plan.  It will be complex.

(4)  After the election, start building support among key political and business leaders for the plan.  Coordinate to the maximum extent possible with the outgoing Administration.

(5)  Once in office, move immediately to implement it.

We do not know if these things are even possible, esp (2).  An unprecedented crisis requires extraordinary responses.

Originally published at Fabius Maximus on Oct 9, 2008 and reproduced here with the author’s permission.

One Response to "We need a new set of solutions for the economic crisis"

  1. Pete Murphy   October 10, 2008 at 8:08 am

    Ultimately, I believe that the U.S.’s economic crisis is rooted in our enormous trade deficit and the destruction of the manufacturing base of our economy. This has produced a dramatic decline in incomes relative to the cost of living. The government has attempted to prop up the economy by bolstering the housing sector. The only way to do that in the face of declining incomes was to deregulate the financial industry, allowing them to reduce lending standards to the point of no standards at all. This approach was doomed to failure from the beginning.Since leading the global drive toward trade liberalization by signing the Global Agreement on Tariffs and Trade in 1947, America has been transformed from the weathiest nation on earth – its preeminent industrial power – into a skid row bum, literally begging the rest of the world for cash to keep us afloat. It’s a disgusting spectacle. Our cumulative trade deficit since 1976, financed by a sell-off of American assets, is now approaching $9 trillion. What will happen when those assets are depleted? The economic collapse that we’re witnessing today!Why? The American work force is the most productive on earth. Our product quality, though it may have fallen short at one time, is now on a par with the Japanese. Our workers have labored tirelessly to improve our competitiveness. Yet our deficit continues to grow. Our median wages and net worth have declined for decades. Our debt has soared.Clearly, there is something amiss with “free trade.” The concept of free trade is rooted in Ricardo’s principle of comparative advantage. In 1817 Ricardo hypothesized that every nation benefits when it trades what it makes best for products made best by other nations. On the surface, it seems to make sense. But is it possible that this theory is flawed in some way? Is there something that Ricardo didn’t consider?At this point, I should introduce myself. I am author of a book titled “Five Short Blasts: A New Economic Theory Exposes The Fatal Flaw in Globalization and Its Consequences for America.” My theory is that, as population density rises beyond some optimum level, per capita consumption begins to decline. This occurs because, as people are forced to crowd together and conserve space, it becomes ever more impractical to own many products. Falling per capita consumption, in the face of rising productivity (per capita output, which always rises), inevitably yields rising unemployment and poverty.This theory has huge ramifications for U.S. policy toward population management (especially immigration policy) and trade. The implications for population policy may be obvious, but why trade? It’s because these effects of an excessive population density – rising unemployment and poverty – are actually imported when we attempt to engage in free trade in manufactured goods with a nation that is much more densely populated. Our economies combine. The work of manufacturing is spread evenly across the combined labor force. But, while the more densely populated nation gets free access to a healthy market, all we get in return is access to a market emaciated by over-crowding and low per capita consumption. The result is an automatic, irreversible trade deficit and loss of jobs, tantamount to economic suicide.One need look no further than the U.S.’s trade data for proof of this effect. Using 2006 data, an in-depth analysis reveals that, of our top twenty per capita trade deficits in manufactured goods (the trade deficit divided by the population of the country in question), eighteen are with nations much more densely populated than our own. Even more revealing, if the nations of the world are divided equally around the median population density, the U.S. had a trade surplus in manufactured goods of $17 billion with the half of nations below the median population density. With the half above the median, we had a $480 billion deficit!Our trade deficit with China is getting all of the attention these days. But, when expressed in per capita terms, our deficit with China in manufactured goods is rather unremarkable – nineteenth on the list. Our per capita deficit with other nations such as Japan, Germany, Mexico, Korea and others (all much more densely populated than the U.S.) is worse. In fact, our largest per capita trade deficit in manufactured goods is with Ireland, a nation twice as densely populated as the U.S. Our per capita deficit with Ireland is twenty-five times worse than China’s. My point is not that our deficit with China isn’t a problem, but rather that it’s exactly what we should have expected when we suddenly applied a trade policy that was a proven failure around the world to a country with one sixth of the world’s population.Ricardo’s principle of comparative advantage is overly simplistic and flawed because it does not take into consideration this population density effect and what happens when two nations grossly disparate in population density attempt to trade freely in manufactured goods. While free trade in natural resources and free trade in manufactured goods between nations of roughly equal population density is indeed beneficial, just as Ricardo predicts, it’s a sure-fire loser when attempting to trade freely in manufactured goods with a nation with an excessive population density.If you‘re interested in learning more about this important new economic theory, then I invite you to visit my web site at OpenWindowPublishingCo.com where you can read the preface for free, join in the blog discussion and, of course, buy the book if you like. (It’s also available at Amazon.com.)Please forgive me for the somewhat spammish nature of the previous paragraph, but I don’t know how else to inject this new theory into the debate about trade without drawing attention to the book that explains the theory.Pete MurphyAuthor, “Five Short Blasts”