Economy

Ideas about the economic and financial situation in 2009

The current financial crisis, combined to an economic crisis in the « real economy », is most likely only the tip of the iceberg of a far more profound structural evolution in the economy. Seeing it as purely financial is going to lead to short term mending of the problems without addressing the underlying problems: “We can’t solve problems by using the same kind of thinking we used when we created them.” Albert Einstein.

 

Even though there are some similarities between the current crisis and the 1929 great depression, the solutions used in the early thirties to bring the economy back to prosperity in those times would certainly not suffice to solve the problem on a long term basis in the present situation.

At least two aspects of the underlying economic crisis should be addressed:

  • The increased rate of technological innovation
  • The widening gap between rich economies and underdeveloped economies.

 

It is indeed partly a weak international financial exchange system and regulation framework that created major problems with the current worldwide situation of banks and stock exchange disasters. However several other more structural factors also contributed to the situation deterioration over several decades, regardless of short term dramatic or apparently successful periods(See various recent  » financial bubbles »)..

  • The increased rate of technological innovation

One of these aspects is the uncertainty about future investments linked to the pace of Information Technology (IT) This is not a recent evolution, it is a profound trend which is changing the orientation of the economy and more broadly the society since the early sixties (Moore 1965, Kurzweil 2001) This trend tied to Data Processing innovation, in turn modifies in depth the whole structure and evolution of industrial and services organisations (Gelsinger 2006). Markets and regulations can’t cope with that exponential rate of change: new products come out before the supply demand equilibrium is reached and/or before adapted regulations are designed and put in place.

This difficulty to intelligently guess future industrial and service trends induced part of the investors to move away from productive investments (industrial and services) to concentrate upon purely financial products which they wrongly thought to be more predictable.

In addition the same technology that is making future prediction more hazardous, also enabled pervasive and faster access to planet wide financial transactions through advanced and easy to use networking technologies (Hitz Turroff 1978), rendering here too market equilibrium far more volatile and subject to crowds like reactions[1].

The other side of uncertainty comes with job definition which changes as fast as do technologies. Jobs also seem to disappear faster than new jobs are created and are replaced by jobs demanding higher skills. Actually some jobs so far deemed to be requiring high level skills have been relocated in countries with low cost white collar manpower with similar high tech skills or purely replaced by automatic advanced IT systems.

All this increases uncertainty among all economic agents. Uncertainty is never favourable to the economy leading to loss of confidence and leading to the “liquidity trap”, while risk, which can be measured in terms of probability, can trigger new business opportunities and high profit rates (Knight 1921).

Uncertainty avoidance was experimentally observed for more general human behaviours (Camerer 2005). The best way to fight uncertainty is to develop systems that produce information in the scientific meaning of this word: information is what reduces uncertainty (Brillion 1962, Moles 1965) by limiting the number of potential outcomes in a given random situation. Such information transforms uncertainty in risk with measurable probabilities. (Trehin 1985,2001)

  • The widening gap between rich and underdeveloped economies.

The widening gap between poor and rich economies can be explained by several factors: The deterioration of trades condition for basic products, the weakness of industrial and service investments in poor countries, the disastrous working conditions linked to an almost complete lack of social protection and the under evaluated monetary exchange rates amplify the market mechanisms distortions already at work through low labour wages. The monetary exchange rates between rich economies and poor economies are indeed often under evaluating the second’s currencies versus the first ones aggravating the price differentials versus rich countries production systems.

These affect both sides’ rich and poor countries.

– Rich countries are affected by lower labour costs and lesser social protection in poorer countries, entailing the two phenomenon of unfair competition and delocalisation of production. Rather recently highly skilled jobs too have been impacted by this situation.

Although some theories claim that market mechanisms will take care of the phenomenon and compensate for job losses in developed economies, “According to an evolutionary perspective, relocation is an aspect of a process of creative destruction that results in real distortions and hence in market disequilibria. Therefore, even in a competitive environment, relocation may be associated with an increasing rate of unemployment and make it necessary for public authorities to combine structural and macroeconomic policies, the former being efficient only if the latter are growth oriented.” (Gaffard Quéré 2005)

– Poor countries are affected directly through decreasing income due to lower prices for basic goods, by extremely difficult labour conditions. They are impacted indirectly as they cannot afford buying goods from rich countries, in particular investing in advanced technologies, given their low income and the unfavourable exchange rate which doesn’t compensate the trade advantage it gives them when selling their products.

– Their lower buying capacity also impact developed countries export potential. In addition lower wages in developed countries reduce the buying power of low and middle income citizens.

Most politicians and media commentators have concentrated upon the question of which financial measures should be taken to fix the world economy dysfunctions. There should be a more profound approach to the current crisis: not only financial market need to be adjusted but all the trade system needs to be adapted to the new economic and technological conditions.

 

  • Both financial and trades regulations need to be rethought in order to take into account the new economic and sociological situation triggered by ever faster technology evolution coupled with extreme potential mobility of people and capital.

 

References

(sames as in French message above)


[1] Note that such types of reactions always existed inside the walls of various stock exchanges buildings but than now these reactions get transmitted through international networks faster than any financial commentator can analyse them.

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