Over at the Library of Economics and Liberty, Arnold Kling has an article on recalculation (reproduced below).
The two key things this otherwise highly pertinent piece neglects are (a) that ‘Recalculation’ is driven by Entrepreneurs – who must therefore not be impeded in their actions and choices – and (b) that ‘stimulus’-driven swings in currencies, interest rates and monetary value, generally, render much of the attempt at ‘Recalculation’ invalid
The Recalculation Story: A Summary
I have had a number of requests for this. I will put it below the fold.
1. Try not to think of macroeconomics in terms of equations or in terms of aggregate demand. Try to learn to think in a new language, rather than translate from the Recalculation language to something you are used to.
2. “Economic activity consists of sustainable patterns of specialization and trade.” That is the mantra of the Recalculation Story.
3. Note how difficult it is to squeeze patterns of specialization and trade into a model of a single representative agent. Robert Solow has more good points.
4. If you cook for yourself and I cook for myself, that is not economic activity. If we eat at each other’s restaurants, that is economic activity. This is true in the national income accounts, and it is justifiable. It is better to have millions of people working for you to produce your food, computers, health care, and so on than to produce them for yourself.
5. Part of the challenge of creating sustainable patterns of specialization and trade can be described as a matching problem. Think of two decks of cards, one with a list of workers with specialized skills and one with a list of occupations that utilize specialize skills. If you draw two cards at random, the chances are that they will not match. The skills of the worker will not match the skills required in the occupation. In that case, the marginal product of the worker in that occupation is very low, and the worker is unemployed.
6. The economy’s calculation problem is to sort the two decks in ways that match workers to occupations in which they have value. This problem becomes more complicated with each increment of technological progress. The number of occupations has increased, because even as some occupations become obsolete, even more occupations emerge as useful. Also, the amount of human capital needed for many occupations has increased.
7. The patterns of specialization and trade are interdependent. In some instances, there is negative feedback. A new pattern that involves automobile production has negative impact on horseshoe makers. In other instances, there is positive feedback. A new pattern that involves automobile production has a positive impact on gasoline refiners.
8. Economic profits are what indicate a sustainable pattern of specialization and trade. Ultimately, the way that we know that we have a good set of matches of workers and occupations is that employers are not losing money.
9. The sustainability of patterns of specialization and trade is always changing. New opportunities emerge, and some older patterns become obsolete.
10. A danger in the economy is that an unsustainable pattern will go unrecognized for a long time. In the recessions of the U.S. between the end of World War II and the 1980’s, excess inventories were accumulated. In the most recent episode, excesses in housing construction and mortgage finance went unrecognized for a long time.
11. If the excesses are merely short-term inventory problems, the old patterns of specialization and trade can be restored once the inventories are worked off.
12. However, if the old patterns of specialization and trade are not sustainable, the economy faces the Recalculation Problem. New patterns of specialization and trade need to be created. While the economy is creating new patterns even in good times, when it faces a Recalculation Problem it cannot create new patterns rapidly enough to prevent widespread unemployment.
13. Government can create temporary jobs for the unemployed. However, that is not the same thing as creating sustainable patterns of specialization and trade. For example, if the government subsidizes a firm that builds solar panels and those solar panels are not efficient, then this does not really represent a sustainable pattern of specialization and trade.
14. The more that patterns of specialization and trade involve government direction of resources, the greater the risk that those patterns are not sustainable.
15. It is possible that lower real wages will help to solve the Recalculation problem. However, generally speaking, when you pick a card from the worker deck and a card from the occupation deck, the match is either a good one or it isn’t.
16. The production process has become more roundabout over the years. Fewer workers are engaged in hands-on production of output. Instead, they are engaged in building what Garett Jones calls organizational capital, as indicated by functions such as marketing communications, management reporting systems, or corporate training. This means that the relationship between output and employment has become looser. It means that patterns of specialization and trade reflect not just what goods and services are produced but how they are produced.