Towards a rational macroeconomic policy post-Covid-19
The Production, Accessibility & Consumption Model (PACM)
This site has explained a range of shortcomings with "conventional" economic policies including Keynesianism, Monetarism and supply side economics (KMS policies). First of all they all are founded on the proposition that the Aggregate Demand Model (ADM) provides the foundation for managing the economy. These presumptions have failed spectacularly several times with Covid-19 occasioning yet another failure albeit rising from a different cause but highlighting, non-the-less, the weakneses of KMS policies.
The other common factor that characterises KMS policies is that they create winners, losers and some who remain in a neutral policy impact state. With time, the plight of the lower income segments becomes worse.
It is these lamentable associations which gave rise to the development of the Real Incomes Approach which offers a foundation for a more rational macroeconomic management of our affairs post-Covid-19.
The initial slide in the performance of the global economy was not a lack of demand but rather a lack of supply. Since many economic units survived and earned their income from servicing supplies from China such companies have had significant problems and some have already failed. So the governor of economic activity in this case was not Aggregate Demand but rather Aggregate production
. The transmission of this impact was that essential products from China were not accessible
, that is the effective supply
was not there. Other aspects of accessibility are access to information on products and accessibility in terms of unit prices.
With Covid-19 impacts now affecting Western economies the purchasing power of many people who are self-isolating and out of work has fallen because the normal prices of rent, mortgages, food and utilities are beyond their ability to pay on a sustained basis over even a few weeks because of lack of nominal income.
This is a practical explanation of the PAC Model of the economy. The PAC Model was developed as part of the operation of economies and was identified in 1975-1976 to explain the financial crisis in the later 1970s when the international petroleum price began to rise substantially, giving rise to slumpflation
that combined high inflation with high unemployment.
Neither Keynesianism nor Monetarism could resolve this issue without imposing severe prejudice on the constituency. This was because they insisted on analysing the circumstances from the standpoint of the Aggregate Demand Model and believing Milton Friedman's assertions as being a basis for applying a poorly thought out policy for which there was no basis of evidence. Indeed, the "solution" in the UK, under the Conservative government of Margaret Thatcher was a mish mash of montarism and supply side economics that led to high interest rates and around 2 million people losing their homes." Indeed, slumpflation was an issue caused by disruption in the circustances of production caused by one major input, petroleum, undergoing very high rates of unit price increase. So inaccessibility was not lack of producion but rather the inability of some production unit to be able to afford this input in the light of the purchasing power of their consumers. Here you can see we are dealing with a real income or purchasing power problem as has arisen under Covid-19. In the late 1970s through mid-1980s many companies further down the supply chain also failed and unemployment rose yet further as a result of a deficit in their real incomes or purchasing power linked to the high prices of the upstream production that depended upon petroleum inputs. The inaccessiblity of these unit prices is a repeat of the real incomes problem further down the chain in a similar way to that now observed under Covid-19.
At the same time that I was working on the Real Incomes Approach in 1975-1976, another group of economists including Mundel, were developing what came to be know as "supply side economics". I became curious to see what this was. However, since I had decided in 1975 to build up the Real Incomes Approach from basic principles and without any reference to any other schools of economic thought, having studied these in some depth at post-graduate levels (Keynesianism and Monetarism). However, when I sat down to review what supply side economics was, it turned out to be a fiscal scheme based on reductions of marginal taxation rates but whose operation was wholly-based on the presumptions of the Aggregate Demand Model logic. As far as I could make out, there were very few supply side elements.Supply side
I need to explain what I mean by supply side. Supply side involves the processes and decisions that determine the economic and financial productivity of a production unit. To manage effectively economic units require business rules that are transparent to the degreee that by following them resource allocations will result in improved quality of output, preferably at declining unit costs and when possible falling unit prices so as to result in companies, their workforce and consumers all benfitting from rising real incomes and purchasing power. Naturally by aggregating the growth in real incomes of such economic units and their consumers one ends up with a real growth in the economy. I did not set out to create a Real Incomes policy or even Supply Side solution. However it was simply as a result of analysis that these elements emerged as the critical elements that were missing from the macroeconomic models and policies. So what had emerged from this work was that the issue was to focus on real income and the only way to do this was to provide economic units with rational guidelines (business rules) to help them organise production to promote real incomes.
An important detail, at the time, was the need to drive inflation out of the economy. It is self-evident that much of the inflation can be traced to the massive rise in petroleum input prices. So the inflation had nothing to do with "demand" but rather production and supply conditions that could not be controlled easily. The only way to get rid of inflation was through steps to improve productivity by substituting petroleum or making use of petroleum in a more effective and efficient manner.
Indeed, at that time it made a lot of sense to begin to consider a Green New Deal to get the world economy off what has been a constantly disruptive force economically and in terms of social strife resulting from warfare.
Without this, inflation would rage on at the mercy of the internatonal price of petroleum. So we see here a general but important principle that in reality what caused inflation was in fact the levels of productivity and the pricing decisions of economic units, linked to the purchasing power of consumers. These are a combination of technical, economic and financial analyses. This is why a coherent policy needs to be related to business rules which can be used by economic units to maximise their real incomes while reducing inflation. Policywise in line with seeking the general interests of the constituency it is important unde such circumstances to encourge economic units to set unit prices according to the purchasing power of consumers so as to penetrate the market. This has the effect of gaining in scale of operation and intensification of learning and accumulating tacit knowledge (know how) which in turn leads to marginal reductions in costs associated with rises in productivity. This of course fans out into a range of corporate decisions relating to technology and techniques, innovation and the importance of a significant need to assist economic units in being successful but defined in terms of the real incomes or value of cash flow, executive, owner, shareholder, workforce real incomes sustained while maintaining market penetration.
To the degree that such a production-based policy results in the enhanced real incomes of all associated with an economic unit it is not much of an intellectual challenge to realise that such an operational structure is generating its own levels of consumption by taking care to set prices at an accessible level to consumers, many of whom work for economic units run along similar lines.
Milton Freidman and others were so wedded to the Aggregate Demand Model and, in his case, the Quantity Theory of Money that he convinced many decision-makers in ministries that to lower inflation it ws necessary to raise interest rate to lower demand. But as explained, demand was not the problem, the problem was the conditions of production. Needless to say the monetarist solution applied under Reagan and Thatcher resulted in rising unemployment and business closures, thousands of US family farmers and householders losing their properties to banks and the same in the UK with over 2,000,000 losing their homes, all int he name of the absurd notion of "trickle down economics". This "medicine" was applied on the basis of the mantra that, "There is no alternative" constituted an immense injustice and abuse of constituents. It was the result of providing too much credence to unproven economic theories to attempt to solve a unique set of economic circustances. The more important abuse arose from the failure of governments to apply principles of constitutional economics involving procedures of transparent public choice. But, in the UK, the government seemed to operate on the assumption that constituents would never understand the issues since only a small select number of their advisers would have been schooled in ADM economics so they would be able to make rational choices. The solution was to impose the policy as an act of decisive and strong governance.
1 Hector McNeill is the Director of SEEL-Systems Engineering Economics Lab.