The End of Technological Growth and Price Deflation?
by Tim Swanson
Following its independence from the United Kingdom, in the early 1950s Indian policy makers implemented a series of five-year development plans based on several econometric growth models. Arguably the best known and most far-reaching was the Mahalanobis model which attempted to encapsulate and define the most efficient flow of production for the multicultural subcontinent. As part of its implementation, India nationalized the commanding heights, industries that policy makers felt were too critical to be left to market forces. And like their contemporary Soviet counterparts, the model assumed too much, overlooked many important details and ultimately failed to catapult the country into prosperity. Despite an abundance of natural resources and relatively cheap labor, growth stagnated for forty years, averaging a mere 3.5% a year, leading to a situation sarcastically dubbed the "Hindu rate of growth." Yet their dismal experience has not stopped other Western countries from partaking in similar endeavors. However, before discussing Western policies, another story should be briefly investigated. The future cannot do without economic logic Several mainstream articles have discussed what role equations and models from financial engineers such as David Li and Michael Osinski played in the current disorder. Li created a mathematical formula modeling risk that was used by nearly every financial firm and ratings agency. Osinski wrote the software that turned mortgages into CMOs (similar to CDOs), software that was used by many large banks and mortgage service providers. Both were at the heart of a world that no longer exists, a world that incorrectly predicted human behavior.
And one problem overlooked by these mainstream exposés is that we, humans, are analog beings with subjective, heterogeneous preferences that continually change. And the quantitative models developed and deployed by financial firms to spread and mitigate risk did not take into account the perverse incentives institutions like the Federal Reserve fed market participants. In addition, everything that policy makers – at every level – are doing is more of the same foolhardy economic planning that leads to lower productivity and more financial strain. But, before lamenting the details of any recent political escapades, another aspect should be brought into the fold. Up and atom In the spring issue of h+ magazine ("Is the Future Cancelled?"), there are several articles, including an interview with scientific luminary Vernor Vinge, that discuss the current economic environment and the long-term impact the recession will have on technological and scientific development. And while each attempts to explain the observable phenomenon we are witnessing, all fail to recognize the same culprit: central planning and spurious assumptions. While Ben Geortzel’s piece does discuss the shortcomings of certain financial models, none of the others say anything about the deleterious role government economic models played in the current crisis. Nor do they identify the enabling antagonists in implementing them: government-managed institutions. Fannie Mae and Freddie Mac underwrote half of all residential mortgages during the most recent boom. The Federal Reserve released the spigots of hundreds of billions of "hot" money which was leveraged upon through fractional-reserve banking. The FDIC institutionalized moral hazard by socializing the risks of reckless bankers at the expense of taxpayers. And various executive agencies transferred tens of billions of taxpayer funds to pet projects managed by special interest groups. In pursuing their ill-advised mandates, each of these parties justified their action through various unsustainable economic growth models. Actions that have created an imbalanced economy which is currently trying to purge itself of malinvestments. Yet according to Vernor Vinge, technological progress may continue even in the absence of a healthy economy, because "it only takes a few companies to keep up with Moore’s Law and thus make the breakthroughs that will bring this strong AI [Artificial Intelligence] to fruition." Cause and effect Worldwide, more than 330,000 tech workers have been laid off since August. Venture capital in the US has declined dramatically, from $35.5 billion in 2007 to $27.9 billion in 2008 (–21%); and first quarter VC just hit a twelve year low. In fact, in the past 12 months only one venture-backed IPO took place (Rackspace). And in a move that arguably punishes future investment, President Obama is raising the capital gains tax to 20% (in contrast, China has a 0% rate on capital gains). While there is no right or wrong number of employees that should be working in a given industry (sometimes fewer is more effective), the software development industry is highly dependent on human capital for developing new code. And both the telecommunication and semiconductor industries are not only capital intensive, with equipment costs in the billions, but also continually need creative engineers. Thus from the perspective that technological growth will persist irrespective of economic conditions, it is dubious that Vinge’s assertion will hold true in the presence of a protracted recession. Yet with all of this gloom there is still one bright area that historically has helped tax producers and innovators keep their head above water.
Throughout the 1990s and 2000s consumer prices typically increased 3–5% annually due to inflation pressures. However globalization as a whole, vis-à-vis trade liberalizations, gains in workplace productivity, and technological progress masked the inflationary effects wrought by central banks. As a consequence, the retail costs of all technological gadgetry typically decreased while simultaneously functionality and performance were upgraded at no additional cost. And then some. For example, most modern smartphones are more powerful than desktop PCs from a decade ago, yet they cost a fraction of the price. Take for instance the 3G iPhone released last year. According to Simon Jeffrey, president of Sega (America), it is as powerful as the Dreamcast console from 10 years ago. Furthermore, silicon-for-silicon it is also more powerful than the original iMac released in 1998, yet adjusted for inflation costs 1/8th the price. And as seen in this chart, this deflationary phenomenon was not merely isolated to a single company in Cupertino:
This is not an endorsement of products from Apple, Dell, Intel or any other firm. Rather, this serves as an illustration to highlight a fallacy in current orthodoxy. Malignant deflationary spiral
However, as an economy grows and becomes more efficient, it should ultimately cost less to produce the same units of goods and service. Price deflation caused by scientific progress and economic efficiencies (e.g., mass production, automation) is actually a beneficial side effect and should be embraced. Thus, in practice, even with the expected knowledge that their purchased products will become outdated and cheaper within a few months, customers did not shun but rather flocked to computer retailers rain or shine. And the numbers reflect this. A scant 40,000 PCs were sold in 1976. By 1984, the number had risen to 2 million. At the close of 1986 this number had tripled to 6 million shipments worldwide. By 1990, PC sales had reached 16 million a year. By 1994 worldwide sales had more than doubled to 36 million. At the peak of the dotcom bubble more than 135 million PCs were sold each year. Following the 2001 recession, growth resumed upward, hitting 170 million by 2004. And while there will be a big dip this year, in 2008 more than 295 million computers were sold worldwide. This figure does not include smartphones, which in 2008, more than 139 million devices were sold globally; up from 37 million in 2005.
In contrast to Keynesian theory, despite the fact that dozens of large multinational companies compete in an environment where prices have persistently decreased throughout the last three decades, this has not led to lower production or lower wages. In fact, the opposite has occurred. In fact on top of competitive pressures, between 2004 and 2008 prices of commodities commonly used in PC components more than doubled. Some such as copper and silicon tripled. Yet PC manufactures across the globe not only cut product costs and upgraded machines, but profited handsomely. And without trillion dollar subsidies or bailouts! However these deflationary benefits may be thwarted in the coming years as government policies worldwide redistribute capital. What impact will this have on the funding of semiconductor foundries, clean rooms, lithographic lasers, die-testing equipment and automated manufacturing as a whole? What happens when productive capital is diverted to the government bond market to fund deficits? Not learning from past mistakes While it is difficult to predict the exact long-term consequences chairman Ben Bernanke’s expansion of the Fed balance sheet will have on consumer prices we can a priori state that all of the bailouts and stimuli will be unable to achieve their stated goals and will actually hamper growth. We know this because free markets are the only method to accurately and efficiently react to prices and allocate resources accordingly. Politicized committees cannot. In addition, we know that taxpayer funds will be channeled through an inefficient, unmotivated bureaucracy that is connected to kleptocratic interest groups. An apparatus that historically over-promises and under-delivers and one that is not always relegated to imbibing and then lambasting the boardrooms of Wall Street. For instance:
So to clarify, it is not just the bankers that have misappropriated state welfare and it is left to the reader to fathom the alternative productive uses those tax dollars could have gone towards (e.g., return it to taxpayers).
Furthermore, the Keynesian growth models promoted by Obama’s economic team naïvely suggest that there is a 1.5x multiplier effect for every dollar the government spends. Yet there is little evidence that this has ever been true and in many cases, only half of that level is ever attained. On top of all of this, economist Benjamin Powell notes that government institutions are intrinsically poor investors and myopic entrepreneurs:
Powell illustrates this with Japan’s Ministry of International Trade and Industry who stymied Sony’s very existence and attempted to micromanage Japan’s domestic automotive industry. On this side of the ocean, despite billions in handouts, government institutions like NASA did not invent anything that private enterprises could not have. And axiomatically, Obama’s industrial policies, whether it is energy or healthcare will also meet the same stillborn fate. Arm, leg and your firstborn At an international level everyone is drinking the same poisonous Keynesian juice. For example, G-20 participating countries recently pledged $1.1 trillion, on top of existing multi-trillion dollar packages, to throw down the financial money pit. Each dollar extracted by tax producers is one that cannot be spent developing sci-fi hardware and software sought after by futurists. Why? Because in effect, every government stimulus is an unseen tax on potential entrepreneurial activity. To compound matters, the US Treasury continually sells billions of securities each month in order to service the more than $11.1 trillion in debt. And contrary to what Congresswoman Maxine Waters suggests, none of that debt is retired. Not only that, but the Treasury actually has to pay annual interest on these securities (usually around 4% a year). Imagine if that level of capital was instead allowed to finance productive, private enterprises instead of government programs!
No matter how deep and wide the current recession ultimately is, policy makers have impeded future growth through methods no more effective than those of the Soviets or Indians. And while deep-pocketed, multinational incumbents such as Intel may survive this period of economic turmoil, current policies and models will make it difficult to fund the next generation of movers and shakers. Furthermore, we have already seen the ill effects of centrally planned interest rates and centrally planned home ownership. We have seen what econometric models are incapable of measuring or quantifying. We have also learned that the government simply creates more problems than it solves, thus the last thing any industry needs is another czar, stimulus, or artificial growth model. So to answer the question posed in h+ "is the future cancelled?" Probably not, but it will remain in slow motion for years to come and will not reach its full potential under this administration or the next. And consequently, due to the highly inflationary acts of central banks over the past 18 months, consumers will be lucky if the deflationary pricing environment of the past 30 years continues into the next 10. April 25, 2009 Tim Swanson [send him mail] is a graduate of Texas A&M University and lives in central China. Visit his blog. Copyright © 2009 by LewRockwell.com. Permission to reprint in whole or in part is gladly granted, provided full credit is given.
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It
should be noted that there is nothing inherently wrong with attempting
to mathematically model human behavior. However, what they and others
like Prasanta Mahalanobis (namesake of the model) attempted to do
was quantify human action using inherently incomplete equations
— using false assumptions to fill in for a continually changing
series of individual preferences (or in their case, risks/demand).
The
benefits of deflation
One
Keynesian doomsday scenario forewarned by technocrats of all political
stripes is an environment in which customers avoid products whose
prices continually fall. In theory, customers would delay purchases
indefinitely, leading to a downward spiral: a decrease in prices
leads to lower production, which leads to lower wages and lower
demand, which leads to lower prices. Ad infinitum.
All
told, more than 1 billion computers were actively in use at the
end of 2008 – and that number is expected to double by 2014–2015.
However,
rather from learning from its past mistakes the US political class
has 
Hindu
rate of growth reincarnated