Gerard Jackson
BrookesNews.Com
Monday 12 January 2004

It was sad state of affairs when in late 2001 economic news from the US surprised and contradicted our economic commentators. For sometime I had been predicting a significant rise in unemployment as America's recession unfolded. Regular readers will know that I'd been saying that the US economy had been in recession for sometime.

As soon as manufacturing began to contract, just as I said it would, the consequences would gradually ripple down the production structure, even though the employment rate remained relatively stable, until it hit the consumption stage. At or close to this point overall unemployment would finally begin to rise. And so it came to pass.

At the beginning of 2001 one of our home-grown economic commentators wrote: "It is remarkable that almost all the commentary is Keynesian (italics added) in assuming that these reductions will either prevent or abate a US slow down or recession within the next 12-18 months. It won't. In fact, because of the lagged effect of interest changes, economic activity in most of that period will be slower as a result of earlier official rate increases — as it will in Australia.

"That does not necessarily mean a recession, of course. I maintain my previously enunciated view that the lack of serious policy imbalances (and particularly the apparently limited extent of bad and/or speculative lending) make the chance of a US recession slight."

The striking thing about this sanguine approach, which generally mirrored the orthodox view, is that it is Keynesian. Only someone wearing Keynesian blinkers could seriously state that there was a "lack of serious policy imbalances" in the US economy.

Good grief! The Fed's Monetary policy has been seriously out of balance for years, which in turn threw the whole production structure out of balance by piling up malinvestments. The massive speculative bubble was a glaring example of monetary and financial imbalances.

Unlike our commentators, I at least have the distinction of being reported as being "one of the few who correctly discounted the US tech-stock bubble" (Los Angeles Times, 12 August 2001 and the Houston Chronicle, 19 August 2001).

The problem is the Keynesian tyranny of aggregates. The vast majority of economists have come to believe that studying certain aggregates, i.e., employment and GDP aggregates, they can discern what is happening to the economy. These magnitudes or macro-variables as they are sometimes called are grossly misleading. Because they are treated as real entities that interact with each other and lend themselves to statistical measurement and testing their micro-foundations are invariably ignored.

This brings us to Professor Lachman striking observation that "The more firmly a macro-economic argument is linked to its micro foundation, the less it lends itself to statistical verification" (Macro-economic Thinking and Market Economy). Now I can't blame most people for thinking that this is just airy-fairy stuff that has no bearing on the real world. Not so.

Even as the American economy was apparently booming, I tried to alert people to the fact that it was a monetary boom that was doomed to collapse. Now this is where the tyranny of aggregates enter the grim economic scene. I constantly stressed that recession would first emerge in manufacturing and then work its way down the capital structure until it reached the final stage, the consumption stage. Which is precisely what happened.

In addition, I also emphasised that as unemployment rose in manufacturing and those services that depended on it, this increase would be offset by the continuing rise in demand for labour at the lower stages of production. The aggregate employment figures would, therefore, show employment remaining relatively stable.

Jerry Jasinowski, president of the National Association of Manufacturers said: "This leaves no doubt that the economy is in recession." Followed by: "Clearly, this recession is no longer confined to manufacturing." It never was. And it was ludicrous of him to claim that the 9-11 "The attacks have had a stunning impact on our economy."

Now we can see why aggregates can be dangerously misleading. If these economists had directed more attention to what was happening at the level of the firm then the sudden rise in rate of unemployment would have come as no surprise. Despite the prevalence of their Keynesian thinking, it's still incredible that so many economists missed the target considering that business slashed 2.2 million jobs in 2000, causing the unemployment rate to rise by 1.5 per centage points.

The sudden leap in unemployment provided striking evidence that the lower stages of production were feeling the pinch. This depressing fact was emphasised by figures showing that, as predicted, a disproportionate loss of jobs occurred in tourism and hospitality, both of which are obviously at the consumption stage. The situation was even gloomier than these figures suggested. In order to avoid dismissal great numbers of workers sensibly accepted wage cuts and short-time working.

GDP was another misleading aggregate. This so-called macro-variable is mistakenly considered a measure of economic growth. It therefore follows that so long as it's positive the economy is healthy. But GDP was positive even as manufacturing was contracting.

In other words, America was in recession even as GDP remained positive for some time. I think it's time our orthodox economists and economic commentators took a closer look at themselves.

Gerard Jackson is Brookes' economics editor