Open thread April 2, 2014 Dan Crawford | April 2, 2014 8:09 am Tags: open thread Comments (6) | Digg Facebook Twitter |
Mark Thoma points us to a NYT article, “The Perpetual Bubble Economy”
which talks about “secular stagnation”. It seems to me that talk of secular stagnation is an indication that economists don’t understand how economies grow. I read last week about the Solow model. It seemed to me to imply an assumption that if the economy invests in production, then consumption would follow.
Did I misunderstand the model?
I think Edward Lambert’s work is important in showing that supply does not imply demand, but I find it lacking the modeling of mechanisms as to why labor share is what it is.
Have I missed something in Edward’s work?
I would observe that economists try to make models that are too simple. Krugman wrote some about this last week, but he emphasized that his simple models have had some utility without any note that understanding something like secular stagnation requires including more factors. The NYT article tries to simplify secular stagnation down to bubbles, but what about before the 1990s?
I would suggest a couple of things that were different before the 1990s. More women were coming into the workforce. The proportion of two-income households was increasing. Demand increased because as more new stuff was produced, more workers would enter the workforce to be able to buy it. I hypothesize that the rate of change of the workforce is an important factor. Decreasing rate of change means demand does not increase.
Exports can also drive growth. Henry Ford was able to decide to pay his workers enough to be able to buy his cars because he was not working in a closed economy. The US benefitted from net exports for most of the 1900s.
(I hypothesize that) in a closed economy, increases in productivity will lead to reductions in demand as worker compensation is reduced. In order for demand to increase it is necessary to have other factors. Those factors have existed for almost all of our economic data, but as economists try to make simple and/or steady state models, they have been ignored – even though they are critically important.
Production implies Capacity which moves up or down with Demand. If Demand gets too low, Capacity is reduced leaving a residue (lack of a better word). Eventually, it becomes too expensive to maintain the Capacity.
“Production implies Capacity which moves up or down with Demand.”
Huh? Capacity is how much can be produced. A sudden drop in demand has no immediate impact on capacity. Capacity is reduced by depreciation. If investment exceeds depreciation, capacity will increase.
The Solow model seems to assume that demand will increase if capacity is increased (by investment in production). I doubt Solow meant it was directly causal, but it seems to me that there are factors which can drive demand that have little to do with investment.
Did you guys ever work in a plant or schedule one? You guys talk a good game; but, the terminology is awry.
A sudden drop in demand means you will end up with more inventory if you do not reduce capacity in the short term. More inventory is the killer of a business as material is the largest portion of the cost of manufacturing. You adjust capacity (cut shifts or portions of shifts or particular machines – automotive will shut down 1-2 weeks in Summer time usually around the 4th.) to meet demand within the level in which it becomes not profitable to run production (breakeven) and the theoretical high limit which is typically 240 days 3 shifts a day. Beyond that point you begin to impact machinery and tooling.
Production is the manufacture of components or product which implies you have the Capacity to do so, the capacity of the plant, equipment, or tooling. Physical theoretical Capacity is not hurt by depreciation, only the value of tooling or equipment is lessened as companies write off value not capacity. Equipment, tooling, plant typically last well beyond the actual depreciation of the same. God knows, I have worked in and consulted in a lot of old ones. During those other days 365-240 = 125 days; maintenance is performed to keep capacity at the theoretical level. .
I work in manufacturing. It seems we are using different terminology, but I am under the impression that yours is not standard. Cutting the number of hours we run the line reduces outs, but it does not reduce capacity.
I suppose from a bean counters point of view “actual depreciation” is about accounting. To me it is about replacing spares. Since we run 7x24x365, depreciation leads to downtime which does reduce capacity. Of course, how to treat a line that makes product that no one wants to buy because it is obsolete, is another question.
You do not plan to 100% of capacity or theoretical capacity. You plan to 80% or 240 days at 3 shifts. Like I said, the other 20% is for maintenance. At 100% over a long period of time, you begin to lose tooling or equipment. If you cut a shift or reduce labor you lower the capacity of the press, tooling, or line. Mine is standard as determined by Ingersoll Engineers. You adjust to meet demand and do not over run or under run.