Collapsing Carrying Capacity… Tragedy of Overshooting
I am of the opinion that the economy is overshooting its natural sustainable level at the moment. There are problems that can occur from that. Below I give a warning from the field of Population Ecology.
Stocks are rising to records partly on the back of a lower labor share in 3rd quarter 2014, which today was adjusted down from 97.3 to 96.2 (non-farm business sector). That is a big adjustment. The profits seen in the stock market are partly based on a big hit to labor share.
Along with the hit to labor share, firms are stepping up hiring in an effort to support profit rates.
You see some talk that maybe the Fed will start to raise its base rate earlier in 2015. From Tim Duy…
“They (the Fed) may be less pleased that stocks keeps hitting record highs as it suggests that financial conditions are easing somewhat, thus perhaps necessitating a faster pace of rate hikes. Over the longer run, I remain wary of the flattening yield curve.”
So the economy is gaining great momentum with nominal rates still at the zero lower bound. Are we overshooting?
The Principle of Overshoot
In the field of Population Ecology, there is a principle for overshooting the carrying capacity of an environment. Population can be sustained at the carrying capacity of an environment. The idea of overshoot is that if the carrying capacity is exceeded too much, the environment will be damaged and carrying capacity will collapse. What does overshooting look like? (source 1, source 2)
The carrying capacity would be like the natural level of output for an economy. If the economy is pushed too far beyond it, we could actually do damage to the economy, such that potential output would drop even further afterwards. The next recession would be that much more grueling.
I know Krugman and others push for overshooting saying that the risks of tightening monetary policy too soon outweigh the benefits. But overshooting has a great risk too. And Krugman acknowledges that we do not know where the natural level of potential output is.
Is secular stagnation the result of overshooting sustainability with years of bubbles before the crisis? Maybe, but I think the drop in labor share is more to blame. However, we still need to be careful that policies are not causing a tremendous overshoot.
I think you are over concerned.
The carrying capacity should be increasing with population. This months growth is barely more than twice the steady state average. Overshooting somewhat when the goal is to catch up to a moving target is far from causing a collapse.
While the economy may not be as agile as a running back, it still has a lot of room for error.
I know a lady in NC, she sells costume jewelry online. Does well at it, she makes $1k a week. I know some guys in upstate NY who spend their days ‘cleaving’ slabs of blue stone from corn fields. They sell the pallets of stone for cash. It’s hard work, but they make a living at it. I know a lady who runs all over the place buying old stuff, she sells most of it through EBay, she hasn’t collected a paycheck in years – she just bought a new car.
I don’t think this is unusual, lots of folks are doing stuff off the books and on the side. My point is that no one really knows what labor income is, and how it’s changed the last five years.
Ask these folks if they’ had a steady job, they’d say “no”. If you you looked through the numbers you’d see that these types of folks are the ones statistically pushing down the work force participation rate.
How big is the black economy? 5-10%, That segment of the economy is growing, and its booming this time of year.
The carrying capacity does not change with changes in population. The population lives within the constraints of the environment. In the case of the economy, potential output does not rise with a rise in output. That is Says law which is false from my perspective and Keynes too.
So the natural level of output is a stable variable. It is not a moving target. We are overshooting that target at the moment and it is not changing.
So if we added those people into the official numbers, what would really change? They have unemployment amongst themselves too. They have a certain level of productivity too. Their black economy is not that much different from the official economy. The ratios would not change much.
The carrying capacity of the economy is something we all live within, whether unofficial or official. The key is to know that it is possible to overshoot a natural limit. And if we do it too much, it can be trouble.
“The carrying capacity does not change with changes in population.”
Of course it does. Firms know they will have more customers so they will modify their plans accordingly and the economy will change because people believe it will change.
The carrying capacity is a different concept than normal economic expansion in a biz cycle. The carrying capacity is related to the productive capacity.
For me the productive capacity of the economy has been very stable since the crisis.
Therefore carrying capacity is also stable because it is a ratio of the productive capacity.
“the productive capacity of the economy has been very stable since the crisis”
But that is an anomoly. It usually grows. With population and with innovation.
I have to ask why you associate economic expansion and biz cycle. The cycles are disturbances superimposed on an underlying growth that is based on increases in population and on innovations which increase standards of living or increase productivity.
We can predict the componenet from population very well.
The last two business cycles were caused because some innovations are unpredictable. The use of the internet was a real innovation that became an economy wide speculative bandwagon until it ended that business cycle in 2000. Hiding the real value of mortgages was a financial innovation that led to speculation in home building that created economy wide distortions until that ended in 2007.
The underlying growth from population growth and innovations like smart phones does not need to cause economic distortion. You should expect to see growth in productive capacity not stability.
Productive capacity grows through time, but its growth oscillates in conjunction with the biz cycle. And a biz cycle has its expansionary phase.
You see factors that are increasing productive capacity, but there are other factors that decrease it, like depreciation of capital that is not maintained, and firms being less than optimally efficient because low nominal rates keeps them in business.
I see that currently, productive capacity on net is not growing. That is a problem because the carrying capacity of the economy is not growing either.