The universe exists because it is in a state of equilibrium, and experience says that whatever we do will function better if it is in balance. We must therefore strive at the start of everything we do to construct the thing in a perfect state of equilibrium and so maintain it for as long as we plan to use it. Needless to say this is true of the engineering works we erect because they are the expression of the laws that nature has revealed to us. But what is of interest to us here is the implication that these laws have on the sciences which relate to human behavior of which economics is most pertinent to this discussion.
There are numerous divisions and subdivisions in economics so that when we speak of an economic system being at equilibrium we mean to say that its macro divisions must be in balance with each other, and its micro subdivisions must be in balance with each other. For example, two of the main divisions of an economy being the production side and the consumption side, they must be maintained in balance. Likewise, a subdivision of the economy being the import/export part of it, there should be a balance between what is imported into a country and what is exported out of it. Doing this throughout the enterprise - be it a nation, a corporation or a household - will help operate it at maximum efficiency and maintain its balance sheet at equilibrium.
With this in mind, we recognize that America has a problem these days which Mohamed El-Erian discusses in an article published in the Wall Street Journal on July 9, 2010 under the title “The Real Tragedy of Persistent Unemployment”. He ends the article like this: “By presenting a multiyear policy proposal, lawmakers will help companies and individuals navigate what is currently a highly fluid and uncertain outlook.” And just ahead of this paragraph, El-Erian gives a hint as to what he wants to see done: “...policy makers should ... come up with a ... strategy that focuses on improving human capital ... education and training; expanding infrastructure and technology investments … by ... encouraging a bigger translation of scientific advances into economy-wide productivity gains...” In my view the country that would benefit the most from such advice would be Japan given that it has an aging population and a shrinking workforce in need of a boost from whatever will make it more productive. As for America, it can certainly benefit from that advice but the country has other needs as well which I shall discuss after expanding on what I mean by balance.
To demonstrate how balance works in engineering I use an example from electronics. When you design an amplifier with several stages you do what is called a coupling between the stages. That is, you build a simple interface circuit via which the signal is transferred from the output of one stage into the input of the next stage. To do this in the most efficient way possible you match the output impedance of one stage with the input impedance of the next. The power will still transfer if the impedances do not match but the higher the mismatch the more power you lose therefore the less efficient you will be. And given that balance means one thing must equal another, there is a mathematical approach that helps in the design of amplifiers. In fact, the use of a mathematical tool called differential calculus comes handy in this regard. But because it takes several years of pre-calculus and at least one year of calculus to understand the subject well, I shall not give a full lesson here. Instead, I shall discuss a simple example which I hope will give a sense of what is involved when using this wonderful branch of mathematics.
Suppose you have a fence that is 20 yards long and you want to make an enclosure that will have the maximum surface area with the condition that the enclosure not be a circle. This means you must make a rectangle of some sort but which rectangle will it be? To find the answer you employ the trial and error method and make a rectangle that is 9 yards long and 1 yard wide. This will use up the 20 yards of the fence since the perimeter, as it is called, is equal to twice the 9 yards of length plus twice the 1 yard of width. You now calculate the surface area of the enclosure and find it to be 9 times 1 equal 9 square yards. You change the configuration of the rectangle and try 8 yards in length and 2 yards in width which results in a surface area of 16 square yards - a little better than before. You now try 7 by 3 and get 21 square yards which is better still. You try 6 by 4 and get the higher value of 24 square yards. And finally, you try 5 by 5 and get 25 square yards which is the maximum surface area you can get with a fence that is 20 yards in length. You conclude that the square is the rectangle that gives the maximum surface area for a given perimeter. And the larger implication of this discovery is that when the two sides of something are in balance with each other (in this case exactly equal to each other) you maximize the value of whatever the thing is.
Instead of employing the method of trial and error you can do the work with calculus and reach the same result. To this end, you set up an equation by letting x be the value of one side of the rectangle. This will make the other side equal to:
(10 - x)
The surface area A of the enclosure will therefore be:
A = x(10 - x) = 10x - x2
(NOTE: the x2 you see here means: x squared)
You recognize the equation:
A = 10x - x2
as being an upside down parabola when traced on a Cartesian graph.
The equation itself is a simple polynomial whose derivative A' is easy to take. It is this:
A' = 10 - 2x
To find the highest point on the parabola which you know will represent the maximum surface area of the rectangle you seek, you make the derivative equal to zero:
A' = 10 - 2x = 0
You solve and find that x = 5
This is the length of one side of the rectangle; the other side will therefore be:
10 - 5 = 5
The two sides being of the same length, the rectangle is actually a square of 5 yards by 5 yards. And this is the result that the trial and error method also gave.
You then make the generalization that to maximize something you must have equilibrium between the two variables that affect the thing. In fact, a similar and more elaborate equation is set up to represent the coupling of electronic circuits. When you solve it, the equation proves that power transfers at maximum efficiency when the output impedance of one stage of the circuit matches (equals) the input impedance of the next stage.
The same should apply to economics where a balance between all its divisions and all its subdivisions should offer a good way to attain maximum growth for a nation's GDP. The problem with economics, however, is that it is not a pure science therefore it has never been possible to use the formulas of the calculus to make predictions that were as exact as those routinely made in science and engineering. But we can put on the hat of the philosopher for a moment and look at the thing this way: We can calculate exactly when a space probe will reach a planet billions of miles away several years from now because we know of all the gravitational forces that will intervene between here and there however vast the empty space between the two points may be. We can also stand at the edge of a precipice, drop a stone and predict exactly when it will hit the ground because no factor will intervene in the interim save for the air whose negligible drag on the stone may be ignored or may be included in the calculation. But if we take that same stone, go on top of a mountain and let it roll down the side of the mountain - attracted by the gravitational pull of the Earth - we cannot predict the exact trajectory that the stone will take or when and where it will stop. And this is because the intervening factors will be hard to determine given the irregular shape of the mountain's side and the infinite number of factors that may intervene throughout the trajectory.
Armed with this insight, we can use it in our approach to economics which has to deal with millions of unpredictable human beings each making hundreds of decisions every day that have the potential to affect the final outcome. That is, in the same way that we can only predict the stone will roll down the side of the mountain till it reaches the ground or be stopped by an obstacle that will retain it at a higher level, we can only predict that the growth of the GDP in a given economy will reach an approximate level and help to solve the problem of unemployment or fail to do so. And of course, all of this is predicated on the assumption that nothing unexpected will intervene in a big way - in which case all bets will be off.
And so we may say that science has given us an insight but not an exact formula to use when designing economic models we wish to make as efficient as possible under circumstances we cannot always foresee. The insight is a simple principle that says all parts of the economic model must be maintained at equilibrium at all time. And this prompts us to seek the answer to questions like these: What happens on the macro level when the two divisions of an economy, mainly the production side and the consumption side are maintained in balance? What happens on the micro level when the import part and the export part of an economy are maintained in balance? And why is it that when a nation, a company or a household maintain their balance sheet at equilibrium, the enterprise operates at maximum efficiency? And so on and so forth.
These questions and all those in the same vein can be answered by making one analogy that will apply to all. Imagine you have a backyard where you may conduct an experiment. You build a four legged stand that is about five feet high, and you place a basin on top of it. You bring a water hose to a faucet that you fasten to the rim of the basin, and you drill a small drain hole at the bottom of the basin. You open the faucet just a little and see the water go to the drain from where it flows out. You increase the incoming water and see a corresponding increase in the outgoing flow. You keep increasing the incoming water till the drain hole can no longer keep up with it at which point the basin gradually fills up with the excess water. You remark that there was a time when the inflow (the production) was less than the potential for outflow (the consumption), and you conclude that the system was not efficient during this time because you did not operate it at maximum potential. On the other hand, there was a time when the production was greater than the consumption, and this also meant that the system was not efficient because some of the resource (the water) that could have been used to do work was stored in the basin instead. Thus, the most efficient moment must have come when the outflow exactly equaled the inflow, meaning the consumption side of the system exactly matched the production side.
This principle applies at the macro level when speaking of a national economy and applies at the micro level when speaking of a single company or even a household. Indeed, some Japanese companies use the principle in a procedure they call “just in time” where the raw materials and the components that enter into the manufacture of what they produce arrive just in time before being processed and/or assembled into the final product. The procedure saves the companies having to go through the routine of cataloging the incoming materials and components, warehousing them and requisitioning them when they are needed. And this is one of the ways that the Japanese have developed to alleviate their demographic shortcomings thus be as efficient as they can be given their circumstances.
But is this method good enough for everyone to adopt? Well, we can immediately see that it would not be good for a country that has a high rate of unemployment such as it is in the United States at this time. But there is also the fact that it is questionable even for a country like Japan because it has a side effect that can neutralize its benefit. The catch here is what is known in science as spurious noise. This is a distortion that can intrude unexpectedly on the operation of a system and change its outcome a little or change it a lot depending on the force of the intrusion. Consequently, it is prudent to have a warehouse of some sort where reserves are maintained and used when the operation does not go as well as expected. Indeed, a trade-off is made whereby a little efficiency is sacrificed in exchange for a corresponding amount of security. In this spirit, families keep money on the side for a rainy day; banks are required by law to maintain some reserves; importers and exporters maintain a certain level of inventory in a warehouse to keep the operation going if and when the supply lines are interrupted. And the list goes on.
Contrary to the Japanese, the Europeans had opted at one time for what they called the philosophy of sustainable growth which meant the adoption of a leisurely approach to life and work. But after two decades of this, something went wrong in that the Asians started to eat the European lunch and grow more voracious with the passage of time. All the while, the Europeans could do nothing in response because the answer would have been to compete against cheap labor with cheaper labor. But there stood the United States of America seemingly doing well in the face of the Asian onslaught, a sight that prompted some European countries to emulate America by borrowing and spending their way into an apparent prosperity. Then came the near meltdown of 2008 which began in America and ended up threatening the European ideal itself, a development that forced the Europeans to rethink their stance. They are still thinking, and the bet is that they will revert back to something like their old approach because no alternative is in sight as yet. This is especially true in a place like Spain where the unemployment rate has hit the 20% level, and everyone was forced to take a leisurely approach to life and work whether or not they liked the idea in the first place.
What should America do now?
To put it simply, any country that has a population larger than a family must plan for the essentials of life and produce at least some of the food it eats, some of the clothes it wears and some of the building material it needs to shelter itself. What every country must avoid is court danger by repeating what the Japanese did in the decade of the Nineteen Eighties when they abandoned the production of the essentials of life in favor of producing high value added products, something they did by pursuing the idea of coming up with “one new invention everyday,” the description given to the mind boggling pursuit they adopted as a national pastime. The Japanese engaged in this pursuit despite the reality that 80% of the expenses made by an average household to buy goods actually go toward the three essential sectors of the economy and not the ephemeral gadgets that may look appealing when they first come out but are useless after the novelty has passed. And when tough times hit, the people reduce what they spend on trivial matters to save the money they have and spend it on food, clothes and housing during the uncertain days that loom ahead.
And the people who today predict that China will eventually abandon the production of low value added products to move up the high value added ladder are making a mistake. From China to Egypt, from India to Jordan and from Brazil to Peru, the countries have learned the lesson of Japan and they will never abandon the activities they know they can count on to keep their economies humming when tough times hit. These countries and all the emerging ones will keep producing the most mundane of goods as they proceed with plans to embrace the leading edge technologies of the time, most of which will come and go; very few of which will withstand the test of time, become a classic and live long enough to prove worthy of the paper on which they were conceived.
Thus, with a population that exceeds 100 million families, America should look again at the industries it has abandoned, especially that they were mostly of the labor intensive type. These industries would have been extremely beneficial to the economy at this time in that they would have brought the balance of trade into a better balance by allowing the country to import less and perhaps export more. Such industries would also have benefited the unemployed by matching the existing labor force with the needs of the labor market thus alleviating the pain of the people who are struggling to find a job - any kind of job - in this period of high unemployment and highly uncertain times. Employment is America's most urgent need today, and to encourage “a bigger translation of scientific advances into economy-wide productivity gains...” like says El-Erian will be good for America when times get back to normal but not now.
To conclude, the political leaders of America must match the actions they take with the economic potential of the country. They should do this even if it means negotiating with a number of other countries to obtain an exemption from some international treaties America has previously signed and has pledged to respect. Concerned about social stability, the Chinese have for all intents and purposes declared force majeure and have traded their currency at a low level to suit their needs, and they have thus become efficient in their own way. So can America show concern about its employment situation, declare force majeure and revive its labor intensive industries by subsidizing them and by erecting various economic barriers to match its own needs and become efficient in its own way.
This is not an emotional tit for tat; it is being rational.