Scarcity

I was told an objection to the Robinson Crusoe/Friday example I gave is that it does not express the scarcity inherent in a modern economy. Specifically, just because Robinson Crusoe doesn’t want to decorate his hut with Friday’s flowers, it doesn’t mean that they’re suddenly worthless. Someone else will buy them for hut decoration at a slightly cheaper price, or they will be used as a product in making flower garlands, or something. More specifically, demand is in some sense robust, and products can be substituted. Now, this is all true, but I was creating a very simple economy to illustrate one idea. But contrary to what was said, the idea of Recalculation does not depend on ignoring scarcity.

Suppose we have a modern economy at equilibrium. There is however much wheat being produced. Then, a few people don’t like bread as much, meaning less demand for bread and hence wheat. Well, this means the price of bread and wheat falls slightly, and because the price is lower, a few people buy a bit more bread that they otherwise wouldn’t have. Also, a bit less wheat goes into making bread and a bit more into making beer. Hence all the wheat is sold, and we are at equilibrium at a slightly lower price. Scarcity makes things robust. Note that things are REALLY robust, because as a second order effect wheat farming has just become a little less profitable, so in the long term farmers will produce a little less wheat and a little more barley, and this will push the price of wheat up a little. So the economy easily finds a new equilibrium, with a marginally lower price for grain.

But notice that all this analysis is at the margin, and substitution is very easy. This is not always the case, particularly in terms of production, i.e. the second order effect. You can turn a wheat field into a barley field quite easily, but if you want to turn your car factory into an iPod factory, then so much of your current plant is useless. And if the transition is hard for the physical capital, think how much worse it is for the human capital. If there is a little less demand for accountants, accountancy firms recruit a little less and fire a little more, salaries go down a little, a few accountants use their skills to transfer to other fields, the lower salaries mean slightly fewer people study accountancy, all is well. Now imagine that demand for accountants falls in half. Suddenly there are mass redundancies in accountancy, and recruitment stops entirely. It was fine for a few accountants to find related work in other fields, but hundreds of thousands can’t do this all at once. If this a long-term thing, these people need to retrain, which will take a very long time – they have permanently lost a huge amount of their human capital. And in fact, these people do not even know if the problem is short-term or long-term. For now they are paralysed.

In a modern economy, where so much of the capital is human capital, and even organisation-specific human capital, this difficulty is therefore huge. And it’s made worse by the extremely complicated ways that products are brought to market these days. That’s why I laugh at the idea that scarcity is an objection to recalculation. Unlike what Bill Woolsey thinks, the problem is not that the bricks, lumber, and so on that used to go into housebuilding can’t be put to other productive uses within the framework of the existing economy. Of course they can! The problem is the construction workers, estate agents, surveyors, mortgage analysts, etc etc. They’re much harder to switch over, and there aren’t proper price signals for seemingly ZMP human capital because of co-ordination problems.

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