We Don't Know
By Arnold Kling
Russ Roberts discusses some survey data in which small businesses report that their biggest problem is lack of sales. Some economists have leaped on this as a decisive data point demonstrating that the problem in the economy is aggregate demand, not supply.
I am trying to get away from the paradigm of aggregate demand and aggregate supply. Instead, you might think of an analogy involving the opening and closing of trade routes. If a new trade route opens, there will be new patterns of specialization and more economic activity. If a trade route shuts down, those patterns will be disrupted. Think of a boom as new trade routes opening, and think of a recession as trade routes shutting down. Keep in mind that this is just a metaphor–a trade “route” need not be something physical.
I’ll discuss the empirical issue below.Since I have been promoting the Recalculation Story, many people have been asking for a decisive test of that story versus aggregate demand. I wish I could come up with one. There are lots of bits of evidence that can be construed as supporting one or the other, but nothing that I think is decisive.
I understand that this is very frustrating. It’s not that I am anti-empirical. It’s just that the controlled experiment is not available to us. What is available to us is fragmentary.
Moreover, I am promoting what I see as a different lens through which to view macroeconomics. It is not that “aggregate spending” and “patterns of sustainable specialization and trade” are mutually exclusive. They are two ways of conceptualizing economic activity, and just about any given observation can be interpreted through either lens.
I continue to believe that our best hope for understanding economic activity is from the new data sets on business dynamics and labor market dynamics. So far, the lessons that I think we can take away from these are:
1. The net job creation numbers are very small relative to the gross flows. Even when the economy is booming, millions of people lose their jobs every month. Even when the economy is floundering, millions of people find jobs every month.
2. Fast-growing firms create most of the jobs. These tend to be young firms, but not necessarily small businesses.
3. Young firms also account for a great deal of job destruction. Young firms tend to die at a high rate.
What does it tell us that in a survey many small businesses say that their biggest problem is lack of sales? Based on my experience as an entrepreneur and talking with other entrepreneurs, I would say that if your biggest problem is not sales, then you are in a relatively comfortable, established position. It is a luxury to be able to complain about taxes or regulation or intellectual property theft or some other problem. Sales are the make-or-break issue for most businesses, certainly for any young business.
From a Recalculation Story perspective, it is possible that what is going on these days is a relatively high rate of formation of weak businesses, by which I mean a business that begins without a sufficient customer base. Such businesses are likely to correctly report that their biggest problem is lack of sales, and such businesses have a high probability of experiencing little growth or outright failure.
The formation of weak businesses rather than strong businesses (if that is what is going on) probably reflects the overall business climate. Many folks on my side of the political fence are ready to blame government and throw around “regime uncertainty” as the reason that businesses are weak today. I was asked to endorse that view last month on a CBC TV program, and I pointedly refused. We don’t know. To me, “regime uncertainty” means that you think we might go fascist or Communist, and the likelihood of that seems lower now than at other points in history, even in my lifetime. As much as government may be expanding its reach, I do not believe that policy uncertainty, much less regime uncertainty, is a major factor for the typical entrepreneur.
To me, the overall business climate is difficult because the Great Recalculation exposed some large, established businesses as unsustainable. What many start-ups do is sell to large, established businesses. When the latter are cutting expenses in order to survive, they are not likely to experiment with the offerings of start-ups.
At some point, large businesses will stabilize, and they will start to look for opportunities to reach new markets and achieve new efficiencies. They will increase their purchases from younger companies, and the result will be new patterns of sustainable specialization and trade.
The collapse of mortgage securitization disrupted many trading patterns, in ways that are too complex to trace. For all we know, it may have caused some small manufacturer of agricultural implements to go out of businesses, because those implements were used by farmers to grow some specialty vegetable served on the tables of Manhattan restaurants frequented by securities lawyers.
Going back to the analogy of trade routes, I think that the Internet continues to open up new trade routes. However, the market has not figured out how to best work with those trade routes.
Entrepreneurs are trying to come up with sustainable businesses in today’s environment. They are failing at a high rate. At some point, enough entrepreneurs will achieve enough successes to bring about full employment.
That is the way the economy looks from a Recalculation Story perspective. I wish that there were some decisive empirical evidence that could tell you to use that perspective rather than the Keynesian perspective. However, I do not think the issue is going to be settled with a single data point.
Again, I do not want to be backed into making the choice “aggregate demand or aggregate supply.” Instead, my guess is that if the Recalculation Story gains traction, it will be because people start to look at the JOLTS data and the business dynamics data from the standpoint of the creation and destruction of patterns of sustainable specialization and trade, and in doing so they lose interest in the distinction between aggregate demand and aggregate supply.