Where Has The Trillion Dollars Gone… and Lessons from Albert
We cannot solve our problems with the same thinking we used when we created them. — Albert Einstein
A few days ago I was doing my usual finger exercises with the cable remote when I stumbled on a Charlie Rose interview with Larry Summers, the former Clinton Treasury Secretary and former Head of Obama’s Economic Council. I listened for a few moments and was about to continue with my finger exercise when something Summers said caught my attention. If you were to look at income distribution (i.e., how income is divided among the population) in the United States, and compare the division now to what it was in 1979 you would find something very troubling. If the distribution today was the same as it was in 1979, 80% of the population (mainly the middle classes) would have $1trillion dollars more than it currently has, and the top 1% would have $1trillion less. This comes to about $11,000 per family for the 80%. In discussing the causes of a slow-growth economy and income inequality, Dr. Summers pointed to the lack of demand as the cause, not lack of supply. And, yet, since the time of Ronald Raegan, the emphasis on the government’ response to the economy and its problems has increasingly been on the supply side of the economic equation, with neglect of the demand side.
A prominent economic theory in politics today seems to be that tax cuts for the rich and for corporations are the only way to stimulate the economy. The old concept of the so-called law of supply and demand seems to have been displaced by new schools of economics discounting the demand side as being unimportant. In fact, it is argued that anything done to help the demand side will negatively impact the economy. For example, think about the arguments against increasing the minimum wage. Today the focus is on supply side of economy, i.e., the rich and corporations, to the neglect of the demand side. We do this in spite of the acknowledged fact that the economy is 73% consumer driven. Where does consumer spending fall? On the demand side of the equation.
Why the focus on one side? How did this situation arise? Part of it, has to do with taxes. Everyone hates them. So a theory that purports to improve everyone’s wealth by cutting taxes is very appealing. In other words, it appears elegant. What does it mean for a theory to be elegant? In the vernacular, it means it’s “cool.” It also means it’s simple.
In physics there was an argument over the duality of a physical entity. Is light a wave or a particle? Big names in physics were divided on each side of the argument. Isaac Newton was the biggest proponent of the particle approach with his so-called corpuscle theory. On the other side were Rene Descartes, Robert Hooke, and Christiaan Huygens, all well-known physicists and mathematicians in their own right.
The apparent nail in the coffin to the particle theory came in the mid-19th century, when in 1865, James Clerk Maxwell, the brilliant Sottish mathematician and physicist published a series of equations known, not surprisingly, as Maxwell’s equations. These equations described light as a wave made up of electric and magnetic fields, the so-called electromagnetic waves. Not only were the equations extremely elegant, but they seemed to explain all the aspects of light, such as refraction, diffraction, reflection, etc. Within a decade or so Maxwell’s equations had been anointed as the as the answer to the centuries-old argument by virtually every physicist. Elegance and simplicity (at least to a physicist or mathematician), just like supply side economics.
Then a strange thing happened. While conducting experiments to further verify Maxwell’s laws, Heinrich Hertz accidentally discovered that light can stimulate metals to emit electrons, the so-called photoelectric effect. A seemingly small and unimportant discovery that was to change the world. Solar cells are a prime example of the application of the photoelectric effect. They produce electricity when exposed to sunlight. Not only did Maxwell’s Equations not predict the effect, but when applied in the right manner, they predicted the wrong answer. According to Maxwell’s Equations, varying both the wavelength (we see it as color) and the intensity of the light would change the rate of electron emission. In other words, shine a brighter light on the metal and more electrons should be emitted. Only that isn’t what occurs. Instead, the electrons only respond to the frequency of the light, not the intensity. There was a threshold frequency for each metal below which electrons were not emitted.
So the Maxwell slam dunk was suddenly derailed. His equations no longer described every aspect of light. For the next two decades, physicists searched for an explanation. It took Albert Einstein to provide the solution. His solution required light to act as a particle with a discrete energy based on the light’s frequency (color). But Einstein went a step further. He argued that light was both a wave and a particle and could act in either sense depending on the application. In other words, light consisted of photons that also acted as a wave. Einstein was awarded the Nobel Prize in 1921 for the photoelectric effect. His 1905 paper on the photoelectric effect started a revolution in physics that eventually led to the Quantum Theory (which, in turn, led to inventions such as lasers and electronic semiconductors.) So, in reality, both sides of the argument of the nature of light were right. In some cases you could use the Maxwell’s wave equations and would be correct. In other instances, you needed to use the particle aspect and Quantum Theory.
I think there’s a lesson here that applies to economics. There are two sides to economics, supply and demand. Ignore either side at your own risk. Ignore the fact that the US economy is 73% consumer driven and let the middle class fade away, and then see what happens. Let income inequality continue to expand, and then tell me who’s left to purchase the supply? The laws governing economics are two-sided. Nature tends to prefer equilibrium, i.e., a balance between two forces. For example, our sun operates as a balance, as an equilibrium between the heat generated by nuclear fusion in its core, and its massive gravity, which compresses the hydrogen in the core sufficiently to create the high temperatures required for fusion. When equilibrium is broken in nature, the effect is usually catastrophic. For the sun, when the hydrogen is expended, the equilibrium will break down and the sun will expand into a red giant, ultimately engulfing the Earth. (Don’t worry, that won’t happen for another four billion years.)
For the last three years US corporate profits have been the highest they’ve been in a long time but with minimal job creation (when compared to the increase in profits) and certainly no wage growth for the middle class. One company reported its highest profit in history and still continued to lay people off. We hear the same old arguments. Cut taxes and cut the budget. Forgo investments in our infrastructure. Keep wages suppressed. We’ve seen some recovery but not nearly what should expect at this time after a deep recession/mild depression.
We have a couple of on-going experiments now occurring that should shed some light on this (please excuse the pun). Kansas and Wisconsin. In Kansas we’ve had an extreme case of tax cuts for the wealthy. State budget deficits abound and the economy is lagging the nationwide in its recovery. In Wisconsin, we’ve had a less extreme but still an energetic application of the supply side-only application. When both are compared to Minnesota, which had a more balanced approach, they are significantly lagging Minnesota’s growth numbers. Are these the equivalent in economics to the photoelectric effect? Is it time for a more balanced theory and approach?
As Einstein said, “We cannot solve our problems with the same thinking we used when we created them.” I also think of another more-known Einstein quote: “Insanity: doing the same thing over and over again and expecting different results.”
We need a more balanced approach, one that accounts for both supply and demand. We need a change in thinking. Albert, where are you when we need you?