The Elastic Economy

Arnold Kling’s superb Tech Central Station article on the elastic economy makes a lot of very important points, and ties up quite a few conceptual loose ends into a neat analysis. Kling argues that over the past 50 years the economy has become more elastic, more robust, and better able to adjust to unanticipated changes.

One way to describe the elastic economy is that it has become more complex. Human wants continue to be relatively simple and basic. The fundamental resources, such as land and labor, are the same. However, there has been an explosion in the variety of ways of converting the fundamental resources into products and services that satisfy basic human wants. There are a large number of paths leading from resources to satisfaction, and just as with the Internet, a variety of paths diminishes the dependence on any one path, making the system as a whole more robust.

This is a profound point. It may sound like a simple consequence of substitutability, but it’s more than that — it’s substitutability plus the wide and varied breadth of human creativity applied to both consumption and production. The consequences of the increased elasticity for government regulation are similarly profound, and as Kling points out, ignoring the effects of substitutabiity and human creativity will increasingly lead to static regulatory institutions that produce bad, unintended outcomes.

Finally, in an elastic economy, as the market becomes more robust, government regulation becomes more clumsy. Price controls become more damaging, as the California energy crisis of two years ago illustrates. Regulatory mandates, such as CAFE fuel economy standards, deliver poor benefits relative to compliance costs. Labor market rigidities become even more dysfunctional, as is shown by the dismal performance of France and Germany.

Overall, the developments that lead to an elastic economy are extending the advantages that the U.S. has over more socialized countries. Centralized bureaucracies become less functional as the economy becomes more elastic. On the other hand, the private sector has become more chaotic but more robust.

And one of the big producers of stasis in this increasingly robust system is a political and regulatory environment that values control and dislikes that appearance of chaos. It may be rather cynical, but I would argue that politicians and other policymakers dislike this increasingly elastic economy because it decreases their sphere of control and influence.

One of the reasons that I find economics so fascinating is its seemingly paradoxical results — the invisible hand says that by acting in your own interests you create value for yourself and for others. Similarly, by being willing to relinquish control you create a more valuable, robust, and stable system. We need to get over that control freak thing.