May 11, 2012

Scenario Consultant Perspective: Friday's Naive Two-By-Two Matrix

Patrick Marren

Paul Krugman has a column in the New York Times today ( entitled "Easy Useless Economics." But he seems to offer in response not "Hard Useful Economics" but rather something like "Easy Useful Economics." Some alternative scenarios leap to mind.

Krugman, the 2008 Nobelist in Economics, calls out those who say that the current unemployment is "structural." He says that, "Instead, the economy has bled jobs across the board, in just about every sector and every occupation, just as it did in the 1930s." And the solution now is the solution that ultimately got us out of the Depression: the scale of massive government spending that accompanied the buildup for World War II. 

Since I am a consultant, a two-by-two matrix of course leaps to mind. Since I am a scenario consultant, I take a completely agnostic view as to which quadrant will prove to be "correct," what the probabilities are, etc. etc. (I have my opinions, of course, as most people do - but professionally, I hold myself to either a higher standard or a dumber standard, depending on how you want to view it.)

The two dimensions of the matrix would be "Cyclical/Structural" on one axis, and "Government Spending/Austerity" on the other.

In Quadrant I, "Structural/Austerity," we find a world in which the nature of our currently high unemployment turns out to have been "structural," or as Krugman defines it, "American workers are stuck in the wrong industries or with the wrong skills." (In other words, really and secretly, Krugman is wrong and Raghuram Rajan and the other "Structuralistas" are right.) For some reason (perhaps because of rapid change and inflexibility of American workers used to doing things a certain way, and used to a certain lifestyle, reacting too slowly to more productive and/or cheaper workers overseas), higher than historically normal unemployment persists, or the adjustment to lower unemployment has been long and painful. At the same time, due either to a political consensus that government stimulus spending is of no use, or else because of a lack of consensus that it DOES work, the government does not spend to help relieve this persistently high unemployment. What's the result? Well, it depends on what you believe. Clearly unemployment has not decreased rapidly, because it is "structural." But would government spending have helped? No -- we have already stipulated that Rajan et al. were right. So what you will see is what appears to be suboptimal employment, with the "cyclical" economists insisting (as Krugman does today) that government spending would have saved the day, and "structuralistas" insisting that nothing more could have been done -- correctly. Since we are omniscient scenario-writers, we know that Rajan was right -- but the unhappy inhabitants of our future cannot know this, so they may find it difficult to choose between the structuralist fatalists and the frustrated Krugman activists.

In Quadrant II, "Structural/Government Spending," we find another world in which the nature of our currently high unemployment turns out to have been "structural," Rajan et al. are correct, and Krugman, beknownst only to us scenario writers and matricizers, was wrong. Higher than historically normal unemployment persists despite lots of government spending.  So what's the result? Well, we secretly know who was right. But for the inhabitants of our unhappy future, it depends on what they want to believe. Clearly unemployment has not decreased enough, because it is "structural." But would LESS government spending have helped? Again, they can't know, even if we do. So what they will see is what appears to be suboptimal employment, with the "cyclical" economists insisting (as Krugman does today) that government spending has been inadequate and things would have been worse without the stimulus we have had; and "structuralistas" saying that they have been proven right -- stimulus simply doesn't work. Even more like today.

In Quadrant III, we have "Cyclical/Government Spending." Presumably, saying our 2012 unemployment was merely cyclical means that in the future it has declined toward long-run averages, or maybe even below (hence the cycle -- when it's not high, it's probably low). More serious government stimulus spending has occurred. This is Krugman World. Paul receives another Nobel, and claims credit for "End[ing] This Depression Now" [title of his 2012 book, which I will review in a subsequent blog entry, god willing and the creek don't rise]. Structural economists, even though we alone secretly know they were wrong, will of course say that government spending had little or no (or negative) impact on the long-run adjustment of the private sector to the new economic realities. Again, the inhabitants of this future cannot know who is actually right.

In Quadrant IV, we have "Cyclical/Austerity." Unemployment turns out to be cyclical in nature -- Krugman was right; but the government does little spending to combat it, as the "Structuralistas" recommend. But adjustment is painful, so Krugman claims, correctly, that he is right -- doing nothing doesn't help. The structuralists wrongly claim they are right, and that government spending would do nothing to help unemployed worker . There is no sure way for the poor future Americans to judge between them.

What conclusions can we draw from these crude scenarios?  Not much, in the absence of other elements.  That's why our scenarios never stop at two dimensions.  It is very difficult to draw strong conclusions from such a bare-bones framework.

But notice that there is one constant through all four scenarios: No matter what happens, economists of all stripes still claim they are right.

This, in my 20 years' experience as a scenario writer, is one of the very tiny set of assumptions that you can safely make about the future, no matter how it evolves.  No economist will ever admit to having been proved wrong about anything, ever.