Saturday, August 06, 2011
Positive Feedback in our Economic System
I learned that a control system is stable if it has negative feedback. To illustrate the concept of feedback, consider the system for regulating the speed of a steam engine. A flyball governor is driven bu a wheel attached to the main drive shaft. The governor operates a lever that changes position if the speed of the engine changes. In a typical arrangement a speed increase causes the lever to move upward and a decrease causes it to move downward. A fixed lever represents the desired speed of the engine. Another lever is connected between the fixed, or set-point lever and the speed lever. This lever, whose position is proportional to the difference between the set-point and the actual speed of the engine, is connected to a mechanism that changes the position of the valve that admits steam to the engine. If the engine speed exceeds the set-point, the linkage causes the steam valve to move toward the closed position. The result is that the engine speed is reduced. If the engine speed is less than the set-point, the same linkage causes the valve to move toward the wide open position, with the result that the engine speed is increased.
With such a control system, whenever the load changes, the engine maintains or comes back to the desired speed. The time required to return to the desired speed depends on the gain or sensitivity of the entire system. Some control systems can very rapidly bring the engine back to the desired speed. Some control systems take some time to bring the engine back to speed.
Now let us suppose that mechanic has made a mistake and connected the parts of the control system incorrectly, such that an increase in engine speed causes the steam valve to open even wider, or a decrease in speed causes it to move toward the closed position. In one case the engine will eventually operate at such a high speed that it may fly to pieces. In the other case the engine will soon shut down completely. Such a system is said to have positive feedback.
I assert that our economic system based on independent suppliers of goods and services and governed by market forces has positive feedback and is inherently unstable. Consider the present predicament of the country. Unemployment is high – around 9 percent. Even workers with jobs are worried about lay-offs. People who do not have jobs have little money to spend. They are using what unemployment insurance they have to eke out their savings to buy as little as possible. Even employed workers are purchasing as little as possible. As a result, there is little demand for goods and services and suppliers are not hiring more workers. As the recession deepens, more workers are laid off and demand for goods and services declines. The feed-back is positive.
Now consider a situation in which there is almost full employment. Workers have money to spend. Everyone is buying goods and services and suppliers have to hire more workers to meet the demand. More workers provide still more customers, and the demand for goods and services increases. The feedback is positive.
We know what happens in each situation. The recession in one case deepens and results in a severe depression. It may take many years for the economy gradually to improve. The exuberance in the other case may lead to a speculative bubble. Certainly the increase in economic activity is limited by the total number of potential workers available. After everyone has a job, the only way to achieve greater production is by using more efficient tools and methods.
In the long run, the economy goes from a “normal” state to either extreme, stays there for a while, and then may change rapidly or slowly to the other extreme. After a peak is reached, the economy can decline rapidly into a recession. Once in recession, the economy climbs slowly back to “normal.” The resulting oscillation in the system is called the “business cycle.”
Economists and politicians have been grappling with this instability problem for centuries. One attempt at a solution that would provide negative feedback is called “Keynesian Economics.” In this approach a strong central government provides the negative feedback by providing temporary employment and unemployment benefits to laid-off workers during a recession and increases taxes on a prosperous population during a boom. The government may also impose regulations to inhibit gambling speculation that occurs during a boom or a bubble. The goal is to smooth out the extremes of the business cycle. Recessions are less severe or deep and booms are less exuberant.
There are some difficulties in implementing the Keynesian solution. The government needs extra money to provide the unemployment benefits and the temporary jobs during a recession. This money can be borrowed, preferably from wealthy individuals within the country. However, the government is required to go into debt and operate at a deficit. During a boom, the government should use extra tax revenue to pay back the debt incurred during the previous recession.
Both of these actions are politically unpopular. Members of the public resent having the government borrow money to provide benefits to unemployed workers during a recession. Such action is contrary to what they are doing. They are tightening their belts and spending less money and giving less to charity, and they think the government should be doing likewise. Also, they resent any increase in taxes, even during good times. They want to keep all their money and spend it on the good things that are available or to speculate on things that seem to be going up and up in price.
Economists and politicians each have important responsibilities. Economists have to develop models of control, like Keynesian Economics, to stabilize the world-wide economic system. Politicians have to implement those models that seem to be the best and explain to the public how the chosen model is supposed to work and why the various actions of government are necessary, even though counter-intuitive. In recent times we have not been well-served by either economists or politicians.