Sunday, November 28, 2010

“It’s the Market Process, Stupid.” – May 9, 2008

<Note: This article was written on May 9, 2008 by Luke Ho-Hyung Lee.

In order to avert a recession, the Fed reduced its key interest rate from 2.25% to 2.0 on April 30, 2008. The price of oil rose to a new record of over $135 a barrel (May, 2008), more than twice what it had been a year previously. The Dow was still hovering above 12,000 (a considerable decline from the dizzying heights before the subprime collapse), but the worst was yet to come. As the 2008 presidential election reached its climax, we were about to witness the nadir, a Dow in the 7,000’s by year’s end. This was not a time for hope and change, but one of fear and trembling.

Borrowing a phrase made popular by President Bill Clinton when he defeated George Herbert Walker Bush for the presidency in 1992 (“It’s the economy, stupid!”), I called this article, “It’s the Market Process, Stupid”. I was hoping that the candidates running for president would heed the warnings, but as it turned out neither of them did. In near exasperation, I wanted to call attention to the horrible state of the market structure. But nobody was listening. It’s time to make drastic changes, before it is too late. That’s what this article is about.>

Nobody will deny that THE current issue is the economy. But, politicians, take heed, it’s not the economy, stupid; it’s the market process. Even though a raft of more economic troubles seems to be coming, there is not the slightest sign of solving the present economic malaise that afflicts us. I’m referring of course to the financial crisis caused by sub-prime mortgage failures, and housing market troubles in general.

Most economic experts have identified massive monetary liquidity, formed in the market over the last several years, as the main cause of the economic malaise. They think that due to high monetary liquidity formed by aggressive expansionary fiscal and monetary policies, a bubble must have been built into the equity market across the board, such as in the housing market and the stock market. This bubble burst is thus linked to the collapse of the housing market. It is what brought about the failure of the sub-prime mortgage system and the turmoil of the stock market. Also, this high monetary liquidity could cause more serious economic troubles with the threat of inflation. Some economic experts even blame Alan Greenspan, former Federal Reserve board chairman, as a cause of the current economic troubles for his policies that caused this high monetary liquidity in the first place. While we’re at it, let’s blame the Bush administration for its support of high monetary liquidity by increasing government spending and adopting tax reduction policies.

In spite of these events, economic experts still cannot suggest clear solutions for these economic troubles. That is because most solutions they suggest are only expedients to escape from the most urgent risks and put off the real healing for the future simply by maintaining the status quo. It could be said that most of their plans contain more potential to amplify future problems, rather than get us out of this mess.

Even in this vortex of doom, many new opinions about causes have been appearing. They say that it’s low consumer spending, the negative employment condition, the credit crunch, the low consumer saving rate, the high trade deficit or even the high federal budget deficit. However, their recommended solutions still remain ambiguous and abstract.

Then what is wrong? Why don’t we find the clear solutions for these problems? The reason is that the supposed causes, which numerous economic experts have suggested until now, are not the real ones. That is, the causes they have suggested are not genuine causes, but simply the secondary results made by some other unidentified cause. Therefore, the solutions for these secondary results cannot solve the real causes, but only temporarily postpone the most serious risks.

Then, what is the real cause of the current economic breakdown?

It’s the market process.

I realize of course that what I’m recommending smacks of economic heresy. Nobody in their right mind has suggested changing the market process. Why now? Because the market process needs fine tuning for the changed market circumstances. It’s past the point where it will fix itself. The existing market systems, which support the present market process, are outmoded for the Modern Information Age. I do not believe in paying homage to sacred cows, like the so-called “Invisible Hand” everyone learned about in introductory economics. If you think I’m suggesting we re-think the market process, then that is precisely what I’m suggesting. Our economic future depends on it.

The Relationship between Communication Changes and Market Process

In the Agricultural Age, when communication was person to person, and transportation was still in a very primitive stage, transactions among people were mainly through barter or through the early village or town markets, which were formed locally.

In the Industrial Age, information sharing and exchanges among people were more widespread. Communications between remote areas were now made possible by the development of the telegraph and telephone, and were accompanied by revolutionary developments in transportation. With these developments, the economy took on a three-tiered functional market process. To manage and develop the economy soundly under this new market process, some of our basic economic principles demanded re-evaluation. It’s time to do that again.

This three-tiered functional market process continued to develop into the two-tiered functional market process, such as that exhibited by the big chain stores in the early twentieth century. These forerunners of the shopping center were made possible by the development of radio and television, by the continuous development of transportation, and by the revolutionary development of inventory control through a bar-code system.

These market processes reflected the new capability of communication and transportation. Accordingly, they could provide relative efficiency and effectiveness. In realizing this, they also created new businesses and jobs to the degree we take for granted today.

Because these market processes were developed with locally restricted, single-source based communication, their development and operation were installed relatively easily. That is, because the effects from them were relatively simple, the business estimate for them was relatively easily and accurately gauged.
Fast forward now to the Modern Information Age. Communication has been transferred from existing single-source based communication to multiple-source based communication. Moreover, with the development of networking technology, these multiple-source based communications could be integrated. Because this multiple- source based networked communication is very economical all over the world, and also possible in all directions, its impact was far greater than first imagined. The result is a new paradigm, which could create far greater effects on efficiency and effectiveness than the existing one could ever make. That is, the single-source based communication, from which only simple arithmetical changes could be expected, had developed into the multiple-source based networked communication, from which geometrically progressive changes could be expected. Moreover, by breaking down the existing local restrictions through the development of the World Wide Web, it could be said that communication was no longer restricted by time and space.

Despite the advantages, these communication changes may have in a sense occurred too rapidly and abruptly. Insufficient thought has been given to how to apply them to other areas, especially to the market process. As a result, we have lost a propitious moment to apply them to the market process, and numerous abnormal phenomena have accumulated in the market and society as a result. What has resulted is the current economic malaise we find ourselves in.

The Role of the Existing Functional Market Process in the Modern Information Age

The existing functional market process is built on a single-source based communication foundation. As such, only simple arithmetical changes of effects on efficiency and effectiveness can be expected from it. Moreover, the creation of new businesses and jobs in an arithmetical way is all that can be expected. We need to fix that. We start by looking at what happened when communication developed from single-source based communication to multiple-source based networked communication, while at the same time the functional market process remained unchanged.

The paramount factors are these – and notice how they are interrelated and interconnected:

  1. The existing functional market process could not have provided satisfactory consuming effects structurally to the market. This is because only arithmetical changes of effects on efficiency and effectiveness could be expected from the existing functional market process. On the contrary, the market, which has been directly influenced by the new communication paradigm, has required more multiplying or geometrically progressive changes. Thus there must have occurred some gaps structurally between the consuming effects provided by the existing functional market process and the market requirement.
  1. Theses structural gaps must eventually have appeared as the missing phenomena of consumer spending in the market. That is, because consumer needs and wants increase faster than consuming effects, consumer spending will eventually be curtailed.
  1. Because the existing functional market process could create new businesses and jobs only in an arithmetical way it could not create enough income to satisfy existing market requirements. It’s as if consumer spending was held back due to the limitations of the market process.
  1. This curtailment of consumer spending must have caused an abrupt increase of consumer price sensitivity, and this must also have caused the abrupt increase of excessive price competition in the market. This situation must have developed concomitantly with the rapid expansion of efficiency-increase-oriented (cost-oriented) globalization activities such as off-shoring and outsourcing toward foreign countries with lower labor costs, and this must also eventually have been directly linked to the decrease of jobs or the reduction of income for lower- and middle-income people in the domestic market. Accordingly, the inequality of earnings between affluent and poor was aggravated.
  1. Moreover, because the existing functional market process has a fixed and closed marketing channel, it could not have handled all products or services. Keep in mind that there has been an vast increase in numbers and kinds of new products and services in the Modern Information Age and this should have required more marketing and distribution costs for new products or services. What this means is that the existing functional market process has actually impeded the creation of new businesses and jobs in the domestic market.
  1. If this situation continues, a vicious cycle will persist between the supply side and the demand side in the domestic market.

Finally, the government has adopted very powerful and ambitious economic policies in an effort to prevent this vicious cycle from occurring and attempted to revitalize the economy. However, it could be also said that the effect of many economic policies, adopted without having made changes in the existing functional market process, will generate little improvement.

The Role of Economic Policies with Existing Functional Market Process in the Modern Information Age

The prevailing free market paradigm has been predicated on the so-called 'Invisible Hand', because general factors, such as interest rate, money supply, tax, employment, and so on, could have chain effects that were easily traceable, and easy and accurate to estimate. Under these circumstances, it was possible to estimate how these general factors influence demand and supply. Therefore, the problems of demand and supply in the economy could also be solved by the fine tuning of these general factors.

The rapid development of the Modern Information Age over the last 20 years has quite simply changed the preliminary conditions for the efficient and effective estimate of a market economy, as follows:

  1. A perfectly competitive condition has been changed into an excessive and severe competitive condition, especially in a price-oriented competitive market.
  1. Due to globalization, the meaning of the efficiently restricted market range was curtailed. In other words, the market range has already spread to the whole world, and thus the restriction for communication and transaction is rapidly becoming meaningless.
  1. Due to the development of multiple-source based networked communication, the estimate on chain effect has already been reduced to near nonsense, and the role of autonomous systematic discipline for the market or economy has been lost.
  1. Therefore, it could be said that the role of dominant economic theory has been already shrunk to the extent of being meaningless in its predictive powers for the new globalized world.

Yet, even though conditions have changed, we have still stood by the economic policies of the past, despite the adverse impacts that can now be plainly seen.

While expansionary economic policies have served us well for directly maintaining or increasing the level of consumer spending, they have done nothing to stimulate economic revitalization. Due to the continuation of these policies, numerous abnormal phenomena and problems have accumulated in the market.

The recent high federal budget deficit, high monetary liquidity, high trade deficit, high inflation potential, and low consumer saving rate are the results from these accumulated abnormal phenomena and problems.

It seems that economic experts still do not recognize the reason and necessity about why the existing market process should be changed, and as they try to find solutions, they compulsively stick to their existing assumptions and principles. Their theories are rather becoming more complicated, ambiguous, and abstract.

Conclusion and Recommendation

The first step to get the economy back on track will be the construction of a stable relationship between the changed communication scene and the market process. That is, efficiency and effectiveness cannot be derived from them until they develop a mutually proper communication to go with a stable market process. If they do not, then the kinds of abnormalities and what economists call externalities (i.e., unintended consequences) cited above will persist.

In looking back at the last 20 years, I believe that communication has developed rapidly through the digital revolution and internet revolution -- from the existing paradigm of single-source based communication to the new paradigm of multiple-source based networked communication. But at the same time, the market process has remained virtually unchanged. For this reason, the variegated abnormal phenomena and problems we are experiencing now can hardly be surprising as we look back at economic events just over the past year.

By implementing the existing expansionary economic policies where the mutually “improper-unstable” relationship between the changed communication and the existing market process has remained in place, it seems that government decision makers have served to institutionalize abnormal phenomena and problems in the market rather than to revitalize the economy.

Therefore, it can be said that the real cause for the current economic malaise will be found in the market process, which is not equipped to handle the needs of the Modern Information Age. For that reason, it can also be said that the development of a new market process with more suitable market systems to the Modern Information Age must be the starting point to solve these numerous economic problems. If a new stable market process is not developed soon, economic problems will persist; and accordingly, national competitiveness, national prosperity, and the welfare and safety of the nation will fall into a graver danger.

Because the development of this new market process will eventually require changing the paradigm of the existing market process, resistance to such changes must also be expected. In addition, the development of new assumptions and principles for the changed new economic circumstances will be needed, and a re-thinking of old economic theories into new ones.

On a positive note, the conditions and circumstances for the development of a new market process are already in place. If decision makers are willing to make the hard choices, it will be relatively easy to implement.

Therefore, we recommend that all government, academic, and corporate heads should work together to find a solution to our economic revitalization through the development of a new market process better suited to the Modern Information Age. This means the development of more effective economic policies for the Modern Information Age. Especially, this means the active assistance and support from the government. New political leadership in January 2009 will be a good time to start, and none to soon. To all who are running for president, both Democrat and Republican: It’s the market process . . .

Written by: Ho-Hyung Lee ( - Ho-Hyung (“Luke”) Lee is by training a lawyer, an international businessman and entrepreneur – and an inventor. He is currently the CEO of UBIMS, Inc. ("Ubiquitous Market System").

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