The Hidden Flaw in Our Economy: Why Didn’t Our Economic Policies Work?

(repost from the Huffington Post, March 8, 2013)

by Luke Ho-Hyung Lee

Revitalizing the economy is now the most important national issue facing not only the United States, but all the G-20 nations, including Japan, Korea and many Euro zone countries.  Even though each country has tried almost every possible policy and investment to revitalize their respective economies, most of them have not been effective.     

Why have the existing policies not been effective?  Why did this situation happen in the first place?  Even though many experts are studying this issue, none have found clear answers, let alone a solution.  Could they be looking in the wrong place?  Or have they missed something crucial in their thinking about the economy?

By way of explanation, I would suggest considering the economic impact of newly developed virtual supply-chain systems in the last three decades of the Modern Information Age.

Conventional systems in the supply chain

Let’s think of the manufacturing and supply chain network – from product manufacturer to distributor to retailer and finally to the consumer.  There were the narrow and curved countryside roads to drive, the mountains to pass, and the rivers to cross between suppliers and customers.  As usual, to increase the delivery speed and efficiency, we have tried to construct highways for the countryside roads, tunnels for the mountains, and bridges for the rivers between them.

In this case, however, let’s imagine that the highways, tunnels, and bridges were all privately developed and owned (mostly, by big companies).  Moreover, the owners weren’t interested in opening these transportation facilities to the public – not even to collect tolls.  They simply wanted the highway-tunnel-bridge system for their own, private use because of its competitive advantage.

What would have happened next in our economy and society?

The most likely development would have been that, due to the superior position of big companies in efficiency, the businesses of small- and medium-size companies would have weakened and eventually been destroyed, and accordingly many jobs in these companies would also have disappeared.  Job creation in the market as a whole would have suffered as demand fell.  In addition, while the profitability of the general service industry fell precipitously, we would have experienced a vicious deflationary cycle with rapid reduction of total consumption.  Correspondingly, the expanding gap between poor and rich would have become inevitable.… Our society could have experienced increasing social and political unrest.… 

In this scenario, what actions would national governments have taken?  First of all, they would have adopted a series of powerful expansionary monetary and fiscal policies and stimulus plans aimed at preventing truly vicious deflation due to reduced total consumption, and activated deregulation to revive the overall market.  Moreover, in order to calm social unrest, the implementation of generous welfare policies would have been unavoidable.  As a result, many national fiscal statuses would have continued to worsen after a lag, pushing weaker national economies toward default.

This looks uncannily like the situation that the world economy including the US has experienced over the last several years.

Fortunately, however, rationally run countries actually have never allowed this hypothetical case to happen.  That is, they have developed many open transportation infrastructural facilities for the public.

But, unfortunately, such rational development has not been the mark of the Modern Information Age.

Newly developed virtual supply chain systems in the Modern Information Age

A business could also improve the efficiency and speed of delivery by using advanced networking, or virtual, systems.  No matter how great the distance nor how complex the connection, whoever is responsible for a function is always clear in a virtual system.  As a result, outsourcing became possible for numerous functions in a supply chain.

We have developed virtual logistics systems and other collaborative functions in the supply chain through the use of IT and advanced networking systems.  Moreover, many companies (mostly big companies) have developed virtual supply chain networks by vertically and horizontally integrating logistics and similar collaborative functions.  The aim was to reduce the number of transactions and functions in supply chains and to improve the efficiency of collaborative functions.

Zara’s case is an example.  Zara, the largest clothing company in the world, developed an information-based supply chain network by vertically and horizontally integrating its logistics and collaborative functions through the use of IT and networking technology and now needs just two weeks to develop a new product and get it to stores, compared with a six-month industry average .  This enables Zara to launch around 10,000 new designs each year, far outdistancing its competition.

But what happened to others in the industry?  Most of Zara’s collaborators--small designers, manufacturers, and stores--became much less competitive than Zara, which absorbed only a few of them.  As we have come to expect, the employment situation for middle- and lower-income workers in this industry relentlessly worsened.  Zara’s IT imitators are now legion all over the market.

A serious flaw in our economy

Without being aware of the larger economic implications, our rationally run countries have accepted privately owned information-based supply chain networks as an economic necessity without calculating the consequences of such a decision.  As a matter of course, most of these networks have been developed by large companies and are used only for their own benefit.  Moreover, even if it is hard to believe, no similar public infrastructure has emerged at all--not a single one in the whole world. This is just as if all physical transportation facilities were privately owned and used only for the owner’s profit!

I believe this has become the hidden driver of the current economic crisis.  It increases the barrier price of entry for new businesses, and it perpetrates bloated costs of doing business in distorted markets.  It also accounts for distortions in demand and in labor.

What should we do for our distorted economy?

We must first repair this flaw by constructing a new public information-based supply chain infrastructure for modern IT-based markets in tradeable goods and services. 

Unfair conditions for small- and medium-size companies and accordingly also for middle- and lower-income workers now permeate the markets that make up the economy as a whole.  Economic policies not taking modern supply chains into account will continue to fail, and will produce no full economic recovery, because enormous amounts of capital are required to feed the oligopolies that emerged from the electronic revolution in private supply chains.

I believe it possible to ensure fair conditions in the market and restore a rationally-run economy along the lines of absolute competition.  This alternative to our current distorted markets will be relatively painless to implement, and over time will eliminate the fruitless economic policies of the past by making them unnecessary.