In the model of the economy as a GDP factory, the most fundamental equation is the production function, Y = f(K,L).
This says that total output (Y) is determined by the total amount of capital (K) and the total amount of labor (L).
Let me stipulate that the economy is legible to the extent that this model can be applied usefully to explain economic developments. I want to point out that the economy, while never as legible as economists might have thought, is rapidly becoming less legible.
For example, the analysis of changes in the trend in productivity requires extremely fine legibility. You start with the measure of Y/L, which is problematic, because you have to add together disparate goods and services to get Y. You have to aggregate all sorts of different specialized workers to get L. Next, to get a trend in productivity, you have to compare Y/L between two periods relatively far apart, say 1986 and 2016. The difference between what you are aggregating then and now is staggering.
Once you look at differences across decades, adjusting for price changes becomes important but impossible. For example, Bret Swanson says that the computing power in his iPhone would have cost $12 million in 1991. If for the purpose of comparing Y/L today to Y/L in 1991 you valued every iPhone at $12 million, you would report an enormous increase in real GDP and hence in productivity.
Finally, to get the change in the productivity trend, you have to attach meaning to the difference of the difference, e.g., the difference between the change in Y/L from 1986 to 2001 and the change in Y/L from 2001 to 2016. That is asking the data to be correct to an additional decimal point.
Here are some other indicators of the decline in legibility:
1. The increasing disconnect between stock prices and earnings. I have made the point about Amazon. In fact, Amazon typifies the decreasing legibility of corporations. Commenters who gave me pushback on Amazon said that they do not think it will end up primarily as a retailer. To me, all the top tech companies have vague business models, particularly if you look ahead several years, and particularly if you compare them with the old industrial giants. Bethlehem made steel. GM made cars. What does FaceGoogle make? Space for ads? Do you think that will still be their primary business five years from now? If so, do you like their prospects? Folks like Ben Thompson seem to think that the business models of all the major tech companies necessarily must evolve radically, which to me makes their future earnings harder to predict.
2. The increasing disconnect between corporate earnings growth and GDP growth. Some of this is due to the fact that a lot of important U.S. corporations are multinationals, so that their earnings are not just a function of what goes on in the U.S. [corrected]
3. The increasing disparities in individual earnings. I bet if you looked at the ratio of the pay of a college president to that of a cafeteria worker today and compared it to that ratio in 1980, it would blow your mind.
4. The increasing disparities in cost of living. I bet if you looked at the ratio of the cost of living in San Francisco to the cost of living in Peoria and compared it to that ratio in 1980, it would blow your mind.
5. Increasing disparities in tastes. The usefulness of a single price index, such as the Consumer Price Index or the GDP deflator, to describe inflation depends on the validity of the assumption of a representative consumer. I don’t see that today. One family shops for groceries at Walmart, and another shops at Whole Foods. One household puts discretionary income into private school for the children, and another puts it into home entertainment.
Still, economists want to treat the economy as if it were legible.
–They tell you that we are in a productivity slump, and we need to explain it and figure out how to solve it. I think that the numbers are not reliable enough to say.
–They tell you that inflation is below target, and central banks are puzzled about how to respond. I think that we see such large changes in relative prices that the very concept of “overall inflation” loses meaning and monetary policy becomes irrelevant until the central banks get into an orgy of money-printing.
–They tell you that “the” real interest rate is low, but what happens if you take health care and education out of the inflation numbers? I mean, if as an entrepreneur you could respond to the scarcity of schools and hospitals (as indicated by rising prices) by borrowing money to launch a new one, then that low real interest rate would mean something. But you can’t do that. Meanwhile, if you’re borrowing to finance a new firm in the solar power business, where prices are going down every year, maybe that interest rate does not look so low.