Rory Robertson Designs a Car

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A new high per­for­mance hybrid car has recent­ly been released by a Ror­ing Motors, Inc. Accord­ing to Man­ag­ing Direc­tor Rory Robert­son, the new “GoFlow­Mo­bile” ™© achieves unpar­al­leled per­for­mance for a hybrid car, by apply­ing a sim­ple insight from eco­nom­ics to the hide-bound world of engi­neer­ing.

Mr Robert­son, an econ­o­mist, took over the firm in a hos­tile pri­vate equi­ty bid, because he saw an oppor­tu­ni­ty to bring eco­nom­ic think­ing to bear on the vexed issue of design­ing the world’s fastest hybrid car.

“I read press report after press report about the com­pa­ny’s dif­fi­cul­ties in pro­duc­ing a hybrid car that was as fast as a con­ven­tion­al one”, Mr Robert­son explained, “and sud­den­ly the light dawned: the design­ers were obsessed about all sorts of ratios that involved com­par­ing stocks to flows!”

“As an expe­ri­enced and well-trained econ­o­mist, I knew that com­par­ing a stock to a flow was a school­boy error–like com­par­ing apples with oranges, as Steve Keen does when he com­pares Debt lev­els to GDP. So I saw an oppor­tu­ni­ty to help them make a break­through, and I took it.”

Mr Robert­son’s first direc­tive on arrival at what used to be known as High Per­for­mance Eco­Mo­tors, was that no stock to flow ratios were to be used by the design team. Sure enough, in a short while the fir­m’s engi­neers achieved a dra­mat­ic break­through. The new GoFlow­Mo­bile achieved per­for­mance lev­els befit­ting a Fer­rari, rather than the slug­gish sedan-lev­el per­for­mance that was the best achieved by estab­lished play­ers like Toy­ota and Hon­da.

The tech­ni­cal details behind the car’s suc­cess are pro­tect­ed by numer­ous patents, but Petra Sell­er, our inves­tiga­tive reporter here at Fan­ta­sy Wheels,  man­aged to find out what the key advance was, when she tracked down the com­pa­ny’s recent­ly retired Chief Engi­neer.

Dr StrangeLove, who took advan­tage of an attrac­tive vol­un­tary redun­dan­cy pack­age short­ly before the release of the car,  was will­ing to speak on con­di­tion that the loca­tion of the mine shaft where he now lives was kept secret.

“The car is so much faster than the oppo­si­tion because it weighs so much less”, Dr StrangeLove explained. “And it weighs less because it has a 1 litre petrol tank.”

“The com­par­i­son of the vol­ume of the fuel tank to the car’s rate of con­sump­tion of petrol was an obvi­ous stock to flow com­par­i­son”, Dr StrangeLove explained. “When Mr Rober­ston freed me from the tyran­ny of school­boy stock to flow com­par­isons, I was able to ignore this ratio and focus just on the flow issues.”

“With the same engine size con­sum­ing the same max­i­mum amount of fuel per minute, but a far small­er tank, less petrol weight, far less tub­ing and so on, the car weighs over 200 kilos less than its pre­de­ces­sor. It is also more stream­lined, with no need to design the car around a bulky fuel tank. So it goes 20 per cent faster with the same engine as in the pre­vi­ous mod­el.”

When Petra asked about any draw­backs to this rad­i­cal design, Dr StrangeLove took a while to com­pose him­self before answer­ing that dri­vers would­n’t know about this prob­lem until after they had pur­chased the car, because the car’s adver­tis­ing also made no ref­er­ences to stock to flow com­par­isons.

“This also was  a great effi­cien­cy. Whole pages of PR that used to extol the car’s range between refu­elling stops were eliminated–since this num­ber was also the result of com­par­ing a stock to a flow”, Dr StrangeLove explained, while gig­gling slight­ly.

As his wheel­chair retreat­ed back into the mine­shaft, Dr StrangeLove vol­un­teered the clos­ing remark that the car, hav­ing been inspired by eco­nom­ic the­o­ry, could do its bit to help to resolve the cur­rent eco­nom­ic cri­sis. “I believe there will be plen­ty of work for unem­ployed econ­o­mists now”, he said, “explain­ing to motorists every 10 kilo­me­tres or so that stock to flow com­par­isons don’t mat­ter.”

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OK, for those who don’t know where this came from, one irri­ta­tion I’ve had to deal with when debat­ing the finan­cial cri­sis with neo­clas­si­cal econ­o­mists is the propo­si­tion that my com­par­i­son of the lev­el of debt to GDP is erro­neous, because I am com­par­ing a stock (the out­stand­ing lev­el of debt) to a flow (GDP, which records the mon­e­tary val­ue of out­put pro­duced per year in an econ­o­my). I’ve had this said to me by an RBA Deputy Gov­er­nor, as well as numer­ous eco­nom­ic com­men­ta­tors. Most recent­ly, Rory Robert­son repeat­ed the same claim in a newlet­ter, which Chris Joye repro­duced in an arti­cle in the Busi­ness Spec­ta­tor, Time to buy a dwelling?:

“Dr Steve Keen amongst oth­ers con­tin­ues to make the school­boy error of com­par­ing debt to income (a stock to a flow — apples to oranges) and miss­es the main game. ”

Every time this fur­phy has been thrown my way, I’ve tried to explain why this spe­cif­ic ratio does mat­ter. Any­one who is not an econ­o­mist (a neo­clas­si­cal econ­o­mist, that is!) has got it almost instant­ly. But neo­clas­si­cal econ­o­mists, who know noth­ing about dynam­ic analy­sis, keep com­ing back with this “com­par­ing a stock to a flow is like com­par­ing apples to oranges” non­sense.

While one has to be very care­ful in dynam­ic analy­sis to dif­fer­en­ti­ate stocks from flows, there are many, many times when the ratio between them mat­ters. But get­ting that through to econ­o­mists who have no sig­nif­i­cant train­ing in dynam­ics at all proved sim­ply impos­si­ble.

So I’ve giv­en up on seri­ous dis­cus­sion: maybe satire might get the point through (sor­ry Rory, but in a school­yard sense, you did ask for this one!). Stock to flow com­par­isons mat­ter because they tell you the capac­i­ty of your sys­tem to main­tain a flow. They abound in engi­neer­ing, which is a dis­ci­pline in which dynam­ic analy­sis is cen­tral.

Econ­o­mists don’t get it because their dis­ci­pline is still over­whelm­ing­ly dom­i­nat­ed by sta­t­ic think­ing.

An edu­ca­tion in dynam­ic analy­sis starts with a course in what are known as “Ordi­nary Dif­fer­en­tial Equa­tions”. You can’t grad­u­ate as an Engi­neer with­out hav­ing done at least a semes­ter length course in them, and your career–if you work in design–is dom­i­nat­ed by apply­ing them to invent­ing new man­u­fac­tured goods that (unlike the econ­o­my itself) actu­al­ly work well almost all of the time.

The vast major­i­ty of econ­o­mists, on the oth­er hand, learn what lit­tle math­e­mat­ics they know from oth­er econ­o­mists in cours­es on “Math­e­mat­i­cal Meth­ods for Eco­nom­ics”, or “Econo­met­rics”, and the like. The vast major­i­ty of these courses–certainly at under­grad­u­ate level–teach some alge­bra and cal­cu­lus (oth­er­wise known as dif­fer­en­ti­a­tion), but not dif­fer­en­tial equa­tions (doing the lat­ter requires knowl­edge of cal­cu­lus and alge­bra, but dif­fer­en­tial equa­tions are inher­ent­ly more dif­fi­cult than dif­fer­en­ti­a­tion). The tech­niques econ­o­mists learn are suit­ed to opti­mi­sa­tion, and equi­lib­ri­um cal­cu­la­tions, but are irrel­e­vant to dynam­ics. Dif­fer­en­tial equa­tions, on the oth­er hand, are essen­tial to the under­stand­ing of dynam­ic sys­tems.

At grad­u­ate lev­el, econ­o­mists some­times gain basic knowl­edge of dif­fer­en­tial equa­tions, but in the cours­es I have seen, this stops at what are known as sec­ond order lin­ear equa­tions. Many of the econ­o­mists who teach math­e­mat­i­cal meth­ods to oth­er econ­o­mists don’t know any­thing above this lev­el either. But the inter­est­ing, real-world-rel­e­vant stuff starts with non­lin­ear equa­tions, espe­cial­ly high­er-order ones (with 3 or more inter­act­ing vari­ables). 

As a result, com­ments like Rory’s–that by com­par­ing a stock to a flow I am com­par­ing apples to oranges–look sophis­ti­cat­ed to oth­er econ­o­mists, and might befud­dle peo­ple with no math­e­mat­i­cal train­ing. But in fact, they betray that econ­o­mists aren’t even equipped to under­stand dynam­ic analysis–something that is rather absurd since the econ­o­my is clear­ly dynam­ic.

This is one of the main rea­sons why they under­stand the econ­o­my so poorly–and why they did­n’t see this cri­sis com­ing, where­as I did (and for the record, I did intro­duc­to­ry and advanced cours­es in dif­fer­en­tial equa­tions with the UNSW Depart­ment of Math­e­mat­ics while com­plet­ing my PhD in eco­nom­ics).

I’ll fin­ish with one more piece of dynam­ic analy­sis. A tech­nique that is drummed into engi­neers is dimen­sion­al analy­sis: look­ing at what sort of num­ber results by com­par­ing the dimen­sions of vari­ables to each oth­er, rather than their val­ues. Let’s apply this to the car exam­ple above, and my Debt to GDP com­par­i­son, to see whether the result­ing dimen­sions makes sense. If so, they would be rel­e­vant con­sid­er­a­tions in whether one should buy a car, and in how you assess the health of an econ­o­my. If not, they could just­ly be ignored.

The ratio of a car’s fuel tank size to the engine’s fuel con­sump­tion (at a giv­en speed) is a com­par­i­son of litres to litres per minute. The result­ing ratio is min­utes:

Litres/Litres/Minute = Min­utes

The stock to flow com­par­i­son of a car’s petrol tank to its usage of petrol per minute there­fore tells you how long you will get between refu­elling stops from a giv­en car dri­ven at a giv­en speed. I would sug­gest you don’t buy a car to which the val­ue of that ratio is “3 min­utes”, no mat­ter how fast it might trav­el in the mean­time.

The ratio of Debt to GDP is a com­par­i­son of dol­lars to dol­lars per year. The result­ing ratio is years:

Dollars/Dollars/Year = Years

Does this mat­ter when assess­ing the health of an econ­o­my? You betcha. Espe­cial­ly when that econ­o­my has been boom­ing along on an orgy of debt-financed spec­u­la­tive spend­ing. The ratio tells you how many years it would take to reduce debt to zero, if all of GDP were devot­ed to doing that.

Now of course it won’t be, and of course any attempt to do so would back­fire because, with all income being direct­ed at debt repay­ment, the econ­o­my would col­lapse for want of effec­tive demand and GDP itself would fall and… hey, isn’t that what’s actu­al­ly hap­pen­ing?

Not because all of income is being direct­ed at debt repay­ment, of course–that is impossible–but because rather than spend­ing being aug­ment­ed by addi­tion­al bor­row­ing, spend­ing is now less than income as indi­vid­u­als (both firms and house­holds) strug­gle to repay debts.

That is an instance of where I have cor­rect­ly applied dimen­sion­al analy­sis to add a flow to the rate of change of a stock: I regard aggre­gate spend­ing in the econ­o­my as the sum of GDP (a flow) plus the change in debt (also a flow).  Add the two, and you get the actu­al sum spend in the economy–aggregate demand (con­ven­tion­al econ­o­mists, who are mis­led into regard­ing mon­ey and debt as irrel­e­vant to the per­for­mance of the real econ­o­my, don’t con­sid­er the change in debt in their mod­els).

The ratio of the change in debt to aggre­gate demand yields a dimen­sion­less num­ber that tells you how much of aggre­gate demand is debt financed. Since debt finance can turn on a dime–it can go from expand­ing to con­tract­ing vir­tu­al­ly overnight–this ratio can tell you more about where the econ­o­my is head­ed than vir­tu­al­ly any oth­er indi­ca­tor.

IF, that is, that “apples to oranges” com­par­i­son of debt to GDP returns a large number–because then changes in debt will also be much, much larg­er than changes in GDP. If, on the oth­er hand, that num­ber is very small–as it was back in the 1960s–then changes in GDP will be larg­er than changes in debt, and the lat­ter will have lit­tle influ­ence on over­all eco­nom­ic activ­i­ty.

The pow­er of this indi­ca­tor is obvi­ous when you look at the cor­re­la­tion between this ratio (Annu­al  Change in Debt/[Annual Change in Debt plus GDP]) and the unem­ploy­ment rate. Back in the 1960s, when the Debt to GDP ratio was low (80–100% in the USA, and between 25–30% in Aus­tralia), there was no par­tic­u­lar cor­re­la­tion. Now, with extreme­ly high debt to GDP ratios (297% in the USA, 159% in Aus­tralia [down from a peak of 165%, but I expect it will rise again in the near future]) the cor­re­la­tion is over­whelm­ing.

The causal mech­a­nism behind this is that, when the debt con­tri­bu­tion to demand drops in a coun­try with a high Debt to GDP ratio, aggre­gate demand col­laps­es. Unem­ploy­ment ris­es soon after. The process is well under way in the USA–which is why de-lever­ag­ing is now the key force dri­ving eco­nom­ic activ­i­ty there. And it is start­ing in Aus­tralia:

It won’t end with debt to GDP lev­els of zero of course (I’ve seen it said that I am anti-debt, and that’s non­sense: I am anti-debt when it finances asset price spec­u­la­tion, but recog­nise the legit­i­mate role of debt in financ­ing invest­ment and the work­ing cap­i­tal needs of firms). But will will end with debt lev­els sub­stan­tial­ly below cur­rent ones, and if we let that process occur “nat­u­ral­ly”, it will take many many years to com­plete. And unem­ploy­ment will go through the roof.

It will also quite prob­a­bly start with an increase in the debt to GDP ratio, as has recent­ly hap­pened in the USA. Amer­i­ca’s ratio has jumped sharply from 290% three months ago to 296.7% in the most recent Flow of Funds data (pub­lished by the Fed­er­al Reserve last week). 

The rea­son is, of course, that though the rate of growth of debt has plum­met­ed, both real out­put and prices are falling in the USA, and at rates that haven’t been seen since the last Great Depres­sion. The same phe­nom­e­non drove the debt to GDP ratio in the USA from 176% at the end of 1929 to a peak of 238% in the depths of the Depres­sion in 1932.

Today, the USA has only begun the process of debt-delever­ag­ing and defla­tion, and it has a debt to GDP ratio of almost 300%. That implies the process of return­ing to a “a ‘good finan­cial soci­ety’ in which the ten­den­cy by busi­ness­es and bankers to engage in spec­u­la­tive finance is con­strained” (quot­ing Hyman Min­sky) may take a good deal longer than it did in 1930.

Yes Rory, some­times stock to flow com­par­isons do mat­ter.

(Any econ­o­mist who wants to learn a lot about dif­fer­en­tial equa­tions should buy a copy of  Dif­fer­en­tial Equa­tions and Their Appli­ca­tions : An Intro­duc­tion to Applied Math­e­mat­ics by Mar­tin Braun. It’s an extreme­ly well writ­ten and engag­ing intro­duc­tion to an area that should be a foun­da­tion­al study for econ­o­mists, but is neglect­ed by a dis­ci­pline that is still locked in a 19th cen­tu­ry, pre-dynam­ic mind­set.)