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Macroeconomics as Coordination

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If your main source of economic information is a newspaper, television news station, or government statistical bureau, you would probably say that macroeconomics is the discipline that studies a handful of aggregate data series, such as consumption, investment, government spending, and total income, for the purpose of understanding the causal relationships among them. The reason people pay attention to those data is that they supposedly hold the key for understanding both business cycles — the periodic episodes of boom and bust that recur in advanced industrial economies — and, with any luck, the way to smooth those cycles. Unfortunately, far too much has been made of that way of understanding the “economy as a whole,” even by (especially by?) those identified as economists.

The science of economics (note: no modifier!) draws our attention to two key aspects of human behavior. The first, which is personal, is the tendency of human beings to economize, that is, to pursue their unsatisfied wants in an efficient manner, which means acquiring what they desire while minimizing what they must give up to acquire it. That is undoubtedly an important aspect of human behavior. But those who discuss the relationships prevailing in the “economy as a whole,” especially when they treat statistical aggregates as choice variables by a hypothetical “representative agent,” focus on the economizing aspect of human behavior at the expense of the other aspect of human behavior to which economics calls our attention. That second aspect, which is interpersonal, is coordination.

 

The nuts and bolts of coordination

The economy comprises millions of persons, each of them pursuing his own interests as efficiently as he knows how. In other words, each is an economizer. Each has plans for how to achieve his interests, very likely concerning the use of a portion of the economy’s scarce resources. However, it is inevitable that, in the absence of some coordinating device, some agents’ plans will be incompatible with others’. For example, I want to bake an apple pie, so I need to get my hands on some apples. But I am not the only one who has a use for apples. Many others want to make apple pies, too. Others want to turn the apples into cider. Still others aren’t interested in transforming the apples into a different consumption good but want to eat them plain. Given that there are not enough apples to satisfy everyone’s demand, it seems as if there is a conflict between the many other potential apple consumers and me. Every apple I use for my purposes is one they cannot use for theirs, and vice versa.

But there is a system that reconciles the conflicting desires to use apples: the price system (to the extent it is unhampered by government). The price of apples, governed by the supply and demand for apples, reconciles the disparate interests of potential apple consumers by attaching to apples a measure of the resources that must be forgone to acquire those apples. The price system, guided by the familiar forces of supply and demand, sets in motion a process tending toward a state of affairs where the number of apples offered by sellers and the number of apples desired by buyers are equal to each other at some price. Notice there is far more going on here than the usual story concerning gains from trade. A functioning market for apples reconciles the interests of apple suppliers and apple demanders, and also reconciles the interests among apple demanders. Those demanders who are willing to give up the resources mandated by the market price acquire the apples; those who are not, look to satisfy their wants in lower-cost ways. What before looked like a conflict situation has resulted in a state of affairs of de facto mutual agreement.

 

There is a system that reconciles the conflicting desires to use apples: the price system.

What is true of apples is true of the many, many other goods and services offered in modern economies. The interests of a multitude of economizing persons, each striving to satisfy his own self-interest, are reconciled by the price system.  In other words, the price system coordinates their plans in such a way that the vast numbers of plans are consistent with one another. The result is an overarching system of social coordination. The macroeconomy — the “economy as a whole” — is operating to satisfy the wants of the disparate persons who act within it, given the constraints of scarcity and plan reconciliation.

 

Coordination and business cycles

Macroeconomics, then, is ultimately about coordination.  When people’s plans are well coordinated, the result is largely satisfaction and harmony. When their plans are not well coordinated, however, the result is largely discontent and conflict. A conception of macroeconomics that focuses on the economizing aspect to the exclusion of the coordination aspect will, by the nature of the methodological window through which it views the world, misdiagnose the situation. Falling business activity and the accompanying unemployment of both labor and capital get blamed on a lack of “aggregate demand,” meaning a lack of private plus government spending. In that view, the solution is to find some way to stimulate the demand such that the desired level of total income, and accompanying levels of employment, once again prevail.

The above stylized business-cycle theory is closest to the Keynesian approach, but it has an element in common with all explanations of business cycles. Specifically, every explanation somehow involves a shortfall of aggregate demand. The crucial aspect is this: Theories that focus on the relationship between aggregates as choice variables tend to point to falling aggregate demand as the cause of recessions. Theories that recognize the importance of social coordination treat falling aggregate demand as a consequence of a more fundamental problem — a systemwide coordination failure.

But what is the cause of the coordination failure? That is a topic hotly debated among economists who work within the coordination paradigm. However, almost all coordination-oriented economists are suspicious of the claim that business cycles are naturally occurring phenomena in market economies. To believe that claim is to believe that somehow enough people had ignored or misinterpreted price signals for so long and to such a degree that a recessionary period of recalculation and reorientation of productive resources is the inevitable result. Is it possible that the plans of entrepreneurs and consumers could become so misaligned, given how well the price system normally coordinates economic activity? Certainly.  But is it probable? Hardly.

Whatever the fundamental explanation of business cycles — and there may be more than one cause — it will be overlooked unless both aspects of economic science, economization and coordination, are taken into account. Trying to explain recessions without reference to coordination is like trying to explain gravity without reference to mass.

This article was originally published in the April 2013 edition of Future of Freedom.

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    Alexander William Salter is a Ph.D. student in economics at George Mason University.