Sunday, April 9, 2017

Rafat's Law: Inflation Elasticity

I've realized laws designed to control externalities and systemic shocks--such as banning secondhand smoke, anti-pollution regulations, or requiring certain levels of retrofitting in earthquake-prone areas--are necessary, while most other laws merely impose social values from elites onto the rest of society, transferring power to lawyers and politicians rather than individuals.

Laws favoring transparency in government are also necessary, though we've learned in America that transparency tends to come from whistleblowers rather than voluntary compliance (See Daniel Ellsberg, Edward Snowden, etc.).

Economic "laws" are the most important, but are usually backwards-looking and therefore inadequate for future reference, especially in a globalized economy with many moving parts.  Yet, as long as the data economists rely upon is relevant, recent, and relatively constant within a specific time period, economic "laws" may help establish the groundwork for further discussion.

I've tried for years to articulate an economic "law" I understand intuitively but cannot explain well.  It deals with the social response to an increasing gap between expected wages, debt loads, and essential services/products such as housing, healthcare, food, and transportation. Economic "experts" don't seem to separate essential vs. non-essential items when evaluating the inflation trajectory of wages and costs.

For example, getting an education costing 5K may not seem like a great deal if minimum wage is $3.50/hr, but it's still within reach. (Tara VanDerveer can still afford to go to college even she's not from an affluent family and eventually land a prestigious coaching job.)  If that same education, with new and fancier departments at the same college, costs 10K when the minimum wage is $7/hr, it's not as good a deal even though we've doubled both the cost and the wages.  In other words, the doubling of wages and costs should produce the same or similar results, but we're seeing that it does not. (Rafat's Law of Inflation Inelasticity: manipulating general wages by fiat to provide more equal opportunity does not solve the price inflation problem because the cost of essential items in modern society is often so much higher than wages that any rise in wages typically causes additional price inflation. Such price inflation relative to wage inflation increases at unsustainable rates due to the high starting price point, low starting wage point, and the compound inflation problem.)

Worst of all, some higher costs, such as education, divert disposable and other income from tangible goods--especially tangible goods that may be transferred at lower values to other buyers if the initial purchase doesn't work out as expected. (You can transfer a paper book to someone else or sell it at a lower price to a used bookstore, but a Kindle selection is worth something only to you.)

Sorry, Warren Buffett--we live in interesting times. 
As the economy moves from tangible goods to services (e.g., data retention, secure networks, Wi-Fi reliability, etc.)--which cannot necessarily be transferred to new owners without modification--it encourages monopolies.  Competitors tend to use the same dominant platforms in the intangible economy and enter as "add ons" rather than something new or within a new ecosystem. No economic theory has explored this new paradigm.

Additionally, inflation in one area that is uneven has effects on more elastic wages and costs, especially as more and more economic activities depend on each other's growth.  Inelastic inflation means some prices such as tuition always increase, even if wage and job growth is uneven or elastic. Yet, one major reason for inflation elasticity is that higher costs in some areas, like tuition, tend to reduce well-paying jobs in that profession relative to unsubsidized tuition costs while solidifying power in the existing legacy group--at least in a democratic political system. Such a phenomenon typically leads to a greater reliance on debt or non-organic sources to spur job growth, adding an unpredictable new factor to an already complex inflation situation.

In short, prices and costs in some areas, such as U.S. tuition and tenured professor wages, are inelastic in the sense they do not experience deflation (though reduced enrollment may occur) because of political and legal support; in contrast, prices and costs in other areas are generally elastic even if an upward trend exists in the long term.

If elasticity in Sector X increases dramatically while inelasticity applies to Sector Y, backlash and social cohesion will occur.  If debt is used to mitigate the gap's effect between the elastic and inelastic sector, further distortions will occur, which are unpredictable to the extent the debt's gains don't flow equally or equitably (see election of Trump).

I don't know the solution to the above problem, but I don't want to have to explain it before we can start a discussion.  I call it "inflation elasticity" for now, but perhaps someone else can explain it better.

Bonus: Another common problem should have a shorthand name. When organizations are small, it is easy to hire likeminded people who interpret regulations and rules similarly. Predictability is almost assured, which leads to better compliance and mutual respect.

As organizations and the output they examine increase in number and complexity, enforcement is handled differently based on different fact scenarios, leading to different results based on arbitrary factors (e.g., which judge or case officer is randomly assigned, etc.).  Dissatisfaction is sure to increase.  As outcomes diverge, the system itself leads to distrust--the exact opposite outcome it was designed to create.

At that point, a leader has to decide how to manage his or her "troops."  If s/he orders them to comply with a singular or non-discretionary interpretation, s/he will fail because no method exists that covers all possible fact scenarios and permutations; at the same time, doing nothing will lead to sustained divergent outcomes, causing more distrust.  If the costs related to such a system continue to increase, regardless of reform or increased consistency, dissatisfaction and distrust will become contempt.

For this reason, almost everyone who grows older begins to appreciate the value of "small" while lamenting "small's" inability to expose its inhabitants to full knowledge and diversity of experience. Yet, I have seen nothing that teaches me how to solve the problem of trust and "big" without resorting to mindless enforcement that doesn't consider relevant differences.

Update on June 2017: my first "law" is explained here: 

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