Chapter 10: System dynamics part I
Outline:
1st Introduction to the
difficulty
2nd The question of the
stability of an order
3rd Order and level of
development
4th The interdependence of
the orders
5th Support of an order by
foreign powers
6th The influence of ideas
and personalities
7th Internal dynamics of
the systems
8th About the convergence
thesis
1st Introduction to the
difficulty
Orders have the task of coordinating individual
decisions. Within the framework of the order analysis, the question is examined
of which basic elements an order consists and which different order types are
possible. Whereas an order conception shows which order systems are desired; it
asks for the guiding principle of an order which, of course, varies according to
the observer's worldview. Within the framework of a theory of the system
dynamics, however, it is examined how orders change in the course of time, the
question is raised which forces have led to the formation of certain orders and
which forces lead to a ruin of an order.
An economic science theory of the order dynamics deals
primarily with orders of the economic process. Within the scope of this
treatise, we will see that societal orders are connected in diverse manners,
that is, for example, that a very definite order of the economic system can
only function properly within the framework of a democratic order of the
political system.
Just for these reasons it is expedient to approach
also the system dynamics of non-economic subsystems of our society. Such a
comprehensive approach is not only appropriate on the basis of the inner
connections of the individual systems of order, though. Furthermore, we have to
assume that the individual subsystems of our society show common features. For
example, Hans Freyer and
The individual subsystems of the society are not only
connected to each other, but have common characteristics, by virtue of these it
has to be reckoned with similar laws. But in this case it is also expedient to
use approaches of different scientific disciplines to analyse the system
dynamics.
If we examine in the following the dynamics of the
economic orders, it is primarily about the development of the overall economic
system. We have already shown in the representation of the order analysis that
an order is composed of a large number of individual elements, that for
example, a market economy is composed of a large number of individual markets.
Here, it can be useful to examine not only the development of the whole
economic system, but also of the individual markets. So was analysed, for example,
mainly the dynamics of monetary systems in the context of foreign economic
theory and shown which currency systems have to be identified as unstable.
2nd The question of the
stability of an order
With the conceptual pair "stable" and
"not stable" we have already addressed the first topic of a theory of
the system dynamics. The concept of the stability has been coined within the
framework of the equilibrium theory. There it is distinguished between the
question of the existence and the stability of equilibrium.
We speak of equilibrium when supply and demand
correspond ex ante. Ex post correspond offer and demand ex definitione,
that means: The offer which is actually distributed corresponds in its value to
the actually demanded and obtained goods; supply and demand are ex post nothing
else but two different sides of one and the same exchange process.
Whereas the ex ante view refers to the quantity of
goods planned by the suppliers respectively planned by the demanders. Here, we
can not assume that both quantities correspond always; since the supply and
demand decisions are made by independent economic units (the enterprises and
the households), it is even probable that the two variables do not coincide,
that thus there is no equilibrium, that this equilibrium must be brought about
by the market process initially.
In the framework of the equilibrium theory it is
spoken thereof that there exists always an equilibrium (is possible) if the
supply curve has a point of intersection with the demand curve, thus if a price
is conceivable, at which the economic plans of the suppliers and demanders
agree with regard to the considered good. The suppliers plan the same quantity
of goods as the demanders.
Even if an equilibrium point exists now, this does not
mean nowhere near that this equilibrium is headed for from any initial position
(thus out of an imbalance) automatically. This problem is addressed by the
question of the stability of the equilibrium. It can only be spoken of a stable
equilibrium when the market itself, from an arbitrary starting point, reduces
the imbalance, thus if an automatic trend to equilibrium is present.
This question of the stability of an equilibrium is of
particular importance, since we must assume in reality that data changes occur
permanently which lead to a shift in the supply and demand curves, and thus
also of the intersection of both curves, so that the question for the stability
of the equilibrium, is not only a one-time question, but is raised again and
again.
In general, it is assumed that a market has a stable
equilibrium because imbalances lead to price variations and these price changes
also prompt the demanders to adapt their economic plans to this changed situation.
The prerequisite is, though, that the price reactions
to market imbalances take place normally, so that demand surpluses lead to
price increases, while supply surpluses lead to price reductions. Such a
reaction is not always expectable. Let us take the case that the proportion of
the fixed costs, that is to say the costs which arise irrespectively of whether
and how much is produced, is particularly high. In this case, a decline in the
demand and a thereby caused supply surplus leads to an increase in the cost per
unit with the result that the enterprises are striving to increase the prices.
Price increases, though, cause the demanders to buy fewer products, although
the supply surplus could only be reduced in the case of an increased demand.
Also the responses in supply and demand to price
variations must take place normally in order to speak of an equilibrium trend.
It can be spoken of a normal demand reaction (elasticity of demand) always when
price reductions lead to an increased demand and price increases lead to a
lower demand. Analogous to this, a normal supply elasticity is present when
price increases lead to supply restrictions, while price reductions lead to a
decrease of the supply.
Also with regard to elasticity, we have to expect
abnormal reactions sometimes. Let us take the case of the supply of the little boatmen, which have
only one small boat, and whose incomes are on the edge of the subsistence
level. If a
general price reduction occurs, this little boatmen are compelled to broaden
their supply, in order to still reach the minimum subsistence level, even
though a equilibrium trend ceteris paribus could only be expected if the supply
would decline.
The case of inferior goods shows that the demand can
take place abnormally sometimes, too. In the case of inferior goods increases
the demand at price increases. This reaction is explained thereby that a price
increase reduces the real income and that especially recipients of a low-income
are forced to shift their demand to inferior products. For example, instead of
butter is then margarine consumed, although according to the assumptions the
fat price has increased. (We insinuate here that margarine is considered as a
less valued product.)
These considerations do not suggest, though, that the
theory of equilibrium would assume that equilibrium can be expected at any
moment or even in the majority of cases, or that it would be at least desirable
for supply and demand to correspond as often as possible. On the contrary, we are assuming that the changes in data that trigger
imbalances are desirable in general, as they either improve production
technology (= technical progress) or consist therein that consumers adjust
their demand to their individual needs. A household notices, for example, that
it could increase its benefit if it would correct its previous demand
decisions.
The only important thing is that these data changes
and the imbalances caused thereby lead thereto that adaptation processes are
triggered automatically, which prevent that cumulation
and thus a permanent increase of the imbalance occurs. No economic unit has the capacity to tolerate arbitrarily large losses
for arbitrarily long time.
Enterprises must file for bankruptcy and therefore
leave the market process when the losses exceed a certain critical limit. Where
this limit lies in detail depends on the amount of the capital and the
creditworthiness of the individual enterprise. The same is true for households, which generally can only get into dept as long as they are creditworthy and / or dispose over
assets.
We thus want to remember: a market can only be
considered as stable if imbalances are reduced again and again. The stability
will then depend in detail on how many data changes are actually occurring, to
which extent these data changes lead to imbalances, how quickly and how
strongly the prices react on these imbalances and, moreover, how quickly and
how strongly supply and demand react on these price variations in normal
direction.
Within the framework of the dynamic price theory
(theory of the cobweb system) it has been shown, though, that we can not always
assume that a continuous approximation process takes place at normal reactions
of the market participants. Often the price approximates the new equilibrium in
periodic fluctuations, as the approximation processes go beyond their goal, for
example, lead to such large reactions in the supply that not only the supply
surplus is reduced, but even a demand surplus arises.
In extreme cases, the market may even diverge more and
more from the equilibrium point, or oscillate around the initial position again
and again like a perpetuum mobile.
At our previous considerations, we referred our
examination to a predefined market system with fixed, consistent rules. We can
extend, though, our equilibrium consideration to the question of whether the
market - the respective system under evaluation - is capable of adapting its
rules to the changed situation in a way that the market system remains.
Let us take again the case of a large share of fixed
costs. We can assume that the share of fixed costs was generally low at the
beginning of the industrialisation, and precisely because of this the supply
reacted normally to imbalances. In the course of the mechanisation of the
production, the capital intensity of the production was more and more
increased, though; with the result that the share of fixed costs in the total
costs also increased more and more. We had seen above that in such a situation
the entrepreneurs are in turn trying to compensate this increase in the fixed
costs by way of price increases and that therefore anomalous price reactions
have to be expected increasingly.
In such a situation, the market is no longer able to
bring about an equilibrium trend while maintaining the hitherto successful
rules, it becomes unstable. It is necessary to adapt the rules to the changed
situation, and it will only be possible to speak of stable market systems if
these enable such an adaptation of the rules.
In this context, however, a definitional problem of
the identification arises. An order system is just characterised by a set of
rules. If these rules change, the question arises whether one can still speak
of the same system, whether the change of even a single rule means that a
changed order system has emerged.
There are two possible answers to this question. According to the scope and quality of the change, it is possible to
distinguish between constitutive and accidental changes, and speak of the same
order system, as long as only accidental rules have been changed. Thus the
order systems show in reality a series of historically determined features,
which are of subordinate importance to the equilibrium process. It may
therefore be appropriate to distinguish only between changes in the features
which are constitutive for the coordination mechanism. However, at this
approach remains the problem that in reality the market process has certainly
undergone also changes in constitutive features, but nevertheless we are still
talking about market processes.
A second possible answer to the identification problem
is that each system is understood as a historical structure which, like living
beings, has a beginning, continues to evolve and adapts to the changes in the
environment permanently and withers away one day. In this case, only at a
complete collapse of the market system it would be spoken of the transition
from one to another system of order.
Now just the example of the Weimar Republic shows that
this approach encounters difficulties also. The market economy system was namely so heavily undermined by numerous dirigiste interventions in the market during this time that
it could not fulfil its actual functions any more; from a purely external point
of view, there still existed a market economy system, which, however, could no
longer fulfil its actual functions, so that in reality a transition to another
system was actually present already.
It is therefore expedient to prefer a middle course;
one will specify a narrowly defined set of features which are constitutive for
the existence of a particular system of order and without these it can no
longer be spoken of the same system, nevertheless it can be referred to as a
system which has been altered but is still a market economy system, if the rules have changed in a manner that the
adjustment process is ensured.
We have already discussed now that the question of the
order dynamics can be made not only for the societal systems as a whole, but
also for a subsystem e.g. for individual markets. The problem of the stability
of an order can be illustrated very clearly by the development of the monetary
order or the foreign exchange market.
After the Second World War, a system of fixed exchange
rates with the dollar as the reserve currency was established within the
framework of the IMF system (International Monetary Fund).
At the beginning of the 70s, this system was replaced worldwide by a system of
flexible exchange rates. Whereby a system of fixed exchange rates, the EMS
system (European Monetary System), was created in turn for
the European countries however, with the ECU as artificial basket currency.
Now it can be shown that the IMF system constituted a
remarkably unstable system. The final collapse of this system in the 70s was
primarily system induced, thus meaning anchored in the structure of the system
itself. In this system, mismatches in the foreign exchange balance, which were
triggered mainly by the expansive economic policy of individual countries, are
only reduced thereby that merely the non-reserve currency countries were forced
to provide for a compensation of foreign exchange balance by the intervention
of the central banks on the foreign exchange markets. Whereas the central
currency country can reduce a deficit in the foreign exchange balance at any
time by expanding its own money supply and by paying deficits with an
international currency which is also the currency of the reserve currency
country.
This system is unstable for two reasons: One reason is
that the member states maintain the right to an autonomous economic policy and
want to keep the currency relations constant concurrently. But both of it is
not possible at the same time. To the extent that imbalances appear consistently in
the foreign exchange balances due to data changes, can these imbalances in turn
be reduced within a liberal system only by adapting either the national price
levels or the exchange rate to this changed situation. In the long term, it is not
possible to keep the exchange rate stable while at the same time permitting the
member countries to pursue an independent, autonomous economic policy. If the
member countries cause foreign exchange deficits of varying degrees by their
expansive economic policy, then only the non-centralised currencies are obliged
to take care of the reduction of the imbalances by monetary policy measures.
The other reason is, that the central currency country
(the USA) had the possibility of settling deficits in the foreign exchange
balance at any time by increasing its own currency, and this contributed not
only to trigger a worldwide inflationary trend; and since thereby the
relationship between the gold reserves of the USA and the international money
supply was becoming increasingly diluted, the readiness of the central banks of
the non-central currency countries to keep their currency reserves in dollars
waned; the probability that the dollar could be converted into gold at any time
if required was reduced drastically, with the result that an increasing number
of countries - France ahead - were striving to convert their foreign exchange
positions into gold. Thus one day the US was forced to stop the free exchange
of dollars into gold.
This danger could have been avoided only if the US had
voluntarily - without having been forced to do so - abandoned to expand its own
money supply by expansive monetary and fiscal policy.
The instability of the IMF system resulted due to even
a further reason, though. The
circumstance that the central banks of the non-central currency countries are
forced to keep the exchange rate on the foreign exchange markets stable by
intervention (i.e. by buying and selling foreign exchange) has changed the way
of speculation. Now we distinguish in general between stabilising and
destabilising speculation. In the case of stabilising speculation expects the
speculator, on the basis of an anticipated increase in the rate of exchange,
that the exchange rate will fall again sooner or later, and will therefore
divest foreign exchange; he thus contributes to the reduction in the rise of
the exchange rate and at the same time causes the foreign exchange balance
mismatch to be reduced.
Whereas in the case of the destabilising speculation
expects the speculator that the rate variations will continue (i.e. that the
current price increase lasts), he will therefore already satisfy his future
demand for foreign exchange by a presently purchase so that the demand for foreign
exchange increases and thereby eventually increases the rise in price. Thus the
imbalance increases with destabilising speculation.
Now it can be assumed that a stabilising speculation
is predominantly made by knowledgeable brokers, whereas a destabilising
speculation can be observed especially in the case of laypersons, whose
information on the foreign exchange market is limited. The system of fixed
exchange rates now favours speculation among the laypersons. The fact that the
central banks are obliged to a stabilising intervention on the foreign exchange
markets entails namely that the currency risk at the buying and selling of
foreign exchange is extremely low. If namely the
deficit of the foreign exchange balance is permanently high, i.e. more foreign
exchange is demanded than offered in the long run, then the pressure on the
deficit countries will rise in order to increase the official exchange rate
since no central bank is able to offer foreign exchange for an indefinite
period of time and thereby supporting the hitherto fixed rate.
If one therefore speculates in the context of a system
of fixed exchange rates, then the associated risk is extremely low; the worst
thing that can happen is that the realignment of the exchange rate keeps
waiting. But the increase of the exchange rate will come sooner or later in any
case, so one will not experience any surprises in the long run and can
therefore divest the foreign exchange, bought before the valorisation, with
profit again.
Often it is argued that speculation occurs
predominantly in systems of flexible exchange rates, but not in systems of
fixed exchange rates. Speculations about exchange rate changes could only be
expected if the exchange rate can fluctuate actually. If the exchange rate was completely constant in the course of time, no
speculation would have to be expected at all.
This approach misjudges two things. On the one hand,
speculation as such does not act necessarily destabilising. This is only true
for part of the speculations, namely, the so-called destabilising speculation,
but precisely this is increasingly taking place in systems of fixed exchange
rates. On the other hand, in a system of fixed exchange rates, it must also be
expected that fluctuations in exchange rates are indeed taking place in the
short term, so that the exchange rate can only be kept constant in the longer
term. Data changes take place in each system; In addition, it should be
considered that precisely the fact that in the traditional systems of fixed
exchange rates the central banks had the right to pursue an autonomous economic
policy which leads automatically thereto that the extents of economic policy
measures are different and that just therefore mismatches of foreign exchange
balances and by this short-term exchange rate fluctuations are to be expected
increasingly.
The thesis that the systems of flexible exchange rates
are more unstable because the scope of speculation would be greater at flexible
exchange rates, and thus the scope of exchange rate fluctuations had to be
necessarily larger than in systems of fixed exchange rates, is therefore wrong,
since only a part of the speculation increases the instability and since a
system of fixed exchange rates increases the share of destabilising
speculation. In systems of flexible exchange rates, however, it is not clear
how the exchange rates will develop in the future. Just for this reason, a part
of the speculators will be expecting rising exchange rates, while another part
will be expecting a falling exchange rate; these differing expectations,
though, contribute to reduce the negative impact of speculation.
In favour of a system of fixed exchange rates, it is
often argued that international trade could only be expected if exchange rates
were largely stable. Only this way could the risk that is associated with
foreign trade be reduced to a level that allowed foreign trade at all.
Foreign trade was indeed welcome as it increased the
productivity and thus the welfare level of the nations. It was also true that every entrepreneur is taking risks with his
productive activities to a higher or lower degree, since no entrepreneur could
be certain that consumers will be asking for their products in the offered
scale and in the offered quality. The risk in international exchange
transactions was much higher than in comparable national exchange deals,
though. On the one hand, it would be much more difficult to obtain reliable
information from abroad than from the interior. On the other hand, any data change in the world was entering into the
free exchange rate, while the national price ratios always refer to only
relatively few data changes in the interior. In order to make international trade possible at all, it was necessary
that the exchange rates were kept reasonably constant.
This argument does not stand to reason. An
entrepreneur who avoids the risk associated with the exchange rate has always
the possibility to transfer this risk to others by means of forward
transactions. Precisely because the ideas about the further development of the
exchange rate are diverging on free foreign exchange markets, there will almost
always be traders who are ready for terminations and the risk associated
therewith (against a surcharge). A risk-averse importer who expects foreign exchange
revenue only for the future period can therefore offer this foreign exchange,
which will be arising only in the future, for a known price today.
Both currency systems covered so far are characterised
by the fact that price and volume changes are always triggered by variations in
supply and demand. The system of flexible exchange rates differs from the
system of free exchange rates only thereby that the central banks appear on the
foreign exchange markets as suppliers or demanders and that these can influence
the currency exchange rate decisively due to their weights.
Now, a part of the economists was sceptical for a long
time about the question of whether the price elasticities on the foreign
exchange markets were sufficient to bring about a reduction in the mismatches
of foreign exchange balance. Now this is a problem that applies principally to
all markets. An equilibrium trend is only present if supply and demand are
reacting to a sufficient degree to price variations.
Nevertheless, there is a substantial difference
between general goods markets and the foreign exchange market. On general goods
markets, it is sufficient that supply and demand react normally and that the
sum of the elasticities is larger than zero. For foreign exchange markets,
however, the tightened condition (the Marshall-Lerner condition) applies, that
the sum of the demand elasticities (with infinitely large supply elasticities!)
is greater than one.
This difference can be explained by the fact that the
price on general goods markets refers to the quantity of goods, but that
the exchange rate refers to magnitudes of value. The good traded
on foreign exchange markets is the foreign currency; the scale of the demanded
foreign exchange depends, though, not only on the number of imported goods but
also on the level of the prices at the same time.
If e.g. the foreign exchange rate rises, then emanate
two differently proceeding effects on the foreign exchange demand. The demand for imported goods declines in the normal case, but the price
to be paid effectively will increase. It depends now on the elasticity of the
volume demand, whether the demand for foreign exchange increases or decreases.
If the elasticity was just one, then the volume effects and price effects would
cancel each other out, and the demand for foreign exchange would remain
constant despite the rise in the exchange rate. Only if the elasticity is
larger than one then the rising price effect prevails and the currency demand
rises as well. The Marshall-Lerner condition applies, according to which there
is only an equilibrium trend on the foreign exchange markets present if the sum
of the import demand elasticities (of interior and abroad) is larger than one.
What’s more, the question of the sufficient level of
import demand elasticities is raised equally for systems with flexible as well
as with fixed exchange rates. In the case of flexible foreign exchange rates it
is the exchange rate; in the case of fixed exchange rates it is the changes in
the national price levels which trigger the adjustments on the foreign exchange
markets. Thus the import demand of the interior depends finally always on the
national prices of goods. In the system
of flexible exchange rates the exchange rate is changing initially, but with it
also the amount of domestic monetary units which must be paid for an import
goods unit; in the system of fixed exchange rates, the domestic prices are
directly changed by means of changes in the domestic money supply.
Thus, if one is convinced that the actual import
demand elasticities are not sufficient to bring about a reduction in the
foreign exchange balance deficit, then the system of fixed exchange rates fails
as well as the system of flexible exchange rates. In this case, a currency
exchange command economy is necessary in order to bring about a compensation
for supply and demand of foreign exchange.
Empirical investigations carried out in the period
after the Second World War seemed to confirm the elasticity pessimism. The sum
of the determined import demand elasticities seemed in fact to be less than
one, so that the Marshall-Lerner condition did not seem to be fulfilled.
In the meantime, one is more optimistic on the issue
of elasticities. On the one hand, it could be shown that the actual import
elasticities are greater than originally assumed; the negative results could
only be achieved by ignoring the fact that in addition to price variations also
quantity variations took place in the observed period.
On the question of the elasticities that are necessary
for an equilibrium, attention was drawn to the fact that generally we are by no
means able to assume infinitely large supply elasticities in reality, but that
at the assumption of finite supply elasticities the sum of the import demand
elasticities may be somewhat lower in order to bring about a reduction of
imbalances in the foreign exchange balance. A formula developed by J. Robinson
teaches hereby about the precise extent of necessary demand elasticities.
To be continued!