Economic Rubik's Cube

Solving a puzzle is meant to be challenging. But when that puzzle is a Rubik’s cube, with 43 quintillion possible combinations (that’s 18 zeros), the task is near impossible.

Players twist and turn the multi-coloured cube’s corners, edges and centre to display one single colour on each of the six sides. Most discover that it’s an unattainable goal as moving one piece to achieve colour alignment scrambles the opposite face.

Just like a Rubik’s Cube, there are many moving parts to an economy and each is a critical piece within a connected puzzle. We expect policymakers to shift the pieces to solve the economic puzzles we face. But the variables typically come together in a unique and different way each time. Also, a policy change in one area can lead to unintended repercussions elsewhere. The result is that solving one problem often creates other problems.

This is why policymakers require thinking that grasps the big picture, including the interrelationships among the full range of causal factors underlying them. We live in a Rubik’s cube world where everything is intricately intertwined (e.g. climate change). Solving the Rubik’s cube of falling productivity, economic inequality, budget deficits, trade imbalances and housing affordability, to name just a few matters, is easier said than done.

All economies face issues and governments intervene to maintain economic stability and improve living standards. Major policy areas – like monetary and fiscal policies – must work in sync to produce optimal outcomes. But sometimes the issues are so complicated – as was the case with the Global Financial Crisis (GFC) – economists, politicians and consumers struggle to understand the multiple dimensions.

The GFC was triggered by a housing bubble in the US which quickly fragmented political, economic and social landscapes around the world. The ensuing financial meltdown brought the free market to the precipice. The GFC starkly reminded us that national economies are linked umbilically in a globalised world. No country was able to decouple and escape the disruption to credit markets.

To avoid systemic collapse, extreme capitalism gave way to extreme intervention. The unfettered excesses of High Street were replaced by frantic spending programs for Main Street. Governments and central banks acted in unison, unveiling remarkable fiscal and monetary policy responses. Multi-billion-dollar stimulus packages and aggressive interest rate cuts were used to stimulate demand.

But the responses to the GFC were not identical. Some countries and economic regions (understandably) twisted the Rubik’s cube to produce bespoke policy actions to shore up their national economy and local financial sector. Most major developed economies fell into recession and authorities deployed multi-pronged rescue plans. Some experimented with Quantitative Easing while others introduced zero interest rates.

Some National Governments including Australia, pumped billions and billions into the pockets of their consumers. That fiscal stimulus package was based on Keynesian economics.

The British economist, John Maynard Keynes, believed that in a downturn fiscal policy should be used to stimulate the economy. The cash transfer to low- and middle-income consumers was designed to reduce the risk of a recession due to a phenomenon called the paradox of thrift.

This paradox describes the dilemma we face when times are tight. During a recession we are encouraged to spend to keep the economy going. But our natural tendency is to save and this triggers a cause-and-effect spiral to decreased economic activity.

The ride to recession begins when we all start saving our money and this reduces consumer spending. This, in turn, causes aggregate demand to fall and this, in turn again, results in a decline in total income. And when income falls, people have less to spend. So, as counter intuitive as it sounds, individual savings makes us collectively poor!

The paradox of thrift is akin to a Rubik’s cube as saving might appear beneficial at an individual level but it’s actually detrimental to the population overall. One person’s spending is another person’s income! Yet again, changing one side of the cube alters the look of other sides.

It can be seen that an economy is as complicated as a Rubik’s cube. This is why the GFC was a humbling experience for economic forecasters. As noted by one commentator:

“An entire field of experts dedicated to studying the behaviour of markets failed to anticipate what may prove to be the biggest economic collapse of our lifetime”.

While there needs to be a major rethink of economic tools and techniques, it’s unreasonable to expect economists to be fortune tellers. In the words of celebrated economist, John Kenneth Galbraith,

“There are two kinds of economists – those who don’t know the future and those who don’t know they don’t know.”

All food for thought!