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Post-Covid-19, time to apply policies based on the Production Accessibility & Consumption Model (PACM)
Part 1


Hector McNeill1
SEEL



Covid-19 provided a case study of the superiority of the Production, Accessibility and Consumption Model (PACM) over the Aggregate Demand Model (ADM) to explain the current crisis resulting from the spread of Covid-19. The PACM was able to explain the slumpflation crisis of the 1970s and 1980s resulting from the major international petroleum price hikes.

The misunderstanding of the essential cause of the slumpflation crisis was caused by a significant confusions that the ADM as a "general theory" that conveniently explains how Keynesianism and the Quantity Theory of Money operate. This is why Keynesianism could not solve the slumpflation crisis and in reality monetarism inflicted serious damage while "solving" the crisis.

This article provides a simple explanation by using the PAC Model to not only explain the crises of the 1970/1980s and 2020 but to also show how it can be used to orientate policy towards macroeconomic decisions that improve productivity and real incomes growth.

The Production, Accessibility & Consumption Model (PACM)

The PAC Model of the economy was initially developed as a result of an analysis of how the economy functioned. It was identified over the period 1975-1976 to explain the financial crisis in the late 1970s which was caused by the international petroleum price rising rapidly, giving rise to slumpflation or the combination of high inflation with high unemployment. The PACM identified events that the ADM logic had assumed were not possible since up until that time low unemployment had been associated with high inflation assuming this to be caused by "high demand". This correlation is depicted in what is known as the Phillips curve (see left) that showed this relationship based on statistics up until that time under policies based on ADM assumptions.

The PAC Model, as a general model, was able to explain the "new situation". As a general model it can be used to analyse any economic situation and all of the crises (1929, 1970s, 2008 and 2020). By way of example I provide a run down of the current crisis.

The current crisis

The Bank of England and the Chancellor's recent actions

The Bank of England's reduction of interest rates and the undertakings of the Chancellor to provide income support for those losing employment are essential compensatory actions in the light of the specific nature and impacts of Covid-19.

They are needed, however, in large part because of a prolonged period of inappropriate ADM-based macroeconomic policies that promote expansion based on debt provided by financial intermediaries. Quantitative Easing (QE) killed off the alternative source of investment funds in the form of accumulated personal savings of constituents. This destroyed the incomes of many relying on fixed incomes placing millions of elderly constituents in a precarious financial situation.

Current extreme difficulties are also caused by generally very low nominal incomes of employees which have followed a trajectory of declining purchasing power and falling real incomes. An increasingly significant cause of this situation is the behaviour of financial intermediaries and larger corporations allocating funds, needed for productivity and employee income-enhancing investments, to their own asset holdings or used to provide executives with enhanced wealth and bonuses. These funds are also used to arrange share buy-backs leading to stock market booms that have no relationship to corporate prospects or efficiency. This stock situation is knowingly unstable because the "demand" is manufactured, confidence only remains as long as the flow of funds is guaranteed to raise prices. When market circumstances threaten the constant flow of Central Bank funds to financial intermediaries, these markets usually crash.

All of the policy "solutions" to all crises have always been based on debt and more business for financial intermediaries in the name of "raising aggregate demand" when each time the problem has been a lack of real incomes policies based on investment in supply side determinants.
To explain the PAC model elements of production, accessibility and consumption I have highlighted these elements in blue in the passages that follow. The initial recent slide in the performance of the global economy was not a lack of demand but rather a lack of supply. Since many economic units survive and earn their income from servicing supplies from China such companies have had significant problems and some have already failed. As a result some people have been laid off and no longer receive their income from the service supply activities of these companies. So the governor of economic activity in this case was not a gap in Aggregate demand but it is a gap in Aggregate production. This gap transmitted an impact in the form of essential products from China not being accessible locally in the market where they are normally consumed, that is, the effective supply was not there. Therefore, even although in the short run consumers were able to afford to purchase the products, if accessible, so consumption (what ADM refers to as "demand") would not have been affected, the lack of supply resulted in low or no consumption but this does not signify a "lack of demand". The other aspect of accessibility, besides unit prices and local availability, is access to information concerning products and services. As Covid-19 bites further, self-isolation and the lack of income resulting from lack of gainful employment, the cash flow of consumers could be compromised leading to a fall in their purchasing power and as a result what were accepted as normal affordable prices can move beyond the state of accessible unit prices leading to a fall in consumption.

The essential point to note here is that all of the main input factors (Goods, Services and Money) and the controlling influences over this whole affair are the following PACM determinants, all of which are supply side determinants:
  • Investment (in production)
  • Production
  • Income gained from employment from production and supply of goods, service and money
  • Logistics (asset holding (storage) as transport through time & transport over distance to market)
  • Local accessibility - being available in the market
  • Price accessibility - affordable unit prices
  • Information accessibility - adequate information on offers of products, services and money in the market
  • Purchasing power determined by nominal incomes and nut pricing decisions
these supply side determinants have determined actual consumption, or lack of it. ADM confuses this with "lack of aggregate demand".

With Covid-19 impacts now affecting Western economies, the purchasing power of many people who are self-isolating and out of work has fallen because the normal prices of rent, mortgages, food and utilities are beyond their ability to pay on a sustained basis over even a few weeks. This is because of lack of nominal income and savings. The generalize low income levels and inability to save, creating a lack of resilience within the population to tide them over difficult periods, is related to a prolonged adherence of policy makers to the Aggregate Demand Model. For example profits and asset holding have risen while real wages have fallen over the last 30 years. During the last decade under Quantative Easing interest rates have been so low as to destroy personal savings and fixed incomes of the elderly, all in the name of the misguided notion of "aggregate demand". The combination of low real incomes, and effectively no savings, has placed most in a precarious state of affairs as is evident from the current situation. This has affected a large proportion of constituents in "developed" and "high income" countries, most of which follow ADM-led policies. This is self-evident but will be explained in more detail in Part 2 of this article.

The table below lays the states of input factors (Goods, Services and Money) associated with the PACM determinants listed above during the four main economic crises since and including that of 1929. All were caused by supply side actions/conditions.

PAC Model
Crisis year
1929
70s80s
2008
2020
Factors
Goods
Services
Money
Goods
Services
Money
Goods
Services
Money
Goods
Services
Money
Supply Side Determinants
Investment
Production
Income
Logistics
Inventory (Assets)
Local accessibility
Price accessibility
Information access
Purchasing power
Demand Side Determinants
Consumption

I have filled in some of the key factors that gave rise or arose during each crisis. It is an interesting exercise to repeat the 2020 exercise, outlined above, for the other economic crisis periods. All of them come out as having been caused by supply side determinants. I will go into more detail on the other periods and in particular what gave rise to PACM in Part 2 of this article.

This table applies to the national picture e.g. UK, no matter where supplies come from. The common factor to all crises was too much money being assigned, over time, to assets including land, real estate, stocks and shares and other forms of wealth holding. This resulted in a draining funds from supply side production investment to improve production efficiency and as a result an increasing proportion of the population employed in the supply of goods, services and money facing a declining purchasing power or real income. All supply side elements (see The outcome of quantitative easing on real incomes - summary note ).

It is notable that the ADM solutions always provide more business for financial intermediation in the name of financing demand, as a solution to each crisis only to be the cause of the following crisis. In the intervening periods banks repeated the process of assigning too much money to assets including land, real estate, stocks and shares and other forms of wealth holding.

Slumpflation

In the 1970s-1980s, the petroleum price crisis and stagflation was a classic supply side problem, somewhat like Covid, but it was not accessibility to the product, it remained available, it was the very high unit prices that reduced consumption because of low price accessibility. Many companies closed for lack of alternative technologies to substitute petroleum. The ADM solution "to drive inflation out of the economy" was to raise interest rates to in excess of 15%. Over 2,000,000 families lost their homes because this policy imposed a conversion of sound mortgage agreement portfolios into failing sub-prime mortgage portfolios, because families could no longer afford to pay the premiums. Needless to say, this reckless policy resulted in an intensification of unemployment the ensuing depression. The continued cause of inflation was the very slow capacity to absorb the petroleum input costs through medium term rises in productivity a supply side issue. However, the high interest rates were applied, justified by the ADM illogic that this inflation was caused by excessive demand. This thoughtless act, that was imposed for some time in the UK and the USA, resulted in it being too expensive to raise loans to invest in cost reduction projects. It also resulted in millions of families losing their homes and family farms; a policy-induced disaster.

The cause of inflation

Inflation has very little to do with "demand". Real Incomes analysis had demonstrated that price rises are the result of ADM policies, being "demand" oriented, doing nothing to provide incentives for companies to compete by moving their price performance ratios in appropriate directions through tactical unit price setting to accessible levels, against the rising costs of inputs, to maintain growth in real incomes. Again, only feasible through policy instruments that impact supply side determinants. Currently, no such policy instruments exist in the ADM policy toolkit which is fixated on demand control, whereas, they do exist in the Real Incomes policy toolkit that enables companies to secure a more effective management of their performance through the manipulation of key supply side determinants. These policy instruments, which assist businesses in this strategic fashion, will be described in Part 2 of this article.

Demand, the magic word

It is not altogether evident why ADM economists confuse consumption that is determined by unit prices and real disposable incomes, with a magical word "demand". People's incomes come from their places or modes of work not from financial intermediaries as indicated under the Real Incomes column in the table above. This is shown as the looped white arrow between production and income in the green Real Incomes column on the left. Therefore inadequate incomes, corporate pricing policies and inflation determine real incomes or purchasing power. These mechanisms all lie on the "supply side" and determine consumption levels. The ADM asserts low consumption is caused by "lack of demand" and can only be resolved by manipulating money supply through variations in centrally-imposed interest rates and "money volume" where such money comes from financial intermediaries in the form of debt. The Bank of England, after following the decades of misleading public declarations base on the mumbo jumbo reference to variations in the "money volume" as a monetary policy instrument, finally admitted, but without fanfair, that the "Money" is in fact private bank loans ( see: Money creation in the modern economy-BoE ), this explains the support of banks and financial intermediatries for ADM policies. Naturally the incomes and wealth of these institutions and their owners have grown enormously at the expense of the real income levels and savings of the majority . This process erodes real incomes and with savings destroyed by QE there has been a trend in many having to resort to short term credit card debt to maintain their standard of living. But with the downward trend in real incomes such short term credit gradually exands into chronic personal debt. The monetarist target of 2% inflation representing "price stability" represents an underlying erosion of the value of money by around 18% each decade which has resulted in the value of the pound being reduced to less than 1% of its value in 1945." Accordingly these ADM justified solutions have placed the economy and the constituents of this country, each time, in an increasingly precarious state of affairs.

Real Incomes policies can enable the country to escape this real incomes depreciation treadmill maintained by the interests of financial intermediation and ably assisted by the Central Banks worldwide.

With the Covid-19 experience providing us with a case study as to why ADM is and always has been a weak basis for determining economic policy, it is to be hoped that as more people understand this to be this case that the constituents of this country will reject the tired mantra that, "There is no alternative" and begin to demand a better alternative.


1 Hector McNeill is the Director of SEEL-Systems Engineering Economics Lab.