Tuesday, April 20, 2010

The Economic Consequence of ...

The economic understanding of supply shocks really only developed in the 1980s as finally economists came to full grips with the implications of the oil shock and the consequent syndrome of stagflation. Put simply, standard theory on how to respond to either inflation or unemployment revolved around fiscal or monetary policy to expand or contract the market.

However, if prices are increasing and unemployment is rising due to a "shift" in aggregate supply due to something dramatic happening to a factor of production then these responses are inadequate. What needs to happen is rapid radjustment of the economy.

That ultimately was the explanation for the success of the neo-liberal crusade - a whole lot of deregulation was necessary to enable economies to adjust to the new price of oil. In hindsight, negative supply shocks aren't all that uncommon, war being a major one on post war labour.

The current air transport shutdown over Europe provides an interesting example. Apart from the fact we can't blame anyone for it, it is important to note that there are three economic impacts.

The first two relate to the movement of people, one for business the other for pleasure. Business movement can be substituted with teleconferencing. Travel for pleasure - vacations - creates a significant damage to many countries tourism industries.

The more significant is the movement of goods. Few people realise the extent of air shipment of foodstuffs -from the exotic and expensive to more mundane matters like oranges and bananas. The source of much of the produce to Europe is less developed countries in Africa, Asia and South America. The interruption to trade ca have significant impact on their economies.

And all of this due to an event that the article linked to above reminds us we can't blame on anyone, not Tony Blair, not George Bush or even the nanny state!

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