It's Demand, Dear Confused One

So Rampel, Yglesias, Krugman, and DeLong provide numbers where the policy-uncertainty "school" of thought has only previously provided anecdotes. It's the same numbers I've pointed to in the past - the NFIB surveys. They suggest that the biggest single problem facing small businesses is demand for their products. A few caveats apply - first, this is clearly subject to Arrow's impossibility theorem so while it's better than anything the policy uncertainty gang has served up it's far from conclusive. There's also a disconcerting lack of obvious data over time available. I'm sure it's somewhere, but we just have a graph.


Russ Roberts points out that "taxation" and "regulation" together are as substantial as demand. But what really matters is which increased the most when the recession hit. It looks like demand clearly did, but I would need the numbers to confirm. In other words - a third of businesses find taxation and regulation to be a problem. OK - no surprise there. If that stays relatively constant in good times and bad, it doesn't do much at all to explain economic downturns - contra Higgs, Catalan, Roberts, etc. Nobody likes taxes, and nobody like regulation - if customers keep showing up it's not surprising you point to red tape as your biggest problem. The question is - (1.) how big of a problem is it, and (2.) is it associated with the current downturn. This data can't answer the first question but it can begin to answer the second. Eye-balling it, the percent of people responding that sales is their biggest problem roughly doubled. It's hard to eyeball the categories further up in the graph, but they don't appear to have had such a rapid increase. But it doesn't appear, for example, that government regulation is any bigger a concern now than it was in the 1990s. That should say something to you people. Demand is a considerably bigger problem.
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Jonathan responds that the policy uncertainty may be causing the demand problems. Certainly - and I've suggested that that's at least part of the story on this blog. But for policy uncertainty to reduce demand you have to have businesses be uncertain first. That will presumably lead to lower investment and hiring, and then you'd see a spike in concerns about demand.
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Jonathan: you simply don't see this in the data.
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Russ Roberts and Arnold Kling raise equally unconvincing concerns (I'm not sure Kling is responding to this post exactly). Karl Smith responds with exactly my reaction to the Kling post: sure you can be clever and think up all these neat little things that could also be going on, but all the evidence suggests that any of these mismatch or asset specificity issues play a smaller role than demand. As Smith writes, the demand "eats up most of the variance".
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Russ raises somewhat better points that don't look like they'll pan out (from eyeballing it), but that I think ultimately I'd need the actual numbers to address. If you can wade through his flippancy there are actually a few real concerns that are worth checking out in the data. Nothing to merit his "I don't see it" comment at the end. If he's not seeing it he's not looking - but still a few things to check out.
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One of the things that Colander mentions in the testimony I linked in the last post is that economic arguments need to pass a "smell test". Here's a smell test - think of a simple AD-AS model. A supply and demand curve. We should all know that, even the non-economists reading this.
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What happens if there is a negative supply shock? Quantity decreases and prices increase, relative to expectations.
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What happens if there is a negative demand shock? Quantity decreases and prices decrease, relative to expectations.
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These are smell tests that anyone should be able to think through. Which example best characterizes what we're going through now? Clearly the demand problem. Now, that obviously doesn't prove everything else Keynesians say, but that should be clear to anyone that comes at these questions objectively. It's reflected in all the macroeconomic data. When people cherry-pick anecdotes to slip into their WSJ op-eds they can get around it, but when you survey firms they say the same thing. That doesn't prove the body of Keynesian theory, but it's a fundamental point everyone should be accepting and it's a good reason to listen carefully to the people that have been thinking and worrying about demand shocks for 75 years.