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Eureka: Backus-Kehoe-Kydland puzzle
by Jay Gutman
2017-11-23 11:10:05
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This puzzle has it that among countries output is a lot more correlated than consumption. This means that while there seems to be a correlation between different countries' output, or GDP, meaning that most countries have similar growth levels but that their consumption level growth varies a great deal from country to country. Many economists are puzzled by this, because the norm is if an economy growth, its consumption levels grow, and the two should be correlated.

puzz001_400Now let me give you a personal example of how this is not true. Then I'll put the whole thing at the macroeconomic level. In December 2010, I made 2,000 bucks working for a company. I quit on January 2nd 2011 because despite working for that company for 40 days, I still had not had a single conversation on the job, let alone have a cup of coffee with a colleague. I did not feel comfortable being surrounded by strangers 40 plus hours a week. It took me about four months to spend the 2,000 bucks. I did not find another job in between. That's about the same amount I was spending before I had that job, having been unemployed from January 2010 to November 2010, having sent about 10,000 job applications in between. 

My personal consumption never really depended on my income. In some cases I made 1,000 bucks a month and spent 1,000, in other cases I made 2,000 bucks a month and spent 1,000. I had a job for the last six months before I quit but my spending did not change significantly from the times I was unemployed and relied on an allowance.

Now let me put all this at the macroeconomic level. Consumption depends on a large range of factors, including demographics, supply of products, population density, availability of transportation, communications, availability of products, efficiency of production lines and many other factors. Per capita consumption might go down in countries with high birth rates and might go up in countries with low birth rates. Countries with poor transportation systems might have lower consumption rates than countries with high-end transportation systems. Countries where the dominant demographic is mid-career level workers might have higher savings rates and lower consumption rates than countries where the dominant demographic is entry-level career workers. A country with low industrialization rates and low economic diversification rates might have lower consumption rates than those highly industrialized and diverse economic production.

The consumption growth rate correlation is said to be .19 which is very low but about confirms what I just said above. Let me break it down for you even further. First let's look at demographics. Each country has its demographic fingerprint if you like. No two countries have similar demographic models although some trends tend to erupt. A country with high fertility rates will have low consumption growth because children are steady consumers, and the dominant demographic is children. A country where the dominant demographic is teenagers or young adults might have high consumer growth because such age groups tend to be consumers, but provided that the country is industrialized and has efficient transportation systems. Because if all you can consume is fruits, vegetables and perhaps imported clothes, you will not have high consumer growth rates.

Let's look at transportation and communications. I love reading and buying books, but live in a country with no online banking. I actually don't possess a bank account. To buy books, I would have to take a taxi, beat the traffic, and perhaps two hours later arrive at the bookstore, pay egregious transportation fees, be told by the taxi that the more he waits the more I will have to pay him, so quickly buy a low selection of books and get back inside the taxi. That is just not an option. The same could be said about buying clothes, household goods or anything else. If I had the good banking system, transportation and communications option, my consumption rates would have gone way up.

Unfortunately this puzzle did not take into account all the variables that make healthy and robust consumer growth or sluggish consumer growth. For example, Equatorial Guinea used to have about 200% GDP growth a year. But the consumer growth rates were sluggish, because a lot of the spendings were in the form of government expenditures, not consumer growth. The same factors are involved, transportation, industrial production, consumer choice, demographics, population concentration etc. You get the idea.

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