A post by Maynard

Good economics? Bad economics? We argue endlessly, but our arguments are mostly misdirected. What are the key points? At a basic level, what makes an economy rise or fall?

I’ll try to cast some light on a much-obscured topic. Read on and learn how five words convey the basic framework of all things economic. Five words, a few connections, and you’ll understand why some policies nurture and others destroy. Here we go!

First word: Consumption. Simple enough. We consume resources (goods and services) that we want or need.

Next word: Production. Where do the resources we consume come from? They must be produced. Nothing is free. Even if it’s just going into the garden to pick an apple off the tree, you’ve got to do some work to get it.

For the sake of brevity, consider production as the composite of all steps needed — manufacture, harvest, transport, etc. — to make the goods or services available for your consumption.

Okay, production, consumption. Simple enough.

Third word: Savings. Savings are when you produce more than you consume. Then you’ve got a surplus. You can set it aside for later, or allocate it to some new undertaking.

Savings are required for an economy to grow. If you consume all you produce and save nothing, then you exist at a subsistence level. Savings grant you the potential to utilize excess resources so as to upgrade your circumstances.

We’ll gloss over the word deficit, or other words relating to the reallocation of wealth, because these words are meaningless in terms of fundamental economics. A deficit is merely a means of tapping into someone else’s savings. This is accomplished through various vehicles, for example borrowing and taxing, not to mention stealing. (Taxes can be direct or indirect — for example, currency depreciation (inflation) is a hidden tax, and the Obamacare mandate is not a tax (so Obama says); yet it compels you to spend your money in such-and-such a way.) Bottom line is that all of forces of redistribution — deficit, taxes, depreciation, mandate, regulation, theft, whatever — are simply the negation of savings. More of the former means less of the latter. I’m noting this as a technical point, not an editorial comment.

This leads to the fourth word, which is Investment. An investment is a special form of consumption, in that resources are used up, not for the purpose of today’s subsistence, but rather for tomorrow’s production.

For example, imagine you have a bean. You can eat (consume) that bean, giving you a meal today and nothing tomorrow. Or you can plant (invest) the bean, meaning you don’t eat it today, but hopefully tomorrow you’ll have more beans. (Note that your investment may or may not bear fruit (or bear beans, as the case may be), depending on circumstances. More on this later.)

With the four words out of five, we have a framework for analyzing any economic proposal. When a plan is proposed, ask yourself: Is this an investment that will result in production? Or is it a plan to boost consumption? What impact does it have on savings?

What does an economy need to prosper? More production? More investment? More savings? More consumption? To answer these questions, we must consider — and this is our final word — Balance.

A functioning economy produces, consumes, invests, and saves in proper balance. Without consumption, you starve in the short term (that is, you have no bean to eat today). Without investment (that is, planting the seed rather than eating it), production will falter (there will be no crop next year), and you’ll starve in the long term. And without saving (you can’t eat all your beans or you’ll have none left to plant!), there can be no investment.

America is failing because we are out of balance. We consume more than we produce, resulting in a perpetual deficit. That means we’ve got to tap into somebody’s savings in order to get through the day.

Why did the markets crash in 2008? Was it because of Bush’s wars? The real estate bubble? Manipulation by Wall Street insiders? We can debate the details furiously, but general problem is an economy out of balance. And the signs of this are everywhere. Budget deficits. Trade deficits. Personal bankruptcies. We’re not living within our means, either as a nation, or as a government, or as individuals.

As long as we are out of balance, we will continue to lurch from crisis to crisis.

To restore balance, we must produce more and/or consume less. We must save more so we can invest more. This is a fundamental economic truth. It is a law of nature.

If politicians respected the laws of nature, then political solutions would be inclined to address our true ailments. Unfortunately the opposite is true.

Politicians are under tremendous pressure, not to solve problems, but to produce instant gratification. The people are hurting now; relief must be granted now.

This is why political solutions to economic problems are almost always counterproductive in the long term. Political solutions tend to enable immediate consumption. Using the example of the bean, politicians are inclined to grab whatever seed beans they can get their hands on and pass it out to be eaten. So we all feel good for the moment, not understanding that there will be a diminished crop next year.

Often political solutions are even more destructive than simply eating our seed grain. Consider the example of the “Cash for Clunkers” program. It sounds nifty. Get old cars off the road, build shiny new cars, put auto workers and dealers to work. What’s not to like?

But consider “Cash for Clunkers” in terms of production/consumption/savings/investment. We start by taking operational cars and destroying them. That’s worse than simple consumption. It’s not like eating your seed grain; it’s more like burning your seed grain. You have technically consumed a perfectly good piece of equipment, and you have nothing to show for it but scrap metal.

Poof!; there goes our wealth. We destroyed it because the government paid us to! This is truly madness.

Then we consume more resources to produce new cars — and keep in mind that much of this production is done by foreigners in foreign lands. Then we buy these cars with borrowed money.

When “Cash for Clunkers” is said and done, we’ve consumed unnecessarily, produced things we shouldn’t have needed, and depleted savings that we don’t have for no good purpose. This is, quite simply, self-destructive.

And this is why politics cannot save us. On the political scale, “Cash for Clunkers” is a winner. Because we see new cars, and we see people at work. That looks good, even as it destroys us. Sort of like a shot of booze gives relief from delirium tremens.

So it goes with the government, which is always trying to address our economic woes through “stimulation” and “investment”. When politicians speak of “stimulating” the economy, they mean to borrow money (largely from foreigners these days) and spend it locally. This keeps domestic salesmen and foreign manufacturers busy for a while, but it merely runs up the debt for no structural gain. Government “investment”, on the other hand, is often even more destructive than government “stimulus”, in that it generally involves allocating resources in an entirely wasteful way. Solyndra (solar), Range Fuels (cellulosic ethanol), and A123 Battery are examples of government “investment”. Instead of building an infrastructure that produces useful goods, we end up with expensive shuttered hulks that produce nothing, and we are left with fewer resources to pay off the debts we incurred pointlessly.

Contrast government wastage against the stock market, which is generally misunderstood in the public eye. Just as government “investments” are the coerced implementation of starry-eyed theories, the stock market is a gauge of real-world productivity. Government undertakings are billion-dollar photo ops that are rarely worth what was put into them; the stock market is a (relatively!) honest contest.

To understand the stock market, again consider the analogy of the bean. You have a bean that you refrained from eating; instead you’re wondering how to plant it. That makes you an investor. You take your bean to the stock market. Every stock is a potential bean field, and they’re all making some claim about why a bean planted in their field will bear the greatest harvest. One bean field has good irrigation, another has rich soil, another is plagued by fewer predators. So many bean fields, and some will be more fruitful than others. You do your research and make your best guess, and you accept the consequences. If people make educated choices, then the national harvest will be greater, and prosperity will be widespread. If, on the other hand, everyone tosses their beans onto a plain of dry rocks, the national harvest will dwindle. (And of course some promoters of bean fields are fraudulent, and they take the beans offered for planting and eat them instead.)

Capitalism generally works because people tend to plant their own beans (that is, invest their own money) with care. Government “investment” fails because it chooses the bean fields that the rational markets have, for good reason, rejected as untenable. But Uncle Sam effectively snatches the bean from your hand and plants it in a field of dry rocks. You would have chosen to invest in a needed oil pipeline that would have returned a profit, but Uncle Sam instead took your money and “invested” in Solyndra. Next year, both you and Uncle Sam are broke.

So the more the government seizes other people’s beans and plants them in fields of its own choosing, the smaller next year’s national harvest will be. A few politically-connected individuals will be richer, but on the whole the nation will be poorer. It’s that simple.

Have you got it? Produce, Consume, Save, and Invest, all in Balance. This is the framework for a functioning economy, under which we all have a shot at producing wealth and retaining the fruits (or beans) of our labors. It is a framework that America has historically embraced, which is why our prosperity grew. We have moved away from this functional framework in the recent era (as the man said, “Change!”), and thus we see our prosperity slipping.

America’s choice is straightforward. We can work to restore our economy to a solid foundation of greater savings, investment, and productivity. Or we can continue on the current path, looting the future in order to keep our orgy of unsustainable indulgence going for one more day, until a crisis (probably in the form of a dollar crash) hits that brings economic activity to a crawl.

I’ll finish by noting that life is not about money, and we were not put on this Earth for the purpose of simply maximizing productivity. The economy is merely a tool that allows us to carry on with this difficult business of living. Our economic advocacy is not an end in itself, but merely a means to an end. And exactly what that end might be is a very personal choice for every one of us. In advocating conservative (that is to say, rational) economics we are advocates not of economy but of humanity. If we can work and be prosperous, then we have flexibility to choose our paths. If we are impoverished and are reduced to a state of dependency, our choices (and our lives) are minimized.

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11 Comments | Leave a comment
  1. n9zf says:

    An excellent summary of what we should be aiming for. Too bad our pols simply can’t grasp this. Great job Maynard

  2. ancientwrrior says:

    It’s not that they can’t grasp that, it’s because they don’t want to. They are more interested in what they can grasp for themselves and not doing the job they were elected to perform.

  3. Shifra says:

    Excellent post, Maynard.

    I would like to offer *my* five words for improving the economy:

    Impeach the Dumb Bastard Now

  4. Kitten says:

    So what you’re telling me is O’Bummer is eating all our beans, and the beans China gave us, and everyone else’s beans who was dumb enough to invest in his economy? I knew it! That’s just wrong, and greedy. It’s all a part of his plan to fundamentally change America.

    I think politicians are under tremendous pressure to win re-election. A precious few are true servant leaders looking to uphold the Constitution while looking out for our best interest (to keep the Gov out of our lives).

    Right on about the laws of nature, they are true…consider the ant.

    Thanks, Maynard, for this lesson in Economics 101. If my college prof was this astute in explaining it, I would’ve stayed awake in class. :-)

  5. flaggman says:

    Brilliant post, Maynard, bravo. Maybe your next lesson could be on the Time Value of Money and interest, explaining the catastrophic impact over time of institutionalized deficit spending. Thanks professor!

  6. LucyLadley says:

    Thank you Maynard! I will be sharing this!

  7. rosebud2186 says:

    And every time you regulate, you drive up price/cost & create opportunity for corruption. Econ 101

  8. otlset says:

    A bean? A whole meal from a single bean? I’m hungry, I’ll get on board if you make it at least a large potato.

  9. midget says:

    My Italian immigrant,uneducated grandparents lived by these 5 basic economic rules. They raised 14 children on 7$ a WEEK.They saved pennies, grew their own grapes they made wine from, grew their own fruits and vegetables and even made their own cheese and sausage from their animals.My father said they froze in the winter but they were happy.And from their SAVINGS of pennies, they bought land and were able to leave it to their heirs.Not a bad legacy that.

  10. Alain41 says:

    http://www.washingtonpost.com/opinions/charles-lane-a-better-way-to-help-working-class/2013/02/18/6e3e6538-7a02-11e2-82e8-61a46c2cde3d_story.html

    From earlier this week, here is a horrible idea. Charles Lane editorial writer for WaPo and former editor of The New Republic, argues for not raising the minimum wage because that would hurt business and employment, better to increase the Earned Income Tax Credit and then index it to cost of living (along with indexing min. wage to cola). Horrible, horrible, horrible!!! Republicans better not fall for such garbage of, here’s a better third way of helping the poor without hurting business. Because it is a far far far far far far far worse way!

    As an aside, Mr. Lane got his bachelors degree from Harvard, and an Order of the Knight M.S.L. from Yale. Harvard & Yale! Diversity!

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