What will it take to fix our economy?

I have no formal training in economics.  While that may appear to be a disadvantage in writing about our economy, I think there may also be advantages! The advantage comes in the form of not being influenced by pre-digested or incompletely understood jargon  - such as might be rapidly absorbed by the first year economics student.  Such absorption of terms often is not accompanied by a true understanding of their meaning and built-in assumptions.  This can make such “knowledge” worse than useless.

In hearing  so much debate about how the US economy is doing, how many jobs have been lost or gained by various government activities – it all struck me as so artificial.  It seemed to me that I knew what things had to happen for an economy to really grow, and it wasn’t this artificial creation of ‘jobs’ by the government.  The more I thought about it, though, the more complex it seemed to be: this made me want to write it all down to get a handle on it.

What is economic progress?

First of all, what, in my view, is real economic progress?  We can look at this, initially, from the consumer side.  Every person is a consumer and must decide what to consume based on a budget and the many products and services that are available.  This includes products which are strictly utilitarian (a razor, writing paper, desks) or ones which are for entertainment (movies, plays, music).   As my initial stab at a definition, I would say that an economy is good to the extent that I can easily obtain these things.  Given the same amount of effort on my part (say, doing the same type of job and having the same hours) the economy is better if I can afford to have more or better things.  This increases my standard of living. 

There is more to it, of course.  What we really want to know is how things are changing over time.  It would, perhaps, be better to say that the economy is progressing to the extent that the average individual’s standard of living improves over time.

This is certainly something that is hard to quantify.  How can you measure how well someone lives or what their standard of living is?  It is difficult.  You might measure what amenities people have, or how many hours they have to work to survive.  One way of measuring it, would be to look at averages.  How much time must be invested, by the average worker, in order to buy one loaf of bread?  This would incorporate the pay of the person along with the cost of the bread and give you an answer across the entire population.  Now if we looked at all the products that most people tend to buy, and looked at the average income of people – perhaps we would then have a better measure of economic progress – which would be a short-hand way of trying to measure one’s quality of life (or standard of living).  We could look at things like the consumer price index and compare it to the average income.  This does not actually compare how hard each job is – which would also be a measure of quality of life.  And it doesn’t include the risks of the job, either.   Other statistics of use might be average life expectancy in addition to quality of life.  I would say, for example, that if the average number of hours worked by a people is lowering, and their ability to have things like cell phones, microwaves, and their own homes – is increasing, and they are living longer, that these are all signs of progress and are getting at what I mean by economic progress.

What is typically measured?

What are typically talked about are not these things but surrogates.  We look less at the availability of cheap cell phones and more at the expansion of cell phone companies, loans taken out by businesses and people, the number of people being hired by these businesses, and how many phones they are producing.  In other words, in most cases we measure the process of economic progress, the activities that are typically performed in the creation of goods and services, not the end results and effect on the consumer.  These surrogates are short-hand ways of measuring the economic engine’s performance .  Their advantage is that they are much easier to measure.  Their disadvantage is they don’t deal with the heart and soul of the economy, which are the effects those products have on the life of the consumer and the effect it will have on the choices that consumer in turn makes.

Who creates the products and services?

So how do all these products, services, and entertainments come to be?  Almost all of us participate in the production of these things.  Either as an employee or owner, we work in the capacity of creating products or services for others.   In the creation of products or services, we are competing for the business of all the consumers out there who can choose our product/service from among many others.

Now each business is working both to increase its profits and, usually, to expand its business to more consumers.  How can they do this?  They mainly do this by improving the product (making it nicer, faster, with greater capacity, etc) or by producing it at less expensively.

So by what mechanism does the economy improve?  This happens when countless instances of the following occur:  a producer improves a product or is able to lower the price such that most consumers tend to choose that product over others.  In other words, when producers innovate – creating products that are perceived as better or cheaper – then that is an instance of economic improvement.  When that occurs, on the whole, countless times in an entire economy, then the standard of living improves and economic progress has occurred.  When this process is allowed to occur over a long period of time, then consumers are able to have better, cheaper things and services and their standard of living has improved.

Now, the more innovative and effective the product, the more of an effect it will have on the economy.  Thus, those who create a whole new type of product that is useful but which has never been seen before, improve the economy to a much greater degree than the average innovator.  So, for example, the development of antibiotics, computers, telephones, televisions, cellular phones, etc. represents large leaps in the productive capacity, health, or access to entertainment available to countless people.  Products and services such as these represent giant leaps in the standard of living of a people.

Now, in light of the effort required (the risk-taking and inventive work) to create real economic progress, how are we to view popular analyses of the economy?

A Job is a Job

You should never try to fake a good economy, as it will only worsen things.  If you looked at a neighbor and notice that he had bought a beautiful new car, was eating out every night, and wore very nice clothes – you might assume he was doing very well, economically.  But if later his house was in foreclosure and his car was repossessed, you might realize that he was simply living beyond his means. 

Some people think we should fake a good national economy.  They feel that if you just take money from some people (tax payers) and give it to others in the form of a ‘job’, that economic progress has occurred.  But, as we note, the real ‘voters’ of whether a product or service is good, are the consumers and payers for that product or service.  And thus, in a true economy, the real reason people have jobs is because consumers have liked, to some degree, the product or service their job goes into producing.  This whole process is thwarted by creating ‘make-work’ jobs.  The consumer doesn’t necessarily want the product or service being produced and money (or votes) are being taken out of their pockets (and therefore) away from other products or services they might actually prefer.  This is waste –and actually undercuts the performance of the economy.  (Given that the government is generally the only provider of roads and certain other services, you might be able to argue that it is therefore legitimate for them to spend money in that regard, and I can agree to a certain degree)  Many people falsely believe, though, that any money spent is ‘good’ for the economy.  We can see that this is really only good for the appearance of an improving economy.

Bail Outs

Bail outs, by my view, would also be counterproductive.  Why use good money (money taken from tax payers who would have used it to buy (vote for) their most preferred products and services - and use it to prop up a company that, by poor investment or production of inferior products, or bad decision-making – has lost in the marketplace?  What is so bad, in the economy, that won’t be made worse by taking such measures?  Indeed, by propping up a bad company, we are unnaturally competing with the better companies.  We are taking away customers that would have gone to the better companies.  There may be other negative effects.  For example, the equipment and supplies that could have been sold off in closing the poorly run company might have been available to be bought by the better run company – at a cheaper price.  In fact, the better run company might have been willing to take over the poorly run company, change management, or make other changes to improve it.  By the government propping it up, we are simply freezing the status quo – preserving the mistakes so that they can be repeated.

So what will it take to fix our economy?  Getting out of the way of those who know how to do it – the inventors, investors, and business owners.  Allowing them more freedom to do their work and eliminating taxation and heavy regulation that ultimately weighs them, and the whole economy, down.  In other words, acting on a better understanding of where true economic progress comes from.

Comments

[James Bernheimer]

That's a nice piece. Although it's hard to read and believe you have no knowledge of Adam Smith :).

I think you make important observations about what an economy really is. It is a mechanism not for employing people directly but for providing goods and services so that individuals don't have to produce everything they need or want for themselves (which then allows for greater specialization of goods and services - I mean would there really be physicians if we were all tasked with hunting or growing our own food, building our own homes, or making our own clothes and furniture?). Employment occurs as a result of providing desirable goods and services. We focus on the economic marker of the employment rate, but that is a surrogate and as you point out only jobs created in response to consumer demand are desirable or sustainable.

Milton Friedman once observed a government excavation project (I forget in what country) that was using shovel labour rather than mechanized diggers and when he asked why, he was told that it was so they could employ more people. To demonstrate the absurdity he replied, "Then why don't you make them all dig with spoons?"

I would add about bail outs the other harm, which is they encourage excessive risk taking. If you are entitled to all the profits you take from a successful gamble but are protected from all the losses when you lose, why wouldn't you take big risks?

[David]

Jim,

Thanks for your comments. Yes, independent reading and exposure to Adam Smith and his followers has undoubtably occurred over time. Especially Ayn Rand's ideas, and those of Milton Friedman and George Reisman: http://www.georgereisman.com/blog/

Dave