A Short Economic Explanation of Nearly Everything

Simple explanations are always suspect. So do with this what you will. It’s my basic framework for thinking about how economies work. It of course doesn’t explain everything; the headline here is tongue-in-cheek. But I find it very useful in thinking about everything else.

This thinking clashes quite definitively with traditional economic teachings. But it conforms very nicely with economic understandings that have demonstrated those teachings to be bunk. (Think: the Cambridge Capital Controversy, wherein the traditionalist economic powerhouse, Samuelson, admitted that his model — the model that almost all economists and many others even today run natively in their heads — was “definitely false.”)

It starts with money.

There is a pool of financial assets, financial “capital.” Stocks, bonds, money (bank deposits and currency), etc. etc.

People and businesses can transfer those financial assets between themselves.

Some of those transfers are in exchange for real goods and services (things that humans can consume immediately or over time to derive real human utility).

Some of those transfers are simply exchanges of one financial asset for another.

Transfers in exchange for real goods (“purchases,” “spending,” “expenditure”) create income, and spur production.

Production yields surplus. (That surplus is monetized through trade, supported over time by new financial-asset creation by banks and governments — allowing producers to turn their surplus into generalized claims, hence giving them incentive to produce.)

Surplus from production is the source of aggregate “saving.” (Though for clarity I prefer to call it accumulation. National/world wealth is about accumulating real stuff, not claims on real stuff, a.k.a. financial assets).

Transfers in exchange for other financial assets may result in better allocation of real resources.

There is a declining marginal propensity to spend (on real goods) out of wealth. So a person with ten million dollars in financial assets will spend a smaller percentage of that each year than a person with ten thousand dollars.

If wealth is more concentrated, that declining propensity means there is less spending per the amount of financial assets; the turnover is lower.

So there’s less production. And less surplus. And less income. And less saving/accumulation. And there’s less pressure/incentive for banks and governments to create and fund new financial assets, because there’s less surplus that needs monetizing. (Paradoxically, spending causes saving.)

Arithmetically, more-equal distribution of wealth means more spending, income, production, surplus, and accumulation.

There are limits, of course. Perfectly equal distribution would result in seriously problematic incentive effects. But with the wildly unequal wealth distribution we see today, it’s not crazy to suggest that the straightforward arithmetic effects utterly overwhelm those incentive effects.

You can see a simple arithmetic model of this thinking here and here, and download the spreadsheet to play with it yourself.

Cross-posted at Asymptosis.