Economic principles are older than history

Economics is incredibly complicated, we are told.  Economists would have us believe so because, otherwise, why would we need them?  Politicians likewise prefer befuddled voters as they are easy to manipulate.  Our economic system is indeed complex because of its enormous scale.  But it is based on some very simple principles, and we can use them to understand fundamental relationships.
 

In case you hadn’t noticed, the global economy is in a funk.  Investors aren’t investing, bankers aren’t lending, consumers aren’t consuming, manufacturers aren’t hiring... what to do?

There is a debate raging on the choice between growth or austerity (reducing debt) to improve things.  By “growth”, its proponents mean public sector spending (hiring more cops, clerks, and teachers), funded by higher taxes or increased borrowing. Those on the other side say that austerity works just fine, thank you very much, it just takes a little longer.  And further, they argue, “growth” could and should be nurtured in the private sector – it need not be a codeword for public spending.

Public sector, private sector, spending, growth, debt, taxes… it’s enough to make your head spin.  What should we do?  How do we decide?

Let’s take a look at how economics began. Imagine a prehistoric tribe made up of ten individuals.  We will focus on the adults and ignore the children for now.  The adults  are divvied up as follows:

• 3 hunters
• 4 gatherers
• 1 shaman (active)
• 1 shaman (retired)
• 1 hunter (disabled)

The three hunters, as you might guess, track, pursue, and take game animals, large and small.  The four gatherers cultivate simple grains and vegetables and collect wild fruits and berries. The hunters and gatherers make up the private sector, as they produce the means to keep the tribe alive.  Their output feeds the entire tribe.

The shaman uses magic to forecast the future, cast spells on the tribe’s enemies, and teaches basic skills to the tribe’s children.  He makes up the public sector.

The disabled hunter, unfortunately, is no longer able to contribute because of a badly wrenched back from trying to haul a large elk.  The retired shaman, too old to prognosticate, and the disabled hunter are social beneficiaries.    

All of the grains, berries, rabbits and venison produced by the hunters and gatherers must be shared with the public sector (current shaman) and the social beneficiaries (retired shaman and disabled hunter).  Every rabbit, sheave of grain, and basket of berries must be shared ten ways, even though only seven are responsible for production. For every 10 rabbits a hunter snares, he must give up 3 to support the public and social beneficiary sectors. This is a tax.

Imagine that a prolonged drought results in poor yields for both hunters and gatherers… the economy is a mess.  People are hungry, starving, and something must be done.  So what is the logical conclusion… shall we hire another shaman from the tribe in the next valley?

That’s what some argue… that by expanding our public sector, economic output will be increased.  But we still have only 3 hunters and 4 gatherers, who must now share their output 11 ways instead of 10.  They are rightfully baffled by this decision, because there are now more mouths to feed but no increase in production to do so.

Does this mean that the public sector is bad and that we shouldn’t support those in need?  Absolutely not!  In our real economy, public servants are crucial to our society’s functioning, keeping us safe from crime, putting out fires, and teaching the next generation of productive citizens.  And it is only decent to sustain those who are truly in need.  But remember that we can only do what we can afford to do.  That is the mistake made by the Greeks – chronic overpromising, living beyond their means.

When the government expands the public sector or expands social benefits, these costs must be paid.  There are only two choices… by raising taxes now or raising taxes later.  In the latter case, we can borrow a surplus from the tribe in the next valley, but it must eventually be repaid (plus interest), which requires a future tax.

This is not meant to convince you to think in any given way, only to think.  When presented with economic alternatives, think.  Then choose.  But do so based on an informed consideration.