What’s Important in Economics?

As an exercise, consider a comparison between three imaginary villages. Everything will be simplified so that the comparison won’t be confounded by extraneous factors. The villages are mostly identical as well, so comparison won’t be difficult. Let’s start by describing one of the villages; the others are the same in every factor that is mentioned. They have the same housing, the same stores, the same prices in those stores, the same transportation, the same living conditions. That’s the beauty of the example. Nothing is different between the villages except what is called out below.

There are ten identical households in a village. In each of the ten identical households there is a wage-earner, who works regular hours and brings home income, which is used by the household to purchase their necessities and some extras. Each worker in the ten households gets the same wage as the other nine, pays the same tax as the other nine, has the same debt, and the same requirements for necessities, such as shelter and food. There aren’t any significant differences between the ten.

In village 1, workers receive a hundred units of money a week. They spend ninety on necessities, save five and use five for extras.

In village 2, workers receive a hundred fifty units of money a week. They spend ninety on necessities, pay interest on their onerous debts with fifty, save five and use five for extras.

In village 3, workers receive a hundred twenty-five units of money a week. They spend ninety on necessities, pay taxes with twenty-five, save five and use five for extras.

These conditions do not change and nothing external disturbs the arrangements.

Which village is better off?

Households in village 2 have great debt and are forced to spend one third of their income on debt interest and never get a chance to pay it off.

Households in village 3 and burdened with onerous taxes which consume twenty percent of their income. They have no way to escape from these taxes.

Households in village 1 have no debts whatsoever and are fortunately free from taxation.

In this example, nothing changes, so the only way to make a comparison is to look at current conditions. There is some emotional attachment that certain people have with debt, so they would necessarily regard village 2 as worse off. Other people have a strong feeling about taxes, and would therefore regard village 3 as worse off. These are not rational reactions.

The only thing that affects the life of the people in the households in these three villages is the amount of money they have left over to spend on necessities, savings and extras. It is identical in the three villages. The three villages have exactly the same standard of living. They would not be separable if you went to the villages, looked them over, and tried to compare them. In each house you visited, life would be the same in the three villages. You could count their possessions, discuss their activities, compare their health, examine their educations, and every last one of these would be identical. You would be unable to discern any difference from any observation of their lives or their environment. The paint on their houses would be the same, the depth of the tread on any vehicles they have is the same, the trimming of their lawns is the same. The commute times are the same. The electric usage is the same. The water and sewer systems are identical.

The purpose of this example is to make the distinction between irrelevant differences and important ones. Net income is important. Whether that income is affected by debt or tax or anything else is irrelevant if the net income is the same. The level of debt is not worth noting. The percentage of taxation is irrelevant. These are simply economic accounting processes and there could be many other variations, besides the simple debt interest and taxes that subtract from gross income to make net income. They would be irrelevant as well.

Why then is there so much concern about debt and taxes, if they are only accounting labels for subtractions from gross income? Even gross income is irrelevant, except as an input into the accounting for the weekly payment to the workers. Village 2 is paid more than village 3 which is paid more than village 1, yet the higher wages mean absolutely nothing.

It may be true that there are a hundred ways to structure a debt, and economists can have some good times figuring them all out, but it means nothing in comparison to net income. Taxes can also take a hundred forms, and there can be a vast amount of clever thinking expended in arranging them. They are irrelevant in all forms. What matters is net income and how it relates to the expenses of the household.

The units of the payments are also irrelevant, as money is simply another accounting device. What matters is the purchasing power of the money, and if had a different label or unit, it would make no difference in our example.

We are not going to be able to construct a just and decent economic system if we concentrate on accounting intricacies and financial constructs. Yet that is what most economics discussion does concentrate on. To make a good economic system it is really necessary to look past these gimmicks of rearranging the distribution of economic benefits and drill down on what is important. It is the final distribution of benefits that makes the difference.

Perhaps some schemes for rearranging benefits are simpler and easier to implement that others. The simplicity or complexity of such schemes are largely irrelevant. These schemes should be regarded as only the means to accomplishing the end, which is the final distribution of income. Labeling various schemes or the details of various schemes as just or fair or real or the inverse of these attributes does absolutely nothing except obscure what economics should be concentrating on: final distributions.

Someone’s infatuation with one of these particular schemes, that is, with one of the means of determining the final distribution, should not be allowed to interfere with the assessment of the final distribution. That final distribution is what should be assessed and the design of it is what should occupy most of the thinking of an economic theory. Perhaps some of these schemes can be more easily explained, but that does not mean anything at all. Some of them might be more easily propagandized, and again, this means nothing.

The final distribution of incomes is the principal subject matter of a just deserts economic theory. There are two ways of approaching the subject, a micro and a macro approach. The micro approach answers the question of how the details of the distribution affect the recipients. Does it motivate them? Does it ring true with the actual utility provided by those receiving the benefits? The macro approach answers the question of change. How does some distribution arrangement lead to a growth in the total annual benefits production. What is the tradeoff between the diversion of benefits into savings and the growth rate of benefits?

There can also be a long discussion on the mechanisms by which savings happen. There can be mandatory rules for savings, or forced savings which happen earlier in the income stream than the receipt of the residual benefits by those they are going to. There can be various supplemental benefits for savings, or threats of future calamity if savings are not at a certain level. These make as much difference as the debt and tax levels. In other words, none at all. What matters is how much goes into savings, which is another name for capital formation.

The discussions of how savings, or capital formation, is translated into increases in productivity, also known as increases in benefits, is something that needs to be part of an economic theory. Exactly how the savings are implemented or enforced or encouraged is not a top-level consideration. What matters is the determination of what happens to productivity when savings are different levels.

After the theory finishes with both the micro approach and the macro approach, from the broadest perspective, then it might step down a notch and figure out how the few simple quantities that make up this overview might be implemented. Note here that the key word is implemented. To be precise, the word implemented does not mean anything except the generation of details to make something happen. If the overview figures out that five percent savings is right for a balance between immediate consumption and future consumption, then all the rest of the work is simply determining some accounting schemes, such as debt, taxes, withholdings, or whatever, to make that happen. Any economic theory which starts at the bottom and tries to work upward is necessarily doomed to failure. There is simply no way sets of details can be mashed together to make up a coherent theory.

Carrot and Stick in Motivation

Motivation is another word whose meaning or implications change with its application. Generally it means the level of emotion that propels someone to accomplish a task, but in economic systems, it means the emotional drive to produce useful things for society. A highly motivated person produces more, because of the additional attention they apply to the task, the speed at which they work, the creativity they introduce into the work, the analysis they do to ensure the task is done well, the length of time they put into it and the amount of thought about it which is generated during times when they are not focused on the task, and even more. Someone with little experience in working might not feel the same effects from motivation, and only have one or a few of the above effects happening, so the definition is vague, but it can still be used.

We do not have a measure for motivation, as it is so diverse and its effects so varied. Productivity increases with motivated workers, both at an instant in time as they work hard and faster and more accurately, but also dynamically increases as they offer ways to improve the task or incorporate these improved ways in their own efforts. Thus, for a given labor expense, measured in individuals employed for a fixed amount of time, more is produced and society in general has more.

Motivation also feels good to those who have it. It produces some positive emotional feedback. This is colloquially expressed in different way, for example, by saying the individual enjoys their work. They do enjoy it, meaning they feel good when they do it and better when they do it well.

One can find a variety of ways that motivation can affect an individual. One saying in our society is to wish that someone starting a career can find work they enjoy. This is somewhat different than saying some people are motivated, meaning anything they do they find motivating. The difference here is from child-rearing. One individual was complimented and praised for doing a particular thing very well, so they choose to find things to do which are analogous to it, and then their brain dredges up the former happy memories, unconsciously, and they have found work which they enjoy. Other individuals might have been complimented and praised for doing everything well, and their brain dredges up these former happy memories, unconsciously, whenever they have a task to do and they put their full attention and energy into it. Motivation is simply a reflection of some details of child-rearing.

Short of a government program for child-rearing counseling or something else to effect child-rearing among large masses of people, economic systems are stuck with dealing with what they have: a mixture of highly motivated people with generic interests, highly motivated people with specific interests, moderately motivated people within the same two divisions, and unmotivated people. It would be very fanciful to assume that people whose child-rearing positioned them in the unmotivated group could be somehow re-indoctrinated to become motivated or that somewhere there is a undiscovered and productive task area that would motivate them. Instead, the economic system needs to be constructed so it can deal with this mix of people.

This is not to say that there are not people apparently in the unmotivated bin who have simply not yet found some task with attributes which motivate them, moderately or even intensely. There needs to be some aptitude and interest testing, in a very in-depth and professional way, which helps people find what tasks that society has to offer which will strike a chord within what their child-rearing has provided them as positive handles.

There is also a negative side of these handles. A task which might otherwise be something that motivates an individual might also raise in that individual some negative feelings, which would undermine the motivation and render the positive connections impotent.

It is also not to say that some counseling or advice or therapy might not change a person from unmotivated to motivated, either by unlocking some positive associations within their mind or by dissolving or mitigating the negative ones. Both of these methods, interest testing and counseling, can change the percentage of those in the unmotivated category. But they would not eliminate it. An economic system has to be able to deal with individuals with that predilection.

There is a difference between an economic system which has to function during times of scarcity, when actual physical needs are not quite being met, and times of abundance, when they are and are even surpassed in a small or large measure. In older times, when famine struck or war destroyed resources or drought persisted or any of a slew of other problems arose, people perished. Historical records show there were such periods, and populations affected declined. While the records are incomplete in this regard, it would be reasonable to assume that motivated people and their families fared better than unmotivated ones. Perhaps it is more reasonable to assume that motivation ceased to be a problem for most people, as hunger is about as strong a motivator as can exist. This is the stick that can exist to solve the motivation problem.

In times of abundance, where society as a whole has sufficient necessities so that all can survive, this stick might or might not endure, depending on how the economic system allocates its rewards. Rewards are things that flow from their sources, which are the productive facilities of the society such as farms and factories, mines and gathering processes such as fishing, through society to the ultimate consumer. In the oldest times, this was ordered by family or village. The farming family consumed what it produced. The village divided up what was caught or produced in the village commons. After that, property rights came into vogue and partially displaced these older methods. Ownership initially became fractionated, with some sort of higher level individuals possessing some rights to the production of goods and the remainder having their own rights. The fractionation system gradually was displaced by an accounting scheme, which had many variations. Accounting led to money, which is a simpler method of accounting than having everyone keep tallies of what they owed and what they were owed.

These methods obscure the basics of what is happening in the society, and when they become the focus of an economic system, they can capture the direction of thought. Distribution methods are merely the means by which some agreed-upon allocation of production takes place. The agreement, implicit or explicit, is something that needs to be examined most carefully, and then, in a new economic system, some methods need to be determined which will implement it. These methods are important, as they may not work, given the common tendency toward corruption, greed, and criminality, but they should not be taken as the fundamental part of an economic system.

Instead, the fundamental part of an economic system is the choice of allocation. Specifically, who makes the decision about allocation, and when might it be changed? Is it done by some subset of individuals on a recurring basis, so that in each interval of time allocation can be redecided? In this situation, rules that this subset choose can be enforced by the next round of allocation. If the subset is so predisposed, productivity can be a significant factor in allocation, and this re-introduces the stick into motivational questions. People who are not motivated on the basis of their child-rearing and good fortune in finding things to do which they enjoy, might well be motivated on the basis of shortages of necessities. If the society grows too complex, there might be and probably would be an introduction of rights, which are simply part of a system of rules in a formal allocation system.

Allocation is a complex problem, and how individuals are categorized is the first step in any formal system. Is the categorization hierarchical? Does a particular region or village or family receive an allocation or is it done on an individual basis? Clearly there are limits on individual allocations based on the capability of those doing the allocation to deal with individuals, meaning to identify them, connect with them, determine the necessary information about them to implement the rules set up, and then to distribute the rewards. In a hierarchical categorization system, allocation also becomes hierarchical. If rewards are distributed on a family basis, the head of the household determines how they are divided within the family.

Levels of hierarchy work better in situations where the data available for allocation is not easily gathered and processed. But no matter what the degree of hierarchy, the question still exists of how to use the stick of motivation, if at all. Those individuals who have found their carrot, a job they enjoy, have no problem with motivation. Those who have not might be presented with the stick of a shortage of allocation. How this works, dynamically, if different types and organizations of society deserves more discussion.

Greed is Good and Bad

Things are a little bit complicated in an economic system, or rather a political-economic system, as the two can only be artificially divided. The political system sets the rules and the economic system implements them.

What is complicated is that the labels we have for various attributes and entities do not discriminate clearly between different functions that are used in a political-economic system. Greed is an excellent example. Greed has the function of motivating people, whether they are wealthy or poor, to do something to gain more rewards, whether it be money in a money economy, or something else in an earlier or possibly a future economy. This motivation leads individuals and collective groups of individuals to accumulate capital. Capital is another good and bad word. Capital is incredibly useful in a society. Capital is used to facilitate the construction of productive facilities, which are still labeled as capital, and infrastructure, such as transportation systems, which are not typically labeled as capital, but which serve the same purpose.

Greed causes motivation, but that motivation can lead to the production of useful items for the society, and a general elevation of living standards, as well as the development of technology of every sort. That motivation can also lead to the development of monopoly control over necessities or desirable items, that allow large accumulations of capital by some small set of individuals which is unrelated to their contribution to society. There are a host of other devices within a society that equally divert production to a small set of individuals; this host of economic devices will continue to be added to as greed propels individuals in that direction. As long as there is greed there will be good from it and there will be bad from it.

Greed is a desire within individuals, and comes with many trappings. Greed might, in one individual, be connected with the construction of productive facilities so strongly that the only method that individual might contemplate for satisfying his or her greed would be the construction of such facilities, which could benefit the entire set of humans in the population, or at least a large subset. Greed might, in another individual, be associated with disparity, and the only methods that would appeal to such an individual would be those which diminish the wealth or income of others and divert such wealth or income to himself or herself, or to the favored target subset of individuals he or she prefers. Here are two extremely distinct results from the same emotion, or rather from emotions labeled as identical through the use of the single word, greed.

It would be somewhat clumsy to create two new words and try to introduce them into the thinking that goes on about political-economic systems. So, it is necessary to fall back on the coupling of adjectives with the common but misunderstood noun, greed. Before that is done, there should be some thought about how many divisions there should be and exactly where the dividing line should be. The division line should be found or constructed according to the uses for the new word phrases. This blog is concerned about seeing if a new economic system can be devised that does not have the failures inherent in other ones which are caused by feedback loops, unappreciated and largely unnoticed.

The principal feedback loop that dominates the later stages of any economic system is the one the large disparity produces: it serves to increase disparity more and more. Excess of wealth leads to a distortion of the political system to allow a larger degree of disparity to be generated. But wealth, as a mechanism for the accumulation of capital that can be used for productive facilities and other infrastructure or facilities that assist in the generation of benefits for the society, comes also with a good part and a bad part.

Thus it is necessary to define just what the political-economic system is supposed to do. There must be some initial goal or task for it, from which other smaller tasks or even word definitions can be derived. Since there is nothing in the universe that gives us it, it has to be chosen by some humans. I’ll try.

Humans evolved to have both sympathy and practicality, both competitiveness and cooperation. Political-economic systems which stress only one element of each of these two pairs fall afoul of the lessons humanity has learned via evolution. Either one of the two in each pair can appear in a simplified political-economic system that will make sense only if the other one is ignored. But ignoring one part of the two pairs leads to a system which has the feedback loops that generate failure eventually. So the task is to create a system which can have both of these aspects, serving as checks and balances on the other one. Some competition is needed to drive up motivation in a cooperative system. Some sympathy is needed in a system which stresses practicality, meaning where only productive elements are supported.

The symbiosis of these two sides, one relating to the distribution of output of the society and the other relating to the spectrum of motivation for increasing or maintaining the rate of output, has to be done in a clever way, one which does not allow gaming of the rules to the detriment of productivity and a just distribution of the outputs. It also cannot interfere with the generation of capital that is necessary for the construction of new facilities and the development of new technology.

Gaming of the system happens in one mode when resources are not utilized as fully as they might be. The typical example is that of productive individuals for whom motivation has failed, and who depend instead on the sympathy aspect of the political-economic system. The other typical example is that of the consumption of the output of society in ways which do not contribute to either the motivation aspect of the society or the capital increase aspect.

The first example has really two parts to it. The label, productive individual, is a snapshot in time, meaning that such an individual could produce useful output for the society. But snapshots in time are misleading. The match of the individual’s abilities to the roles that can employ them in society can change, meaning the individual must somehow be able to adapt to the changes in the society that surrounds him or her. And again, gaming of the system has to be avoided, so that an individual cannot linger in the adaptation stage, meaning learning or training or educating or even healing stage, for longer than necessary.

The other half of the things to be avoided related to the generation of capital, and concurrently, in the avoidance of the destruction of it for no useful-to-society purpose, or for a purpose which is substantially less than could be found by other means. Capital is generated when consumption is reduced below production, and the difference is diverted into the formation of capital. Consumption can be reduced directly at the source of the output, by never diverting it to individuals. A second way is to send it to individuals, but impose a tax upon consumption, diverting that tax to the formation of capital.

This raises the question of what is the desired role of consumption? Is it an item upon which those afflicted with greed can focus, so that disparate consumption is the goal of this subset of society? Is it an item that those afflicted with excessive sympathy can focus, so that consumption by the non-productive and even those gaming the system can be raised? Or is there some middle ground here, related to the middle ground that must be found between sympathy and practicality and cooperation and competition?

Consider, before attempting to devise some complex set of rules to fulfill these goals, what pitfalls might lay ahead. One pitfall is the difficulty of measurement or assessment. How would society measure if an individual is gaming the system, and could be productive but is motivated to not be? The problem with simple measurement tools is that they are always gamed. Always. Creating some sort of test means that those who will take the test will try to figure out the best way to score correctly on the test, at the least amount of effort and with the least effect on the rest of their lives. So measurement has to be done not as a test that can be gamed, but as an ongoing observation. Again, the cost of observations becomes a pitfall, as if societies output is diverted more into the observational process than would be lost to those gaming the measurement, there is only a negative benefit from the imposition of observational programs. Once again, if the goal is to maximize some output of society, some gaming might have to be tolerated.

It seems that the discussion here has set the stage for the concoction of some possible ways to implement a Just Deserts economic system, but the obstacles are formidable. But if they were not formidable, the system would have been obvious to all long ago.

Capital, Productive and Unproductive

Here’s a serious problem with any Just Deserts economic scheme. In order to build factories and tractors and other stuff useful for the production of useful goods, there has to be some arrangement for this building. Somehow people have to mine the materials, process them into components, put them together and make the useful stuff. They want something in return for their effort. Perhaps they will take promises of future payment, but more likely they want payment concurrently with their work. So, where does it come from?

One way is for someone who has something of value stored somehow can use it to pay the workers. This we can call capital. If there is some new system of economic rewards, and nobody gets to be extremely well-off, how is this storing of value going to take place? To put it another way, rich people in the wild west system take their money and invest it in productive goods, which are then used to make useful goods. With a system that does not allow anyone to become extremely rich, what alternative methods would the system have to introduce to continue the production of useful capital?

In earlier times, the question was irrelevant. If someone needed something productive, like a pot or a spear, they could make it themselves, or barter something they had for whatever it was they needed. Besides self-help and bartering, an individual who needed something and had nothing to barter could expect a ‘big man’ of the clan to provide it as part of the trappings of his position, or a group would form to provide an early form of charity. Specialization came creeping in to these situations, with someone doing a bit more of spear-making or pottery than they needed for themselves, and theirs were better so they spent more time doing their specialty and less on the more generic tasks, relying on barter to fill any gaps. There was still no need for anything that might be called capital.

Once agriculture was in vogue, there had to be governance, which could control who tilled what fields and who reaped what fields, and who received the crops. The governance could be a continuous thing, making on-the-spot decisions every time something had to be done, or it could simply lead to customs and later rules, so someone might be attached to a particular field and do everything needed to bring in the crops, together with whatever shared work contributed to it, such as irrigation. Once the love of one’s children and the generalization of providing for them became amalgamated with governance of the agricultural areas, inheritance can begin, and then capital exists, but only in the form of real estate.

Differential productivity and acquisitiveness can play a role in establishing wealth. If the bartering process does not lead to a roughly equal distribution of goods, because of the productivity of some specialist craftsmen or hunters or farmers, and if they choose to be motivated by personal gain or desire for familial gain, they can orchestrate the bartering arrangements to grow wealthy. If the governance people do not step in to prevent this, wealth will become disparate in the area of personal property, assuming that is accepted by the clan.

Even as early as primitive agricultural times, the dominant feedback loop relating to wealth and governance can start to churn. Those who have wealth and are motivated more by acquisitiveness than charity or the ‘big man’ tradition, can make arrangements with those who govern if they are also so motivated. Rules and decisions by those in governance can favor gradual increases in disparity, provided those in governance share in the bounty.

Thus capital formation can be surmised to have occurred several millennia ago, in primitive tribes, once greed becomes more dominant in a small subset of the population of a small cohesive group than the earlier traditions of caring for all. Since there is a tremendously strong feedback loop to increase it once it does become established, there is no question as to why it still exists despite all the transformations that civilization has seen pass by.

Other psychological processes aid in its persistence, such as the imitation of those who are in charge of governing. Once they adopt the habit of increasing their wealth, charity and gifting those less fortunate become less dominant in the minds of successive generations. This is especially true of those who are most subject to this example, the children of the governed and the wealthy. Whether or not it becomes a universal goal is not too important, as long as the general population becomes accepting of that. And this particular transformation brings in a third specialty group, the theologians or teachers or whoever is responsible for promulgating the cultural traditions. They may also become part of the subset which becomes wealthiest or may only be in a lesser tier, but they provide acceptance of this practice in the minds of the large body of population, and thus disparity, meaning the accumulation of privately controlled capital, can continue to exist and at times grow.

Step forward in time, and the realization that capital used productively can assist in the accumulation of wealth, in the minds of those who favor it, can lead to the growth of the prosperity of the group, or the larger organization if groups have become associated into cities or something even larger. Providing all the hunters with spears which fly straight and don’t break means hunting is more productive. Providing all farmers with seeds and implements means more crops. Dwellings, once they become non-nomadic, can become more robust and comfortable, and convenient for such things as storing grain, another form of wealth accumulation.

As the association of groups becomes larger, the feedback loop for wealth accumulation develops even more disparity, and the use of wealth as productive capital sets up another feedback loop to increase disparity even more. These are very natural loops, based on human mental patterns, which indicates why they exist everywhere and in all time periods. There should be no illusions that something so fundamental can be eliminated or replaced. The most that can be hoped for with a Just Deserts economic system or any other is the modification of it, so the same basic human instincts can be satisfied, but not to the degree that the earlier systems have allowed. The two natural feedback loops must continue to work, but there needs to be some siphoning of the results of them which does not break down their functioning.

There are two avenues which can be invented to preserve the formation of capital, which is essential to the improvement of prosperity of the population involved. Would they actually work?

One is to simply reduce the effects of the feedback loops by something like a tax. Could a tax be designed so that the generation of productive capital is not diminished, while reducing disparity? Quite possibly, disparity reduction will have its own collateral effects in the generation of more productive capital, but would that compensate for the loss of productive capital in the original holders of wealth?

Consider a snapshot in time. Some productive capital exists and serves to increase the prosperity of the population. Much of the prosperity goes to the wealthy subset of the population, where it is turned into both unproductive capital, meaning consumption of luxury or things analogous, and productive capital, meaning that which can be used to promote future prosperity. If the unproductive capital is taxed highly, but not prohibited, that might not reduce the generation of productive capital. Some unproductive capital is needed to continue the motivation of the wealthy to generate more. Thus, one possible mechanism is the taxation in some appropriate way of non-productive use of capital, but not to a prohibitive level. This might be done by some progressive scheme.

The second way would be to accumulate capital directly at the source, such as a tax on output. This would reduce the total amount flowing to both the wealthy and the remainder of the population, but perhaps not affect disparity as much as the first way. However, this method diverts some output to the control of those involved in governance, who are participants in the wealth disparity system engendered by the two feedback loops. It divides up the wealthy into two classes, one of which has more access to large amounts of capital than the other. The first scheme does the same, possibly in a different mechanism, in that taxes on non-productive uses of capital must go somewhere, most likely controlled those in governance, and this opens the door to similar misuse.

Both schemes for better use of the output of productive enterprise suffer from the same failings. One is that a smaller group of potentially wealthy individuals gain control over much more of the output of productive activity. Another related one is that, beside diversion into corrupt loopholes, the utility of the taxed or diverted capital might not be as high as if some highly motivated individuals, highly trained as well, were in charge of it. Something else must be found or some further adaptations of the two schemes mentioned here need to be concocted.