The Economics of Spending
Much of the debate in government economic policies is based on Keynesianism. The theory is that government spending and taxes have big effects on the economy. When governments spend more, more people get jobs as a result. When governments lower taxes, people have more money to spend, and since one person's spending is another person's income, the economy is better with more spending.
Much less common government economic policies are based on classical economics. The theory of classical economics is that in the long run, supply is what matters, and demand does not directly impact supply. As all of the economic output is based on supply, spending does not matter in the long run, because prices will adjust to the demand, including labour prices, so there is no net change.
One idea that is common from those pushing for higher government spending is that one person's spending is another person's income. While it is true that every time one person spends money it ends up being someone else's income, this is not the same as economic output. If it were, a nation could become rich by handing everyone free money everyday. Currency is not food or any other good -- it is valueless. As it is valueless, economic growth can only come from increases in productivity. One person's spending is another person's income, but this is not the whole story.
Money represents value provided for which no value has been received. If someone owns 1% of the currency in a region, it does not mean they own 1% of that region's economy. It means that this person has provided 1% of the value provided to the region that has not been taken from the region. Once the currency is spent, if the amount is 1 million dollars, then the effect on the economy, is that 1 million dollars of work has been lost, and one person has received one million dollars of relative value. Each time money is spent, it is one person's loss for a future gain, and another person's gain for a previous loss. As the currency has no value, the people who receive the currency that is spent do not benefit from the work they have done, until they spend it. When they spend it, they dilute the money market, thereby decreasing the value of all of the other dollars. If demand increases for a certain product, the value created is only between the buyer and the producers. It is an economic burden to the rest of the economy, because the producers spend their time serving the buyer instead of serving other people in the economy, therefore increasing the labour costs.
For example, consider an example where there are three people in an economy, and three products: food, houses, and movies. As food is a necessity, it provides an infinite amount of value to its consumers. For this example, let one unit of food be enough food to feed one person for a day, and one housing unit be one square foot for one year. If someone has any more food than one unit per year, the extra food has no value to that person. Movies provide a lot less value than food or housing, and the more movies someone has, the less value more movies will provide for them. Houses do not have infinite value, as one can live without a house, but having a house provides much more value to people than movies. Having a house that is small is much better than having no house, and having a large house is a little better than having a small house. For this example, let one unit of value be equal to the first movie someone sees, or the first unit of housing, decreasing by 1% for each additional unit of housing and 1% for each additional movie seen in a year.
If we start the economy with no goods to start off, the people will all gather food until there is enough for themselves. Let us say that at current productivity, each person must work the entire day to produce enough food for that person for a day. In this case the productivity is 1 food unit per person-day of work. In order to have trade, one person makes food currency credits which he uses to buy all the food at the end of the day, and sell the food that he gathered and bought, back to the other two. One person gathers apples(he will be called person A), another gathers bananas(he will be called person B), and the person making the currency gathers corn(he will be called person C); and they gather 10 of each of their foods(10 apples, 10 bananas, and 10 ears of corn, respectively). Person C makes the currency, and trades 2 units of currency for person A's and person B's 2 units of food. They all agree that the currency will only be created by person C, and traded for food at 0.1 units of currency per item of food. They all accept that person C will always trade their currency back for food. They also accept that their currency represents the value they have provided to person C in food, as person C has no use their food once he has enough food for himself.
In this situation, how can the economy be improved? In order for the economy to improve, productivity must improve as there is no way for things to improve if all of the people's time is spent gathering food. Keynesian thinking is that demand should increase to improve the economy. If the people agree Keynesian thinking is the way to go, and allow person C creates 2 more currency, so that there are 4 units of currency instead of 2 for the same amount of food, what will the effect be? As one person's spending is another person's income, the incomes of all three people will double, as persons A and B receive 2 units of currency each instead of 1 each day, and person C will receive 4 units of currency back when they are spent. However productivity has not increased, so how is this possible? One person's spending is another person's income, however this does not take into account the dilution of the currency. The purchasing power of the currency has halved, so person C doubles the food prices, because the other two people are willing to pay double because they make double their previous incomes. If persons A and B have no money saved there is no effect on the economy, as the people have doubled their incomes and halved the purchasing power of the currency, therefore producing no net effect. However, if person A has 1/2 of a currency unit saved and person B has none saved, then there is an increase in inequality. In that case, person A's savings loses half of its purchasing power, and because it represents real food that is in person C's possession which does not lose half of its value, the value of person A's currency that is lost goes to person C. The amount of food represented by person A's currency is only 1/4 units of food despite the 1/2 units of food that were given in exchange for it. Because the currency has been diluted to make the prices double, people with assets other than money get half of the value retained in the money. In this way, Keynesianism causes inequality, because the rich tend to own more non-money assets, whereas the poor often rent the property where they live, and have a large portion of their assets in money. Therefore, spending cannot improve the economy if productivity does not improve.
The economy cannot be improved without increasing the output of food, as the people cannot spend any of their time doing anything other than gathering food at their current production. The value of the economy excluding necessities is nothing. The total value of an economy is always infinite, as food has infinite value to its consumers. If the people start using agriculture to get their food, so that they can produce the same amount with 2/3 of the work, then one person can start working on houses. If person C stops producing corn to start producing houses, and he can produce one unit of housing per day, then the economy can now support 122 square feet per person. The value of the economy excluding food is now 210 units. When persons A and B receive their currency, they can now use it pay person C for rent. Persons A and B now receive 3/2 of a currency unit each day, because their work produces 3/2 of the food it previously did, so they can now spend 1/2 a currency unit each day on rent. This will put the price of housing at 0.004 units of currency per square foot per day (which is 1/2 of a unit currency unit for 122 square feet per day). In the real world this price would be slightly higher, because people would not want to work as much, but for simplicity, we assume free time has no value. If agricultural output increases so that one person can feed the other two, and person B starts producing houses, the amount of housing units will double, but based on the regression numbers used earlier, the value of the economy excluding food will not double, but increase from 210 units to 273 units. The value of the housing has not quadrupled, but the price has, as now person A will now eat one of currency unit's worth of food, and spends the other 2 units on rent. This shows what happens in the the real economy, as someone cannot use all of a house beyond a certain size, so the increase in the value it provides decreases as it gets bigger. The value that a small house provides to its inhabitants compared to no house is much more than the value a house with an infinite size compared to a small house. The problems that occur with having no house are much bigger than the problems that occur with having a small house.
If a politician said that in order to improve the economy, we should write an extra zero on every currency bill, and move the decimal place one place to the right in all banks accounts so that everyone is ten times richer, the politician would be mocked by nearly everyone for not understanding economics. If everyone were ten times richer in terms of dollar amounts, companies would charge ten times as much for their products to keep with demand, and employees would need to be paid ten times as much to afford their expenses which are now ten times as much. Any company that did not raise the wages would soon have no employees, as they would all leave to companies that can afford to pay them more with their ten fold increase in profits. Increasing the money by ten times would not really be a bad idea, as the economy would adapt to it, but to think that it would improve the economy is completely false.
However, when a politician wants to increase the minimum wage, increase spending for programs to help out the poor, or cut taxes, many of the same people who would have mocked the politician in the previous paragraph, would applaud this politician for his good ideas. You cannot improve the economy without improving productivity. However many would say that you transfer wealth within the economy without improving the economy. For example, perhaps raising the minimum wage makes the poor richer at the expense of the rich.
In the example economy of three people, it is decided that person B needs a wage increase, because his productivity is lower than the other two. Person A is rich, because he has invented farm equipment and construction equipment that allows him to produce enough food for the three people in half of a day, so he now produces movies and houses, makes 5 units of currency per day(3 units for food, 1 unit for housing, and 1 unit for movies), and has 500 units saved. Person B still makes 3/2 units per day with no money saved. Person C has invested in house construction equipment, and now makes 3 units per day with 300 units saved. It is decided that there will be a minimum wage of 2 units per day. Because person B makes and upkeeps 3/11 of the housing market, 3/11 of the housing market will be more expensive from 12/3 000 to 16/3 000 currency units per day per square-foot. The economy cannot support this, because there are not 2 extra units to be paid out, so there is no way to employ person B. The demand, however, is not used up. In a larger economy, the, "person Bs" of the world would have the same amount of money coming in, but spread about less people. If persons C and A spread the extra cost evenly proportional to their income, the housing demand will decrease by 20% ((3/11)/(4/3)). When the central bank sees the unemployment, they lower interest rates to inflate the money supply. This causes a readjustment in prices so that a currency unit is worth 3/4 of what it used to be, and the situation is the same as before, as the, "person Bs," make 2 units that are worth what 3/2 used to be worth, except that persons A and C have less valuable savings. You cannot increase person B's wage without a proportional increase in unemployment, and eventually a proportional decrease in purchasing power.
Taxes have a negative effect on the economy, if the money from taxes would have gone to investments had there been no tax. Non-progressive taxes have no effect on the economy, except inflation, because people need to be paid more to get the same amount they did before. Progressive taxes redistribute wealth, but cannot increase or decrease it(except if it causes investments to not be made). If person A has one unit taken away per day by a government and burned, the effect will be that there is one less unit spent on housing, so the price will be lowered to meet the new demand. This will cause person A to have less wealth, and persons B and C to have more, because of the lowered costs.
Spending, including government spending, is just using money to get the economy to do what the buyer wants it to, at the expense of the rest of the economy. If person A spends 4 out of his 5 currency units per day, it is the same as the savings being burned, and will increase the purchasing power of everyone else in the economy. If a politician wants to increase spending and taxes by 10%, they are saying they want to increase everyone's money by 10%, then take that money away and burn it.
There is no way of improving an economy through spending. The only way to improve an economy is to increase productivity through investments, innovation, research, and knowledge. Spending is not good for an economy, because it increases labour costs which diverts labour that could be used for investing, innovating, researching and learning, to goods and services that only benefit the person using them while they are being used.
Much less common government economic policies are based on classical economics. The theory of classical economics is that in the long run, supply is what matters, and demand does not directly impact supply. As all of the economic output is based on supply, spending does not matter in the long run, because prices will adjust to the demand, including labour prices, so there is no net change.
One idea that is common from those pushing for higher government spending is that one person's spending is another person's income. While it is true that every time one person spends money it ends up being someone else's income, this is not the same as economic output. If it were, a nation could become rich by handing everyone free money everyday. Currency is not food or any other good -- it is valueless. As it is valueless, economic growth can only come from increases in productivity. One person's spending is another person's income, but this is not the whole story.
Money represents value provided for which no value has been received. If someone owns 1% of the currency in a region, it does not mean they own 1% of that region's economy. It means that this person has provided 1% of the value provided to the region that has not been taken from the region. Once the currency is spent, if the amount is 1 million dollars, then the effect on the economy, is that 1 million dollars of work has been lost, and one person has received one million dollars of relative value. Each time money is spent, it is one person's loss for a future gain, and another person's gain for a previous loss. As the currency has no value, the people who receive the currency that is spent do not benefit from the work they have done, until they spend it. When they spend it, they dilute the money market, thereby decreasing the value of all of the other dollars. If demand increases for a certain product, the value created is only between the buyer and the producers. It is an economic burden to the rest of the economy, because the producers spend their time serving the buyer instead of serving other people in the economy, therefore increasing the labour costs.
For example, consider an example where there are three people in an economy, and three products: food, houses, and movies. As food is a necessity, it provides an infinite amount of value to its consumers. For this example, let one unit of food be enough food to feed one person for a day, and one housing unit be one square foot for one year. If someone has any more food than one unit per year, the extra food has no value to that person. Movies provide a lot less value than food or housing, and the more movies someone has, the less value more movies will provide for them. Houses do not have infinite value, as one can live without a house, but having a house provides much more value to people than movies. Having a house that is small is much better than having no house, and having a large house is a little better than having a small house. For this example, let one unit of value be equal to the first movie someone sees, or the first unit of housing, decreasing by 1% for each additional unit of housing and 1% for each additional movie seen in a year.
If we start the economy with no goods to start off, the people will all gather food until there is enough for themselves. Let us say that at current productivity, each person must work the entire day to produce enough food for that person for a day. In this case the productivity is 1 food unit per person-day of work. In order to have trade, one person makes food currency credits which he uses to buy all the food at the end of the day, and sell the food that he gathered and bought, back to the other two. One person gathers apples(he will be called person A), another gathers bananas(he will be called person B), and the person making the currency gathers corn(he will be called person C); and they gather 10 of each of their foods(10 apples, 10 bananas, and 10 ears of corn, respectively). Person C makes the currency, and trades 2 units of currency for person A's and person B's 2 units of food. They all agree that the currency will only be created by person C, and traded for food at 0.1 units of currency per item of food. They all accept that person C will always trade their currency back for food. They also accept that their currency represents the value they have provided to person C in food, as person C has no use their food once he has enough food for himself.
In this situation, how can the economy be improved? In order for the economy to improve, productivity must improve as there is no way for things to improve if all of the people's time is spent gathering food. Keynesian thinking is that demand should increase to improve the economy. If the people agree Keynesian thinking is the way to go, and allow person C creates 2 more currency, so that there are 4 units of currency instead of 2 for the same amount of food, what will the effect be? As one person's spending is another person's income, the incomes of all three people will double, as persons A and B receive 2 units of currency each instead of 1 each day, and person C will receive 4 units of currency back when they are spent. However productivity has not increased, so how is this possible? One person's spending is another person's income, however this does not take into account the dilution of the currency. The purchasing power of the currency has halved, so person C doubles the food prices, because the other two people are willing to pay double because they make double their previous incomes. If persons A and B have no money saved there is no effect on the economy, as the people have doubled their incomes and halved the purchasing power of the currency, therefore producing no net effect. However, if person A has 1/2 of a currency unit saved and person B has none saved, then there is an increase in inequality. In that case, person A's savings loses half of its purchasing power, and because it represents real food that is in person C's possession which does not lose half of its value, the value of person A's currency that is lost goes to person C. The amount of food represented by person A's currency is only 1/4 units of food despite the 1/2 units of food that were given in exchange for it. Because the currency has been diluted to make the prices double, people with assets other than money get half of the value retained in the money. In this way, Keynesianism causes inequality, because the rich tend to own more non-money assets, whereas the poor often rent the property where they live, and have a large portion of their assets in money. Therefore, spending cannot improve the economy if productivity does not improve.
The economy cannot be improved without increasing the output of food, as the people cannot spend any of their time doing anything other than gathering food at their current production. The value of the economy excluding necessities is nothing. The total value of an economy is always infinite, as food has infinite value to its consumers. If the people start using agriculture to get their food, so that they can produce the same amount with 2/3 of the work, then one person can start working on houses. If person C stops producing corn to start producing houses, and he can produce one unit of housing per day, then the economy can now support 122 square feet per person. The value of the economy excluding food is now 210 units. When persons A and B receive their currency, they can now use it pay person C for rent. Persons A and B now receive 3/2 of a currency unit each day, because their work produces 3/2 of the food it previously did, so they can now spend 1/2 a currency unit each day on rent. This will put the price of housing at 0.004 units of currency per square foot per day (which is 1/2 of a unit currency unit for 122 square feet per day). In the real world this price would be slightly higher, because people would not want to work as much, but for simplicity, we assume free time has no value. If agricultural output increases so that one person can feed the other two, and person B starts producing houses, the amount of housing units will double, but based on the regression numbers used earlier, the value of the economy excluding food will not double, but increase from 210 units to 273 units. The value of the housing has not quadrupled, but the price has, as now person A will now eat one of currency unit's worth of food, and spends the other 2 units on rent. This shows what happens in the the real economy, as someone cannot use all of a house beyond a certain size, so the increase in the value it provides decreases as it gets bigger. The value that a small house provides to its inhabitants compared to no house is much more than the value a house with an infinite size compared to a small house. The problems that occur with having no house are much bigger than the problems that occur with having a small house.
If a politician said that in order to improve the economy, we should write an extra zero on every currency bill, and move the decimal place one place to the right in all banks accounts so that everyone is ten times richer, the politician would be mocked by nearly everyone for not understanding economics. If everyone were ten times richer in terms of dollar amounts, companies would charge ten times as much for their products to keep with demand, and employees would need to be paid ten times as much to afford their expenses which are now ten times as much. Any company that did not raise the wages would soon have no employees, as they would all leave to companies that can afford to pay them more with their ten fold increase in profits. Increasing the money by ten times would not really be a bad idea, as the economy would adapt to it, but to think that it would improve the economy is completely false.
However, when a politician wants to increase the minimum wage, increase spending for programs to help out the poor, or cut taxes, many of the same people who would have mocked the politician in the previous paragraph, would applaud this politician for his good ideas. You cannot improve the economy without improving productivity. However many would say that you transfer wealth within the economy without improving the economy. For example, perhaps raising the minimum wage makes the poor richer at the expense of the rich.
In the example economy of three people, it is decided that person B needs a wage increase, because his productivity is lower than the other two. Person A is rich, because he has invented farm equipment and construction equipment that allows him to produce enough food for the three people in half of a day, so he now produces movies and houses, makes 5 units of currency per day(3 units for food, 1 unit for housing, and 1 unit for movies), and has 500 units saved. Person B still makes 3/2 units per day with no money saved. Person C has invested in house construction equipment, and now makes 3 units per day with 300 units saved. It is decided that there will be a minimum wage of 2 units per day. Because person B makes and upkeeps 3/11 of the housing market, 3/11 of the housing market will be more expensive from 12/3 000 to 16/3 000 currency units per day per square-foot. The economy cannot support this, because there are not 2 extra units to be paid out, so there is no way to employ person B. The demand, however, is not used up. In a larger economy, the, "person Bs" of the world would have the same amount of money coming in, but spread about less people. If persons C and A spread the extra cost evenly proportional to their income, the housing demand will decrease by 20% ((3/11)/(4/3)). When the central bank sees the unemployment, they lower interest rates to inflate the money supply. This causes a readjustment in prices so that a currency unit is worth 3/4 of what it used to be, and the situation is the same as before, as the, "person Bs," make 2 units that are worth what 3/2 used to be worth, except that persons A and C have less valuable savings. You cannot increase person B's wage without a proportional increase in unemployment, and eventually a proportional decrease in purchasing power.
Taxes have a negative effect on the economy, if the money from taxes would have gone to investments had there been no tax. Non-progressive taxes have no effect on the economy, except inflation, because people need to be paid more to get the same amount they did before. Progressive taxes redistribute wealth, but cannot increase or decrease it(except if it causes investments to not be made). If person A has one unit taken away per day by a government and burned, the effect will be that there is one less unit spent on housing, so the price will be lowered to meet the new demand. This will cause person A to have less wealth, and persons B and C to have more, because of the lowered costs.
Spending, including government spending, is just using money to get the economy to do what the buyer wants it to, at the expense of the rest of the economy. If person A spends 4 out of his 5 currency units per day, it is the same as the savings being burned, and will increase the purchasing power of everyone else in the economy. If a politician wants to increase spending and taxes by 10%, they are saying they want to increase everyone's money by 10%, then take that money away and burn it.
There is no way of improving an economy through spending. The only way to improve an economy is to increase productivity through investments, innovation, research, and knowledge. Spending is not good for an economy, because it increases labour costs which diverts labour that could be used for investing, innovating, researching and learning, to goods and services that only benefit the person using them while they are being used.
This content may be reused without permission, as long as World Developers is cited.
Comments
1581