I am an engineer, which means I like to model things. Take a big, overly complicated dynamic system and make it easier to understand. What is bigger & more complicated than our economy over time? Our galaxy? OK. The earth’s biosphere? Sure. The human body? Hmm… correct.
Can agree that it is probably in the top ten?
Seriously, by using models that we can understand complex systems and make intelligent decisions.
From my book, “What the Hell is an Economy”, here my first attempt at modelling an economy over time:
However, after recently reading “Apocalypse Never” (highly recommended!), I realized that the model needs to be updated, it is missing a critical step, namely the education of the workforce.
And I decided to make it more “user friendly.”
Here is my updated model:
What does this all mean? It represents the concept that an economy is always running as people work, goods and services are produced, and wealth is created, transferred, and consumed.
Start at the top, where hopefully some “excess wealth” was created from the last cycle. It is this precious excess economic wealth that can be used for all sorts of things, such as science R&D, building infrastructure, development of new technologies, startups, new product development, and as recently added, education of the workforce.
All of which enhance labor, making it more productive. Apply this labor to economic resources, and per Adam Smith, economic wealth is created. The more enhanced the labor, the more wealth created, all per capita.
But as we know, some people create more wealth than others, some get paid more than others. In response, our democratically elected representative government, reflecting the compassionate will of our society, redistributes much of this wealth. After which most of the created wealth is immediately consumed, providing shelter, food, etc., i.e., the necessities of life.
With hopefully, some excess wealth left over.
The goal of an economy is to create this excess wealth, because only then will the quality of life improve for all. Which implies that the goal, over time, must be to enhance the labor as much as possible, to maximize the amount of excess wealth, balanced with just the right amount of compassion.
At one time all economies were agriculturally intensive, with very inefficient ox’s and plows used for farming. Over time, many economies managed to transition from agriculture to more manufacturing-based economies, a good example being China today. By making farm labor more productive (using tractors, etc.), a smaller percentage of the workforce is required to grow the food, freeing up labor for more profitable manufacturing.
Which requires a workforce trained to manufacture products, something that cannot happen overnight, and requires some consumption of the excess wealth.
A similar transition converts an economy from relatively low-tech manufacturing (i.e., clothing production) to high tech manufacturing (jumbo jets). Requiring an even higher level of workforce education.
The reality is that the economies that succeed in this transition will enjoy higher levels of excess wealth creation, higher standards of living, and ultimately, will be the source of new scientific and medical breakthroughs.
Sitting in the middle of the wheel are the “Good Economic Decisions” that reflect the billions of daily economic decisions pertaining to the creation, transfer and consumption of economic wealth. What to buy, where to work, what startups to invest in, what products to develop, what education to receive, etc.
The better these decisions are, the more excess wealth is created.
Meaning that the more targeted goal is to make these economic decisions as “good” as possible.
What results in “good” economic decisions?
A mostly decentralized economy. Individual rights and responsibility. A strong work ethic. Rule of law. Education that reflects the needs of the economy. A stable currency. A functioning and fair marketplace. An efficient banking system. Investment opportunities. Private property rights.
And the opposite…
Too much centralization. Lack of individual rights. Excessive dependency. A lacking work ethic. High level of corruption. Poor education choices. High rate of inflation. Market bubbles and other distortions. High level of unbanked. Lack of investment opportunities. Lack of private property rights.
As an example, when our federal government decides to be overly compassionate, to transfer wealth from everyone (via high inflation) to those that made poor college related decisions, you should assume that less excess wealth will be created in the short term, resulting in less wealth creation in the future.
Not the best economic decision.
It cannot be emphasized enough how important it is to maximize the creation of this excess wealth, as it is required to advance science and technology, the only true path for solving global poverty, addressing climate change, etc.
Rather than mandating carbon reduction goals by some arbitrary future year, or by ever-increasing the size and scope of wealth redistribution or squandering vast amounts of wealth by subsidizing the development of the wrong products, perhaps our political leaders would be better serving us by understanding economics, and simply focus on maximizing the creation of this excess wealth. Make our economy more efficient. Encouraging as many people as possible to be productive.
And let the wealth empowered scientists and engineers solve the problems.
Is it possible that we are losing ground, not producing any new excess wealth? Is there an observable sign? I believe that high inflation is that warning sign.
Time will tell. Are we solving more or less problems than a generation ago?