A simple way to think about the economy

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What is "an economy"?

I define an economy here as the sum of goods and resources available in a given place (like a country) and how people use and interact with these resources (like going to work).

An economy is about what people do with what they have.

Because an economy is about what people do, the economy itself changes as things in the world change. In a word: dynamic.

It does not remain fixed over time.

All resources are scare - apart from air, maybe? "Scarce" simply means limited. When things such as water, building materials, or food sources are scare, a question naturally arises: how best to allocate these scarce resources?

That is, we accept that we don't have an unlimited supply of stuff in the world, so what should we do with the stuff we have that will create a beneficial impact for the world and its people?

Economics - fundamentally - is the study of how best to allocate scarce resources in a given place in space and time; it's not about money (1). Economics encourages us to look at the world as it is (with limitations) rather than how we would like it to be (the ideal we can all easily imagine in our minds eye).

Any genuine conversation in economics can begin only when we agree that 1) there is not an unlimited supply of things in the world (education, food, water, building materials etc.) and 2) it is an empirical question of how we can best use these, rather than a foregone conclusion.

An empirical question means that it's up for debate; perhaps we can decide how to best allocate our resources in an economy through tests in the world. The point of studying economics is to help us make better decisions with the limited things we have.

Broadly speaking, across history, there have been two main approaches to solving the problem of allocating scarce resources (what people should do for work, where, with what materials etc).

‌Given that the world is made up of scare resources that all have alternative uses, there have been two major schools of thought about what to do about this fact:

1) Decentralised, market economies

2) Centralised, state economies

A fundamental theme of decentralised, market economies is: freedom

Western countries all adopt forms of decentralised market economies.

If you are lucky enough to live in the West, you'll have noticed that the government doesn't force you to work in a certain job (although, you will probably have to work). Instead, a market economy assumes that it is the people themselves who are best suited to judge how to live their lives and carry out economic transactions - where to work, how to manage their livelihoods etc.

In a market economy nobody is in charge of the whole operation. There is nobody at "the top" looking down and forcing people to do this or to do that.

We can use computing power as a metaphor. Top-down decision making represents a concentration of computing power all in one place. Indeed, all the eggs are in one basket.

But in a market economy the computing power is distributed to all the people who make up that economy. That is, each person is their own source of computing power and knows better than anyone else how to make best uses of it with the resources that are available to them at this particular place, in this particular time.

Market economies, therefore, make use of the fact that nobody in society can ever hope to command all of the knowledge that is there to be commanded (2). Instead, knowledge is distributed across society, and individual people each hold knowledge that is local, valid and important to their own unique circumstances.

Thus the economy is made up of parts of scattered knowledge (the people themselves) and will function as a whole more effectively if we leave the decision making up to the individual people in that economy , rather than attempting to order them into particular positions or places.

The question asked is: how best to allocate scarce resources? And the market economies answer is to: outsource the problem to the people.

It tacitly assumed that the best possible economic outcome for everybody will be achieved if everyone in that economy is left free to make their own decisions, find their own work, progress into jobs that they like or are available to them.

This assumption is fundamentally optimistic; it assumes that we ought to trust people to make good decisions, which ultimately makes the world a better place (3). Whether it does this is an empirical question to be examined later, but for now what is important is to understand the underlying assumption of a market economy.

To the extent that this happens, the economy, in a decentralised market economy, simply describes what is important to the collection of individuals at that particular place, at that particular time.

In summary of market economies

Market economies assume that: the world and its economy will be a better place if we allow normal people to go about their business, acquire skills, get educated wherever possible, and make the best use of the resources in an economy in a way that best suits their unique individual circumstances.

A fundamental theme of centralised state economies is: equality.

Other countries throughout history such as China, Russia, Cuba, and Venezuela have adopted centralised, state economies. State economies are essentially communist style economies (4). They are centralised because it is believed that the state can make better decisions than people, which will make things more equal for everyone in the society.

Indeed, decentralised economies do generate vast inequalities, as some benefit more than others from the allocation of scarce resources.

The proposition of state economies is simple: we can do economics better if the state has more control over how scarce resources are allocated. A famous quote reads:

"From each according to his ability, to each according to his needs" (5)

That is, people have different abilities but not different needs. People in an economy should be treated based on their needs, not their abilities.

Most people will agree that we all have needs (hunger, to feel accepted, shelter from the elements etc), and that people deserve to be treated equally. This is the premise of state run economies. At the level of emotion - of feeling - most people would agree with this.

In centralised economies, government officials, orderlies and associates sit down together and put pen to paper, deciding what things will be worth, who should work where, what work needs to be done, what work doesn't need to be done, what should be imported, exported, priced at, and who deserves what (1).

Because we want to make sure that people have access to basic human needs (food , shelter, etc), the government needs to take responsibility for distributing resources to people; eventually the people themselves will be in control of production and the resources.

In a communist system, the final ideal is to have the people themselves in charge of production and resources; the assumption is that this is the best way to achieve equality and fairness in the allocation of scarce resources within an economy (6).

In short, centralised economies treat the economy like pieces on a chess board to be arranged at the discretion of the government that happen to be in charge. The computing power is centralised in the hands of a few; all the eggs are in one basket.

Summary of centralised state economies

State economies assume that: the world and its economy will be a better place if we have government allocate scarce resources to its people in a way that is equal, so that individuals in society all have work, shelter, and food.

‌There is nothing inherently superior to a decentralised or centralised economy. They are both abstract concepts, ideas.

Ideas exist in our minds, they are concepts or theories. But what matters is where theory meets practice. That is, when these ideas are applied to the world where flesh and blood human beings live (7).

I have written about this here.

Indeed, it remains an empirical question as to which approach is better. History does offer us such a test because both economies have been implemented at scale in different societies, at different times.

References

1) Thomas Sowell, Basic economics (2000) free audiobook: https://www.youtube.com/watch?v=Vp7pEICUG0g&ab_channel=johnnyleiser

2) Thomas Sowell, Intellectuals and society (2015) free audiobook:

3) Steven Pinker, The better angels of our nature (2012)

4) Stephen Hicks, Explaining postmodernism free audiobook:

5) Karl Marx, https://en.wikipedia.org/wiki/From_each_according_to_his_ability,_to_each_according_to_his_needs

6) Karl Marx & Friedrich Engels, The Communist Manifesto (2000/1848) free audiobook:

7) Thomas Sowell, Economic facts and fallacies (2011)