The Healthy Economy

We can describe an economy as a platform to reward wealth creation and to make possible a division of labor (labour), so that each person just works at what they happen to be best at. This is accomplished by facilitating the intersection of the two sides of the economy, supply and demand.

Unfortunately, things do not always operate smoothly in the economy. The ideal is for the economy to make it possible so that we can just "do all that we can do" or in other words, reach our wealth-creation potential.

But what exactly is the exact difference between a healthy and an unhealthy economy? I would like to present my concept of what differentiates the two.

The vital difference lies in what we will refer to as "spirals" in the economy. A healthy economy is one that is free of these destructive spirals. A healthy modern economy turns out to be a lot like the wing of an aircraft in flight. It is desirable to have a smooth flow of air over the wing, rather than eddies and turbulence.

A healthy economy is balanced between it's supply and demand sides. Spiraling begins when we upset this balance by trying to expand either the supply or demand side, realtive to the other.

The first destructive spiral is the inflationary spiral. This gets started when we expand the demand side of the economy, relative to the supply side. In other words, moving too far left by paying out too much money relative to production. This imbalance simply corrects in the form of inflation. But then workers, seeing that their buying power has diminished, demand raises and cost of living adjustments, often by going on strike. This means paying out still more money, relative to production, and we have an inflationary spiral underway that is difficult to break, except by recession.

The second destructive spiral is the recessionary spiral. When supply is not matched by demand, the balance of the economy is again upset. This imbalance can be caused by an increase in production without a corresponding increase in wages, or by real wages being reduced by inflation. This would mean that goods and services would remain unsold. Since it does not make sense for companies to produce any thing that is not going to sell, they tend to cut back on production for a while. But this means that workers are let go and so have even less money to spend, furthering the spiral.

There can be a wage-price spiral for another reason. I described this in detail in the posting "The Wage-Price Spiral Made Really Simple" on this blog. When production of actual goods becomes so efficient that fewer people, relative to the work force as a whole, are working at actually producing something, this tends to drive up both wages and prices. This is because, as I described, the wages of the non-production workers must "hitch a ride" on the production sector. This spiral is caused by an increase in production efficiency without a corresponding increase in new ideas, so that a decreasing proportion of workers actually work at producing something. This spiral is destructive because it drives production work to other countries where prices are lower.

The fourth destructive spiral is represented by the so-called "bubbles" that appear in the economy periodically. I have described this in detail in the posting "Economic Boom And Bust Cycles" on the economics blog. This spiral takes place when there is a rush of investment to a given sector of the economy, such as housing. This causes prices to rise in that sector and other would-be investors, expecting prices to continue to rise, are also drawn in, causing prices in that sector to rise even more. But as I explained in "Economic Boom And Bust Cycles", there must be a balance between the various sectors of the economy based on what I referred to as "fundamental importance". This balance is similar in concept to, but separate from, the essential balance between the supply and demand sides of the economy. Put simply, we cannot enlarge one sector of the economy out of logical proportion to the others. When we do, we end up with a bubble that will, sooner or later, burst. There are only two real ways to expand the economy, more people as workers and consumers or more ideas for production, which must be balanced by wages.

The fifth destructive spiral is the wealth spiral. Money inevitably equals power. The risk is that those with money will use their power to set things up so that still more money flows their way. The wealthy are important to the economy because it is they who tend to start new production. But if too much money, relative to the total supply, is in the hands of the wealthy, this means less in the hands of the average consumer. Since most products are made for the average consumer, and the wealthy do not spend as high a proportion of their total wealth on the goods and services that the economy produces, this can only mean that there will be production that remains unsold because consumers could not afford it, and this leads us to our recessionary spiral.

Finally we have our sixth destructive spiral, the poverty spiral. The strange, and sad, thing about being poor is that the poor tend to actually pay more for things. This is known in America as "The Poverty Trap" because the fact that things cost more make it very difficult to escape poverty. The root of the poverty spiral is the modern dependence on credit. When someone does not have money, and they miss payments on credit cards or other loans, this lowers their credit rating. Then if they get a mortgage, it will be with a considerably higher interest rate. If a person cannot afford a car, they may have to shop at local convenience stores where prices are higher, instead of at supermarkets. If a person does not have a bank account, they have to cash their paychecks at local stores which charge a fee. When someone buys something such as a television on an installment plan, they end up paying considerably more than they would if they could have afforded to buy it outright. They are thus trapped in poverty because so many things cost more.

A healthy economy is one that is, plainly and simply, free of these destructive spirals.