Monday, June 18, 2012

Macroeconomic thoughts on the prosperity

A very interesting mix of intellectual and contextual inputs marked recent weeks for me. I have been reading the "Introduction to Post-Keynesian Economics" by Lavoi while also ruminating about the nature of money in general. In parallel I chanced upon a copy of the Communist Manifesto that I had bought some time ago. Last but not the least, I had a short vacation in South Africa last week - which prompted me to think about the issue of macro-level prosperity yet again.

Conclusions first. Firstly, the macro prosperity of a given society is a very strong function of the amount of work people are willing to do and their ingenuity. The first decides the total amount of person-hours available to the society while the latter influences how well these hours are utilized.
Secondly, the distribution of wealth and income amongst the members of the society is driven by the institutions evolved within the society. Institutions here is used in a much wider sense of organizations of all sorts as well as established conventions and social habits. Private property, rule of law, rational system of justice, centralization of use of force to the state, international trade relations driven by nations etc are all examples of institutions.

Now to the details.
What makes a group of people more or less prosperous? Let us first define prosperity. Without attempting to be exhaustive and accurate, I would describe (rather than define) prosperity as the state of availability of almost all basic necessities of life (list subjective) and ample access to the opportunity to get the incremental luxuries (list subjective). US and Scandanavia are definitely prosperous, India is not and South Africa has islands of prosperity in it.
Now that we have described prosperity, let us conduct a thought experiment on a group of say 10 people in a decentish farm land. To start with let us say that they all work at the farm and produce enough to eat for everyone. If they work little harder, they will have more to eat and vice-versa. This amounts to the first half of the first of our conclusions above. In general more work the society does, the more it has to consume.
Now to the trickier developments. Let us say someone discovered the wheel barrow (who discovered it specifically is irrelevant now, but highly important in the later part below on distribution of wealth). Now 5 people are enough to produce more than enough for everyone to eat. Let us say these 5 already produce more than the 10 did earlier.
It is logical then to hope that either all 10 will work half of what they did earlier or 5 will start to work on something else. Mathematically these are idential possibilities. However, behaviorally it is unlikely that all 10 will work proportionately less. Even if they do, they will tend to use their spare time as if 5 were upto something else.
The big question is - what do these 5 do? That brings us to the second half of the first half of our conclusions. If the society is dumb (smaller brains, malnourished people, lack of proper communication or any other hindrance to being smart), they will be effectively forced to idle. What happens here then goes already into the second conclusion of distribution of wealth. Let us park it for now and return to what non-dumb societies do. Mostly the spare 5 people will engage in creating some goods or services which would improve the society's consumption - and thus welfare and prosperity (calm down environmentalists and rural utopianists - i know consumption is not welfare and all that, i am barely refering to this very primitive group of farming 10 people only).
They could weave better clothes, improve farming further, write poetry or study the movement of stars for season predictions. Either way, if they do something that adds value to the society as whole, they will end up improving general standard of living.
They could idle out of choice as well. Which together with the fate of the dumb society, brings us to the question of distribution of wealth.
In the all-10-farming mode, let us say they were sharing their produce generally equally - not entirely independent of the expectation that they were also probably producing similar amounts anyway. Now if the discoverer of the wheel barrow decided to keep the invention private and use it to make extra produce for herself, the economy of this small society would evolve differently. This discoverer would then start to "save" some produce - to the extent feasible. Eventually she would be able to "hire" the services of some others to farm for her using the wheelbarrow. At this stage, the smart society will still do well since its individual will then quickly move to doing something else useful. There is a catch though. What is useful will start to get influenced by the now richer members of the society. That is still not too bad if the not so rich still get to use some of the new goods and services.
The dumb society is not so lucky. If the spare personhours are not spent on anything "useful" in any way, very soon, the discoverer of the wheelbarrow will start to use her produce to buy everyone's time to her bidding. In effect thus, she and her employees are now producing everything that the society needs in terms of food. As stated above, the wheelbarrow allows 5 alone to produce all that the society as a whole demands. The balance 5 (either actual 5 people or half of everyone's time) now are "unemployed" in the conventional sense. The income has shifted in favor of the discoverer and there is sustained unemployment in this society. This by the way, will be the new equillibrium - with the macro output of the society same as earlier but distribution much different from earlier.

This taken to the logical conclusion points to the painful reason for more complex modern economies to remain in low prosperity levels for long periods of time. This is the reason of institutional constraints. These constraints thus effectively make a society dumb - while the individuals are quite smart in isolation, the collective is dumb because the way they organize themselves has structural limitations. A low prosperity society thus is essentially a suboptimally organized group of people in terms of its economic institutions. Agreed that it can be dumb as well and may have cultural reasons to be low on hard-work as well as ingenuity. But taken at the level of modern nation states, the statistics alone of the typical distribution of human attributes of intelligence and creativity would dictate that each modern country would have a fair number of smart people and would thus be adequately endowed.

Where to from here?
Well, the biggest task of a modern state on the front of pursuit of economic prosperity for its people is to simply build and promote a set of institutions that make the economic organization optimal - weeding out the obstacles and outdated institutions being a part of this task.
In English that would translate into the following
1. Relevant skill building through education (not arts, science, commerce but vocational and actual application oriented skills - while keeping arts for the genuine scholars of languages and social studies - not entirely different from what the recent movie "Faltu" propounded)
2. Promoting creation of new goods and services (increasing productivity in agriculture and manufacturing would keep reducing the labor intensity of these industries and its important to keep using the spare personhours to keep exploring something new that people can buy)
3. Democratizing access to credit while maintaining acceptable governance standards - microcredit and mSME credit is a good start but profit seeking in these by banks and credit providers might suck out most of the value generated by them into returns on capital rather than on labor.
4. Keynsian state - using spare capacities everywhere (and especially through slower times of business and agri cycles) to create public goods - to which there is no end. One can start with the essentials like roads and ports and slowly move to creating stadia, large hadron colliders (and even pyramids for crying out loud, if everything else seems to be in place).
(This state will create money supply in the process but in the post-Keynsian thought, that is almost immaterial. More on that later.)

The above translation into English of the first para of "Where to from here?" is highly India-centric. Greece could revive its economy using some other interpretation of this first para and US and Japan could interpret it in their own ways.
For exmple, in Greece, the people indeed seem to be working far less than what the national income seems to suggest and that is funded by loans. The sub-optimality of economic organization there is that the prosperity is based on access to cheap loans and that needs correction.
For US, the over-reliance on real estate and financial services activities was the sub-optimality and correcting that would mean getting people to start being skilled in some other things and starting to produce those - how about cars, defence equipment or some version of modern-day pyramids (say a much bigger international space station) - considering the low cost of borrowing for the American state.