A Primer on Economics for Engaged Citizenship
Arthur Warmoth, Ph.D.
The Economy as a System
Economic Systems. The purpose of economic institutions is to mobilize human and natural resources for the efficient, sustainable satisfaction of the full range of human needs. Economic systems should be designed to enhance human wealth and well-being while managing the interface between human and ecological systems.
Abraham Maslow’s hierarchy of needs (1954) offers a useful schematic model of the full range of human needs:
Š Physiological needs
Š Safety needs
Š Love & belongingness needs
Š Need for esteem and self-esteem
Š Need for self-actualization
Maslow and others have also postulated a transpersonal or spiritual realm of various higher needs, including truth, beauty, justice, and transcendence. The conventional economics of commodities and markets deals primarily with the lower levels of human needs that are addressed by material consumption, making greed the only path to security and self-esteem. It is important to recognize that economics of higher needs is based on human relationships, rather than the accumulation of material goods.
The principal components of an economic system are:
Š The Money System
Š The Price-Auction Market System
Š The Banking System
Š The Economic Commons System (Governments & Nongovernmental Organizations--NGOs)
Functions of Money. Money is generally recognized by economists as serving two basic functions: Medium of Exchange, and Store of Value.
Accounting Systems. Accounting systems are information management systems that coordinate and integrate the relationship of the components of the economic system with the production of goods and services in the “real economy”
Accounting systems must be based on a close relationship to the ecology of real wealth in real time.
The tendency of contemporary corporations to create wealth by manipulating legal and accounting systems, rather than by producing real wealth in real time, was labeled “paper entrepreneurialism” by Robert B. Reich (in The Next American Frontier, 1983). Fueled by the seductive complexifying power of information technology, this trend culminated in the financial scandals of Enron, Arthur Anderson, Global Crossing, K-Mart, Tyco, Merrill Lynch, Adelphia, WorldCom, and AOL-Time Warner. Those members of the middle class who saw their 401(k)s evaporate in this fiscal trainwreck—and those of us who are concerned about the future of our investments—might well look to alternative investment models such as microlending, stakeholder ownership (Jeff Gates, The Ownership Solution, 1998), and Natural Capitalism (Paul Hawken, Amory & L Hunter Lovins, 1999).
Real Wealth. Tangible and intangible goods and services that contribute to human well-being and the satisfaction of human needs. Wealth my be in the form of consumption goods and relationships enjoyed in real time, or in the form of assets that contribute to the potential for future consumption
Triple Bottom Line Accounting. The Triple Bottom Line accounting model was proposed by John Elkington in 1998. The three bottom lines are ecological, social, and economic--planet, people, profits. This approach puts the assessment of ecological and social sustainability on a par with financial advantage in the decision-making process.
The Five Types of Capital Assets. Mark Anielski (2007) has refined the Triple Bottom Line approach by defining five essential domains of capital assets, all of which are needed for an economic system aimed at promoting the good life by satisfying human needs. The five domains of capital are:
o Human Capital (the knowledge and talents of individual human beings).
o Social Capital (social relationships and institutions).
o Natural Capital (the gifts from nature that are given freely but which require human stewardshp for human survival)
o Built [Constructed Physical] Capital (everything that has been made or manufactured using both human and natural capital; the tools and infrastructure for our overall economic well-being).
o Financial Capital (money or anything denominated in monetary terms; all of our financial institutions and arrangements). (pp. 74-76)
Human resources (social and human capital) are relatively more abundant than natural resources (natural capital) in relation to their utility in satisfying human needs; therefore the economics of human labor should be an economics of abundance, not an economics of scarcity.
Chronic social problems such as education, health care, and social services for the working poor primarily require the mobilization of local human resources to solve. This would “prime the pump” in the current stagnant economy as well as contributing to the sustainability of local economies, making them more recession-resistant. To do this means investing more in education and less in paramilitary social control.
The Money System
Money. “Money is an agreement, within a community, to use something as a means of payment.” (Bernard Lietaer, The Future of Money, 2001, p. 41)
It should be noted that the “something” needs to be countable, and that “means of payment” is one of the two major functions of money generally recognized by economists: Money serves as a medium of exchange. (The second conventionally recognized function of money is as a store of value.) This definition describes the function of money at all times and places.
The unit defined as “money” is the basis of all accounting systems.
The Money Supply: Measurement of the money supply attempts to quantify the total amount of negotiable legal tender in circulation. Monetary theorists argue that managing the total supply of money in circulation is the essential responsibility of monetary authorities. The generally accepted components of the money supply include:
M0: currency (notes and coins) in circulation and in bank vaults, plus reserves which commercial banks hold in their accounts with the central bank (minimum reserves and excess reserves). M0 is usually called the monetary base - the base from which other forms of money (like checking deposits, listed below) are created - and is traditionally the most liquid measure of the money supply.
M1: currency in circulation + checkable deposits (checking deposits, officially called demand deposits, and other deposits that work like checking deposits) + traveler's checks. M1 represents the assets that strictly conform to the definition of money: assets that can be used to pay for a good or service or to repay debt. Although checks linked to checking deposits are gradually becoming less popular, debit cards linked to these deposits are becoming more popular. Like checks, debit cards, as a means to complete a transaction through their links to checkable deposits, can also be considered as a form of money.
M2: M1 + savings deposits, time deposits less than $100,000 and money market deposit accounts for individuals. M2 represents money and "close substitutes" for money. M2 is a broader classification of money than M1. Economists use M2 when looking to quantify the amount of money in circulation and trying to explain different economic monetary conditions. M2 is a key economic indicator used to forecast inflation.
M3: M2 + large time deposits, institutional money-market funds, short-term repurchase agreements, along with other larger liquid assets. M3 is no longer published or revealed to the public by the US central bank. (Wikipedia)
The Velocity of Money. In addition to the amount of money in circulation, the amount of economic activity is a function of how rapidly the average unit of account circulates. If a dollar facilitates a purchase every day, it generates more economic activity than a dollar that only changes hands once a week. The argument for local currencies and buy local first campaigns is tied to the fact that these practices maximize local economic activity because they maximize the circulation of currency in the local/regional economy.
National Currencies. National currencies are legal tender, which means they must be accepted in payment of debts. Modern national currencies as “debt-based fiat currencies.” This means that they are created on the authority of national governments, which authorizes the creation of new credit. That means that the new money appears as debt-encumbered accounts that are the proceeds of bank loans.
Complementary Currencies. Other types of currencies are being created by communities that contract to use something other than national currencies as means of payment. Complementary currencies tend to appear during periods of recession/depression. Modern information management technology makes the creation of complementary currencies more cost effective. There are two major types of complementary currencies:
Inflation. Inflation is the result of expansion of the money supply that exceeds the value of goods and services being produced. This can result from the monetary authority pursuing growth and full employment at the expense of controlling inflation.
Recession/Depression. Recession is the result of insufficient money in circulation to actualize all of the potential economic transactions in the economy. In other words, it is a situation in which a shortage of liquidity leads to the significant underutilization of productive capacity.
The relationship between inflation is not symmetrical. Since national currencies come into being as credit, a shortage of credit occurs when banks and related financial institutions have insufficient reserves because of excess investment in “toxic assets.” It can also result in an excess of “intention to save” over “intention to invest” because of a loss of confidence on the part of investors (Keynes, 1935; Krugman, 2008/9.)
The Price-Auction Market System
The Market. Money functions as a Medium of Exchange in the price-auction market. The market follows the law of supply and demand and is which is suitable for goods and services that can be produced and consumed by individuals or individual families or enterprises. It requires a complementary “economics of the commons,” which includes all resources, goods, services, and assets that must be produced and/or consumed (used), at least in part, collectively.
Microeconomics. The economics of supply and demand in a price-auction market for goods and services produced and consumed by individuals and families or individual businesses and governments. For supply and demand to work, no producer can command enough market share to be able to manipulate prices independent of competition
Supply and Demand. The intersection of supply and demand curves is generally quite efficient in allocating resources in the price-auction market. This is Adam Smith’s “invisible hand.” However, political decisions are required to manage supply and demand in the economics of the commons (q.v.).
Wages. Wages (including salaries) are compensation to the human labor needed to produce wealth and well-being. As Henry Ford understood, wages must be sufficient to purchase (consume) the output of the productive capacity of the economy. Consumption financed by debt is unsustainable. Wages & Salaries determine the quantity of individual consumption in the national economy.
The Banking System
Savings. The second basic function of money is to serve as a function. of money. “Store of value” refers to the fact that holding onto money is a way to store purchasing power not needed today in order to make purchases tomorrow.
Investment. However, the situation is not that simple. Resources not needed to produce for current consumption must be directed toward producing organizations and technologies that will increase the future capacity for producing for consumption in both the public and private sectors. Investment is managed by both private and public enterprises. John Maynard Keynes in his classic General Theory of Employment, Interest, and Money, (1935) established the principle that the savings in one place in the economy must be used to invest in another. Equalizing, or keeping in balance, income and expenses is necessary for the market economy of function. If expenditures for current consumption do not equal income, the difference must be made up by expenditures for productive investment that will generate real wealth in the future. Otherwise the money supply just dries up.
Banking & Financial Services. Translating savings into productive investments is the legitimate function of banks and financial services institutions. When the process is working, savings are recorded as financial assets that are tied to assets that create genuine wealth and well-being in the realtime economy in the future.
Return on Investment: The return on legitimate investments in real wealth productivity takes three forms:
Š Profits are income based on the difference between income from sales and the cost of production
Š Interest is the return on savings invested, based on a return of a fixed percentage of the amount invested.
Š Dividends are a return on savings invested, based on an ownership share in a profitable enterprise.
The Economic Commons System
The Economic Commons. All social system and ecological system assets essential to, or useful for, human wealth and well-being that cannot be produced and/or distributed to individuals operating in price auction markets. Today we find that most aspects of the commons, ranging from the integrity of the environment to the social fabric of our communities, are in a state of crisis. This is because we simply do not know how to think about the economics of these critical systems, including elements of the commons such as politics, health care, education, public safety, retirement security, employment security, energy, transportation, environmental quality, land use, affordable housing, and culture and the arts.
Macroeconomics. The economics of the entire system of individual and collective production and consumption.
[M]acroeconomics involves the "sum total of economic activity, dealing with the issues of growth, inflation and unemployment, and with national economic policies relating to these issues" and the effects of government actions (such as changing taxation levels) on them. (Wikipedia)
Taxes: Taxes determine the balance between individual and collective production and consumption in an economy. (Take home wages and salaries, not taxes, determine the level of individual consumption.)
Functions of Government: There are two basic economic functions of governments:
1. Manage the production of goods and services that are consumed collectively. (Many public goods and services—education, health care—have individual and collective consumption components.) Public goods and services can actually be produced by government agencies, NGOs, or private enterprises. Providers in all of these should ideally compete on the basis of cost and quality. (Osborne & Gaebler, 1992)
2. Manage the economic system as a whole through regulations and incentives that optimize the balance between market and commons productivity in the service of the full range of human needs.
Mark Anielski. (2007). The Economics of Happiness: Building Genuine Wealth. Gabriola Island, BC: New Society Publishers.
Edgar Cahn. (2004). No More Throw-Away People: The Co–Production Imperative (2nd ed.). Washington, DC: Essential Books.
John Elkington. (1998). Cannibals with Forks: the Triple Bottom Line of 21st Century Business. Gabriola Island, BC: New Society Publishers.
Jeff Gates. (1998). The Ownership Solution: Toward a Shared Capitalism for the 21st Century. Reading, MA: Addison-Wesley.
Thomas H. Greco, Jr. (2001). Money: Understanding and Creating Alternatives to Legal Tender. White River Junction, VT: Chelsea Green.
Paul Hawken, Amory Lovins & L. Hunter Lovins. (1999). Natural Capitalism: Creating the Next Industrial Revolution. Boston, Little, Brown & Co.
John Maynard Keynes. (1935) The General Theory of Employment, Interest, and Money. New York: Harcourt, Brace & World.
Paul Krugman. (2008/9). The Return of Depression Economics.
Bernard Lietaer. (2001). The Future of Money: Creating New Wealth, Work, and a Wiser World. London: Century.
David Osborne & Ted Gaebler. (1992). Reinventing Government. Reading, MA: Addison-Wesley.
Robert B. Reich (1983). The Next American Frontier. New York: New York Times Books.