A Short Economic Explanation of Nearly Everything

November 18th, 2013

Simple explanations are always suspect. So do with this what you will. It’s my basic framework for thinking about how economies work. It of course doesn’t explain everything; the headline here is tongue-in-cheek. But I find it very useful in thinking about everything else.

This thinking clashes quite definitively with traditional economic teachings. But it conforms very nicely with economic understandings that have demonstrated those teachings to be bunk. (Think: the Cambridge Capital Controversy, wherein the traditionalist economic powerhouse, Samuelson, admitted that his model — the model that almost all economists and many others even today run natively in their heads — was “definitely false.”)

It starts with money.

There is a pool of financial assets, ownership claims, on real capital and its future output (so-called “financial capital”): Stocks, bonds, money (bank deposits and currency), deeds, etc. etc.

People and businesses can transfer those ownership claims between themselves — cash for a deed, stock for cash, etc.

Some of those transfers are in exchange for real goods and services (things that humans can consume immediately or over time to derive real human utility).

Some of those transfers are simply exchanges of one claim for another.

Transfers in exchange for real goods (“purchases,” “spending,” “expenditure”) spur production.

Production yields surplus. (That surplus is monetized through trade, supported over time by new financial-asset creation by banks and governments — allowing producers to turn their surplus into generalized claims, hence giving them incentive to produce.)

Surplus from production is the source of aggregate “saving.” (Though for clarity I prefer to call it accumulation. National/world wealth is about accumulating real stuff, not claims on real stuff, a.k.a. financial assets).

Transfers in exchange for other financial assets may result in better allocation of real resources.

There is a declining marginal propensity to spend (on real goods) out of wealth. So a person with ten million dollars in financial assets will spend a smaller percentage of that each year than a person with ten thousand dollars.

If wealth is more concentrated, that declining propensity means there is less spending per the amount of financial assets; the turnover, or velocity, is lower.

So higher concentrations mean there’s less production for a given stock of wealth. And less surplus. And less income. And less saving/accumulation. And there’s less pressure/incentive for banks and governments to create and fund new financial assets, because there’s less surplus that needs monetizing.

Paradoxically, spending causes saving.

Arithmetically, more-equal distribution of wealth means more spending, income, production, surplus, accumulation, and wealth.

There are limits, of course. Perfectly equal distribution would result in seriously problematic incentive effects. But with the wildly unequal wealth distribution we see today, it’s not crazy to suggest that the straightforward arithmetic effects utterly overwhelm those incentive effects.

You can see a simple arithmetic model of this thinking here and here, and download the spreadsheet to play with it yourself.

Cross-posted at Angry Bear.

  1. Detroit Dan
    November 19th, 2013 at 10:54 | #1

    Makes sense to me. Thanks!

    The role of government can be added to generate a more complex and realistic picture. There are social goods and services as well as private goods and services in any functioning economy, and the way in which these are mixed in the economy is a critical factor.

  2. November 19th, 2013 at 19:07 | #2

    @Detroit Dan Right. And you gotta figure in the Fed especially. But this framework has been working pretty well for me bolt on additional stuff and think about it.

  3. jt26
    November 20th, 2013 at 17:34 | #3

    To some extent concentrated wealth may not be a problem if they are willing to invest (even if they are not willing to “spend”). From my imperfect reading of history books, there was enormous investment during the industrial revolution, even when wealth was highly skewed. Are rich citizens just lacking imagination, or are they logically reacting to 15 years of poor VC returns? If rich Germans in the 1930s could have imagined what would happen after 1950, would they have supported a war? Was it lack of imagination, or were they just reacting to a past and future decade of poor return on capital? Maybe we need rich people not to give their wealth away, but rather to invest it away – a Bill Gates for imagination.

  4. Asymptosis
    November 21st, 2013 at 08:31 | #4


    One takeaway from this framework, it seems to me, is that when wealth is more concentrated, real investment is less attractive because revenues and profits are constrained. A vicious cycle.

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