A meditation on the nature of economic advice

car parts

My son sent me the picture with the following note:

I just came across this photo today and it’s actually how I’ve always thought of your economics. In particular, if someone pours money into the manufacture of cars (for example), and it’s not value adding, there are all these other companies that feed into the process (i.e. the parts manufacturers) that will eventually get hurt as well, and then the economy as a whole.

This is what we mean when we talk about the structure of production. Producing a car is the work of an economy with many different producers of inputs all across the economy, and where each of these producers also has the same need for inputs which are also spread across the economy.

When government indulge in their wasteful spending, it is not just the end products that are produced but they distort the structure of production so that all of the inputs into their non-value-adding forms of production also get produced. When the ability to finance these valueless activities is finally exhausted, it is not just the final government demand that is wound back but so too are all of the inputs down the line. The economy may have looked good for about a quarter or two but it was a delusion that gets discovered soon enough.

The other aspect my son does not touch on which is also crucial to understanding how an economy works, but which is almost never mentioned by most economists, is that every one of these inputs was a premeditated form of production that did not spring spontaneously into existence. Each was the product of a decision by someone somewhere to produce these various inputs and was a decision made well in the past before the car assembly began. The notion that aggregate demand is what drives an economy rather than the premeditated directives of entrepreneurs whose production is entirely financed by the economy’s stock of savings is wilfully inane. Yet this is what we teach and such shallow concepts are now the stock and trade of the entire profession. It is no wonder economic advice is so dreadful when economists never actually learn how an economy actually works.

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