Would the Real Economy Please Stand Up

More-or-less an exegesis of The Manual Economy. Warning: I am not an economist; this is speculative.

I.

What does “the economy” mean to you? What do those words point to in the world? If I say instead “the banana”, that’s a pretty well-defined concrete object. If I say “the marriage”, that’s way less concrete but still has pretty well-defined boundaries in a lot of ways. But when I say “the economy”… well. Isn’t everything kinda part of the economy? It starts to involve a lot of hand-waving and ambiguity.

Just as the idea of “marriage” is made up of roughly three distinct pieces in reality (a legal piece, a social piece, and a now-optional religious piece), I like to think of the “economy” as really made up of a few fairly distinct pieces. Like two kids in a trench-coat, every economy is really two economies trying to sneak into a movie theatre together: a concrete economy made of goods and services, and a virtual economic coordination mechanism. These two economies usually stay approximately isomorphic to each other; when I buy a banana there are two parallel exchanges, one in money and one in bananas. Think of it like double-entry bookkeeping.

To draw out this distinction, imagine two alternative worlds. Imagine first the world vaguely hinted at in The Manual Economy, the world where money and all other coordination mechanisms have completely disappeared, but life carries on completely normally. In this world people still work, and receive goods. There are still “rich” and “poor” lifestyles, and poverty traps, and all the rest. It’s just that there’s no terrestrial coordination mechanism anymore; the economy stays coordinated because some twisted god wills it to be so. In this world you don’t go buy a banana. You go take a banana from the store without giving anything in return. The twisted god controlling us all merely wills it so that poor people don’t go take all the bananas.

For our second imaginary world, take the mirror image of the first. In this world money, and banks, and mortgages and all the rest still exist. People get paycheques, and try to make their rent each month, and get punished when they’re late paying their bills. But also it’s basically The Matrix; everybody eats and sleeps and lives in a permanent tube with no actual goods or services being exchanged. In our first imaginary world, we had a concrete economy running somehow with no coordination. In our second, we have a coordination mechanism running somehow with no concrete economy to coordinate.

Neither of these imaginary worlds are intended to be realistic or “stable” realities in any sense. They’re designed to provide a sense of what these two economies look like when completely isolated from each other. In reality, they depend on each other to stay standing, just as both kids depend on each other to successfully purchase that movie ticket.

II.

I said before that these two economies, the concrete and the coordination, are generally isomorphic. But they aren’t always isomorphic to each other, and unsurprisingly, all the interesting stuff (bubbles, crashes, government stimulus, most white-collar crime, etc.) happens in the gaps where they diverge.

Let’s start with the dual-economy view of an economic crash. In fact, like “the economy” itself, the dual-economy view implies that there are actually two main types of economic crash, depending on which piece of the economy has actually crashed. The easy one to talk about is a concrete economic crash, which can happen when there’s a shock to actual production somewhere. Say that a new disease destroys all of the food crops in North America in the span of a few weeks; this is a real economic crash because all of a sudden the real economic capacity of the continent has drastically shrunk. The problem isn’t one of coordination; even if you coordinate everything perfectly, there just isn’t enough food.

This sounds bad, but the other kind of crash is in some ways worse. When the coordination mechanism crashes instead, there’s generally still enough real economic capacity for everybody to get what they want, it’s just wildly misallocated. This is what happens when for example speculation drives up the price of a particular good until the bubble finally bursts. That can happen even though production and consumption of the good in question stayed perfectly even throughout the entire run. There were no shifts in real supply or demand to justify the bubble. The bubble wasn’t created by a shortage, and didn’t burst because of a surplus in the market. The coordination mechanism simply failed. This kind of crash is what we’ve seen the most of recently: entire neighbourhoods evicted from their subprime mortgages while the homeless crowd the streets; people going hungry while food rots in a warehouse a few blocks away.

The virtual economy can crash because of a bug in the “software” of the coordination mechanism, without affecting the fundamentals of there being enough real capacity to produce all the food, shelter, goods, services, etc. that people actually want. Conversely, the concrete economy can crash (say because of a global pandemic that forces most real economic activity to grind to a halt) but as long as the software is resilient the coordinating mechanism will keep chugging along, coordinating whatever economic activity is left. It’s arguable whether this is a bug or a feature.

III.

Another interesting place where this dual-economy view comes in handy is getting a possible sense of why national debts are so weird. As far as I can tell, the consensus among professional economists is something along the lines of “you don’t want it to get too high relative to GDP, but an increasing absolute national debt isn’t a problem the way it would be for an individual”. This has always struck me as counter-intuitive, and I think a dual-economy model makes it a little clearer.

Debt is an abstract concept, which puts it firmly into the coordination side of the economy. It’s a promise of real economic activity in the future, which allows economic coordination across time. Importantly, there is no real economic “lack” behind debt; you can’t have a physically negative number of bananas. Debt is always just a number on a balance sheet. Just like personal debt can be a useful tool in the form of a credit card – assuming you hold up “both sides” of the temporal bargain by paying it off promptly in the future – so too can national debt. But whereas a personal debt is tied to your personal ability to pay it off, which is finite and limited, national debt is tied to the theoretically-infinite national future.

Now obviously we don’t expect any country to last forever. There’s the heat death of the universe to worry about after all. But the timescales are so wildly different that it’s hard to reason about. It seems plausibly reasonable to sell a twenty-year mortgage to a thirty-year-old human, even if they’re already in debt, but rather less reasonable to sell it to somebody already pushing one hundred. The earnings potential and lifespan just don’t seem to be there to support the future end of the bargain. But it’s entirely reasonable to believe that major economic powers might continue to exist in some form for hundreds more years, and even continue to grow economically through that time. Today’s national debt is an attempt to coordinate real economic activity across time with our future, much larger, national economic future.

Interestingly, a similar kind of analysis can be applied to fractional-reserve banking (with deposits viewed as individual loans to the bank).

IV.

I am not very confident in the above analysis, but even if it’s mostly garbage I think that treating the virtual and the concrete economies as separate entities has helped me. “The economy” has always seemed like a big ball of spaghetti with a bunch of arbitrary rules, and I feel like this is a good step towards drawing out a gears-level understanding, even if a lot of the details are wrong.

Hopefully it helps you, too.

One thought on “Would the Real Economy Please Stand Up

  1. I have a couple objections.

    First, your characterization of the 2008 crash isn’t really accurate, there really was an increase in the supply of new houses during the bubble and the crash was caused by a surplus. New builds had been financed by issuing mortgages to people who couldn’t afford them and all hell broke loose when banks could no longer ignore the fact that the debt they held wasn’t going to be paid. It’s not that there weren’t people who would have like homes, but those people didn’t have enough money to pay for there construction.

    Second, there’s no disanalogy between countries and people in the notion that the amount debt that’s advisable is proportional to your income. The big difference comes from the fact that countries’ debt is typically denominated in a currency that they themselves control. In theory, the Bank of Canada could pay off the majority of the federal and provincial debt tomorrow by just issuing new money, the only issue is the inflation this would cause.

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