The Econosphere: how the economy really works

The economy. It’s all folks seem to talk about. At the same how many of us really understand its inner workings? Why do economies succeed? Why do they fail and what’s the best way to heal a failing economy? These are the questions that Craig Thomas addresses in his new book, The Econosphere. Thomas is veteran private-sector economist with deep experience within firms like Citigroup, where he served as research director for Citi Property Investors and specialized in regional, macro and real estate economics. Thomas is well known for his ability to explain complex theory in an entertaining way.

Craig, welcome to Smart Planet, what’s the difference between the economy and the Econosphere?

I’m pleased to respond that there is absolutely no difference between the economy and the Econosphere.

Shakespeare wrote, “What's in a name? That which we call a rose by any other name would smell as sweet.” But many of us don’t think of the economy as something as pleasant a rose; we think of it as a bum-deal, or a system that’s stacked against us.

Our economy is our social environment, analogous in every way to our physical environment. It is a self-sustaining system that if left reasonably unfettered provides us with the signals and incentives that allow this planet to support its billions of inhabitants, each generation typically doing better than the last.

Just think of its perfection: You wake in the morning and desire a cup of coffee. Somehow that information was passed halfway around the world and among many thousands of individuals such that each person works in synchronicity to refine and transport the means with which you will brew that cup of coffee—heck, someone will even have it brewed and waiting for you if you want to take that route.

It is an amazing system, and thus undeserving of a name that has such a negative connotation among so many. We know our atmosphere provides us oxygen, we know that our biosphere more broadly provides us with the raw materials of life, and we should know that our Econosphere, or our economy, provides the essential signals that have allowed for the upward ascension of humanity.

I’m an economist, but I also consider myself an environmentalist—one who is deeply concerned with the health of our Econosphere, our social environment.

What do we need to know to at a very basic level to understand the Econosphere?

We have four basic laws of the Econosphere:

1. Law of Growth - Each new person brings additional new wealth to the world.

The essential raw material that creates value and wealth in our economy is the human potential. We have what we are born with, and what we make with that potential through education, training, collaboration and experience. The consumption of this potential, via trading precious leisure time for productive time is the fountain from which our economy spills forth. We’re born with what will sustain us, and that is why our Econosphere is a sustainable system.

2. Law of Information – No matter the problem, better information is always part of the solution.

The market is perfect; it is information that is imperfect. Recessions happen because we acted on poor information. For example, house prices will rise forever, Americans always pay their mortgages, etc… The problem in the housing bust was that our information was incorrect, not that our market economy mediates the distribution of capital.

Unfortunately, policy responses to recessions often hinge on “fixing the Econosphere,” as opposed to improving the information. You can’t improve the Econosphere any more than you can improve upon nature. We were one high school-level personal finance course away from avoiding this entire recession. We should be helping individuals acquire the information to make the best decisions possible; unfortunately, we are trying to warp incentives within the Econosphere and substitute the wisdom of billions of individuals with the judgment of a small group policymakers.

3. Law of Sustainability – Bounty comes from people and nothing else. The animating force of the Econosphere is humanity.

We worry a great deal about exhausting our physical raw materials, but the only raw material that really matters is us, humanity. For instance, oil is worthless in the ground; it is only valuable if we bring it to the surface, refine it, and use it for things like transportation or to heat our homes. All of the value in a gallon of oil comes from the human elements: demanding it as a component of our daily activities, and our refining it into products. It is only people that matter. As long as we have people, our Econosphere is sustainable. Of course you can argue that if we exhaust, say, clean water, we will exhaust our supply of people, as well. True. Fortunately, the Econosphere provides incentives such that we consume less of and produce more of those things that are scarce and of most value to us.

4. Law of Plenty – The Econosphere never takes from one to give to another.

Because all value spills forth from our trading our precious leisure time for time in the market producing goods and services valued by our fellow men and women, we will never have what is cynically referred to as a “zero sum game.” A zero sum game is system where there is a winner, and a loser. If one acquires, say, one dollar, that means that someone else has lost one dollar. Hogwash!

We do not have a fixed amount of wealth in our Econosphere. Rather, each of us creates wealth each day by using our abilities to produce goods and services to trade for the fruit of others’ abilities. Sure, some peoples’ abilities are more valuable than others, but that is not a zero sum game. Quite the contrary. The Econosphere if a benevolent system, where we can take our one raw material, our potential, and use that potential in the production of goods and services valued by others. Humanity is its own renewable resource, and the Econosphere guides us to get the maximum value from that key resource.

What are some false assumptions we make about the economy? How do we fail in our understanding?

The number one false assumption that is so often our undoing is the belief that our Econosphere is a fixed “pie” that we slice up. People assume that there is a certain amount of wealth in this world and that life is all about fighting for one’s own piece of the pie. Many do not realize that it is individuals producing and trading that create the economy each and every day. It is never about getting your slice of the pie; you bake your own slice! If we realized that, we would concentrate our efforts toward investing in the individual such that each person can get the most out of his or her productive life, as well as on protecting our natural Econosphere from harm.

Instead, because we think it is all about distribution of existing wealth, much of our activities, including the creation of needless mental anxiety and our often ill-advised public policy crusades, center on the distribution of wealth. The problem with that is that these efforts are not only soul-sapping in that they make us feel dependent on policymakers, but it also erodes our natural incentives to innovate and make more with our lives. We create our own wealth, and whether we are successful in that effort depends a great deal on having a healthy, unspoiled Econosphere in which to do it.

You talk about the surprising gift of inequality. What’s that mean?

The gift on inequality sounds kind of mean, doesn’t it? Well, I don’t mean it to be that way. What I mean is this: because there are varied outcomes to our activities, it makes us try harder. And the harder each of us tries, the better our collective outcome will be. If our outcomes were all the same no matter how hard we tried, we wouldn’t try hard. Think of it this way, if a race didn’t name a winner, would any of the participants run hard?

The possibility of improving the comfort and happiness of one’s self, one’s family, friends, one’s community is what creates innovation. Without innovation, we would still be cavemen. The existence of, and possibility of being like, say, Bill Gates, Warren Buffet or the guy down the street who was able to take his family on a nice vacation is the fuel in our economy’s tank. Without inequality, we would all be equally worse off.

How do governments influence economies?

Governments are a bit of an alien force within the Econosphere. They must be desirable, otherwise we would neither create nor support them, but they are not entirely governed by the same forces that govern individuals and firms. Moreover, they tend to outgrow their original mandate, which is to protect property rights.

The problem is that governments have a captive audience. If you do not like a certain product you will stop purchasing it, and the firm that produces it will suffer as a result. But, if you don’t like what policymakers are producing, you still have to pay your taxes. Absent a revolution, you are a permanent customer.

In a democracy, you can vote for one person or another, and thus exercise a right to choose, but the government will still remain. Moreover, because political lives tend to have phases, getting voted out of office is likely the beginning of a career as a lobbyist, board member or consultant acting as an intermediary between government bureaucracies and industry. The more wealth that government charges itself with distributing, the more valuable it is to employ such insiders in order to influence the distribution of those dollars.

All this means that the primary incentive of government is to get bigger, not necessarily better. The bigger it gets, the more it will distort the natural incentives provided by our Econosphere.

The real danger is that as government gets bigger, it will pollute the Econosphere such that it cannot support its inhabitants. Two vivid examples of this are China and India, both of which plunged their populations into extreme poverty by completely pushing out their market economies and substituting public policy, communism and socialism respectively, in their place. It was only after they re-cultivated natural market incentives that they were able to clean-up their Econosphere, and the result has been rapid increases in productivity and wealth. China and India are the story of this decade and decades to come, all because they became enlightened as to the degradation of their social environments. They saved and restored their Econosphere!

On a scale of 1-10 how healthy is our economy and what’s needed?

If ten is good and one is bad, let’s give it a six. We have seen some extraordinary adjustments made on the part of individuals and firms in what has been a very deep recession. We saw consumers pull back in their discretionary spending more sharply than we ever have in modern times. We saw them begin to quickly pay down their debt burdens and increase their savings to make up for wealth lost in their homes. We have seen many people transition away from ailing industries and make inroads into new vocations.

On the part of firms, we have also seen many difficult decision made in terms of headcounts and business configurations. We also saw the deepest inventory drawdown that we have ever seen since we began keeping track. All of these moves are not only incredibly smart and rational, but have set the stage for the recovery we are now starting to see.

Unfortunately, I also think that we have a bit of a self-inflicted information problem that will retard our growth in the quarters ahead. We have made uncertain so many policies, that we have made our information far less accurate than it otherwise would have been. What will healthcare cost? How will it work? What will taxes be? What will energy policy be? We have promised incentives to small businesses such as subsidized loans and hiring tax incentives. Until we know what those are, why would anyone hire anybody if they could possibly wait?

Where the Econosphere has been free to provide incentives and direct the activities of individuals and firms, we have seen great strides that will help us emerge as a strong economy. Where the Econosphere is not so healthy, the public sector, we have seen a great deal of unproductive activity that will keep us from recovering as quickly as we might have.

Will we experience significant inflation?

Yes, there is a 100% chance of inflation in the forecast. It’s inevitable; in fact it is already here. On a year-over-year basis, the consumer price index swung from -0.2% in October to 1.9% in November. It will accelerate further in December. As for the producer price index, over that same period it swung from -1.9% to 2.7%. That said, it will be at least a year before we see truly disruptive inflation. We have too much excess capacity and underutilized labor for businesses and workers to push for higher prices and compensation just yet. However, once we see higher capacity utilization and more people at work, the ramifications of our gluttonous fiscal policy will become evident in a quickly devaluing currency and higher consumer prices.

What’s the best way to profit in today’s economy?

There are only two things that people can do to create more value: work more and work more productively. There are only so many hours you can work in a week, so there are limits there. There are, however, no limits to productivity. First, know that your outcome depends on your productivity; seek out and apply yourself to where you can be most productive. If you need additional training, get it. This may mean writing-off losses on a home, picking up your family and moving to a new city. It may mean making dramatic changes. This is the tough love of the Econosphere. However, if you understand that the outcomes that you see are the result of individual decisions, and train yourself to appreciate the signals that the Econosphere is providing you—chiefly through market prices—you will achieve that epiphany that the world is not chaos. The Econosphere is predictable, as is your role within it. This understanding will help you make rational decisions for yourself and your loved ones.

That said, our purpose on this earth is not to make the most money, rather it is to maximize “utility.” Utility is an economist’s term that essentially means “happiness.” We work to maximize our happiness. That means a combination of life pursuing avocations as well as vocations—time at the beach, and time at work. We naturally find that balance as long as we are able to follow the Econosphere’s signals.

The reason I wrote the Econosphere is that as I have worked as an economist over the years, I have come to see the Econosphere as a system that allows each of us to get the most out of our chief raw material, our life. I want to help others to understand this so that they can achieve better outcomes and greater happiness; but there is a selfish reason I wrote the book, as well. I know that the more people there are who love and appreciate our Econosphere, the more people will want to protect it. I desperately want to protect our natural Econosphere, and we will need everyone’s help to do it. We have an Earth Day, but not an Economy Day. Maybe someday that will change. I surely hope that we can save our natural Econosphere so that it can provide for each of us and for future generations.

Thanks Craig!

To learn more about Craig’s book visit www.theeconosphere.com

This post was originally published on Smartplanet.com