March 24, 2011

Economics for cavemen

When economics gets too complex for people like me I sometimes ask ‘what would work for a caveman?’
Sounds crazy, but we really are a tribal species and many of the things that drive our prosperity today are the same things that aided our survival when we lived in small tribes.

Our economy has become so complex that the rationale behind economic decisions is often unclear, leaving us to confuse activity with prosperity. Furthermore, the extreme division of labor, the proliferation of tightly-controlled media and the politicizing of economic issues has created a system in which prosperity is often measured by the success of the relatively few, usually at the expense of others. True economic prosperity is not a zero sum game. But, unfortunately, many of the growth-oriented policies made today simply transfer wealth from one group (including the unborn and the future) to another.

In reality, our economic success today is shaped by the same basic framework as our ancestors – only, we’ve added multiple layers of complexity. By looking back to a smaller, simpler version of society we can more easily pinpoint some of the decisions that would have made the most sense then and apply them today. More importantly, by looking back we can distinguish between choices that truly improve societal prosperity from those that simply transfer wealth from one entity to another.

Understanding the difference can save $trillions in wasted resources and result in a more tightly woven social fabric. Recent riots in Greece and the Middle East underscore how important it is to get it right.

Below I’ll look at a five sources of growth and relate them to the world of our tribal ancestors:

1. Productivity improvement via application of capital (I.e. give the tribe better tools) – adding technology to human capital can yield big gains. The first societies to discover and distribute hunting tools among all its members caught more prey and gained societal wealth. But those gains saw diminishing marginal returns as more capital was added, unless the capital was a form of disruptive technology. For example, give someone a spear and they will catch more prey; give them a second spear and the increase in prey caught will decline. But give that person a rifle and they will again see big marginal gains.

Investment in human capital (ie education and training) is said by some to have steady marginal returns. I contest the application of this claim – while education is extremely beneficial (give someone a spear and teach them how to use the spear) there is clearly a cap to the benefits of education at the individual level. This is especially true if that education doesn’t directly satisfy some societal need.

2. Population growth – a growing tribe with ample resources could initially experience economic prosperity as its citizens specialized, becoming more productive in their particular areas of expertise. Even without productivity gains population growth would lead to aggregate economic growth, but on a per person basis tribe members were not better off. In the long run, population growth was detrimental to the tribe’s economic status as resources became strained. We live in a big world but there’s no question that resources are finite and eventually all tribes – old and modern – hit their physical limits.

3. Plunder – this is clearly a zero sum game. Tribes that stole from other tribe members and called it progress are delusional. Tribes that stole from other tribes gained in the short run, but as a global society were no better off. Today, we may not call it ‘plunder’ but there are certainly many policies today that simply take from one group and give to another.

4. Secular decline in financing costs – due to lower inflation and risk premia, and greater supply of funds. Within a tribe two fish mongers may have had great ideas: one would increase the number of fish available to the entire tribe; the other would add another fish monger, but at the competitive expense of other fish mongers. Both required a loan to get started. In a society that wasn’t willing to take risk, or was willing to lend only at punitive rates, neither project would start. In a society in which capital was allocated to the most productive projects, the first fish monger would get the loan and society would gain. Unfortunately, in today’s complex and politicized economy it is difficult to distinguish between projects that create wealth for a special interest group and those that improve the state of society as a whole. Why bother distinguishing? Taking  it back to the fish monger example, if you were a leader of a tribe you would support the fish monger that adds to the production of fish because the tribe’s survival depended on it.

5. Secular decline in resource costs – new discoveries and production. Our economy is so complex that we’ve disconnected ourselves from the realities of physics. Somehow we believe that the laws of economics conquers all and that we have complete control over our fate. Unfortunately reality is not so, and history demonstrates there is a link between resource costs (as a manifestation of supply and demand) and economic prosperity. For a tribe living in a cave the physical world was a daily reality. At the most basic level, if a small tribe was dependent on wood for survival what would happen if it discovered a new forest? Tribe members would bask in plenty and the population would thrive as it built more and better shelters, canoes, lights more campfires, etc.. Suddenly it became possible to do more. The opposite is also true – if existing wood supply was suddenly halved tribe members would be forced to share resources, shrink production and make do with less.

While my tribal examples are not anthropologically accurate (and may not be the best examples), these are just five examples of alternative ways to evaluate decisions made in today’s world. I’m trying to provide an alternative framework for evaluating complex economic decisions – when choosing policies we need to distinguish between those that provide an aggregate benefit and those that simply transfer wealth. Often it is difficult to make the distinction, but if something was good for our tribal ancestors, it is likely good for modern society.

If it didn’t make sense for a small tribe, does it make sense today? How do you think this applies to cash for clunkers, QE2, ethanol subsidies, the Japanese tsunami? I think you’ll find that many sources of ‘growth’ are simply wealth transfers from one group to another or from future generations to the present.
Honestly, I haven’t run this concept past anyone…so let me know what you think.