|December 31, 2006||Posted by Fred Foldvary under Progress Report, The Progress Report|
The Evenly Rotating Economy
by Fred E. Foldvary, Senior Editor
by Fred E. Foldvary, Senior Editor
Imagine a world of economic science fiction in which the exact same economic activity occurs repeatedly. There is perfect knowledge about all the economic variables, including the future.
In the evenly rotating economy, people are born, grow up, work, play, and die, but the population does not change. A new-born person will do exactly the same things and have the same preferences as the person who just died. Resources do not get depleted, technology does not change, and the laws of the land always stay the same. The amount of pollution is constant. Thus there is no change from what has occurred before.
In this evenly rotating economy, the factors of production receive their shares of wealth according to their marginal products, their contributions to output. If a worker adds $20 to the value of output from one hour of labor, his wage is $20 per hour. The same applies to capital goods and land rent, except that land rent is also a differential between the productivity of a plot and that of the least productive land. In the evenly rotating economy, there is full employment, since all employers, including the self-employed, know the availability of all labor.
Interest rates are positive in the evenly rotating economy because folks generally prefer to get goods sooner rather than later. So future goods, if bought today, sell at a discount, and the rate of discount becomes the rate of interest, the premium paid to shift purchases to the present day.
In this world with no uncertainty, there is no scope for entrepreneurship. There are no new inventions and no product and marketing innovations. Everybody knows what the supply and demand are and will be for all goods. Economic profits, beyond costs, only come from economic monopoly, the inability to expand supply, as with land. There is human activity, but no true human action, because there are no real choices and decisions to make.
In the evenly rotating economy, there can be a government that imposes taxes which do not change. The taxes can be on activity such as labor and consumption, in which case the tax acts like a higher cost of production, reducing the quantities produced, and creating a waste of resources and less human welfare. Or the revenue can be on negative externalities, such as pollution and congestion, as well as on land rent, in which case there is no economic waste from the sheer transfer of revenue.
Since the population does not grow and the future is known with certainty, there is no business cycle in the evenly rotating economy. There is also no money, since everybody knows exactly when they will be exchanging goods, so for example a worker does not need to be paid in money because he will instead obtain the equivalent in goods, as will the landlord and the merchant. Land rent and wages are constant, as are interest rates and the relative prices of all goods.
The model of the evenly rotating economy was originated by the Austrian-school economist Ludwig von Mises. Whereas the state of rest of neoclassical theory is the static general equilibrium at some moment in time (where the prices and quantities of all resources and goods are simultaneously determined), the Austrian schools market-process equilibrium theory is dynamic, taking place over time, but as a model of unchanging momentum.
What is the purpose of such an impossible imaginary mental construct? We can understand economic change more deeply if we first envision an economy without change. We can understand human action better by realizing that action ultimately aims at bringing about a state of affairs in which there is no longer any action. Real-world human action takes place in the context of uncertainty, where the future is imagined but not known.
Its like understanding the acceleration of a block of wood down an inclined plane in physics. We can understand the force of gravity better if we first analyze how fast the block would move without friction. Then we put the friction in, to see how it changes the speed.
Likewise, we can understand the economy better if we imagine how a pure free market would operate. Then we put in the real-world interventions and see how that changes the outcomes. So in the same methodology, we imagine the evenly rotating economy, and then we can better appreciate how the existence of uncertainty and change affect the economy. We can then better understand the vital role played by entrepreneurship, as we are all entrepreneurs. We seeking the best means towards our most important ends in the context of uncertainty as we speculate on possible future variables in an ever changing world.
The real economy is usually moving towards the evenly rotating economy as every exchange, the buying and selling of goods and resources, exhausts the gains to be made from trade. People are always moving towards satisfying their wants, and if there are no changes, eventually all wants would be satisfied on a continuing basis. But in reality, the variables do change, and we dont know how they will change in the future.
With the future uncertain, nobody really knows the variables of the evenly rotating economy, and psychological elements may make people overly optimistic. Folks tend to be too confident of their abilities and get emotionally attached to past variables such as their purchase prices, so that they feel uneasy realizing losses. With the future unknown, optimist speculators, gleefully borrowing at too-low interest rates due to injections of money by the state, win the bids for commodities and real estate, expecting upward trends to continue. But such speculative buying increases demand and prices higher than what actual users would pay, eventually leading to a crash. Speculation can be disequilibrating, misjudging the variables of the evenly rotating economy.
In the real world of change, uncertainty, and perverse psychology, government agents cannot possibly know how to direct the economy, yet folks put their trust in the benevolence and omniscience of chiefs of state. Government can make the economy worse in the evenly rotating economy by restricting and taxing enterprise and consumption. In the real world of change and uncertainty, governmental failure is that much greater. We can better understand the distortions caused by government intervention by realizing the fact that the economy does not evenly rotate.
Copyright 2006 by Fred E. Foldvary. All rights reserved. No part of this material may be reproduced or transmitted in any form or by any means, electronic or mechanical, which includes but is not limited to facsimile transmission, photocopying, recording, rekeying, or using any information storage or retrieval system, without giving full credit to Fred Foldvary and The Progress Report. Also see:
Foldvary: Macroeconomics Summarized
Fred Foldvary on The Broken Window
Fred Foldvary: A Geoist Robinson Crusoe Story
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