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Scarcity is not Optional

January 9, 2012

Scarcity is the starting point for economic analysis. It is the fundamental reality which we, as physical beings confront. All creatures struggle for nutrients and space, and all humans require various resources to survive. Without scarcity, choice is reduced to preference without tradeoffs. People would do what they wanted and their actions would have no impact on others. Scarcity imposes a need to ration, a need to be careful about allocation and a world where each of our consumption decisions affects the billions of other people who share our planet. Scarcity is not something we can wish away. It cannot be avoided by financial tricks. It cannot be suspended by a popular vote or by a powerful dictator.

Wealth of Nations
One of Adam Smith’s key insights was that a country’s consumption was proportional to how much it could produce. If a country produces 1,000,000 woolen coats, it can consume 1,000,000 woolen coats, or it can trade and consume an equivalent value of goods. Focusing on production cuts out the extraneous nonsense. You reap what you sow. The main reason why poor countries are poor is because they don’t produce much and vice versa.

Political Allocation
Making a resource allocation politically determined instead of market determined does nothing to alleviate scarcity. Workers are still needed to work and natural resources are still consumed. If anything, additional resources are consumed as government production is generally less efficient than market production. There are arguments in favor of government production in various markets, but pretending that changing market to government production can get us more of everything is disingenuous and wrong. Discussions involving health care, in particular, are often plagued by this sort of sloppy thinking.

Debt and Finance
Does issuing debt increase the amount of natural resources in the world? No. Does it create more trained workers, more capital, or speed up innovation? No (Update: Maybe). Therefore, debt issuance cannot expand the real economy. It can increase aggregate demand, if the central bank does not offset its effects. It can even transfer resources from one person to another. But unless a financial transaction changes real productive resources (for example, by lowering transactions costs), it can neither increase nor reduce real production, and thus consumption.

Further Reading
Sumner on savings and investment.
Nick Rowe on savings.

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4 Comments leave one →
  1. January 12, 2012 11:18 am

    “Does issuing debt increase the amount of natural resources in the world? No.”

    OK. But it can increase their availability. Many of the holes we’ve dug around the world were financed with debt.

    “Does it create more trained workers, more capital, or speed up innovation? No.”

    Are you sure? What if I take out a student loan to obtain an engineering degree? Or if you’re referring to govt debt, then what about those of us who received quality primary educations as the result of municipal debt floats? Both examples mean more human capital and higher potential for innovation, no? And vocational and employee or similar training programs financed with debt would certainly create more trained workers.

    “Therefore, debt issuance cannot expand the real economy.”

    As above, I think it can. All we have to do is think about the fact that debt is simply one method for employing savings, and like the others (e.g., equity) has always been used to finance productive investment.

    And of course, when an economy is operating below capacity–when its available real resources are not fully utilized–then “debt” in the form of sovereign govt liabilities can absolutely expand real output and incomes.

    That GMU kool-aid must still be coursing through you. 😉

    (I love that that econ dept exists, btw, just so we’re clear. Let me know if I’ve misunderstood your argument.)

    • January 12, 2012 11:20 am

      Re “debt…has always been used to finance productive investment,” that’s obviously prone to misinterpretation, my bad. Clearly, not all debt has been or is used to finance productive investment.

  2. January 12, 2012 3:19 pm

    The “No” was wrong, but it was wrong by less than you might think. The relevant alternative is not “no investment”, but investment financed by some other means. Debt financing increases real resources by the amount it reduces transactions costs over other methods of financing investment. Government debt increases real resouces by the amount it reduces deadweight losses over taxation financed spending. I would argue that debt financing is relatively high deadweight loss relative to taxation financing, but it’s debatable.

    I do note that debt issuance can expand AD, however, if you wanted more AD, just print more money. For a given level of AD, I don’t think there is any benefit to high levels of debt, since debt increases fragility of the financial system.

    The kool-aid at GMU is delicious, you should try it. GMU is a varied place, which has faculty representing a wide variety of viewpoints, not just Austrianism. Really the only viewpoint that is underrepresented is New Keynesianism, but you can get that anywhere.

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