Warsaw School of Economics — photo by flickr user Jeremiasz Dx
Thanks to Blogger and the Twitterverse, I’ve been talking recently with Tony Wang of Philosopher 2.0 about the nature of value creation in society. In addition to trading some emails and other online communication, we had in the past couple of weeks what I told him were the two most intellectually challenging conversations I’ve had all year, each of which lasted well past an hour on the phone. One of these conversations was mostly spent working out a brain wrinkle I’ve been having with economics, which has direct bearing on all of the work we do in the creative economy: how does value actually get created? I don’t mean this from the perspective of an individual actor – obviously, if I sell something at a profit, I create value for me. Rather, I’m talking about creating value inside the whole system. As in, how does worldwide economic growth actually happen? What simple, day-to-day actions of actual people translate directly into money being there that didn’t exist before? You would think this would be a simple question to answer, maybe even, you know, the first one that gets addressed in an economics class. But I’ve tried asking a number of people who have studied economics seriously or do it for a living, and everyone tells me something a little different – if they try to answer the question at all.
One economist told me that the creation of value basically boils down to work. So, if you put people to work who weren’t working before (like women in the past century, for example), you create a whole lot of value. Furthermore, if something happens to make more work possible in the same amount of time (like an improvement in technology), value creation can happen that way too. But where does the money come from to pay for this increased value? Think about it like this. Let’s say that there’s a mini-world with a population of six people. They all have their own farms and so they get the food they need to live on that way, and let’s say they all have a small amount of money to spend. Three of them make jewelry in their spare time and three of them make baskets. It turns out that the people who don’t make jewelry would like jewelry, and likewise with the baskets. So the people who make jewelry sell stuff to the people who make baskets, and vice versa, and everybody’s happy.
I did this little thought exercise on my own, and it turns out that no matter what changes you make to the system (i.e., someone has a child who starts working, someone magically gets a jewelry factory and starts selling more jewelry, someone introduces a new product, etc.), the total money supply never changes. It just gets shifted around to different people. The only things that will make the money supply increase are if (a) people get together and decide to print up more money (which just means each individual unit of money is worth less) or (b) one person decides to loan someone else their money on the expectation that they’ll get paid back with future money. In the latter case, the loan gets counted as an asset even as the actual cash gets transferred to someone else, so it’s double-counted in a way. This, as it turns out, is one of the primary means of money creation in the real world. But I’m not quite sure I understand how one can lend money out on the expectation that more is going to come in when there isn’t really an alternative way of creating “more” in the first place.
As it turned out, my conversation with Tony helped clarify my thinking around the problem. It turns out that the money supply issue is a bit of a red herring in my example. There are actually at least three different measures of economic wealth one can talk about. One is cash itself, which we’ve been discussing. But cash is really just a technology – a shorthand we use to make trade easier. Another, larger, measure is the total value of all of the financial assets on the balance sheets of every company and individual in the world. Anyone who’s studied accounting knows that cash makes up only a small portion of these assets; they also include the book value of things like real estate, equipment, durable goods, investments, and yes, money you’ve lent to other people. Finally, the largest of all is GDP, which measures the value of the total transactions in an economy. So in other words, when people trade on Wall Street like maniacs, total GDP goes up even if nothing is happening to the fundamentals of the underlying companies. An increase in the velocity of money – the frequency at which transactions happen – will increase GDP even if the money supply itself doesn’t increase.
Of these three, I’m most interested in what makes the total value of assets increase, besides just pumping out new loans and/or inflating the money supply. I’m starting to gather that the answer is nothing – but that that’s potentially okay. It’s potentially okay because we can create new value even if we don’t create more money. They are two separate concepts. In my little six-person world above, if somebody invents a machine to produce more food than people had previously been eating, and people’s appetite for food had not already been sated, that person has created new value. Everyone can eat more than they did before, and so quality of life has improved. But since the money supply hasn’t increased, everyone’s dollar buys more food (and more happiness/utility) than it did before. The dollar is actually more valuable than it used to be. So to bring things back into equilibrium, it makes sense in a way to increase the money supply. It’s the only way that we can keep the relationship of currency to value at a somewhat constant rate. So if we can rely on this continuing to happen in the future, it’s okay to lend to others on the expectation that future money will be created out of nothing, as long as we don’t overestimate the rate of value creation in society.
This, however, leaves unanswered the question of what we mean by “value.” Since we’re not, in fact, talking about money, what is it? And what makes more of it possible? Is it technology alone? New workers? Education? Some combination of all of the above and more? I’m leaning towards the last option, but I’m still working on it. If you’re an econ whiz and this is all review to you, a) I apologize for boring the hell out of you and b) please share your wisdom with us in the comments.