In the course of my occasional blog discussion with Tony Wang about the nature of value (economic and otherwise), I’ve gotten us off on a bit of a philosophical tangent: namely, exploring the question of whether a pluralist value system–one in which we don’t assign any judgment to what one person believes/wishes versus another–is a sufficient framework to allow us to determine what rules/policies/social structures are optimal for the human race at any given moment in history. In his latest post, Tony says,

I think it’s ok to disagree on what’s valuable. Do Ian and I really have to duke it out and come to some sort of shared valuation of happiness, freedom, and egalitarianism in order to talk about organizational structures? Or is it ok if Ian values happiness a bit more and I value freedom and egalitarianism a bit more? If pluralism is not ok then the alternative is that we would all have to agree on our relative valuations of happiness, freedom, egalitarianism, etc. before we moved forward in any substantive conversation. And to be honest, I think that’s counterproductive.

I agree with Tony as far as the first sentence. No, we don’t have to agree on what’s valuable – he might care more about education and I might care about economic empowerment, or he might care about science whereas I care about the arts. That’s fine. My point is that as long as there is some means of reliably measuring or knowing what each individual values and how deeply, it should be possible to come up with a single set of rules/policies/social structures that works optimally given the specific mix of people in the world. (When I say “a single set,” I am including among the possibilities a decentralized system that would take into account local differences and customs, etc. In fact, there would likely have to be at least some decentralization in order to maximize collective benefit.) It would just be a straight-up modeling exercise, albeit one with a potentially gigantic number of parameters. Note that the “values” I am talking about are different from preferences as considered in a market-based context: whereas markets are shaped by participants’ immediate preferences when presented with a limited set of possibilities, here I refer instead to values or long-term goals that people would strive to uphold regardless of the extent to which they may be realistic at that moment.

I would imagine that this line of thinking intersects rather significantly with happiness economics, which I am dismayed to admit I haven’t yet had a chance to explore to the extent I’d like. Indeed, we could go ahead and simply equate utility with happiness, though doing so requires an assumption that human desires can all eventually be reduced to one goal (and also an assumption that people actually know what makes them happy). Even if we don’t, however, we can still work with a finite list of desired “final” outcomes (e.g., world peace, personal prosperity, universal submission to His Noodly Appendage, etc.) as long as we have an idea of how many people care about them and how deeply (and in which direction). The next step after these goals have been identified would be to design an enormous “logic model for the world” that would consider what intermediate factors impact each goal and what societal levers can be manipulated to facilitate the movement of those indicators in a positive direction. It is very likely that in some cases, the intermediate factors (or even the goals themselves) will compete with each other — helping one in a specific way will hurt another. Banning guns, e.g., may be helpful for the goal of world peace but may hinder the goal of individual liberty. In such cases, the relative weights of each goal matter, as does the measure’s ability to impact each goal. So, if banning civilian gun ownership is much more likely to hinder individual liberties than it is to help achieve world peace, and more people care about liberty than peace, then we don’t ban guns. The logic model’s construction would need constant revision as our understanding of the causal links between various regulations and social behavior improves, but given its fundamental basis in logic and science, it should be possible to make one that is as “correct” as possible within the limits of human knowledge.

So why don’t we get off our asses and just do this already? Well, unfortunately, that necessary condition I mentioned at the top–knowing what people value and how deeply–is a work in progress. We don’t have enough information about that now, probably, to be able to perform an exercise like the one I described. But I think we’re getting closer to being able to do it every year that passes, and I think it’s entirely possible that within Tony’s and my lifetimes we will have enough good data to be able to at least get a good start on it.

In the meantime, there are tools we already use to approximate what people’s value systems might look like. The most significant one is the market economy. Friedmanesque true believers claim that most social interventions on the part of government and others are superfluous, because markets already reflect the preferences of the people participating in them–as long as all transactions are voluntary, there are no deceptive practices, transaction costs are minimal, and anyone can participate. And it is certainly true that markets can do wonderful things when all of these factors are in place. One problem, though, is that they often aren’t–and many times, existing participants (especially suppliers) have powerful incentives to keep it that way. Furthermore, many market transactions have things called externalities, costs or benefits that accrue to third parties who are not part of the transaction (and thus do not participate voluntarily). A third problem is that markets have a way of leveraging existing inequalities and power differentials between participants by putting greater amounts of wealth in the hands of those who already have it — a quality exacerbated considerably by our practice of handing down family inheritances from one generation to the next. Finally, markets use money as their currency and also as a proxy for value — but as we discovered earlier this year, money and value are not at all the same thing. In fact, the observed relationship between money and happiness is murky at best.

All of these factors lead to what are known as market failures — situations in which the market economy, despite working as designed, fails to achieve an optimal outcome for the whole. And in such situations, we have the government to take up the slack. In many arenas, including defense, national security, emergency services, low-income housing, some health care and education, and the law, the government takes part in the marketplace directly. Furthermore, the United States has recognized and systematized a third legal status of organization, the 501(c)(3) public charity, to which it provides indirect subsidy in the form of tax exemption. Thus, in this country, we are provided with three sectors with which to try to maximize social good.

Market failures aren’t in and of themselves a bad thing, but they are bad when they result in a loss or non-optimization of collective utility. The arenas in which the government operates through direct action or indirect subsidy are those arenas that it has defined as poor fits for the market economy–essentially, where it thinks market failures that are bad for society are likely to occur. These arenas can provide us with a hint as to the proper and optimal organization of activities if our overall goal is to maximize social good. For the most part, though, these designations come from an earlier era, and the world has changed a lot in the past couple of generations. So part of our job over the next several posts will be to re-examine each of these arenas and try to come to our own conclusions about whether each one might be better suited for market solutions or not, and if not, whether direct government action or third-party nonprofit/NGO intervention makes more sense.

Tony weighed in on the subject two weeks ago with a post entitled “The Implicit Theory of Value.” In it, he sort of shrugs his shoulders at my attempts to map out a set of causal links to a specific goal (in this case, “increased transactions for goods and services”), saying that

…if we assume utilitarianism is true and believe that we should maximize the greatest good, the question then becomes what is the good? And I think here is where we find contentious beliefs, even among reasonable and good people. Is it ok to sacrifice environmental goals to alleviate poverty? Is economic growth better than no economic growth? How should we weigh the arts against other issues like homelessness? Given $1,000,000 each person would choose to allocate money differently; some would give more to international health while others would give more to domestic education. To debate which issues are more important may ultimately prove ineffectual – if the past two millennia since Plato and Socrates and the diversity of philanthropic interests are any indication.

Essentially, Tony is saying that it’s all well and good to be able to map out a strategy to achieve a certain goal, but it doesn’t do us much good unless we know what the goal should be. And how should we determine that with any degree of logical rigor? Tony seems to think that it’s no use bothering to try; instead, he lays out a fundamentally pluralistic vision of value, arguing that decisions we make as individuals and organizations are informed by an “implicit theory of value,” a particular set of priorities, judgments, and beliefs unique to each of us:

In any conversation about social change or social justice, we necessarily assume some sort of implicit theory of value – that we believe certain things are better than others.The belief can be as simple as believing that justice is better than injustice, or as controversial as believing that removing a thousand tons of carbon is better than feeding ten children. But it is under this implicit theory of value and the corollaries that it can be maximized and that the choices we face can theoretically be measured for the value that they generate, that we can best understand the sectors.

Before we fast-forward to the discussion about the sectors, though, I’d like to spend a little more time contemplating this pluralistic framework for thinking about value, because I’m not sure if I totally accept it. To be sure, there are many things to like about this system, not least of which is that it unburdens from us the responsibility to decide what’s good and what isn’t. Effectively, utilitarianism argues for crowdsourcing morality–the more people who believe a thing more strongly, the more right it is. Yet this refusal to privilege certain values over others can get us into trouble, I think. To take an extreme example for illustrative purposes, a whole lot of people in the 1700s thought that slavery was a perfectly legitimate industry and business practice, and derived significant utility in both financial and nonfinancial terms from having slaves at their disposal. So does the fact that the collective utility of slavery was much higher then than it is now mean that it was reasonable, or at least not as wrong, at the time?

Well, perhaps not, if we consider that the slaves experienced significant negative utility from being forced to endure atrocities for their entire lives. So in fact, we can presume that the net utility for society was hurt by slavery, even if some people benefited from it. And certainly we can declare that slavery was not the optimal path to maximizing the collective utility for all human beings.

If we’re going to go that far, however, I don’t see why we have to stop there. If our goal is to maximize collective utility, why do we need a pluralist notion of what value means? Doesn’t value just equal utility? And aren’t there some absolutes, some things we pretty much know to be true about what human beings want and don’t want? Each one may not be true for all human beings, but even if we have a rough idea what percentages of people care about which things and how deeply, unless those things change drastically over time and between cultures, shouldn’t it be possible to set up policies and practices (and philanthropic systems) that maximize collective utility?

At the risk of embarrassing myself (if, indeed, I haven’t already) by treading tired old ground in the field of philosophy, I want to try to get some additional clarity on these questions before we take the plunge into what will eventually become a conversation about organizational structures — because I feel that a strong understanding of the relative value of various issues can only aid our understanding of the relative value of organizational structures within those issues.

I’ve chosen to limit the conversation for now to transactions for goods and services, even though I think it’s a crappy measure of value, because I want to demonstrate how even in this most familiar territory to economists, externalities play a huge role. The umbrella concept of “social good,” under which concepts like environmentalism and public health reside, is usually thought of as fundamentally separate from a country’s, a system’s, a world’s economic health. But as you’ll see below and as I’ll explore in more detail in the next post, they are in fact inextricably linked.

The diagram you see above is what’s known as a “theory of change” (or, in some corners, a “logic model”), a tool commonly used in the philanthropic sector. In this case, I’ve applied it to the concept of increasing economic transactions for goods and services, which is more or less the idea behind GDP. In a policy-level theory of change, the basic process is first to identify the goal that we want to achieve, and then walk back the logical steps leading to that goal. We continue this process iteratively until we finally arrive at actions, concrete steps that we can take today or tomorrow that will set us along the path to achieving the goal. It’s an incredibly powerful tool that has uses in all sorts of contexts. In this case, I’m using it to think about the nature of value.

I’ve identified seven antecedents to increased transactions for goods and services, as follows:

More people want goods and services. Pretty self-explanatory, this is about increasing the demand for stuff by increasing the number of active buyers in the market. This could take place through a population increase, by means of people living longer (which I guess can also lead to population increase), and through bringing people in to the market who weren’t buying before, principally by activating the purchasing power of the “bottom of the pyramid” — the 40% of the world’s population that currently lives on $2 or less a day).

Greater capacity to provide goods and services. The supply-side corollary to the above. It doesn’t do much good if more people want goods and services if capacity doesn’t exist to produce those goods and services. There’s both a human dimension and a, shall we say, non-sentient dimension to this. First, we can increase capacity to produce things by putting more people to work. If there are more people in the world (because of a population increase) or more people work who weren’t working before (e.g., women, children, the elderly), that increases the world’s productive capacity. But it’s not just about humans: if we can make machines to do our work for us, or take better advantage of natural resources, or come up with new operational processes and organizational systems that increase efficiency, all of these things increase productive capacity as well.

Greater variety of goods and services available. Most consumers do not have an infinite taste for any given product, especially products that are durable and not essential necessities of life. No matter how useful they might find the product, they’re only going to want so many. But if there are new kinds of products to choose from, the consumer might well buy some of them, thus increasing the net total of transactions. New products with market appeal will generally fall into one of three categories: complements to existing products that make them more appealing or useful (think a protective case for your iPhone, or a bar to go along with a new music venue); substitutes for existing products that make the older editions obsolete (think new versions of old software, or the updated car designs that come out every year); or entirely new concepts that often feature some sort of disruptive innovation and have little precedent in previous products (think the television or the phonograph).

People buy more previously available goods and services. Sometimes increasing transactions is as simple as making sure people know that the available goods exist. That’s where marketing comes in, though at its extreme (or most professional) it can take on the more sinister role of artificially inducing demand by preying on humans’ psychological quirks. [That’s one reason why this model is incomplete: by making increased transactions the sole stated goal, it endorses several socially undesirable practices (like this one, or child labor) as legitimate intermediate outcomes. We’ll address this in the next post.] The other way in which people might buy more previously available goods and services is if those goods and services suddenly become more useful–either because someone figured out a new use for them, or because a new product, desirable in itself, uses the old product as a complement. (Think old TV shows, which found a new life because of cable television and specifically Nick at Nite.)

Buying and selling becomes easier and/or faster. Sometimes, even if there’s a buyer and a seller, making a transaction can be costly or difficult. If someone in Peoria has a copy of an out-of-print book and you’re in San Francisco looking for that book, you’re not going to find it. Or at least that was the case before Amazon Marketplace and eBay. Now, it’s a few clicks of a mouse and we’re off to the library. Technologies like these increase the velocity of money–the frequency at which transactions can happen, and thus the overall number of transactions.

People spend money instead of hoarding it. Assuming money is the currency of transactions, it doesn’t serve the goal in question when people who could engage in transactions elect not to because they are afraid of running out. When that happens, trade dries up and the possibilities start to contract, as we’re seeing in this latest recession. Clearly, confidence–on the part of consumers, investors, and firms alike–is important, as is liquidity (the ability to access quickly and easily what financial assets you do have).

Impending market disruptions are avoided. I chose my wording here carefully, because just avoiding market disruptions doesn’t lead to increased transactions. You have to avoid market disruptions that would have happened had you not taken steps to avoid them. Now, we obviously don’t know exactly what’s going to happen in the future, so the easiest way to think about this problem is in terms of risk. The list of possible catastrophes that could result in a major hindrance of market activity is endless, but some of the more obvious risks include war (including nuclear war); natural disasters such as hurricanes, tornadoes, floods, and earthquakes; terrorism (physical or electronic); environmental problems, most notably global warming; and systemic financial risk of the kind that we saw in the recent banking crisis. Taking care of (or just mitigating) a problem with a high severity and high risk will provide the greatest benefit to the ultimate goal, increased financial transactions.

This theory of change for economic growth is just a first cut – the result of maybe a couple hours’ worth of thinking about the question systematically. If you have thoughts about how it could be improved, I welcome your input. I can already name a couple of deficiencies: it only goes three levels deep, which leaves out quite a lot of detail — and even then, of course, it only considers a very narrow conception of economic growth. But you can already see how, even using pure GDP as the end goal, traditional economic growth strategies (cut taxes! deregulate!) only address a small portion of the relevant levers. Issues that we’re accustomed to thinking of as totally separate from economic development, including fighting global warming, working towards peace and security in the Middle East, increasing the life expectancy of our citizens through better health care, and extending a helping hand to the world’s poorest citizens, are all directly linked to economic growth. And if economic health is more than just the volume of transactions, if it’s in fact about improving quality of life, then these supposedly “external” considerations are all the more important.

The economic issues that I’ve been wrestling with for the past two years center around the concept of externalities. An externality is a cost or benefit imposed upon or granted to anyone who is not party to a direct transaction. Although we usually tend associate them with negative effects, most commonly environmental impacts like pollution and global warming, important positive externalities are possible as well, like network effects associated with the widespread adoption of common standards, or the positive spllover that a new art gallery opening has on the value of the house across the street. In the hot dog vs. wireless example above, we have positive externalities such as network effects and knowledge spillover on the wireless side, vs. negative externalities of an increase in obesity, decline in overall health, and the environmental consequences of meeting the demand for meat products on the hot dog side. Since externalities by definition do not affect the transaction itself, economists have a nasty habit of ignoring them (the issue is first mentioned in chapter 17 of my microeconomics textbook, and is tellingly the only topic without an article yet in right-leaning economist Russell Roberts’s “Ten Key Ideas: Opening the Door to the Economic Way of Thinking”). Yet in any kind of public policy work, whether in government, nonprofit, or social enterprise contexts, thinking about the whole is essential — and that means thinking seriously about externalities.

The Holy Grail of economic thinking is a way to have externalities accurately reflected in prices, much the same way that investors (try to) price out risk in financial transactions. Numerous initiatives in this direction, from investment heuristics like SROI, expected return, and Best Available Charitable Option to broad-based macroeconomic indices like the Genuine Progress Indicator, have tried to integrate several different concepts of value into one overarching social metric. By choosing to deal with life in all of its complexities, however, they forfeit the easy modeling that’s possible in traditional economics’ vacuum-packed artificial world, making the pursuit of exactitude exceedingly difficult. Not to mention that these tools can suffer from conceptual difficulties of their own. I plan to explore them more carefully in the coming weeks, but my initial sense is that they typically narrow the focus to only a few externalities, deal with them in a manner that greatly oversimplifies the way they actually work, and treat them as isolated linear effects rather than complex functions that interact with and are affected by each other. It’s not to say that they aren’t steps in the right direction, but the destination appears to be a long way off yet.

For now, though, we can at least think about what kinds of economic activity ought to be relevant to those concerned about maximizing positive externalities and minimizing relevant ones. Rather than trying to develop a single unifying theory of value, which is, as President Obama might say, above my pay grade for the moment, I want to focus the discussion initially on financial transactions alone. In doing so, I hope to preserve at least some hope of being able to price externalities in to existing models, figuring that a business case for some of these things could made more easily that way.

We can do this via a simple method: 1) pinpoint desirable economic outcomes; 2) step back and say “how is this made possible?”; 3) repeat. This is the same method used for developing theories of change at the philanthropic level, and can be incredibly effective for mapping out short-term strategies for long-term goals. Working this out, even at a very high level, will take much more than one post. But here is the first step in case you want to follow along at home. Since I’ve chosen to limit things to the language that economists already use, there’s exactly one desirable economic outcome: more transactions for more goods and services. Thus the first question is: what makes such a thing possible?

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?

Josh Futrell chimed in with a helpful review of microeconomics, excerpted here:

I think that “value” is result of the human energy and creativity to manipulate raw materials and create utility where there was none before.

Let’s say that I am a farmer in the example above who transforms the land to grow crops, which then provide value to them in the form of food. If I did not do so, my family and I would risk starvation or have no commodity to trade for other goods and services. So, through our work, we are adding value to own lives and, as a result, to the society as a whole. This is on a purely substantive level.

[…]

Finally, let’s say that I am a farmer who admires the jewelry made by my counterparts. I see value in it because of the way it looks and the way it makes me feel when I see it, wear it, or give it as a gift. Further, let’s say that I cannot make this jewelry on my own: either I do not have the innate skill necessary to create an object that elicits the same utility or the effort/energy to acquire the skills and tools to make such an object greatly outweighs the price the other farmer is asking in trade. I offer a trade and if the basket maker sees value in my offered trade (be it food or a basket), they accept. Value is then created for both.

This is how the artist traditionally adds value.

[…]

I think that the bottom line is that it is the exertions that we, as human beings, make improve our lives and welfare beyond the bare minimum needed to sustain life that create value. We do this by 1) making a living by exchanging our effort, time, and knowledge for goods or money, 2) purchasing goods or services that have utilitarian purposes or creating entities that provide them, and 3) purchasing goods or services that have emotional/artistic value or developing the skills needed to provide them.

To which I responded:

Thanks, Josh, this is great. I realize now that I was a little imprecise at the end of my post. You’ve basically said that value = utility, whether utility in the sense of efficiency (i.e., I can be more productive with the time saved from my basket), or a psychic utility like happiness. OK, I agree with you. The bigger question for me, though, is the second one: what makes more of it (value/utility) possible? We’ve identified a couple of examples already. Baskets are a technology. It improves productivity, which means that I can do more work in the same amount of time. That increases value, assuming there’s a market for the additional work. (But what if there isn’t? Does that make the technology useless? I guess so–until someone else adds value by building off of it to make something that people will use.) Jewelry is a new product. There’s no direct productive use for it, but it makes the customer happy. It makes the customer happy, presumably, in a way that wasn’t possible before. So we have created value. But what if the farmer doesn’t like the jewelry, and therefore it goes unsold (=0 value), but then 30 years later after the jeweler’s dead, the farmer’s son discovers it in his abandoned house and wants to keep it? Does the jewelry suddenly gain value simply because now there’s a customer for it? But how would we know, since there was no transaction to record how people valued things?

This is where the arts and economics start not getting along so well. Despite having dissociated the notion of value from the notion of money in theory, in practice any kind of real-world economic analysis has the two intimately linked. Which means that if some kind of transaction or activity doesn’t involve money, it doesn’t get counted – even if it creates, as Josh describes, a whole lot of utility. Certainly lots of artmaking falls into this category – as does volunteering, in-kind donations, and open-source software development, all things that can clearly increase value (especially if there are productivity gains involved). Now, that value will most likely show up in economic transactions somewhere, eventually – whether it’s by businesses that are made possible by the existence of Linux, or real estate values that go up because of the contributions of artists, etc. – but the problem is that the source of that value is exceedingly hard to track. Especially in tricky network economies in which every new entrant makes everyone else’s membership in the network more valuable.

As far as I can tell, value comes from two things: 1) productivity and 2) happiness. They are not the same thing, and can sometimes be in conflict. I’m not sure what exactly the right balance is, nor exactly how one would go about figuring it out. But here’s what I am thinking:

1. I would like to know what economists think and say about volunteerism, specifically how they value people’s time when they aren’t getting paid for that time. What is used as the baseline?
2. I would like to know more about “happiness economics” (which I understand is big at Princeton) and Bhutan’s concept of Gross National Happiness.
3. I would like to think about what kinds of things make more productivity possible. Not just the obvious stuff (more capital! more labor!) but looking beyond that: what makes more capital possible? what makes more labor possible? what makes efficiency improvements possible?
4. I would like to learn more about how the monetary supply and the overall value of things (“quality of life,” I suppose) are kept in balance with each other, if indeed they are.

Stay tuned.

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.