Saturday, February 28, 2009

A Good Stimulus Analogy

Here is a good analogy regarding the recently passed economic stimulus:

Shortly after class, an economics student approaches his economics professor and says, "I don't understand this stimulus bill. Can you explain it to me?"

The professor replied, "I don't have anytime to explain it at my office, but if you come over to my house on Saturday and help me with my weekend project, I'll be glad to explain it to you." The student agreed.

At the agreed-upon time, the student showed up at the professor's house. The professor stated that the weekend project involved his backyard pool.

They both went out back to the pool, and the professor handed the student a bucket. Demonstrating with his own bucket, the professor said, "First, go over to the deep end, and fill your bucket with as much water as you can." The student did as he was instructed.
The professor then continued, "Follow me over to the shallow end, and then dump all the water from your bucket into it." The student was naturally confused, but did as he was told.

The professor then explained they were going to do this many more times, and began walking back to the deep end of the pool. The confused student asked, "Excuse me, but why are we doing this?"

The professor matter-of-factly stated that he was trying to make the shallow end much deeper.

The student didn't think the economics professor was serious, but figured that he would find out the real story soon enough. However, after the 6th trip between the shallow end and the deep end, the student began to become worried that his economics professor had gone mad. The student finally replied, "All we're doing is wasting valuable time and effort on unproductive pursuits. Even worse, when this process is all over, everything will be at the same level it was before, so all you'll really have accomplished is the destruction of what could have been truly productive action!"

The professor put down his bucket and replied with a smile, "Congratulations, and welcome to socialism. You now understand the stimulus bill."

This analogy demonstrates one method in which wealth can be destroyed. Given that we have a finite lifespan and can only do so much during our lifetime, any moment we do not create wealth is a moment in which wealth that could have been created will now never come into existence. The time that it takes for the stimulus to collect and distribute the money will be potential wealth that is lost forever.

But this is not the only method in which wealth is destroyed. To be clear, wealth is created when one creates a product/service that is worth more than what had to be paid in the costs of production. If it takes $90 to create a piece of technology that is valued at $120 on the market, then $30 of wealth is created per unit*. In the same vein, wealth is destroyed if time is wasted by creating a product/service that is equal to the cost of production (again the issue of time) or is worth less than the cost of production. So if money is taken away from Skillful Joe and given to Average Joe, wealth is not only destroyed in the actual transfer but also by Average Joe, who cannot seem to make a decent profit. Worst yet, if money is taken away from Skillful Joe and Average Joe (Skillful Joe is always taxed) and then given to Below-Average Joe, then wealth is destroyed at an even faster rate because BA Joe is always going bankrupt and throwing money into a black hole.

This list is not exhaustive, but it does illustrate how taxation is harmful, no matter what the intention.

One way that the stimulus will destroy wealth in its own special is by creating economic distortions that may deceive all the Joes into throwing his money into a profit venture that is really a false boom. The distribution of money (in cases where money is printed and put into the economy or when one area is taxed for the benefit of another) can sometimes lead to, at first, a concentration of money in one area of the economy. The concentration of what appears to be “profits” may deceive some people into thinking that that particular area is very profitable and then engage in it when in reality no new value has been created. Once the money has been fully absorbed into the economy people will see their profitable venture was in truth not profitable at all, and the saturation of competitors, products, and services drives the value way down.

Numbers do not lie, but the people manipulating them do.

*This assumes a sound monetary policy, which in that case one can properly measure value in monetary terms. Since the U.S. does not follow a sound policy, I would recommend measuring value in terms of purchasing power, i.e., how many goods and services one afford.

1 comment:

Burgess Laughlin said...

> "Here is a good analogy . . ."

I think the analogy is "good" because it is clear and memorable for anyone likely to think in principles about politics. Thank you for posting it.

I find it fascinating to watch, over the past five months or so, pro-capitalism weblog writers gradually increase not only their knowledge of the unfolding mess the welfare state has caused, but also their arsenal of responses. Developing such responses takes time, especially for those who have not already specialized in the particular area of the crisis du jour.

I see this seemingly slow response as inevitable. Why? Because reason requires time and effort. Mysticism requires neither. Nevertheless, reason can win in this seemingly asymmetrical debate.