Wednesday, 14 January 2015

Probably over most people's heads, but here's how I see it.

In some ways, you can envisage the economy as something like the fresh water system.

It starts with little puddles and springs up in the mountains and on hillsides, these flow into small streams, then into larger streams, then merge into tributary rivers which ultimately merge into larger rivers which then flow out into the open sea.

By analogy:

Individual transactions = little puddles and mountain springs

Everything starts with individual transactions. Some are profitable for both parties, some for just one party and some for neither, there's a lot of trial an error involved and nobody really knows. But overall there are benefits when people make these millions of little exchanges or transactions each day.

Similarly, puddles dry up quickly and mountain streams only flow if it has been raining further uphill. They are not always there.

Profits and wages = large streams and tributary rivers

Most businesses make profits. Some people like to split this up into the arbitrary categories of "profits" and "wages" but really they are the same thing. Businesses enter into thousands or millions of little transactions, most of which generate a small profit, some generate losses, but overall, they net off to a profit. Sometimes, a business or a business model fails, the loss making transactions start to outweight the profitable ones and *bang* the business is gone and the workers are unemployed.

Similarly, while some small springs and streams can dry up, overall, the rivers they flow into will usually be getting water from somewhere or other, larger rivers are more predictable.

Rents = the largest rivers which flow into the open sea

If, and only if, there are businesses making profits and workers needing housing, then rents arise.

Like large rivers flowing into the sea, these are the most stable thing in the economy. Such rivers are highly unlikely to dry up, there will always be water flowing in from somewhere or other, they are the most predictable of all. If one business or worker isn't prepared to pay the rent or purchase price, then another one will. If one tributary dries up a bit, another one will still be flowing.

And when the water flows into the sea, it is lost. It turns from valuable fresh water into worthless sea water. Nobody can use it to generate hydro-electricity, drive water mills, drink it, or use it to grow food, for cooking and washing, most indutrial processes etc.

(For sure, we need water in the sea for international shipping and fisheries, that's salt water not fresh water and a separate topic.)

The analogy which regular readers probably saw coming...

The open sea fills the same purpose and provides the same benefits to the nation as private collection or enjoyment of rents. None whatsoever. It just scoops up as much as possible of what everybody else contributes or what's left over.

So if collecting taxes is the same as diverting fresh water, from where should the government collect it, in terms of causing the least damage to the economy and re-cycling the rent (fresh water) back into the economy, or in terms of predictability or the lowest collection costs?

From mountain springs, small streams, larger streams or from tidal estuaries? If you collect water just at the point where it would have flowed into the open sea, it has absolutely no effect on the rest of the water system.

So... should the government be taxing transactions, wages, profits or rents? If it taxes rents i.e. land values, then this simply has no effect on the rest of the economy.

Here endeth today's lesson.


Lola said...

Oops. You are forgetting the water cycle. The water in the little streams on top of the mountains gets there from rain which is the precipitation of the water sucked up from the Oceans by evaporation. It is veritably the cycle of life. Which is what seekers after economic rents aren't.
Overall the water cycle is more like the economy as it provides the sustenance to grow value by carrying mineral and nutrients to plants and life. Maybe like 'money'?
Water is always useful (even seawater which not only carries more gold dissolved in it than is available in all the ore in the ground, but also provides a universal highway for trade).
Dare I humbly suggest you have another go?

Mark Wadsworth said...

L, rain is even less predictable than little puddles or mountain springs. If the government tries to raise money by collecting rain..?

And "the ocean", like a land owner, it does not do any work; it is the sun shining down which turns sea water back into fresh water and gives it back to us.

Lola said...

Precisely. The economy is possibly as random as rain - that's why the government cannot run it (the socialism calculation problem). But it needs to collect some of the rain (money) somewhere. Does it collect it as it passes through the economy or does it as you suggest suck a bit up from the sea? Yes, taking it from the sea has less deadweight effects but it is still taking money (water) out of the economy - the government not being the 'economy'. But that will still reduce the water for the economy.
Suppose we think of rent seekers as also taking water from the sea and the government taking some of that water from the rent seekers? That would have no additional dead weight costs over those caused by the rent seekers. Whatever you do, as land is a monopoly you cannot stop rent seekers. You just have to minimise their negative impact.