Sunday, June 03, 2012

Money as electricity: an economic metaphor

It's tough to wrap your head around economics. The Infamous Brad does a better job than most, and he gets it way more right than a lot of professional economists, when he asserts that the government should act like a household with intermittent income. Basically, when your income comes in widely-spaced chunks, you should be frugal (spend less than you earn) when times are good so you can be profligate (spend more than you earn) during the lean times. This approach entails acting counter-cyclically. The alternative, acting cyclically, would be disastrous: when you have a lot of income, you spend it all (and maybe even more, because you expect you'll getting another windfall each month like clockwork, n'est pas); between paydays, you don't spend anything, letting your income-generating infrastructure decay. Brad describes the perfect way to manage a household with an intermittent income stream. If you think about government as such a household, you will be an adequate citizen and voter: when spending is put to a vote, you will almost always vote in such a way that the national economy does not collapse. You will not, however, actually understand how the national economy works, and managing the national economy like any kind of household, even a counter-cyclical intermittent-income household, is extremely limited. The government is fundamentally unlike a household.

A better metaphor — still imperfect, but closer to the truth — is to look at money like electricity, and the government like a nuclear power plant. Households have to allocate the supply of electricity amongst themselves, but the government is not part of that allocation, it is the ultimate supplier of electricity. Thus the financial wealth of a household is like its share of the supply of electricity, but the government is, by definition, "maximally wealthy", it has all the electricity.

Of course, you can't actually do anything with only electricity. Without toasters, refrigerators, stoves, electric cars, etc., a supply of electricity would be completely useless. So we have to use electricity and human time and energy, i.e. labor, to build toasters, refrigerators, etc., and then we have to use electricity and labor to operate those devices. And again, since there is a limited supply of electricity (and labor), we want to somehow allocate how much electricity each household uses. Households "spend" by actually using the electricity they're allocated to make toast, keep food cold, make dinner, or drive to the park, or to make toasters, refrigerators, stoves, or cars. Households can "save" electricity by not actually using some or all of the electricity they're allocated.

The analogy to a "depressed" economy is when people aren't using very much electricity; the analogy to an "overheated" economy is when people are using every kilowatt-hour the power plant can produce and wanting more. The question then becomes: how do we manage the nuclear power plant? As the administrators, we can either encourage people in general or specifically chosen people to use more or less electricity. We can also decide when to use electricity and labor to increase the capacity of the power plant: should we do so when people aren't using much electricity or when people are using a lot of electricity?

One feature of modern economics that this metaphor illustrates accurately is the nature of savings. It's very difficult and inefficient to physically save electricity: batteries are heavy, expensive, leaky, and they have very limited storage space relative to generating capacity. We can and should save physically save some electricity (the power plant tends to wear out faster if it's constantly changing the amount of electricity generated minute-by-minute, and there's a considerable time lag between the decision to increase or decrease the supply of electricity and the actual appearance of electricity on the grid). A much easier way to "save", however, is for one household to let another household physically use the first household's allocation of electricity for a month or so; in return, the second household will let the first use the second's allocation in some later month. From the perspective of the power plant, there's no change in the net usage of electricity, but from the households' perspective, the first has saved electricity one month and withdrawn their savings in the later month; the second has borrowed electricity from the first and paid it back later.

The power plant cannot itself save in this manner. It can, however, use the same sort of tools to help encourage or discourage electricity use among households. If some household has an allocation it doesn't want to use, and no one else wants to use it, the power plant can (if it chooses) "borrow" the allocation; there's never any problem with "paying it back," because of course the power plant generates electricity.

The metaphor makes counter-cyclical policy clearer.

When the economy is "overheated", when people are using as much electricity as the plant can produce, we want to strictly allocate who gets how much electricity. If one household can turn a kilowatt-hour of electricity into 2 toasters, and another can turn a kilowatt-hour into 2.1 toasters, we want to move the allocation of electricity from the first household to the second. When the economy is good, electricity should be in some sense "expensive".

It's tempting to say that when people are using all the electricity we have and are yelling for more, we should increase the capacity of the power plant. However, a couple of severe practical problems arise. First, it uses up a lot of electricity now to make all the things necessary to increase the production of electricity later. That means that to improve the plant when times are good means that everyone has to use less electricity, for quite a while, precisely at the time when they want more. No individual household wants to cut its own electrical usage; they all want those guys over there to cut theirs. Trying to negotiate an agreement to cut everyone's usage "fairly" is an exercise in herding cats. Besides, when electricity is "expensive", everyone will be trying individually to be more efficient in their use of electricity, which increases the effective amount of electricity, i.e. the number of toasters (and number of pieces of toast) per kilowatt-hour of electricity.

What does it mean to say the economy is "depressed"? It's not that people don't want to use electricity — we assume that people as a whole want as much electricity as they can get, up to infinity — it's that the people who have been allocated the use of electricity are trying to "save" it, but no one is "borrowing" it. (I think the money as electricity metaphor can illuminate why this state of affairs can happen, but it will require a whole 'nother post.) This is the time to make electricity "cheap". So you only make 1 toaster per kilowatt-hour; better to make the toaster than let the kilowatt-hour go to waste. Additionally, this is the perfect time to increase the capacity of the power plant: no private household is actually using the excess capacity, so no one will miss it when the power plant appropriates it to increase capacity. And sooner or later, when people start using a lot of electricity again, they'll welcome the increased capacity.

Like all metaphors, the money as electricity metaphor is inexact. We can make it correspond to economic reality a little more closely by adjusting our terms a little bit. "Electricity" corresponds more closely to labor power, the capacity to turn human time and energy into goods for consumption; using electricity is analogous to performing labor, transforming labor power into commodities. The power plant is more like a coal- or oil-fired plant: it takes considerable effort to generate electricity, corresponding to the effort it takes to feed, house, clothe, and otherwise provide for human workers; power plants wear out and need to be periodically reproduced, just as human beings age and die and we need to have and rear children to replace them. Money is the allocation or social permission to use electricity. When firms compete, they are competing (in part) to use electricity (turn labor power into commodities) more efficiently. Increasing the total amount of electricity is analogous to making labor power more efficient overall, with no one firm becoming "specially" efficient.

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