Economics 9708/43 — October/November 2015

The economy as ‘a machine’

The economy has been spoken about as if it were a machine. Its businesses are ‘the engines of job creation’; they change ‘inputs into outputs’ and ‘generate profits’. In this approach, markets are assumed to be productively efficient, consumers rational, incentives are obvious and outcomes certain. This means that any regulation of the market is undesirable because it hinders the workings of the machine.

However, there is no evidence that markets are always efficient and there is no evidence of a prosperous economy that does not also have strong regulation and an active government. Recessions and economic downturns should have caused this ‘machine’ idea of an efficient economy to be discredited. Yet, this view still influences economic policy.

What is required is a theoretical framework for the economy that recognises that economies are not simple and predictable but complex; that understands that intended outcomes do not always happen. Consumers’ decisions are not precise but approximate. The economy should be thought of as ‘a garden’, not ‘a machine’. In this idea the economy cannot be completely efficient but if managed effectively it can work reasonably well.

Consider regulation. In the ‘machine’ idea, regulation is an unfortunate interruption of the process of income generation. The machine should be left to run on its own. Perfectly free markets are the ideal. Less regulation will automatically lead to more prosperity. In the ‘garden’ idea it is recognised that the economy requires regulation. The control of harmful activities and the encouragement of beneficial activities will enable the economy to become more efficient.

Consider spending. Government spending should not be thought of as a single action which uses money as an engine uses fuel. Rather, it is part of a continuous process that circulates money through spending. Also, some of this spending helps to develop the economy because it will be spent on education, health and roads, although not all spending is equally useful.

It has been argued that the most prosperous economies are those that tax and spend the most. Less spending cannot revive a weak economy, but more spending can. Employment is not created by profits. It is a consequence of a circular process that starts with consumer demand and spending. The customer is the true job creator and resources are allocated according to their preferences.

Source: Adapted from the RSA Journal, Winter 2012