14 August 2011

Economics is not Accounting

In the economics sphere, a common misconception is “my loss is someone else’s gain” and vice versa.  While this conception is true in competitive situations involving pecuniary exchange, it does not hold when it comes to the wealth of nations.  As such, populist remarks like “rich people are getting richer on poor people’s back” is basic rubbish. 

Unlike accounting, economics is not a zero-sum game; that is, someone else’s loss does not necessarily translate to your gain.  Generally, when wealth is generated, it lifts all boats (the question of equitable distribution is a legitimate one – but that is a whole other topic).  Likewise, when wealth is destroyed, it generally hits everyone across the board (and it does hurt the less wealthy proportionally harder).

The same is true for international wealth of nations.  In today’s highly interconnected financial markets, a single nation’s economic faltering (unless it is North Korea or a similarly disintegrated locale) is indicative of a larger contagion that has the potential of affecting other nations.  And, if the contagion is in a large center like US, EU, or China, it has a high probability of making everyone sick. 

In October 2008 while I was in the US, I received more than one call from Russia where my contact gleefully lamented the “American crisis,” the undertone of the conversation being “America had it coming” and “Russia is rising again.”  While the crisis was American-made, it became the world’s crisis; in turn, it affected Russia more severely than it did its American epicenter. 

The brief period of gleeful lament came about again this year when (the American) Standard and Poor’s rating agency downgraded America’s credit rating from AAA to AA+.  In the early periods of market gyration, a few Russian acquaintances indicated that they lamented the latest difficulty in America while hardly containing their giddiness.  It was not before long before the Russian ruble declined some 10% against the American dollar as the greenback was spiraling downwards against other major currencies.  Their moods changed quickly.

The fall of the Russian ruble against the dollar deserves a quick explanation:  Russia has an oil-driven economy.  Oil markets are priced in US dollars.  A slowing American economy signals less consumer demand, which implies less production and hence less energy usage.  Because America has the largest world economy and the world’s largest importer of foreign goods, a slowing American economy slows the world economy.  Oil is the source of a good portion of the world energy.  Hence, a slower world economy means less demand for oil, therefore falling oil prices denominated in dollars, and therefore more pressure on the Russian economy and currency as measured against the dollar.

Let’s get back to the difference between accounting and economics.  The emotional kick that comes from a competitive situation between two parties involving money exchange is understandable.  These are gaming situations where there could be a clear winner and loser.  The same emotional sensations are misplaced, if not stupid, in the broader economic sense.  In the short run – that is in a timespan that matters for the individual – the poor do not get richer when the rich get poorer; in fact the poor are likely to get poorer under these circumstances.  Likewise, and country X does not benefit when country Y declines.  Countries X and Y tend to rise and fall together.

Very unfortunately, populist political rhetoric – often purposefully – confuses the differences between economics and accounting.  Elections can become battles between the haves and the have-nots instead of about policies that benefit everyone.  And nationalistic feelings lead to a brief satisfying tinge once a former enemy declines; it is also those feelings that very often get in the way of effective national policy for economic diversification (away from oil in Russia’s case), better integration with world markets, and a more sustainable, predictable prosperity engine that lifts everyone’s boat.

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