Saturday, March 17, 2012

The Other Unseen Economy

In Bastiat's famous Broken Window Fallacy, he discusses the necessity of a sort of 'seen' and 'unseen' aspect to economic reasoning. In Bastiat's example, the 'unseen' aspect of things was also unreal -- it was the chain of events which did not happen, but might have. Depending upon whether or not a certain hypothetical window is broken, two entirely different sequences of events might play out, one of which is generally 'seen' -- the one with the broken window -- and one which is 'unseen' because people do not generally notice or remark on what happens when things like windows remain intact. They are expected to remain intact. If we believe Bastiat's reasoning, the 'unseen' path in which the window remained intact would have resulted in a wealthier world, but it tends to go unnoticed, such that people have an irrational tendency to associate destruction with economic activity -- and therefore presumably wealth.

Bastiat was highlighting not just the economics of destruction, but also incidentally an important characteristic of economics which separates it from the other sciences -- the inability to run controlled experiments. By the nature of the situation, in the science of economics it is usually impossible to observe 'what would have happened.' The economist is almost always stuck resorting to comparisons of situations that aren't really comparable and doing the best he can with theory and statistics.

The unseen economy I would like to talk about here, however, is a bit different from that notion. This economy is quite real, and important. By reading this very essay, gentle reader, you are a participant. 'Seen' and 'unseen' as I am using them refer to visibility to economic 'measures.' Generally what I mean by 'seen' in this distinction is that the bulk of the value transfer in such an exchange occurs by means of money or barter, so that there is 1) a clear and overt means of price formation by the participants, and 2) at least ostensibly a way to 'measure' and record such exchanges in the form of income, expenditure, and the like for use in economic calculation, such as profit-and-loss, and in data collection for the compilation of statistics.

Most people clearly recognize the seen economy -- it is what one generally thinks of when thinking of the word 'economy.' But arguably the unseen is the larger and more important. In the case concerning the economy of the essay you are presently reading, I have composed it without the expectation of receiving payment, and you are reading (and hopefully enjoying) it without any transfer to me. Production and consumption, without a trace.

Now, I do confess that this distinction is not completely clear cut. Certainly, in an indirect way, we each paid for our respective internet access and computer interfaces, and certainly cash transactions in the normal economy often go unreported. I do not claim that I am making a distinction full of some profound truth about the matter. I am only making an abstraction in dividing up the economy in the way that I am, and the importance of this abstraction is not in its own consistency and veracity (as, obviously, it in itself is 'untrue' as a conception of reality by sheer virtue of it being an abstraction of reality and not reality itself) but whether or not one can learn anything useful by making such a distinction and toying with it in his mind. Clearly, there is much economic activity that goes on which does not show up on the accountant's ledger, and that is what I want to talk about.

The Seen vs. The Unseen Economy

There are far more important examples of the unseen economy than my example of internet content -- though that in itself is a large and growing segment of this statistically invisible system. The informal interactions and transactions of the unseen economy probably form the greater part of our lives in terms of family, household, and community. For purposes of illustration, probably the bulk of the more important segments are to be found in the home.

Generally speaking, people keep track of statistical nonsense in their relations with others, mostly because they have to for certain particular purposes, as in business and for paying taxes. But when they come home, they become practical, mainly because they can. Most would consider holding cash accounts for 'goods and services' rendered by other family members a sign of dysfunction, except maybe as a way to teach children about money. Yet there is most assuredly a 'domestic economy' complete with a division of labor and a stock of capital goods in practically every household.

When one buys a product like a screwdriver or dishwasher, or even an easy chair or the house itself, he buys it with a mind to the services it will render to him, and not usually for mere posession of the thing. It is for this reason that I am inclined to consider all of these goods to be capital goods -- not just the obvious tools -- because they provide 'output' in the form of enjoyment and utility over time. It is this enjoyment which is desired and consumed and which could be provided by other means and arrangements -- like renting the home or the furniture -- that would more clearly point to the nature of the way that they provide value to us. Theoretically, I suppose, the 'rent' could be considered a discounted amortization of the purchase price, and the 'consumption' of the good could be said to play out over time, but I would prefer not to get bogged down in that kind of discussion. Almost all of these goods 'look like' capital goods in the respect of providing a stream of enjoyment, so I shall treat them as such.

The point is that most people spend their lives in a dwelling surrounded by goods and people whose 'output' they enjoy and who also provide benefits to those others through their own 'output.' And as any particular individual could rearrange his life to find some more optimal arrangement of things (by, say, commiting suicide, as a more extreme example and as would seem the logical course of action if what I am arguing is untrue) one must assume that in this enjoyment exists some residue of 'profit' derived from said arrangements, in the same way that a real estate investor recognizes a profit from the ownership of a house which he rents out and is not merely recovering his invested sum over time. This 'income' is, of course, completely unaccounted for (and probably unaccountable by any devisable means), but no less real.

This can range from the more obvious -- the cultivation of a vegetable garden in the back yard for 'domestic consumption' -- to the simple enjoyment of leisure and conversation. Some is 'paid for,' in some part in money terms, as with the purchase of the house or the vegetable seeds, and some is completely free, as with marriage and the bearing of children.

OK, maybe not completely free.

Another such example which I think is rather interesting is education. Many people pay a great deal to receive an education, and to be sure this is a capital asset just as much as any other, especially in that in most cases it helps to secure stream of income. In that respect, at least theoretically it should be possible to get an idea of the value of this asset by discounting the income stream to a net present value. Yet in a calculation of net worth, it is doubtful whether anyone would include such a thing among his assets. But even where it does not secure an income, it certainly aids in understanding the situations one finds oneself in, which is a very valuable thing that certainly contributes to the utility and enjoyment of life. Even 'upbringing' could be considered an asset in this regard, but most people simply do not conceive of it in this way.

The sights and sounds of one's neighborhood and surroundings, books read at the public library, or better yet, over the internet, playing with the neighborhood kids, or meeting up with and enjoying the company of a love interest are all very economic acts. Yes, these things took some money-transacting efforts to arrange, but the bulk of such transactions are not actually tracked in a hard-and-fast quid-pro-cash manner. In almost all cases these enjoyments could easily be multiplied manifold with practically no adjustment to the seen economy, merely by a change in behavior. The house, the computer and internet connection, your family and children all have highly variable 'utilities' depending on how they are 'employed.' They are there, whether you choose to spend time enjoying them or not, or however you choose to engage with them. They can simply get older and run down as they slowly slip away, or grow and become closer and dearer. GDP has little or nothing to do with these choices.

In fact, if you think about it, enjoying them more and better 'utilizing' them can actually shrink GDP -- by reducing demand for more material consumption available in the seen economy and taking people away from their usual grindstones which are needed to get at the money to acquire them. Which, as a matter of fact, I think is a very important point that I'll take up later. For now, I'd like to look at what I think is a more concrete manifestation of this phenomenon.

Disaster Economics

When the devastating earthquake and tsunami hit Japan in 2001 it touched off another round of an age old economic debate among the talking heads on TV -- are disasters good or bad for the economy?  It seems that there must be a perpetual revisiting of the shrine of Bastiat's broken window.

There is always a group of thinkers ready to point out that disasters create a need to rebuild, and therefore an urgent demand for labor and materials which did not previously exist. This, they say, helps to spur economic growth. Oher observers will trot out the Broken Window Fallacy to argue the opposite, I think mostly correctly. They will point out that economic growth is a matter of the accumulation of capital to afford higher productivity, such that clearly the destruction of capital is not the way to produce growth. Taken to its logical conclusion, a savvy economist of the first opinion might as well recommend government paying mercenaries to blow up one's own cities to help spur the economy!

Naturally, both camps tend to agree that if the second opinion is true, then the destruction of capital should result in lower GDP following the disaster. But if the first opinion is true, then GDP should increase. So, it appears to stand to reason that settlement of the argument merely requires them to sit back and wait to see, and -- lo and behold! -- they observe little or no perceptible decrease in GDP, and perhaps even an increase!** Bastiat must be rolling in his grave! Keynesians rejoice -- long live aggregate demand! Ring in the new Nazis, let's have a war and get out of this slump!

Most likely, anyone reading an essay such as this will be fairly sure that the second camp is actually correct, or at least closer to the truth, yet the paradox could do with some explaining. Part of the explanation I think probably has to do with a sort of non-marginal factor in the change. Most of the time, economic decisions tend to be difficult to make because they are being made on the margin. The system is already operating near an optimum as far as most actors are able to tell, so that changes to it tend to be only marginal improvements at best, and almost everything done is just barely profitable.

But when one is suddenly left with bare rock and debris where a thriving city used to be, it is pretty clear what needs to be done -- clean up and rebuild. Most advanced economies are pretty good at this, and there is a sort of economy and non-marginal reward to action here which is not normally present, especially as reflected in a statistic like GDP. It's not every day that construction of 1000 new houses in one small location suddenly becomes a profitable proposition. Usually they are spread out all over the place and of dubious -- i.e. marginal -- benefit to build. So, in a loopy sort of way, I think the first camp has a point in a way it hadn't really intended.

But on the whole I think that most of the answer can be supplied by the kinds of effects I am talking about in the seen and unseen -- but not necessarily Bastiat's seen and unseen. Most of the destruction actually occurred in the unseen economy -- lost and ruined lives, which the seen economy had existed to serve. People are dead and devastated, for crying out loud! They would much rather be living contented lives with their loved ones in warm and comfortable houses than huddled and miserable in a shelter. But even where no life is lost, a great deal of unseen production is. The mass of enjoyment produced and consumed in intact neighborhoods and families is gone, and I have to imagine that if the magnitude of this could be somehow be assessed, it would far outweigh the actual physical destruction which can be observed.

But even in that aspect there is a sort of secondary element of the unseen. It may be true that one can clearly see and assess the value of the actual devastation in terms of replacement cost. But actual, total capitalization is a far more complex thing. To my knowledge, total capitalization as a sort of Gross Domestic Capitalization to parallel Gross Domestic Product isn't really a measured statistic, as this would be a very difficult thing to do. So even the visible element of the loss remains a bit unseen.

On the flipside, most of the processes of recovery are primarily seen, material, and easily captured in the GDP statistic. Charity is surely a component of recovery, and much of that is probably unseen, but the building of houses, cleanup, restoration of utilities and the like are almost exclusively going to be done within the seen economy.

Thus, the boost to material production in the process of recovery contributes to a statistic like GDP, while the losses in unseen production which neightboorhoods full of happy people had been enjoying goes mostly uncounted, and cannot be subtracted out. In this way, the observed boost to GDP is, I think, only an artifact of the fact that the unseen economy is not captured by the statistic. If it could be, I think the lost unseen production would vastly outweigh the extra production triggered by recovery and the destructiveness such events would be clear and obvious.

And so it is that a horribly immiserating and destructive occurrence can come to be seen as beneficial to the economy. The destruction of a real, thriving and productive set of activites comes to be seen as instrumental in the creation of circumstances of apparent prosperity, but actual poverty. It is a deception not easy to untangle. No doubt, for those heavily invested in such things, these types of effects could constitute a strong incentive towards the recommendation of some rather perverse policies, with very real and very negative consequences.

Clearly, this is a potentially dangerous thing.

The Powers That Be and the Unseen Economy

By dint of their nature as non-monetized transactions, the activities of the unseen economy are largely impervious to taxation and to inflation, at least through direct effects. These two activities are only able to impinge on this economy indirectly, though by this indirect route they can be quite inflential, in my estimation.

This is both a blessing and a curse. Because they can't be taxed or the value they create expropriated through currency devaluation, the activities of the unseen economy can serve as a safe harbor that the normal routes of redistribution have difficulty reaching. Profitable activities, though they yield no actual money profits, can be undertaken here in relative security.

The public, I believe, as much as it may make use of the unseen economy, does not much recognize its existence, and in some ways this is a strong defense mechanism against intrusion. The Clinton administration attempted to fudge income statistics in making an argument for higher taxes by including 'imputed rent' on real estate based on exactly the kind of unseen income I'm talking about. His economists understood this phenomenon, but luckily the public did not. The 'accounting trick' led to rumors that this 'income' would be taxed, which apparently sounded so outrageous to voters, who considered it utterly irrational and a poorly disguised contrivance for grabbing more of their money, that the move wound up being something of a black eye to the administration. Ignorance of the effect of unseen income proved quite effective at squelching any thought of taxation of it, and while I agree that the tax was outrageous, I think the basic economic insight actually was not. 

Unfortunately, as that episode makes clear, I am not describing something unknown to the more sophisticated kinds of people who make a living by parasitizing the productive activity of others. By its nature, the unseen economy is largely out of reach of their grasping hands; they know it, and they don't like it. Worse, increasing taxation of the seen economy would have a natural tendency to push more activity into the unseen and thus invigorating it as an indirect effect. It therefore also serves as something of a partial escape hatch from such money-grabs. The unseen economy is thus in the crosshairs for these people, who have only partially cracked the secrets of effectively parasitizing it.

I do think, however, that there are some effective mechanisms for doing so. Although the activities cannot be directly taxed, their minor components which do make an appearance into the seen economy can be taxed rather heavily at these points. Some of these activities are apparently so central to our lives that there is relatively low elasticity in demand. Thus we find unusually high taxes and pricing on communication services -- telephone, cable, etc. -- that would, I think, otherwise be unthinkable on the basis of marginal costs of production alone. Yes, there are many characteristics of monopoly in these markets, but that only prevents competition from driving down prices. It doesn't prevent people from walking away altogether, and the fact that they don't I think suggests a rather great utility, beyond mere entertainment. No doubt there are many other such cases.

But probably the most effective method for getting at the unseen economy is by draining it into the seen economy with inflation. The two economies necessarily exist in a sort of competition. People must in the course of their lives divide their attentions between the two. By making the seen economy artifically profitable with inflating currency, the world of finance incentivises focus on activities in the seen economy versus the unseen. As a result, attention and activities of production are drawn away from family life and the informal and towards the material and official. Further, the inflated profits allow increased levels of taxation and government spending without disincentivising economic activity in the taxable sphere.

Meanwhile, the real profits of this frenetic creative activity are teased away from real producers by the inflationary activities themselves. Cheap debt, printed money, new stock issues and leveraging allow those on the inside to stake ever larger claims on existing capital and its product. Those who sacrificed their families and personal callings for the sake of material gain watch the fruit of their sacrifice slowly slip away into the hands of others. Those who do not make the sacrifice find themselves slowly left behind. Only the very canny can play this game well enough to realize a net gain.

Thus, the unseen economy is not directly parasitized, it is starved to feed the seen economy for which there are much better tools for such leaching. Though inflation has no ability to parasitize the unseen economy directly, it is quite effective in its indirect effects.

Thirdly, I can hardly mention the example of the Japanese tsunami without bringing up the subject of war. Needless to say, those who stand to profit through war -- and there are certainly at least some -- stand to profit through war. They also stand to profit through inflation to pay for war, through the issue of debt to pay for war, and through the diversion of productive activity into the seen economy to pay the taxes to pay for war, both by means of inflation and through the economics of destruction previously mentioned. The politicians who benefit from support by these groups profit directly and indirectly through war, and therefore through inflation and debt to pay for war. Note -- this is (rather obviously) not an argument that all wars are to be opposed, only that war does set such incentives in motion, and a rather constant state of war will necessarily create a large constituency interested in the perpetuation of this state of affairs and an impoverishment of the general population both in seen and unseen terms.  This is something to keep in mind as one listens to arguments that the US 'must' go on some new military adventure.

In general, politicians profit from policies which increase the available resource base for the buying of votes, and for rewarding other avenues of support with government contracts, financing, and the like. Therefore, politicians tend to profit from those activities which boost GDP and are subject to taxation, irrespective of whether these activities actually increase the theoretical total economic output that also includes the unseen economy. That component is basically irrelevant to them. To the extent that the populace associates increasing wealth purely with GDP growth, publicly touting GDP growth also increases their popularity. As a class, they have a strong interest in those activities which move productive activity away from the unseen economy and into the seen economy, which means that they have both direct and indirect interests in inflationary policies. For them, the unseen economy is little more than a drain of activity away from processes which are beneficial them.


A division between a seen and an unseen economy, which for some readers may be more a conjuring of an unseen economy in addition to and alongside the everyday variety, seems to me a useful way to think about some important dynamics which have shaped and are continuing to shape the present situation, mainly for the worse. In short, I have described the unseen economy to contain those activities which are undertaken without much conscious regard to normally understood economic transactions and yet are nevertheless economic in nature and fundamental parts of human life. In thinking about this dual system it appears that welfare and warfare type activities are among the chief threats to this system, generally through certain activities of governments and finance.

To the extent that actors in these sectors are granted increasing scope and influence over the law and custom which governs economic behavior, it is only to be expected that they will use this influence to increasingly funnel activities into the 'official' economic regimen. They will naturally initiate a slow bleeding away of the body of informal and spontaneous activities which constitute and define so much of life as family and community, and then ransack the puffed-up formal economy for their own ends.

But upon reflection, it seems to me that the initiation of this particular dynamic, or of any similar dynamic of this general type, is dependent upon a society as a whole (or at least, in general) losing sight of the value inherent in its own way of life, so that it permits and even encourages the kinds of changes which allow these intrusions rather than erecting strict checks on fundamental changes to fundamental practices. How is it that people are open to, say, changing a money system away from one with a guaranteed redemption in gold, except that they are able to be sold on the idea that they are being offered something better, or at least willing to ignore it when such a change is foisted on them? How is it that, later on, they find the 'necessity' of responding to the incentives touched off by such 'compromises' so compelling that they are willing to allow it to intrude on arrangements they find valuable in their families and communities?  The fact that a population changes a very fundamental custom in such a way implies that they are open to making very foundational changes to their ways of life in return for a promise of material gain -- and less likely to resist other such changes which appear to promise similar effects, even when not presented in the form of a political contest. After all, without inflation, the dynamics of the unseen economy are greatly secured, and it intrusions are far more difficult.  Without inflation, the temptation to abandon traditional arrangements in pursuit of phony economic gains practically disappears.  Checking erosion of custom at one point effectively curbs far more drastic erosion at many others.

In other words, it seems to me that much of this dynamic cannot be pinned quite so squarely on government qua government or banks qua banks as it may at first seem, as dynamics intrinsic to their nature and inseparable from their existence, but also depends on a certain frame of mind in the culture at large. Banks and governments are themselves creatures of custom and therefore subject to notions of propriety in social custom -- the very forces they are being observed to impinge upon! If any authority in this rather complex relation may be said to be primary, it must be that of the culture to set the customs which govern whatever forms of social interaction are permitted by society -- including banking and governing. That would seem rather reflexive, even if the form chosen is effectively something like 'freedom of contract and association.' The 'right' of these institutions to be held blameless and their methods 'sacred' when their activities begin to impact and degrade the fundamental norms and customs of the host culture must of necessity be secondary, I should think, as the creature must be secondary to the creator.

Of course, if a society is to assert some sort of sovereignty over its notions of property and money, and therefore over the customs which govern the practices of these institutions, it must at a minimum be conscious of them and have formed a clear idea of what they are. And it certainly wouldn't hurt if the ideas were actually accurate as to their desired objects and the proposed customs really secured what was intended.  But if any mode of relation and conduct is more fundamental to the identity and constitution of a society, and therefore of more concern as to its preservation and integrity, it is the very basic modes of life which these institutions are intruding upon, and not the modes which govern the conduct and relations of these institutions. If it simply isn't possible to arrive at the 'perfect' conception of a mode of governing these institutions in perfect peace and liberty, and one or the other is to be subordinated in a culture which values itself, one would think the latter to be the obvious choice, as to choose the former is plainly suicide.

The disease of which I speak, then, appears to be of the sort in which creature usurps and destroys its creator.  As it seems to me, it is the willingness of the culture to despise its own norms and values which allows them to be modified so readily. The ultimate check on a con-man is the willingness of others to accept and participate in his scheme. If there is no or little faith that the present way of things is valuable in and of itself, that things should be done or arranged a certain way because it is the right way, if one is forever open to 'a better deal', with no sacred thing spared from the bargaining table, it would seem only a matter of time before some such sequence of events would eventually play out.

It is probably not to be expected that even a slim minority could understand and foresee the consequences of every circumlocution in this ancient game. But I do think it is reasonable to expect a certain expenditure of thought on the matter in general, a certain measure of value and attachment given to ancient practices, and a degree of reluctance to permit infringements on the sacred parts of life, not to mention a certain humility with respect to the ability of human beings to rationally order their affairs without touching off unintended consequences.  One would think that customary checks which exist to prevent the seizure of vast powers in sensitive areas of market function -- as with the right of redemption of money for gold, a rigid prohibition on the power of government to establish a national bank, whether public or private, or other such measures -- would be vigorously defended, or at least get a better hearing, among people who cherished their way of life. Many people seem to understand this in terms of guns and free speech in the realm of political life, but when it comes to the issue of money and markets in economic life, it appears that their sentiments are quite open to compromise. So, the usurpers, finding the castle gate locked, simply climb over the undefended wall, and in the end it does not matter exactly how they got in, the result is the same.

That, perhaps, is the chief lesson.  We are, quite possibly, much wealthier than we can imagine in the unseen and intangible, but that wealth is secured in delicate ways that are not always easy to comprehend. It only takes a deal or two with the devil to lose it all.

** I wrote this without consulting GDP statistics for Japan.  It appears that immediately post-tsunami, GDP shrank somewhat (about 1%) then later grew at a somewhat elevated rate, at least by Japanese standards.  The reader may interpret this as he may.  Once again, what exactly the net impact was may never be known, as a control experiment is impossible.

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