4: How much will Germany capitalize Greece to restore its industry so that it can pay Germany back?.
Saturday, June 27, 2015
Greece and Germany have essentially only four things to talk about. And these are not the things they have been talking about.
1: How big a piece of Greece do the Germans want?
2: What percentage of the Greek GDP do the Germans want?
3: How long do they want it for?
And since because the trade deficit, mostly with Germany, and austerity have damaged the Greek economy, perhaps beyond its ability to repair itself:
4: How much will Germany capitalize Greece to restore its industry so that it can pay Germany back?.
4: How much will Germany capitalize Greece to restore its industry so that it can pay Germany back?.
What the Greeks have to talk about among themselves is by how much, and for how long, they want to remain burdened by a corrupt aristocracy that essentially sold out the rest of the country to the Germans.
If these issues are not addressed, the Greeks will have to escape outside of the box they have apparently been thinking in, if they are to come to terms with the reality of their situation.
The standard definition of money is in error.
The standard definition of money is given in terms of its three functions:
1: Money is a medium of exchange.
2: Money is a measure of value.
3: Money is a store of value.
Number 1 is at best misleading. Numbers 2 and 3 are simply wrong, and these things are easy to show. It is also easy to show that this is important.
First, the actual definition of money:
1: Money is a token, or instrument, of demand, which is exchanged for goods or services. Or simply: Money is demand.
2: Money is a measure of demand.
3: Money is a store of demand.
In the standard definition, Number 3 cannot possibly be true. Were Number 3 true, money would have value of itself. The value of money would be independent of what ever else an economy produced. But consider, the best monies are those instruments which have no intrinsic value whatever. How can any amount of something which has no value, be a store of value? Even where commodities have been used for money, (and this may be the origin of the error,) they have tended to be those commodities, precious metals, for instance, which, because of their properties, were of only limited economic use. The reason for this is known and simple: These commodities had to be more valuable as money than they were valuable as commodities. If they were more valuable as commodities, they would be consumed, and so their use as money would disappear. But this implies that the value of these commodities, as money, over their value as a commodity, is not intrinsic, but as with plain fiat money, purely a matter of other factors. That is, the value of the commodity as money is not based on any intrinsic value of the commodity to the economy.
So fiat money has no intrinsic value, and therefore cannot be a store of value. If the economy produced only money, that money would have no value. It does not have value as, say, a refrigerator full of food has value, or a tank filled with gasoline. But, what the third function of money actually is is as a store of demand. If you have $100 in the bank, or in your pocket, you have a store of demand, which you can keep as long as you want, and when you choose to, you can spend it. You can demand something which is offered for sale, to the amount of $100.
Then you can take your $100 of tokens of demand and you can go to the grocery store and with it buy $100 worth of food. This shows that money is also a measure of demand: You have as much demand for food, or anything else, as $100 will purchase. If you have more money, you have more demand. If you have less money, you have less demand. If you have no money, you have no demand.
Money is not a store of value. Can it reliably be a measure of value? Economically worthless things may be in much demand, and therefore command a price beyond their value. Yachts, for instance. Economically valuable things may be in little demand, or supplied at prices below their value. Water, for instance. With money, you have demand for these things, at the prices they are offered. But their prices do not reflect their economic value, only the amount of demand, the amount of money, which must be exchanged for them.
This counters the claim that the only value a thing has is that set and measured by the market: The toys of the wealthy are much in demand, but of little value. The goods needed by the poor are to them of great value, but it may be that those poor are only able to demand a meager portion of them. Markets only measure demand. They need not measure value. This is the primary inadequacy of markets.
So because money is demand, or more exactly a token or instrument of demand, it serves as a 'medium' of exchange: Because money is not demand for any particular good or service, but is demand for any offered good or service, it may be exchanged for any offered good or service. Money is a medium not in the sense of being an environment for exchange, but in the sense of being a generalized instrument. It is an abstract good, which is offered in exchange for other goods and services. The individual who exchanges his good or service for money then himself has equal demand on others for different goods or services. Money thus flows opposite to the flow of goods and services, not to the degree of the value of these goods and services, but according to the demand for these goods and services that are offered.
Goods or services are thus exchanged for an equal demand on other goods or services. Money, then, is an instrument for comparing the demand for dissimilar objects. However, we have shown it is not reliable for comparing the value of dissimilar objects.
By mistaking demand for value, the standard definition of money thus implicitly fails to distinguish between the value of an object, and the demand for that object. In an informal sense, this results in the failure to distinguish between the needs of an economy, and its wants.To provide another example, the economy 'needs' streetlights in Highland Park, Mi. It 'wants' yachts in Newport, RI.
If we regard the economy as like a tree, money cannot distinguish between the fruits of a tree, and its roots.
There is a larger issue. The standard definition of money goes back, essentially unchanged, to 1875. See eg. Wikipedia. It is, implicitly, a key part of the foundations of the entire field of economics. That it is in error calls into question the soundness of the entire economics project.
Wednesday, May 6, 2015
A recent post over at Bloomberg Business:' Global Labor Glut Sinking Wages Means U.S. Needs to Get Schooled' http://www.bloomberg.com/news/articles/2015-05-04/global-labor-glut-sinking-wages-means-u-s-needs-to-get-schooled is nonsense.
From the post: "The most effective way of combating this oversupply [of workers] is to promote increased training and education of U.S. workers so they can provide skills unavailable elsewhere to employers, according to experts who have studied the problem."
Education will not maintain US wages in the face of international competition. Once foreign countries are able to supply sufficient basic education, both in quantity and quality, there is nothing to stop them investing in the necessary specialized education needed for their own workers... Information (education) is more transferable than labor. .The development of skills in foreign countries cannot be prevented. The US cannot embargo the export of information..Any advantage in education is transitory, requiring a continuing race of investment in human capital.. Further, since the cost of education in US is greater than the cost of the same education in foreign countries, the US is at a disadvantage in such a race. For example, it is economically efficient for foreign countries to import US educators to train their own work force. For the same pay as in US, foreign nations can often supply a much. higher standard of living. And because education in the US is more expensive, it makes greater sense for international corporations to invest in the education of the foreign workers, rather than American workers.... Finally, the high cost of maintaining and developing capital discourages the investment in education in the US, aggravating the competitive disadvantage in which American labor finds itself. The result of this is that, over time, US labor's disadvantage will increase, and their wages continue to decline. This decline in wages will not result in greater competitiveness, because of the decrease in the capitalization.of American labor force.
Thursday, April 30, 2015
Power is the ability to impose consequences, on the world, and on people. It is the ability to impose positive consequences, or negative consequences. Usually, these consist of rewards, for behavior pleasing to the powerful, or punishments, for behavior displeasing to the powerful. Of course, consequences may also be applied arbitrarily, but this wastes power. Power may also be applied inefficiently, which is also wasteful of power.
In today’s world, the wealthy and many political leaders have the most power, and thus the ability to impose the most consequence. The power of other institutions to influence the evolution of society and the economy has been significantly reduced. While there are also other indicators of this, the reduced influence of these institutions can be seen in the combination of diminished material income, and increased dependency upon capital for such income as they retain.
In a democracy, political leaders are expected to represent the will of people, and the interest of the people and the wealthy do not coincide. While both the wealthy and the people desire order and security, the wealthy and the people are always in competition for wealth and power. Since the people are dispersed, and the difference between what they have and what they need is less, unless they unite in will and action, they are at a decisive disadvantage to wealth. The most important and unified instrument of the will and action of the people is their government. Where the government is the strongest and most coherent agent of the wealth and power of the people, the wealthy will always seek to overcome, corrupt and capture it, that they may use it to help gather the wealth and power of the people to themselves. On the other hand, seldom does an established government seek to take the wealth and power of the wealthy from them, since these tend to be regarded by the government and the people as legitimately acquired, and generally supposed to be applied to the benefit of the people.
The wealthy are not monolithic. However, they all share the same desire to enhance their own personal wealth. While some are less principled in seeking and achieving this goal than others, none is so principled as to willingly give any substantial portion of his wealth and income to the people. And so, few can afford to allow the unprincipled behavior of other wealthy to go without answer. Where some of wealthy still act as a check of the unprincipled behavior of other wealthy, the efforts of the wealthy to seize control of the government may be mitigated. However, where the rewards for unprincipled behavior become substantially greater than the rewards for more responsible behavior, the ability and inclination of those wealthy who might be regarded as responsible, must be expected to decrease. The pressure on the government to first pass laws and adopt policies allowing for its corruption, and then laws which further its corruption, thus increases, along with the degree of control of the government by the wealthy. Efforts to oppose this process by interest groups from among the people are also increasingly repressed. It should be noted that the effective transfer of control of government is an enormous transfer of wealth and power from the people to the wealthy, a transfer which usually goes unremarked.
As wealth becomes concentrated, and its influence on politics increases, the political leaders lose effective power, however, and become mere agents of the wealthy in the application of their power. As this happens, political leaders, through the government, increasingly impose the will of the wealthy upon the people, whose interests they, and the government no longer represent. Interestingly, even those interests the people once had in common with the wealthy, order and security, no longer completely serve the people, since they now also serve to enable the oppression of the people by the wealthy. Once their government is captive of the wealthy, so long as the people are orderly and seek security, the wealthy and their captive government, through commerce and law, will strip the people of their property and rights. In this respect, an important instrument of positive power becomes degraded, as the people increasingly perceive their desires for order and security to be in, the net, harmful to themselves.
In theory, of course, in a democracy, political leaders never ‘had power,’ as they were expected to be agents of the people, in transmitting and executing their will. However, the ability of the people to control these agents, that is the power of the people over them, was always limited. The people were always limited in how and how much they could reward their representatives. While they could offer rewards besides the material, those material rewards they could offer were in principle limited. Further, the perceived value of these non-material rewards were always under attack by the wealthy. And in general the people could only punish their representatives by not re-electing them to their office. The people were also limited in their ability to acquire information about many of the actions of their representatives. For these reasons, and also because there were often a variety of ways to accomplish goals, political leaders always possessed a certain amount of discretion. That is, a certain amount of their power actually originated from their own office. Where, however, they are ‘elected’ by the wealthy, the wealthy have much more control over them, being able to both reward and punish them more, and also being more informed as to their actions, so most of this discretion is absent. (Because the wealthy are able supply greater reward, the expectation of that reward is higher. Thus the punishment associated with the withdrawal of that reward would be greater.) Because of this, an ‘elected’ government can be expected to become a more effective agent of the wealthy than it ever was of the people. Since the rewards to politicians change, we would expect the people who choose to become politicians to change, also. We would expect them to become more self interested, and less public spirited. We would also expect them to become more authoritarian and dogmatic, and less authoritative and pragmatic. We would also expect them to be more sectarian and divisive, and less inclusive and unifying.
We would expect them to identify with and seek to emulate their wealthy patrons, and devalue the rest of the population, especially the poor and other groups whose interests diverge from those of their patrons. Indeed, we would expect many to become wealthy themselves. However, so far as they must maintain the appearance of serving the interests of the people, they may be expected to engage in tactics which enable this. Since their actions no longer serve the people, but favor the wealthy, those actions must be hidden from the people and obscured. The people must be misled, and distracted by other activities which are irrelevant to the projects of the wealthy. In particular the wealthy are indifferent to the divisions of the people, Yet, because these divisions are a powerful distraction to the people, the wealthy are prepared to exploit and aggravate them.
In this they are aided so far as the wealthy control the media. The media serves its owners. As society is segmented, so too is the media. Through the media the attention of the people is channeled, directed, and to a large extent, molded. The real actions of the wealthy and their servants in government, and the consequences of those actions, are downplayed or even ignored. The importance of events which distract the people is exaggerated and those events dwelt upon. The information provided by the media increasingly diverges from reality, and action based on that divergence becomes counterproductive. However, the information provided by the media is also what the wealthy wants the people to hear. The wealthy are aware of this process. It is circular, and insofar as it progresses, it is perceived by the wealthy, and at some level at to some extent perceived by the people themselves, to render the people unfit for self-government, and requiring outside control of their activities. It is this self-perception which renders the police state increasingly palatable to the people. It is, however, not because they see themselves as requiring greater external restraint, but because they see their neighbors as requiring greater external restraint. This heightened level of fear also increases the motivation in the individual to arm himself.
Different segments of society become aware of the unresponsiveness and even the oppressive nature of their government at different times. Those people long at the bottom of the economic ladder do not notice, since they are most disadvantaged in any society. However, as society is plundered, each level of society plunders the levels below it. Awareness thus tends to progress up the economic scale, but may be uneven, depending on the institutional and economic relationships between the levels. This awareness erodes the belief in the legitimacy of the government by the people.
So wealth, or capital, has power so far as it is able to impose both positive and negative consequences on labor and consumers. It gives rewards to labor through increases in wages and grants of authority, and punishes labor by discharging it, or laying it off. (Of course, capital does not always interpret its own actions this way.) However, as society becomes increasingly unequal, the ability of the wealthy to impose positive consequences decreases, This because the rewards to labor that the wealthy bestow come from the income consumers spend on goods and services, and this income is decreasing as the wealthy increase their share of both that income and the wealth that comes from accumulating it. Indeed, this quantity can only decrease, unless compensated for by a greater rate of growth, or transfer of income from the wealthy to the worker. This transfer, however, is contrary to the goal of the wealthy, which is an ever increasing stream of income to themselves.
The reward the wealthy offer to labor of accumulated wealth is decreasing, and the income from that wealth also. And, in its reduction of everything to material worth, the intrinsic value of labor, of work for works sake, is also devalued. The wealthy see actual work as degrading, and this is eventually understood by labor; that laborers are regarded as fools, a vision that is reinforced by the abstract forms that work takes among the wealthy, and the disproportionate rewards the give to themselves and each other for such work as they do perform.
This means the wealthy must increasingly rely on negative consequences to exert their power. In particular, they must increasingly use force to contain and restrain the activities of labor. Further, these negative consequences must continually escalate, to compensate for the negative consequences of the diminishing reward schedule given labor.
It is intrinsic to capital and the wealthy that they devalue the other rewards that a society has to offer its members, since this relatively enhances the value of the rewards they offer society, and so enhances their power. They do this through their control of the media, through their control of government, and directly by how they invest their capital. (And of course, they also spend resources exaggerating the value of the rewards, and diminishing the apparent costs of those rewards, that they offer.) It is necessarily part of their strategy to corrupt and co-opt the social, intellectual, and spiritual institutions that otherwise would provide these rewards, and which otherwise might provide a countervailing authority to their exercise of power. Doing so, they necessarily corrupt and devalue the rewards that these institutions themselves provide. But this process is part and parcel of capital’s decapitalization and plundering of society. All institutions require both wealth and income to sustain themselves. Where the wealth and income of these institutions can remain independent of capital, they can remain an independent and countervailing force. Therefore, capital seeks to both erode and co-opt the sources of wealth and income that support these institutions. Once the sources of wealth and income of these opposing institutions are co-opted, they may be withdrawn, and the institutions destroyed. Institutions that are dependent on income from the government, thus become vulnerable when the wealthy gain effective control of that government. Indeed, it is evidence of capital’s control of government that they are able to do this. And even where these institutions are not destroyed, they will be rendered compliant to the interests of capital, since the only other source of income is increasingly capital itself.
Further evidence of the control of the government by capital is that the government is set to tasks which, while beneficial to the wealthy, are either of no benefit to the people, or damaging to the wealth and income of the people. Further, tasks which might be beneficial to the people are attacked and diminished, especially if they cost the wealthy income. Most importantly, while war may be beneficial to the people, despite its costs to the people, and on occasion also be necessary, war need not be either of these. However, whether or not war is either beneficial to the people or necessary, it is always a great source of profit to the wealthy. When war is fought for profit, however, its goal is not victory, but perpetuation, and the maximization of that profit. Since without victory, there can be no profit from the capture of foreign resources, all profit must be taken from the people. What also must be taken from the people is the stream of resources from which that profit is derived. These resources could otherwise be spent to the benefit of the people, and instead are effectively destroyed.
So, the question arises, why hasn’t capital captured the government before now?
The first reason is the fact that the activities of government are, of themselves, not particularly profitable. This is because, ordinarily, the discount rate for government investment is much lower than that of private capital. One could say that, ideally, and in the limit, government is in the business of the preservation of resources, and the discount rate goes to zero. Thus, a government responsive to the needs of its society will maintain its infrastructure. When government is captured by capital, however, the discount rate goes up, public assets are sold at a discount, and infrastructure is allowed to decay. (The discount rate goes up because capital is effectively taking its profits from government in reduced taxation.) The second reason is that it is often much more difficult for a private entity to capture the return on these kinds of investments, than it is for the larger society. (For these reasons together, education tends to be relegated to the public sphere.)
So taken together, these reasons imply that ordinarily capital will seek greater profits elsewhere. And as long as it can do so, that is where its efforts will lie. And as long as it has access to an expanding base of resources, capital will remain dispersed. That is, as long as access to resources expanded faster than the profit rate, capital would remain dispersed. But in recent times, this has ceased to happen, and return to real capital has declined.
However, the acquisition of resources and their modification and distribution throughout society, the provisioning of society, is merely an instrument to capital’s actual goal of acquiring a society’s wealth through ever greater monetary profits. Where greater profit can be obtained through manipulation of an economy, rather than providing for it, this is where capital will next turn. Since this is process is essentially the wealthy transferring assets from the people to themselves without any substantial compensation, it can be expected to be resisted by the government. Thus, the government must be captured by the wealthy before it can be done efficiently.
And the final reason that we haven't previously observed capital to capture the government is that one of the most important activities of government is to counterbalance the accumulation and concentration of profit in society. The government must distribute final demand throughout the economy, in order to sustain the people and their institutions. When government ceases to do this, the ability of the people and their institutions to sustain themselves collapses. So the final reason is that no society long survives the capture of its government by the wealthy.
Saturday, February 28, 2015
We like to think of capitalism as an economic system different in kind, and not just degree. It does seem to be the most efficient system to exploit its environment ever designed. And we can conclude this because capitalism has driven its less efficient competitors out of business.
But what is capitalism’s environment? Capitalism’s environment is two fold: First is the physical environment. Capitalism’s original reason was to more efficiently, and at greater scale, harvest and exploit the resources society needed from the physical environment, and provide them to society, and in a greater abundance and at a lower cost than ever before. And this it did.
But the rest of capitalism’s environment is that same society and economy for which it provided, and still provides, and processes, resources. However, it is becoming more difficult to extract resources from nature, and produce real goods for society. The costs are higher. The increase in costs is greater than the increase in society’s ability to pay, with its current infrastructure. This means it is increasingly more difficult to extract profits.
But clearly, the capitalist will seek to go to where the profit is greatest. When the profit is greatest exploiting the environment, by providing things society needs or wants, that is where the capitalist will go
But if the capitalist can gain a greater profit, the capitalist can be expected to do what is necessary to do so, if society is not effective in preventing him from doing this. For instance, if the capitalist can effectively reduce his costs by damaging the rest of society, he must be expected to do so. Under these circumstances, we must expect him to damage society, because the sole duty of the capitalist is to enhance and maximize his own profits. (We address Milton Freidman’s discussion of this for corporations at: http://anamecon.blogspot.com/2012/06/milton-friedman-social-responsibility.html
The human motivating force for capitalism is not so often discussed: It is acting according to a narrowly defined self-interest, one that excludes the interests of any larger society.) The first is by externalizing some of the cost of producing real benefits, real goods or services, to society. For instance, one way is by discharging pollution from the production of goods or services into the environment, and not cleaning up this pollution for society, or compensating society for the damage this pollution inflicts upon it. Also, the capitalist may manipulate government to subsidize his production, so more is produced at greater cost and at greater profit to him than is beneficial to society. The capitalist, should either opportunity arise, must also be expected to enhance his profits through monopoly or monopsony, at the expense of the larger society.
When, however, the profit is greatest exploiting society directly, that is what the capitalist can be expected to do. Since in the process of exploiting society directly, nothing is actually produced, these methods are all aimed at manipulating demand, with the goal of maximizing one’s own share of demand, and minimizing the share of others.
Obviously the activity of thieves does not benefit society. They transfer demand from others, others who are often productive individuals, to themselves, who are not productive individuals, and often to the extent of damaging the productivity of the individuals they steal from. Where theft is made legal, as through allowing and even encouraging manipulative finance, it must be expected to proceed and grow apace. Consider the selling of credit default swaps, capital appreciation bonds to municipalities, leveraged buy-outs, and other malfeasances of Wall Street and the banking sector.
Resources are expended in this process, and indeed destroyed. This is a consequence of the nature of debt, which can only, in real terms, be repaid by productive individuals and companies. It is thus, in the net, the laying of debt on the productive sectors of an economy. This hampers them, reduces their profitability, and discourages investment in them, and in consequence encouraging ‘investment,’ that is the transferring of demand, to the non-productive sectors of the economy.
Clearly, this process is destructive of the economy. As real production is increasingly replaced by fictitious ‘production,’ we should expect the economy to be less and less capable of maintaining itself. This would first be compensated for by importing increasing quantities of goods and material factors of production. However, we should expect increasing poverty, decreasing investment in the real economy and infrastructure, decreasing market for real production, and eventual economic collapse.
Sunday, January 11, 2015
Walmart promises lower prices. But at what cost to society? Locally, the consumer seems to benefit. But what about the domestic producer, who may be put out of business when a foreign supplier is chosen over him? He is also a consumer.
We further discuss the situation of unbalanced trade, where one country runs a trade deficit with another country. For previous discussions, see: http://anamecon.blogspot.com/2011/03/free-trade-welfare-and-debt.html and the pointer there.
We start with a retail outlet, which sells the product of a domestic producer. The domestic producer (or it may be many producers) produces quantity Q of his product at price P, at the equilibrium point e, intersection of the supply S and demand D curves (blue and red dashed curves.) The quantity Q goods sell at price P for total revenue to the producer, or producers, of P x Q. This is also the price paid by the total of all consumers.
A foreign producer produces at price P’ less than P. If the domestic producer cannot produce at P’, the retailer chooses the foreign producer. The supply curve shifts down by the difference between the prices, P – P’, in the diagram to the solid S curve, and the new equilibrium point is at e’. This would be an improvement for the consumer. He would get more goods, at a lower price. However, this is not the whole story, because the domestic producer is also a consumer. The consumer is also a producer. The revenue which formerly went to the domestic producer, P x Q, is lost to the domestic market. The new amount of revenue, P’ x Q’, the size of the market at e’, goes overseas, to the foreign producer. Or would if e’ was the new equilibrium point.
But it is not, because the domestic producer, no longer in the market, shuts down, and the demand is shifted down by P because of the loss of revenue to the domestic producer. This revenue the domestic producer no longer has to consume with.
Thus the new equilibrium point is really at e”, the new intersection of the shifted demand and supply curves. Since the price the original producer charges, P, is always greater than the difference between the domestic price and the foreign price, P – P’, Q” is to the left of the original Q. That is, after the retailer changes to a foreign supplier, the new equilibrium quantity is less than the original quantity Q. However, the real situation is actually worse, because the equilibrium quantity Q” is not a true equilibrium point.
The true equilibrium point is at quantity Q* = 0. That is, without balanced reciprocal trade, the equilibrium is at zero imports. It may take a long time to get there, but the net final result is merely the destruction of domestic production. The economy is no longer able to import except by selling off capital. But in this it is limited, also. There is only so much capital. There does exist, however, the argument from debt: The economy can be maintained by borrowing. But this is in the long term false, and any net import must eventually be paid for by destruction of future production. Further, because of the costs of borrowing, the amount of future productive capacity destroyed is greater than would be destroyed without borrowing. Borrowing makes a bad situation worse.
Let’s take a different look at the change in situation. Consider first the domestic economy as a closed system. The flows of money (Black) and goods (Red) stay within the domestic boundaries, and the system is in equilibrium, by which we mean that roughly the flows compensate for each other. (The rest of the economy consists of other producers and consumers.) There may be changes, but these are accompanied by corresponding changes in other flows.
If, however we introduce unbalanced trade, money is exported to the foreign economy and goods are imported from the foreign economy. Since there is no flow of money into the domestic producer, the domestic producer closes down. As a result, all flows of goods and services to and from the domestic producer close down.
We observe, like water through the drain in a sink, money continuously flows out of the domestic economy. Goods flow in, but unless the goods are capital goods, (and they would likely not be, because the return on investment is lower in the country running the deficit,) they are consumed and need to be continually replenished. The continual loss of money represents ever increasing demand (money is demand) by the foreign economy on the domestic economy, while the domestic producer has been eliminated. The domestic economy is thus ever less able to pay an increasing debt. It is certainly less able to repay with production. But it is also increasingly unable to repay this debt even with capital, because the value of capital has decreased, since its return is lower due to the foreign competition.
For comparison, we draw the same diagram with balanced trade, where the domestic producer has found a foreign buyer for his production. Note that, while the domestic economy is here balanced, the upper foreign economy in the diagram runs a deficit wrt the domestic economy, and the lower foreign economy in the diagram runs a surplus wrt the domestic economy. In the long run, these tendencies would have to be compensated for, by trade between the two foreign countries, just as they would have to be compensated for in the domestic economy.
So, what would be the effects of a trade deficit on the domestic economy. We already know that the domestic producer shuts down, resulting in a shift downward in the demand curve greater than the downward shift in the supply curve. Since the new equilibrium point e” is to the left of the original equilibrium point e, the quantity supplied at Q” is less than the original quantity supplied at Q. However, the same phenomenon happens for all imported goods. All imported goods are supplied at lower quantities than were originally produced by domestic producers. Otherwise the domestically produced good would be preferred by domestic consumers.
On the level of the individual, the mean income decreases, and is greater than the decrease in price. That is, in real terms, the average consumer is poorer, because of the trade deficit, than he was before there was a deficit. The decrease in price does him no good, because the decrease in his income is greater. From a social point of view, poverty increases, and income and (long term) spending of the average individual decreases. From an economic point of view, capital investment decreases, and indeed, on average, the economy is decapitalized, that is, its capacity for production decreases. This has the implication that the costs of capitalization increase. Another way of putting this is that the return on investment decreases. The economy is less able to maintain itself and its infrastructure can be expected to be under maintained, and to decline.
The results of running a trade deficit demonstrate the need for government regulation of trade. Clearly, a private entity may increase his profit while destroying a part of the domestic economy, if it is not compensated for. The free market credo would be that this is just too bad for the domestic producer. This should be discouraged, because the damage is not restricted to the domestic producer.
It also shows some of the consequences of incompetent, or if it be, treasonous, government, allowing or even encouraging the destruction of the livelihood of many of its citizens.
Finally, it shows that it is sometimes necessary to think two steps, instead of only one, in reaching conclusions.