A take on Economic Systems

As I had committed in my last (First) post quite some time back, I am back. I really thought a lot on what I should write on, to make my life simpler I took this generic discussion topic.

Now this post can be titled as “Capitalism vs Communism”, “Advantages of Monetary System” and may be many more. My intent is simply to put to paper my understanding of the economic systems and also evaluate some pros and cons. Just a word of caution, this may not lead to any insight if you are looking for one but may just make certain things more obvious.

Let me start with one of the basis of our Economic systems i.e. money. Why do we need money, or what is money. One, it is a medium that provides a common basis for transactions; second it provides a method of storing effort. Well that is the catch. How much effort would people put if there was no way to store it? Simple, just enough to meet the short term consumption requirement. Thus it means that people like us would not be slogging for 40-50 hours a week if there was no way to store our effort in form of Money. Surprisingly this stored effort gives rise to another term called “Capital”. Any stored effort is called capital. But capital does not consist of only “Effort”; any un-used resource on earth is also capital. We can assume that God had provided the earth with some start-up Capital in form of Natural resources. One straight forward insight that comes from this explanation is that Human ingenuity of using any existing resource to create any good/service will lead to creation/discovery of additional capital. Thus the advantages of monetary system are as follows
It enables transaction of goods and services with ease
It enables storage of effort which provides a motivation for people to work more
It encourages people to find out ways of using natural resources, which as pointed out earlier can be equated with capital or effort

Now the next question, what do we do with all the stored effort. It has a macro and a micro view. Micro view is of an individual who may want to use part of his stored effort for future consumption (It could be either same level of consumption without any effort or higher level of consumption) or improving his quality of his output by investing in tools/technology. Macro view is that this effort can be directed to people who want to either improve efficiency of their output or create new goods and services to exhaust the stored effort or use it for public good. This is what the role of bank is, to direct stored efforts to productive use. This also brings us to the two ways of allocating capital i.e. Capitalist vs Communist.

The core issue is only the allocation of capital i.e. stored effort and resources. What capitalism does, it just puts the surplus Effort in the market place, and one who has the most productive plan of utilizing this effort gets it. Communism on the other had authorizes the community leadership to deploy it for the benefit of the whole community. Now it is a child’s play to predict the outcomes.

Lets take communism. Since the community leadership will automatically get the power to allocate the capital, it will eventually lead to these leaders deploying the effort in first insuring that the leadership is absolute as they will otherwise loose their control over community capital. Hence they will invest in creating a strong force to crush the community members who question the capital allocation decisions. Also nothing forces the leaders to allocate capital productively (Since they are not paying any cost on the capital), thus a lot of stored effort goes waste in activities which neither create new products/ services nor increases the efficiency of people.
In case of capitalism, one good thing is that the allocation of capital and community leadership are distinct. Thus capital gets allocated through a market mechanism where owners of capital and users of capital interact directly. However this will lead to a situation where user of capital will line up some great ideas of productively utilizing capital to secure the maximum amount of it. This will time and again lead to one-upmanship where smarter people through their ability to convince or through past record will secure more capital over some genuine and more productive opportunities. If such inefficiencies in allocation are few and far then it will only lead to marginally lower benefit to society but allocation of assets on a large scale to unproductive ideas will lead to Bubble and Bust cycle.

Now it is quite clear that communism may do well if leadership is not in-secure and largely honest (China may be one example). Capitalism will succeed if market does not have information asymmetry, leading to efficient price discovery and allocation.
One reason makes communism less attractive, it will utilize all stored efforts for common good thus drying up motivation for putting in extra effort for an individual. At a macro level it will lead to less stored effort or capital creation and this coupled with largely in-efficient allocation will ultimately be catastrophic as was seen in erstwhile USSR.

So this discussion comes to a close here. Looking to extend the construct to cover other aspects of our economic system in future posts. Bye for now.