In the last chapter, we defined the ‘economy’ as being ‘the system by which people produce and consume goods and services’. We said that the primary purpose of those goods and services is to enable us to do the same things that other animals need to do in order to live:
- Find food | - Reproduce |
- Find shelter | - Keep safe |
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In this chapter we are going to look at the fundamentals underlying all economies, whether human or of other animals: the essential ingredients that must be present for production to occur, what sets the level of production at any point in time, why production may fluctuate in the short term, what sets the maximum production possible and how that maximum can grow over time.
All animals have to ‘produce’ goods and services to cover their needs, often engaging in quite elaborate activities to produce food and/or shelter. Many species live socially and cooperate with one another, some in complex societies where individuals have different types of job and cooperate to survive; bees are one such example. If however an animal is solitary and produces what it needs by itself for much of its life, then its ‘economy’ can be a simpler one because it does not involve cooperation with others of its kind.
There are three essential ingredients required (or if you prefer ‘conditions that must be met’) for an economy to produce; if any are missing there won’t be any production. There must be:
Let’s take as an example a polar bear. Adult polar bears tend to live solitary lives except in the mating season or if a mother with cubs. Seals make up most of their diet. So ‘production’ for our bear consists of a successful seal hunt. The number of seals she catches will depend on which of the three production ingredients is the most limiting: how much she wants to eat seal (hunger), the seal resources available (abundance of accessible seals); and how much work effort she is able to put into the task (more if she is young and fit, less if she is old or sick). Sometimes the limit might be zero production, if she is not hungry, or there are scarcely any seals to be had, or she is not strong enough to hunt.
Thinking now in human terms, let’s take a closer look at each of these three ingredients:
The three input ingredients for production are illustrated in Figure 2.3. Unless all three ingredients – want, resources and work effort – are present, production will not occur. Production is limited by whichever one is in shortest supply.
The three-ingredient model tells us that the level of production – how much gets produced at any point in time – depends on which of the three ingredients runs out first (reaches its limit): Want, Resources or Effort. The level has to be somewhere between zero and the maximum that the person or people whose economy it is could produce if they worked as hard as possible and had abundant resources available. To illustrate this we will first look at what limits how much is produced in the simplest case: a one-person economy in which that person has to produce everything for him or herself.
Imagine a woman cast away on a small island who has to do everything for herself. Such a situation (but with a man as the castaway) is described in the famous novel Robinson Crusoe by Daniel Defoe: Crusoe is shipwrecked on a remote tropical island and has to survive alone for some years. The example of a castaway on an island also makes it easy to imagine a situation of finite resources, e.g. the amount timber to build with or burn on a cooking fire is limited to the number of trees on the island.
In our castaway’s economy, how much gets produced depends on which of the three ingredients – Want, Resources, Work – runs out (reaches its limit) first. So the three possibilities are:
a) Want (i.e. desire or appetite) runs out first: If our castaway doesn’t want very much, then she may well leave resources unused and work only part of the time. Perhaps she spends part of the day picking fruit but then has had all that she wants and prefers to rest, even though plenty more fruit is available to be picked.
b) Resources run out first: If our castaway wants more than can be made with the island’s resources, she may again work for only part of the time that she could, because before the day has ended she has already done all the work that there is to do, e.g. picked every ripe fruit there is. Note that our castaway behaves as if she owns everything on the island, so she can use any resource that exists.
c) Working Effort runs out first: If our castaway wants a lot and resources are abundant, she will work all day and the amount she produces is limited only by the amount of work she is physically capable of. For example, she has been picking and eating fruit all day, but picking it is hard work so she is tired out and has to stop and rest, even though there is no shortage of fruit, and she’d still like to eat more.
Many non-human creatures actually do pass most of their lives much like our human castaway. They work alone most of the time – as spiders and polar bears do – or they work in the company only of a mate, as many birds do. Like our castaway, they have relatively simple economies, and it’s easy to see that how much they produce is limited by the same three factors, how much they want/desire the produce, the resources available and their capacity to work.
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In human economies we are very interested in how the level of production fluctuates over the short term. We observe that economic output seems to go up and down in a cyclical manner, varying from ‘boom’ to ‘slump’ and back again over periods of months or years. Politicians and economists are keen to understand these cycles and to learn how to avoid or minimise the slumps.
We said that how much gets produced depends on which of the three ingredients – Want, Resources, Work – runs out first. So a variation in one or more of these three ingredients, is the cause of any fluctuation in output. The one responsible is the ingredient that is already in shortest supply (i.e. at its limit) or that has now become so. To illustrate this, let’s go back to our castaway.
Note that for our castaway, a lower level of production (a ‘slump’) is not a problem if the cause is that she wants less and is therefore working less. It’s merely a choice: she prefers time for leisure or a rest to the extra output she could have generated had she worked for that time. Similarly, slumps in real economies would not be a problem if they occurred because everyone in society had chosen to work a bit less and consume a bit less – but unfortunately when overall consumption drops, the resulting reductions in work-needed tend to be very unevenly distributed, i.e. some people are likely to become unemployed.
The peaks and troughs (booms and slumps) that we see in the levels of production of a human or other animal’s economy, do not necessarily tell us what the maximum output is, that the animal could produce if it chose to work flat out and had bountiful resources available. It may be able to produce more than the peak levels we observe, but simply doesn’t need or want to, or is constrained by insufficient resources.
What determines the maximum possible output that an animal or group of animals can produce? The maximum output will be generated if they all work as hard as they can and resources are abundant. What that maximum is, depends on the capabilities of the animal concerned – qualities like strength, knowledge, skill and intelligence.
You might well ask: “If an animal’s ‘capabilities’ decide the maximum it can produce, why don’t we include it in the list of ‘ingredients’ that set the level of production, along with want, resources and effort?” The reason for not doing so is that at any point in history, an animal’s capabilities are fixed. Those capabilities, such as its physical and mental abilities and its level of scientific and technical development, are not something that ‘run out’ – a recession doesn’t occur because we’ve used up all the scientific knowledge. Furthermore, we don’t experience our capabilities as a limiting factor because we take them for granted. Imagine a farmer one thousand years ago who has hired ten men to dig a trench. Dissatisfied with progress he asks them how it can be done faster. The men are not likely to suggest delaying the job some 800 years until mechanical excavators get invented, nor waiting for millions of years for evolution to produce a stronger worker; they’ll say he needs to increase effort by employing more men or paying them to work longer hours.
For most animals, their capabilities change only slowly with evolution and adaptation to changing environments. If you go back far enough in time, the ancestor of dolphins was a four-legged mammal living on dry land.1 Dolphins acquired the knowledge of how to swim, along with a body suited to swimming, by evolving over millions of years: small genetic changes accumulated over many generations until they were a very different animal to their furry ancestor, and far far better at catching fish. But genetic change is slow (particularly in large, long-lived animals). An ants nest or a lion from Roman times two thousand years ago would look much the same as one from today. However, the other way to pass on knowledge is simply to teach it to the next generation – no genetic change is required.
Humans can pass on a huge body of learnt knowledge to our children through our complex spoken and written language over the course of what nowadays may be twenty years or more of education. So it is that humans have gone from catching next to no fish a few thousand years ago to hoovering up vast (and unsustainable) quantities, not by any change to our bodies through evolution but by developing ever more sophisticated technology and passing on the knowledge to our children.
Many other animals also teach their young but cannot match us in the sheer volume of knowledge passed on. A few non-human primates, have learnt to make use of stones as tools. The long-tailed macaques of Thailand use simple stone tools to smash open shellfish on the seashore, and in recent years have begun using stones to crack open oil palm nuts on the plantations inland. As this behaviour is limited to certain populations, it would appear to be an example of a learnt skill that is passed on from one generation to the next.
Amazingly, some conventional economics books don’t always make it clear that growth is the direct result of technical advance. In one standard economics textbook, a section that purports to analyse growth begins with the assertion that ‘In an economy with no technical progress growth will occur because there will always be investment in capital goods which are long-lived and so will accumulate, thus making labour more productive’. This is nonsense because:
These points are easy to understand if we return to our castaway. She might find that clearing a short track to the beach she visits daily to collect shellfish is a worthwhile capital investment that increases what she can produce, because the saving in time spent maintaining it is less than the time she used to have to spend picking her way through the undergrowth. But building more and more tracks all over the island does not make sense because at some point maintaining them would be more work than any saving. To obtain the best economic performance she needs to apply the technology she knows in the most effective combination, not pile up ‘capital goods’ – whether they be tools or jungle tracks – that require more effort to build and maintain that the saving they offer. The only way to improve on that best performance is by technical advances: if she develops a better way to fish, hunt or collect food, that produces more for the same effort, then her maximum output increases.
The level of an animal’s economic output is determined by which of the three ingredients required for production runs out first: wants, resources, or work effort. Fluctuations of output in the short term, are due to changes in the amount of one or more of those three ingredients. Long-term change to the maximum an animal can produce are due to changes in its capabilities thanks to its evolution or, and especially in the case of humans, thanks to its acquisition of learnt knowledge that it is able to pass on to its children.
Short term and long term are relative to the animal concerned. For an animal whose capabilities depend mainly on evolutionary change, ‘short term’ may be many thousands of years if it evolves only slowly. For humans, ‘short term’ may be as little as a few months or years as human capabilities are changing rapidly year by year due to our ability to learn and pass on what we have learnt to our descendants.
So far we have used simple examples like a castaway or a single-animal economy to illustrate economic fundamentals. But humans along with many other animals – bees, ants, lions, wolves, etc. – are social beings and usually work in groups, with different individuals specialising in different types of work. So we shall need next to consider a ‘social’ economy. But the basic wants, resources, work effort model considered in this chapter gives us some general pointers:
Lastly, we’ve got this far without any reference to money – and deliberately so. Can that be right – isn’t economics all about money – is there an economy without it? Of course there is! If it were otherwise, no other animal would have an economy since no other animal uses money; we humans wouldn’t have had an economy either for almost all of our 200,000 years existence as Homo sapiens, since the use of coins dates back less than 3,000 years.2
1Dolphins like whales, are not fish but mammals, whose ancestors were land animals. Much further back in time, all land vertebrates evolved from fish.
2The first use of coins is believed to be during the first millennium BC, though before that some societies used ‘commodity money’ – goods like peppercorns, shells, barley or gold, that had their own value but could also be used for payment.
