Pie Economics: A Way To Understand Economic Balance

Wednesday, 13 May 2020, 10:51 am
Article: Keith Rankin

Economies as Pie Charts

Most of us are familiar with the expressions 'economic pie' or 'economic cake'. The 'pie' metaphor is probably best, because pies represent a holdall food item, less homogeneous in their finished forms than are cakes. Further, most of us are familiar with pie charts. Yesterday I published National Income: a Pie Chart, which shows the key divisions of income, and also shows how we should think of reserve capacity in our national economies.

The divided pie represents gross domestic product (GDP) and other similar concepts; it is the 'material economy'. In a closed economy – an economy without foreign trade, investment, and migration – the 'other similar concepts' represent different aspects of the same pie. Thus, statisticians can measure the size of the GDP in three different ways: by totalling production (the finished goods and services which the pie contains), by totalling spending (expenditure) on those goods and services, and by totalling incomes (as per the chart referred to above).

It is conventional to divide material economies into two sectors – public and private – and then to divide the private sector into businesses and households. (Different accounting methods may define these divisions in some different ways, but the broad outlines are universally accepted.)

A particularly useful form of economic pie chart has a broad ring around the outside. This represents spare capacity – and should be understood as an economic 'good' rather than as an economic 'bad'. An economy without this outer ring can be classed as 'maxed out' and 'highly stressed'. In my chart I call this ring the 'relaxation' zone, representing the 'life' component of 'work-life balance'.

Economic Happiness and Work-Life Balance

Happiness arises from having the time to do the things we want to do, the environments we require to do those things, and having the consumer goods and services that give us sustenance and enjoyment.

If we consider a camera, it’s a consumer good that we can use in our spare time, in the physical and social environments that we enjoy being present in. The economic happiness of amateur photographers depends on having the things (cameras), having the time, and being in places. The complementary balance – between things, times and places – varies for different people. Some people will give more weight than others, to having time relative to having purchases; relaxing on a beach may not require many purchases. Ultimately, all three are important, and interdependent.

From a happiness point of view, economic growth can be understood as the annual increase in the size of the whole pie, including its outer ring. From a conventional macroeconomic view, however, economic growth is simply the annual increase in the size of the inner pie.

One way many growth-focussed policymakers seek to get higher growth is to raise the size of the inner pie by reducing the size of the outer ring. We have to stop thinking this way, and to realise that – especially in our brave new post-Covid world – we should be looking to do the opposite: to accept a reduction of the inner (divided) pie while expanding the outer ring. While this may or may not increase total economic happiness, it certainly rebalances our economic lives.

Economic Pandemics

An economic pandemic is a global economic crisis. The Great depression of the 1930s was an economic pandemic. The global financial crisis of 2008 – a financial pandemic – unleashed an economic pandemic. The Covid19 global emergency has already become an economic pandemic; a pandemic that will most likely outlast the viral pandemic. Economic pandemics permanently change our economic landscapes, and their associated intellectual landscapes.

Sometimes, the changes are for the better. At other times we learn the wrong lessons. Typically, changes for the better and wrong lessons both happen. We already know, this time, that people have had more time to re-evaluate their personal notions of economic happiness. Many people do not want to return to their past overstressed lives; their priorities have changed.

In economic pandemics, the medium-term economic consequence has been restraint in consumer spending; structural increases in the financial surpluses of the household sector. This means households save more, repay more debt, withdraw less savings, and take out fewer new loans.

Intrinsically, the financial balances of the three major sectors must add to zero. If one sector – in this case the household sector – strongly affirms a desire to run large surplus balances, then other sectors must run deficits large enough to offset these surpluses. Traditionally economists have assumed the business sector will run these offsetting deficits; induced to do so, if necessary, by low interest rates. However, a little remarked-on fact has been, since around the turn of the century, that businesses – especially the big corporates – have been choosing to run surpluses. Further, businesses must run surpluses when they are repaying debt.

When both households and businesses are choosing to (or having to) run surplus balances, the only way the global economy can survive is if governments run financial deficits – big deficits, and ongoing deficits.

The 2008 global financial crisis happened because of huge pressures being placed on households to run deficits. The principal mechanism was to push home mortgages onto people who never had a hope of being able to service those loans to completion. As a way of getting out of the global financial crisis, governments – albeit with some reluctance – took on the huge financial (budget) deficits required. China took the lead, to the extent that we can argue China itself saved the global capitalist economy, through the willingness of its governments to spend on domestic infrastructure and housing.

But then things turned sour. As soon as 2010, many western governments turned first to 'fiscal consolidation' and then on to outright 'austerity'. In essence, they tried to 'pay the money back' when households and businesses were still trying to run financial surpluses. In reality, governments can only reduce their debts – running financial surpluses – when the private sector (households and businesses taken together) is running deficits. Government debt is paid back when and only when the rest of the economy is feeling good; only when the private sector is running deficits. The result of the premature attempts by governments – in the 2010s' decade – to repay debt was that the households and businesses of the world ended up much less able to repay their debts. Japan's government, to its credit, kept out of this push to reduce government debt. The European Union nations' governments were the worst offenders.

Helping People versus Helping Businesses

In this economic pandemic, many households and many businesses will become technically insolvent. So governments will have no choice but to run huge financial deficits, and to keep doing so until the private sectors are in positions to (and have the will to) run financial deficits; that is, until the private sectors become net borrowers and investors.

So, who should governments help the most? Households or businesses? It is already clear that demand for international tourism (especially intercontinental tourism) will be suppressed for quite some time, by restrictions (and fears of quickly imposed new restrictions that could leave tourists stranded), by fear of visiting places which may still seem dangerous to visit, and by higher travel costs. Governments should not go far to assist a business sector for which there is no assurance of substantial post-pandemic consumer demand.

From the 1960s, intercontinental passenger shipping died out (when air travel became a more viable alternative). However, the international shipping industry did not die. Likewise, aviation will not die; rather it will join other transport modes in becoming principally a freight service. My sense is that this will also be true, to a lesser extent, in relation to domestic air travel.

What will happen, I believe, will be a substantial rise in virtual tourism – we have already seen the growth of the 'Slow TV' industry. (Note that this will involve consumers having more time, and not needing to buy much more than they already have.) And we will see a rise in long distance trips, by car and by bicycle rather than by bus and train. We may also see rises in long distance walking, though not necessarily on the backcountry tourist trails that may risk congestion in dedicated accommodation facilities.

Government policies need to inject money from their balance sheets into households' balance sheets, and to leave households to decide which goods and services people buy more of, and less of; to decide which businesses to buy from. Through consumer sovereignty, the market mechanism should be allowed to determine the future allocation of resources. Governments should only be 'picking winners' to the extent of their own purchases, and not through direct business subsidies.

We also need to ensure that this market mechanism is extended to the 'macro' level, meaning that households – acting individually, but differently from the past – can choose work-life balances that optimise their reassessed economic happiness. We need to make it possible for those who want to work less to do so (ie by not punishing people who make this choice), and to make it possible for people who want more paid work to do so (and without punishing them by removing existing subsistence benefits).

Back to the Income Pie

The income version of the economic pie chart shows that, if the combined private sector insists on running financial surpluses (meaning is not willing to buy its full share of the pie), then the government (public) sector needs to buy the private sector's unbought portion. In financial balance terms, it means that governments must run financial deficits until there is no longer an unbought private portion; if they do not, then the pie shrinks and intended surpluses cannot be achieved. It is only when the private sector optimistically chooses to take on a deficit (ie chooses to buy more than its combined private income share) that the government sector can reduce the accumulated debt on its balance sheet by buying less than its income share. (At such times of private sector expansion, tax revenues automatically rise faster than GDP, so the government sectors' debts automatically fall. No debt repayment policy is required.)

Households should determine their own work-life balances, not governments. This propensity of governments (to set this balance for us) is the feature of 'socialism' which rankles with many people. When households prefer to take productivity gains in the form of more relaxed lifestyles, then governments should not be acting to prevent this choice. If households do make the 'more relaxation' choice that I believe they will want to make, it necessarily means that the business sector will become smaller. If fewer businesses – or more correctly, fewer hours of paid work – are required to service our ongoing material needs and wants, then so be it.

We get income in part from what we do (labour income), and in part from our economic property rights. The market economy itself will not suffer if the balance between labour income and property income changes. The economy will suffer however if income distribution between households becomes more unequal. Indeed, given many past years of rising income and property inequality, the market economy itself would be enhanced with a less unequal distribution of property income.

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Keith Rankin

Political Economist, Scoop Columnist

Keith Rankin taught economics at Unitec in Mt Albert since 1999. An economic historian by training, his research has included an analysis of labour supply in the Great Depression of the 1930s, and has included estimates of New Zealand's GNP going back to the 1850s.

Keith believes that many of the economic issues that beguile us cannot be understood by relying on the orthodox interpretations of our social science disciplines. Keith favours a critical approach that emphasises new perspectives rather than simply opposing those practices and policies that we don't like.

Keith retired in 2020 and lives with his family in Glen Eden, Auckland.

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