I was reading a friend's blog over at the Scratching post when I came across a very interesting sub-post by MISH on FIV. Mish compared the economics theories that have dominated macro-economic practice since 1930 to the common sense approach most eighth grade graduates would take... Very humorous and he brings up a good point... has the field of Macro Economics missed the mark? Our recent recession would indicate that the combined efforts of Keyns, Friedman, and even Hayek can not predict how and why a economy grows or fails.
But I think that MISH over-simplifies, implying that the world economy is a fixed size making balancing spending with saving as the only way to success. But that argument is countered simply by looking at the last 100 years, it is clear that the the economy is expanding but how fast? and why?
I like to combine basic physics with economics... applying the conservation of energy law to monetary policy. The applicable interpretation goes something like this; the economy is the total sum of energy created by a the people in the economy. The economy grows when the people work more to add value, but it shrinks when the population takes more than they contribute. Value is fluid across the economy much like currency (or mass and velocity in the analogy), making it easy for the economy to aggregate total value but very difficult to decompose and analyze.
So the bottom line, is that Monitarists and Keynesian theories work better if the population is adding more value through work than they are extracting through consumption. What does that mean for governments? That means that successful governments will incentivize people to add more value than they extract, making the economic pie bigger. If a nation's economic pie is bigger than the population needs, everyone is comparatively richer than they were when the economy was smaller.
Unfortunately this concept eventually runs up against entropy, or the tendency of all energy to seek it's lowest form. In economic terms the lowest energy state is the hunter and gather, or subsistence state. The implication to policy makers is that no matter how great the stimulus for increased productivity, there is always a tendency for a population to slip into less productive habits.
Which brings us back to today's problems... We built a big economy, with lots of potential, but policy makers became lazy and didn't continue to incentiveize the economy to grow honestly. Additionally we allowed our accounting practices to become clouded, impairing our ability to track real value generation. Policy makers allowed corruption to infiltrate the economy, stealing value from the core of our economy until it was a hollow shell of what it appeared to be, a real potemkin village.
It seems to me that in the future, Government should proceed on two tracks, first create a very transparent financial system that allows the true value of an economy to be exposed. Second, it should incentivize value creation at the core of the economy; creating an innovative, efficient environment for companies to succeed or fail on their own merit.
Sounds simple, right?