Tuesday, January 6, 2009

Are we really any poorer now?

There is a painfully obvious agreement that our economy is not as good as it was 6 months ago. But from a high level, you might ask how could that be? We still have the same number of factories, the same number of farms, the same number of hospitals, the same roads, water systems, and electrical systems. We still have roughly the same number of people with the same skills and know-how. And we have almost the same amount of natural resources. There has been a slight ongoing decline in nonrenewable resources, with oil being the prime example, but that is unrelated to the current sudden decline in the economy in the last 6 months. So how can our economy be poorer in any real tangible way?

For any economy to function, what’s needed besides all the above artifacts is a set of organized relationships between the different parts of the economy. Because of a high degree of specialization, no parts of the economy are self sufficient. They all depend on a set of trusting relationships with other parts of the economy to function. The other important aspect of the economy is that it is full of time delays. A factory worker may go to work on a daily basis knowing that he won’t get paid for his effort until the end of the month. A farmer who plants a field knows that it will be several months before any crops can be harvested. When a new business is started or construction on a new factory is begun, it can often take a few years before the effort generates any profit. Investments in research can sometimes take more than a decade to pay off. In all these cases, there is a set of relationships and trust with the rest of the economy that there will be a future payback for the investment and work done today.

So yes, the economy really is not as good as it was 6 months ago, and we are really poorer. What we lost was the set of organize relationships and trust between different parts of the economy. We lost trust in many of the large institutions, and we lost trust that there will be a worthwhile future payback for current investment and efforts. Though not as tangible as physical factories and infrastructure, trusting relationships are a painfully obvious key component of a healthy functioning economy. One of the fallouts of the current economic crisis is that the vital role of relationships will be viewed with more respect from now on.