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Keep the money-go-round spinning

We are all connected and interdependent

The smooth functioning of the economy relies on people paying for stuff, and the providers of that stuff spending the money they earn elsewhere. It's simple but drives our economic livelihoods. For example, a customer purchases coffee at a cafe, the cafe then spends the money they make with a supplier of coffee beans, who can then pay their workers and so on. This post will talk about the interconnected nature of the economy and how that connectivity is compromised during COVID-19.

We are all economically connected and interdependent. Both production and consumption rely on this connectivity. Without other people willing to purchase what we produce and fund our lifestyles there would be no good reason to turn up to work (beyond perhaps job satisfaction). In the absence of these transactions, the economy breaks down.

Adam Smith famously attributed this market motivation to self-interest:

“It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.”

This is to say, through self-interested actions we create stuff for others who buy what we make which allows us to purchase things. That's not the whole story, people do sometimes act against their own interest, but it's definitely an integral part of the mix.

Man watching TV showing the interdependence of the economy

Specialisation in professions reinforces our interdependence. Lawyers understand the law. Builders how to build. A lawyer will struggle to build a house for themselves. We aren't able to fulfill all our needs by ourselves. Even Bill Gates wouldn't be able to buy a burger if others hadn't put the effort into making the ingredients. The money wouldn't matter. Often this specialisation is strengthened with training, marketing or legal conditions. Interdependence drives our consumption as if we want what someone else can make, we usually have to pay for it.

This is straightforward stuff conceptually but of course can go much deeper and has interesting implications for Govt policy, particularly during COVID-19.

The money we spend has flow-on effects well beyond the initial transaction

Economists use techniques like Input-Output modeling to understand the effects of spending and interdependency between sectors. So it's possible to estimate what happens to say GDP or employment if $1 million is spent on construction. This allows policymakers to understand the net effects of policy and spending on the economy, and particular industries or regions.

The outputs from one industry become the inputs for another. So spending in one part of the economy will flow to other parts too. The construction industry benefits directly in terms of revenue and employment from an additional $1 million, however, their suppliers such as steel manufacturers and designers benefit too. So, for example, there may be five jobs created in construction, with an additional two jobs in steel and one job in design. Typically those industries most closely connected to where spending is happening benefit more compared to those on the periphery.

With that in mind, be wary of who will benefit most from COVID-19 stimulus spending. It's not just about throwing large amounts of money at the economy, but how that money is being distributed. Jobs for the boys as part of a COVID-19 infrastructure binge doesn't necessarily benefit everybody.

When one part of the connection snaps, the rest falters

People, organisations and resources interconnect to form the economy. If one part of link snaps it ripples through the remainder. We are seeing that through COVID-19 with business failure and reduced spending in one area affecting others. Tourism and hospitality of course have been most badly hit, but the broader economy relying on those sectors being healthy is suffering too.

The economic system is hugely complex, but it's worth thinking about it in simple terms. If restaurants and cafes shut down because people aren't comfortable going out to eat, then initially chefs, baristas and waiters could lose their jobs. Beyond that, we can expect job losses throughout the entire supply chain. Producers of vegetables, cutlery, sauces, meat, coffee, alcohol and furniture could all see sales decline as businesses wind down. Tertiary education would even be affected if students see less reason to train in that field. All organisations relying on spending by cafe and restaurants will experience a downturn, and those connected to them, and so on.

The size of the entities at risk matters in terms of their ability to weather the storm. A mega factory producing bread for millions of people is less at risk than a small corner bakery. Large entities have greater opportunity to redeploy staff, reduce cost and access funds to sustain themselves. Though (hardly) anybody is escaping harm during COVID-19.

Looking after the one supports the many

With people unable to go out and spend as usual during COVID-19 the whole economic system is compromised. The implication for governments trying to keep the economy alive is to try and catch businesses before they fail, and ensure people have spending money. Part of the challenge here is that it's not possible to spend as usual though with social-distancing measures. Delivery and online platforms help but it's not a perfect substitute. I've harped on about sustaining spending subject for a while now because it is so dam important.

Support options exist. Governments are working overtime to stimulate the economy. Helicopter money, wage-subsidies, big-spending initiatives and guaranteed income are all worthwhile. People who are able to keep spending could also look at how they can step up and help their locals. Low-interest rates also help as they should in theory encourage spending and mean debt is more serviceable. How we get through this and when it will end is still anyone's guess. The more we can do to keep all ships afloat, the better.


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