What I learned by reading Alan Greenspan's book

Reading Alan Greenspan's book, The Age of Turbulence, has been a fascinating experience for me. I always struggled to understand how the world's economy works, and I think (perhaps dangerously?) that I mostly get it now.

So here are the questions I wish my kids would ask me someday about it, and the responses I think I'd like to give. Not sure how much is directly attributable to AG (some of it's probably Warren Buffet too), but I won't take personal credit for any of it that's right.

So how does the economy work, anyway?

Simply, the world is full of people making things other people want.

You (or someone you love =) makes or does something for someone else, and they trade you for something you want -- usually money.

Another way to think of it is "adding value". If you buy parts for $10, put them together and sell the product for $100, you created $90-worth of value. People make money and provide for their families by adding value. That's how places like Hong Kong and Singapore and Japan, with very few natural resources, manage to be such wealthy places -- they've figured out how to add lots of value to "stuff".

We're constantly consuming that value too, e.g. making a $3 burger disappear, putting miles and years on our cars that decrease the value, etc. So if we just stopped working, we'd quickly consume the value we've stored in the fridge, bank accounts, gas in the car, etc. -- and that's when the pain starts.

But as we figure out how to create value faster, our standard of living improves.

How come the US is so much better off than places like Africa and South America?

We in the US are incredibly more productive than they were a few hundred years ago. Why? Division of labor is one reason. If you have enough people around, each person can do one thing and get really good at it, and therefore be really efficient.

Education is another. It helps us figure out how to waste less time and make stuff better, faster, and cheaper.

Time is yet another -- it takes awhile to figure out how to build really good cordless drills, but now that we've got it worked out, lots of people can have one and use them to create value faster than we could before. We as a society invested the time, and now are reaping the benefits.

Here's an example. Suppose I could build 50,000 incredibly awesome dishwashers a day for $10 apiece, everyone would certainly be impressed at my efficiency =) -- and pretty soon everyone would have an incredibly awesome dishwasher, and their lives would (arguably) be better for it. Although an extreme example, that's a big part of what's going on. We build lots of great stuff faster and cheaper than other places, and have been doing it for awhile now.

... But China makes lots of things cheaply, how come they're still so poor?

They're doing better now, actually, but they still have problems. One, even though they produce *tons* of stuff, in many cases they're not adding as much value as their US counterparts. I'm sure iPods are made up of 5-cents worth of raw material (silicon, lithium, carbon, etc.), which (mostly) Chinese companies turn into a $15 unit (that's a guess) that Apple sells for $149. Apple's adding the lion's share of the value with their engineering, design, marketing, distribution channels, etc.

AG talks about another problem that other countries have: limited (or absent) property rights. If every time I get something it gets taken away from me (stolen by thieves, confiscated/taxed by the gov't), I'm going to start putting my energy into protecting or hiding my stuff instead of building whatever it is I'm good at building. So I go down to only a hundred $10 dishwashers a day and spend the rest of my time putting bars on my windows and a wall around my house. Then we might as well be in South America. And a lot fewer people will have incredibly awesome dishwashers.

Why can't the government just pay for everything?

It could.

China and Russia are great examples of the government trying to do and pay for everything. Have you heard about hordes of people wanting to emigrate there? Me neither, those places are mostly economic wrecks. Yet how funny is it that the Obama administration's policies look a lot more like socialism/communism than what brought us to where we are today.

AG talks about "economic populism", which is what South American presidents tend to end up with -- promising to spend government money to do all kinds of things for the people that the government can't afford to do. It gets them elected, but isn't a sustainable way to run a government.

For example, just because you promise free national healthcare doesn't mean that a bunch of doctors, nurses, and pharmacists will start working for free -- someone has to pay them to do all that work. In other words, somebody somewhere has to be producing the "value" that will be given/paid to those doctors and nurses -- and if it's not the employers of productive employees, who will it be? Likely you and me. And if you get sick more often than most, you probably like the sound of that. If not, though, you'll be paying for other people's doctor bills. Simple as that.

Remember, it's *our* money the government is spending! And although I'm fine with them building roads, maintaining the military, running the courts and police, etc., I'm not thrilled about government giving money to abortion clinics, paying for everyone's health care, sponsoring people's unemployment, subsidizing farming, etc.

So why not let American businesses foot the bill for the national healthcare system?

Consider how much of the value created in this country comes from American businesses. A lot! Jobs too. But our businesses are competing with those from China, Singapore, Japan, etc. Pushing the healthcare burden onto our businesses slows them down and drives up their prices. My $10 dishwasher will have to get a bit more expensive if I have to pay ten thousand dollars a year in healthcare for each of my employees -- and that makes it easier for a Chinese company to come in and undercut me. And if they do and drive me out of business, I'm out of a job, and not only do we lose my business' contributions to the national healthcare system, we also have a few more unemployed people to support.

American business is the engine that drives our country forward and creates value -- let's streamline it, not burden it down!

...

This next one's a little different from the other questions, but I'm not sure where else to put it:

If we get a lot of our oil from the Saudis, why don't they jack up the prices? It seems like they've got us stuck, a rich country with an oil addiction seems like a perfect target for price gouging.

I never understood this, I just always assumed they would be happy if the prices were to skyrocket and stay as high as possible.

But as with every balancing act, AG points out that as prices go up, people start figuring out how to get their energy elsewhere, or how to go without. And if pressed, we could come up with some cool stuff that would permanently lower our consumption rates. With Venezuela and Russia also churning out oil, a drop in consumption would upset the balance and put a glut of oil on the market and force prices to instead go far lower. (If everybody in the country already had one of my incredibly awesome dishwashers, how much do you think I could sell one for?) According to AG, that scenario happened in the 70's and the rate of "growth in consumption" "never fully recovered even as prices fell".

If that's the Saudis primary source of income, you can see why they don't want to mess too much with it.

Interesting.

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Just a reminder, none of this is really mine (except for the wrong stuff) -- credit goes to AG (and to a lesser extent Warren Buffet). Still, if you made it this far, I hope that means you found something interesting or useful. =)