Doughnut economics #3

Key idea #3: there’s more to the economy than the market, and it isn’t self-contained, as many mainstream economists believe.

Thanks to Rob Liu for granting permission to reprint this from the Conscioused website.

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A classic economic model often used to explain the world is the circular flow diagram. It pictures the economy as a closed system in which income flows between businesses and households – with banks, governments and trade playing intermediary roles. It’s a powerful image that continues to shape the way we think about the economy.

There’s just one catch – it’s wrong!

However powerful the market is, it isn’t the only economic sector that creates value. The state provides goods and labor to lay roads and educate children. Then there are shared resources like public land or Wikipedia.

Individual households also play a vital role in economic life, even if this sometimes goes unnoticed. A good example of this comes from the life of the famous Scottish economist Adam Smith. In his work, Smith eloquently described the way that markets mobilize individual self-interest to provide for the common good, such as how a grocer is motivated to sell someone everything they need to make dinner.

So where did Smith write his great work The Wealth of Nations?

Based on his theory, Smith should have been paying someone for the service of a comfortable lodging, right? In fact, he moved back in with his mother. While he was writing, she prepared meals and did chores. His work, in other words, depended on unpaid labor. Without it, he wouldn’t have been able to concentrate on his book.

Yet he never mentions this in his work. Perhaps he just didn’t notice it. That hasn’t changed much since the eighteenth century. Mainstream economic theory still has a blind spot when it comes to unpaid household labor.

There’s another flaw in the circular flow model: The economy isn’t a truly closed system. All economic activity depends on the resources provided by the sun and our own planet. Herman Daly and other ecological economists deployed a useful term in the 1970s to describe this. According to them, the economy is an open subsystem of the earth’s closed system.

Without the energy and raw materials we get from the sun and the earth, economic life would grind to a halt. When we take more from the earth than it gives us and expect it to absorb more waste than it can handle, we find ourselves in a “full world.” Daly argues that we’re already living in a full world. The earth simply can’t replenish vital resources as quickly as we deplete them. That’s another reason to change the way we think about the economy!