The natural economy
The first economy is the "natural" economy, and it consists of man behaving in his ordinarily occurring state of trying to improve his lot. I described this natural state here. From the post:
"If you had a couple of islands with, let's say, one thousand people on each, and each of these islands had governments that only protected persons and their property from harm, theft, or abuse, would these people not engage in wealth creation-- as in, the formation of capital and consumer goods, tools, and land improvements-- and exchange good and services with each other?
Clearly when granted protection from harm or theft but otherwise left to his own devices, such behavior is the natural state of man! When left alone, men don't just sit around naked eating rocks-- they do everything in their power to survive and improve their lot!"
This "natural" economy, which includes the black market, is governed by the rules very clearly understood and articulated by both the "classical" economists of the 18th and 19th centuries and the Austrian school today, culminating-- in my opinion-- in Rothbard's work "Man, Economy, and State". These fundamental rules of economics-- built painstakingly upon irrefutable truths and logical deduction, and validated by centuries of history-- govern this "natural" economy. Even contemporary "new neoclassical synthesis" economists would probably read Rothbard's work, for instance, and not really find anything to disagree with; the rules articulated therein aren't that complicated, they simply describe "how things work" in the natural economy.
One thing to note: "Natural" is somewhat of a misnomer-- there are some prerequisites needed for people to engage in wealth creation. For instance, people need their own well-being and the well-being of their property protected. But the prerequisites are so few that "natural" is as good of a term as any to describe this first economy.
The money economy
The second economy is the one built on top of the "natural" economy-- I'll call it the "money" economy for lack of a better term.
The "money" economy is created by governments and central banks, and consists of measures that subvert the ordinary behavior of human beings, and that siphon resources from the "natural" economy in an attempt to use central planning on some subset of the world's finite resources.
Every culture in the history of the world has had both of these economies-- the sizes of them has simply varied. For instance, in 19th century America the "natural" economy was huge, while the "money" economy was tiny. Today, the situation is inverted-- the "money" economy is massive, while the "natural" economy is relatively insignificant.
If the "natural" economy is simply people engaging in wealth creation as they are ordinarily apt to do-- such as described in the earlier italicized quote-- then what are some examples of the "money" economy? Here are just a few:
- Central bank money creation, debt financing, and expansive balance sheets
- Tariffs, price controls such as minimum wage and interest rate manipulation, and special interest subsidies
- Special exemptions in the tax code
- Taxation to fund anything other than prerequisites for the "natural" economy
- Regulations to protect anything other than prerequisites for the "natural" economy
If the "natural" economy is governed by the well-understood and time-tested laws of classical economics, then what laws govern ths "money" economy?
Today, the group trying to understand this second economy are students of the "new neoclassical synthesis" and the book on these laws is in the process of being written, because the sheer size of today's "money" economy is absolutely unprecedented in human history. Regulatory costs in America exceed 1.7 trillion dollars, and there are virtually no sectors left not being centrally planned to a significant degree; central banks around the world are creating tens of billions of units of new currency per month, independent of GDP growth or production; and the US tax code is 73,954 pages long.
The sheer size and complexity of today's "money" economy is so unprecedented that no one is quite sure what the outcome will be.
One aspect of the "money" economy that is certain however is that every single aspect of it, however minor, is a diversion of our limited resources away from where they would ordinarily be deployed, and towards some alternate usage. This alternate usage could either be the intentional aim of a central planner, or-- as is frequently the case-- an unintentional side effect of the central planner's policies.
It's easy to prove that the "money" economy diverts resources from where they would naturally be deployed-- in other words, malinvested-- by simply considering the following: what would be the purpose of proposing the laws and controls in the first place if the market was already behaving in the ways the central planner favors? Obviously, the laws and controls were only put in place because the market was not naturally behaving in the way the new laws wish for it to behave.
How did we wind up with two economies?
As mentioned above, every civilization has had these two economies-- they've just varied in size. The only state in which man would not have a "money" economy would be a state in which the "natural" economy couldn't flourish, which would mean man would have no economy at all. And without the "natural" economy, there wouldn't be any wealth for the "money" economy to divert-- once again, man would be in a state with no economy at all. Consider the two economies to be in a sort of symbiosis with one another.
One might ask, "if it's broadly accepted that people acting in their own self interest most efficiently deploy capital, then why interfere at all?" The answer is that there are times when it is necessary to mis allocate capital-- for instance, to field an army for self-defense, or a police force to protect people and their property from abuse or theft, respectively.
Additionally, most countries in the world have, at one point or another, decided that it was necessary to have government-mandated charity in the form of social welfare programs. As has been abundantly clear for several decades across most of the developed world, it is not possible to afford a welfare state without a large "money" economy. Therefore, one of the "money" economy's goals is to try to get something for nothing-- to increase prosperity faster than the rate of production while simultaneously keeping the inevitable payback costs to a level that will not essentially destroy civilization, in a worst-case scenario. We'll see whether that's possible or not in the coming years-- as mentioned earlier, the book is being written as you read this.
Why is there so much disagreement in the field of economics?
The outcomes and problems inherent in the "natural" economy are easy to explain and understand; as mentioned above, the school of classical economics is very well developed and extremely time-tested. The same advantages are not enjoyed by the "money" economy however.
In fact, the students of the "money" economy have already completely failed in their fundamental analysis more than once, the most recent time being the reason why their school is now called the new neoclassical synthesis: the "old" neoclassical synthesis collapsed in the 1970s when many of its core tenets, such as the Phillips Curve, were shown to be obviously fallacious based on the world's events at the time.
Today, a similar breakdown of "money" economy understanding is happening, and the "new" neoclassical synthesis is being proven to be at least partially falacious. This will probably lead to a new new neoclassical synthesis.
But that aside, the biggest take-away from the fact that there are, in fact, two economies operating simultaneously is this: mainstream, or "new neoclassical synthesis" economics, and "heterodox" schools like Austrian theory aren't, in fact, competing theories-- they are theories describing two completely different things. This is why there is so much superficial disagreement in the field between the two sets of economists.
Put another way, let's say you got Peter Schiff and Paul Krugman in a room together and set them at debating. A layman listening in would probably remark, "How can two people who supposedly know a lot about economics disagree so completely on just about everything?" Again, the reason for this is that they aren't even debating about the same object; Peter Schiff would think they are debating about cars, while Paul Krugman would think they are debating about bicycles-- it's no wonder they can't even agree on how many wheels the object has, much less anything else!