The Oldest Error in Economics
Most bad economics comes down to one mistake, repeated in different disguises. People assume the economic pie is fixed. If someone gains, someone else must lose. This is the zero-sum fallacy, and it is older than economics itself.
It is not hard to see where the instinct comes from. For most of human history, wealth really was fixed, at least in the short run. A tribe hunting and gathering on a fixed territory faced a limited supply of game and berries. If one family took more, another family took less. Zero-sum thinking was not a mistake in that world. It was an accurate description of it.
The trouble is that the same instinct survived the arrival of trade, production, and specialization, none of which existed on the savannah. Modern economies are not fixed pies. They are pies that grow when people trade, invest, and innovate. But the old intuition still runs deep, and it surfaces again and again in economic thinking, almost always wrong.
Take exchange itself. Many people believe that in any deal there must be a winner and a loser. If you buy a coat for £50, the assumption runs, either you overpaid or the seller undersold. In fact both sides gain, or the trade would not happen. You value the coat more than your £50, and the seller values the £50 more than the coat. Nobody loses. Two people become better off, and no third party is worse off either.
This is not a subtle point, but it contradicts something people feel to be true, so it is forgotten the moment the subject turns to trade between nations, or between rich and poor, or between borrower and lender.
Trade between countries is the clearest case. The old mercantilist idea, that a country grows rich by selling more than it buys, has been dead in economic theory for two centuries and alive in political rhetoric the whole time. It rests on the same fallacy as the coat example, scaled up.
If a British exporter sells machinery to a German buyer, both are richer for it. The transaction does not make Britain rich and Germany poor, any more than a bakery selling bread makes its customers poor. Yet the language of trade deficits and surpluses still treats exports as wins and imports as losses, as though a country's shop till were the measure of its wealth rather than what its people actually get to consume.
The same fallacy explains why speculators and middlemen are so often despised. The claim is that they add nothing, that they merely take a cut ofvalue created by others. But speculators who buy low and sell high are performing a service. They are moving goods from where they are less wanted to where they are more wanted, or from a time of surplus to a time of shortage.
A middleman who connects a producer in one country with a customer in another is solving a real problem, namely that the producer and the customer would otherwise never have found each other. Strip out the middleman and the trade very often does not happen at all. Nobody gains, least of all the producer.
Interest works the same way, and provokes the same reaction.
A lender who charges interest is often accused of getting money for nothing. But the lender is not getting nothing. He is giving up the use of his money for a period, at real cost to himself, and interest is his compensation for that cost and for the risk that he will not be repaid. The borrower, meanwhile, gets to use money now that he would otherwise have had to wait years to save. Both sides gain from the arrangement, which is why they enter into it voluntarily.
Taxation debates carry a milder version of the same error. It is often assumed that when a government raises the tax rate, it simply collects a larger share of a fixed amount of economic activity. In reality, higher rates change behaviour. Investment is deferred, activity moves elsewhere, and reported income falls. The size of the pie is not fixed while government decides how to slice it. The slicing itself changes the size.
None of this is difficult economics. It is mostly a matter of remembering that trade is voluntary, and that people do not enter into deals which make them worse off. But this simple fact keeps losing out to an older and more compelling one, the sense, wired into us over tens of thousands of years of a genuinely fixed world, that somebody's gain must be somebody else's loss.
Modern economies does not work that way, and has not for a very long time. Prosperity comes from exchange, not despite it. The countries and individuals who understand this outperform those who do not, and they have been doing so since long before economics had a name.
Madsen Pirie