To understand the health of an economy, it is not enough to simply consider a single metric like the total money supply or GDP. A national economy is better modeled as a dynamic system of financial flows. This framework can inform internal fiscal policies as well as provide direction for international development plans.
In the US, the economy is dominated by two loops: the consumption and wages loop and the investment and returns loop. Understanding this dynamic is crucial for assessing the effects of policy, especially in the aftermath of the recent financial crisis. Existing policies have injected too much money into the capital loop, dramatically increasing both consumer debt and investor savings since 1980. Capital savings remain uninvested, because labor cannot afford any more consumption. Correcting this imbalance would benefit all sectors of the economy, while averting future crashes.
Money also flows between countries through the global economy. This free flow of trade has been considered a boon for developing economies, but it may counterintuitively undermine their growth. The US and other developed countries engage in international trade, but their own economies originally grew out of small-scale financial loops within urban centers. In contrast, a developing country with open borders participating in free trade can see a single export industry dominate their economic system. The rest of their economy remains undeveloped, and highly mobile investment capital flows out of the country.
Understanding the dynamics of financial flows provides essential insight into promoting economic growth and development. In the US, redirecting monetary policy in favor of the poor and working class would not only relieve income inequality, but foster more sustainable economic growth for capital and labor both. When it comes to international development efforts, interventions should focus on strengthening diversified local flows of money. Otherwise, monetary aid is likely to flow back out of the developing economy.
Phone: 617-547-4100 | Fax: 617-661-7711 | Email: office at necsi.edu
277 Broadway Cambridge, MA USA