The Two Markets

the economies of the economy

An economy is actually a series of economies linked together, at the local, regional, national, and ultimately the international levels. For this reason, in other languages it is also called the conjuncture (German Konjunktur; French conjuncture). [1]

In her book Cities and the Wealth of Nations, Jane Jacobs takes this insight one step further, viewing economies at their fundamental level as city-based and city-centered units, with with the larger economy being an interconnected complex of cities. For our present purposes we do not need to advance Jacobs’ thesis further, but it is well worth the reader’s perusal.

These economies likewise generate flows between each other, goods and services on the one hand and money flows on the other. But since they do not run in perfect synchronization, there will be imbalances generated between them. These come about, for instance, by the emergence of greater demand for the goods of one economy over the other, leading to an excess of “imports” to one economy, which are “exports” from the other. This imbalance will trigger a rebalancing, as prices and wages diverge. In the export economy, prices and wages will rise as a result of the net money inflow from exports; in the import economy, the reverse will happen. Higher prices and wages, in turn, will draw mobile factors of production, seeing as how a greater return can be obtained there. Mobile factors of production include raw materials, intermediate goods (goods used in the manufacture of other goods), and labor. On the other hand, lower prices and wages in the import economy attract capital and thus investment.

new-4b watermark

Figure 4: Flows Between Economies, Unbalanced












Figure 4 gives an idea of how this works. In the economy experiencing a trade surplus (the “export economy”), production exceeds consumption, which yields the excess (the “imports” arrow). The balance of trade is thus unbalanced. In the economy with the trade deficit (the “import economy”), consumption exceeds production, and the excess effective demand pays for the imports that supplement indigenous production. How is this excess demand financed, since in this economy consumption exceeds production (and thus remuneration)? We will discuss this important phenomenon in due course.

For now, it is important to point out that, barring interventions, the balance will be redressed by various shifts. First, so-called “mobile” factors of production, primarily labor, will migrate from the import to the export economy, in pursuit of the higher wages obtained there. This will shift consumption from the import to the export economy. Second, lower prices and wages in the import economy will attract investment and, eventually, new production, shifting production from the export to the import economy. The shifts are reflected in the respective arrows in figure 5: production is in balance with consumption, and the balances of trade and of payments are likewise in balance.

Figure 5: Flows Between Economies, Balanced
Figure 5: Flows Between Economies, Balanced

[1]Carl Menger wrote eloquently about the need to study the economy in this manner, as a conjuncture of economies rather than as a monolithic national economy. “The nation as such is not a large subject that has needs, that works, practices economy, and consumes; and what is called ‘national economy’ is therefore not the economy of a nation in the true sense of the word. ‘National economy’ is not a phenomenon analogous to the singular economies in the nation to which also the economy of finance belongs. It is not a large singular economy; just as little is it one opposed to or existing along with the singular economies in the nation. It is in its most general form of phenomena a peculiar complication of singular economies….  Whoever wants to understand theoretically the phenomena of ‘national economy,’ those complicated human phenomena which we are accustomed to designate with this expression, must for this reason attempt to go back to their true elements, to the singular economies in the nation, and to investigate the laws by which the former are built up from the latter. But whoever takes the opposite road fails to recognize the nature of ‘national economy.’ He moves on the foundation of a fiction, but at the same time he fails to recognize the most important problem of the exact orientation of theoretical research, the problem of reducing complicated phenomena to their elements.” Investigations into the Method of the Social Sciences, with Special Reference to Economics (New York : New York University Press, 1985 [1963], p. 93; cf. also Appendix 1. The original German edition was published in 1883.