Thursday, August 25, 2011

The Economy Is Not Like A Sports Game

A good example of a zero sum game is a sports game. In every match or tournament, every team's (or player's in individualist sports like tennis or golf) success comes at the expense of other team's. There can only be 8 teams that for example make it to the quarter finals in the World Cup, meaning that the other 8 teams in the group stage must by necessity lose. And of the 8 teams that made it to the quarter finals, only 4 can make it to the semi finals, meaning that the other 4 teams must lose. And only 2 of the 4 teams in the semi finals can make it to the final, meaning that the other 2 must lose. And in the final, only one team can win while the other must lose.

Now left-liberal blogger Matthew Yglesias thinks that this is a good analogy for the economy. He argues that Estonia's success in turning its economy around can't be replicated in all the other countries with deep economic problems because there is supposedly only a "finite level of demand" that nations are competing for, and that therefore Estonia's success has been achieved at the expense of others, just like victories in sport championships are achieved at the expense of other teams.

There are 3 reasons why this is wrong. First of all, though it is true that trade- and current account balances are zero sum games on a global level it is certainly not one at the Euro area level as the Euro area is only a limited part of the world.
And furthermore, reductions in external deficits in for example Greece and Portugal or increases in the Estonian surplus can be achieved by reductions in the large surpluses of for example Germany, Holland and Finland.

And secondly, Estonia's 8.4% growth has not been achieved through higher net exports. In fact, Estonia's trade and current account surplus has been somewhat lower this year than the previous year.

And thirdly and perhaps most importantly, it is not true that there is only a finite level of demand and that economic growth is therefore a zero sum game. When new productive activities are performed, it is not just supply but also demand that increases. That is why "aggregate demand" always increases during for example periods of technological progress, and that is also why for example the strong increase in exports in Estonia has been associated with just as strong (in fact, slightly stronger) increase in imports.

That is why following the Estonian role model would be good for Greece, Portugal, Ireland, Italy and Spain-and why that would help and not hurt the rest of Europe as well.


Blogger The Positive Sum Strategist said...

Thanks for highlighting this distinction. I think a lot of politicians and pundits make a similar mistake because their world of politics is ultimately a zero sum game (boiling down to election or distribution of power). Then, when they look at the market, they project the same type of game. From there, it's easy to make the wrong analogy using sports.

If politicians and pundits would treat the market as an ultimate positive sum game, it would make life a lot easier for most of humanity.

Yglesias made the opposite mistake in March 2010 when he claimed that public policy is not zero sum. In fact, it has to be, especially in the case of a progressive tax policy. Thanks for your post.

9:41 PM  

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