Our economy is a mystery to almost everyone, including economists. Let me explain the way I see the situation:
(1) The big thing that pulls the economy forward is the time-shifting nature of debt and debt-like instruments.
If we want any kind of specialization, we need some sort of long-term obligation that will make that specialization worthwhile. If one hunter-gatherer specializes in finding flints that will start fires, that hunter-gatherer needs some sort of guarantee that others, who are finding food, will share some of their food with him, so that the group, as a whole, can prosper. Others, who specialize in gathering firewood, or in childcare, also need some kind of guarantee that their efforts will be rewarded.
At first, these obligations were enforced by social norms such as, “If you don’t follow the rules of the group, we will throw you out.” Gradually, reciprocal obligations became more formalized, and included more time shifting, “If you will work for me, I will pay you at the end of the month.” Or, “If you will pay my transportation costs to a land of more opportunity, I will repay you with 10% of my wages for the first five years.” Or, “I will sell you this piece of land, if you will pay me x amount per month for y years.”
In some cases, the loan (or loan-like agreements) takes the form of stock ownership of an enterprise. In this case, the promise is for future dividends, and the possibility of growth in the value of the stock, in return for the use of funds. Even though we generally refer to one type of loan-like agreement as “equity ownership” and the other as “debt,” they have a great deal of similarity. Funds are being provided to the enterprise, with the expectation of greater return in the future.
As another example, governments make promises for future benefits, such as Social Security, healthcare, and payments to the unemployed. These payments are not guaranteed, so are not considered debt. Even without a guarantee, they act in many ways like debt. Citizens plan their lives around these payments, even though they may be reduced or eliminated.
Surprisingly, even “cash” is debt. It is similar to a bond that pays zero interest and has no redemption date; this type of bond can also be easily transferred from person to person. Since cash can be hidden under mattresses, it too can be used as a device for time-shifting.
(2) The big thing that goes wrong in this time-shifting approach to operating the economy is the loss of what I would call an “opportunity gradient.”