Understanding Economic Balance using the Household Model

By Mark Sowers

November 2018

People who rally against federal deficit spending often compare the Federal Budget to a household budget. "A family should never spend more than it can afford," they say. "Our government shouldn't either."

The analogy is generaly not accurate because the rules that governments follow when paying bills are somewhat different than the rules a family must follow. But I think the analogy can help us understand an important economic concept that may not be so obvious at first glance.

The first thing many young people do after graduating high school is invest in their education. This usually means placing themselves deep in debt (student loans) without having a job that will support that debt. But most people consider that debt acceptable. The hope is that a little investment now will pay off with a better outcome later on.

Then as these young people start their family, they often buy a house. This purchase adds significantly to the debt they already have.

What is interesting is that the people who claim that budgets should be balanced and that you should never spend more than you have, don't seem to advocate against home-ownership or getting an education. They understand that going into debt can, in some circumstances, lead to a better life for everyone in their family.

What folks who make the government/family comparison seem to forget is that when family-members support each other, they generate economic benefits. A family is not just a group of individuals where each member is independent and self-sufficient. After all, if everyone is self-sufficient, then what do you need a family for?

A family is there to support each other. To help each other. A family doesn't simply ignore members who don't pull their weight. A family doesn't shout, "Get a job!" to those who are not yet ready, or are no longer able, to hold one.

A family will encourage and promote its members who will be productive in the future. A family will also will take care of those who are no longer able to be self-sufficient.

A family recognizes that some of its members will be the more economically productive, while others will play more supportive roles. These supportive members of the family are just as valued and cared for, even if they may not be as economically productive (at least not directly).

In a traditional family from 50+ years ago (the 'ideal' family that many folks are nostalgic for) there was one member who was economically productive and provided for the rest. Other family members didn't earn a paycheck, but that was OK because they understood that a person's economic productivity is not the only standard by which you measure someone's worth.

Even in a traditional family, the resources of the family were shared among all members. All members benefitted from having food, shelter, and healthcare. Non-working family members were never told they can only have food that their own paycheck provided for. They were never told that if they get sick, they better get a job that covers their healthcare costs.

The reason the family works so well from an economic standpoint is that it takes the hard-earned money from the wage-earner, and distributes those resources in a way that benefits everyone within that family. This is not seen as hurting or discouraging the wage-earner, because that wage-earner reaps rewards other than monetary wealth.

This distribution system allows for a very important economic concept to come into play. This is the concept of division of labor. Instead of everyone having to do everything for themselves, with the division of labor the person who is good at raising the children does so. The person who is good at earning a paycheck does so. The person who is good at learning new things so that they can become successful later in life does so. This system is much more economically efficient than everyone trying to do all these things for themselves.

And making any system more economically efficient, usually leads to better outcomes for all involved.

Notice that the family-system is built upon economic efficiency, not individual economic self-sufficiency.

You can see this same idea of economic efficiency at work in the systems of the house itself.

Back in the old days, large houses used to have several fireplaces, one in each room, to help keep the whole house warm. Each room had to produce its own heat. This system was dirty, took a lot of work to maintain, and didn't keep every location in the house comfortable. In other words, it was inefficient.

But with advancements in technology, we now use a central boiler or furnace instead of fireplaces. A single furnace is able to produce more than enough raw heat to keep the whole house warm. And it does so more cleanly, with less maintenance, and at a lower cost than the old fireplace system. In other words, it is much more economically efficient. Because of the obvious benefits of this technology, new houses are built with a boiler or furnace instead of several fireplaces.

This particular advancement in technology is great. But in order effectively use that boost in efficiency, you need to add one other very important element.

Imagine you lived in one of those old houses with a fireplace in every room. A salesman comes to your door and offers to replace all your fireplaces with a much more efficient furnace. He shows you the numbers that prove that the furnace will generate more heat, more cleanly, and at a much lower cost than your current fireplaces. And he is right. The numbers do add up. So you rip out all your old fireplaces and install a furnace.

But when the first cold snap hits you realize there is a problem. All the heat is concentrated in the room where the furnace is located. The rest of the house is cold. "No problem", says the furnace salesman. "Just keep the doors to each room open and the heat will trickle-down to all the other rooms."

Again he is right. Even the room farthest from the furnace will be warmer than it otherwise would be if there was no heat source at all. The furnace has raised the temperature in all rooms. Maybe the temperature did not rise equally, but all rooms felt a 'rising tide' of heat compared to a house with no heat at all. And this happened at a much lower cost than several fireplaces.

The problem of course is that this efficient furnace has created some other inefficiencies. Family members now rarely use the outer rooms because they are too cold. And they almost never use the furnace room because it is too hot. So they end up living in a very narrow zone, and the rest of the house has essentially gone to waste.

The very important element that the furnace salesman didn't tell you about is the 'ventilation system'. This is the fan and ductwork that distributes the heat from the furnace all around the house. It's true that adding such a distribution system does add inefficiencies. The fan and ductwork cost quite a bit of money upfront to install. They also use more energy on a day-to-day basis, so they add an ongoing expense.

When you measure a heating system's value based solely on its ability to produce the most heat at the lowest cost, a furnace without a distribution system is clearly the winner. But when you measure a heating system's value based on how well it improves the lives of everyone in the house, while still keeping costs low, then the furnace with the distribution system is a much better option than a furnace alone.

Even with all the added costs and inefficiencies of the distribution system, the furnace with the distribution system is still much more efficient overall than having a fireplace in each room.

This concept applies more generally as well. Yes, distribution systems by themselves are inefficient. But when used with the most efficient generation-method possible, the combined system is still much more efficient than most other options.

When it comes to generating wealth, no other system comes close to capitalism, technology improvements, and free markets. By their very nature, the combination of capitalism, technology, and free markets are able to adjust to changing conditions, and produce innovations at a far faster pace than any other economic system. It is the most efficient economic system known, and therefore it is the system we should use as a basis for economic growth.

But to run effectively, it needs a distribution system so that the economic gains can be realized by all who participate. The key to a successful economic system is to have both a supply and a demand for products. Both of these are equally important to making the system work. Without supply, the demand goes unmet. Without demand, a supply is worthless. Both sides must be nurtured.

Capitalism creates the supply. But if customers don't have money to spend, then having a large supply of products benefits nobody. It is the distribution of profits that keeps the equation balanced. Not all profits, mind you. Profits are critical to creating incentives, and producers need to be allowed to benefit from their hard work. But if producers keep all the profits, then the buyers will have nothing left to buy with, and producers won't be able to sell their products. Everyone loses.

The government's role in an effective economic system is to distribute some of the profits to the rest of the 'family'. Everyone in the 'family' should be able to expect that they will have food, shelter, and healthcare. Even though a member may not be contributing directly to the 'family's' finances, they are contributing to the overall economy through their purchases.

Every room in a house serves an important function, even if that function does not involve producing heat. And likewise, every person in an economy serves an important function, even if that function does not involve directly producing income.