Transfer Payments are good for the Economy

Amit Gupta
8 min readDec 24, 2017
Trickle Down Economics. Tribune Media, South Florida Sun Sentinal

It is an easy and obvious argument to make that transfer payments do not increase total wealth. How can moving money from one person’s pocket to the another’s actually do anything? A transfer payment such as medicare, medicaid, social security, or any other form of entitlement or social welfare program, is essentially a way to move money from someone who is rich to someone who is poor. If you’re poor this is an easy system to like because it inherently means you benefit by receiving “someone else’s” money, and if you’re rich this seems terrible as you are losing your money to someone you do not know, and thus can easily label as undeserving. Even if you did know the person first hand, it is hard to ever give something up, especially that which you perceive you have earned or deserved.

Transfers are supposedly wasteful because they do not involve the purchase or creation of capital stock.One of the most basic rules we learn in macroeconomics is to ignore transfer payments as part of government spending when calculating GDP. Government consumption and government investment are what increase GDP since they involve the purchase of goods or the production of new capital stock whereas transfers are just moving money around. The irony of the argument is that economics is all about moving money around. Every time money changes hands it signifies an increase in the GDP, not because the money itself has done anything, but because it’s movement is coupled to the exchange of a good or service. Money has made the world a better place by acting as a supreme medium of exchange because exchanges benefit society. Money allows a system where we don’t all have to be farmers to eat. Instead we can each specialize in the fields that best suit us, create value for people we do not necessarily ever need to meet, earn money in exchange for the value we create, and spend that money on things that bring value to us such as food, housing, and entertainment. Money permits the free flow of goods and services by enabling trade, thus expanding our production-possibilities frontiers.

The most harmful thing money can do is become stagnant. Money that is stagnant does not induce any form of wealth creation or improvement of people’s lives because it is not being exchanged for anything. In reality, money is just a way to extract out human effort from the system. The value of everything we buy is inherently priced in terms of the value of human effort needed to make it. Whether that is ore that has to be dug out of the ground, plants that have to be cultivated and harvested, or services that have to be performed by someone, the value of everything we spend our money on comes from the fact that we are inducing someone to work. This work is energy people input into the system (our societies) and is what keeps it running and improving. The total wealth any society has is the amount of productive energy its citizens are willing to expend. Even in a globalized economy, our wealth comes from the energy of our own citizens who produce goods and services we either use within our own society or trade with other societies. Every time we import a good we send out our domestic currency to that country as a chit entitling them to our goods and services, redeemable whensoever they choose.

So what does everything above have to do with transfer payments? How does moving money from your hands to my hands without the exchange of a good or service, the point of money, benefit anyone? From the outset it appears to be a zero sum game where no new wealth is created. The industry that most derides welfare, but itself is actually one giant system of transfer payments, is finance. Many argue that finance is a zero-sum game, and anyone familiar with me knows my general antipathy towards Wall Street. If we take for example the wealth management industry, you have a large pool of investors who each giver their money to different money managers. Each manager competes against the other managers to achieve the highest return on investment, and eventually the managers return whatever money is left over, after their gains and losses, to the investors minus fees. The end result is a redistribution of money among the investor pool with a sizeable portion extracted by the money managers in exchange for their services. What we get by the end looks like a simple redistribution of wealth, but the movement of money also resulted in the allocation of capital to different projects that need financing, as wells as the fair valuation of different companies debt and equity. These are important results because the proper allocation of capital is what allows companies to innovate and pursue positive net present value projects. These projects require an input of capital from someone not currently using it for goods and services, and allows the company to create new goods and services it can sell for money, then return that money to the investors who use it to exchange for more goods and services.

Thus, the allocation of capital takes us from a state of stasis where nothing is being done with one’s money to a point where it can be used to positively induce human effort towards productive effort. This required a market for transactions as well as fairly priced debt and equity so that investors and companies would both get a fair deal. Combined, the two things prevent money from going stagnant, and instead keeps it flowing. It is why the banking industry is of utmost importance to an economy because it prevents money from being hoarded and sequestered away. Instead, money is continually being put to use in order to generate constant productivity. It is also the reason why fractional reserve banking is an amazing system that creates a way for the Fed to pump money into the economy, in excess of the monetary base, in order to generate more exchanges of goods and services as banks loan out money to those who need it for making purchases or investments.

Transfer payments are an important way to keep money moving, that do in fact generate greater wealth. The world we live in today is one where wealth is constantly leaving the majority of people and being sequestered away by the top of the societal pyramid. We are seeing growing wealth and income inequality in the United States which is a dangerous state, for both the rich and the poor. If poor people have no money, then they cannot afford to buy anything from others that is not of the utmost necessity to their immediate survival (should they even have money for food and housing which many conservatives seem not to care about). The lack of the poor having any spending power means that new technology is not produced for the poor which leads to a lack of innovation because there is no sizable market for innovation. Innovations come out of their ability to make life better for a large number of people and requires pain points from people who demand an improvement.

Think just about innovations in the house. If you have a bunch of lords and ladies in their mansions with the cheap labor of servants living on the edge of poverty, the nobility have little pain. They do not need an electric dishwasher because someone does the dishes for them; they do not need a vacuum cleaner because someone sweeps the floor; they do not need a toilet because someone comes in and cleans out the chamber pot for them.

Now should the lords and ladies pay taxes which transfer wealth the servant class, you have an entirely different system. The extra money afford the serfs a newfound independence. The people can purchase leisure with their free time, and thus have a greater reason to value their time. Since they are no longer living on the edge of death, they have greater leverage which to demand higher wages from the rich which increases the price of labor. Now that the people have more money to spend, and the rich have less, fewer people are employed as basic servants and others can seek to improve each others’ lives. The working people do not have an army of servants to cook, clean, and do the dishes for them, so they require labor saving devices. Since they are not on the edge of death they can spend money on more than just food, and can improve their personal hygiene to take care of themselves. Innovators now have a greater market to serve that demand new technologies to make life better for the people. In fact, these innovators may just be the same landed elite who once commanded the people as servants, but now have found a way to remain wealthy while improving the lives of everyone else.

The above example was far-fetched, but illustrated an important point that an income distribution creates a system that improves overall welfare. It is extremely important to have a system where labor is expensive because that is what forms the basis for innovation because we have an incentive to create new technologies that free up our time for more productive tasks. When it is cheap for rich people to get poor people to do everything for them, and poor people have no money to spend on anything, society does not progress. In a capitalist society, everyone is incentivized to increase their personal wealth which requires creating value for others. You never want to reach a state where wealth is amassed and never depleted because then the amount of energy being put into the system slows down and grinds to a halt.

Transfers enable a circulation of money that is spent on improving the health and human capital of the majority of people, as well as giving them the money they need to spend on new innovations and on each other’s goods and services. This inherently increases the overall wealth of a society because the poor hoard less and spend more than the rich, and their sheer size gives rise to new markets for innovation. The fact that we have capitalism ensures people are always seeking to create value for others. Transfers create a leaky bucket that prevents any one person from growing complacent and sitting on money, because it keeps flowing out, which encourages them to find ways to create value for others in order to keep money coming in at an equal or higher rate. The flow of money gives rise to new innovators who can either come from the rich or poor class, but now have opportunities to amass money for themselves by capturing money from the majority of people in exchange for creating value. Some of that money will flow back down again to the rest of society, so that another innovator can capture it, then it will flow out again and the cycle continues promoting hard work and innovation from everyone in the system. Transfers create a necessary gradient that keeps money flowing, and thus promotes trade and value creation. Laughably, it forms the best type of trickle-down effect that Reaganomics never could. Beyond just helping the poor and granting them basic necessities and human dignity, transfers helps society as a whole by promoting innovation, capitalism, and free enterprise.