From the Notebook

Some Thoughts about the Economy

blogqz01 | 02 November, 2009 16:50

The topic of economy includes many things, and it is a topic that is lack of clarity. So, in this post, I am going to talk about a few things related to current economic crisis.

Unemployment is a lingering problem for now. So, I like to ask questions about unemployment. Going back to basic, in a perfect society, unemployment should not be a serious problem.

Assuming people are willing to work, and have certain skills or ability to be trained to obtain certain skills, then everyone should be able to perform certain tasks that will provide certain value to the society, thus should be able to work.

Thus, the phenomenon of high unemployment reflects the inefficiency in the society, and wastes of the human power. When there are capitals available for investment, then it reflects the ineffective use of capital.

In ancient times, especially in Christian countries, lending practices were restricted based on moral issue and for fear of increase instability of the society. However, lending in broader sense was not absent event in those times. When land owners permit others to use the land to produce crops in exchange for part of the produce, it was lending.

The positive use of lending practice is when the capital put in will generate more value out put. However, in the market economy, measurement about value could be complicated.

For example, if the market demands for certain product are in certain level, then increasing productivities would likely to reduce the price of the product, and even if the demand increases, the actual return might not increase. Thus even though the investment generates added value, it would not necessarily generate return of the investment, especially profits.

However, if the investment is used to improve the quality of the product in significant way (mostly to increase features of the products) then the value of the product is increased, thus even if no additional output is provided, there could be a return in the investment greater than the input. And, the added value could be enough to generate a profit (although it might also but be the case).

If the investment is used to generate a product or service that is in high demand, then the return could very much be to assure a profit. If the investment is used to generate certain product that has no market demand, then the investment can be a total loss.

The goal for the provider of particular product or service is to provide the product or service that is in high demand. Therefore, market information is gold. Finding demands and meet the demand will assure success and profit on the investment.

However, from the society point of view, there is a bigger question about whether the overall demand is increasing. Otherwise, the overall return on the investment could not be sustained.

Theoretically, if new investment are put into business, then it will be used to hire new people, buy equipment, and so on, then it will increase the demand. But if the investment is a total loss, then the demand is not re-occurring, thus loss in business investment will result in reduction in demand. The more loss, the less of demand, this will pull down the economic development.

In addition, although new investment can increase demand, the new investment cannot create the demand required for profit. From the real world prospect, the new investment could generate more values that justify the profits for investment. For example, if you borrow money to sustain your livelihood in order to produce product, the goods you produced could be greater than you consumed.

The disconnection between the market economic model and the real world value generation seems to be a fundamental flaw in market economy. Different attempts had been used to solve the problem generated by the economic model. However, because people failed to pay close attention to the source of the problem, no solution is sustainable.

For example, many people believe that the key to sustain economic development is to find new demand, which is interpreted as finding new market. Thus the early days of capitalism history had been filled with cases for forcing free trade to other countries. But, even if this attend is successful without resistance, soon the world will run out of new market.

New approaches in generating demand include increasing the consumer spending by providing and increasing consumer lending. But the problem about consumer lending is that it does not increase the overall market demand, it actually reduce the overall market demand. Unlike commercial loans, the consumer loans cannot generate income for the consumers, and the interests paid for the loans are reductions of the purchasing power.

In addition, the way consumer loans are provided by private financial institutions is counter effective to the economy. When time is good, they tend to issue more consumer loans so that it will generate balloon effect that more demand will be provided than usually. And when the time is bad, they will provide less consumer loans so that the market condition will be worsened than usual.

To go into further detail, there are two kinds of consumer loans: credit card loans, and home mortgage loans. The effects of these two loans are different. Credit card loans are loans that are generally used for direct purchase of goods or services, thus this kind of loans will have effect on the demand of market for goods or services that will directly increase employment.

Home mortgage loans, on another hand, have different effects. As homes are unique things that supplies cannot be quickly increased, dramatic increase in home mortgage loans that generate demands will likely to dramatic increase home prices that the long term effect will most likely be raising labor cost and reducing purchasing power for other consumptions.

Raising home price will have immediate benefit: home equity loans can be use to increase the purchasing power of existing home owners, and construction jobs will be generated from new construction works. If the increase in home prices is due to economic development, i.e., due to greater employment and increased income, then it is nature that runs its course, thus sustainable.

If the home mortgage loans are given to people beyond their ability to pay, the increase in home prices are obviously the bubble effect. For this reason, I could not see the reason for permit the practice of “balloon payment loans”. To me, the only effect is to artificially generate demands that will destabilize the home market and economy.

Focus on home prices and home construction increase is due to the fact that in United State, construction industry is a relatively reliable industry for generating domestic employment. But since the effect is not direct, the benefit is not reliable, and may be outweighed by other factors.

There are many talks about outsourcing, and it often turns into the people in United States versus the people in China, India and some other countries. But the reality is not so. The effect of outsourcing is not that people in China, India, etc. win at the expenses of people in United States. What people in China or India gain is not directly related to what people in United States lose, otherwise there would not be any point for doing so.

People in China, India and other countries cannot rely on taking jobs from people in United States as source for their economic grow. The population of China and India combined is about ten times as much as United States, it is simply impossible for them to rely on United States to fuel their economic development (at least not for long).

What is troubling about outsourcing is that it did not actually generate sufficient middle class in China or India, while reduced the middle class population in United States. What it actually did is further concentrate of the wealth on smaller amount of people.

The health of market economy relies on the economic equality. For the market economy to work well, wealth ought to be spread, the broader the better. If most people have reasonable amount of money, the demand on the market will be greater than if only small amount of people have the most amount of money, because most likely they would not be able to consume the money on goods or services to fulfill the requirement of demands.

The structure of business in United States has been a topic in recent time. Less new companies emerged, and merger and acquisition practices accelerated. There are frequent discussions about executive pays in large corporations. But the problems go further.

The idea of free market economy is that it will provide free and viable environment for competitions and may the best win. But as corporations grow in sizes, the mere sizes alone become an advantage in market position preventing free competitions, and often become obstacles for changes and innovations.

Internally, the structure of most businesses is basically hieratic structure. Democracy and freedom do not usually apply in most businesses. In addition, as the ownership and control are in effect mostly separated, abuse of power, and private club culture basically created a new ruling class that often are out of touch and untouchable. The viability of private enterprises is undermined.

This business landscape is the results of focusing on price and market share alone (related with the policy on capital gain taxes). If people interpret competition only based on prices, then larger market share and large corporation using any measure that reduce production cost would be the key.

But as I mention in the beginning of this post, this method would not necessary provide return on investment, especially generate profit. It will require constantly increased market size and constant cost cutting. Or, firm with monopoly power will use it to unfairly obtain their share disproportionate to the value provided.

Questionable advertising and marketing campaign that miss lead consumer to use certain product or service is the result of this practice. The type of business does not attempt to find and meet the demands, they try to trick the consumer to use their product or service, even if the consumer would not otherwise need to do so. This type of practices requires higher cost on advertising, and may often cause damage or other negative effect on consumers.

From the society and consumer point of view, businesses should pay more attentions on finding and fulfilling real consumer needs. For this purpose, more small and medium sizes businesses ought to emerge.

The development of internet provides more and more transparency for communications, which will help to reduce the marketing barriers for small business, and help to establish direct communications with the consumers for finding and tailoring into consumer needs.

Mass production certainly reduces the price of goods, but it often result in product overload, which is wasteful of natural resources (which will generate environmental problems), and often reduce the quality of consumer experience.

Creative is a commodity that cannot be mass produced, and are at least inefficient for the machine trying to produce (no matter how advance the artificial intelligence advanced), but the value could be tremendous.

As small business would most likely have the motivation, drive, freedom and flexibility to be creative, there should be and could be more and more small business that will emerge to better serve the society.

From the society point of view, the increase in productivity should transform into increase in purchasing power in order to provide needed return for investment. Therefore, government oversight should include monitoring increases in productivities and to make monitory adjustment and the use the money to fund new governmental project that generate more demand in economy and have positive impact on the future of economy and society development.

Government actions have been used to counter the economic cycles. But the focus primarily is on adjusting the interest rate. Lower interest rate often directly results in higher home prices, thus often provide a source of instability in the economy that may be out of control. A more direct result effect on the economy may be obtained by direct or indirect involving in consumer lending, i.e., to expend lending in downtime, and reduce lending in better time.

The government can also initiate or back projects that will direct investments from vicious cycles into generating positive effects. For example, as I suggested in my earlier post regarding direct sea water into desert, the transformation of land will increase the value of the land and make it more useful and productive. Thus the investment will generate return and even profit.

It seems to me this project would provide good use of capital and human resources. For the world point of view, it will reduce global warming, reduce nature disaster such as hurricane, tornados, storms, floods, droughts, and even wild fires. Some materials (including new materials using nanotechnology) can be used to prevent cross contamination of the fresh ground water), and in the future, bio-chemical agents can be used to convert salt water into fresh water.

**Please look for my later posts regarding Economy, modern life, "Stop Global Warming - Change the World" and other related posts about discussions related to issues in this post.