The goal is to provide an explanation of how an economy works and, more important, understand how it works. What makes an economy difficult is the size, all of the parts work the same on a smaller scale but when there are lots of interconnecting parts, it gets complicated. Now, consider that instead of lots of interconnecting parts, consider if there are millions and millions of interconnecting parts, now it gets complicated.
The nice part is that everything works the same on a large scale as a small scale, but when considering each part, the number of steps and connections expand along with the options and variations. On top of everything else, you must also consider the unknown. Most projections fail because there are too many variations that are not considered and can have a dramatic impact.
Consider the oil shortage of 2008, gas prices were high and this is having an impact on the economy, the discussion of why is coming up later, right now, the topic is a variation that no one expected. When the price of a particular commodity is excessive, the world's inventors and innovators start popping up and generate alternatives. Here is the basic underlying principle, profit inspires innovation. Anyone can develop something new if there is an opportunity to make a profit but so many of these people need to wait for the price of the existing commodity to rise. During the shortage of 2008, two primary alternatives were developed. First, there is fracking, a method of extracting oil and gas from shale rock. Second, a number of smaller oil fields were developed, oil fields that Obama had tried to suppress. The price of oil provided the means for the development and expansion of these new technology.
The economist failed to understand these changes so they failed to recognize the impact of the alternate sources of energy. In considering the economy, part of the problem is predicting the unknown. Yes, this is difficult but the solution is to consider where there are potential problems from shortages and price increases will occur, then attempt to identify the impact of the solution. No, you can't predict fracking, but you can predict the eventual development of an alternative energy.
ECONOMICS OF CONSUMPTION
When considering economics, you must understand that the entire economy is based on the consumption of goods and services by 'consumers'. Consumers are defined as anyone that buys goods or services and some of these goods may be parts to other finished products. Everything that is bought by consumers is produced by someone else, this production is the result of the consumption demand. This demand is filled by producers based on the profit motive of providing goods and services.
Back to the basic principle of economics, everything is based on a profit motive. Unless something has the potential for profit, then the demand will be unfilled, which brings us back to the options and alternatives. Let's consider the consumer and the demand. If the consumer was willing to pay any price for any product then just make the biggest, the fastest, the best product but price is always a problem because of the scarcity of resources (including the money the consumer has to spend). The goal is to always get the greatest fulfillment at the least price and this is where competition comes in. The producer of the product must provide the most cost effective solution to a particular need, designing trade offs of durability, functionality and cost.
In that last paragraph several topics were introduced that need further explanation. First, the scarcity of resources, second, fulfillment at the least price, and third, competition. Scarcity of resources is a fact of life for both the producer and the consumer. The consumer has a limited amount of money to spend on goods and services and must prioritize the desire to satisfy these needs. However, the flip side is also true, the producer must find the required materials at the lowest possible price and, when the price of those materials have an impact on the price of the final product, the producer will seek an alternate material.
From the perspective of the consumer, While it would be nice to be able to buy whatever you want for almost nothing, this is unrealistic. Everyone has desires that they want fulfilled. This is based on a hierarchy of need starting with food and ending with purchases just for the fun of it. When these desires are satisfied (for the consumer) this is fulfillment and the fulfillment, when combined with the scarcity of resources this means you want to spend the least amount of money: fulfillment at the least price. Of course, there is a flip side and for the producer, the fulfillment relates to the acquisition of the materials for producing the consumer products, once again, at the price which allows the producer to make the needed profit.
Lastly, the concept of competition. This is very simple, every seller of products wants you to buy from them so they must offer the best price and the greatest fulfillment. However, every producer wants you to buy their product, so they will offer a variation of the best price with the best features, in hopes that the fulfillment offered by their product will exceed the fulfillment of other products. Remember, every person has different needs so their fulfillment requirements are different. Competition throws a new wrench in the works because every producer will develop new materials for the product to reduce the overall costs to make the product less expensive. On the flip side, competition is exercised by every consumer because they are looking for the best product at the lowest price to satisfy their needs, part of the 'Keep up with the Jones' mindset.
The pricing of material is based on scarcity and can be pretty consistent as long as the demand does not jump. Besides material there are two big components of the producers cost structure. The first is the facilities and the second is the labor. The utilization of each component can vary depending on how the components are integrated. Facilities are considered to be the physical structures that are used for the production of the products. Bear in mind that there is no way to detail every variation, the facilities for oil conversion from crude to finished products can cover acres where the small businessman may have a shop that is no more than 1,000 square feet. The facilities must be capable of generating the volume of product needed to satisfy the demand so it changes for every company. The business must make the decision as to how to allocate the costs of the facilities in relation to the desired labor costs.
This is a relationship that, 50 years ago, would not have been an issue. The current levels of technology provide the means to replace manual labor with mechanical or electronic options. The functions performed by manual labor, in many manufacturing operations, is comprised of performing the same repetitive motions. Technology has developed the robotic ability to duplicate the motions, eliminating the human contribution. The cost of implementing the technology is offset by the long term savings of the elimination of manual labor. This is where the decision is made as to the overall level of the investment made in the facilities. This investment provides the means to reduce labor costs however, this same decision creates specific limitations on the potential variations that can be made to the production facilities and output. One consideration is that the mechanical/electronic systems will require staffing that is higher trained and compensated than the average production worker, so there is a trade off which results in overall lower production costs but a work force that is more highly trained than before. Consider also that properly designed and maintained mechanical/electronic systems will provide more consistent quality than the same functions performed by human, not necessarily higher quality but more consistent quality.
Labor is the only commodity which can be sold by the individual to the consumer in the business. Every member of labor comes with a specific set of skills, characteristics and abilities. Most important, the cost of obtaining this labor by a business from the individual does not have a set rate. Every consumer, in conjunction with the market as a whole, will offer a price for the labor being provided, which may be unique to the skill set being offered. The value that labor contributes to the business is what the offered price is based on, labor which provides a unique set of skills can contribute more value to the business than an unskilled worker providing labor.
One of the issues is the cost of providing the training which will bring the labor to a more productive level with higher contributed value to the business. In the past, an apprentice was assigned to a skilled labor and learned the skills through training from the skilled labor, often at no compensation or minimal compensation because this time was an investment in the future productivity. Society no longer permits unpaid apprentices, preferring to be stuck with labor that has no skills but believes that putting in time is the same thing and contributing to the business.
The three basic components of the economy are Material, Facilities and Labor. These three components are integrated in various ways to create each product that is consumed, The purpose of this study is to figure out how to integrate these components in the manner that provides the greatest increase in productivity across the entire economy.
The primary issues that must be resolved is how to develop the economy to provide the greatest number of jobs with the highest average income per person. The economy is judged by growth in output as measured by value, showing a percentage increase or decrease. In order to create jobs, we need a growth in the national output. Now think back through the previous discussions and consider, how can you create new jobs knowing that these jobs must generate output and that output must be consumed by someone somewhere? This is a vicious cycle, create jobs and the jobs buy stuff, creating a demand requiring additional output requiring new jobs, but there is one problem, the output must be consumed because inventory cannot be allowed to build up. The problem is a matter of where the output will be consumed and by whom. In order for the jobs to consume the output, the labor compensation must be high enough to provide disposable income. This is one of the really stupid problems in many economic claims, while it is possible for average 'income' to increase, if the basic costs of living are maintained then disposable income will increase, but in the recent past, if the income rose, it was offset by overwhelming increases in the health care costs.
If we are living in a closed environment, then the output would be bought by the population maintaining a cycle, but we live in a world where other people generate output and sell it to us, and we sell to them. Whenever any imported products are purchased by domestic jobs, there is a negative balance created which leads to a loss of jobs domestically, it is critical that output leaving the country matches or exceeds imports or there is a problem. You wonder why???
Very simple, the best paying jobs are jobs that are engaged in manufacturing because value is created and the labor pool is utilized. As the labor pool is utilized then the average compensation levels increase providing the means to purchase more of the domestic product. In a market where the imports create a negative balance, the good jobs reduce which means that the service industry jobs increase. This is not a slap against the service industry, but the lowest compensation is found in this area. Which brings up the problems with a minimum wage. Read the discussion on minimum wage.
Manufacturing has moved some of the production facilities out of the country because of the options of lower wages for labor, providing the means for the cost to be lower, providing higher profits for selling the same price with the lower cost. As discussed earlier, the option to lower labor costs is the investment in facilities. While this could provide opportunity to increase manufacturing in this country, part of the issue is convincing the consumer that these products are better than the options (back to competition).
In order to make products that are comparable in price, domestic labor cannot be solely used and must be integrated with machine/electronic options. This will permit the price to be lower but the labor involved is reduced so the number of jobs will also be reduced and the number of consumers drops. This makes the product consumption lower in the domestic market and the product must compete on the international market. The nice thing is that the reduced labor involved will be higher paid because of the need to manage the interfacing with the machine/electronic options.
Many leaders have declared that they will increase the jobs by introducing high tech jobs, providing a means of increasing the pay structure. The problem is still the same, while there may be a limited number of high tech jobs, these are limited because once the processes are established for the manufacturing, these manufacturing functions can be exported for the actual labor portion of the operation, in much the same way that Apple has developed the iPhone in the USA but shifted manufacturing to Taiwan. In order to maintain the manufacturing operations in the USA, the issue with the labor must be solved because continued union controlled high paying low productivity jobs cannot solve the problem.
Yes, this is a slam on unions because unions have failed to grow and change with the changes in the economy. Unions were started to force business owners to provide higher compensation levels, however, as the market developed, the union was no longer needed to maintain the compensation levels because the worker can move from one company to another for better money because of the demand for skilled labor in a competitive market. In order for unions to remain relevant, the unions must work with the business to make the employees more valuable, more trained/skilled and more productive.
Unions have, over the years, become the bully and aggressor of the labor market. However, this is not in the best interests of the worker or the business. Unions strive to provide coverage for the worker without regard to the employee to perform at the highest level, instead seeking for the mediocre level. Unions should provide continued training and growth assistance to the employee in their growth, developing paths for an entry level employee to grow in the productivity and quality. However, this is not the path the unions follow, they stress membership and dues and membership means that they must be willing to accept anyone as a member and bring the average productivity down to include the new participation level.
Unions have the option to provide information to members so that the members can provide for their own future through retirement savings but they union would prefer to collect dues and promise the delivery of pension benefits. However, there is a concept called unfunded liabilities in which the balances maintained by the union for these benefits is not sufficient to cover the long term disbursements required by the pension plan. Unions could negotiate compensation rates which are beneficial to high productive employees however, this would not be acceptable to those employees that do not want to make the effort. Instead, unions work towards conformity and seniority.
On to the real problem. Consumption must be feasible based on the price of the product. For generations, in the past, the world was willing to buy USA made products because of the technology, however, other countries have stolen the technology and the failure of the government to enforce the laws has permitted these countries to steal the technology then produce the products with lower costs and, therefore, lower prices. Consumption of these products reduced the production options of the domestic market, therefore shifting these jobs and compensation to other job levels. As this shift progressed, the average compensation drops, not providing the populace with the ability to consume at the needs levels of domestic products.
The question becomes the best approach to reverse this problem. Step one is the federal government must enforce laws regarding patents and production of developed products. There is a reason that the VHS tape systems were not being manufactured in the US towards the end of the cycle because the foreign companies copied the designs and manufactured the goods at lower prices, destroying the domestic production. At this point in time, China has stolen considerable technology and the Obama administration has failed to enforce laws, losing US advantages and manufacturing.
Second, the time has come to review every manufacturing process that has left the US over the decades including conversion of cotton to fabric and steel production. These industries left the US because they are labor intensive. We need to convert all of these industries to automated systems, requiring little manufacturing labor but considerable electronic and mechanical maintenance and development services will provide high paying jobs. The issue is that converting to electronic and mechanical systems allows production to be reduced or increase, as needed, to meet demand. The critical components are: first, production capabilities that can meet the cost component needed to compete against international options, and, second, products that can provide consistent quality that can meet or exceed the quality of other production options.
Third, development of new high tech products and capability. The US has the capability to out develop every country because of the profit motive. This motive allows any person to imagine a new concept. Consider the scope of wealth that has been developed by the explosion of software for smart phones, millions of apps sold for $0.99 each results in an explosion of wealth at all levels of the economy. The newest apps can be developed by the individual and marketed and sold by the individual through a market that allows the market to determine the quality of a product by buying or rejecting that product. The market has developed thousands of new games to distract the user, but at the same time, thousands of new business and personal growth apps have been developed, all distributed through a the Internet.
New products are, so often, the result of small business growth and garage developers, there is so much development from the imagination of the individual. New products are the result of someone wondering if this can be done or how about that. This exploring inquisitive attitude is a result of the freedom of capitalism. Capitalism does not require permission or prior approval (as long as it is not illegal). Capitalism has one overriding requirement, that the product offer a means to generate a profit. Unlike Socialism, which allocates resources, capitalism permits anyone to acquire the required resources and attempt to create a new or improved version.
What does it take to energize an economy? First, jobs must exist that provide income with an opportunity for growth, advancement. Second, the output of the economy must be managed to allow for the consumption of the output while providing a profit. The jobs create disposable income and the output, generated at a profitable level, provides the means to create the cycle needed to maintain the economy.
Never believe a politician when they offer an answer that cannot be supported with answers. Jobs don't exist because of wishful thinking, jobs exist because there is a reason for people to hire other people and to create output. When a politician declares that things are improving, look at your own life and determine if your life is better. That answer determines whether or not the economy is improving for each person and it is the combination of all of the people that determine how well the economy is doing.