Far too many discourses equate inflation, money supply, stock market indicators, commodity ETFs etc to the growth of human civilization. These are man made complications that obfuscate reality.
Economic progress is not the growth in stock market, bond prices, abstract indexes or employment indicators. It is the quality of life that can be afforded by the society. Quality of life includes consumption of basics, non-basic and leisure goods (needs and wants).
In very simplistic terms, economic progress can be defined as
- An increased quality of life (consumption) keeping work constant (or)
- maintaining the quality of life(consumption) while reducing the work require to achieve it
Progress = consumption/ work
Let us again strip the problem down to a 2 person economy.
Savings and capital formation from nitingregory
In essence Productivity is what drives human progress.
4 crucial features of productivity that have been eliminated for the purposes of the presentation
- SAVINGS/ CAPITAL – The Font of productivity: The savings of the mini society allow investment in capital. The capital formation is what allows them to become more productive and create more goods for consumption. The surplus of rice is generated from investment in capital (E.g. tractor)
Savings are good – They represent a sacrifice of under consumption today to create something of value that will make everyone richer tomorrow. For example to make that tractor, the farmer will have to stop farming and invest time and energy in making the equipment. It is possible that he might have failed many times causing his output of rice to fall and him going hungry (delayed gratification).
Socialism advocates that the fruits of productivity increase must be equally distributed. However , I believe that while the gains of creating a tractor in this example accrue to everybody (consumers, employees and investors) they have to accrue disproportionately to investors. This is because only a higher reward will incentivize capital formation (delayed gratification). If all the fruits are equally distributed it leaves little incentive for people to invest in capital formation. “All this does is that it prevents savings/capital and labor to be allocated towards a new value generating sector.”
- PRICE – The Channel of productivity:This is the most vilified and probably the most important driver that allows the chain of events described in the presentation to happen. “Price” directs the allocation of labor and capital. For example when there is a supply glut of rice in an economy, the price falls and the least competitive rice farmers will be pushed out because they can no longer produce the good profitably. This excess labor can then be re-allocated towards fulfilling a new need (E.g.: carrots, mobile phones etc…)
Price subsidies given by the government is nothing but a transfer in savings from one section of the society to support hidden unemployment in a dying sector*. “All this does is that it prevents savings/capital and labor to be allocated towards a new value generating sector.”
- INTEREST – The measure of productivity:This is an indicator that savings are being allocated towards capital formation that improves productivity. (Capital formation is risky business, it can go either way). When the interest is high (e.g.: 100%) it means that if you take a loan of a bushel of rice to help feed some employees while you make a tractor, then the tractorhas to allow you to make 2 bushels of rice to ensure you repay the loan and interest in 2 years.
Zero interest rate environments mean that the incremental productivity required from capital formation is very low. This kind of a scenario favors consumption and not saving. It does not reward under-consumption and saving because saving a bushel of rice to lend as capital will only return one bushel of rice. “All this does is that it prevents savings/capital and labor to be allocated towards a new value generating sector.”
- MONEY:This prevailing form of exchange has been removed from the example. The form of exchange the society actually adopts is only semantics. It could be gold, silver, copper, paper. The medium of exchange in itself does not drive any progress. More paper printed in this microcosm does not magically generate new rice/carrot to boost consumption.
The notion that Quantitative easing will boost consumption is misplaced. QE will transfer savings from savers of the society to the remaining. “All this does is that it prevents savings/capital and labor to be allocated towards a new value generating sector.”
A far more lucid presentation by Irwin Shiff is given : http://www.youtube.com/watch?v=bFxvy9XyUtg
* History is replete with instances where developed nations like US, Britain have indulged in subsidies and protectionism of certain manufacturing sectors on the way to becoming developed nations.This has been vividly argued in “23 things they don’t tell you about capitalism” and “Bad Samaritans”. This is an apparent dichotomy that needs to be resolved. This kind of Infant Industry Protection is beneficial when the sector being protected is high productivity/ value adding sector. In essence the government steps in to act like an entrepreneur to force the nations savings into capital formation in a particular sector. The same subsidy is a wasteful expenditure when it is propping up a low-productivity sector like farming (sans technology)
The secondary question of whether the market or the government is better suited to this role of capital allocation is a bit more messy. The free market has the tendency to lock developing countries into low-productivity sectors. Eg: In free trade between Germany and China, if the only goods exchanged are cars (from Germany) and brooms (from China) then China could potentially keep getting better at making brooms however the per-capita income can never improve unless it produces something of more value.
Now it would not be rational for an investor to invest in an auto factory in China. Most of the human capital has no engineers, there is no physical capital etc…The investor would have to take a protracted period of losses before his investment actually bears fruit. Only the government can fill this gap.
The move to higher productivity sectors is better for BOTH Germany and China. If you go back to the slideshow, the total output in the 2 person economy increases because the productivity of both people increase in tandem giving the outcome of abundance and choice.
For example if person A could make all the food required in the economy but person B continues to produce rice, then there would be no telephone in the economy.A richer and more productive China becomes a larger trading partner for Germany. Instead of trading 1 car for a 100 brooms. Germany can produce 5 cars (abundance) and exchange 3 cars for 2 motorcycles (choice).