Saturday, January 5, 2013

Would the Real Economy Please Rise?


I have been reading on economics again, and it's led me to more confusion than clarity, particularly in terms of the level of real economic activity that occurs within contemporary society.   That is, much of economic activity consists of actions that do not deliver any real value to society in terms of prosperity as a result of production and consumption.

I don't mean that in the brainless, anti-capitalist sense.  To my way of thinking, capitalism is a means by which people in free markets interact - people produce things that are desired by other people, and the capitalist system allows buyers to elicit signals, by their willingness to buy quantity at price, that are sent to the producers who can then respond by providing what is demanded, where buyers are willing to pay the costs of production and provide a reward in the form of profit for producing that which is most wanted and undertaking the risk inherent in productive activity.   All activities are voluntary, as opposed to economic systems in which there is centralized control and a bureaucracy that is out of touch with the nature of demand and the requirements of production make arbitrary decisions, and suffer no consequences.

The real economic activity in any system is the production of consumable value - so to swing back to the point, any action that creates something that can be directly consumed is productive, and arguably any supporting service (furnishing supplies to the producer, transporting goods to the consumer, etc.) may fall into a gray area, but can be reasonably subsumed into valid economic activity because its absence would mean the producer would be unable to produce and/or the consumer to consume the value inherent in the goods.

What I mean buy "actions that do not deliver any real value to society" are activities that are wholly unrelated to consumable goods - specifically, in terms of investing or brokering second-hand financial instruments.  The initiation of securities provides capital that is injected directly into productive activity.  However, when investments are sold from one investor to another, there is no capital provided toward the actual production of consumable goods, nor is the act of production or consumption enhanced in any way.  Payment is made for the license to consume, or to collect a share of the profit/interest.  The factory makes the same amount of goods, regardless of who owns it.

To get back on track (again), consider this example:  A farmer who needs funds for planting and tending his crop sells the a bushel of wheat, to be delivered at the harvest, for $20.  He does not presently have wheat, but in future shall, and the buyer in such an arrangement is aware of the risk and has made a rational decision to accept the offer.  Unless he intends to hold the right and consume the wheat himself, he is motivated to purchase because he anticipates in a vague way that the value of wheat will rise, and he stands to profit by the difference, and the difference itself seems a reasonable reward for the risk he is taking that the wheat will not ultimately be delivered.

The person who buys the right to have this bushel for $20 sells it to another person for $21, who sells it to another for $22, who sells it to another for $23, then to another for $24, and to another at $25.  When the harvest takes place, the person who takes delivery of it has paid $25 for the wheat, and we can fairly say that $25 is the market price.

The notion that the farmer has lost $5 in profit is a distraction, and likely unfounded or at least unjustified: he has no grounds for being upset that he might have sold his wheat for $25/bu instead of $20/bu if he had instead sought other means to finance his production at the onset.  But he did not do so, and accepted the risk of lost profit by naming his price, and got the price he asked for what he willingly sold.   He otherwise would not have been able to produce anything at all.   So let's set that aside.

What is of greater concern to me is that measures of the total economic activity will reflect $135 in activity - the ultimate buyer and consumer of the wheat generate $25 worth of real value (a tangible product that satisfies a human need was produced and consumed), with the remaining $110 representing transactions that do not generate any real value (the right of consumption passed though several hands).

And so, I'm left to wonder: how much of the nominal volume of economic activity in a market represents real economic activity (the production of goods that deliver a benefit in being consumed) as opposed to the amount that represents no real value, only the right to receive value being passed from hand to hand?   And does this not create the illusion of prosperity when the volume of goods being produced and consumed is a small fraction of the overall economic activity?

Perhaps I've misconstrued the way in which measurements of economic activity are calculated - but I don't think that to be the case - and I strongly suspect that the privation that exists even within seemingly wealthy economies is deeply concealed by nonproductive transactions that bloat and distort the perception of the actual level of value-generating activity.


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