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What’s wrong with our economy?

· October 27, 2013

Something is not right with our economy. But, is that something just a temporary glitch that will straighten itself out over time? Or, are we talking about an inherent flaw in the system that will ultimately bring about its own downfall?

I think most of us can feel that something is not right with our economy. But, is that something just a temporary glitch that will straighten itself out over time? Or, are we talking about an inherent flaw in the system that will ultimately bring about its own downfall? And, if the system is flawed, how serious is the problem and what can be done about it?

In this post, I’m going to try to answers these questions.

Current economic system

Let’s begin by discussing the factors that influence our current economic system.

Current economic system

Current economic system

Factor #1: population

How population impacts the current economic system

Impact of population on the current economic system

The first factor is population. Because we all have needs, we create demand simply by being. In other words, the size of the population is the primary determinant of how many products and services are required. The relationship is positive: the more people there are, the more products and services are needed.

Where there is a demand, there is also a production. The primary role of production is to supply products and services to satisfy the demand. Once these products and services are created, they are made available for consumption.

Production also creates jobs. Increased demand for products and services increases the need for production, which in turn creates more jobs. Jobs generate income that is needed to pay for the products and services. When people have jobs, they can afford to pay (more) for more products and services.

In summary,┬ápopulation creates demand that is met by production. Production creates jobs that puts money into peoples’ hands. People then buy and consume whatever has been produced.

Factor #2: profit orientation

Now let’s look at the next factor: profit orientation.

Profit maximization (or accumulation of capital) is the primary driving force behind economic activity within our current economic system. Owners strive to increase the return on their capital by focusing on increasing two things: demand and productivity.

Growing demand

How advertising impacts the current economic system

Impact of advertising on the current economic system

Demand can be artificially increased in a number of ways, which I collectively—and rather incorrectly—call advertising here. The word advertising by far doesn’t encompass everything that is done to artificially increase demand, but it is a word that is readily understood and well-represents the concept. In a more broader sense, we’re talking about any kind of activity that influences how people think about their wants and needs.

When demand is raised through advertising, it has a positive correlation with everything discussed under the Population factor above, except for the size of the population. In other words, as a result of advertising, the same number of people suddenly demand more products and services. This demand is met by more production, which results in more jobs, more income and higher consumption.

Improving productivity

How productivity gains impact the economy

Impact of productivity growth on the economy

The second thing capital owners try to do to increase the return on their investment, is to increase productivity. Productivity is a function of resources utilization. The aim is to produce maximum output with minimum input. Labor is one such input and there is a negative correlation between productivity and jobs. This means that increase in labor productivity—when not coupled with increased production—results in lost jobs. Consequently, when jobs are lost, income falls and consumption decreases.

Thus, somewhat paradoxically, a more efficient production results in a lesser ability of the population to satisfy their needs through consumption because their income decreased and they cannot afford to pay for all the products and services.

Factor #3: natural resources

How the current economic system impacts natural resources

Impact of the economic system on natural resources

The final factor is resources, namely natural resources.

Production of most products and services depends on the availability of natural resources, which are being depleted in the process of production.

Whenever natural resources are scarce, it pushes us to think of better ways to reduce our dependency on them, through improved productivity. Increases in productivity make the use of natural resources more efficient, but never actually increase their stock.

What’s wrong with this picture?

Problem #1: limited natural resources

If we had an access to unlimited natural resources, or knew how to create products and services without depleting the available natural resources, we could theoretically increase production—and, consequently, satisfy the needs of any number of population—to infinity. However, that is not the case (at least, not right now).

Our natural resources are limited. Therefore, there is an upper limit to how much we can use in the production process. Yes, we’re continually discovering new sources, new and better ways to extract them and more efficient ways to utilize them. But, it doesn’t change the fact that, at any given moment, there is only so much that we can take before there is nothing left.

(By the way, even so-called renewable resources are limited. The limit is imposed by the total stock available at any given moment and by the time it takes to replenish it.)

What does this mean? It means that we cannot grow our economy for ever. There will come a time when we will hit, and begin exceeding, the limit imposed by the availability of natural resources. When that happens, we will essentially start spending our own future (and that of our children). If taken too far, the end result could easily be the extinction of humanity.

One problem is, however, that we don’t really know where that limit lies. Several studies attempted to identify it, but there is no widespread consensus. Furthermore, the situation varies from one part of the globe to another. So, the urgency of this problem is not felt everywhere to the same degree.

Problem #2: growing unemployment

This one is even trickier than natural resources.

As a result of an ever-growing productivity, less and less people are needed to produce more and more products and services. The only way there can be enough of jobs for everyone is if the job losses caused by productivity gains are balanced out with jobs created by growing demand and production.

However, if you look at the impact an ever-growing production has on natural resources—and add to it the advances in technology that, slowly but surely, make human involvement in the production process obsolete—you will find it inevitable that, in the future, productivity gains will permanently outpace production growth to the point when the economy won’t be able to offer enough of jobs to its populace.

(In fact, in my post on unemployment, I’m arguing that it’s only a matter of time before we will all┬ábe unemployed.)

In the short term, this will resemble a typical economic recession. In the long term, this will bring about a total collapse of the economy.

Conclusion

To answer the questions posed at the beginning of this post:

This is no temporary glitch. There are inherent flaws in the current economic system and it’s only a question of time before the system will collapse and stop working, altogether.

Whether we will smoothly transit into a new economic system through peaceful evolution, or face a world-shattering revolution very much depends on how fast we are able to react and what solutions we will choose to apply.

In the next post, I will try to outline the types of solutions that will be needed to ensure that we won’t kill each other in the process of transiting from one system to another.