How to genuinely fix the economy?

Problems

In my recent analysis of our current economic system, I identified two problems. They are:

  1. Limited natural resources. Our natural resources—including the renewable ones—are limited. Therefore, it is not possible to grow our economy forever without putting in danger our very ability to survive on this planet.
  2. Growing unemployment. Advances in productivity—including in technology—are causing the demand for labor to decrease. In the short run, this creates unemployment. In the long run, most (if not all) humans in the production processes will be made redundant.

Solutions

In this post, I’m going to outline priorities for dealing with these two problems.

Priority #1: stop population growth

There is no hope of our survival on Earth without halting the population growth. It is absolutely necessary that the number of people on the planet stabilizes and doesn’t growth any further.

If we don’t stop the population growth, it is certain that we will reach a point when the cumulative needs of the population will exceed the amount of resources available.

Fortunately, this priority is sufficiently recognized by mainstream policy makers throughout the world, both locally and internationally, and there are many programs addressing it.

Priority #2: use natural resources sustainably

Sustainable use of natural resources means that their availability doesn’t diminish in time. In other words, we use only as much resources as can recuperate within a given time period.

This priority is well-recognized among policy makers internationally, however, progress is slow at best. On one hand, advances in productivity help make the use of natural resources more efficient. Furthermore, since productivity gains are seen as the primary source of economic growth, both mainstream policy makers and owners invest heavily into productivity improvements.

On the other hand, equally significant investments are made into artificially inflating the demand for products and services and into increasing the production. These types of investments have a negative effect on the availability of natural resources and usually go hand-in-hand with productivity improvements.

As a result, most actual work is spearheaded by non-governmental, grassroots organizations. Luckily, it seems that more and more people are slowly turning away from consumerism and towards more environmentally friendly approaches.

Priority #3: decouple consumption from jobs and income

Increased productivity causes unemployment. When people lack jobs, their income drops and their ability to satisfy their needs through purchases diminishes. This in turn reduces the overall demand, which negatively affects production. When production decreases, more jobs are lost and the cycle repeats itself in a self-fueled downward spiral.

The only way out of this is a new economic system in which the ability of people to satisfy their needs does not depend on the level of their income. Unfortunately, for some reason, this priority remains completely unrecognized by either the mainstream policy makers or the general public. Even among independent thinkers, there are only very few who are actively concerned with this issue.

Conclusion

The problems outlined in my previous post pose a tremendous challenge to our society. It is clear that the status quo has to change. The only question is, will it happen as a guided, step-by-step process from one system to another (evolution) to the benefit of everybody? Or, will it occur in form of an uncontrolled, radical, disruptive change (revolution) that could potentially endanger our very existence on this planet? I sincerely hope it’s the former.

What’s wrong with our economy?

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, population 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 be 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.

Thoughts on unemployment

Here’s a thought: we will all be unemployed at one point in the future!

100% unemployment rate? Sounds crazy, I know. Even I was surprised by this conclusion. But, please, bear with me as I explain my thought process…

Priority #1: profit maximization

Let’s start with business owners. All business owners have one thing in common: their desire to maximize profit.

Now, simplified, profit is the difference between money collected and money spent for delivering a product or service.

Business 101: What is profit
Business 101: What is profit

And, there are only three ways how profit can be increased:

1. Sell more units

Profit Maximization #1: Sell More Units
Profit Maximization #1: Sell More Units

2. Charge more per unit sold

Profit Maximization #2: Charge More Per Unit
Profit Maximization #2: Charge More Per Unit

3. Reduce costs per unit sold

Profit Maximization #3: Reduce Costs Per Unit Sold
Profit Maximization #3: Reduce Costs Per Unit Sold

Profit maximization requires cost reduction

Now, of the three above, the last one—reducing costs—holds the biggest potential because it allows for the biggest leverage in the marketplace. If you can produce cheaper than your competitors, you can undercut their prices and, effectively, price them out of the market. Or, you can spend the extra money on branding and advertising. Or, you can use it to acquire your competition. Or, you can do all of the above.

Therefore, it is only natural that business owners will try to reduce their costs to the best of their abilities and potential. They really have no choice. If they don’t try to reduce costs, chances are that somebody else will. Then, they will undercut their prices and ultimately push them out of the market (and, potentially, out of business). It’s how cut-throat competition got its name.

Cost reduction is essential to business survival
Cost reduction is essential to business survival

Cost reduction through reducing labor costs

Labor is usually a significant cost item among business expenses and, therefore, a frequent target for cost reductions. Cost of labor can be reduced in many different ways. For example:

  • Design processes that require less work hours.
  • Design processes that require less workers.
  • Design processes where most work is done by the cheapest workforce.
  • Carry out processes more efficiently (less time wasted).
  • Create an environment where people are happy to stay and perform well even with lower pay.
  • Move business operations to places with cheaper workforce.
  • Replace humans with technology.

Whole industries were born out of the desire to reduce the labor costs. The logical consequence of those efforts is inevitable:

  • Less and less people are needed to produce more and more goods/services.
  • Jobs move geographically to areas with cheaper workforce.
  • Jobs cease to exist because they are no longer part of the process.
  • Jobs previously carried out by humans are now performed by machines.

No humans? No problem!

If work can be done cheaper without human involvement, it will be done. It’s only a matter of time before computers will think independently and have more intelligence than the brightest of humans. Consequently, it’s only a matter of time before all humans will be replaced by machines in the production process.

When that time comes, we all will find ourselves out of jobs. Unemployed and unemployable. Forever.

What that will do to our economy (and the humanity) is a topic for another post.

Is there data to support this?

I’m always looking for new data. If you come across something interesting, please let me know by leaving a comment below.

Less people are needed to produce more goods — YES

Output per employee hour, US, Non-financial corporate sector 1947 -2012.
U.S. non-financial corporate sector productivity (1947-2012). Source: Bureau of Labor Statistics

The output per hour in all non-financial businesses in the United States, increased by 453% between 1947 and 2012. It means that the same number of employees can nowadays produce 4.5 times more goods than they were able to produce 65 years ago. It also means that instead of 9 employees in 1947, only 2 were needed in 2012 to produce the same amount of goods.

The same trend can be observed internationally:

International Comparisons of Manufacturing Productivity and Unit Labor Cost Trends
International productivity trends in manufacturing (1950-2010). Source: Bureau of Labor Statistics

Jobs move to cheaper countries

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Jobs no longer part of the process

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Human are replaced by machines

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What do you think?

Am I going too far in my conclusions? Is my logic flawed? Please tell me by leaving a comment below!

Updates

9/25/2013

  • Added 2 charts showing the increase in productivity over time (output per employee).
  • Fixed minor spelling and grammar mistakes.