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Oversimplified Formula Of Economic Problems

Sometimes it's easier for people who use math to visualize problems to see relationships in a formula. So I created some formulas that show relationships.

The exclamation mark means that a symbol can only be on one side of the equation, because of importance. Red indicates the symbol is a problem.

The economy represented as what key players think is important, and the way it is working:

Legend:

  • VW: Vapor wealth (stock), which varies in value and has no true value until cashed
  • II∆2: Investor Irrationality, bearish, bullish, which varies exponentially with change and degree of P
  • P: Corporate profits, upon which stock market values are based (In this case, per item or service)
  • C: Consumption, which drives corporate profits (In this case, per item or service)

Currently our economy is driven up or down by the stock market. Most companies are slaves to increasing stock price, enforced by investors and the board of directors. Nothing is more important than raising stock prices.

Notice that what drives our economy is not actual Profit x Consumption. It's irrationality based on small changes in P x C. The larger the change in P x C, the more exponential the change in stock prices. This is a problem. This is the tale not only wagging the dog, it's shaking the dog. How can the economy remain stable in such a state?

Profit and Cost

Legend:

  • Profit: Gross Revenue minus Costs, then taxed to get net income
  • R: Revenue, which is all the funds coming into a business, mostly through sales
  • Ct: Total Cost, which is the money it takes to create, distribute, and sell a product or service
  • L: Labor cost
  • H: Hours (labor)
  • $/hr: Dollars per hour for labor
  • M: material cost - costs for material used for making products
  • O: Overhead cost, which includes R&D (if any), management, equipment, asset depreciation, write offs and losses, utilities, distribution costs, sales costs

To achieve a rise in stock prices, the business must do any of several things. On the profit side, it can raise prices, which may harm its market share and total volume of sales; it can put less product in the same box at the same price or make it look like it improved the product to raise the price, and this may also hurt its market share; it can sell more product or service, which is accomplished by expanding the market, which is expensive; or increasing sales in the same market by increasing market share, which is expensive; or introducing new products, which is expensive. During and following recessions and during bear markets, companies don't invest in anything risky.

On the cost side, businesses can raise stock prices by reducing production costs, which usually means eliminating hours per unit. Innovation to increase productivity means an investment in new technology, which is expensive. So existing labor can work more hours, which is less expensive.

Companies also resort to gimmicks to raise stock prices, such as taking money that should be reinvested in operating and expansion funds and using them as profit; and mergers and acquisitions, which results in removing labor. Merger-mania has been the rage since the 1990s. Mergers and acquisitions gain more product, revenue, and expertise and reduce costs.

So for the all important rise in P in the first formula, the second formula shows that in difficult times, P will likely be increased through controlling costs. In healthier economic times, gains in productivity and prices usually increase P at a 2 to 4% rate, which is what the Federal reserve targets. This in turn translates to some gain in wages. Market growth translates to an increase in laborers. But in difficult financial times, increasing P is likely to mean a downward push on the number of laborers, the number of labor hours, and labor dollars per hour. So we will see how that is a problem.

Since the 2001 recession, labor has failed to see increased waqes from gains in productivity.

Consumption Depends on Consumer Wages

Legend:

  • C: Consumption, which drives corporate profits (In this case, per item or service)
  • Profit: Gross Revenue minus Costs, then taxed to get net income
  • R: Revenue, which is all the funds coming into a business, mostly through sales
  • CDF: Consumer Discretionary Funds
  • I: Industry, Business to Business

In this formula, you can see that consumption goes up with consumer wages, either directly or filtered through another B to B company. So when you put this in the first formula, consumption goes up or down with wages. But when the business squeeze is on wages, as in the second formula, consumption can't go up. So profit can't go up, and stock prices can't go up. It's a feedback loop. Higher wages stimulate consumption, which stimulates higher wages.

The primary dependency in this formula is wages, not stock prices. Everything in the economy, from GDP to stock prices to the well-being of citizens, depends on wages and the number of employed. Wages run the economy.

There are two common approaches to calculating GDP, to look at the nation's economic health:

Expenditure approach to calculating GDP starts with expenditures: GDP = consumption, investment, government spending and net exports.

Income approach to calculating GDP starts with earned income: GDP = wages, rents, interest, profits.

The nation's health is not in the stock market or in industry, or in how much the nation produces. It's in the well-being of the population, and the ability of the consumer to buy products and services.

Nation's health = individual Wealth + Discretionary Income + Spending

The nation's health being a product of the stock market, is a recipe for Mr. Toad's Wild Ride. The economy shouldn't be jolting along by investor whims. But the stock market has become more and more the focus of business. Key indicators such as wage increases from increases in productivity, and labor participation rate, have lagged horribly in the last 15 years. So we can keep doing what were doing, channeling money into the financial institutions all we want, but if it doesn't get to the consumer, all it does is increase the temporary wealth of investors and companies as vapor. That increased vapor either gets taken out of the market and hoarded by investors, or disappears with the fall of stock prices when consumers quit buying. We have to target full employment and wage increases or we keep going down. Since there isn't a 1:1 cost of wages to industrial profit, it's less, all participants should get wealthier with increased employment and wages.