Wednesday, June 13, 2012

Basics of Economics part 3, Production and Consumption

This post has taken a long time to work out, because I was continually dissatisfied with it, and ultimately deleted everything and started from scratch. As the title suggests, this post builds on two earlier posts; it would be best to go back and read them before reading this, though this also touches on some fundamentals that are quite comprehensible without the background of the prior posts.

Production and Scale:

From an economic standpoint, production is the creation of anything with marketable value. This includes everything from a Ferrari sports car, to a piece of wood you personally carve to serve as a decoration with your pocket-knife. Not every produced item ends up on the market, but it does end up being used where one could have instead purchased something off the market for the same purpose. To gain some idea of how a modern economy functions as far as production and consumption goes, I'm going to try to give readers here an impression of the scale a modern economy is capable of functioning on.

Back in yon days of medieval time, the vast majority of economic production was subsistence food production; basically, people farming for the food they needed to live. It's been roughly a year since I last researched this, but as I recall, the percentage of labor division was something in the order of 80-90% dedicated to agriculture. Even with this degree of labor involvement, the nature of muscle-driven agriculture and lack of food preservation methods meant that famine could easily cause mass starvation in a region or nation.

In modern day USA, the division of labor into agriculture is roughly 2%. To put this into perspective, 88 out of every 90 men and women involved in agriculture being able to quit, and move on to some other occupation. Further, the USA exports huge portions of its agricultural output, and on top of that, the nation is functionally immune to famine, due to the many different regions where agriculture is conducted, modern refrigeration and preservation, and modern shipping/globalized economy.

If a particular crop fails in a particular region in a modern nation, most people not directly involved won't even notice, because all they'll experience is some minor price fluctuation at the grocery store. That's it. That's a massive force-multiplication of the production effects of labor.

Now let's move on to metal-working. Most people in modern nations have at least some conception of what was involved in blacksmithing and metal working before industrialization. For a quick recap, there was mining ore (by muscle-powered tools), hauling ore (via muscle or sail-powered transportation), smelting ore (in a hand-constructed smelter), then working ore with muscle-powered hammers and other tools in a forge. Many, many man-hours per finished tool or weapon.

In modern day, mining is handled largely by machines(though I'm not as up on the details of this), transportation is entirely automated, smelting/refining is handled by machines, and final shaping is handled entirely by machines. Metal-working has become so cheap that we mass-produce pop cans for a few cents, made out of aluminum and steel. And your average person working a low wage job can buy a dozen or two of them for a single hour's pay. And it's what's inside the can that they're actually paying for, the can itself is just packaging.

I hope this gives some idea of just how incredibly much industrialization and modernization in general has been a force-multiplier for how much production comes out of a man-hour of labor. In modern nations, the poor (poor, not destitute) live like wealthy merchants once did, in heated houses with glass windows, running water, and electrical appliances that outperform a servant staff. Those who are middle-class or above live better than kings did three hundred years ago.

This understanding of the scale of production is critically important to understand the nature of a modern economy. Now I'll move on to how production and consumption tie into each other.

Production and Consumption:

As stated earlier, everything that an individual makes with a market value, can be considered production. Consumption can be considered the acquisition of a product by its end-user (discounting later resale of used items, such as garage sales and junkyards). To put it more directly; agriculture will produce beef, lettuce, tomatoes, onions, milk, tomatoes, mustard seeds/plants, wheat, yeast, etc, which will the be processed into a hamburger patty, sliced tomatoes, sliced onion, cheese, ketchup, mustard, and a bun, which will then be assembled into a cheeseburger, which will then be sold to the end consumer, who eats it. (At least I assume so, people do strange things with fast food sometimes).

In this chain of economic transactions, you have initial production via agriculture, who are paid by those who turn milk into cheese, wheat&etc into bread, cows into hamburger patties, and etc, for their goods. These processed goods are then purchased by a restaurant or fast food joint, who assemble it into a cheeseburger, whereafter it is sold to the consumer. There are several stages of economic transactions, and in each stage of transaction (in a healthy economy), the person being paid for their product receives moneys totaling their own cost to produce the product, with an additional amount to compensate them for their labor cost. This is called 'profit,' and every individual profits monetarily, save the end consumer, who gained one cheeseburger instead. Note, some products may go directly from the farm to the restaurant, or skip other phases of production, and this doesn't count the shipping element as drivers and whatnot are paid, but all are involved as well.

In this way, not only does each individual or company receive the funds necessary to continue operations, but also enough money to pay for their own housing, food, medical costs, etc. This is healthy economic activity.

In a second example, we will take the production of a house. I won't even try to list all the components and labor that go into the production of a modern house, suffice to say, it's complicated. Ultimately, however, you end up with a lot of money being spent, and ending up in a lot of different people's hands, and in exchange, somebody now owns a house. Unlike with the cheeseburger example, in this case, the house is an essentially permanent product; if it's made of more durable materials, and is properly maintained, it can last hundreds of years. This is an end product that endures, and will be available for continued use, and, as such, is an accumulation of wealth.

This chain of production and consumption is the essence of economic activity, and is defined by the appetites and desires I described back in part 1. As each person along the chain earns their income, it enables them to purchase and 'consume' products themselves, and thus economic activity is self-reinforcing, the more that is produced and consumed, the more that can be produced and consumed. In a dynamic modern economy, due to the immense and still growing force multiplier of modern technology, there will always be more demand for labor. This is because it is continually easier to create wealth, and thus, there is more or less continually more wealth that can be spent employing more people.

To give an example, in the USA in 1948, the Unemployment rate was 3.8% amongst those over the age of sixteen. In 2010, it was reported as 9.6%, but this is not counting any number of ways that people not working have been discounted from that number. Regardless, the unemployment rate in 2010 was more than double that of 1948, despite increased industrialization, more advanced industrial processes, and the information age, making production vastly cheaper, and thus the creation of wealth vastly cheaper.

Now, there is some degree of labor loss that occurs due to automation, machines doing the work that individuals used to, but this is only a temporary situation, workers will retrain themselves, find new work, or retire. Even discounting this, subsequent generations will be trained for more modern occupations. It is an unfortunate hardship for those in the situation, but in a sufficiently dynamic economy, they will be able to find some kind of alternate work, because the demand will simply be so high. In the past, due to the division of labor, this was more difficult, but now, the proportion of people employed in unskilled manufacturing work in modern nations is quite low.

So, in summary, despite every man-hour of labor accomplishing more, going farther, creating more, we are now in a situation where unemployment is higher. Economics are not some mysterious, incomprehensible force, this is not happening for no reason. I will go into why in the next post, Incompetence and Corruption, the issue I originally intended to handle in this post.