Products and Services

One of the ideas that have been advanced repeatedly during the recent economic crisis, recession, and prolonged stagnated recovery is the notion of “stimulus” as a way to revive the economy. This strategy is based on Keynesian economic theory, and is predicated on the notion that when an economy drops into recession, the fundamental problem is a shortage of people consuming. The solution offered by Keynesian economist is intervention by government entities through monetary expansion, and spending to fill the perceived gap in spending. The fundamental underpinning of Keynesian theory is the notion that consumption creates production.

An alternative view to the Keynesian theory is the one advanced by Jean-Babtiste Say, contributing to the larger Classical economic theory. A principal idea advanced by Say was known as Say’s Law or the idea that “Products are purchased with Products.” This theory underscores the fact that wealth is defined by what is produced, and shuffling products from one person to another in an accelerated manner does not increase the total amount of wealth. According to Say’s law, a general economic recession is not the result of insufficient consumption, but incorrect production… namely that production has been over-pursued in some areas (such as home building) and under-pursued in others.

Furthermore, attempting to “solve” problems by printing more money does absolutely nothing to increase or change the total amount of production or the total amount of wealth. When more money chases the same amount of products and services, the result is high prices or inflation. Recent increases in food and energy costs, in the wake of massive monetary expansion by the US Federal Reserve have caused many to re-visit Classical and Austrian economic theory.

The importance of Say’s law is frequently difficult for people to directly see, since most employees don’t work for products… they work for money. Thus, people equate the money that they earn with wealth. However, it is nothing of the sort… money is simply paper. Wealth is what you can buy with the money. Since most people work in the preparation, sale, or delivery of some product or service, it is ultimately true that the products and services we buy are purchased with the products and services we create. Money is simply the medium through which this transaction takes place.

Another important aspect of Say’s law is the notion that products and services are not homogeneous. What this means is that producing more of something people aren’t willing to pay for is not the path to wealth. This situation is actually the cause of market sector crashes when excess production cannot be sold profitably. Furthermore, if government bailouts are created to “save” the companies that gambled incorrectly, it results in a perpetuation of low-value production that impedes economic growth.

In a dynamic, market economy, downturns in a sector such as home building will result in price declines that eventually attract investment capital without the necessity of government incentives. The people who built speculative houses in the expectation of big profits would go bankrupt. The assets of those companies would be sold off at a discount. The companies that acted prudently would be able to purchase those assets very inexpensively and launch new growth initiatives. The problem confronted with bailouts is that they reward irresponsible behavior while punishing those who are responsible by denying them investment opportunities that would emerge if prices adjusted to their true value.

This is where the fundamental flaw of Keynesian theory comes to bear. In the view of Keynesians, supply and demand are aggregated. This view combines the production, consumption, and unemployment from healthy sectors with unhealthy ones. Whenever a large correction occurs, this leads to the conclusion that the whole economy is unhealthy. However, that is not necessarily true… even in the worst of recessions, there are frequently sectors of the economy that are perfectly healthy. Attempting to address a so-called aggregate problem with aggregate solutions results in subsidies for foolish investments and penalties for responsible investors.

Furthermore, stimulus programs are necessarily administered by government agencies and financial institutions that extract a significant amount of overhead from the total amount that is spent. This is where the problem of intermediaries emerges. In a market system, intermediaries only exist in situations where they add value to the system… otherwise the buyers and sellers would ‘cut out the middleman’ to get greater volumes and lower prices. However, in the world of legislative fiat, middlemen stand between the money and the products, taking a percentage of the transaction and doing absolutely nothing to enhance or optimize the quantity or quality of total output.

This ultimately devolves into what many have called “Crony Capitalism” where large corporations dominate the marketplace, not because of any particular skill in creating or selling products and services, but because their connections to lawmakers allow for advantages that other firms do not enjoy. The financial institutions and automotive companies that avoided bankruptcy and maintained all of their leadership / business practices serve as primary examples of this principle. If AIG had been allowed to go bankrupt, its assets would have been sold off at a discount and a new competitor would have emerged to fill the vacancy created by AIG’s departure. This company would have every incentive to hire the AIG employees who were responsible, and would have no incentive to hire the people who cause the company to collapse.

In the end, products and services are truly paid for with other products and services. Attempting to circumvent this simple economic reality has resulted in tremendous mis-allocations of capital, and enriched politically connected organizations, while preventing real economic growth from emerging. Unfortunately, we do not have the capacity to stop this trend as individuals. However, we do have the ability to adjust our own decisions so that the impact of these trends on our lives is minimized.

The most important thing that any person can do is to work and live in the “real” economy that produces real products and services for real people that they purchase by producing real products and services for other real people. The runway for extracting resources through smoke-and-mirrors financial manipulation is drawing short. The time is quickly approaching when governments can no longer afford to rely on smoke-and-mirrors to disguise fiscal problems and unfunded promises that cannot be kept. When this reality finally emerges, it be very painful for many people who have become dependent on the fictional reality. Make sure that your well being is built on a solid foundation.