Economics
...or why are things so expensive?

 I never studied economics at school, so the theories of economics are largely still a closed book to me. However I do recall paying some attention to announcements on Radio 4 about rates of inflation. In my youth, I found myself a bit angry when I heard it announced that 'the rate of inflation has fallen' - I remember shouting out, to no-one in particular 'but that still means prices are going up!'. I used to attribute ever increasing prices to greed and dishonesty amongst shopkeepers and/or manufacturers. So much for projection ! I was fairly outraged when, on decimal day 1971, the price of a Mars bar rose from 8d to 4p. I knew that was a substantial increase of 1.6d - I saw decimalization mostly as a way to try to hide price increases. Then the 1/2p piece was taken out of circulation, which meant price rises would always be in 1p steps...


Nowadays, I'm a bit more rigorous in my desire to understand why things are expensive in some countries and cheap in others. It still puzzles me why UK is 'Rip Off Britain' - why for example a bowl of rice in a Thai restaurant in Cambridge is thirty times more expensive than a similar bowl of rice in a restaurant in Hangzhou ? I'm not sure that present day economics really has an answer to 'why?' questions - the discipline seems to be more interested in 'how?' - how it is that prices change, or are different in different markets, rather than about why such differences have arisen.


I recently read an excellent article by Peter Drucker (from 'The Frontiers of Management') on two economists, Keynes and Schumpeter. He noted that whilst Keynes was well known, Schumpeter was much less so. Indeed, I'd never heard of him before reading the article. Drucker predicted that it would be Schumpeter's ideas, rather than those of Keynes, that would find themselves on the ascendent in the 21st century - so it seems that in Drucker's view, Schumpeter was an economist before his time. The wikipedia article on Schumpeter says that his ideas couldn't be formulated in the mathematics of his day, that they needed a non-linear approach. So given that I'm in search of some new ways of understanding economics, Schumpeter seems like a jolly good person to get to know the thinking of.

One of his ideas, that of 'creative destruction' was cited by Drucker as a way to understand profit in business. According to Drucker, profit had been rather a difty word - he says "this dilemma had driven the most brilliant of the 19th century economists, John Stuart Mill, to embrace socialism in his later years'. Profit was immoral, according to Marx, effectively stealing from the worker. Schumpeter seems to have been someone who, far from considering profit immoral, saw it as necessary. It seems to me that Schumpeter's model of the business was an essentially biological one - profit was growth and this was essential to fuel creative destruction.

So then, having liberated profit from the murky realms of morality, is there such a thing as an appropriate amount of pofit to make ? When, in the newspapers, we read of 'obscene wage rises' for chief executives of multi-national companies, is there any argument beyond the moral one to make ? I've a gut feeling that there is, but putting together a theoretical model will take a while...

 

Firstly, to estimate an appropriate amount of profit, we'd have to do some jolly careful accounting. As a check that the accounting has been done properly, we could see if the business is sustainable in the very long term. Does it operate with cyclical models for all of its resources and processes, or is it passing the costs of environmental degradation onto someone else - either outside its own boundary or into the future ? Secondly, what's the role of money (cash) in profit? Does having an appropriate amount of profit mean that the company will merely be self-sustaining, or will it actually generate cash. If it does generate cash, what would happen to that cash ? Thirdly, is a healthy company always going to be one that's expanding ? Is non-expansion a sign of non-growth and therefore not healthy ? Or is the generation of cash merely the residue of below optimum expansion ? Answers to these questions, and further questions, to be considered later...

A tengent - by observation, the western model of business is to generate profits through marketing. This involves extensive advertising, and advertising is expensive. For example, I recently read the annual accounts of CafeDirect, on sales of around £15million, the costs of marketing were around £3million, staff salaries came to only about £1million. This is a relatively ethical company, I reckon less ethical companies spend more. Advertising costs represent money which can't contribute to the quality of the final product. Of course, there are second-order effects - more marketing drives up sales, which can generate economies of scale, which improves value for money if all other things are equal.more...