A persistent situation has developed among the current political and economic climate that forebodes of large potential problems in the future. This situation finds its source in a phenomenon that we refer to as "." The way this effect manifests itself is a stalwart refusal to recognize and adapt to the economic realities. This issue is modestly problematic when constrained to people and absolutely catastrophic when employed by the political authorities.
The reason for this is because people are limited in the extent to which they can impact the overall marketplace. However, political authorities can establish highly destructive rules and regulations that have the ability to cripple an otherwise vibrant economy. Of the many pitfalls and problems that public officials can find themselves caught up in, there are three main principles that drive the most evasion of obvious economic truths. These principles are that spending isn't free, profits and losses are equally important, and that prices communicate knowledge.
Reality #1: Spending Isn't Free
Against the backdrop of huge deficits in both the US and Euro-Zone, this truism cannot possibly be expressed poignantly enough. Every time that any person, business, or government spends money, that money must come from somewhere. In the cases of people or businesses, the spending frequently comes from either savings or credit. In the case of governments, it can also come from 'monetary expansion' or simply printing new money. In all cases, it is not free.
The world is a place where resources are limited. These resources are often represented in terms of money, but there is no scheme that can ever be devised to create new resources out of nothing. When savings are spent, those savings are not available for spending on anything else. When money is borrowed, it must be paid back... with interest. When new money is created, it devalues the money already in circulation. Any time that money is spent, it represents a choice to bear a certain cost in exchange for a certain outcome.
Thus, the fundamental question for people, businesses, and governments is one of whether their money/resources are being spent in the most effective way possible. It is certainly true that the notion of effectiveness is inherently subjective. However, it is also true that when people are spending their own money, they do so much more effectively than people spending other people's money.
When investors borrow to build a new factory, they do so because the rate of return from the factory is expected to exceed the cost of interest on the loan. When people spend their savings, they do so because they value what they are buying greater than having a certain amount of money available to spend on something else. When the government borrows or prints money to spend on "stimulus" projects, the net result is to either create or destroy value. Projects more valuable than the alternative uses create value, and projects less valuable than the alternatives destroy value.
When one considers that political decisions are made by people who must be re-elected at regular intervals, and who are spending other people's money, it is not difficult to see how large sums of money are spent on value destroying projects that benefit a particular political constituency. If we seek economic growth, then net spending needs to be concentrated in areas that will generate more value than the (full) cost of the resources. It is not possible to create affluence through borrowing to spend on value destroying projects.
Reality #2: Profits and Losses are Equally Important
Another key concept that seems to have been lost over the past five years is the importance of losses in a free market. Profits exist to encourage innovation and risk-taking, but the risk of loss must be present to encourage prudence, and to weed-out under-performing entities so that the capital can be deployed more profitably elsewhere. Problems emerge when the government seeks to insulate certain businesses from the impact of losses. When profits are guaranteed, and losses are bailed out, the result is highly inefficient entities that funnel benefits to their insiders.
The reason for this is because in a competitive market, businesses who take excessive risk or have incompetent management will eventually go bankrupt. In this scenario, the assets of the business will be sold off at a discount to other entities who behaved more responsibly. The profit and loss system systematically channels resources from under-performing entities to those who are more effective and more prudent.
The problem that many people see in this process is the 'creative destruction' aspect of economic growth that pushes some companies out of business while new enterprises emerge and grow. In response to this churn of business fortunes, many companies seek protection of their business, while people seek projection of their jobs. Unfortunately, all of this creates a barrier against the systematic re-allocation of resources toward their most effective use.
Reality #3: Prices Communicate Knowledge
The third, and least well understood of the fundamental realities is that prices communicate knowledge. When prices for a particular product or service are high, it signals to entrepreneurs that there is an opportunity for profit. This opportunity attracts new competitors, and this competition often places downward pressure on the prices. Similarly, when prices are pressed down low by weak demand relative to the amount of supply in the market, it is a signal to the marketplace that there are too many entities in competition with one another.
The problem that many government's run into regarding prices is their attempts to manipulate prices for political reasons. Almost every politician in the world will complain about the high price of health care. However, very few ask why health care costs are so expensive. Much of the reason comes from the fact that most people access health care through insurance plans where they do not personally bear the costs of care. This means that they have no incentive to economize, and often consume much more care then they would if they were directly responsible for the costs.
This phenomenon bears itself out over and over in nearly every corner of the economy. Most of the people who are upset about prices fail to realize that the prices are communicating valuable information. Instead, they accuse the business charging the prices of 'greed' when the business is really just a messenger of market realities. High gasoline prices stem from a relative shortage of petroleum that drives up market prices. These market prices are created by other people who are competing for the same petroleum. The reason the prices rise is because exploration of petroleum has not kept pace with demand. Thus, the problem is not one of rapacious oil companies, but regulations that constrain supply. Nobody is able to maintain high prices for long when competing against somebody else who is willing to sell for less.
As we have seen, the phenomenon of "" has a distinctive impact on each individual's personal, professional, and financial life. The impact of these fallacious misunderstandings escalate as the scope of influence grows. As each of us go throughout our own lives, we must stay aware of the fundamental realities so that we can learn to recognize opportunities and take intelligent action. It is only through embracing the obvious and understanding the reality that we will be able to create a life of happiness and fulfillment for ourselves and the people we care about.
Sincere Thanks,
Douglas J Utberg, MBA
Founder - Business of Life LLC: http://BusinessOfLifeLLC.com/
Subscribe to "The Business of Life" Newsletter: http://businessoflifellc.com/featured/newsletter-info/
"Business, Life, and Everything In-Between"
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Economics Article FeedFind More ArticlesSearchSimilar ArticlesThe Ten Keys to Building Your Coaching Business Beyond the Next LevelThe Government Stimulus Fallacy21 Most Rapid Ways to Maximise Business GrowthWhat Money is and is Not - Part 1Is More Money Better?Guilt, Violence & MoneyKeys To The Golden Door - 10 Steps to Success For Women and Minorities in Business10 Business Fundamentals For SuccessLooking For More Business Deals That Need None of Your Dollars? They Are Out There, Just AskValue, Efficiency, and the Billable HourRecent ArticlesHow To Solve The Homeless SituationProgressivism Isn't Progress, VIIIHow Secure Is Your "Secure" Job?A True Comparison Of Increasing Debt Between Bush And Obama AdministrationsHow To Compete With ChinaWould Einstein Think Us Insane?What Will Happen If Greece Defaults?A Cluster of (Minor) ErrorsThe US Recovery Is Producing SurprisesA Sigh Of Relief For The Economic Status Of The USSubmitted On January 12, 2012. Viewed 5 times. Word count: 1,241.MLA Style Citation:Utberg, Doug".".12 Jan. 2012EzineArticles.com.26 Jan. 2012
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