11. Sustainability of the system as is

The model is depicting functioning of economy where wider inner economy (WIE), represented by businesses and consumers are producing goods and services and consuming them.  Profit accumulation centers (PAC) are these companies and consumers which are saving their profit (wages) to banks and are not consuming them. So members of PAC are also these employees that do not spend their salary but save it.  Part of the profits accumulated in PAC is coming through taxes back into the WIE circulation. Further part of profits (savings) is coming back to WIE partially as profit consumption. State is borrowing from PAC for its functioning and transfer programs and these resources are returning to WIE.

Based on the previous it looks that capitalism without debt or printing of new money goes bust rather quickly. As it is still “functioning”, there is significant debt there and monetary easing is happening quite often. The question is: how long it would last without these helper crutches. That means how long the economy could be functioning based on following assumptions:

  • Balanced external trade

(No positive trade surpluses or positive surplus from services or financial operations)

It is obvious that in case of positive external flows the longevity of the system is bigger. That explains the efforts of countries to gain colonies and proexportal behavior of companies which I described in chapter international trade.

So let´s say that external environment is not contributing to stability of the system nor it is worsening it.  With trade deficits the situation will be obviously much worse than with balanced trade.

  • The state will not be borrowing for its functioning and state budget will be fully balanced.
  • The Central bank will not be printing any new money, so there will be no monetary easing
  • The consumers will not be indebting themselves, they will only spend what they have earned as wages

Before we continue with calculation, we need to ascertain when there will be the situation that we can say that the economy already stopped functioning as desired.  This threshold is purely an arbitrary criterion, as the state of bust can be described with many variables: fall in GDP, unemployment level, inflation rate … For our model we can set this as fall of GDP by 20%. I think that there are not many people who would say that everything is OK if economy goes that way.

The simplified model calculates the results based on these assumptions. In the first year, companies are anticipating sales of 110$ and are paying their workers’ wages of 100$. As there is no adequate buying power available, such sales will not be achieved, instead only sales of 103$ (corresponding with available buying power, distributed in the form of wages plus tax 3$ originated in previous year). That means not all companies will reach their goal and some production will not be realized. If we say that all companies that made their sales made them at planned margin (10%), there is a cost base of 94$ (94 x 1.1=103) representing the production of the successful ones matched with sales(buying power) of 103$. Some of that (9$-3$tax=6$) is coming from wages of those companies, that did not sell anything and went bust, paying just salaries but not making any sales. As there is a profit in this year (some companies were 100% successful), government collect its taxes 2.8$ and this amount is going to be distributed through various transfers during next year.

Second year unsuccessful companies are gone and no longer producing anything or paying any wages. They are gone as in this model by paying salaries during previous year they exhausted all their capital and are no longer part of our equation. So remaining companies are now predicting sales at the previous year’s sales, that is 103$ and are going to pay the same wages as before, 94$. They are sure they will reach this as they had no problems achieving the same result previous year. But they are somehow mistaken: the previous year sales were achieved only with contribution of wages paid by now already nonexistent companies that went bust in the 1st year. There will be some addition to buying power in the form of government transfer programs financed by previous years taxes but this addition (2.8$) will only partially supplement missing wages of 9$!  So real sales in second year will consist of distributed wages of 94$+2.8$ taxes= 96$. That means that again some companies will not make any sales and only 88$ cost base will be satisfied (still maintaining 10% margin). New taxes will be paid and cycle will repeat again and again with ever shrinking economy size, partially supported with taxes but at the volume that is not catching up with falling aggregate wages.

With this particular scenario, at profit margin 10% and taxes of 30% the overall GDP will shrink by 20% in just 4 years!

If we say that if there is not enough buying power in the system the companies will not make full planned profit margin and instead of some companies making full 10% and others recording no sales at all the more likely scenario is that profit margin of all will shrink to some extent.

In that case we can model the situation with different margin percentage as by diminishing the achieved profit margin the companies will adapt to such lower profits and we can use this lower number as a basis for new analysis.  (If they didn’t adapt and instead of resigning to lower profits they would cut wages to maintain the say 10%, we would be back at the square one and 10% scenario would apply)

So for example 2% profit margin yields such results:

We can see that with lower profit margin the economy survives substantially longer (some 20 years) before it reaches decline of 20% GDP.

The point of this analysis is to explain to the reader in a very simple model that economy without additional buying power in the form of transfers, financed either through debt of monetary policy will be only deteriorating. The existence of the profit is draining the available buying power and so causing the GDP to shrink year by year.

The only salvation would be if ALL the profit made would be fully reinvested (returned) to the economy.

Even with 99% of profit reinvestment, there would still be a drag to the system in the form of negative GDP of roughly -0.06% per year. Sounds insignificant, but paints a picture of importance and inevitability of additional measures in economy policy if we want to have any positive GDP growth at all. The measures possible and their impact to debt and inflation will be discussed in more detail at the chapters of Model.