9. Levels of productivity

Our model apart from explaining the necessity of deficits also provides additional information about the best possible use of them – as transfers to the consumers.

Basic equation of business is:

Profit = buying power (sales) – wages (all costs)

Entrepreneurs understand very well that wages part.
In their understanding is:  profit = sales – wages – (other costs).

So the lower are the wages in their company, the higher the profit they should theoretically be able to achieve. Therefore there is an extraordinary pressure to lower the wages, diminish the power of unions, strengthening the political influence of power of capital owners. And there is nothing else they could be doing as if they would be raising the salaries above the level of their competitors, sooner or later they would go bust for sure. The problem is that by doing that they are in the same way lowering their future sales at the global scale – buying power. As businesses are not able to coordinate all their activities and profit planned (not to say to agree on it) nor calculate the consequences of their wages decisions at the global scale there is an inevitable role of state to set the minimal wages as well as manage the transfers to citizens.

Why transfers?

Because prices of production are set the way which makes it impossible for them to buy all the production just from their wages. Simply because of the profit margin their buying power in the form of wages is not enough to represent the full buying power needed to full realization of planned sales. Businesses do not know that, their production capacity is set for full production (whatever this may be, they are planning to make a profit). Consumers are solving this dilemma through personal loans, which are temporarily boosting their buying power to needed level which is corresponding with economy potential – planned sales.

Their wages can be described as:    Wageoptimal =  Wageplanned(insufficient) + Wage supplementloan

This increase of wages to optimal level is just temporary as every loan needs to be repaid.
Therefore the employees are regularly asking for pay raises so they could replace their temporary boost of buying power represented by loans with permanent in the form of pay rise. However, such increase would mean that businesses have to increase their prices, otherwise they have nothing to finance that pay rise from. With global rise of prices, inflation is getting employees back to square one. Only their wages and prices are for few percent higher but their real buying power remains unchanged. Therefore their efforts to increase their living standards by asking for pay rise are doomed to fail from system point of view. The solution is in transfers from the state which can replace loans and so supplement employees buying power to optimal.

New wages equation will be:   Wageoptimal = Wageplanned(infufficient) + Wage supplementtransfer

This model is without cyclical influences, only question to solve is the proportion of monetary policy and taxation to finance the transfers and I am suggesting a way to address it in chapter Periodical taxation of savings and profits. However, this question remains open as long as there will be category of profit, which is not coming back into economy as consumption.

There is no rest for the wicked.

 Useful point of this analysis is the following:

Some economy schools of thought are saying that people living on debt are living above their means and one and only correct way how to finance the consumption is an income or savings. The life above the means is in our model not the correct economy category. What we need to distinguish is category of potential economy output, which is given by planned production capacity (planned sales) and real buying power (which is always lower than planned sales). Therefore life above the means is not in fact life above the means of economy as a whole. Economy is able to produce always more than people are able to spend from their salaries. This is the basis of our model, this is the way the system is set up. If the planned sales are achieved in certain areas, it is only because people indebted themselves or sacrificed other consumption in another area of economy where planned sales were not achieved. Therefore life on debt is just a wrong way of financing missing buying power, which is causing the cyclicality of economy.

If there would be no life “above the means”, the economy would very soon get into recession as buying power would be permanently insufficient.

The second piece of knowledge is that attempts of employees to increase their buying power through loans are leading to temporary boost in economy performance to maximal production capacity, which is gradually falling back to below potential output and even further due to repayments of loans and interests. If there is no restoration of such employees buying power through transfers (at least the interest part), recession follows.  

There are always two types of economies:

One is the economy of real resources ( production capacities, natural resources, energies) and potential of this source economy is determining factor how much can we really afford

The second economy is economy of finances, which is distributing the buying power according certain politically set mechanisms. This second (financial) economy is not saying what we can as society aggregately afford. It is only saying what we can buy based on amount of money in circulation (allocated to us – if from personal perspective) and set prices. It is important to understand that difference as it is a key to understand how we are viewing the economical processes and ways of sorting the economy problems.  What we can buy is not the same as what we can really afford (in production terms). 

The subtlety is maybe too disguised, the true meaning is that we can afford substantially more that current financial system is showing us as possible in the forms of money.
We have become slaves of our monetary viewing of the world.

There are multiple of examples:

The boom in house building and following crush due to no repayment of mortgages was an exact showcase of this principle:  the economy was able in reality to produce what was needed, that is houses for the people that needed their own roof above their heads. These houses were constructed and there was no depletion of all natural resources on the planet. The consumption of bricks, mortar did not cause a crater into mother Earth that would signal the end of the world as we know it.  There was no harmful reallocation of workforce into industry which nobody needs.  Workers working at the building sites were getting their wages and spending them in industries which were prospering as a result. Problem was only the financial side of the economy which caused that flows of money did not allow new homeowners to repay mortgages as planned.  But this is not evidence that society as a whole was living above its means, that something was created which should had not and what nobody needed. After millions of house repossessions are there ordinary people without roof above their heads and their houses are empty. That need is still here, was fulfilled (the houses were built) but what went wrong are the redistribution mechanisms of financial side of the economy which did not allow to close the equation in a way to make it balanced.       


Take an example of a cinema, which can be used as prototype of all services in society and is very easy to understand:

If the show is sold at 20%, this means that 80% capacity remained unused.  If remaining 80% cinemagoers would take part as well, it would not increase the material costs of Movie Company not for a cent.  (Let´s forget about the seat amortization Smile ). So if cinema is visited by only 20% possible guests, there is an irrevocable loss of sales which will never come back.  And now imagine that these 80% potential guests that did not visit the show because of financial reasons decided to take out a loan and buy tickets that way. Would it be correct to say that they started to live above their means? What would here mean really to live as society above our means? The build capacity of cinemas all over the country and available film titles represent the real economy potential. This is what we can really afford. If not all the screens are full every day there is no way speaking about living above our means. If the service is unused, it’s potential to provide benefit cease to exist in time, where it could be provided. If people are not going to cinemas, they are not enjoying themselves just because they have no money we cannot speak about saving some precious natural resources and living in line with our means and availability of such resources. It is only the result of failure of financial economy which again failed in redistribution of buying power and so prevented us from living AT the level of our means.