Friday, April 25, 2008

21st Century Economics

The best way I can explain the global economy today is from the perspective of the following equation:

Value of Production = Labor + Knowledge + Materials + Investment + Power

Now, remember the value is allocated across these factors based on the basic rules of competition. In that sense, the United States (and the developed world) has long had an advantage in three factors: Knowledge, Investment, and Power (think global brands or other forms of market power). And this advantage allowed them to bring relatively more value and wealth to their countries. Company X could invest in developing country Y. They could pay there employees next to nothing, and then send both the goods and the profits back to the home country. This wealth would then be dispersed throughout the population.

Everyone knows that globalization has greatly increased the working population, driving down the value of pure labor. (Supply goes up, returns go down) But other factors have also come into play. These workers have seen the developed world's living standards, and they see all the goods which they are producing, and they decide that they want these things too. And more importantly, they are acquiring the ability to do so without the developed world. First, they have developed modern financial systems, so they have the ability to raise capital and finance large investments on their own. Second, they are rapidly acquiring expertise and knowledge from us. Finally, their power over in the global economy is rising. As the competitive advantages start to deteriorate, then more competition takes place- and production can go up.

This sounds great for long term growth because the rest of the world is raising their living standards. The problem is there is now a new bottleneck. Demand for production has increased significantly, but the supply of materials remains static. So now there is a new advantage from the control over scarce materials. This is why we are seeing such large increases in basic goods- food, energy, raw materials, etc. In the short term, things seem surely to become more difficult and costly. But long-term optimists can take comfort that the solutions to these problems are going to have to come from scientific and technological progress (Or war... see post). And in that sense, the developed world still has a very large advantage in terms of the possession and acquisition of knowledge.

Feel free to critique.

No comments: