Economics 101 started with a quote, “For something that is so integral to shaping our daily lives, most people do not take the time to understand the subject deeply.” I’ve spent a fair chunk of time wondering why that is - that people don’t take the time to understand economics. I think it comes down to a generic dislike of math(which there are a slew of reasons for), which lives beneath the majority of economic theory. But economics would not be a field of study in its own right if it were just another math topic. The other massive field that lives beneath economic theories is psychology. Economics is the study of how decisions are made. Math provides a language through which to interpret information. Psychology provides meaning to that language. It’s ironic, though, that economics is of little interest to so many given that so many find psychology intriguing - especially when it’s wondering why people decide to drive across 3 lanes because they missed their turn or the pros and cons of bribing a 3 year old with candy.
Thinking about how we make decisions is actually pretty interesting, for me at least. As I see it, the bottom line is that life is a series of decisions for every individual. Sometimes there are 6 options and sometimes there is 1 option and sometimes we don’t recognize that we’re making a decision. How we choose to evaluate and choose from the options in front of us is based on how we value each of those options, so to understand decisions we have to understand value. Value is different from person to person, and I don’t think we’ve been able to fully capture the psychological aspects of how we value different things, at least not yet. But we do have something that we can understand - price.
"Price is what you pay. Value is what you get." - Warren Buffett
Price gives a lot of information very quickly in today’s world. Price supplies the relative cost of something with respect to the cost of other things. It tells the relative cost of something compared to how much you have available to spend. But perhaps most importantly, price is an indicator of how much work was put into producing something. When you go to the store and look at item #4011(bananas) and see that they cost a little over 50 cents per pound, you know that it probably cost somewhere slightly lower than that, maybe 50 cents exactly, for the store to buy them. That bunch of bananas probably passed through a distribution center somewhere, and maybe came from some wholesaler before that, who had gotten them from a banana farmer somewhere in Latin America. The cost of paying the workers at the farm, buying and maintaining any tools that they use, owning the land that the farm sits on, paying for the transport of the bananas to the wholesaler, who also has workers to pay and a building to rent, and then the transportation to a distribution center that has workers too, and then the staff at the grocery store that you went to and the lights and the display that the bananas were sitting on. The cost of all of that is wrapped up in a quick piece of information - “SALE Bananas 56c/pound!”. That information is wild and crazy and amazing to me and it’s not even what I wanted to talk about when I started this. Price is just a number, and it’s how we got to it that I think is really of interest.
To make it where I want to go, we have to move in the opposite direction. The 56 cents per pound “goes” somewhere when you decide to buy that bunch of bananas. It gets sliced up into however many pieces made up the process of getting that bunch of bananas conveniently placed on display at your local grocery store. You paid for convenience. What I really want to talk about is how those 56 cents get sliced up among everyone involved. I think the easiest section to slice up is the farm where the bananas were grown. Let’s say that the farm gets 20 cents out of those 56. 4 of those cents go into the price of renting the land, 8 of those cents pay the salaries of the workers, 6 of those cents go into the cost of the seeds and water and harvesting baskets and whatever other materials go into growing and harvesting bananas, and the remaining 2 cents are profit. So, the question that I have to pose is “Who gets the profit?”.
Before I try to answer that question, I want to name the 3 non-profit values(cents) that I gave before. In order, they were Land(rents), Labor(wages), and Capital(profits). These, in addition to the knowledge of how to grow bananas are the “factors of production”. Ok, so I basically did answer the question. The profits go to capital. Seeds, water, and baskets aren’t a good indicator of who capital is, but, in short, capital is the ownership of the business. The profit that the owner of the business gets is whatever is left over after paying all of the costs. Pays rent to the landowner, pays wages to the workers, pays the water bill and such, and pockets the extra 2 cents. This distribution of value is capitalism in a nutshell - the name checks out. This distribution of value is why ownership and compensation are so very important.
It’s with that in mind that I want to consider Adam Smith’s The Wealth of Nations (1776). The point he made all those years ago was that it is the amount of labor that has gone into a thing’s creation, that saves the buyer from having to go through the same labor, that sets the value of something. Your convenience. But he also notes, “In this state of things, the whole produce of labour does not always belong to the laborer. He must in most cases share it with the owner of the stock which employs him.” This disclaimer is important. How the “produce” of labor is shared is a philosophical dilemma. Karl Marx’ took great issue with Smith’s viewpoint and gave expansive arguments against it in Capital (1867). Marx is well known for The Communist Manifesto (1848), which goes well beyond this distribution of profit question. But in simple terms: Smith would say that capital should get the profit because without the seeds for bananas, the workers wouldn't have jobs. Marx would say that the workers, who's skills and labor produces the bananas should get the profit.
When you think about today's world, it's whether you as an employee own a stake in the company that you work for or not. In fact there's a massive market for ownership in companies - it's the stock market and it's globally worth somewhere around $70 trillion. I don't want to dive too deeply into a discussion of the stock market, but it would suffice to say that the biggest stakeholders in the stock market are the biggest owners of value in the world today.
To summarize, value is widely considered to be the sum of the costs associated with creating something. Price is a convenient number that is widely used to condense all of the components of value into something quick and easy to understand. How that value gets distributed to all of the individuals involved in the creation of something is significantly more complex and has been at the core of a variety of world shaping events and problems.
For nearly half a century this conflict was realized as the Cold War and still now we see it highlighted as economic inequality. The inequality problem arises as wages are "set" by owners to reflect cost of living, but profits are not constrained in the same way. Particularly, the share of value going to corporate profits has grown massively while wages have fallen.
These trends are important to note especially as we’ve moved past the overt Capitalism vs Communism experiment of the late 20th century. The Cold war is over, but the the conflict that lived at its core has not reached resolution. We’ve moved from feudalism to mercantilism to capitalism vs communism to capitalism. Each system has attempted to drive value creation and prosperity; and each system has been overcome by a more efficient system that followed. As I see it, the question that is being asked today is what comes after capitalism as we’ve come to know it?