Note: Entry #41 begins a series of blogs about General Motors.  How did an apparent culture change over time likely lead to bankruptcy and an apparent disregard for addressing safety issues.  Such actions by corporations affect societal attitudes.

(Want a PDF version for Entries #1-10, #11-20, #21-30 formatted for tablets and e-books?  Click links for download.  America’s 5th Revolution Volume I (Entries 1-10), America’s 5th Revolution Volume II (Entries 11-20), America’s 5th Revolution Volume III (Entries 21-30)

Scene: Jordan Visiting College Campus. Meets Former Economics Professor.

Jordan: “Professor, nice to see you again. Been a while since I was in one of your classes.”

albert_einstein_professor croppedProfessor: “Yes, a long time. I understand you’re spending a lot of time in Washington.

Jordan: “Too much time. I need these kinds of breaks to keep my thinking straight.”

Prof (laughing): “You’re not saying people inside the Beltway have distorted thinking?”

Jordan: “I’ll skip my thoughts on that one. But if you have a few minutes I would like to get your thoughts on some serious issues facing the country.”

Prof: “I’ve got about an hour before my next lecture. What’s on your mind?”

Jordan: “There are some disturbing trends in the economy.

Prof: “Such as?”

Jordan: “The United States needs to generate more wealth as a country. Taxing the rich does not create wealth, merely redistributes income. Like moving money from one pocket to another. What policies should we consider implementing to create more wealth for society? Not just wealth for some individual or some company but wealth for society.”

Prof: “Great question. Creating wealth is a simple concept but far more difficult to execute.”

Jordan: “Let’s pretend we are back in Econ 101. Explain the concept and then we can talk about execution.”

Prof: “OK students, quiet down. Just kidding. For me the easiest way to understand how to create wealth for society is to think manufacturing.”

Jordan: “Exactly what do you mean by manufacturing?

Prof: “Most people think manufacturing as making cars or airplanes or furniture. But in the broadest sense manufacturing is the process by which value is added to a product.”

Jordan: “If I understand, then farming can be considered manufacturing. You start out with seeds and you end up with a bunch of corn. Mining would also be the same. Start out with dirt and end up with say iron ore.”

Prof: “Let’s use your examples. How is wealth created? Let’s take raw material – iron ore, corn, lumber. Step 1 is consider the value of that raw material on its own – a hunk of iron ore, stalk of corn or a tree. Step 2 is think about a product that uses the raw material. Step 3 is compare value between the raw material and the finished product?”

Jordan: “Let’s take this coffee mug. The raw material is some type of clay and some paint for decorations.”

I Luv NY Mug CroppedProf: “Good example. What would you pay for the clay and paint as raw materials?”

Jordan: “Nothing because they are of no value to me.”

Prof: “What did you pay for the coffee mug — $10?

Jordan: “Try $20.  It’s a nice mug.”

Prof: “So value went from $0 for the raw material to $20 as a coffee mug?”

Jordan: “Yes. Whoever made the mug must have created the value.”

Prof: “He does remember Econ 101. Actually there are some other people in the chain but you have the idea.”

Jordan: “The other people – the trucking company, the place where I bought the mug, the company that mined the clay and the company that made the paint – all contributed to the wealth creation.”

Prof: “On a very simplest level, none of those people would be working if you didn’t buy the coffee mug.”

Jordan: “So each one of the companies involved in making and then getting the coffee mug to me contributed to value creation?”

Prof: “One can argue that the people between the potter and the buyer are merely middlemen. You could have purchased the coffee mug directly from the maker.”

Jordan: “So the middleman might not really add value, bur rather…call it ‘facilitate’?”

Prof: “The word ‘facilitate’ will work. ‘Catalyst’ will work also. A catalyst allows a reaction to occur without becoming part of the reaction.”

Jordan: “Hasn’t the internet started to replace the middleman? Many more companies seem to be selling directly to the customer.”

Prof: “The internet has been a disruptive force to the middleman, or distribution system. For centuries people in developed countries bought in physical stores. Virtually all these stores were operated by merchants who sold the goods but did not make the goods.”

Jordan: “Now, with the internet, in many cases I can buy directly from the manufacturer and have the product delivered to my location – no more brick-and-mortar store.”

Prof: “A lot of jobs associated with…call it merchandising business…have been eliminated.”

Jordan: “Did those people really add value and create wealth?”

Prof: “Technically, no. But what they did do was enable a lot more people to buy the product. Without the middleman, the potter who made the coffee mug would have a very limited population to sell to. With the middleman, the potential for sales expanded exponentially.”

Jordan: “Now the potter can use the internet and reach many more people than before. In some cases maybe even more people than with the middleman.”

Prof: “And keep more of the profits since no payment to the middleman.”

Jordan: “At the same time, employment declines because fewer people are working to distribute the product. So did we really create any additional wealth by selling on the internet?”

Prof: “Answering a related question will help you set policies for wealth creation.”

Jordan: “Where are we headed?”

Prof: “What if the coffee mug is no longer made in the US but now made in say China…bad pun, I know.”

Jordan: “I’ll forgive you. If the mug is made in China, the wealth created between the raw material and the finished product – coffee mug – stays in China and not the US.”

Prof: “You’ve got it.

Jordan: “Rather than $20 being spread among US companies, the only value in the US is for transportation and distribution — maybe $5-6. The potter is cut out completely.”

Prof: “One can make a good argument that no wealth is created for US society when products are manufactured outside this country. What we as a society confuse is wealth creation for an individual or company compared to wealth creation for society.”

Jordan: “Macro and micro economics. Or as a friend of mine calls it macro schmacro and micro schmicro economics.”

Prof: “I’ll remember those terms. But the distinction is important. What is of benefit to an individual or a company…schmicro economics…is not always a benefit to society…schmacro economics.”

Jordan: “Moving production of coffee mugs to China might generate more profits for a specific company…schmicro…but overall the US loses wealth as a result…schmacro.  Correct?”

Prof: “Yes…but…and the ‘but’ is the value of trade between countries.”

Jordan: “So trading between countries is not just a one-way street but can create wealth in both countries?”

Prof: “Trading is important because more demand can be created. Just like the internet opened up new markets for the potter who made the coffee mug, trade opens up new markets for countries.”

Jordan: “But isn’t trade usually one sided. I mean the country that exports seems to benefit the most.”

Prof: “The country doing the exporting is usually more efficient at making those products than the country buying the products. But for trade to work the country buying has to offer something in return – another product at a lower cost or some raw material that has value.”

Coffee beansJordan: “Let’s take coffee. Brazil is more efficient at growing coffee beans than the US mainland. Therefore, the US should buy coffee beans from Brazil.”

Prof: “The US is also very efficient at growing certain crops – corn, soybeans, wheat. And it exports lots of those crops.”

Jordan: “But Brazil and the US are not as efficient at producing electronics as say China. So Brazil might trade coffee beans for US wheat and the US might trade corn for electronics made in China.”

CornProf: “You’ve got it the basics. In theory…and I emphasize theory…each country trades products that it produces more efficiently. As a result products made in another country are less costly to consumers and wealth is created in each of the countries.”

Jordan: “I realize understanding wealth creation has many more variables. But the gist of it seems taking a raw material and refining it so it is worth more. Clay becomes a coffee mug. Wheat becomes flour which becomes a cake. Silica becomes silicon which becomes an electronic circuit which becomes a computer.”

Prof: “Very good Jordan.”

Jordan: “Prof, I have a somewhat related question that has bothered me for some time.”

Prof: “Which is…?”

Jordan: “The manufacturing of electronics is mostly automated. Labor cost as a percent of the cost of the product must be very low. So what is the advantage of making so many electronic products in Asia? Lead times are long and it is hard to protect intellectual property.”

Prof: “Let’s take a break and come back to that question. But I want to put the answer in the context of your first question – what policies will help the US create more wealth for society and not just individuals or certain companies?”

Jordan: “Good.  Now I want to refill by coffee mug.  Let’s see where this was made?”

 

 

 

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