Skip to comments.Funding vs. Income - Why Liberals Don't Understand Economics
Posted on 06/12/2012 10:10:36 AM PDT by TexasNative2000
How do you make money?
A seemingly simple question, but it has serious ramifications. How you answer goes a long way towards your view on how the economy works and what must be done in order for the economy to thrive.
Ostensibly, we all want to make money - to provide for ourselves and our families, to save for the future, to support good and worthy causes. Only the monks and Spartans among us seek not to do so. They view money as a hindrance at best and, at worst, evil.
Understanding the process by which one makes money is the most fundamental element of the economy because it determines your approach to work and your approach to policy discussions about the economy.
Here, I will claim a perspective that is my own. I view this question through the lenses of experience and education. It has been my experience that making money is the result of working at a job in the marketplace, either for yourself or someone else, providing a good or service for which the market is willing to pay, and, as a direct result, earning an income. Over time, this income based on your performance allows you to provide, save, and give. This income stream, as it is described, is based on continued success in your work. If you dont perform, you dont earn. Such are the realities of the market place.
This experience of mine is backed up my education in the field of economics, and by the general experience of millions of others in our economy.
But that is my experience. Is it everyones experience? No. There are other ways to make money. Many of them look similar, but are not based on exactly the same premises. For example, those who work in not-for-profit businesses seek to make money by asking others to support their work. This is work that isnt seen by the market as being of direct economic value, but of charitable or educational value. It is supporting good and worthy causes as we described earlier. One may help run a charitable organization for orphans or for medical research or for any number of causes.
By saying that they are seen as not having direct economic value, it simply means that the benefits they provide are generally to people who are not able to pay for the services. It doesnt diminish the work itself or the value of the work being done. It simply means that it occurs in a different dynamic. The ability to make money isnt based exclusively on the ability to provide the services in question. The ability to make money in these cases is also based on the ability to raise funds to operate. It is a different dynamic. Not better or worse, but different.
A slightly different dynamic is found in the field of higher education. Here, both market forces and non-profit forces are at work. Students pay tuition and other costs, but institutions also find themselves asking for support, either from governmental agencies, state legislatures, foundations, or wealthy patrons. Specifically, researchers may seek grants for specific projects and get funded from these sources for a specific project or period of time.
In cases where funds are sought from donors, the ability to raise money is the key. Whether by means of persuasive grant requests, emotional tugs of the heart, personal connections, or other access to funds, the ongoing effort of raising money is the key to making money. Again, this is neither better nor worse than any other way of making money, just different.
So what happens when public policy makers discuss ways to stimulate job creation and income generation for citizens? That depends on what type of experience the policy makers have in making money.
Traditionally, economic policy makers have been from the market sector of our economy. They would bring their experiences into the policy discussions and solutions were based on market principles of creating market-based jobs for the purposes of income creation.
But what happens when the economic policy makers are made up of people whose experiences are only non-profit or academic settings? Do they have a working understanding of how the economy works for a vast majority of people? Or is their individual paradigm so strong, so narrow, and so ingrained that they believe that people make money by being funded?
If so, they proceed with policies that encourage funding. But who does the funding? Given that we are talking about public policy, the funding is done by government agencies or legislative bodies at the expense of taxpayers. The funds are 'granted' in an effort to create jobs because the policy makers think that is how jobs are created.
Solyndra is the perfect example. As a green-energy company - the preferred economic subset of liberals - Solyndra was the perfect vehicle for job creation. As with their experience in academia and non-profits, policy makers CHOSE Solyndra for the receipt of federal-funding on the basis of being the "right kind of company". Would these same policy makers choose a steel mill? A foundry? A logging and mining operation? Of course not. They are not choosing on the basis of economic realities, but policy preferences. To them, this is no different than choosing one grant proposal over another because they prefer the subject matter of the winning grant proposal.
THIS is why having the levers of power is SO CRITICAL to liberals. If they do not control the purse strings, they cannot fund the types of businesses they want to, therefore they will not grow. They literally think this is true.
This view also informs their view about the dynamics of budgets. If tax rates are lowered, they actually believe that tax receipts will fall, therefore "shrinking the pie" of money that can be spent on funding companies.
Listen for this line of thinking as you hear policy discussions regarding economic growth and budgets. Liberal public policy makers are not grounded in economic reality enough to make rational policy.
Thanks for the well-thought-out article — I certainly found nothing to argue with in it...
But (and there’s always a ‘but’, isn’t there??) I suggest that there is a more basic lack of understanding that, unfortunately, isn’t entirely limited to the Liberal sphere..
“Wealth” is not the same thing as “Money”....
It’s something that I (not a trained economist) have managed to figure out from applying a bit of common sense to observation, and maybe you can provide a *Conservative* Economist’s view....
President Bass Ackwards actually thinks the public sector supports the private sector and not the other way around.
It bears recalling that much of the Ruling Class is wealthy...and may well have no discernible income stream at all.
I support making 'money' not jobs. If jobs are created from making money, it is proper.
Alot of companies are doing extremely well in the recession, and they have cut lots of 'jobs', but are making money. They have streamlined and developed their production and service.
Secondly. It is not only Solyndra and other top down creations that are the problem.
Our central planners have been picking and choosing winners for way too long. They target home buyers with tax incentives and other 'winners' instead of simply cutting taxes for all. This targeted approach leads to bubbles and other distortions in the market.
When the guy goes up to look at the rooms the manager takes off with the money and pays the hotel bill to the baker who supplies the hotel with donuts and baked goods.
The baker then takes the money and goes and pays his grain supplier for goods owed.
The grain supplier then takes the money and goes and pays his bar bill at the local tavern.
The tavern owner then pays the local lady of the evening money he owed for services rendered.
Then lady then takes the money and goes back to the hotel to pay for rooms she owed on.
The guy comes down to the desk clerk and says the rooms are unacceptable and is then given his hundred dollars back.
That's how the private sector is understood by Libs and Dems.
I agree with the article, but it stopped short. This would be a good place to have included an explanation of the difference between gross revenues and profit.
TV shows and news media do a major disservice to the public by misusing the term “profit”. Examples are the “Auction Hunters” and similar type shows. The text and discussion at the end of the show presents the amount the successful purchasers paid for the items auctioned and the amount they received when disposing of them, with the difference in the two amounts being called “profit”. Since the participants in these shows have other expenses, at best the correct term would be “gross profit”. In the show referenced, Ton and Alan have some other expenses that eat into their gross profit: the cost of their transportation in the van they use to travel across country, the cost of the van, the cost of the lodging and meals, etc. We’ll call these indirect costs “overhead”. Once the overhead costs are subtracted from the gross profit, net profit results - and it’s usually nowhere near the extreme amounts presented as “profit” on these shows, adding fuel to the liberal misrepresentation of just what is meant by profit.
I work for a government consultant. A rule of thumb overhead cost for companies in my business sector is around 150% of direct labor costs, give or take. This means that these companies - to even break even - must take in actual labor costs plus the 150% of direct labor costs just to break even. Our profit margins are not very high, by contract they range from about 10% to 15% of total labor and overhead. But in actuality, it is very rare that the lump sum labor contract costs are not exceeded, due to inefficiencies, unforseen conditions, or mostly from the unwillingness of government client managers or their support staff to promptly provide the direction they’re contracted to provide. This means that in many instances firms actually lose money.
And those are the pure, cold, hard facts.
How very true and a crucial concept that liberals don't seem to get. Money is simply a representation of the value created in the wealth creation process.
I occasionally get into discussions with liberal friends and try to help them. The following is one of my attempts, but it seems to be on topic here:
The primary difference between those on the left and those on the right seems to be their perception of what wealth is and how it is distributed. We need to look at the definitions of wealth and distribute before we go any further.
The left views wealth as the money thats out there and it always seems to be defined in zero-sum terms. In other words, if someone gets more, someone else necessarily gets less. The right, on the other hand, views wealth as a constantly changing measure of value created within the system. Wealth grows each time someone adds a little bit of value (or a great deal of value) to society. It is, in effect, generated out of thin air by the thoughts and actions of individuals. Money is simply a physical means to exchange wealth that has been created.
In the exceptional video series What We Believe, Bill Whittle calls money work tokens. That is a great way to look at money. In a pure barter system, one person exchanges his efforts for the efforts of another. In Whittles series, he uses the example of a hunter tribe with great skill at making spears and a gatherer tribe with great skill in making baskets. When the hunter tribe trades a spear for a basket from the gatherer tribe, it represents their efforts their work. The spear or the basket are a work token. As the world has become more complex, the barter system became inefficient because you couldnt always directly trade what you had for what you wanted. Money was the solution to that dilemma. Money became a representation of the effort you put into making whatever it was you were good at making (or the ideas you had) and made exchange with others much simpler. Among other things, it allowed that hunter tribe and that gatherer tribe to trade increments of their work effort instead of whole spears or whole baskets.
Franciscos Money Speech from Ayn Rands Atlas Shrugged is a much longer explanation, but worth the read, nevertheless. In the speech, he calls money the material shape of the principle that men who wish to deal with one another must deal by trade and give value for value.
Distribute is a term often misused by the left. Money is only distributed in a statistical sense. The vision of income distribution by the left is that of a small cabal of guys with huge cigars in a dimly lit back room deciding who gets what. That, of course, is silly. In every step in the process of wealth creation, individuals decide what amount of their effort they are willing to trade for the effort of another
how many work tokens
how much money. Everyone wants to sell their effort for as much as possible and to buy someone elses effort for as little as possible. It is only when the two individuals find a cost that is fair to both does the deal take place. Each side earns their money, it isnt distributed.
——Money is simply a physical means to exchange wealth that has been created.-——
Can’t be stated enough. Common sense is surprisingly uncommon.
The Wealth Creation Process
This formula is an attempt to quantify the wealth creation process and identify the factors that are a part of creating wealth.
Where R = Resources; s = scarcity of those resources; K = Knowledge; a = applicability of that knowledge; P = Physical Effort; e = the expertise with which that effort is applied; I = Ideas; c = the inherent creativity of that idea; D = Demand; and W = Wealth
An understanding of the factors that make up the formula can explain the variance in the amount of wealth earned by individuals in any given creation scenario. A great deal of physical effort at a low skill level, for example, does not have the same effect as a good idea that is creative and unique. Likewise, a great deal of knowledge that is not applicable does not have the same effect as a smaller amount of knowledge that is directly applicable to a given endeavor.
Applying this formula to a CEO and a worker within the same company shows that even if the worker exerts a great deal of physical effort at a low skill level, he simply does not have the effect that a CEO with specifically applicable knowledge and creative ideas has on the overall amount of wealth created by that company. And neither worker nor CEO can match the effect that demand for their final output has in the overall equation.
Of the factors in the formula for wealth creation, only Demand can be zero. Many of the factors can be extremely small numbers, but each factor is required in some measure to create a product. The governing factor in the creation of wealth is the demand for that product or service. Satisfying a large demand creates a large amount of wealth. Producing a fantastically innovative product for which there is no demand creates no wealth.
Looking at the individual factors, the formula starts with Resources. These can be natural resources such as iron ore, they can be the product of a previous wealth creation formula such as component parts, and they can be capital or any of a number of different raw resources. While some wealth is created by stronger influence of ideas and creativity, the transfer of that wealth must always take some physical form and thus requires some resource. Even wealth that is purely idea based must be communicated through film or the printed page or on silicon. Conversely, a raw material may require little imagination or skill to bring to market but creates a great deal of wealth because it is in high demand.
The knowledge component of the formula refers to accumulated knowledge of processes and ideas. There may be little historical knowledge behind truly inventive ideas, but even the mundane knowledge of the marketplace within which the idea will be traded is required. The knowledge must also be specifically applicable to the process. A great deal of knowledge of French Literature is not as valuable in the construction of a building as the specific and mundane knowledge of waterproofing details.
Physical effort may not be a significant factor in the overall equation, but the skill with which that physical effort is expended most certainly is. I am reminded of an old joke:
A guy takes his car into the shop complaining that the engine is running roughly. The mechanic opens the hood and listens intently to the engine. After several minutes, the mechanic walks to his tool box and retrieves a ball-peen hammer. He leans over the engine and gives the motor a quick strike. The engine immediately begins to run as smoothly as the day it was made. The customer is amazed and asks What do I owe you?. The mechanic replies $500.00. The customer objects All you did was hit the engine with a hammer! That is true replies the mechanic, Im charging you $5.00 labor for hitting the engine and $495.00 for knowing where to hit it.
Next to demand, the factor that has the potential to change the outcome of the equation most is the creative idea that is at the root of any wealth creation. That creative idea may be as simple as a slightly better production method or as complex as imagining a brand new technology, but that idea is the foundation upon which all the other factors are built.
The wealth creation equation explains why the CEO earns a larger share of the wealth created than does the worker, but it also serves as a guide to which aspects of personal development will position a person best for being a more valuable contributor in the wealth creation process. Possessing knowledge is good. Possessing specific knowledge is better. Having physical ability is good. Developing that ability into a skill is better. Seeking fields that encourage creative problem solving and learning to apply your knowledge, skill and the resources available in a creative way can lead to vast amounts of wealth.
This equation does not measure such things as luck in the success of an endeavor, but merely measures the components of creating wealth. Obviously, if someone is at the right place at the right time to
write a brand new operating system for the first personal computers that IBM would produce, they have a very good chance of becoming the wealthiest person in the world. This equation does not measure such things but instead examines how, with relatively few resources, a great deal of specific knowledge of computers and the marketplace, a relatively small physical exertion but at a very high skill level and building on a truly revolutionary idea of creating a brand new language for computers at a time when the demand for those computers was about to skyrocket, an immense amount of wealth is created.
” D = Demand; “
Wouldn’t it be more accurate to substitute “M=Market” for “D=Demand”??
It seems to my admittedly non-professional eye that there are many instances where ‘demand’ can exist, but not at a price that would cover the costs involved in the other items in your equation, in which case no “Wealth” would be created...
If I manufacture a “New and Improved” buggy whip, and nobody buys them at a price which covers my costs (plus profit) have I ‘created wealth’, or have I wasted resources, or even ‘destroyed wealth’ under the law of “Opportunity Cost” (the materials, time, and talent used to manufacture the unsaleable buggy whips are not available for other, more productive, uses)??
What’s missing is “creating wealth vs. redistributing money”, and that “both wealth and money are not durable”.
Too many assume that the economy is just a matter of stirring the pot, getting money to move around. If somebody doesn’t have money, they can just be given money from somewhere else and that’s supposed to resolve a problem.
A hamburger is something with intrinsic value. That’s wealth.
As a farmer (I’m not), I could take nigh unto nothing and raise a cow, lettuce, tomatoes, and wheat - then make a hamburger. That’s creating wealth.
You could buy that hamburger from me for $1; we exchange a token of value for something of value. That’s money.
You eat the hamburger, which is something with intrinsic value; the value is digested. Wealth is not durable.
I have $1, and a few hours later you’re hungry again; because you have no money, Barry takes that dollar from me and gives it to you. That’s redistributing money.
I sold my hamburger and was taxed 100% on my revenue from it; because I have nothing taxable but am now poor, Barry prints another dollar and gives it to me - there is now $2, but the value of each dollar suffers 50% inflation. Money is not durable.
Now we have two dollars and no hamburgers. All value has been destroyed, and no matter how much money is printed there is no more value until someone creates it independent of the money supply.
Creation of wealth attracts money; those lacking wealth give money to obtain it. Wealth being non-durable, the latter soon find themselves with neither. Leftists think they can just take money from the former and give it to the latter, and are perplexed by (A) the continuing accumulation of money by wealth creators, and (B) the decline of wealth creation as wealth creators see little benefit beyond giving away what they create just so they can keep getting their own money back. As wealth creation declines, more money is printed in the theory that it can buy more wealth, and more prohibitory regulations are enacted to shore up the flow of money within the system - further discouraging additional wealth creation. Those thinking money=wealth end up destroying the creation of value, leaving an economy with lots of money to spend and nothing to buy.
Interesting point. I chose “Demand” as much for its common usage in the “Supply and Demand” terminology, but I take your point.
In cases where demand is insufficient to cover the costs of production and profit, even to the point of no demand, it lowers the overall value of that side of the equation and less (or no) wealth is created.
“Market” seems less specific in definition. Good feedback. Something to think on. Thanks for taking the time.
I would also add that "price" is not the same thing as "value".
I was relying on the perhaps archaic (Econ 101 was a long, long time ago) definition of “Market” as the place where Supply and Demand meet on the Price Curve....
My primary intent in this was to illuminate what is, I believe, a tangible, fundamental difference in how liberals look at the dynamics of economic growth as compared to how the rest of us look at the subject. The question is often asked whether liberals are ignorant or whether they are malicious regarding the economy. I think that they are, to a large extent, ignorant for precisely the reasons I stated - particularly when such a large percentage of current economic policy makers have never set eyes on the P&L statement of a private firm.
I appreciate everyone's comments. Thank you.
Thank you for the excellent illustration.