Sunday, November 2, 2014

Profits and Economic Growth for everyone! A case for Innovation

Imagine you had to pump a deflated ball. Increasing its pressure increases the volume until there are no more air spaces. You’d have to stop, won’t you? But you don’t. If you’d stopped, the ball would stop expanding and would remain so until the air slowly escapes with use – back to being deflated and another round of pumping. If you don’t stop, seeking to interfere, something would have to give and you’d end up at another crisis – a deflated ball but the second round of pumping might be more disastrous.

Well, if you thought the ball was the economy, a closed one, and the pressure, aggregate profits, you are right. An article by Gennady Bilych, department of Management, UPEC Corporation, Profit and Economic Growth, and published in 2012 painted this self-same scenario. The cyclic nature of economic fluctuations were modeled on corporate profits. He argues that during the expansion phases of the cycle, the markets are imperfectly competitive, if not monopolies, and because profits will favor the innovative, more efficient corporations invest in innovations, gathering profits which attracts other companies into the market like honeys to bees. Eventually, economic growth becomes zero at the peak of the cycle. Businesses stop making profits. The markets are now perfectly competitive. Then comes the crisis and a phase of economic contraction results. The most efficient survive because they just break-even; they earn normal profits. At the trough of the cycle, only effective innovations can resurrect another expansion.

A demonstration, possibly against huge corporate profits and exploitation. France. Paris 17 on Wikimedia Commons
Nobody likes imperfect competition. It brings up memories of exploitation, of monopolies and allocative and productive inefficiencies. In attempting to marry microeconomics to macroeconomics, Bilych argues that imperfect competitions fosters economic growth when innovation, the introduction of new technologies, new materials or more efficient management strategies, thrives. Innovation increases marginal productivity of labor, makes business produce more commodities at the same or even higher prices, and helps them generate more profits. Inflation grows but so does employment. Workers get paid more and everyone seems happy.

Eventually, increased profits and economic growth does not last for long. How long it does last depends on the quantity and complexity of available innovations. Entrepreneurship thrives, consumer confidence is high and positive but profits turn out eventually to be zero because the playing field slowly becomes more competitive and hence, firms no longer make profits. Economic growth becomes zero. The market become perfectly competitive. Before long, firms leave the market, unemployment increases and inflation falls. A business crisis ensues. Economic contraction.

These cyclical fluctuations are not recent. They have been in existence since feudalism and slavery. They have only become more troubling in the nineteenth century.

Interest follows the same route as profits. Interests grow during expansions when profits are high and businesses can afford to pay. Interests are savings saying in effect: compensate me in the future if I give you money as loans to increase production and profits. The supply chain is now perfectly vertical and straight during a contraction. Producers increase production at a loss. Interest rates fall.

The government is also in the picture. It could decide to interfere during a crisis, lowering interest rates so as to increase economic activity, increase investment and expand output. When the results are short-lived, lower interest rates are loans for inefficient companies who cannot pay back the interest, leading to catastrophes which could spread to the banking sector. So, innovation has a better way of resolving business crisis than regulation. Innovation blesses the efficient with profits and takes those profits back to labor as wages or have them plowed into investments as rent paid to… labor!

In brief, if the markets are allowed a free rein, there would be no case for exploitation, no need for leakages because producer profits eventually become consumer profits and then becomes producer profits and the circle continues ad infinitum until another crisis strikes…

Does the economy then export commodities or securities? If there was no exploitation, why does the primary question, inequality, still exist?

The next innovation, please!
The blog piece was inspired by the article, Profit and Economic Growth published by Macrothink Institute, a private organization dedicated to scientific research and publication.

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