Basics of Economics -1

The basics of economics, as laid out by Adam Smith in The Wealth of Nations (seems like the only book worth reading in economics to me) are missed by most people-including many well known economists and financial planners and bankers.

Here are some key points of Economics, thanks to Adam Smith.

1. Society progressed by increased division of labor-specialization leads to more efficient production.
2. For division of labor to come about, you need capital (think tools-workers need tools to work on to produce more). As capital in a society progresses, division of labor also progresses alongside it. More capital in a society leads to more efficient division of labor.
3. Efforts of Government should be directed to increase production of things. This brings down their costs (increases surplus production)-leading to more exchanges.
4. Parsimony and savings result in accumulation of capital and should be encouraged. Consumption of goods should be discouraged. Consumption should only be a percentage of net capital gained-so that there is continual accumulation of capital in the society. This is well understood when considering a single individual-a man who saves comes out ahead-someone who consumes only a small portion of their capital has a brighter future.

There's more to The Wealth of Nations than this-but these are some of the most important points.

Consumption can be looked at as the return of goods to their basic forms which have no resale value-carbon and CO2 for coal and oil, wood and glass turning into living room decorations with little resale value, etc. This is similar to the treatment of Hayek in his order of goods-higher order goods being the more basic commodities, and lower order goods being the more finished products. I like to think of the order of goods in reverse-because the "evolution" of goods is easier for me to understand that way-lower order goods being turned to higher order goods by the work of man, using capital (tools) and labor ( man hours).

An example of how everyone has got it all wrong with the $168 billion stimulus package in the US earlier in the year.

The package is often said to boost consumption and therefore economic growth. See News release here today, for example. That is not right. Why?

If you give me money to buy more apples, does that increase automatically the amount of apple production or the net production of society? No. Consumption is a drain on capital. It leads to destruction of capital. You don't want a society to consume more---you want it to produce more and save more. That $168 Billion should be used by judicious people to invest more in improving their specializations, getting better jobs, etc-in other words, improving division of labor to increase net production (goods and services is an arbitrary distinction-services can be looked at as intangible goods). Consumption does not increase economic growth-it is economic growth which increases consumption. They have it backwards there. As the net production of a society grows, assuming a fixed percentage is being consumed-the consumed portion keeps on increasing in time.

-Sanjay