Principle 6: Small capitalized companies are better than giant corporations

Economics Based on the Balance of Demand, Real Value and Trade (Principle #6 of Socio-Economics)

In order to empower everyone to contribute productive value, the socio-economic model should be made as simple as possible. Gone will be the financial concepts created by the selfish hand such as futures trading, stock markets, derivatives, and profit maximization. Retained, but greatly simplified or modified, will be macroeconomic concepts such as interest rates, money supply, exchange rates, and GDP. New concepts such as “profit rate”, “ordinary profits”, and “corn index” will be introduced in future papers.

Instead of money and profit maximization, the goal of socio-economics will be the creation and spread of value throughout society through a subset of principles which I call the Value-Trade Theory. This theory makes an assumption that people undertake economic activity in order to add value for themselves or for other people through human action and trade according to their individual or group interests. For this reason, it classifies all economic terms, concepts, and actions under three umbrella concepts based on the writings of Adam Smith:

Demand – the needs and wants, or the actions and concepts manifesting the needs and wants of individuals or groups of individuals. Value – the goods and services, or the actions and concepts leading to the goods and services, which are valued high enough to satisfy the demand Capital – anything used to produce valuable goods or services Industry – any action done on capital to produce valuable goods or services, or concepts leading to such production Trade – the exchange of goods or services or measures or concepts leading to such, done between individuals or groups of individuals, done freely in order to satisfy each one’s demand/s.

Adam Smith STOCK REVENUE Goods for consumption Fixed Capital Industry Circulating Capital Value-Trade Theory DEMAND VALUE (Capital) VALUE (Industry) TRADE Manifests as: Needs & Wants Knowledge, Skill, Land, Machinery, Equipment, Raw Materials, Inputs, Ingredients, Work in Process Education, Research, Farming, Mining, Construction, Work, Labor, Service Activities, Manufacturing, Processing, Finished Inventory, etc. Enrollment, Employment, Currency, Deposits, Loans, Exports&Imports, Quotas, Trade Barriers, Barter, Contracts, etc. Measured by: Population, Demographics, etc Educational Attainment, Qualifications, Prices, Asset Valuation, etc. Test scores, grades, Productivity, Quality Control, Industrial Output, Inventory Quantity, etc. Purchasing Power, Money Supply, Interest Rates, Inflation, GDP, Balance of Payments, Employment Rate, etc. Table 1. The five concepts in the Value-Trade Theory compared with the concepts in Adam Smith’s The Wealth of Nations

A tree that produces fruits is not considered economic activity until a human harvests such fruit for trade with others. A person who produces vandalism of no societal value will not be considered performing economic activity, but a person who paints a wall nicely (industry) using his own skills (capital) may be considered doing an economic service worthy of being paid (trade through employment). Each unit of value must be traded in order to satisfy the needs and wants of a population. The journey from demand to value creation to satisfaction and/or recapitalization constitutes one iteration of an economic process comprising many small economic activities.

ScreenShot010Figure 1. One iteration of an economic process in the Value-Trade theory

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Figure 2. The creation of value from capital, arising from demand (either effectual or absolute), motivated by personal dharma, and subsequent movement of value through society through trade, which then travels back to replenish capital spent or return directly to satisfy demand.

Purchasing power, represent by Trade, will measure how each unit of real value is successfully ‘transferred’ to satisfy each unit of need, and will be the key measure of the economy instead of the GDP:

Though the..revenue of all the..inhabitants of any country..is paid to them in money, their real riches, however..must always be..in proportion to the quantity of consumable goods which they can..purchase..The whole revenue of all of them taken together is evidently not equal to both the money and the consumable goods; but only..to the latter..than to the former (Book 2, Chap. 2, Par. 20)… That revenue, therefore, cannot consist in those metal pieces, of which the amount is so much inferior to its value, but in the power of purchasing, in the goods which can successively be bought with them as they circulate from hand to hand (Par. 22).

A hungry person who cannot afford to buy food will indicate negative purchasing power, while a rich man who can acquire all the food available will indicate an excessively high purchasing power. The aggregate ratio between demographics, production, inventory, sales, etc. for every town, city, or region for a certain time period will indicate the manageable balance (not an equilibrium) and efficiency of the economic processes for that area. Each healthy iteration will then be the basis for the next iteration, leading to sustainable growth. Unhealthy ratios will indicate that either value or trade is either too high or too low and must be probed just like gears in a machine are individually inspected to ensure smooth operations . This will nip economic mistakes in the bud, preventing imbalances from growing into boom and bust cycles.

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Figure 3. The Value-Trade Theory seeks a manageable balance between demand, value, and trade for all

The sequence of each iteration will be from Bar 1 to Bar 4, then back to Bar 1:

Bar 1 – Every population will have needs and wants that must be addressed. Bar 2 – Through self-interest, individuals arrange capital to create value. Bar 3 – Individuals process the capital through human action, generating industry and valuable goods and services. Bar 4 – The goods and services are exchanged for money of equal value. The money will then be exchanged for the goods and services needed to satisfy their demand or replace or maintain the capital expended. This completes one iteration. Unlike the marginalist theories that derive profits from arbitrage or differences in prices, profits in the Value-Trade theory are derived from the differences in the efficiency or skill in production. Let us say, that in a bakery, an unskilled baker can bake one donut per minute, a semi-skilled baker can bake three, and a skilled baker can bake five. If each baker is allowed to get a share of the produce of his own labor, “natural pricing” will justly give the skilled baker more profit, encouraging sellers to improve their skills and productivity, instead of inducing scarcity or relying on information asymmetry. Line 5 – The real values produced and traded in the iteration should always be roughly equal or are in proportion to the capital employed. Any gross inequality will indicate an economic mistake, such as when a company “cooks its books”. In the bakery example, a baker can never make more donuts in one minute than is humanly possible unless he increases his capital by employing machines. He can also cannot sell more donuts than what he has in stock, unless the buyer has full faith in his ability to deliver in the future. Socio-economics prohibits futures trading to third parties as this exposes others to risk and is detrimental to the sustainability of the economy: The speculative merchant exercises no one regular, established, or well-known branch of business. He is a corn merchant this year, and a wine merchant the next, and a sugar, tobacco, or tea merchant the year after. He enters into every trade when he foresees that it is likely to be more than commonly profitable, and he quits it when he foresees that its profits are likely to return to the level of other trades. His profits and losses, therefore, can bear no regular proportion to those of any one established and well-known branch of business. A bold adventurer may sometimes acquire a considerable fortune by two or three successful speculations; but is just as likely to lose one by two or three unsuccessful ones. (WN, Book 1, Chapter 10, Par. 41)

Bar 6 – New demand is generated after the old ones have been addressed, or dynamically as the value-perception changes, markets expand, the population increases, etc. Bar 7 – Participants continue to allocate capital, create value, and perform trade to address these new demands if human dharma is free and empowered. Each unit of demand creates the impetus for individuals to create a corresponding unit of value which is circulated through trade. Goods and services which fail to have the value needed to meet the demand are not traded, as people tend to avoid low-quality ones and gravitate towards those of high quality for the lowest price. Thus, free trade based on human dharma naturally filters goods and services with value and circulates them throughout society. Although low-value goods and services will not enter the Value-Trade equations, the capital loss resulting from wasted time, effort, and materials will still be taken into account for the next iteration. Continuous and balanced industry and trade will eventually increase the value in a society leading to new development and innovations. The essence of this theory is summarized below:

(Bar 2 & 3) The general industry of the society never can exceed what the capital of the society can employ…(Bar 3) Every individual who employs his capital..necessarily endeavours..the greatest possible value…(Bar 4) or to exchange for the greatest quantity either of money or of other goods. (Line 5) But the annual revenue of every society (Trade)..is precisely the same thing with that exchangeable value (Industry) (Pars. 3, 5, 8, and 9). The quantity of industry..is..regulated by the annual demand, in such a manner that the average annual produce may..be equal to the average annual consumption (Book 1, Chap. 10, Par. 49). When we compute the quantity of industry..we must always have regard to..provisions, materials, and finished work: the other, which consists in money..must always be deducted (Book 2, Chap. 2, Par. 37). If the paper money which the bank advances never exceeds this value..it can never exceed the quantity which the circulation of the country can easily absorb and employ. Though the stream..continually running out from its coffers may be very large, that which is continually running into them must be at least equally large..If, on the contrary, the sum of the repayments..falls commonly..short..those coffers must soon be exhausted altogether. (Book 2, Chap. 2, Par. 60)

Sample Corporation Cash 1,000,000 Long Term Debt 5,000,000 Fixed Assets 9,000,000 Equity 5,000,000 Total Assets 10,000,000 Total Liabilities 10,000,000 Table 2. The Assets (Value) and Liabilities (Trade) of a Company (Society) are precisely of the same value