Understanding Economics in One Hour, Part Three

The Factors of Production

Emile Woolf, Going Postal

In the light of the law formulated by Jean-Baptiste Say, the true focus of economics is production, or wealth creation, the subject of Adam Smith’s immortal tome “An Inquiry into the Nature and Causes of the Wealth of Nations”.

The establishment of every productive enterprise is preceded by judiciously assembling and combining the fundamental factors necessary for fulfilling its particular purpose. Those factors are land, labour and capital.

Land is provided by nature; labour is provided by people; and capital is provided by savings out of profits of past production – either your production or borrowed from others. Each of these factors commands a “return” for its use – rent, in the case of land; wages in the case of labour; and interest in the case of capital.

As you might expect when human nature, flawed almost by definition, is concerned, the application of these factors has its dark side: land can be stolen, misappropriated or deliberately kept out of use (hoarded); labour may be forced and exploited; and profit (the source of capital) may be abused by price-rigging, monopoly or market manipulation, into greed and theft.

[In Keynes’ graphic example, land is clearly not used productively – digging and filling is an abuse of this factor. Labour, as a factor, is abused when coerced into undertaking completely unproductive, useless, work. Capital is abused when wasted on spades that will be worn out on effort that has no purpose, value or yield.]

Land

Although land is a gift of nature, in the modern era all productive land is “enclosed”, in private or public ownership. The “return” for the use of land in production is rent, payable to its owner – and is not to be confused with the rent of buildings, equipment, vehicles and so on – which is simply payment for the use of someone else’s assets.

But the source of this factor is, of course, land. When you are next in the City of London raise your eyes to the inscription above the Royal Exchange, in the very heart of the world of finance, trade and commerce, and you will read: “The Earth is the Lord’s and the fullness thereof “, taken from Psalms and Corinthians. It serves as an eloquent, and salutary, reminder of who the ultimate landlord is!

Labour

Labour applied to land can, on its own, be productive, but only in the very limited sense that the act of plucking an apple from a tree will provide you with some sustenance. For all practical purposes we are not, by nature, self-reliant, and hence the most productive outcome will always derive from (i) division of labour into specialisms arising from aptitude, talent and opportunity; and (ii) trade, which enables us to take advantage of other people’s work.

Some of you will remember, from childhood, AA Milne’s delightful poem “The Old Sailor” about a solitary sailor shipwrecked on a desert island. He is so overwhelmed by the things he needs to do to satisfy his multiple needs – hat to avoid sunstroke, water to drink, fish-hooks, and much more – that he can never decide where to begin. The final verse is a gem:

“And so in the end he did nothing at all,
But basked on the shingle wrapped up in a shawl.
And I think it was dreadful the way he behaved –
He did nothing but bask until he was saved!”

Division of labour is tricky when there’s only one of you!

The long journey that began with hand-to-mouth subsistence has been marked with many milestones: division of labour, specialisation, exchange through trade, mechanisation, automation, robotics – it will never end. The nature of the work changes at every stage, but there is always more, much more, to be done.

The flavour of this progression may be glimpsed if we take another look at your highly instructive £20 banknote. It shows a profile of Adam Smith, accompanied by the following statement: “The division of labour in pin manufacturing; and the great increase in the quantity of work that results”.

The lesson this conveys is that of the “Invisible Hand”, the self-organization principle of the market – namely that, in the case of pins, the metal-cutter, pin-drawer, roller, finisher, pin-head maker, all worked together to increase their combined productivity, and thereby increase the wealth of society as a whole.

Clearly, advances in technology will always entail job losses and associated pain – but this is the price, suffered by the few, of progress that benefits society as a whole. The entire historical catalogue of industrial strife, the machine-smashing Luddite movement, job-protection law, large-scale redundancies, protectionism, workers’ rights, union-backed job reservation rules – all exist as testimony to the ultimate futility of efforts to derail the inexorable march of progress towards higher living standards.

Politicians are quick to seize on the notion that robots will make millions jobless. Some have even hit on the idea of imposing a “robot tax” to redistribute the proceeds of technology to the new masses of unemployed.

Actual evidence of job-stealing androids is sparse. More people are in work than ever before. Among 16 to 64-year olds in the UK, 74.5% are working. Lower employment rates in Southern Europe are a hangover from the financial crisis, not technology. At no previous time, nor now, have technological advances resulted in millions of long-term unemployed.

This is yet another lesson in the danger of focussing on what is seen, while failing to discern the unseen. Narrow-sighted reaction against these advances did not foresee the rise of the service economy. Or the jobs actually created by the rise of computers. Witness the articulated robot arms used to illustrate every news story about the motor industry.

Indeed, latest studies have found that automation in fact created far more jobs than it destroyed in 18 advanced economies between 1970 and 2007. Automation raises productivity and consumer incomes, boosting real demand and employment across the whole economy. It also lowers the cost of inputs for downstream industries, again boosting employment.

Certain work that involves caring for others, recognising individual or cultural sensitivities, or sheer creativity, will always be difficult to automate. Automation can certainly lead to significant changes in the way that jobs are performed, rather than to outright elimination. This means working with the robots rather than competing against them.

[As I write, the French people yet again have to endure the crippling affliction of countrywide rail strikes against President Macron’s recourse to “executive power” to reform labour laws that bestow privilege on a single group while disregarding the wider community.

Ironically, Macron is kept in office by the very unions that he is now battling. His current efforts mirror those of his predecessor – and several before him – efforts that failed totally to redress the blatant abuses that favour employees of SNCF, the nationalised rail company, while disregarding the consequences for the poor users.

Jobs-for-life; 25-hour working week; automatic annual pay rises; retirement at 50 for TGV drivers; end-of-year bonuses; journey bonuses; TGV bonuses; coal bonuses; holiday gratuities; annual bonuses; generous overtime; away-from-base premiums (non-taxable); free healthcare; free travel for drivers and their families; and, for SNCF office-workers, a “lack-of-bonus” bonus. The result is an annual salary, net of tax, of more than £60,000 for a 40-year-old TGV driver.

It should come as no surprise that SNCF’s annual expenditure budget of €15 billion is exactly double its total revenues!

The unionised set-up at Air France, the national carrier, is no better. Every attempt to introduce reform is met by rigid intransigence, even bringing the entire country to a standstill – autoroutes blocked, post undelivered, train and air crews on strike, rubbish uncollected.]

Capital

Capital is not a primary factor of production since its existence is obviously attributable to earlier production. Capital is the seed-corn that has been set aside in the form of savings, rather than consumed, out of profits achieved by past production. It is the “wherewithal” made available to facilitate new production. Its owner, the “capitalist”, has invested it with a view to profit. The investor of capital may or may not be the “entrepreneur” who originated the entire enterprise.

The entrepreneur is the visionary who combines the factors of production and brings the enterprise into being – work that is often classified as a fourth factor of production, because without it the venture would lack direction, organisation or effective management. It would flounder and fail.

As already noted the “return” for the use of capital is interest at a rate that, if left to the market, would be determined quite naturally. But benighted governments pursuing the Keynesian creed don’t believe in the operation of free markets. The Keynesian god, as we know, is demand: surely, if people and businesses – and governments – can borrow and buy things on credit while paying next to nothing for the privilege, the ensuing increase in demand will solve all problems!
 

© Emile Woolf May 2018 (website)
 

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