The most important economic principle
On a dark cold winter day in Hyde Park, Illinois, in a small stone eating hall, it became crystal clear. I was fortunate enough to eat with a visiting professor named Marvin Goodfriend. Professor Goodfriend was a vice president at the Richmond Federal Reserve but was teaching graduate students at the University of Chicago. I happened to be one of them. It was another in a long line of miserable winter days in Chicago, and we were hunkered down in the cafeteria of one of the many gargoyled buildings that create the feeling of dread and loathing at the U of C. We were talking about the economy and economics when he turned and smiled his glinty smile and said:
“Profits go to zero.”
Professor Goodfriend went on. The cycle is always the same. We experience a technological breakout or advancement. A huge profit opportunity or window is created. However, the window does not stay open forever. The profits are always being eroded. The market can become saturated. Large markets draw competition, and prices of raw materials and labor get driven up. The erosion takes place in several different ways, and at different rates, but the profits will move toward zero- until the next technological breakout.
I don’t know if professor Goodfriend , who was very young in 1988, remembers our lunch. He had many students and probably talked to many of them, as he was quite popular and extremely nice. I will never forget that lesson, although the specific conversation is fragmented. The concept that Profits go to Zero guides my decision making on a daily basis. I always anticipate the opportunity, or window, will not remain open forever. Whether it be a business venture or an investment, we should always evaluate the decision with this underlying tenet. If the market is still growing, then profits can grow, but marginal profits will be under pressure.
An excellent way to think of this is to think of a fish swimming upstream. Just staying still results in the fish moving backwards. If he wants to stay in the same place, he must swim, and to advance he must swim harder.
There is an old joke, that the only fish that goes with the current is a dead fish. That’s kind of how I feel about companies in saturated and highly competitive industries. They’re dead fish.
On a country-wide scale and for that matter a global scale- we are all dead fish. The whole world is saturated and highly competitive. All countries are helping to saturate the markets. We have more than triple the global capacity for cars than the current market. We make computers now that are 100,000 times faster than the computer I used while at the U of C, and they cost half as much. We have seen the prices of copper and steel, and other industrial metals increase; we have seen the prices of labor in Asia and Europe increase. The profits of the world are dropping. This is the source of the global recession.
Until we have an enormous technological breakthrough which can boost the economy of the world, the United States, with the world’s highest standard of living is going to face more economic hardship.
The politicians and bankers are wasting our money and resources on the same rather archaic technologies of the past. The thought that team Obama is proud to announce that their stimulus package involves repaving roads makes me shudder. Infrastructure maintenance will stimulate nothing; it’s just a form of government subsidy. Spending hundreds of billions of dollars on washed up, out-dated concepts will only lead to a weakened federal balance sheet and more competition in those well trampled arenas. The government needs to facilitate technological advancement and help to develop opportunities. The administration should not concern itself with companies that are no longer able to swim in their respective currents. The individuals who work at these institutions should have access to resources. Resources the government should provide to re-educate and assist the individuals- help them advance, and find their next opportunity. We should never think of a corporation as being made up of individuals. The corporation is a not a citizen who should be protected. The corporation is a nexus of rules that is created to create a profit. Once it is no longer capable- break it up, and assist the individuals who are impacted.
Profits go to zero, corporations go to zero. We should not be surprised or shocked or remorseful. Let them go, and move forward. The alternative path leads to lower standards of living, as the government wastes our resources on unhealthy and bloated companies that can not compete any longer. The companies use every tool at their disposal to be saved- including the heart wrenching plea- “we will put so many people out of work.” Our government should respond to the corporation with the retort- “Our citizens will be assisted, good bye.”- let the ship sink, but save the souls on board.
Joy to the world – Peter
Tags: economics, globalization, inventions, Obama, Profits go to zero., recession, University of Chicago
