Monday, May 27, 2013

Balance between investment and expenditures

One economic principle I recently discovered is the theory that there is a balance between investment and expenditures in a society and somewhere on the range where each is 100% going towards investment or expenditures, and in the middle there is a balance where there is both investment in new companies and expenditures in older companies.

First, some background.

Both investment and spending are critical for an economy to run. When a company begins it needs money to put together its capital to start a business, storefronts, materials, etc. This money comes from angel investors and banks. For the angel investors, they usually get stock in the company, and banks receive the money back plus interest. This is the easiest and most effective way to create an environment where businesses can start.

Once the business has hit the ground, it needs customers. At this point in the business' development while they might occasionally take out a loan, most growth will come by selling its services to customers. Most businesses will be marketing to individuals for a whole range of services. There are fewer cases at this point for taking out loans, though issuing stock is often a good way to get cash for future growth. Sometimes corporations will buy up their stock when the price is low (or that of another corporation) and then sell the stock when it is higher which is an extremely efficient way to make money to grow the company. The number one goal of a corporation is to generate income for its owners, and this is historically done most effectively by building a trusted brand with long-term employees because turnover is costly. When an employee has a literal stake in the company, he/she has an incentive to create returns for the company because he/she will receive a personal benefit for increasing the company's value, and has a smaller incentive to move to another job, which is mutually beneficial for both manager and employee (who are both owners in this scenario). This is one reason Microsoft and other technology companies are so successful, people have few incentives to move between those corporations because beyond making a large salary as a programmer, people working for these companies often receive stock as part of their compensation. They make the owner's interests tied in with the employee's interests and levels the playing field, which benefits everyone involved.

In order to make certain that an established company can keep growing in the long-term, it needs to ensure that it has a great product that people will keep buying, and have a competitive edge over their competitors. If a company makes poor products, people will stop buying it. That is a major reason why the American car industry collapsed in 2008 because they were not competing with Toyota et al from Japan and Korea. The customer must come first, it is in the interest of everyone involved because customers can always shop somewhere else.

On the macroeconomic level, the policy maker needs to look at it with an incentive to grow the economy, and whether he/she looks at it from the business owner's perspective or the customer/employee's perspective, the answer is the same. People need to have enough money to buy products. If this is forgotten than there won't be money flowing through the economy so businesses can grow, and this means that people who work need to be paid a decent amount of money. Not only will it reduce turnover (read costs) for businesses which increases the medium-term bottom line, but it will create an economic system where social mobility is more prevalent and that people will the ability to create new products and businesses which is how innovation works best. people will have better products at lower costs because of competition. Companies will be easy to form, and if a company is doing really poorly than bankruptcy will be an option whether it is a restructuring or dissolving the whole company. Everyone benefits financially in the long-run from an economy where innovation is high and people can purchase new products.

In conclusion, it is important to realize that both investment and consumer spending are critical to maintaining a high quality economy, and economists, politicians, and businessmen must realize the balance that is economics.

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