Before we can ever properly evaluate Ohio’s–or any government’s–economic policy, we must first understand the various factors at work in a division of labor economy and their necessary roles [read on OCR: “Let’s Divide the Work”]. In such an economy, each person focuses on producing one thing or a few things while relying on others to produce the vast majority of wealth necessary to satisfy our needs and wants.
It’s now time to explore several critical factors on which a division of labor economy hinges, starting with the most vital: the accumulation of savings and capital.
Capital is the accumulated wealth owned by individuals and businesses that is used for earning a profit. It includes items such as tools, factories, machinery, equipment, buildings, inventories, supplies, and various goods owned by businesses and entrepreneurs. Capital also entails money owned by businesses and funds lent to consumers to purchase items, like houses and automobiles, that most consumers do not have enough savings to purchase. Capital comes from savings. Savings is simply the result of abstaining from consuming one’s own funds. Abstaining from spending on consumption makes possible the equivalent spending on capital goods for the purpose of production.
A foundation of savings is needed before an underdeveloped economy can transform into a division of labor economy. Savings is necessary in order to release people from working on the immediate production of food so they can focus on producing other things. Without savings, everyone would have to focus their labor on securing their next immediate meal. Recall the island economy in the first article of this series [read on OCR: “Our Need for Wealth”]. Before Person A can start focusing on his efforts to grow apples, he must have accumulated enough stocks of food (i.e., fish) to live off so he doesn’t have to focus his efforts on gathering his next meal. Only the certainty of the next needed meal, based on an accumulation of savings, frees Person A to start focusing efforts on the production of other wealth. Of course, the larger the accumulation of savings of fish, the more time Person A can spend on producing apples rather than searching for food.
Similarly, the accumulation of capital is necessary for a division of labor economy to grow from its infancy. Capital is first needed to raise the productivity of producers of food so that it is not necessary for everyone’s efforts to focus on food production. The fewer people required for producing food needed for all, the more other people can devote their work to producing wealth other than food. For example, if Person A, thanks to an accumulation of savings, had time to create a fishing net which could catch numerous fish, Person A could produce enough food for multiple individuals. The fishing net, (Person A’s capital), frees Persons B and C to spend time and resources producing wealth besides food, like boats and huts.
As the economy grows and becomes more complex, savings is necessary in a division of labor economy as it transforms from a barter economy to one that utilizes money. Savings enables people to be paid within a reasonable period of time after the completion of their work. For example, most workers expect to be paid every few weeks even while their employers may not recover revenue from their work for months. Fortunately, the payment of wages comes from savings. Imagine the chain of production for a sandwich maker. A farmer must plant seeds (capital) to grow wheat to sell to a flour mill. The owner of the flour mill must use the wheat (its capital) to create flour to sell to a bakery. An owner of the bakery must use the flour (its capital) to bake bread. And of course, the sandwich maker must use the bread (its capital) to sell sandwiches to a consumer. Absent the existence of savings, none of the parties in the chain of production would get paid until the consumer buys the sandwich from the sandwich maker, who then pays the baker, who then pays the owner of the flour mill, who then pays the farmer. Therefore, the existence of savings is necessary for each party in the chain of production to be paid in a reasonable amount of time before the ultimate and final purchase by the consumer of the sandwich.
The continual increase in capital accumulation expands a division of labor economy through enabling large scale production. For instance, if a furniture producer has a machine that allows him to produce only a few couches a day, other furniture producers will be needed to meet market demands. However, if the furniture producer has a factory full of machines, he can produce thousands of couches in a day. Fewer furniture producers are needed. Thus, the more the furniture producer abstains from consumption and uses the savings for the purchase of capital, the more the division of labor economy can expand.
Forgetting the need for savings and capital is disastrous to a division of labor economy. As we examine the concepts of savings and capital in more detail , we’ll see that government stimulus programs cannot fix our economic problems, because they further deplete an already weak foundation of savings and capital. In fact, the personal savings rate in the U.S. has recently reached record lows in modern recorded history. For now, however, it is important to understand that in a division of labor economy, savings and capital are our tools for creating needed wealth.
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