Sunday, September 13, 2009

Economics @ Home © Volume 1 Issue 8

Output and Growth - Part 1

Output and economic growth is one of the longest standing issues in economics. The two innocent concepts seem simple enough. The words mean exactly what you think they mean, or is it? While we can grasp their English meanings intuitively, I would like to formalize our thinking about output and growth and explain why these concepts are important to us in a macro and more importantly, in a micro scale.

In conventional economics, output is usually related to Gross Domestic Product (GDP), or some other derived variant like real GDP, real GDP per capita, GNI, PPP-adjusted GDP and the list goes on. I am not going to go too much into detail on how these figures are calculated but it suffices to say that they are an estimate of how much goods (and services) are produced by an economy. It can also measure the income of an economy as people get paid for what they produce. This seems to make more sense and easier to grasp as a concept because it is somewhat difficult to quantify the value of certain goods and especially services produced.

Just with this definition alone, you can probably see why output is important to us. It is a measure of our income and last I checked, our income was our source of sustenance. Of course, we must remember that we are currently thinking about output in terms of a macro-economic scale. Knowing what output is seems innocent enough, but knowing how this output comes about is another monster altogether.

As I said, I will spare you the gore, but it is vital that I go through what is important when it comes to output. First of all, we have to agree that it is in our best interest to maximize output. It is all well and good to talk about how we should be environmental friendly and talk about conservation of resources but that only alludes to the point that I am getting to. Because of the goal of output maximizing, it is then vital to optimally allocate our resources. That is to say, minimize waste and maximize productive output with a predetermined allocated amount of resources. We must allocate our resources efficiently.

A simple comparison between Malaysia and Singapore will make the difference between the effectiveness of resources allocation glaring. In a previous issue of Economics @ Home, I explained that Singapore's national income per capita (a measure of output) has grown to more than triple that of Malaysia's within the span of 30 years. That was already assuming that both countries started with the same base. Why and how did this happen? Singapore's small size did help, but not because they had nowhere else to spend its money, but because it spent it in the right places. Singapore did not try to build the tallest buildings in the world. It wasn't enough for Malaysia to build one, but TWO tallest buildings, which are already forgotten. If only "Entrapment" was a super big hit. Maybe more people would have said, "Hey!!! Those are the twin towers!!". That was never to be, at least not in this parallel universe.

Going back to the point of resource allocation. If you looked at the export data of Malaysia and Singapore, you would be amazed that Singapore as a country exported more in terms of value compared to Malaysia. You must ask yourself, how does a small country that has nothing, export more than a country that has oil, palm oil, rubber and whatever else? Remember that we were once number ONE in the world for some of these products.

Of course the answer is a combination of 1001 reasons and things that the Singapore government did and the Malaysian government didn't do. Malaysians laugh at jokes made about the Singapore government. Very few Singaporeans laugh at jokes made about the Malaysian government simply because those jokes are not made up. They are true stories that are exceptionally hilarious! Just the other day, OC Phang of PKFZ fame said that she did not understand the term cash flow projection. So I went around asking 12-15 year-olds what they thought cash flow projection meant. All of them got the idea albeit not the exact definition correct.

While I am not going to go through the 1001 reasons that I mentioned, I will elaborate on a few important points. Singapore stressed on the importance of providing value-added services. Exporting raw materials and commodities have no value-added-ness. The price of these goods are determined by the world market. If crude oil is USD80 today, we can only sell it at USD80. By providing exclusive value-added services, we would have differentiated our products from the homogeneous commodities and thus give ourselves pricing power. Consequently, pricing power raises our export value and income. Now that I have said it, the idea seems trivial. Why do we not provide value-added service? To add value to any good and service, there has to be invention and innovation, which is a by-product of education. As long as our education system is filled with potholes and bumps, there is no way that Malaysia can be a champion of value-added-ness.

On a macro scale, output is a determinant of our income. While it is fun and games to talk about output on a macro scale, thinking about it seems boring because when we really examine the issue, it is hard to see how this affects us as individuals. So what if my country does well or not? All I have to do is to make sure I work hard or smart or however you want to work, and earn enough money for myself and my family and my noble goals. Why do I need to bother about output?

Perhaps the link from the individual to an economy is hard to see, as the performance of the economy is a mere aggregation of individual performances. Actually, the same concepts apply to the individual as well. In fact, this concept of maximizing output is so inherent in our everyday lives that we take it for granted. Even a 12 year-old can tell you that he wants the most bang for his buck, however unethical it is for a 12 year-old to be talking about obtaining banging for his buck.

We commonly think of material goods as resources. Day in and day out, we try to get the most value with our money. Although it may be common sense, I will still say it (because common sense is ever so uncommon these days): time is also another important resource. Everyone has 24 hours each day and it is only too cliched to say that we should make the best of the time that we have. We hear our parents tell us that all the time. While studying does give us good grades and perhaps a well-paying job, it probably isn't fun. So then, how do we really make the best of our time? Maybe I will attempt an article on this topic in a future issue.

Another important intangible resource is our mind. I have seen brilliant ideas go to waste simply because they were not put into action. My meek attempt at improving the output of my mind is to contribute a weekly newsletter that has a miniscule readership.

Going back to the main points, the idea of maximizing productive output is almost intuitive. I say this because we can always construct another bridge to nowhere or a building that is taller than the currently tallest building in the world and this would still contribute to national income. That is why the keyword here is "productive". If left completely to demand and supply, most of the goods that are produced would only be those that provide maximum utility. It is the role of the government to provide incentives for allocating resources to productive output.

What then, is productive output? To put it simply, they are products that can help generate growth. Growth not only allows us to produce more output in absolute terms, but ideally, it should allow us to produce more output with the same amount of resources that is to say, improve efficiency. I will talk more about growth, its importance, and perhaps attempt to figure out how to obtain it in the second part of this article next week. Until then, I wish that you can find the most bang for your buck.

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