Digital Economics E-Book

Jens Christensen

• Herausgeber: Books on Demand
• Kategorie: Geisteswissenschaft
• Sprache: Englisch
• Veröffentlichungsjahr: 2016

Seitenzahl: 672

Beschreibung

In the 2010s, new technological and business trends threaten, or promise, to disrupt multiple industries to such a degree that we might be moving into a new and fourth industrial revolution. The background and content of these new developments are laid out in the book from a holistic perspective. Based on an outline of the nature and developments of the market economy, business, global business industries and IT, the new technological and business trends are thoroughly dealt with, including issues such as internet, mobile, cloud, big data, internet of things, 3D-printing, the sharing economy, social media, gamification, and the way they transform industries and businesses

Leseprobe

Contents

Abbreviations

Chapter 1 Introduction

Chapter 2 Market Economy

What is Economics?

The Individuals as Heroes

The Role of Prices

The Role of Businesses

Work and Pay

Investment

Reducing Risk

The National Economy

Output

Income

Competitiveness

Money and Banks

Money

Banks

Government

Functions

Financing

International Trade

Advantages

Restrictions

Chapter 3 Business

From Market Economy to Business

Classical Economics

Neo-Classical Economics

The Business Approach to Economics

The Firm

The Value Chain

Sustained Competitive Advantage

Functions of the Value Chain

Manufacturing

Procurement/Supply Chain

Marketing and CRM

Corporate Finance

Human Resources

Communications

R & D and Innovation

Data Center

Project Management

Strategy

Business Model

The Organization

Organization Theory

Organization Design

The Evolution of Organization Design

Organizations and IT

The Industry

Positioning

Clusters

Nations

Stages of National Development

Megatrends

Globalization

Digitization

Biotechnology

Nanotechnology

Resources and Sustainability

Economic Growth

Demographic Change

Urbanization

Individualization

Supplementary Methods

PESTLE

SWOT

Chapter 4 Business Industries

The Business World

Food

Beverages

Tobacco

Forest, Paper and Packaging

Textiles, Clothing and Accessories

Minerals and Metals

Construction

Energy

Chemicals

Healthcare, Pharma and Medico

Personal Care

Transportation

Wholesale

Retail

IT

Finance & Insurance

Business Services

Facility Services

Tourism, Entertainment and Media

Military

Police and Courts

Social Care

Education and Research

Government

Non-Governmental Organizations

Crime

Household and Family

Chapter 5 IT

The IT Industry

IT Infrastructure

Eras of IT Infrastructure

Infrastructure Components

New Hardware Platforms

Networking

Databases

Business Intelligence

Data Analytics

Enterprise Systems

Core Business Processes and IT

Information Systems of the Value Chain

Enterprise Software

Supply Chain Management Systems

Customer Relationship Management Systems

Digital Strategy

Chapter 6 Digital Transformation

Technological Drivers

Connected World

Mobile Breakthrough

Mobile Industry

Mobile Enterprise

Cloud Computing

Big Data

Data Production and Traffic

Data Growth and Data Value

Data Driven Companies

The Internet of Things

Smart Manufacturing

3D-Printing

The Sharing Economy

Social Media

The Social Media Industry

Social Media in Organizations

Gamification

Transforming Industries

Transportation

Logistics

Finance

Consumer

Health Care

IT and Media

Digital Enterprise

Digital Business Models

Abbreviations

ABC

Activity Based Costing

B2B

Business-to-Business

B2C

Business-to-Consumer

BI

Business Intelligence

BPM

Business Performance Management

BYOD

Bring Your Own Device

CAD

Computer Aided Management

CAM

Computer Aided Manufacturing

CAN

Controller Area Network

CEO

Chief Executive Officer

CFO

Chief Financial Officer

CIM

Computer Integrated Manufacturing

CIO

Chief Information Officer

CMS

Content Management System

CPU

Central Processing Unit

CTO

Chief Technology Officer

DBMS

Database Management System

EDI

Electronic Data Interchange

EMM

Enterprise Mobility Management

ERP

Enterprise Resource Planning

EVA

Economic Value Added

FMS

Flexible Manufacturing System

FTP

File Transfer Protocol

DGP

Gross Domestic Product

GE

General Electric

GM

General Motors

GPS

Global Positioning System

GPU

Graphics Processing Unit

HANA

High Performance Analytics Appliance

HP

Hewlett-Packard

HR

Human Resources

HRM

Human Resources Management

HTTP

Hypertext Transfer Protocol

HVAC

Heating, Ventilation, and Air Conditioning

IaaS

Infrastructure as a Service

IoE

Internet of Everything

IoT

Internet of Things

IP

Internet Protocol

IT

Information Technology

KPI

Key Performance Indicator

LED

Light-Emitting Diode

LTE

Long-Term Evolution

MAM

Mobile Applications Management

MCM

Mobile Content Management

MDM

Mobile Device Management

MES

Manufacturing Execution System

M-form

Multi-functional/divisional

MIT

Massachusetts Institute of Technology

M2M

Machine-to-Machine

MRI

Magnetic Resonance Imaging

MRP

Manufacturing Resource Planning

NGO

Non-Governmental Organization

OLAP

Online Analytical Processing

OS

Operating System

PaaS

Platform as a Service

PLC

Programmable Logic Controller

PLM

Plant/Product Lifecycle Management

PESTLE

Political, Economic, Social, Technological, Environmental, Legal

RAM

Random Access memories

R & D

Research and Development

RFID

Radio Frequency Identification

ROI

Result Of Investment

SaaS

Software as a Service

SME

Small and Medium Sized Enterprise

SMS

Short Message Service

SOA

Service Oriented Architecture

SWOT

Strengths, Weaknesses, Opportunities, Threats

UPS

United Parcel Service

XML

Extensible Markup Language

Chapter 1

Introduction

 

During the 1990s and 2000s, a third industrial revolution transformed business, technology and society into the kind of world we virtually live in today in the 2010s. The business world and companies globalized and information technology moved from back office to front office and began its ubiquitous spreading. By way of the PC, mobiles and the Internet, a new digital and connected age began to emerge. Despite its growing importance, however, by 2010 IT continued to be regarded as one function along with the other business functions. This state of affairs began to change rather quickly as we entered the 2010s.

What had been more or less peripheral activities in the previous decade moved in some cases to the top of the business agenda. New technologies, especially digital, and empowered consumers threatened to disrupt established industries. As the changes became more visible around the mid-2010s, the transformation began to look like an emerging new industrial revolution, the fourth industrial revolution. It is just the beginning of transformations. A wider breakthrough of new business and technological trends are not likely to happen until the next decade, however. Nevertheless, things are moving pretty fast, as leading corporations and multiple start-ups are investing heavily in a line of new technologies and adapting their business models to a rapidly changing world. Governments are beginning to support the transformation process, too.

No matter how much things are changing, what does not change is the fact that the market economy and business continue to rule the world, in combination with governments. Furthermore, the radical changes of the 1990s and 2000s form the basis from which the transformation process is taking place. We shall therefore start by outlining the nature of market economy as well as that of business (chapter 2 and 3). In addition, the business structure of global industries and applied information technology will be dealt with (chapter 4 and 5). From this starting point, the emerging transformation of business and technology will be treated more thoroughly (chapter 6). These new developments are documented as best as possible from multiple current sources, often institutions and companies analyzing business and technology trends.

Unlike some previous attempts to treat the idea of ‘digital economics’ as a field of its own, isolated from the rest of the economy,1 we shall take a holistic and integrated approach to the subject. We look for the disruptive business potentials of digital technologies, contrary to some specific economic method.

1    Carl Shapiro and Hal R. Varian (1999): Information Rules. A Strategic Guide to the Network Economy; Martin Peitz and Joel Waldfogel, Ed. (2012): The Oxford Handbook of the Digital Economy. Oxford, UK: Oxford University Press.

Chapter 2

Market Economy

 

What is economics?

According to mainstream neo-classical economics theory, ‘economics is the study of the use of scarce resources which have alternative uses’.2 Scarce means that what everybody wants add up to more than there is. It is not a matter of missing basic needs. It is reality that constrains people. ‘There has never been enough to satisfy everyone completely. That is the real constraint. That is what scarcity means’. Unmet needs are inherent in all societies at all times. Different economies are just different ways of dealing with scarcity. At least that is what neo-classical economics want us to believe. There is much truth in this statement, although this is not the whole truth.

Economics is partly about consumers’ consumption of the output of goods and services, partly about producing that output from scarce resources in the first place. In production, inputs from the use of land, labor, capital and other resources are turned into output. The consequences of these decisions determine a country’s standard of living. Those decisions and their consequences can be more important than the resources themselves, for there are poor countries with rich natural resources, such as Venezuela, Nigeria and other African countries as well as semi-developed countries such as Russia, whereas rich countries such as Japan and Switzerland include very few natural resources.

Economics is also about ‘alternative uses’, because each resource may be used in different ways. Iron ores can be used to produce many different steel products ranging from small tools to automobiles and factory constructions and petroleum may be turned into gasoline or plastics. How much of each resource should be allocated to each of its many uses in an efficient way that is what economics is about. Different countries have different ways of making decisions about the allocation of scare resources. Those decisions and consequently the efficiency of production affect directly the standard of living of societies. Economics is not about money. Money is simply a tool for getting real things done. The government cannot make us all rich by simply printing more money. It is the produced volume of goods and services which determines whether a country is poor or rich.

Economics is not a matter of opinion or emotions. It is a systematic study of cause and effect, ‘showing what happens when you do specific things in specific ways’. Basic economic principles do not follow lines of ideology and political convictions. They remain the same, no matter what. Controversies in economics are not simply a matter of opinion. Reality shows the consequences of decisions taken on the basis of economic analysis. ‘Economics is a body of tested knowledge and principles derived from that knowledge’. Without understanding how an economy works, good intentions can lead to counterproductive, or even disastrous, consequences for whole nations, which are seen in countries such as Zimbabwe and Venezuela. Conversely, fundamental changes in Indian and Chinese economic policies since the late twentieth century have led to economic growth, including a relative decline in poverty and the rise of a large middle class. Economics is about rational choices leading to efficient use of resources. In this sense, it may be used in all business and organizational contexts.

A certain group of economists think the economic approach may be extended to include all spheres of life. Accordingly, they define economy as the study of rational choice in any situation of life.3 That life is full of rational choices, such as should I study this subject or something different, what is best for my future carrier, should I buy this house, should I marry this person or not, shall we have children, and any other questions of life. According to these economists, economics is not defined by its subject but by its theoretical approach. We shall not subscribe to this approach but define economics as the study of the economy.

But if we take a closer look than just the neo-classical definition of economy as the allocation of scare resources, then what is economy?4 At first, you might say that the economy is anything dealing with money - earning, spending, and borrowing money, and so on. This is part of the story. When we talk of money, we do not mean physical money, such as a banknote and a coin. This is shown every day when we pay by way of electronic cards. Money is really just a symbol of what resources you can get with a certain amount of money. It represents some value, because everybody else accepts this relationship between symbol and reality, which in the end is guaranteed by your national central bank. Money and other financial claims such as shares, bonds and other financial products are dealt with by the financial sector. Does the financial industry equate economics then? No, it is only a small part of the economy (some 5%).

Money and claims to resources may be generated in many ways. This is another part of the story of economics. The most common way to get money is to have a job or be your own boss. So a lot of economics is about jobs. From the point of view of the individual worker, a job is about getting a job and how much you are paid. This depends on your skills and the demands for your skills, which again is heavily influenced by the changing nature of competition as a result of developments in technology, international markets and so on.

Working conditions are also affected by political regulations and decisions concerning the labor market, such as restrictions or lack of restrictions on international movements of labor, prohibition of child labor, environmental rules, etc.

You can also get money through transfers, i.e., by simply given you money. This may be either in the form of cash or kind, for example from your parents, charity, and from the government.

Once you get access to money, you use it to buy consumer goods, such as food, clothes, energy, housing, and other goods to fulfil your basic needs. Next, we spend money for higher ‘mental’ wants such as books and computers as well as services including a haircut, visiting bars and restaurants, and going on a holiday abroad. So a lot of economics deals with the study of consumption.

In order to be consumed, these goods and services have to be produced in the first place – goods in farms and factories and services in offices and shops; this is the field of production – an area of economics that has been rather neglected since recent times, because the mainstream Neo-classical school stresses the importance of exchange and consumption rather than production. In standard economics textbooks, production appears as a ‘black box’, in which somehow labor (human work) and capital (machines) are combined to produce goods and services. There is little recognition that production is a lot more than combining abstract labor and capital. Actually, how efficient this black-box is organized and developed through technologies, skills and procedures in accordance with the changing nature of competition in the surrounding world is the foundation of wealth creation. Most economists leave the study of these things to ‘other people’, who are dealing with engineering and business. That is why you cannot just study the economy along the line of mainstream economics alone, if you truly want to understand and explain the economic phenomena of modern societies. One limitation on the neo-classical approach is its individual perspective of economics.

The individuals as heroes

The dominant Neo-classical view is that economics is the ‘science of rational choice’.5 According to this view, choices are made by individuals, who are assumed to be selfish and only interested in maximizing their own or at their family’s welfare. All individuals are seen to choose the most costefficient way to achieve their goal. ‘As a consumer, each individual has a self-generated preference system’ that specifies what he likes. Looking at market prices of different things, he chooses the goods and services that maximize his utility. Through the market system, the choices of individual consumers tell the producers what the demands are for their products at different prices (the demand curve). ‘The quantity that the producers are willing to supply at each price (the supply curve) is determined by their own rational choices, made with a view to maximizing their profits. In making these choices, producers evaluate costs of production’, based on the prices of different and potential inputs. ‘The market equilibrium is attained when the demand curve and the supply curve meet’.

For decades, this individualist vision of the economy has become the dominant one. One reason for that is that it corresponds with the idea of individual freedom. Here is no higher authority than the market to tell individuals what they should consume and produce. An alternative system would have to be based on bureaucracies deciding what to be produced and distributed for consumption. But why, then, are there societies that combine free markets with dictatorship, such as in China? And why do governments in democratic countries regulate so much of the economy? Well, some would say that they shouldn’t and that they really harm the economy by reducing productivity and the rational use of resources. In this case, strong political influence of the economy is not based on rational economic considerations, but the resulting clash of different group interests.

When it comes to individuals, they do not just have selfish interests. Sometimes we are just generous, curious, fair, honest, and feel a sense of duty, friendship, and love. At other times, we take a long-term perspective. Because people have multiple roles in their lives, they may act differently in different roles. In addition, our knowledge of the world is sometimes vague or twisted. As a result, we are often not that rational in our choices. It is better to say that we are acting according to bounded rationality.

And where do individual preferences come from? Preferences are strongly formed by our social environment. Coming from different backgrounds, you don’t just consume different things but you also get to want different things. People are embedded in societies. They are socialized and not individuals separated completely from each other. Individuals are products of their societies and particular social background. People are also manipulated by other people. All aspects of life involve such manipulation, such as political propaganda, education, religion, mass media, and advertising.

On the other hand, mainstream economics is not just useless. It points to the fundamental relationships of supply and demand and it is also right in saying that prices are the coordinating factor of the market economy.

The Role of Prices

Let’s follow the reasoning of the importance of prices in allocating resources.6 In a market economy, activities are coordinated by way of prices. Prices make sure that people get food, clothes, and housing, no matter whether they are produced in your own country or they stem from other countries. The alternative to prices is bureaucracy. Imagine what a monumental bureaucracy it would take to feed large cities such as London, Paris, New York, Tokyo, Beijing or Shanghai. Instead, the simple mechanism of prices does the same job faster, cheaper and better.

But does the lack of economic planning not lead to chaos? Each consumer or producer make individual transactions with other individuals on terms they can agree on. These terms are mediated by way of prices which are not restricted to particular individuals. Prices mediate all economic transactions. They are the mediator of the market economy as such. During the past two centuries, the market economy has expanded to include all parts of the world. Global market economic interaction makes sure that information on better prices and products somewhere in the world makes producers and consumers everywhere act to get access to these goods. In other cases, price information is bad news. Many people want to live in houses or apartments with a sea view or in a quiet place down town, but soon they find out that such goods are too expensive. When the demand exceeds the supply of things, prices go up. But high prices are not the reason we cannot all live in these places. It is the reality that prevents us from fulfilling all wishes, because there are not enough of such dwellings in high demand. Prices simply mediate that reality. In other cases, prices are good news. For example, very rapidly computers have become cheaper and better as a result of technological changes, of which we are often not aware of. But prices mediate the result and makes people act accordingly. Prices are like messengers that make people react.

Prices are not just messengers and ways of transferring money. Their primary role is to provide economic incentives to affect producers and consumers in their behavior in the use of resources and their resulting products. Prices guide consumers as well as producers. Just as prices guide consumption, consumption tells the producer what consumers want. If consumers do not buy for example a certain car, it will make the producer stop manufacturing it or to reduce its price. So producers have to produce what the consumers want, otherwise they will not make a profit and might go bankrupt. Although producers and consumers are only looking out for themselves, guided by prices, their decisions ensure the preconditions for an efficient use of resources as a whole, although not sufficient to stand alone.

Prices connect you with anyone, anywhere in the world where markets operate freely, so that places and their companies with the lowest prices for particular goods can sell those goods around the world. As a result, you may wear shirts made in China, shoes produced in Italy, cars manufactured in Japan and computers made in the USA. Prices responding to supply and demand make natural resources to move from places where they are abundant, such as iron and coal in Australia, to places where they are lacking, such as Japan. A failure of the wheat crop in Russia or Ukraine would raise the prices and incomes of farmers in the USA. When supply exceeds demand, prices go down and vice versa. So, free market prices help to secure an efficient allocation of resources around the world. The negative consequences of lacking free market prices was clearly seen in the plan economy of former USSR where unsold goods often piled in warehouses while people were short of other things. It was simply impossible for planners continuously and efficiently to make supply and demand meet.

Looking more closely at how prices work to allocate scarce resources with alternative uses we will see that they also apply to complex situations. When consumers for example want many things that include the same ingredients in their production, such as cheese, ice cream and yogurt that are all made from milk, producers will adapt their supply and use of milk to changing demands of the various dairy products. Dairies have to buy milk and other resources in order to produce what the market wants. This is a matter of costs to dairies while being an income to farmers and providers of packaging and other components. Prices and costs interconnect in the so-called supply chain of all those parties necessary to produce and consume products. By way of prices, dairies strive to coordinate the use of resources to make supply and demand meet for all kinds of dairy products. If not, dairies might end up with warehouses filled with un-sold products of one kind while being unable to supply other goods in demand. Such inefficiency would lead not only to unprofitable and ruining businesses but also to consumer wants on the level of society.

Supply and demand are regulated by way of prices. But want about ‘need’? Is there an objective or fixed need and supply? No, need and supply are all regulated by way of prices. Falling prices create falling supplies and vice versa. People tend to buy more at a lower price and less at a higher price. Nor do products have ‘real’ values different from their prices. Fluctuating prices are just a reflection of changing demands. Prices reflect the value of things. We pay a certain price for a product, be it milk or a computer, because these products are more valuable to us than the money we pay for them. And producers are willing to sell at certain prices because they gain from it. Transactions between buyer and seller make sense only if value is subjective, each gaining from the process. Economic transactions are not a zero-sum, where one part gains while the other part loses.

The driving force behind shifting prices is competition. Competition is the key to the operation of a price-coordinated economy. Competition makes prices converge, but it causes also resources to flow towards the greatest unsatisfied demand, until higher prices and profits are evened out by competition. Then resources seek out new fields of high demand and earnings. In the process, these movements may be so radical that whole fields of industries are destructed by being replaced by technologically more advanced areas, such as moving from horse carriers to automobiles and more recently from fixed line telephones to wireless phones and smartphones.

All these transactions and changes are caused by individual consumers and producers. We are all part of it and dependent on what other people do. Prices make all this happen. But as resources are scarce, we cannot meet all needs. It is always a trade-off between choices and solutions, and whatever trade-off is made it will still leave unmet needs. Furthermore, price control such as rent control, which is applied to many cities and countries throughout the world, often lead to housing shortages rather than a fairer sharing of dwellings. For example, New York City has had rent control longer than any other major American city. One consequence has been that the annual rate of turnover of apartments in New York is less than half the national average, leading to a dramatic shortage of dwellings and ironically enough higher average rents, because builders have incentives to build only luxury apartments to prices above the rent-control level. In addition, rent control may lead to hoarding of apartments that people seldom use, increasing the shortage of dwellings. In third world countries such as Egypt, rent control has led to a catastrophic lack of housing in Cairo. Price control almost invariably creates black markets, where prices are not only higher than the legally permitted prices, but also higher than they would be in a free market.

Subsidies to farmers in order to keep prices higher are being used around the globe. It creates a food surplus. But a surplus, like a shortage, is a price phenomenon. People might still be starving, like in India, while stored food bought at high prices are rotting in large warehouses. Furthermore, it seems that rich farmers and large corporations benefit the most from such subsidies. The common farmer or man may not be able to understand the true consequences of such political support. From a national and even global perspective, it distorts the allocating of resources in a way that is damaging to those you want to help, the common farmer and the poor man. It all boils down to understanding that the mechanisms of the market are impersonal, while the choices made by individuals are as personal as any other choice.

The market economy is a competitive system of supply and demand that is mediated by prices. And every person is part of this competition. We compete with others for goods, payments, salaries, jobs, apartments, etc. Based on your income, which is the price of your value creating capabilities, you have access to a corresponding share of the output of others. Price controls, subsidies, or other substitutes for price allocation reduce the incentives for self-rationing, on the other hand. When price controls make goods artificially cheaper, or more expensive, it benefits some, but leaves less for others. Society as a whole always has to pay the full costs

A price-coordinated economy facilitates incremental substitutions, but political decision-making tends towards categorical priorities, i.e., one thing is considered absolutely more important than another and leading to laws and policies accordingly. There are chronic complaints about government bureaucracy (red tape) in countries around the world. Governmental rules are easily introduced and they might be useful in some way or other, but seldom, it is asked: at what cost? People who are spending their own money are confronted with those costs constantly, but people who are spending the taxpayers’ money, or who are simply imposing uncounted costs on businesses, homeowners, and others, have no real incentives to uncover additional costs. In the same way, allocation of resources is artificially affected by subsidies or taxes for ‘bad’ things (such as tobacco and alcoholics). In both cases, it maximizes the distortions made by consumers and producers.

Furthermore, prices reflect costs in turning inputs into outputs. And these costs do not go away, because a law prevents them from being mediated through prices in the marketplace, for example health. You cannot bring down prices paid for medical care, because they reflect the actual costs of medical care – the years of training doctors, the resources used in building and equipping hospitals, the billions used in research for developing a new medication, etc. This underlying reality is mediated through prices.

These are the mechanisms that rule in a market economy. You are paid according to the value you are able to create and goods and services are priced according to demand. Whether this results in losers and winners is another question. And even if you want to even out inequalities, economic values have to be created in the first place, or else there is nothing to redistribute.

The Role of Businesses

Looking at the realities of the world, since the late 19th century most economic activities have been undertaken not by individuals but by large organizations with complex internal decision-making structures.7 Today, the most important producers are large corporations, employing millions of workers in many countries throughout the world. These companies dominate the world’s output and international trade as well as develop and provide frontline technologies. Furthermore, a large share of international trade is actually intra-firm trade, or transfer of inputs and outputs within the same transnational corporation, e.g., subsidies of Toyota’s component factories in Thailand are selling their output to Toyota assembly factories in Japan and elsewhere, counting as Thailand’s export.8 But these are not genuine market transactions. Depending on ownership, transactions between for example H&M and sewing factories in China may be either based on intra-firm or arm’s length relations.

Companies live in a competitive environment of changing conditions of supply and demand. A free-market economy allows entrepreneurs to arise and challenge established companies and the latter to take necessary steps to survive. Success depends on the ability to adapt to changes in the economic environment in order to create a profitable business. Sudden change can leave firms behind, if their competitors are quicker to respond. Sometimes the changes are technological, as in the IT industry, and sometimes these changes are social and economic resulting from new consumer trends, as in the fashion industry. Other examples of social changes include the consequences for retail stores when people decades ago began to move from the city to suburbs. The automobile made this possible. It required a relocation of stores. Some leading retailers did not manage to do so or reacted too late, allowing newer stores to profit from the changes, including the rise of Wal-Mart, but also the consolidation of retail chains in practically all countries. Furthermore, widespread refrigerators and freezers made it possible to stock perishable items which led to fewer trips to grocery stores, supporting the competitive advantage of large and lowpriced stores. Nowadays, a knowledge- and technology-based business environment concentrated in central parts of expanding cities tend to reverse this development. So, success depends on the ability to read economic, social and technological trends and the ability and willingness of company-management for timely adaption.

Decisions in corporations are made by people, such as CEO’s. But those individuals do not make decisions for their companies in the way in which individual consumers make decisions for themselves. At the root of corporate decisions lie shareholders. While some large companies are still owned by families (for example Danish Maersk) and you find dominant shareholders (such as Mark Zuckerberg of Facebook), most large companies do not have one controlling shareholder. Ownership is normally dispersed among many shareholders, often including a few large ones and many small investors.

Dispersed ownership means that professional management has effective control over most of the world’s largest companies, despite not owning any or perhaps just a small amount of shares, known as the ‘separation of ownership and control’. This may create a ‘principal-agent problem’, in which the agent (management) may pursue business goals contrary to those of their principals (shareholders, represented by the board of directors), for example that of maximizing sales contrary to profits. The principal-agent problem may be reduced by an easy road to replace executives or by paying parts of managerial salaries in their own companies’ stocks. Another important ‘principle-agent’ dimension concerns the relationship between employer and employees. Today, management is much interested in aligning these parties because of the growing importance of employee competences.

Workers and governments also exercise significant influences on corporate decision-making, especially in mainland Europe, by way of worker representations as well as government regulations and ownership of shares in private-sector companies (for example, Stora Enso includes Finnish government ownership and SAS Scandinavian includes governmental ownership). Workers and governments have different goals from those of shareholders and professional managers. Workers want to minimize job losses, increase job security and improve working conditions. The government has to consider the interests of other groups than the company in questions such as supplier firms, local communities, etc. As a result, companies with a strong worker and government involvement in management (Scandinavia, Germany and the Netherlands) may behave differently from companies dominated more by shareholders and professional managers (USA and UK and elsewhere). What governments in developed countries have in common, however, is a need to ensure the workings of a free-market. For example, anti-monopolistic laws and regulations are enforced in the USA and the EU.

The complexity of corporate decisions can be seen from the case of Volkswagen, the German car-maker. It has a major family owner (Porsche- Piech family) that can legally enforce any decision it wants. But in reality, VW, like other large German companies, has a two-tier board system with strong worker representation. The company is also 20% owned by the state government of Niedersachsen. As a result, decisions in VW are reached through complicated processes of bargaining, involving shareholders, professional managers, workers and the population. And in the end, VW is strongly influenced by consumers who may or may not buy their cars.

Some large companies are cooperatives owned by their producers, users, employees or independent smaller firms. Many European countries have large consumer companies, such as the Scandinavian Coop, the Swiss Coop, and the British Co-op chain. Unlike limited companies, coops can pass on more discounts to consumers because they do not have share-holders to pay. Many banks started as savings cooperatives of farmers, and some large banks like the Dutch Rabobank and the French Credit Agricole still are. Although more rare than previously, producer cooperatives continue to exist, including a few large companies such as Mondragon Cooperative Corporation of Spain (conglomerate) and John Lewis Partnership of Britain (retail). The most common examples of producer cooperatives are dairy farmers’ cooperatives, in which farmers own their cows but together process and sell the milk and milk products of their dairies. Large cooperative dairy companies include Danish-Swedish Arla, Fonterra of New Zealand, Dairy Farmers of America in the USA, Amul in India, German DMK, and Dutch FrieslandCampina.

In many respects, the government is the single most important economic factor. It is by far the single largest employer. In developed countries, it includes up to half the national output. The government also affects how other economic actors behave by regulating markets, including the environment, working conditions, etc. Only, governments do not manufacture and sell the goods and services of modern societies. They live on taxes, which is a share of the value created by business being transferred to the authorities by way of taxation.

Government decision-making is even more complicated than the most complex private corporations. Governments do many more things than companies do, and have to accommodate far more actors with much more diverse goals. This is especially the case in democracies, which seek to compromise between the interests of different parties and groups. And political decisions have to be implemented by bureaucrats, which then have their own hierarchical decision rules, procedures and established systems and traditions. In addition, politicians and bureaucrats are lobbied by all sorts of groups.

International organizations are important, too. Some can provide money for loans, such as The World Bank and the International Monetary Fund (IMF), requiring certain economic policies to be adopted by the lending part. Another group of international organizations are influential because they set rules, such as the World Trade Organization (WTO) setting rules for international investment and trade. Finally, various UN organizations are important because they lend legitimacy to certain ideas and offer a forum for public discussion, especially concerning developing countries, such as FAO (agriculture) UNIDO (industrial development), WHO (health), ILO (labor), and UNESCO (education and culture).

So, understanding the market economy includes much more than individuals and prices. ‘Only when we take into account the multi-faceted and limited nature of individuals, while recognizing the importance of large corporations with complex structures internal decision mechanisms, will we able to build theories that allow us to understand the complexity of choices in real-world economics’.9

Work and Pay

Since the breakthrough of agriculture thousands of years ago, work has been the fundament of human life.10 Despite its overwhelming presence and importance in our lives, work is a relatively minor subject in economics. Insofar work is mentioned, it is basically treated as a means to get income. Although indentured and forced labor still exists as well as child labor, free labor is the most common form of labor in the 21st century. Work is also important in the sense that it makes up an important part of our identity, our intellectual capacity and well-being as well as influences us psychologically by way of the pressure put on our work by employers. We are also influenced by governmental activities such as education systems preparing us for future jobs and laws regulating working conditions, unemployment benefits, etc.

As a result of growing economic growth and increasing importance of knowledge, job conditions have improved much in recent decades. At least this is the case in developed countries. Working conditions are much longer and worse in developing countries. In one way or another, shifting unemployment is part of capitalism in both developed and developing countries. According to neoclassical economics, unemployment is a necessary tool to impose discipline on workers and keep wages down. Marxian and Schumpeterian approaches (see below) would also point to the fact that cycles cause ups and downs in the number of unemployed people and that structural unemployment follows from radical changes of technology and markets. According to Keynesian thinking and policies, such ups and downs may be offset by relevant increases or decreases of governmental demand (see below on Keynes).

The discussion of equality and inequality and their importance to economic development has been going on for decades and has even moved up the political agenda in recent times. In addition to the victims of a growing gap between rich and poor, the usual answer is the common sense one that too much inequality is not good for economic growth, neither is too much equality. The importance of the welfare state indicates that politics matters in determining the level of inequality and equality. Besides inequality of income, there is also inequality in terms of ownership of assets or human capital (skills) as well as discrimination of groups of people according to ethnicity, religion, gender, sexuality, and the like (on inequality, see below: National Economy).

But what determines how much people are paid for their work? Again to get an answer, we have to involve neo-classical economic thinking. The answer is: supply and demand. Some people are paid higher salaries because they are in short supply and vice versa, but also because it takes a long time to train for example an engineer. And because not everybody is capable of mastering such training, there is not an abundance of engineers relative to the demand. On the demand side, employers graduate salaries according to what engineers and other skilled people can add to a company’s earnings.

The productivity of any input in the production process depends on the quantity of other inputs, as well as its own, including technology and the way of organization. In all occupations, your productivity depends not only on your own work, but also on cooperating factors, such as the quality of equipment, management and other workers around you. Whatever the source of a given individual’s productivity, that productivity determines the upper limit of how far an employer will pay for that person’s services. Just as any worker’s value can be improved by complementary factors (other workers, machinery, and management), so the worker’s value can also be reduced by other factors over which the individual worker has no control, such as different transportation costs and levels of corruption.

Wages serve the same economic function as other prices, so that each resource gets used where it is most valued. Some people earn more than others, for various reasons. Some people are older and more experienced. Some are better trained and educated. As a result, people in different stages of their lives also earn different salaries. This is a different situation from that of people living and dying in poverty and people living and dying in luxury. In the end, some people make more money than others. Rich and poor people do exist. While in highly developed countries they form a minority, they continue to make up the majority in developing countries. In the course of the past half century, income at the individual level has been rising continuously, primarily in industrialized countries. It must be remembered, too, that incomes often are volatile, especially at the top, and change throughout the stages of individual lives.

Differences in skills are another obvious reason to differences in productivity and wages. A skilled worker earns more than an unskilled worker, and an experienced worker earns more than an unexperienced worker. The dwindling importance of physical strength and jobs and the rising importance of skills and experience as economies grow more technologically and economically complex tend to reduce economic inequalities between sexes and increase the gap between skilled and unskilled people. The question of discrimination against women or blacks in the labor market is a question about whether there are substantial differences in pay between women and men, white and black in the same fields with the same qualifications and level of productivity.

Employers do not operate in isolation but in markets. Businesses compete against each other for employees as well as for competing for customers. Mistaken decisions incur costs and can have serious consequences for companies. Empirical evidence indicates that discrimination tends to be greater when the costs are lower and lower when the costs are greater. Discrimination makes not only people applying for jobs suffer. Companies suffer, too. Politically enforced minimum wage laws and rules of job security, trade and profit controls also tend to create unemployment because wages are set above the level of workers’ productivity and such rules create barriers for entry of new competition.

While everything requires labor for its production, practically nothing can be produced by labor alone. Farmers need land, taxi drivers need cars, airlines need aircrafts, ship owners need ships, film makers need technology for recording and editing, software developers need computers, etc. That is, you need not only labor but also capital and with the increasing importance of technology, the capital side is expanding at the expense of labor. Capital requires investments.

Investment

For society as a whole, investment is the most important kind of planning for the future.11 Instead of being consumed today, resources are used to produce for example machinery, factories and knowledge institutions that will cause future production to be greater than it would be otherwise. Because the future cannot be known in advance, investments necessarily involve risks. These risks must be compensated for if investments are to continue. The cost of keeping people alive while waiting for them to take their academic degrees or oil explorations to find places where oil wells can be drilled, they are all investments that must be repaid if such investments are to be continued. If the return of the investment is not enough to make it worthwhile, fewer people will do that particular investment in the future. Where consumers and companies do not value what is being produced, the investment will not pay off. Risks are linked to investments because the outcome is first seen later on, when the resulting activities meet the marketplace.

Investments take many forms. In reality they are mainly of two kinds: investments in human capital and investments in production facilities. Human capital includes skills achieved by practice as well as formal education. On the one hand, too little formal schooling may not be good while on the other hand, too much schooling may undermine entrepreneurial skills.

As for return on investment, many important factors are not that visible, including the many management decisions that have to be made in determining where to locate, what kind of equipment to acquire, and what policies to follow in dealing with suppliers, consumers, and employees. Similarly, all the firms that went out of business because they failed to do things right are also invisible. It is easy to regard the visible factors as the sole or most important factors, but it might create misunderstandings and economically harmful laws. For centuries, money-lenders have been widely condemned in many cultures for receiving back more money than they lent, i.e., getting an ‘unearned’ income for waiting for payment and for taking risks. Today, misconceptions about money-lending often take the form of laws attempting to help borrowers by giving them more leeway in repaying loans. But anything that makes it difficult to collect a debt when it falls due makes it less likely that loans will be made in the first place.

Interest, as the price paid for investment funds, plays the same allocational role as other prices in bringing supply and demand into balance. When interest rates are low, it is more profitable to borrow money to invest in building houses, modernizing a factory or launching other economic ventures. On the other hand, low interest rates reduce incentives to save. Higher interest rates lead more people to save money, but lead fewer investors to borrow that money when borrowing is more expensive. In the real world, fluctuating rates, like fluctuating prices in general, constantly redirect resources in different directions as technology, demand and other factors change. Because interest rates are symptoms of an underlying reality, laws and government policies that change interest rates have repercussions throughout the economy. In addition to interest paid for the time delay in receiving the money back, you also pay for the risk that the loan will not be repaid, or repaid in time, or repaid in full. What is called interest also includes the costs of processing the loan.

Speculation is another kind of investment. In this case, you buy things that do not yet exist or whose value has yet to be determined, or both. For example, you can speculate in the future rise of the stock of a company. Exploring for oil is another costly speculation, since millions of dollars may be spent before discovering whether there is in fact any oil at all and enough oil to repay the money spent. Many things are bought in hopes of future earnings which may or may not materialize – such as scripts for movies that may never be made, paintings that may or may not increase in value, and foreign currencies that may go up in value or go down. A way of reducing risks, which is inherent in all aspects of human life, including for example the wheat crop of farmers, is to transfer the risk to somebody else for some fee. Just like the rest of the economy, competition determines the price of speculation and therefore the speculator’s profit. Commodity markets, such as wheat or soybean, are not restricted to big business. Farmers in advanced as well as little advanced countries, for instance India, follow the prices for commodity futures. Speculations are made in other merchandizes, too, such as silver and gold. Inventories include risks, too. Having either too large or too small an inventory means losing money. Clearly, profits are best for those businesses which come closest to the optima size of inventory.

Although many goods and services are bought for immediate use, many other benefits come in a stream over time, whether as a season’s ticket to football games or an annuity that will make monthly pension payments to you after you retire. That whole stream of benefits may be purchased at a given moment for what the economists call its present value, i.e., the price actually paid. The implications of present value affect economic decisions and their consequences in many fields.

When a home, business, or farm is maintained, repaired or improved today determines how long it will last and how well it will operate in the future. But the owner does not have to wait to see the future effects on the property’s value. These future benefits are immediately reflected in the property’s present value. Conversely, if the city announces that it is going to build a sewage treatment plant next to your home, the value of your home will decline immediately. Present value links the future to the present in many ways. For instance, you can purchase an annuity for a certain price for the rest of your life from an insurance company, i.e., you transfer the risk to the insurance company for a price. The insurance company, for its part, reduces its risks since it can predict the average lifespan of millions of people to whom it has sold annuities.

Another example is how present value profoundly affects the discovery and use of natural resources. There may be enough oil underground to last for centuries, but its present value determines how much oil will repay what it costs anyone to discover it at any given time. A failure to understand this basic economic reality has for generations led to numerous false predictions that we were ‘running out’ of petroleum, coal, or some other natural resource. Known reserves of natural resources are not simply a matter of how much physical stuff there is in the ground. Just as prices are crucial to all things, so are present values. How much of any given natural resource is known to exist depends on how much it costs to know. The cost of producing oil includes not only the costs of geological exploration but also the costs of drilling expensive dry holes before striking oil. As these costs mount up while more and more oil is being discovered around the world, the growing abundance of known supplies of oil reduces its price through supply and demand. At a certain point, it no longer pays to keep exploring. As more and more of the known reserves of oil get used up, the present value of each barrel of the remaining oil begins to rise and once more, exploration for additional oil becomes profitable. The economic considerations which apply to petroleum apply to other natural resources as well, for example metals.

Reducing risks

Risks in economic activities can be dealt with in a wide variety of ways. In addition to commodity speculation and inventory management, other ways of dealing with risk include stocks and bonds and the like. Stocks and bonds are connected to assets such as houses and businesses. Whenever such assets increase in value over time, the increase is called a ‘capital gain’. Capital gain is a form of income, just like wages. But unlike wages, capital gain is not being paid right after it is earned, but usually only after an interval of some years. The capital gain is only realized when the house or business is sold. Until then, an increase in value is just an ‘unrealized capital gain’. When you put money into an interest paying savings account or a pension fund in order to get back a larger amount of money later on, you receive a capital gain, too. Banks lending money with interest are doing this today as a trade-off for a higher sum of money in the future.

Rents are payments for the risks of not getting your money back, for inflation, taxation and other risk factors, depending on how long you must wait to get you money back, too. Risks may be associated with assets such as bonds and stocks, but also with human capital, for example when loans are given to students, hoping they will sometime get their degree and they will be able to pay back their debt, including rents.

Insurance include risks as well. In exchange for a premium paid by policyholders, insurance companies assumes the risk of compensating for losses caused by automobile accidents, houses catching fire, and people getting ill and unable to work. By way of advanced analyses and software systems, insurance companies for their part seek to reduce these risks. Insurance companies segment the population and charge different prices for people with different risks, such as lower prices for safe drivers and higher prices for people living in dangerous neighborhoods. Life insurance is another form of risks. You do not know the time of death, but the insurance company is familiar with the average age of death among millions of policy-holders and can determine the price accordingly. It applies to all kinds of insurance that risks are being reduced to sellers as well as buyers. Competition between insurance companies keeps prices down.

Government regulations can either increase or decrease the risks faced by insurance companies and their customers. For example, government require people to take measures against firing risks, using safety belts in cars and making comprehensive motor insurance obligatory. Risk is a matter of economic calculation. It has nothing to do with fairness or moral. Laws banning insurance companies from taking higher premiums on the basis of genetic tests or differing between sexes all lead to higher prices for some people who in a free market would pay less.

When government steps in to deal with risks, such as a general health or natural disaster insurance, the financial risks are not paid by those who create them, as with insurance, but are instead paid by taxpayers. In this way, the government makes it less expensive for people to live in risky places and more costly to society as a whole, because people behave more risky than they would if they had to bear the costs themselves. Furthermore, governmental monopolies in fields of insurance have little incentives to reduce future risks and to improve service, including faster responses, huge costs and no incentives to relocate to more safe surroundings (such as the slow response to the Katrina Hurricane in New Orleans).

Risk is inescapable and all around. People and assets may be sheltered from risk, but only at the cost of having someone else bear that risk. Whenever government intervenes it reduces the productive allocation of resources by way of prices.

While risk is calculable, uncertainty is not. When investors and consumers are uncertain about government policies, then they may sit on their money until the situation becomes clarified.

Time is money, too. This is seen when payment is delayed, because it imposes costs on others, including private companies, consumers as well as government bureaucracies. Economic adjustments take time, too, in markets as well as politics. Governments may bring current benefits to people at future costs or pass plans to be fulfilled in a distant future. While reasons of fairness are often used to justify political decisions, businesses have to anticipate future consequences in the concept of ‘present value’.

The National Economy

Just as there are economic principles which apply to particular markets for particular goods and services, so there are principles which apply to the economy as a whole.12 For example, just as there is a demand for particular goods and services, so there is an aggregate demand for the total output of the whole nation. And aggregate demand can fluctuate, just as demand for individual products can fluctuate. In matters of prices and wages, a total national economy never adjusts as fast as individual markets and companies.

What applies to particular parts of the economy does not automatically apply to the whole, however. Thousands of people may be laid off in some industries while employment increases in other industries leading to a low unemployment rate in total. Government intervention in one industry to save jobs will always be at the expense of jobs lost elsewhere in the economy because the costs of saving jobs are based on taxes. So, in the end there are no net savings of jobs for the economy as a whole. This principle of ‘fallacy of composition’ applies not only to economics. If an individual stands up in a sports stadium he might see the game better, but if everybody stands up, everybody will not see better. What is true for one person may not be true for all people.

National Output

National output continues to grow throughout most parts of the world.13 While income is measured in money, real income is measured by what that money can buy in real goods and services. The total real income consists of real goods and services, not money. The total real income of everyone in the national economy and the total output are one and the same thing. The economists’ favored measure for output is ‘Gross Domestic Product’ (GDP). Roughly speaking, it is the total monetary value of what has been produced within a country over a particular period of time, usually a year.

In calculating GDP, we measure output, or product, by ‘value added’. Value added is the value of a producer’s output minus the intermediate inputs it has used. A bakery may earn $250.000 a year by selling bread and pastries, but it paid $150.000 in order to buy various intermediate inputs, such as flour, butter, eggs, sugar, electricity, etc. Consequently, it only added $100.000 of value to those inputs.

If we didn’t take away the value of intermediate inputs and added up the final outputs of all producers, we would count many producers twice or even three times, including for example the miller who sold flour to the baker, and the farmer who sold wheat to the miller.

Still, the added value is a gross result. In order to get the ‘Net Domestic Product’ (NDP), you would have to remove the used parts of capital goods, basically the machines, i.e., in the case of the bakery, ovens, dough mixers and the like. Capital goods are not consumed and incorporated into the output in the same way as flour to bread, but with use their economic value is reduced, known as ‘depreciation’. NDP presents a more accurate picture of what the economy has produced than GDP does. But we tend to use GDP instead of NDP, because it is difficult to estimate and agree on ways of measuring it, and because GDP is widely used and documented.

By ‘domestic’ in GDP means that it measures all companies within the boundary of the country. Some companies in a country are foreign subsidiaries, however, and American, Danish, German and companies of other countries have subsidiaries in foreign countries, too. The measure of all the output produced by all national companies, rather than the output produced within your border, is called Gross National Product (GNP).

The relationship between GDP and GNP differs from country to country. In the US and Norway it is more or less the same. With many foreign firms inside their borders and few domestic firms producing abroad, GDP exceeds GNP in countries such as Canada, Brazil and India. Sweden and Switzerland are in a reverse situation, because they have more of their own firms abroad than foreign firms operating within their borders. However, GDP is more often used because in the short run it is the more accurate indicator of the level of productive activities within a country, although GNP might be a better measure in the long-term.