Wednesday, August 10, 2011

The politics of free stuff

The United States of America would not exist without riots. Nor would many other modern nations. Riots like the one 1770 in Boston are an integral part of revolutions, and most nations had some on their way from earlier more tyrannical forms of government to modern democracy. Having said that, the London rioters make for rather unlikely revolutionaries. As one lady in the middle of it said so correctly: "we are not all gathering together and fighting for a cause. We are running out of Footlocker and theifin shoes." Stories of rioters using Blackberries to text each other about where to get "free stuff" and mostly targeting brand clothing and electronics stores cast doubts on both the motivation and degree of poverty of the rioters.

Nevertheless British politicians dismissing the rioters as just criminals don't get the whole picture either. There were far too many of them to be just a criminal gang, it was more like a movement. And then you have to ask yourself why so many young people considered rioting and looting a better use of their time than what they were doing otherwise. Unemployment is not an excuse for criminal behavior, but often enough the root cause.

Of course rioting will not solve anything in the short term, and we are still a long way from a revolution. Nevertheless I wouldn't totally exclude the possibility of a revolution either, not if we continue like this. Politicians not only looked very helpless in face of these riots, they also offered only the full panoply of all the wrong solutions: The left thinks more welfare would calm the youths down, while the right wants to lock them all up and remove their benefits. The former plan of redistribution isn't economically sustainable, and the latter plan is the direct way into a police state. If you have 25% youth unemployment, you can't just lock them all up.

I believe the solution to be very different, not redistribution but a different distribution of the added value produced by companies right when they produce that value. And I believe the culprit who caused things to go wrong wasn't some politician, but an accountant hundreds of years ago, when the rules of company accounting were first invented. Let me explain:

Companies create value. They turn some lower value inputs like raw materials and energy into final products which have a higher value. Or they create value through services, like the distribution of goods. The added value the company creates is then flowing to the various stakeholders of a company, mostly the investors and the workers. A proper measure of how good a company works would calculate the added value created by the company by counting the value of the goods or services produced, and deducting the cost of the raw materials and energy consumed in the process.

Unfortunately real companies don't calculate like that. They do count the value of the good or services produced and deduce the cost, but at some point in time some accountant decided that salaries were a cost. That is an extremely narrow view, which is only true if you are the investor, and the only added value created that interests you is the one going into your own pocket. From a larger point of view, for society, it only matters how much total value is added, not whether that added value lands in the pocket of the investor, or in the pockets of the workforce.

This wrong way of accounting for investors profit instead of total added value over the centuries has led to companies doing their utmost to become "more efficient" by reducing labor cost. If money given to employees is a "loss", you strive to avoid that loss. What companies should have done instead is searching for the optimum number of workers which would maximize the total added value created by the company. It is pretty certain that this optimimum for total wealth creation would mean more employment, even if the share of the profits for investors would be somewhat smaller. But the benefit for society would be huge: Less unemployment, more value creation, and more money going towards people who actually spend that money, thus growing the economy even further. And ultimately less riots. Because if you can afford to shop for expensive trainers at Footlocker, you're less likely to go looting them.

Salaries are not a cost, they are an important part of the value created by a company.

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