Saving is the first step to achieving material prosperity. Individuals save - that is, abstain from consumption today - thereby releasing present goods, which are employed in further production activity. The purpose of further production is to produce consumable goods in the future. The future is a specific time when the consumer expects to receive (back) those goods for consumption.
The time duration of abstaining from consumption is called the waiting time which coincides with the length of the production process.
Thus the saving and production activities have the following elements;
- Existence of a sufficient quantity of consumption goods today
- The willingness to postpone consumption
- Being cognizant of the various methods of production, that is, alternative production possibilities that can be applied to the consumer goods
- Existence of technological improvements so that a greater than proportionate increase in output is realized for a given increase in input
- Matching production length with the time when the future consumption is expected to happen
All the above elements are self-explanatory, except a few details could be added for the last mentioned point.
Since consumption is postponed and therefore expected to occur on a specific time in the near future, the length of the production process should be such that it spits out consumer goods that temporally match with the future wants. That is, the tail-end of the production process should coincide with the event when future want-satisfaction is expected to occur.
The length of the production process also has a bearing on the productivity of the process itself. A longer waiting time - between the postponement of consumption and actual consumption in the future - allows for arranging factory processes in such a manner that a higher degree of productivity is possible. On the other hand, a shorter production length is associated with less productivity: a mere conversion of inputs to output with no greater than proportionate increase compared to inputs. With shorter waiting time, producers cannot afford to employ complex processes that ensure higher output, but instead, they cut short the productivity problem by employing simple conversion of input to output.
It looks obvious which waiting time is optimal. Yet, why is this not so evident in practice. The answer to that is the universal constraint of time-preference. That is, given a want, a sooner rather than later, preference is exhibited by individuals. Individual always prefer an existing want to be satisfied with present goods rather than future goods. An earlier post, A Fundamental Exposition of Interest Rates, explains time-preference in greater detail.
When a surplus of present goods exists, it is possible to save for the future. A saving in 'specie' is a rudimentary form of saving where consumable goods are simply hoarded for future consumption. The other, more sophisticated alternative, is to put the goods into a productive process. We have seen above the benefits of a production process. Even in the absence of longer production processes, a shorter production process would still be necessary in order to satisfy future wants.
Therefore, lack of productivity benefits of a longer waiting time doesn't dissuade all other production activities.
Managing such a production process is critical. Let's focus now some of the pre-requisites for running a proper production operation;
- The first requirement in order to start production activity is the existence of present goods, that is savings.
- An additional stream of consumer goods required for consumption during the production process. This is required for want-satisfaction of actors involved in the production process whose time-preference outweighs the waiting time of the production process that they are involved in. This is also called subsidence goods.
- An intelligent framework of capital, financial and cost accounting systems.
(Again) the last point deserves elaboration. One of the advantages of transactions with the medium of money (over barter) is the ability to make economic calculations. Monetary denomination of transactions enables computation of prices, margins, output, surplus, capital and other measurables which aid entrepreneurial decision-making.
With the benefit of economic calculation made possible through money, an intelligent framework of aforesaid accounting is necessary for the following reasons;
- Ability to assign a value to the capital (savings) via a single measure. Separate identifiability of different types of capital goods is required too.
- Measure the expenditures laid out of capital for production.
- Compare the above data with technically determined estimates. This is how efficiency is measured.
- Economic theory largely ignores idiosyncratic efficiency and addresses these under the umbrella terminology of technology.
- Measure the length of the production process. Recollect, that it must coincide with the objective measure of waiting-time.
- Take incomes into account.
- Determine whether the capital-unit produced more than it consumed.
- Assess whether incomes exceeded expenditures
- Perform a holistic assessment of the capital-to-consumer goods transformation process and conclude whether initial capital remained intact, reduced or increased at the end of the production process.
The assessment mentioned above is conclusive on the success or failure of the project.
The accounting framework is also capable of mirroring the intermediate stages of the production process in economic-calculation terms. The tasks involved in attributing initial capital to working capital through the various stages of production processes is a complex task. However, it is necessary a task for validating the integrity and efficiency of the process. As discussed above, efficiency by itself is not an economic concern. But, in the broader assessment of production, intermittent snapshots help confirm if the production process would successfully lead to the end objective of want-satisfaction of the consumer.
In short, a good accounting framework should reveal the following errors in the production process;
- Variance in the length of the production: Production time might take longer than expected. This threatens the consumer's waiting-time moment.
- The Threat to margins: Actual return of the venture might be lower than projected. This in fact upsets the want-satisfaction of the entrepreneur which he expected to while he embarked on the venture. Similar to a consumer, the entrepreneur himself is a consumer who postponed his immediate instincts of consumption by investing capital for greater consumption at a later date.
- Inefficiency in production: Longer waiting time inevitably leads to better technology. A higher than proportionate increase in output versus input is normally expected. However, an actual lower degree of output implies inefficiencies and losses in the production process, which the entrepreneur must take into account.
Any of the errors above are expected to be identified in the intermediate stages of the production process with the employment of intellectual tools of accounting.
The above description adequately addresses challenges of a business unit as it transforms accumulated capital, by adding other factors of production such as land and labour, into consumption goods. As we zoom out, we have the market economy where numerous business units perform similar activity as the one stated above.
Following are some of the characteristics of the market economy;
- The capital transformation process is a continuous, non-stop process. This is despite our stylized economic-construct of discrete production length matching consumer waiting-time.
- There is a steady flow of consumption goods at every moment in time. Production schedules initiated in the past make it seem like there is no waiting time necessary.
- Input becomes output, those outputs become input and goes in similar fashion in downstream processes.
- New capital gets either created or lost.
- Technological improvements pervade the economy tending to improve output. Universities, vocation schools, technical schools and books help transfer know-how through various agents.
- Competition forces out inefficient capital-units. While many units engage in satisfying future consumer wants, however, their execution doesn't meet consumer wants. These units are forced out by successful ones.
In the market economy there is a continuous production of other factors of production, that is, intermediary goods or capital goods. Capital goods aid in the production of consumer goods. An economy which never saved will initially have to create intermediary goods before it can produce consumer goods. On the other hand, an economy which had a head start in saving will have sufficient intermediary goods to produce consumer goods in greater quantity, variety and at lower prices. This is the essential difference between a developed, industrialized economy versus one that has just begun in the path of saving and capital creation.