-----Original Message-----
From: dchaplin@nimbus2.zsd.co.za [mailto:dchaplin@nimbus2.zsd.co.za] On Behalf Of dchaplin@zsd.co.za
Sent: Wednesday, June 09, 2004 4:15 PM
To: MensaZA@yahoogroups.com
Subject: [MensaZA] Whats the point of being in business?

What follows is a short paper on the rationale of business and the exchange of value, written around a casual conversation I had with someone a few months ago. For those whose eyes glaze over at the the very thought of economics, scroll down to the ++++++++++++++++++ and get back to discussing more interesting stuff.

Question: What’s the point of being in business?

Answer: ‘To make money’. Wrong. If this was your answer, your business will probably fail, unless you are just lucky. Go to jail. Do not pass go, do not collect R200.

So, what is the right answer? First, a basic economics lesson.

We all tend to think of the (monetary) value of things as a crisp quantification, universally applicable – the market price of the share, the valuation of the property, the price of the loaf of bread. However, all of those things have different values in the eyes of different people, and even to the same people at different times. If we all agreed on the exact value of things, there would be no commerce at all and things would be quite stagnant. The very reason for trade, in anything, is to be found in the fact that value perception is not universal. Each of us ascribes a different value to things, and trade and exchange result from different perceptions of the same thing’s intrinsic value.

For example, when you buy a liter of milk from the supermarket for say R5, that transaction takes place because you believe the milk is worth MORE than R5, while the supermarket believes it is worth LESS than R5. If both parties believed it was worth exactly R5, no transaction would take place, because you would not bother to spend effort to swop R5 worth of coin (which you have already) for R5 worth of milk. And why would the supermarket bother to run the expense of a cashier to make the exchange when it could just hold on to the R5 worth of milk? You make the transaction because you gain from it: you give up R5 and you receive something worth more to you than R5. The supermarket for its part would prefer to receive R5 because the milk is worth less than that in their hands. Both parties benefit to some extent from the transaction.

In a perfect world, if the supermarket values the milk at, say, R4 and you value the milk at R6, each party has gained value of R1 exactly from the R5 transaction. However, it is more likely that the benefit is skewed: So if the milk is worth say R2,50 in the supermarket’s hands, while it is worth R5,20 in yours, and you buy the milk for R5, you gained value of 20c, and the supermarket gained R2,50 in value, from the same transaction (which nicely illustrates asymmetric market power in action, but that’s not our main point here). Even though not everybody benefits equally, every participant in every trade benefits to some extent, because if you paid for the item, you valued it at more than the price you paid (If you didn’t, you wouldn’t have bought it). And if you sold it, you valued it at less than the price received. This fundamental difference in perceived value is what drives every single commercial transaction, every day, millions upon millions of them. Collectively, all of these transactions and their pricing send signals to determine how much of what will be produced by society, and where to send it. Adam Smith’s ‘Invisible Hand’ in action, tirelessly and unconsciously working for the benefit of everybody, and hence the centerpiece of the Capitalist free market prescription. But it doesn’t always work.

Returning to the question: ‘What’s the point of being in business?’ (We’ll get back to the wrong ‘making money’ answer shortly because there’s lots more to be said about it). Some might say that it all depends on what sort of business: a restaurant? import/export business? Whatever you love doing most? Yes, there are probably as many reasons for being in business as there are businesses. But all are united by a common purpose, and if this purpose is ignored, the venture will probably fail, whatever sector you are in, however much you love what you do, and however well you apply the latest acronymic management techniques dispensed by the gurus. The point of being in business is value: is to provide things (or services) that others find more valuable than you do. That’s it, really. If you get that wrong, your business definitely won’t last - even if you do make some money temporarily. But if you get it right, you won’t be able to avoid making money, consistently and sustainably. In game-theoretic terms, business among such players becomes a positive-sum game, in which the payoffs are collectively larger than the costs, and the ongoing generation of value builds the collective wealth base of the whole society. This is the realisation of the much-vaunted capitalist free-market prescription. This value-delivery principle is a centrally important point usually ignored by most economics texts – indeed, many capitalists passionately believe in the maxim ‘greed is good’, citing self-interest as the engine that drives a market economy. But this is a misconception – self-interest is not a synonym for greed, and naked greed is exactly what prevents capitalism from working properly.

Returning to the wrong answer to our opening question: if the primary aim of being in business is ‘to make money’, the resource allocation role of the market and the market-driven wealth creation mechanism throughout society is subverted. Business becomes an adversarial conflict, in which the maximal extraction of value from others is seen as the cardinal virtue, while the delivery of any more value than absolutely necessary is seen as a sinful weakness. Business becomes, in the words of JM Keynes, a matter of ‘passing the bad half-crown to the other fellow’. This is (initially) a zero-sum game, in which one person’s payoff is another’s cost, and it is not sustainable: the ‘making money’ directive, aggregated across society as a whole, becomes a corrosive influence that generates waste and eventually destroys wealth, because effort is spent on ever-more inventive ways of extracting value from others (For example, tort litigation, pyramid schemes, unwarranted churning in financial markets to maximize comissions, elaborate tax ‘avoision ’ structures, price manipulation, currency speculation, and of course ordinary crimes like theft and extortion….the list is endless). Clearly, it is only through the creation of fresh value that the collective wealth of society is increased. Sustained focus on value-extraction and the corresponding loss of fresh value-creation yields a society-wide aggregate excess of costs over payoffs, so the zero-sum game actually turns out to be a negative-sum game. This will inevitably result in the decay of society and its infrastructure. The collective wealth of society is both decreased, and is concentrated in fewer hands – a certain recipe for inevitable collapse.

So making money is not the point of being in business – it’s no more than the by-product. Indeed, money is meaningless in and of itself – it is merely an accounting mechanism that identifies its holder as a partial claimant on the current stock of real wealth held by society at large. To the extent that the money held by any individual arose out of his historical contribution of value to that total stock of wealth, capitalism is working perfectly, and is indefinitely sustainable. To the extent that the money in an individual’s hands arrived there without his having injected value into society’s total wealth stock, the sustainability of the economy and the very fabric of society is called into question. Being in business to make money is like driving a car with your eyes fixed on the odometer instead of the road – the trip won’t last very long, and you probably won’t get to your destination alive.

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