3 Economic Lessons from World Events
Finance is useful in large part because of its ability to convert qualitative principles into quantitative dollar amounts. In a cost/benefit analysis a financial analyst converts both cost and benefit into a discounted cash flow then compares them. In a valuation a financial analyst assigns a dollar value to assets and their depreciation using the same process in order to compares them to liabilities.
Perhaps finance is even more useful in the reverse process of using quantitative observations to recognize qualitative concepts. We previously wrote about Growth Investor Philip Fisher’s qualitative checklist of good management. We also wrote about the lessons financial analysis provides about branding.
Where finance considers our money, economics considers everyone’s money. Economics is academic business, which means that similar analyses are useful. While economic analysis tend to be more abstract, they are also more generalizable.
When converting qualitative factors into quantitative dollar amounts, economics focuses on changes in price. In microeconomics, a single market’s supply and demand push against each other to an equilibrium point. In macroeconomics, aggregate supply and aggregate demand do something similar across all markets.
When converting quantitative factors into qualitative lessons, economics becomes almost philosophical. In microeconomics, we learn that self-interest can be healthy as long as it is balanced by competition and the “invisible hand” identified by Adam Smith. In macroeconomics, we learn that decisions have inevitable consequences; even when consequences only affect monetary valuations, consequences always show up somewhere.
Current events teach three lessons that everyone should learn.
Oil indexes are down as much as 78 percent from their 3-year high. Amid severe losses by oil firms, at least one writer speculated about what our world will look like when they all go bankrupt and we have to learn to live without oil. The lesson here is that economics education has room for improvement.
Apocalypticists are looking only at the short-run, forgetting that in the long-run all markets reach equilibrium. Low prices will indeed likely force some oil firms to close their door, shift capital in other directions, and get new jobs. Indeed, that is what low price is supposed to do. In capitalism, price works as an incentive to shift production toward high value and efficiency. Politics and power aside, apparently OPEC countries have an innate competitive advantage that the market is compelled to respect. That spells a bad day for US oil firms. But the global oil market will do just fine. As oversupply continues to push prices down, eventually consumption with either rise (as more cars are purchased and driven further) or production will fall (as firms exit and downsize). When that happens, the oversupply will end and the price of oil will stabilize. That’s the concept of balance.
Balance is one of those timeless principles that shows up in economics, Newton’s third law, and a dancer’s technique. It plays a central role in each of these. It plays an equally central role in running a business.
Building a business requires a time investment in recruiting, process development, technology, marketing, sales, management, training, financing, and countless other areas. Approaching each investment with balance doesn’t mean allocating exactly equal times to each. Balance means allowing the pressing needs of each to balance against each other. Your time is best invested wherever the cost savings or revenue generation are the highest. Just make sure to not let small immediate pressures outweigh large long-term pressures.
Nigeria showed up on economist.com as an example of the cost of dishonesty. Nigeria has rich oil resources, but it isn’t suffering because of the drop in oil price. Economists PricewaterhouseCoopers (PwC) compared Nigeria’s economy to comparable oil-driven economies in Ghana, Malaysia, and Colombia. PwC economists estimate that Nigeria’s economy would be as much as 37 percent bigger if Nigerian public officials could be as honest (or less dishonest) as the officials in the comparable countries. That would mean something to the 61 percent of Nigerians who live in absolute poverty.
Honesty is essential because it connect current decisions to future outcomes. When current decisions and future outcomes are connected, individuals can plan, negotiate, and cooperate. When individuals can plan, negotiate, and cooperate, economic drivers like supply and demand can structure an economy. Being honest does not require pessimism. Being honest does require accuracy.
Honesty is one of those timeless principles that shows up in economics, political science, and family psychology. It plays a central role in each. It also plays a central role in running a business.
Business owners communicate with many groups, and there exists an opportunity for dishonesty with each. Dishonesty frequently costs more than anticipated in the long-term. Even if your business plan is aimed at the short-term and you plan to change your identity each time, dishonesty will cost you the chance to build your personal brand. A good personal brand can mean a great deal.
Brazil is having a rough time. Political corruption has cost the country billions and insufficient infrastructure has outraged the populace. The BRL has lost half its value, and further inflation has only been slowed by a Central Bank interest rate of 14.25 percent. Brazil could be a lesson on balance and the importance of honesty. It is also a lesson on the importance of work.
This lesson comes with at least two examples. First, Brazilians average retirement age is 55, meaning that 40 percent of government spending goes toward pensions. While there are good reasons to support aging populace unable to care for itself, the reality is that someone has to pay for it. That means work. Second, the Brazilian problem with inflation is disrupting its ability to grow. Lest we fool ourselves into thinking that creative financing can solve all problems, we should recall that inflation can undo all financial gains in a moment unless it is balanced by qualitative production that helps real people with real problems. That means work too.
Work is one of those timeless principles that shows up in economics, education, and even basic human psychology. It plays a central role in each. It also plays a central role in running a business.
Business owners manage all sorts of things, but management can distract from the all-important need to inspire in others the desire to work. Consultants call this “leadership.” Doing hard things is hard for even good people to do. That’s why they call it work. Getting people to do hard things well is the essence of leadership.
Number crunching is not the only thing we do for you at Preferred CFO. Included with our basic functions are the insights we have gained over several lifetimes of financial analysis. Running a business is difficult enough to require assistance. We respectfully request that you allow us to help. Businesses with no full-time Chief Financial Officer should carefully consider the advantages of a part-time Chief Financial Officer . Preferred CFO provides an outsourced option that is the most affordable way to gain long-term competent advice without the higher cost of full-time staffed officer.
Please speak with Preferred CFO for help with your valuations.