Capitalism and free enterprise is a great system. Like magic, it can make everything work out where people get what they need at prices they can afford. It creates abundance and makes the products we need available right where we need them to be. It requires that everyone who is able do at least as much as is needed to provide for himself. It also causes people to let others use their tools and their processes so that they can be far more productive than they could be on their own.

But capitalism can be short circuited if we allow certain actions that are not based on free enterprise principles to be used, causing the system to not work well. We’re seeing that in the US after years of outsourcing manufacturing, and now customer service and other services that were done here before. Having men and women both work has also had an effect. Today we’ll look at the things that are causing the economy to be suboptimal and what we need to change to fix them. Bottom line: We need to be paying more for things.

(Note, if you click on a link in this post and buy something from Amazon (even if you buy something different from where the link takes you), The Small Investor will receive a small commission from your purchase.  This costs you nothing extra and is the way that we at The Small Investor are repaid for our hard work, bringing you this great content.  It is a win-win for both of us since it keeps great advice coming to you (for free) and helps put food on the table for us.  If you don’t want to buy something from Amazon or buy a book, how about at least telling your friends and family about our website as a great place to learn about investing and personal finance.  Thanks!)

Working properly, the system will ensure needs are met

If people are working in critical roles under capitalism and the system is not short-circuited, they will be able to make at least enough to meet their basic needs. The reason is fairly simple. If someone spends all of his available time doing something, he will need to make enough doing that role to cover his needs. Otherwise he and his family would starve, become homeless, or otherwise end up in a situation that would prevent him from being there to do the needed task.

My new mini-book is available for just $2.99. Order your copy today!

Note that we’re talking about critical tasks/roles: Things others cannot do without. These are things like providing electrical power, issuing permits that allow people to run their businesses, and hauling food to stores for people to buy. (Things like being a server in a restaurant would not qualify because people do not need to go to a restaurant to eat.) If the pay were too low for people to spend their time in these roles, people would spend their time in other roles and the tasks would not get done.

Because they are needed tasks, the price of the service could be raised until enough could be paid and someone was willing to take the role. This would be at least as much as that person in the role needed to buy necessities. So, like magic, everything works out and the person performing the service makes enough to at least get by and others get the goods and services they need for the minimum price at which the service could be provided.

Having two people in the household can affect how much is paid. Now, because there are two workers, the two together only need to make enough to cover the household income needs, reducing how much must be paid for the task. If you have two-income households competing against single-income households, they’ll win the job because they can take a lower salary. (Factors like the need to pay for childcare will raise the cost of two-income households, so they will not necessarily be able to work for half as much.) Eventually this makes it necessary for all households to have two incomes since that is the only way to get enough income to cover everything. This is about the state we are currently in.

Non-critical roles can pay less

For non-critical roles like making music or selling toys, the pay can be less than the person needs to survive. Someone who is working in a role providing these items cannot just raise the price as needed. Because it is an optional role that people don’t really need, if you try to charge more for it than it is worth to them, people will simply not buy it. The amount you can sell the good or service for is based entirely on how valuable it is to the person buying it. Once you try to raise the price above this level, you’ll simply not sell any. People will also switch to cheaper versions.

There can be optional items that are quite valuable to people, like fine sports cars and night at vacation resorts. As long as people are generating enough extra income in their lives to pay for their necessities and also buy these luxuries, you can make quite a bit of money providing these things, well more than you need to buy the necessities. There is nothing to say, however, that you will be able to make enough selling luxuries to cover your needs. Because people can do without these things, they will just go without them at a certain price level.

SmallIvy Book of Investing: Book 1: Investing to Become Wealthy

Outside workers can break the system

Having two workers in a family will cause wages to drop. Companies sending work overseas will also affect the system. If overseas workers will work for less because their standard of living is lower than those in the US, it means that companies can hire them instead of domestic workers. If people live in tiny homes, walk everywhere they go, and otherwise live a lower lower cost life than US workers, they can take less in wages and still make what they need to survive.

When companies hire overseas workers (or migrant workers only in the country a short period of time and who are desperate for work), it has two important effects on the system:

1. It means a US worker may not have a job supplying the needed items. Because the US worker needs to make more than the foreign worker to make ends meet, he cannot work at the rate the foreign worker can. So, he loses the job and it goes overseas. Because he is now sitting idle rather than working, he does not produce anything that goes into the US market, so his production is lost. Without a way of supporting himself, he may also need to go on welfare, so others are left paying to support him rather than him supporting himself. This makes things more expensive as taxes increase to pay for welfare.
2. The money flows into the foreign economy. If there is a trade imbalance, where more money if flowing to foreign countries than is flowing back to the US, it means that there will be less wealth in the US markets. Instead of US workers being paid, who then spend the money in the US on our goods and services, it goes to the foreign country and the workers spend the money there. With fewer people able to buy things in the US, it can reduce sales and availability of jobs in the US even more than were lost when the jobs went overseas since there is less demand for US goods. Yes, US citizens may pay less for things, but they may lose more wealth in lost production than they save when they buy things.

Investing to Win

Fixing the system may mean paying more for things

The solution to solving the problem can be a bitter pill to swallow: You need to force companies to make the items in the US. This can be done by law, but it could also be done by imposing a tariff on items and labor done overseas so that the savings realized by paying workers less is offset by the increase in the cost of importing the items. The goal is to make companies set up in the US and pay the wages required by US workers.

As explained at the start of this article, as long as there are enough workers for their to be competition for the jobs, the wages will be at the minimum level needed for those workers to get the necessities they need. If the workers have special skills or are especially efficient, they will be able to make more than that. The goal is to ensure that there are enough jobs that pay enough for people to support themselves and their families that people are able to find ways to make enough money for their needs.

Because you’re paying people more or you are paying a tariff, items will cost more. There is no way around this. But the additional cost will be offset somewhat by the increase in demand for items in the US. The owner of an ice cream parlor may pay more for a car, but he may find that he sells more ice cream because there are more people with jobs who are able to buy his products. For a large part all that ends up happening is that the numerical price for things increases, not the number of hours you actually need to work in a given job to buy the item.

(For ways to increase your free cash flow and use it to build wealth, check out FIREd by Fifty, How to Generate the Cash Flow You Need to Retire Early.)

Quality can increase

Another factor that can help offset the increase in cost of goods is that the quality of goods can increase. When you’re paying someone $10 per day to make shoes, the cost of labor becomes a very minor factor in how much profit you make. You find ways to get cheaper materials and cheaper production methods to save money on production and be able to make more money per pair of shoes sold.

If you’re paying people $300 per day, saving a dime on a pair of laces no longer is worth It. In fact, because you are now charging more for the items, you find that improving quality means customers may buy your item rather than a competitors because your quality is better. The result can be that, yes, you pay more for items, but they last longer and are just nicer in general. You may also find that it is worth it to repair products rather than throwing them out and buying new, which creates even more jobs and allows you to save money it the long run.

You can wear a cheap pair of shoes and throw them out every year, or you can wear an expensive pair of shoes and resole them every year. The cost is the same. And in the latter case, you get to wear nice shoes.

To ask a question, email  smallivy@smallivy.com or leave the question in a comment.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.