Inefficiencies – what kinds are there [Economics] [Manufacturing]


In last week’s article, I said I was going to discuss PFMEAs and control plans this week, specifically what they are & how private industry uses those tools to do 3 things:

  • Understand how they add value to the services and products they deliver
  • Manage risk when it comes to the delivery of the service or product
  • Quantify risk when changing decisions, specifically managing the ever important “quality/$” relationship

By utilizing control plans and PFMEAs, private industry is able to gauge where they stand in their market and improve it from a productive efficiency standpoint. Productive efficiencies are strictly related to how a private company manages their costs. However, I have not detailed the types of inefficiencies that exist in systems, in general, and it’s important to understand what kinds of “fat” are present before discussing control plans and PFMEAs. Control plans and PFMEAs are not something that you’ll learn after reading one article, as they are fairly complex. How they administer processes is quite remarkable so it’s better we take the slow and steady approach to gain a better appreciation for their complexity. For this reason, I’m going to hold off on the ever-important control plan & PFMEA discussion for 2 more weeks (two articles are being released today since I’ll be on vacation in Alberta next week) and talk about the kinds of inefficiencies that exist first.

I’ll talk about the following in order:

  1. Productive efficiency
  2. Social Efficiency
  3. Allocative Efficiency
  4. Technological Efficiency

Productive Efficiency

I introduced Productive efficiency above and the concept is important in all industries whether the industry players know it or not. Productive efficiency relates to how costs are managed and documented. Companies now place a greater emphasis and focus on knowing every single one of their costs and avoiding non-value add costs. This is because if you’re manufacturing a good, and a different company does it for a lower cost then they’d be able to offer it at a lower price. This would certainly spell doom for your company especially if price is the determining factor for your customers. This is what separates the lean and efficient companies (like Walmart) from other companies (Ma & Pop stores it’s destroyed) and one of the main reasons why certain companies end up taking over an industry. This issue is becoming more and more prevalent in Canada, with the issuance of corporate welfare programs by the different levels of government. What corporate welfare does is it gives certain companies a competitive advantage compared to the (small) businesses who do not and will probably never receive these lump sum payments. It tilts the playing field in the direction of these corporations and it de-incentivizes the government from becoming lean itself. This is because the government can just dole out these payments to companies, masking the fact that the companies are choosing to locate here because the government legally bribed them. Government shouldn’t need to incentivize companies with corporate welfare to invest in Canada, but the age old arguments (we have a better educated and more skilled workforce) no longer work. With free trade agreements popping up, left right and centre, the world’s economy is becoming more global and governments are not doing enough to educate people. Corporate welfare is a very easy solution to a complex problem (e.g. how to incentivize companies to invest in your country) and easy solutions can be accomplished by anyone – Mexico can also give out corporate welfare, citing Ontario’s lead and boom! We’re back to square one. Think about the following, a company is thinking about where to set up shop, let the chart below summarize some key variables for industrial players:

Where would you invest if you owned a company?

Country Corporate tax rate Cost of labour (per hour) Cost of Electricity (per kwh)
A 30% $3 $0.0590
B 26.5% $30 $0.085

Let’s just say one of those is Ontario and the other is Mexico. At the end of the day, when we issue corporate welfare to a company, we do this to mask the massive taxes and payments we have to otherwise make to government. It’s not fair to small businesses, and since Premier Wynne charges only the top rates (up to 10k/hour) to sit down and meet with her, it brings about an ethical dilemma that should not exist to begin with.

Social Efficiency

But enough about productive efficiency, let’s tackle social efficiency next. A very important saying in manufacturing is that “no snowflake in an avalanche feels responsible”, as this speaks to the collective impact of many small actions and how the cumulative effect can be very big. In economics, if two parties agree to a service at a specific price, any effects on third parties that are not captured in the price are termed externalities. Think air pollution from mining oil out of the bitumen sands of Alberta. A negative externality can usually be mitigated through the implementation of pigouvian (consumption) taxes as this will lower demand for the good/service. Imagine carbon taxes, which will be the norm in the (near) future. These negative externalities are also termed social inefficiencies because the private costs borne between parties in a transaction, did not take them into account. You don’t realize the full brunt of small inefficiencies in a process until it operates at full capacity. Imagine a product that’s mass produced, you make 5000 of those products a day. Imagine saving a nickel from each product by adjusting the process, that’s $90k cost savings a year. Most manufacturing lines that run 24/7 actually make closer to 15000 items a day, and this lack of focus on efficiency would not be tolerated at any level at those companies. But forget manufacturing for a second and replace making 5000 products a day with feeding 7 billion mouths a day. Point being, even though we don’t appreciate the inefficiencies that exist in our day-to-day lives doesn’t mean they don’t add up to significant costs that can be avoided.

What politician’s brains understand but their mouths do not speak

I am someone who believes everyone should pay their fair share if they want to take part in society and after watching the Jungle Book, the Law of the Jungle has never rang so true. However what politicians don’t want to communicate to the populace is that when you increase the taxes on really high-income earners, they already have methods to reduce the taxes they pay. In economic’s speak, the elasticity of taxing higher income earners is more elastic than it would be on income earners in lower tax brackets. Don’t think governments are unaware of this by the way. Before the Federal Liberals got elected in 2015, they ran on an estimated increase from their adjustment of the high income tax bracket of $2.8B in revenue. After they got elected it was adjusted to $2.0B, and we’ll only see how much it actually brings in. There have been cases where governments have increased taxes on high earners, then subsequently cancelled the tax increases because the initial forecast did not take into account this ability of high income earners to shield their income to pay lesser taxes. So when the government announces new (inefficient) spending and say they’ll get other people to pay for it, be skeptical because you will end up paying for it.

–Back to the article–

Allocative Inefficiencies

So far we’ve talked about social & productive inefficiencies, the next types of inefficiencies we’ll discuss are technological & allocative inefficiencies. Allocative inefficiencies are strictly related to the welfare of a nation. It’s when the goods on the market do not meet what the market wants. Think about communist China killing off 15M people (accidentally) during the Cultural Revolution because of famine. This was due to a fear of bad information travelling up to the upper echelons of Chinese political society; specifically who was going to deliver that negative information to Mao because he had a habit of killing off those who did. Allocative inefficiencies can happen for a variety of reasons and imperfect information is a leading root cause. Not pursuing information is a quality that’s reflective of politicians of all stripes, however since I don’t know how their time is currently invested it’s not something I can say… yet.

Technological Inefficiencies

Technological inefficiency is one of the largest inefficiencies that’s stopping Canada from being a 21st century powerhouse. The first country to create a system to educate their youth on the technical merit of coding will bear the fruits of their labour and take humanity into the next revolution.  We’ll discuss technological efficiency as it provides a more logical way to think about technological inefficiency.

Technological efficiency is the ability to create products (or services) with a fixed set of inputs. Think about if you owned a farm and had 10 hours of labour and 100 dollars as your inputs and you have a month to harvest crops. In the year 1900 (or present day Zimbabwe), if you were tasked to plow a 10’ by 10’ field, you’d take your $100, buy $50 dollars worth of seeds, $20 dollars worth of water, $20 worth of digging equipment and remainder of the $10 might go towards rent. If you spent a month working the field for 10 hours, you’d consider it a success as you did your job for 10 hours a day for 30 days (300 total labour hours). In today’s day, if you had the technical prowess, you might be able to buy an Arduino & motor (and all electrical components) for $20 dollars, spending the rest of the money on the same things as the 1900 case, but you might be able to automate plowing it. So now instead of spending 300 labour hours plowing the field, you could spend a portion of that time coding the plowing (say 100 hours) and then you’d have the remaining 200 hours to focus on something else; one of the main reasons I’m writing this article and not working the fields with a pick axe.  The main point is that today, investing in capital can accomplish the tasks that labour did exclusively in previous generations. Economists have termed this that the marginal product of capital has a better return than the marginal product of labour (for some jobs). This is industry & region specific and this is one of the primary reasons you won’t see automated burger machines at the McDonalds in South East Asia and they’ll only be in the Western World; or in other words, the marginal product of capital exceeds the marginal product of labour in Western countries (maybe due to a minimum wage) and will continue to do so as coding becomes more widespread. This is actually the economic analysis for why Marc Andreeson said that “software is eating the world”.

Note to policy makers

If I were a student (or a parent of a student), I’d be livid that education boards across the country haven’t tried making coding mandatory. Here’s where the nay-sayers will say that you can’t force anyone to learn anything but unless we try to implement some sort of coding curriculum, we won’t know what doesn’t work. When trying to figure out what works, knowing what doesn’t work is equally as important. This is “the cream rising to the top” or in other words this is the end effect that competition plays on the world. Compeititon allows the market (e.g. people) to choose what types of products/services they like and what kinds they do not like. In what was supposed to be next week’s article (but I’m releasing today because vacay) I discuss another type of efficiency that I’ve termed “gatekeeper inefficiency”.

Back to coding, it’s clearly the future of labour and the fact that governments have been idle on this education policy is a crime against the future generation. The future generation eventually becomes the current generation, but the government stays the government. Read my article on competition in school systems to understand my thinking when it comes to innovation in the education sector.

P.S. Since there exist a few law’s of the jungle, I’m not talking about survival of the fittest, I was referring to the:

Now this is the Law of the Jungle — as old and as true as the sky;
And the Wolf that shall keep it may prosper, but the Wolf that shall break it must die.
As the creeper that girdles the tree-trunk the Law runneth forward and back —
For the strength of the Pack is the Wolf, and the strength of the Wolf is the Pack.

Which to me, means that the human race doesn’t depend on any one person, but the collective efforts of a team.

Article was written by gtareguy (Greater Toronto area real Estate guy) . I release a new article every Friday and I write about economics, the nba and real estate in the GTA. 


Author: gtareguy

Real Estate Investor Raptors fan (don't cry for me this year) Mech Eng Graduate

7 thoughts on “Inefficiencies – what kinds are there [Economics] [Manufacturing]”

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s