Purchasing Power as Replacement to GDP

Explaining Adam Smith's Digression on Silver (and how it leads to a replacement of GDP)

The Digression on the Value of Silver in Chapter 11 of Book 1 is one of the longest and most difficult chapters in Adam Smith's The Wealth of Nations. I started publishing the simplified version of The Wealth of Nations from Book 3 instead of Book 1 simply because I knew that simplifying the Digression in Book 1 would require a lot more time and effort.

The first step is to organize the Digression which starts at Paragraph 96 and ends at Paragraph 239. For reference, I used both the 'capitalist' econlib version and the 'socialist' marxist.org version

The first step is to organize the digression into topics as below:


The second step is to explain why Smith arranged his topics in that order:

Smith wanted to prove that gold and silver prices are not correlated with the wealth or poverty of society. Instead, he wanted to prove that it is the money price of some rude produce relative to the main food grain (such as wheat), which is the clearest indicator of a society's wealth or poverty.

To do this, he had to:

In the same way, we want to objectively prove that GDP (measured in dollars) is not a proof of the wealth of a country, so we follow Smith's methodology in getting the 'grain values' of key rude produce to easily say whether the US or China or the EU is really wealthier and which country's wealth is based more on real value, instead of fake or nominal value. Who wouldn't want to live in a country that has more real value and is more resistant to economic crises?

Value of the Digression on Silver for SORAnomics

SORAnomics uses two measures combined to replace GDP as a measure of a country's wealth:

Purchasing power is the net revenue from GDP or gross revenue of a society. It is made up of the net profits that go to the wallets of business owners, and wages that goes to the wallets of employees. The expenses for tax payments, interest payments, fees, etc. are deducted from the computation of net revenue. For example, the GDP or gross revenue of Singapore is nominally $323.9 b. Its purchasing power would be the GDP minus tax payments to government and the cost of money used up in producing that GDP. This cost of money is the expense in banking and financing the money used to circulate value and could be totally removed if all humans gained perfect cognition and fellow feeling with other humans. There are two ways to compute Purchasing Power just as there are two ways to compute GDP via income and expenditure approaches. The first way is Top-down from tax returns and the other way is a Bottom-up approach by measuring the actual purchases of diffferent sectors.

The money which circulates the society's whole revenue among its members makes no part of that revenue. The great wheel of circulation is different from the goods which are circulated through it. The society's revenue is in those goods, not in the wheel that circulates them. In computing any society's gross or net revenue, we must always deduct the whole value of money from the whole annual circulation of money and goods. The value of money can never make a part of the society's gross or net revenue. (Wealth of Nations, Book 2)

The Grain index, as stated in the Digression is the ratio of the price of commodities to the price of grain. For example:

So it means that chicken is really cheaper in the Philippines, meaning that while Vietnamese enjoy cheaper rice, Filipinos enjoy luxuries better (to Smith, meat is a luxury). This is consistent if we replace chickens with cars. A Toyota Vios is 16,000 kg rice in the Philippines, but 44,250 kg rice in Vietnam.

The amount of the metal pieces which circulate in any country must always be of much less value than the worth of that money. But the power of purchasing or the goods which can be bought with that money, must always be the same value with that money. The revenue of those who receive that money must be of the same value with the money they receive. That revenue consists in the power of purchasing or the goods which can be bought. It cannot consist in those metal pieces of which the amount is so much inferior to its value. (Wealth of Nations, Book 2)




GDP per capita $100,345 (1st place, 13x Vietnam) $8,936 (2nd place, 1.19x Vietnam) $7,510 (3rd place)
Rice Prices per kg 75 US cents or 1.1 SGD (2nd place or 1.5x Vietnam) 80 US cents or 40 PHP (3rd or 1.6x Vietnam) 50 US cents or 12k VND (1st place or cheapest)
Chicken Prices in rice 4.22 kg rice (2nd place or 1.3x Philippines) 3.25 kg rice (1st place) 8.33 kg rice (3rd place or 2.56x Philippines)
Toyota Vios in rice 73,636 kg rice (3rd place or 4.46x Philippines) 16,500 kg rice (1st place) 44,250 kg rice (2nd place or 2.68x Philippines)
Toyota Alphard Luxury Van in rice 206,000 kg rice (2nd place or 2.25x Philippines) 91,250 kg rice (1st place) 336,000 kg rice (3rd place or 3.7x Philippines)

Both Economics and SORAnomics will conclude that Singapore is the most prosperous country and Vietnam the least prosperous of the three, from the supply side. But from the demand side, SORAnomics can reveal much more info:

So by combining supply side GDP or Purchasing Power and demand side Grain index, we can get a more granular picture of the real economic situation of a society. By plotting the ratios of prices of different products and services relative to the Grain index annually, we can even determine the economic direction of a society and can better iron out kinks in a society's supply and demand. We can even use the data to plot exactly when the grain ratios started to change to then pinpoint specific laws that caused the problem or improvement.

In contrast, modern Economics measures the supply-side as gross supply or GDP (Gross product), and measures demand-side as CPI or nominal consumer prices measured in currency. This makes it difficult to value goods and services during bubbles and hyperinflation, causing a disruption in the supply chain like what happened in Zimbabwe. If a financial crisis hits a SORA system, the valuation can merely switch to the Grain index to keep the supply chain humming.

Under Economics, a country can theoretically have a single giant corporation exporting everything, having huge GDP while its workers starve to produce those exports at low cost. A GDP standard would still rate the starving country as wealthy. Our dual system, on the other hand, would properly expose the real poverty hidden by the nominal wealth just as it exposed the hidden middle-class poverty in Vietnam and the real poverty in the Philippines. In addition, our dual index eliminates the need for complicated subjective factors that are present in other indices like the Human Development Index, Happy Planet Index, Better Life Index, etc. The subjetiveness is only in what items are pegged aganst the Grain index.

The Big Mac index has some of the basic ideas of Smith's commodity-based valuation system, explained in the Digression, as it uses a real, useful thing to valuate a mere piece of paper with a number written on it.



Measure of Supply GDP as Gross Domestic Product or the gross sales in a country Purchasing Power as the net revenue in a country after taxes, or whatever goes to the wallets of employees and business owners.
Measure of Demand Consumer Price Index or prices of year X relative to year Y Grain Index or prices of different goods and services relative to grain. For basics, it is fuel, electricity, water, rent, basic medical services and common non-essentials (meat, milk). For luxuries, cars, condominiums, etc.
Subjective Measures Arbitrary, depending on think tank (Human Development index, Happiness index, etc) Not-so-arbitrary. Measures are integrated in the items included in the Grain index. For example, a rich country might include prime beef and pork in the index, but a vegetarian country might not. In general, meat is included since Smith included it in his digression.