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Tuesday, September 28, 2021
A Brief Summary of the Theory of 'Upstream Industry'
Chan Kung

The theory of "upstream industry" means that, under the condition of excess capital, due to a large amount of capital investment, a large explosion of demand has spawned, which tightens the consumer side. This in turn, causes the upstream side of the production side to garner greater pricing power and voice. This theoretical explanation is based on the long-term follow-up study of capital surplus activities, and on the basis of the Crisis Triangle model.

The Crisis Triangle model points out that urbanization will inevitably lead to the expansion of capital, causing excess capital, and even economic crises including financial crises. Under the condition of excess capital, there will be overproduction. This also means that large-scale manufacturing and production will worsen debt and increase inventory. In addition to this, the social classification model points out that in regard to the world's production activities and the structure of each country's GDP, most countries can be defined as two different types of society, one is a production-based society, the other is a consumption-based society. These two different types of societies have differentiated inflation and consumption responses to capital surplus.

In a production-based society, large-scale production activities under conditions of excess capital will lead to the deterioration of debts and defaults. The continuation of large-scale production activities will drive the upstream of the industrial chain, causing pressures to the supply side. This results in tighter supply of major raw materials, mineral resources and even labor and other front-end factors, and prices will increase or even lose control. Affected by this, in the entire industrial chain, the pricing power and market voice of upstream industries will then take shape, and will gradually stabilize due to the continuation of excess capital.

On the other hand, consumption-based societies are mainly concentrated in developed countries. The middle class in these countries accounts for a large proportion of the economy, where the economic growth is mainly supported by consumption. In such a society, the main manifestation of excess capital is that, on the one hand, urbanization is still an ongoing process, and the population, including foreign migrants, continues to concentrate and flow to central cities. On the other hand, macro stimulus measures in these countries continue to increase the money supply. All this to a certain extent, stimulates and promotes the expansion and expansion of consumer activities. Then there is inflation driven by demand expansion, especially when there are problems in the supply chain. For developed countries to cope with this type of inflation, their possible strategic policy adjustments are to further increase the level of welfare and prevent inflation from exerting excessive pressure on the huge middle class population.

In 2021, despite the disruptive factors of such as the COVID-19 pandemic and the attempts to control it, we can still see that resource price inflation in upstream industries and relative price deflation in downstream output products exist almost concurrently. International shipping prices have risen to historical levels, and the Baltic Dry Index has also reached historical highs due to China's exports. The price of container freight has increased by more than 10 times, and there are no ready-made containers. Prices of raw materials are rising, and the same go to logistics costs, but the prices of finished products in the downstream industry have basically not risen, and business operators are struggling to survive.

Facing such daunting problems, technical analyses often carry too many assumptions, or are at the lower end of the problem structure, and fail to provide good explanations of the current economic phenomena and challenges. For example, although there are many detailed analyses concerning the impact of the industrial proportion structure on the economy and consumption, they are all at the lower end of the problem structure; while this is important for academics in various fields, their substantial significance for macroeconomic operation and regulation is quite limited.

The impact of semiconductor chip prices on the automotive industry this year for instance, has been rather extreme. Fourteen U.S. automotive manufacturing factories alone have been shut down due to the shortage of upstream semiconductor chip supply. Manufacturing plants and even many large companies have suspended their global investment activities. As the upstream of the battery industry, lithium materials have a huge impact on the battery industry. California, the most stringent environmental protection state in the U.S., even began to discuss and start the mining of lithium mines. Of course, there is also the impact of iron ore on the steel industry, and the impact of coal on the power generation industry, and so on. The pricing power and even industrial control power of these upstream industries have been clearly formed and gradually stabilized in today's capital surplus. Even if the fluctuating influence of the pandemic factor is not considered, this kind of impact will still exist, and it is merely a matter of magnitude, level and intensity.

The theory of "upstream industry" is not merely an academic exercise, but has a significant impact on strategic policies. First of all, among the options for trade war tools, one cannot simply rely on economic analysis, as these "powerful tools" identified by economic analysis may not be true. Second is the issue of inflation control. Different types of society will have different price reflections. While conventional economists suggest "when there is more money, then there is inflation", the reality is that policies need to be defined according to the type of society. Third, in China's case, the social classification model supports the basic principle of "common prosperity" and supports the necessity of social transformation. Only by shifting from a production-based society to a consumption-based society can the middle class grow and "common prosperity" be realized. Fourth, the resource taxation of local governments is promising with the support of the theory of "upstream industry"; this is especially true for the local government of resource exporting regions, where resource taxation has the conditions to become a powerful financial means. Fifth, the theory of "upstream industry" obviously has multiple and complex influences on environmental protection and ecological policies. Sixth, the "upstream industry" theory has an impact on the trend of industrial investment and encourages industrial investment to be deployed in the resource industry. Seventh, the "upstream industry" theory has a significant impact on the industrial layout, and many industries are bound to adjust the layout due to price changes.

It can be seen from the above that the "upstream industry" theory has a great impact on national strategic policies, and it has a major bearing on the prosperity and stability of the economy. Many problems seem deceptively simple, but in actual policy operations, if the policymakers are blindly driven by public opinion and the so-called "common sense", they might face more problems later.

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