Saturday, July 3, 2010

Prosperity: What's An Economy For?

I'm going to be writing a series on what I have come to call "Money-Free Economics." By this I don't mean economics of a barter system or of an economy without money; rather, I mean economics that ignores money and goes to the underlying real-wealth economy that money facilitates. I acknowledge up front that this creates a certain amount of distortion. There are features and processes of a modern economy that can't be understood without addressing money, among them interest rates, the effects of government fiscal policies, and speculative investment -- to name but three of many. But money also creates distortions. In particular, schools of economics that address money without touching on the underlying economy of goods and services often create severe distortions by treating money as if it existed and operated independently of the goods and services for which it is a token of exchange -- as if only money, not stuff, mattered. Moreover, those features of an economy that require addressing money to understand are already covered well by professional economists in their various schools. On these matters they don't require any help from me (often it's the other way around). But when economists present something as stupid as, for example, the laissez-faire interpretations of the Laffer Curve, or explanations for recession that rely entirely on monetary factors and ignore the distribution of wealth, I know that they have focused on money to the point where they have forgotten that it is just a token of exchange and not real wealth, because when you put those in money-free terms their nonsensical nature becomes obvious. So, to address the follies of economists and the politicians who quote them, I shall engage in an exercise, presenting economic concepts in ways that don't use money at all.

I'll begin today with an examination of what an economy is and what it's for in money-free terms.

An economy is, to begin with, a social arrangement. It involves assigning of ownership, division of labor, and rules of exchange and trade. In a modern society it is always a function of law. That wasn't always so, because human beings have not always lived under the rule of law, but even in pre-civilized times when there was no law as such and no formal government, there were still rules about who owned what, who was supposed to do what, and who got what in the end.

What this social arrangement is meant to do is to regulate and facilitate the production and distribution of wealth. Wealth, as I pointed out in the last entry, consists of goods and services. Going into a bit more detail, wealth consists of eight things: food, clothing, shelter, tools, toys, entertainment, advice, and assistance. Everything you or anyone else ever buys or sells falls into one or more of those categories. The economy is a social arrangement whereby these eight things are produced and gotten to the people who want and can use them. Those are the two criteria of economic success. As long as those eight things can be produced in enough quality and quantity and distributed to everyone who needs and wants them, the economy is a success. When either of these functions fails, the economy fails. If not enough food can be grown, or if the food that is grown can't be gotten to the people who need to eat it, there is famine. If not enough housing can be built, or if housing is built but sits vacant while people are homeless, there is a housing crisis. And so on.

Every failure of the economy, every depression, every recession, every instance of runaway inflation, every bubble collapse, even the economic failure that occurs after a military defeat, manifests ultimately in a failure either of production or of distribution or both. Even when the cause (or at least the trigger) of the economic problems is fiscal or monetary, such as a stock-market crash or the collapse of a housing or real estate or some other bubble, it always comes down in the end to a failure to produce or a failure to distribute. If it does not, then it is a nonexistent problem as far as the overall economy is concerned.

Problems can occur on either the production or the distribution side. An example of a production-side problem is a severe drought that results in crop failure. This creates a shortage of food and starvation. Another example is the devastation created by war, as for example in Germany during and after World War II, when Allied bombing and Allied and Soviet invasion destroyed German factories and industrial capacity, as well as German roads and railroads. A third example, more subtle, is the impact on the U.S. economy of the OPEC oil embargo from 1973 until 1983, which caused shortages of a crucial raw material. An economy that is in a pre-industrial state and is trying to industrialize also faces production challenges, not in the sense of losing production but in the sense of wanting to increase it. In general, production of wealth requires raw materials, labor, knowledge, and organization, and a shortage of any of these (for whatever reason) results in a deficit of production.

Problems of production are severe, but problems of distribution can be equally severe. The Irish potato famine was, at root, a distribution problem. It had a proximate cause on the production side, a potato disease that caused crop failures, but this would not have resulted in famine except that the Irish wheat lands were all in the control of aristocratic landholders who were entitled to the wheat crops for export purposes. That's the reason why ordinary Irish people were dependent on a potato diet in the first place. A more nearly equal distribution of Ireland's food crops would have meant that when the potato harvest failed, the people could eat other foods. Severe maldistribution of the nation's agricultural wealth meant that the potato blight became the potato famine.

The Great Depression and similar breakdowns in the years before it (for example the Long Depression that began in 1873 and lasted longer than the Great Depression itself, although it was not quite as severe) were also breakdowns of distribution. The economies of the advanced nations, such as the United States, suffered no shortages of raw materials, labor, knowledge, or organization, and there were initially no problems of production. But the goods produced were not distributed to the people who would use them. Because of the system of private capital property ownership, the goods produced in a factory (say) belonged to the factory's owner, and anyone who wanted those goods had to exchange items of value for them (by way of money, of course). Since not enough of the people who wanted the goods had the value to exchange for them, they could not be sold and so sat in warehouses being of no use to anyone.

The distorting effect of money can be easily seen in this entire sequence of events, which were caused by a desire on the part of capital property owners to keep to themselves as much of the wealth produced as they could. As long as we think in terms of money, this is perfectly understandable: the rich wanted to become richer. But if we think in money-free terms, the silliness of it becomes clearer. How much in the way of food, clothing, shelter, tools, toys, entertainment, advice, and assistance does even the richest person need? How much of these things does he even want? How much can he use? After a certain point, all that stuff is wanted not for use but for sale, and if a relatively few rich people own almost everything of value, for what can it be sold?

Here is the fundamental flaw of capitalism. It is predicated and focused on the accumulation of individual fortunes, which means that ultimately it undercuts its own basis resulting in economic breakdowns due to maldistribution of wealth and consequent depressed demand. Economists have gone to great lengths to refuse to acknowledge this. There is, or used to be, a concept in economics called "overproduction" or "surplus production" which meant that the economy was producing more stuff than people could use, so that in order to maintain full employment and productivity it needed to be sold abroad. But the economy has not historically ever actually produced more stuff than people could use (although that's theoretically possible). It has just produced more stuff than the people who wanted to use it could buy. That's a very different thing. The demand for goods and services depends not only on people's desire for things, but also on what they have to trade for them, and for most people the latter is exhausted long before the former. (Those for whom it is not, exhaust their desire to buy instead. Either way, stuff remains unsold.)

One of the things about economics today, even more than its disconnect from the economy of stuff and its focus on the arcane economy of money, is the refusal of many of its practitioners to think about the elephant in the room: the distribution of wealth. Even when an economist (by this stage of the game usually one long dead) takes a money-free approach, it often suffers from this flaw. A good example is Say's Law.

Say's Law is an economic principle attributed (somewhat incorrectly, but that's by-the-way) to the French economist Jean-Baptiste Say, who lived and worked in the late 18th and early 19th century. Say argued that there could never be a general glut of goods -- too much on the market to be sold -- because all goods produced created value with which to buy other goods, and goods are exchanged only for goods even when they are exchanged by way of money. As far as it goes, that's true -- but it also very much matters whether the goods produced are owned, and so exchangeable, by those who desire the other goods produced. Or in other words, it matters how widely wealth is shared. The fact that wealth exists to exchange for all products produced in the form of other products does no good on a practical basis unless those goods are in possession of those who wish to make the purchase.

One finds many critiques of Say's Law among economists, but rarely will one find this fundamental flaw recognized. John Maynard Keynes, for example, identified three assumptions underlying Say's Law: a barter model of money (goods are exchanged for goods), flexible prices (that can rapidly adjust upwards or downwards with little or no "stickyness"), and no government intervention. Keynes himself disputed the second assumption, arguing that prices are not necessarily flexible. Others have disputed the first or the third. (And here one does run into the distorting effect that arises from money-free economics, because there are aspects of a money economy which do not perfectly mirror a barter economy. However, that is not the real problem with Say's Law.) It's true that the idea does rest on at least the first two of those assumptions, but it also rests on another which is self-evidently false: the equal or near-equal distribution of wealth.

It's a curious thing, this refusal even of a supposedly "progressive" economist such as Keynes to address the central problem of inequality even though his own work naturally lends itself to doing so. Those who do address it usually seem to confine themselves to the moral aspects of it without considering the economic aspects. But the economic aspects are also real and also important.

Returning to the two functions of an economy, production and distribution of wealth, we may consider the template to be the economy of a pre-civilized community, in which a small band of human beings own all capital property in common and share tasks and wealth more or less equally. Production-side problems arose often enough in the form of shortages, but distribution-side problems did not. Even when production problems happened, it was never due to failures of organization, but only of natural resources, knowledge, or labor. The economy functioned in the manner Marx described as "communism," the end-state of his theoretical economic progression: from each according to his ability, to each according to his needs. Now, my personal opinion is that Marx had to have been smoking something to believe that an advanced economy, whose essence is impersonality, could ever operate communistically in this fashion. But we may nonetheless take that ancient pattern as, in terms of distribution and of the organization of labor and natural resources, the ideal, and evaluate our modern substitutes in terms of how closely they approximate this ideal. The truth is, of course, that they fall far short -- but in fairness, they have a much more complicated problem to solve.

In future posts, I'll consider historical economies that worked better than the one we have now, along with some spectacular historical failures. Finally, I'll speculate about alternatives to capitalism as it currently exists. In all cases, I'll approach the questions through money-free economics, in order to keep it as simple and non-arcane as possible.

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