Capitalism by a Better Name: Sweeter Still

Karl Marx is usually credited with coining the term “capitalism” to describe the economic system of our age.  The prior system, feudalism, accorded power and wealth to those that controlled the land.  Marx observed that power and wealth had shifted to those that controlled capital.  The irony of describing today’s economy as capitalistic is that for Marx capitalism, as he thought of it, was only a small portion of the overarching system that really set him off.

The plain fact is that prosperity and productivity had nothing to do with Marx’s ire.  The Communist Manifesto contains arguably the greatest paean to the productivity of the new system ever penned to paper:

Marx3“The bourgeoisie, in its reign of barely a hundred years, has created more massive and more colossal productive power than have all previous generations put together.  Subjection of nature’s forces to man, machinery, application of chemistry to agriculture and industry, steam navigation, railways, electric telegraphs, clearing of whole continents for cultivation, canalization of rivers, whole populations conjured out of the ground – what earlier century had even an intimation that such productive power slept in the womb of social labor?”

Wow!  After that you would think Marx would be wild about the bourgeoisie reign.  Note that Marx did not refer to a capitalist system, but to actions and accomplishments of a class of people.  Indeed they were an entirely new class of people eschewing the status of birth for the status of wealth, relentlessly pursuing profit.

This all suggests something deeper and broader for Marx’s negative sentiments found in his manifesto.  In what I believe is the greatest paragraph in all of English nonfiction prose, the Communist Manifesto contains the answer.  Having read both Capital by Marx and Conditions Of The Working Class In 1844 by Engels, I believe the following ideas are from Marx, but the words were Engels’:

“Constant revolutionizing of production, uninterrupted disturbance of all social relations, everlasting uncertainty and agitation, distinguish the bourgeois epoch from all earlier times.  All fixed, fast-frozen relationships, with their train of venerable ideas and opinions, are swept away, all new-formed ones become obsolete before they can ossify.  All that is solid melts into air, all that is holy is profaned, and men at last are forced to face with sober senses the real conditions of their lives and their relations with their fellow men.”

This is powerful stuff.  The context of this text embedded in the Communist Manifesto is clearly negative in its thrust.  Yet, a free market objectivist like me can only be moved by its eloquence, perception and accuracy.  Unlike Marx, I revel in this new state of affairs.  Unfortunately most are not unlike Marx.

In the narrowest sense, Marx preferred the old status based system because it favored lazy intellectuals like him.  Later in the Communist Manifesto he notes that professionals, intellectuals, artists etc. merge into the working class and:

“[L]ive only so long as they find work, and … find work only so long as their labor increases capital.  These workers, who must sell themselves piecemeal, are a commodity like every other article of commerce, and are consequently exposed to all the vicissitudes of competition, to all the fluctuations of the market.”

Heaven forbid!  Intellectuals, professionals and artists have to actually work for a living providing something people actually want and for which they will pay.  Dare I say it, they must be commercial!!!

More broadly and fundamentally, Marx strikes a deeply harmonious cord with the evolutionary base of the human psyche.  The new system, which the word “capitalism” does not fully encompass, is as much about actions and change as it is about a market economy, laissez faire and globalization.  Marx was the first to fully understand this.  He was the canary in the coalmine of the industrial revolution noting that the new system brought constant, even accelerating change.

Humans are wired to detest change.  For all of the history of life on earth change was always bad.  Organisms strive to be in a place where they met their needs, and once there any new development was surely negative.  This is why, despite the colossal productive prosperity all around us we are far from content, let alone happy.

Slow motion legs of business people walkingWe live in The Age Of Angst!  Ours is the only truly unique age in all of history – future as well as past.  Until yesterday, from a historical perspective, a person would be born, live and die in a world essentially unchanged.  That is why ancient structures were built to last forever (and more than a few succeeding in that aim).

Therefore the correct word to describe the past’s prevailing world view was not cyclical, but circular.  Details differed here and there, but everything eventually returned to its original position.  Pestilence and war commonly caused havoc.  Technology caused minor lifestyle differences.  The world remained the same.

That world view has been obliterated.  In my lifetime the world has been turned upside down and inside out not once, but going on twice.  Historical processes that changed fundamental cultural traits like manners, dress, attitudes toward sex and women, marriage, family and religion used to take centuries and now take decades or less.

It is more than ideas and opinions that are swept away.  We are in the only age where there is no cultural consensus about anything.  People are making it up as they go along because there is no cultural point of reference.  Until our age the notion of a fulfilling marital relationship or being a good parent had no meaning.  You rose at dawn, worked like hell all day, hopefully ate afterword and dropped of exhaustion at dusk.  There was not time or energy for anything else.

In a few hundred years or so humanity will probably sort this all out bringing a close to this only real age of change.  We need a new word or phrase to denote this system impelling accelerating change referred to by Marx as the reign of the bourgeoise.  The concept of the free market is incomplete.  Liberty and law may be better.  Any suggestions?

Karl Marx Photo Credit: http://www.PhillWeb.net

Importance of Free Trade to the US

No contentious issue has more agreement among economists than that trade protectionism is detrimental to all concerned. Yet no issue is less understood by the public and politicians.  The typical claim is made that high wage countries cannot compete against countries where labor is exploited by low pay and terrible working conditions. By that reasoning California and New York cannot compete against Arkansas. In addition to huge wage differentials between California and Arkansas, there are no trade, legal, or language barriers to contend with. Therefore, according to arguments of trade protectionists, there should be massive outsourcing to Arkansas, Louisiana and Mississippi from California and New York. Obviously, this has not happened. Also, wages in Japan skyrocketed relative to US wages throughout the post war period with no effect on their huge trade surplus.
Image of globe in networkThe genesis of persistent trade imbalances has only a little to do with wages and working conditions. To understand why, we must start with the basics. When I get a haircut, I have established a trade deficit with my barber. He can take the money and buy something from me, buy something from someone else, or save the money. This same scenario can be aggregated to a nation as a whole. When we purchase clothing made in China, the Chinese have the same three choices as my barber. In recent decades the net of all such choices by citizens around the world outside the US has been to save much of the money earned through trade.
Now, having saved a chunk of the money earned through trade, our frugal foreigners must choose what to do with the dollars they have not spent. They can trade the dollars for other currencies, or they can invest those dollars in the US. The overwhelming choice has been to invest in the US because of the relative strength of our political economy. That is exactly equal to our trade deficit. As our economy weakens in combination with profligate monetary policies our currency will lose value.
Sideshows like currency devaluation, overvaluation and manipulation are irrelevant to our trade deficit. No amount of currency devaluation by our treasury will reduce our trade deficit as long as we spend and foreigners save. Our currency has plummeted over the past 40 years, sometimes so fast as to be on the verge of utter collapse, yet the trade deficit soared. The value of our currency is a sensitive barometer of the strength of our political economy and something that touches every one of us every day. It is insane to want that measure reduced in value.

Prior to WWI, as a debtor nation, our borrowing and spending was primarily for investment purposes (as in capital equipment). Today the trade deficit is for consumption. The consequences are very different. When we borrowed for investment our currency strengthened along with our economy because we were increasing our productive capital. Our borrowing for consumption means we have literally consumed – actually hocked – our productive capital.
Until now the effects of profligate money printing and extreme economy wide debt have been muted because foreigners have considered the US a great place to invest their savings, though at reduced exchange rates for our dollar. That is about to change.

Supply/Demand and Profits: The Case of Oil

The most fundamental thing we all understand about economics without taking a course, the law of supply and demand, is flawed and incomplete. We intuitively feel that increased demand bids up prices, which then brings on new supply. Other things being equal, this works reasonably well. Other things are almost never equal.

Let’s take oil and gasoline as an example.

Gasoline prices may be rising, but if crude oil prices are rising faster than gasoline prices no new supply will come onto the market.  OilPumpSmallIt is even possible that supply may be reduced because crude prices rise so rapidly that refining and distribution costs are not covered, resulting in losses for gasoline producers. So, in order for rising prices of gasoline to bring on a rising supply, producers must be showing a profit.

This is not good enough. Hefty profits alone are not sufficient to bring on rising supply or increased competition. Wal Mart makes huge profits, but we do not see competitors flooding into the market to compete with them. The reason is that Wal Mart works on razor thin profit margins.

If prices are rising while profit margins are declining it is unlikely that new supply will be forthcoming. Therefore, new supply may be expected only when rising prices signals entrepreneurs to take a look, and rising profit margins induce them to wade in. In fact, there are plenty of examples where increased supply keeps coming even in the face of declining prices such as in the computer industry today. The higher the profit margins the greater the flood of new supply. I call this The Reiss Rule of Obscene Profit Margins: Relatively high and rising profit margins (not rising prices) result in increased supply.

Profit margin analysis is old hat to financial professionals, but apparently alien territory for economists. As proof I cite the windfall profits tax enacted under the Carter administration and recently re-proposed by certain policy analysts when oil prices were soaring. On the other side of the ledger I cite the special tax breaks enacted early in W’s administration when oil was in the $25 range. If you had any clue about what you just read, then it would have been obvious that we did exactly the wrong thing in each case.

When oil soared and profit margins rose for oil production in the 70’s the market signals screamed for more supply. By enacting a new “windfall profits” tax on producers plus a raft of onerous and costly regulations we did more than punish success. The windfall profits tax had a devastating effect on production because it led to sharply shrinking profit margins and severely dampened the market’s signals to potential investment by new oil producing entrepreneurs. This only exacerbated the problem.

Dollar sign 50

This is just one example of how those with the hubris to believe they know better than everyone else how the markets should behave actually do things that distort market signals and make things worse. Prices, profits and losses are the market mechanisms that transmit the information necessary for producers and consumers to make decisions that most efficiently allocate available resources. All the smartest guys in the room armed with all the computers in the universe can do no better.

Parenthetically, if one must interfere with the market when oil prices are high, then it follows that measures taken should increase incentives to produce more oil, not less. Therefore, reducing taxes on oil producers would be a better policy response to high oil prices than the typical, politically motivated, knee jerk reaction for higher taxes.

Income Inequality

In order to become more prosperous we need to become more productive. Greater productivity requires more capital (e.g. machinery, software), and better methods. Both require the workers at every level to develop skills to operate in higher productivity environments. This guarantees to a mathematical certainty that income inequality will increase as our overall standard of living goes up.

As we become more productive prosperity increases as defined by a rise in the median income (half earning more than the median and half earning less). Participating in step with the rising median income requires increasing ones skills.

In particular, to keep pace, we must increase our intellectual skills. The reason for this is that, beyond a very basic level of productivity, rising prosperity means intellectualizing the production process. Muscles and stamina give only a small boost to productivity. The difference in output between the strongest and average human being is small by comparison with the intellectual harnessing of the power of machines.

YellowGreen

We all start life with a labor market value of zero. Some never develop much in the way of skills. Business owners (especially small business owners) will tell you that it is not uncommon for employees lacking even the simplest skills like showing up on time. Such people continue to have a minimal value in the labor market.

With the median income rising as we become more productive and skilled, it therefore follows that those who never develop skills will fall further and further behind. This is the most basic reason for rising income inequality. It is a metaphysically required byproduct of rising prosperity. The same analysis applies to every level of skills as each skill set becomes increasingly valuable as productivity and prosperity rises.

There is another aspect of this analysis which relates to uniquely talented individuals and the increase in the total output of the economy. When the average person earns barely more than subsistence, there is little left for discretionary purchases like a movie ticket, music album, a day at Yankee stadium or an I-Phone. As the economy grows the money available for discretionary spending grows faster. However, the number of uniquely talented individuals barely increases at all. The number of professional football players in the NFL has grown perhaps four fold in the last 50 years while the economy has grown more that twenty fold. Therefore, the best (even average) players must experience a much sharper rise in income than the median. Also, the number of top 10 songs each week have not increased at all.

The fairness of this situation is a philosophical, not an economic issue. Future installments will show that any attempt to reduce this inequality effect will do significant damage to the economy as a whole and make everyone worse off. Only relatively poor or small homogenous economies can have muted inequality effects.

Ask yourself which economy is better for everyone (given that the poorest get enough to eat, clothes and basic shelter) – one where the deciles increase arithmetically or geometrically? The arithmetic progression is 1, 2, 3, 4, 5, 6, 7, 8, 9, 10. An example of a geometric progression of income deciles is 1, 2, 4, 8, 16, 64, 128, 256, 512, 1024. This example used a geometric factor of 100% difference in deciles. A stark difference would also occur at substantially smaller differences.

Even the lowest incomes today earn a standard of living far superior to even royalty 250 years ago. Not long ago poverty meant not having enough food. Nobody has to be concerned with enough to eat (obesity is the problem today) and no matter how rich you were back then you could not travel faster than a horse, and you had to defecate into a pot or a pit with no plumbing.

Fundamental Theorem Of Economics

Adam Smith is the father of economics but Jean-Baptiste Say stated the most important fact about economics, “Supply creates its own demand.”  In recent decades this statement known as Say’s Law has been sneered at by believers in the current orthodoxy that the consumer drives the economy.

smith

Reflect upon this statement for a moment.  What do we mean by “demand”?  We all want lots of stuff, but can afford to buy much less than what we want.  Therefore demand in this context means that which we can afford to pay for in the marketplace.

The next consideration is how we get the wherewithal to demand anything.  In common language we speak of where we get the money.  Someone can give it to us, we could steal it, or we could earn it.  Even if money is given to us, or stolen by us, someone had to earn it first.

This last point brings us just a step away from nailing down the principle involved here.  Someone had to earn the money first.  That means someone had to do something to get the money.  Someone had to act to create something of value (a good or service) for which another person was willing to give him money.

Now we have completed the circle.  In order to “demand” something someone had to first perform a creative act – an act that produces something.  Therefore, we can now restate Says Law as “Supply is the only source of demand.”  Without someone creating, producing, supply there can be no demand.  In more common terms this means that nothing can be consumed before it is produced.

This may sound trite, but it is a profound truth that is completely ignored by present day theoreticians and politicians.  It is a metaphysical truth.  Restated as The Fundamental Theorem of Economics we have “Production precedes consumption.”

Understanding this allows us to deduce and thoroughly understand the source of prosperity and points the way to deciding which policies promote prosperity.  If we want to consume more we must produce more.  This applies to each of us individually and all of us collectively.  If you want more you can work longer, harder and smarter.

Working longer and harder is viscerally understood.  Working smarter is a conceptual idea that can be reworded as working more productively.  Over the very short term we must work longer and harder to become wealthier.  Unfortunately, our individual mental and physical capabilities combined with time limitations severely restrict how wealthy we can become by only working harder and longer.

Beyond the very short term, in order to dramatically increase wealth and prosperity we must work smarter.  We must become more productive.  We must produce more, produce it better (higher quality), produce it faster, produce it more efficiently (at less cost).

This all derives form our fundamental theorem, “Production precedes consumption.”  Now we have a reference point and tool to help us make reasoned decisions about economic policy issues.  We can ask whether a proposed statute or regulation increases or decreases productivity. For that matter we can better understand what, if any, government activities enhance productivity.

Contribued by:
Steve Reiss @ SedonaSteve.wordpress.com