Tuesday, July 5, 2016

How Unmitigated Capitalism Distorts Markets

Sometime folks of my political persuasion wonder why, at times, the populist sentiment in the country seems to favor economic policies that do not help much of the populace.   There are many reasons for it, I am sure, but I believe that one reason is the belief in a “just world”.   This is the idea that everything happens for a reason and that people generally get what they deserve.   It makes sense to believe this if one is economically successful - a doctor, a financially successful business owner or one who has inherited wealth would have it in their interest to believe that they are being justly rewarded.

But why do so many of the working poor believe this?   Perhaps one reason is that believing in a just world is comforting.  Sure, I may not have the economic security that I would like, despite working two jobs, but I’d rather believe that I deserve this than that I am being cheated by the system in some way.   If I believe I deserve it, then I may not have economic security, but I have existential security.  I believe that there is a general order that is operating things correctly.  The alternative is to believe that the current state of affairs is simply made by people just like me - and that is frightening.  It’s easier to believe that things are the way they are because generally people deserve their lot in life.

The great irony here is that the view of “personal responsibility” - that I completely deserve my lot in life through my own actions - is actually an attempt to jettison personal responsibility for the way the world itself actually is.   As long as a minimum of security is met (no one is super hungry perhaps?) it’s easier to believe everything is how it should be already.  Surely things can’t really be super wrong….can they?

One way a person might justify this way of thinking, believing in a just world, in particular how it relates to economic results, is by believing in markets.   If I have a skill or a good to sell, then the principle of supply and demand should control my success.   If I am “unskilled”, then I offer less to society and can’t expect much in return.

This makes some sense.  Obviously a person who invents a great new technology or goes through the enormous amount of hoops to become a doctor should receive economic rewards that are greater than a person who has a high school degree and just wants to work for a living (although surely there is nothing wrong with that!).  I don’t think there is much of anyone these days that believes in equal outcomes in the economy, despite the rhetoric on the right.

But what if markets are not operating in an untouchable vacuum?  What if certain policies affect markets and distort them?   What then happens to the “just world” view?

Capitalism is a pretty darn good system.  By using money, a useful (but complete) fiction, we can spread goods and services across the economy, facilitating trade and investment.   Money is just dead useful that way.   A bartering system creates massive inefficiencies - can you imagine having to construct an elaborate series of trades just to obtain what you need everyday? 

So money is a fantastic idea.  It’s nothing but paper, or blips on a screen more likely these days, but it greases the wheels of the actual trade of goods and services.

But there is a fatal flaw in the system. 

If I make a product and sell it, or work, and accumulate capital (money) but I don't spend it on other goods and services - in other words, if I save - then what happens?   Everyone else in the system of exchange has less money to facilitate trade.  The baker who wants a hat can’t buy a hat - she doesn’t have the money.  And perhaps she works hard and makes excellent bread, but someone else in the chain, who wants bread, doesn’t have the money, because I didn’t spend my money.   A depressing effect begins to occur.   Saving stifles trade.  Keynes called this “the paradox of thrift.”    Financial wealth, which is created through saving, leads directly to financial poverty elsewhere in the system.

But wait! Most people who save do not put the money under the mattress, of course.  They invest it.  And this is great in many ways. They don’t want to spend right now, so they put money somewhere - the bank, stock market, etc. - and someone else ends up with the money who can spend it - on building a business, for instance.

So everything is great, right?  Not really.

The investor isn’t giving away money here.  He wants a return. He’s not trying to facilitate trade, rather he wants more money - so all the money that he invested must quantitatively grow, pulling even more capital away from other parts of the economy.   

But isn’t that money also invested?   Sort of.

When money continues to creep into fewer and fewer hands, which as you can see is an essential aspect of the way capitalism works, then the velocity of money (speed of spending) utilized on real goods and services tends to be depressed.  Imagine I buy a stock instead of spending my money on a tangible good.  I now own a stock and that money sits in someone else’s hands, the person who sold me the stock.  Then she buys a stock and the money goes to someone else’s hands, etc. etc.     The money is being traded back and forth in different savings vehicles.  The cash is sitting temporally in brokerage firms.  Yes, a lot of the money raised in stock sales is sometimes used to buy real goods and services for a company, but once again - returns are expected!   And those returns end up being traded around in savings vehicles which slows down the purchase of real goods and services in the economy. 

So when capitalism is working the way it’s designed to work, there is an upward gravity of money which has a depressing effect on the trade of real goods and services.  And this is when fiscal failures start to happen.

What is a fiscal failure?   It’s a point in the economy where something is needed, and there are people and resources ready to make it happen, but there is simply not enough money present.  But remember, money is a fiction.   The philosopher Alan Watts once made the point that saying we don’t have enough money is like saying builders don’t have enough inches to measure with, so they can’t build.  Today, some economists use the example that saying we don’t have enough money is like saying the NBA doesn’t have enough points to put on the board for the next game.  In other words, money is fiction.  But it’s the way our economy works, and when it becomes lop-sided in one part of the system, through certain policy decisions, then there is trouble.  It’s a (fiscal) failure of the system.

Say a school needs to be rebuilt.  And say there are two dozen construction workers who are unemployed.  And say there are plenty of actual resources - food, gas, building materials, etc. - in the economy for the potential workers to work with and for them to buy with their potential income.  And yet the job is not happening and the construction workers are idle, and the resources are sitting on shelves.  There is zero reason for this in terms of actual resources.  This is a fiscal failure.  It’s a failure of money!   A legitimate market is there, but through a lack of financial resources - NOT real resources (that is key) - we have a distortion to that market and it doesn’t function well.

Then what happens to other workers in the economy when multiples fiscal failure lead to fewer jobs?   The market for labor is depressed, and wages tend to go down.   Not necessarily because workers are “unskilled” and unneeded, but because they are under-valued due to market distortions caused by fiscal failures.   And because employers are having to pay less for labor, the upward gravity of capital is heightened and it creates a negative feedback loop.

So the progression is like this -  The upward gravity of capital leads to fiscal failures, which lead to market distortions, which lead to heightened inequality, which leads to more upward gravity of capital, etc.

How do we fix this?  It seems a fatal flaw in capitalism that will eventually disrupt markets completely.

Luckily there are ways to mitigate for the upward gravity of capital. 

One - a progressive tax system.  As one takes more financial resources for oneself through income, we tax that income progressively higher.

Two - We try to keep a steady rate of modest inflation in the economy, which somewhat punishes a lack of spending.  If your savings are losing value, then spending becomes more attractive.  The opposite is deflation, which tends to cripple spending.

Three - We create a minimum wage.

What else we should do:

We should raise taxes on the higher income brackets.   Remember, every person pays the same taxes on income - a lawyer earning $250,000 a year pays the same amount of taxes on her first $10,000 as a checker at Wal-Mart.  But she pays more on the amounts earned over certain thresholds.

We should raise the capital gains tax.  This is so low it’s silly.  We tax invested capital at a lower rate than labor much of the time.  The idea is that if I give you money to buy a taxi cab, I get taxed 15% on all the income.  But If I buy a taxi cab myself and drive it, I am possibly taxed much higher. 

We should get rid of the upper limit on payroll taxes (Socials Security, Medicare, etc. taxes).   A worker at McDonald’s pays a higher percentage of his income to payroll taxes than the wealthy lawyer, because one doesn’t pay payroll taxes on income over a certain amount.  This is unjust.

We should raise the minimum wage.  It should be done slowly, to mitigate for sudden shocks, but it should be done steadily.   Putting more money in the hands of spenders - and those making close to minimum wage cannot afford to save much - will increase the velocity of money in the economy.

Note that none of these issues are presented specifically in moral terms.  They are presented as economic necessities to create a capitalism that rewards hard work and creativity and that does not distort markets to the detriment of the working and middle classes.

As evidence for the points presented here, look at the Great Depression and the Great Recession.   Were either of these terrible periods of extreme economic hardship because of a problem with actual resources?  Was there a massive famine?  Did we run out of energy?  No.  It was the direct result of out of control savings vehicles increasing the upward gravity of capital, decreasing investment in the production of actual goods and resources, and eventually leading to the distortion of markets through massive fiscal failures. 

Capitalism simply must be regulated well in order for it to serve markets.  Or else markets will end up the slave to capital, and working families will suffer.   To regulate capitalism is not “anti-capitalist”, rather it is an essential aspect of preserving the innovation, hard work and freedom that quality capitalism can enhance.