Reality Economics

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Michael Hudson:

"Erik Reinert’s Reality Economics group has revived the awareness of economists whose names have disappeared from most histories of economic thought, even as many schools have dropped courses in that topic itself. Most students only are taught today’s mainstream orthodoxy, not being informed of the equally long history of another canon – one that turns out to be more helpful in explaining economic history and today’s dynamics.

Looking at today’s global economy, the obvious question to ask is why more economies haven’t achieved the technological potential reached by North America and Europe. Given the fact that technology is fairly universal, why aren’t all nations operating up to this potential?

Most of the papers produced by the working group here in Oslo have emphasized increasing returns and the technological basis for comparative advantage. Reviving the 19th-century writings of German and American national economists, Reinert and his colleagues have reviewed the arguments why latecomers may require protective tariffs, subsidies and public infrastructure investment to catch up, especially in the spheres of education and public health. Increasing returns tend to widen the competitive advantage of leading industrial nations (whose agriculture has achieved equally remarkable productivity gains by being industrialized into agribusiness). The effect is to render labor, capital and technology in the less developed periphery obsolete, under-educated and under-supplied with public infrastructure. The result is a chronic trade and payments deficit, building up over time to impose a heavy foreign-debt burden.

The technological core of economies is wrapped in a framework of property laws, financial practices and taxes that vary sharply from one country to another. This institutional context imposes an extractive overhead of property claims and debt service that are largely a vestige of the conquest of Europe by the Vikings and their kin, who appropriated the public commons and levied property rents. These military conquerors were followed by the Templars and Italian bankers, who legitimized the charging of interest and standing royal war debts.

The financial counterpart to increasing returns in the production sector is the “magic of compound interest” – the tendency of debts to multiply by purely mathematical principles, independent of the “real” economy’s ability to pay. Early analysts of compound interest pointed out that the debt overhead tends to expand autonomously, eating into the “real” economy, slowing it down and polarizing property and income by diverting revenue away from production and consumption to pay creditors.

What distinguishes the “other canon” from today’s dominant orthodoxy is its rejection of the assumption that economies tend to stabilize automatically in a fair and equitable balance, and hence do not require government regulation – and that public enterprises operate more efficiently if transferred into private hands. Accusing government planning of being inherently inefficient and hence needlessly costly, today’s self-proclaimed neoliberals claim that the dynamics of free markets will overpower whatever government planners try to impose.

Defending the need for active public policy, the other canon finds that such a balance requires that markets be shaped by selective taxation, public regulation, subsidies and infrastructure investment. Privatization of public enterprises and other parts of the public domain adds to their cost of production by building in financial charges and capital gains by owners, and higher payments to the financial managers who end up as planners of these assets.

According to this approach, the slogan of “free markets” is merely a euphemism for centralizing planning power in the hands of financial and other vested interests that are seeking to break away (that is, “free”) of oversight, regulation and taxation by elected officials. They seek above all to make central banks independent – that is, controlled by the commercial banking interest – and to concentrate trade and tax policy in the hands of the IMF and World Bank globally, and domestically in an Executive Branch controlled by financial and property lobbyists. Thanks largely to the privatization of election financing and its rising media advertising costs in today’s political campaigns, the vested property and financial interests have succeeded in un-taxing and deregulating themselves. This is just the opposite policy from that advocated by the classical liberal political economists from Adam Smith through John Stuart Mill. To these “original” liberals, a free market meant a market free of free lunches for the rentier interests. Their idea of freedom was one of equal opportunity for all economic players.

It is important to recognize that every economy is planned. Forward planning began in the Neolithic to schedule the planting and harvesting of crops, as well as sea and caravan trade and the festivals that organized the community’s basic rhythms. The calendar emerged as the major planning vehicle, usually kept by sky-chiefs. In today’s world, corporations plan how much to produce for the market, how much advertising can create a demand for their products and build brand loyalty, and where to focus research and development spending. Their lobbyists ask governments to invest in infrastructure, grant subsidies, price supports and tax concessions (“loopholes”), rezone land sites, regulate foreign trade and provide police protection against fraud and other crime. Consumers plan how much to allocate for education and save for retirement, how long to stay in school, and seek regulation of workplace conditions, public health and related shaping of the economic context in which market forces operate.

Given the fact that all market participants engage in forward planning of one sort or another, the great political question concerns just who is to do the planning. To the extent that government relinquishes this role, planning passes into the hands of the economy’s financial managers. When the government steps aside, they pick up the slack. Unfortunately, their time frame is shorter and their aims are more narrowly self-serving than those of public officials. Most seriously of all, they seek the economic rent and extractive financial returns that classical liberals and Progressive-Era reformers sought to minimize by government regulation or taxation.

Today’s pattern of economic development and taxation is not what most 19th-century economists expected to see. Viewing economic evolution in terms of rising productive powers – and hence, living standards – they thought that economic management would pass naturally into the hands of industrial engineers under a regime of democratic parliamentary reform. They also expected governments to play a growing role, above all in by providing the infrastructure needed to make domestic industry and agriculture more competitive, and to prevent monopolies and other special interests from extracting rent or otherwise profiteering from the economy at large.

The classical economists characterized economic rent as “unearned income,” and John Stuart Mill called capital gains an “unearned increment,” best typified by the rising land values that accrued to landlords “in their sleep.” The aim was for prices to reflect only the returns to socially and technologically necessary costs of production, and to maintain an economy in which after-tax income is earned, not achieved by property privileges of special interests. Taxes levied on these rentier gains would be paid out of the economy’s “free lunch.” Rather than raising prices, taxing these returns keeps land values and the price of stocks in monopolies low.

To defend their moral and fiscal right to this income, and to minimize public regulation and taxation of price gains for land, stocks and bonds, the rentier interests depicted their returns not as extractive but as a bona fide cost of doing business, and hence earned. They even went so far as to claim that these returns acted as the mainspring of economic growth. On this basis the rentier lobbies in modern times have advocated that taxes should be levied on labor, not on the land’s economic rent or the extortionate prices and related gains demanded by monopolies." (http://michael-hudson.com/2007/08/why-the-%E2%80%9Cmiracle-of-compound-interest%E2%80%9D-leads-to-financial-crises/)