Understanding Capitalism Part V: Evolution of the American Economy
Understanding Capitalism Part V: Evolution of the American Economy
By - March 15, 2013
When the United States of America
was founded in 1787 it was the most egalitarian Western nation in the
world for citizens of European descent, indeed one of the most egalitarian major societies in all of human
history. It was the relative equality of white American society that made America
such an attractive place for European immigrants and a "land of
opportunity". Understanding capitalism, its impact on economies in
general, and its impact on America in particular, requires both a knowledge
of American economic history and an understanding of economic theory. Let's
first take a look at the history of the American economy, and then delve
into economic theory as is relates to the history of the American economy
and capitalism in general.
When America was founded noble aristocracies ruled Europe, and virtually every
major nation on earth was dominated by a feudal system of some sort or
another. In Japan, China, India, the Ottoman Empire, and across Europe,
massive under-classes of property-less peasants were dominated by a relative
few who owned and controlled the property of the nation. The Industrial
Revolution was just beginning to dawn in England, but the economies of the
world were still dominated by agriculture. As such, land was of course the
most significant form of capital and virtually all of the land in every
"civilized" nation was owned by a relative few, being split primarily among
the nobility and religious institutions.
In the British colonies of America, however, the rule of aristocracies had never been solidly
established. Though aristocrats coming to America from Europe enjoyed
initial advantages in the "New World", the widespread availability of land and
the small population meant that there was more than enough land for everyone
who came to America from Europe to obtain their own land at little or no
cost. During the early colonial period land could be obtained simply by
"right of discovery", which meant that anyone could claim any land that was
not already claimed by other Christians. This right was
granted in the colonial charters issued by the English crown, and similar
such charters were issued by other European nations for their colonies. When
land was found that was inhabited by natives, the natives were either killed,
driven off, or some trade agreement was made to ensure that the natives
would leave the land and allow the Europeans to take it over. Property
rights in the British colonies were still based on the English feudal system
however. All of the land was technically owned by the king of England, and
was considered on loan to the title holders. This made little difference in
America in terms of land use, but understanding the feudal heritage of
property right law is important for understanding the development of modern
property rights. Under the feudal system labor was not recognized as
imparting a right to property. This is because all property was owned by the
king and titles were granted to a hierarchy of administrative lords who retained
rights to the value produced using said property. Recognizing a right to
property created by labor would have unraveled the entire feudal system,
since the feudal hierarchy was effectively a hierarchy of non-laborers who
derived all of their income via ownership or title to property upon which
laborers worked and created value, which was all then owned by the title
holders - ultimately the king.
As Thomas Paine later noted in The Rights of Man:
The aristocracy are not the farmers who work the land, and raise the
produce, but are the mere consumers of the rent; and when compared with
the active world, are the drones, a seraglio of males, who neither
collect the honey nor form the hive, but exist only for lazy enjoyment. - Thomas Paine; The Rights of Man, 1791
It was in opposition to this system of ownership that John Locke famously put
forward his statements that the right to ownership of property was a product
of labor.
[E]very man has a "property" in his own "person." This nobody has any
right to but himself. The "labour" of his body and the "work" of his
hands, we may say, are properly his. Whatsoever, then, he removes out of
the state that Nature hath provided and left it in, he hath mixed his
labour with it, and joined to it something that is his own, and thereby
makes it his property. It being by him removed from the common state
Nature placed it in, it hath by this labour something annexed to it that
excludes the common right of other men. For this "labour" being the
unquestionable property of the labourer, no man but he can have a right
to what that is once joined to, at least where there is enough, and as
good left in common for others. - John Locke; Second Treaties on Civil
Government, 1690
What happened in the British colonies of America, however, was that
virtually all Europeans were able to become their own lords. While the
feudal system of property rights technically remained the same, the fact
that almost everyone (white males) owned their own capital
meant that (white male) individuals did retain ownership to the value created by their
own labor, but that right to ownership remained granted through property
rights, not through a right of labor.
Estimates from the colonial period show that land was by far the dominant
form of capital during the colonial period. It is estimated that as of 1774
land accounted for 56% of privately held wealth, with slaves accounting for
19%, livestock accounting for 9%, and tools & equipment accounting for 3%.
Ultimately land was granted in five ways within the colonies:
via ownership shares in the companies which came to America, via headright
grants (a set amount of land per person in a family), by purchase from the
local governments, by squatters rights, and via special-purpose grants from
local governments. The result of this was essentially that the most
significant capital, land, was "free" or very cheap to acquire in the New
World, which ultimately had the effect of bringing about the conditions
whereby nearly every white male was able to own their own property, and to
thus secure for themselves the right to ownership of the products of their
own labor.
Not only was land cheap and easy to acquire in the New World, but
importantly land owners had the right to do with the land whatever they
wanted, with very few limits. However taxes had to be paid on land, which
made simply holding large blocks of land and doing nothing with it generally
unaffordable. This drove a more equal distribution of land, because it was
generally only affordable to own as much land as one could actively extract
revenue from. The overall effect of this practice was to encourage
widespread family farming in colonial America, which was by design. The
colonists, and indeed even the English Crown, wanted to encourage land use,
not simply land acquisition for acquisition's sake.
Nevertheless, land speculation became quite popular in the colonies and
remained very popular well after the founding of the country. Land
speculation was the first major speculative market in America. Several
factors made land speculation an almost no-lose proposition for the early
inhabitants. Firstly, land could be acquired for next to nothing, and
secondly the population was increasing rapidly, with new people arriving
daily. Obviously this meant that people could come to America, acquire a
large amount of land at little cost, hold onto it for a short while, and
then sell it for significant profits.
All of these factors contributed to the fact that early Americans
strongly associated private capital ownership with both individual freedom
and equality. In America the right of individuals to effectively own land
and to actually be able to use it in practice, as well as to run their own
businesses largely free of the taxes and regulations imposed on businesses by the
Crown in England (which were used to benefit the aristocracy), made individuals more equal than they
were in Europe.
In Europe all property was owned by kings, and was administered via a
feudal hierarchy of nobles who collected taxes from their subjects, not
for the benefit of the public or for use in creating public goods, but
rather as their form of private income. In Europe massive inequality was a
product of consolidated property ownership, where a relatively small number
of people owned and controlled all of the property. In Europe the "property
owners" were the nobility and the church. As such, property rights in Europe
were viewed completely differently than in America. In Europe property
rights granted the nobility the right to property ownership, thereby
disenfranchising the bulk of the population. In Europe workers worked on
property owned by nobles and they had to pay a tax to the property
owners for a portion of everything that they created. These taxes were the
basis of the incomes of the nobility. The nobility generally did not
have to work at all if they didn't want to and had few obligations to use
their incomes for anything other than their personal enjoyment. Some
aristocrats gave money to charity, some didn't. Some aristocrats used their
resources to engage in scientific pursuits or to develop public works, other
used it to have orgies and elaborate parties, and of course some did all of
the above.
When Alexis de Tocqueville visited America in the early 1800s he was most
strongly stuck by the relative social and economic equality that existed in
the United States. He was so impressed by American equality in fact that it
is the first thing he mentions in his classic work
Democracy in America, and it is what he claims inspired him to
write the book. Below is the introduction to Democracy in America, published in
1835:
Amongst the novel objects that attracted my attention during my stay
in the United States, nothing struck me more forcibly than the
general equality of conditions. I readily discovered the prodigious
influence which this primary fact exercises on the whole course of
society, by giving a certain direction to public opinion, and a certain
tenor to the laws; by imparting new maxims to the governing powers, and
peculiar habits to the governed. I speedily perceived that the influence
of this fact extends far beyond the political character and the laws of
the country, and that it has no less empire over civil society than over
the Government; it creates opinions, engenders sentiments, suggests
the ordinary practices of life, and modifies whatever it does not
produce. The more I advanced in the study of American society,
the more I perceived that the equality of conditions is the fundamental
fact from which all others seem to be derived, and the central point
at which all my observations constantly terminated. I then turned my
thoughts to our own hemisphere, where I imagined that I discerned
something analogous to the spectacle which the New World presented to
me. I observed that the equality of conditions is daily progressing
towards those extreme limits which it seems to have reached in the
United States, and that the democracy which governs the American
communities appears to be rapidly rising into power in Europe. I hence
conceived the idea of the book which is now before the reader.
Tocqueville goes on to state in other sections:
As soon as land was held on any other than a feudal tenure, and
personal property began in its turn to confer influence and power, every
improvement which was introduced in commerce or manufacture was a fresh
element of the equality of conditions.
...
The social condition of the Americans is eminently democratic; this
was its character at the foundation of the Colonies, and is still more
strongly marked at the present day. I have stated in the preceding
chapter that great equality existed among the emigrants who settled on
the shores of New England. The germ of aristocracy was never planted in
that part of the Union.
...
In America there are comparatively few who are rich enough to live
without a profession. ... In America most of the rich men were formerly
poor; most of those who now enjoy leisure were absorbed in business
during their youth;...
...
America, then, exhibits in her social state a most extraordinary
phenomenon. Men are there seen on a greater equality in point of fortune
and intellect, or, in other words, more equal in their strength, than in
any other country of the world, or in any age of which history has
preserved the remembrance.
This is not to say that there was total equality in America, clearly
there wasn't, and Democracy in America has been criticized for
turning a largely blind eye to the role of slavery and other issues of
inequality in America, but what was clear was that there was much greater
equality in America among the free citizens than there was in Europe at the
time, because in America virtually everyone was a property owner. There were
still indentured servants in America, there were still people living in
poverty in the cities, women generally couldn't own property, and of course
there was slavery, but despite all these things, the level of equality was
still much much greater than in Europe, or practically any other
technologically developed society in history.
As of 1774 it is estimated that the wealthiest 10% of the population held
roughly 42% of the wealth, with the greatest disparity being in the Southern
colonies. Today, by comparison, it is estimated that the wealthiest 5% of the population
holds roughly 64% of the wealth and the top 10% holds roughly 75% of the
wealth.
At the time of the revolution roughly 85% of American colonists were
farmers, and roughly 90% of free citizens worked for themselves or in family
businesses. The remaining 10% were largely either paid free laborers
typically working in New England in places like ship yards, apprentices
working in a trade for a master craftsman, or indentured servants. Roughly
12% of the total colonial population were slaves, with about 30% of the
population of the Southern colonies being slaves. The graph below shows the
percentage of the American workforce dedicated to agriculture throughout the
19th century. As of 1860, just prior to the Civil War, roughly 14% of the
American workforce was working in manufacturing, with the remaining portion
of non-agricultural workers engaged in the services sector.
source: Stanley Lebergott, Manpower in Economic Growth: The American
Records Since 1800; 1963, p. 510
Due to the relationship between gender and property ownership, a large
portion of free laborers were women and children, because of course women
and children either couldn't or didn't own property. Most manufacturing
prior to the Civil War still took place in the home, but the portion of
manufacturing taking place outside the home had grown steadily over time prior to
industrialization, and became essentially the only means of manufacturing after
industrialization. In the early 19th century what happened was women and
girls who were seen as unneeded workers on family farms often left home to
travel to towns and cities where they worked as paid laborers in
increasingly mechanized collective manufacturing facilities. The dominant
manufacturing industry in early America was textile production, based
largely on the cotton supplied from the South, and it was in this industry
that many women worked. Women typically had no income at all on the family
farms (just food and boarding), so even though their incomes were low
and they were often exploited by manufactures, manufacturing gave them at
least some income and a level of independence. Male free laborers were
almost entirely first generation immigrants who had not yet obtained any
property of their own, or free non-whites. Prior to the Civil War as much as
40% of the non-agricultural workforce
was comprised of women and children, while the free agricultural workforce was only 5% female.
Female agricultural workers, other than slaves, were virtually all family
members of male farm owners. Of the women in manufacturing, essentially all
of them were unpropertied wage laborers, while most of the men in
manufacturing were both owners and workers.
women in pre-industrial home-based manufacturing
women in early industrial textile manufacturing
At this point, free laborers had very few rights. Prior to 1820 people who didn't own
property, in the form of land, home, or business, did not have the right to
vote, and free laborers had very few legal protections regarding
compensation for their labor. Workers could be fired without pay for work
done, workers could be held responsible for the cost of supplies and for
damages to capital, and if an employer went bankrupt or out of business
(which was quite common) laborers generally had no expectation of being able to receive any owed
compensation. Again, the relationship between labor and capital descended
directly from the feudal system, where all rights were defined by property
ownership because it was through property ownership that the hierarchy of
the nobility was defined. The difference in America was that every male
citizen was free to become a "feudal lord" and free laborers were free to move
from lord to lord, or to become lords themselves, but the relationship
between the propertied and the propertyless remained relatively unchanged.
While the widespread ownership of private property
was a defining characteristic of the American condition, most of the land in
America remained public property owned by states and the federal government
until after the Civil War. As of the Civil War, roughly 65% of incorporated American land
was still public domain, not privately held by anyone.
This public land was often used by individuals for private gain. The uses
of the public lands included farming, fur trapping, hunting, mining, cattle
grazing, and timber harvesting. In each of these cases, the use of public
lands essentially acted as the use of shared capital, i.e. collectively held
capital. Public lands did play an important role in providing a means for
propertyless individuals to work for themselves and generate enough wealth
to become property owners themselves. There were of course also many abuses
of the public lands, with numerous schemes where individuals created false
deeds to public lands and sold the land to individuals, in which cases
sometimes the individuals retained rights to the land and sometimes they
didn't. The public lands were also widely exploited by loggers and miners
who would in some cases clear cut the land, reaping great profits, leaving
destruction in their wake and paying no compensation to the state for their
use of the resources.
In the 1820s laws regarding the use of private property were
radically changed in America. English law had long established the right of
private property owners (remember these were mostly the aristocracy at the
time) to be free from any negative impacts on their property caused by the
use of another person's private property. This granted private property
owners prescriptive rights, meaning that their ownership granted them a right
to the quality of their property and others could not do anything that world
force unwanted externalities upon them. In practice this meant that in the
case of two land owners next to one another, the one couldn't erect a
building that would cast a shadow on the property of the other, the one
couldn't erect a mill that would muddy the waters of the other down-stream,
etc. Clearly this would stifle development, and the primary concern of early
Americans was development, so prescriptive rights were largely eliminated in
America and replaced with priority rights. Priority rights gave priority to
the property owner to modify their property and use it as they wanted, even
if it caused negative impacts on others. Under the older laws things like
pollution were fundamentally illegal, under the new laws that swept across
America pollution and negative impacts on others became the norm. The new
laws largely removed the responsibility of property owners from having to
compensate other property owners for the negative impacts that their use had
upon them. This paved the way for the development of industries that
produced noise, smoke, trash, etc., which consumed water and diverted
rivers, and which had widespread negative impacts on others in general.
By granting property owners free right to negatively impact others
through the use of their private property, this gave rise to the role of
negative externalities as a driver of profits. Negative externalities are
negative economic impacts that result from some action, the costs of which
are born by someone other than those who caused the impact. This allows
producers to produce goods more cheaply, because a portion of the cost of
production is born by others. The producer reaps the full reward for the
sale of their goods, but does not pay the full cost of production, pushing
that cost off onto others, thus increasing the profit margins of the
producer at a cost to others.
In the period from the American Revolution to the Civil War there was a
general increase in economic inequality. This was most pronounced in the
South, where slavery was practiced. Increases in inequality generally
corresponded with the decline of family farming, growing concentrations of
capital ownership (mostly in the form of land and slaves), and in the early
rise of small factories. In the South the plantation system was resulting in
growing concentrations of capital, whereby
large-scale plantations were increasing in size and in their share of the
economy. This was pushing small farmers out and leading to a growing number
of free white laborers working on large plantations instead of owning their
own farms. Likewise, the large plantations were largely self-sufficient and
independent, housing their own machine shops and producing much of their own
food and equipment, thus the growth of the plantations did not lead to
overall economic expansion in the South the way that growing factories in
the North lead to overall economic expansion by increasing demand for
supporting good and services.
sugar plantation
With the early rise of small factories artisan labor was in decline.
Income for self-employed artisans grew more slowly than others as more
manufacturing was being done outside the home in small factories. In the
period prior to the Civil War organized labor was
essentially nonexistent in America. Unions were considered a form of conspiracy, and
had been illegal under English law for centuries on grounds of conspiracy
and treason, given that the unions were in effect organizations of unpropertied workers who attempted to "conspire" together to their benefit
at the expense of their lords and ultimately the propertied interests of the
king. The attitude toward unions as nefarious conspiracies against the
interests of property holders remained in America, and in American law.
Generally the laws of the United States did not recognize any right to
ownership of property created by laborers prior to the Civil War, as any
laws recognizing a right to property inherent in labor would have called the
system of slavery into question as well. However, a
few states passed some laws that eased the restrictions on unions making the
formation of labor unions legal (within those states), however actions such
as strikes and much in the way of exercise of any real power remained
illegal.
From the founding of the country through to the presidency of FDR in the
1930s, the primary populist interests were those of the small farmers. In
the period prior to the Civil War the major economic conflicts of interests
were not between labor and capital owners (because there were so few free
laborers who had any political rights to begin with) they were between
the farmers, the bankers, and the merchants and manufacturers. This is key to understanding
the development of many of America's economic institutions and laws, as well
as American politics.
American populism is historically rooted in socially conservative farming
culture, defined by small capital ownership and the defense of small capital
owners against larger capital owners, especially against banking.
America's small farmers developed a unique economic and political outlook
that was very different from other economic and political platforms around
the world. This is because American farmers did own their own property,
unlike farmers in virtually all other countries, especially Europe. American
farmers were socially conservative, and held tightly to longstanding
Christian notions about interest and banking, namely that all usury
(interest) was a form of theft and should be illegal.
What existed in America, essentially up until the post World War II era,
was a powerful political block rooted in the farmers that was strongly socially conservative,
anti-Semitic, anti-banking, anti-corporate, anti-free-market, anti-labor,
and strongly reliant on the federal government for support and economic
regulation. These populists viewed the east coast financial centers and
industrialists with tremendous suspicion. They sought government control and
regulation of prices, they were strongly opposed to government subsidies for
corporations, they were opposed to the right of foreigners or corporations
to own land in America, and they sought the nationalization of things like
banks and infrastructure so that the federal government could set prices
below "market value" for things like interest rates and transportation fees.
This brings us to major differences between the development of
industrialized capitalism in America and Europe. Capital ownership was never
widespread in Europe like it was in America. The Europeans all went
essentially from feudal systems of government and property ownership
directly to democratic systems of government and the development of
industrialized economies, without a situation in which virtually all
families owned their own capital. The bulk of the European population went from
being serfs to being wage-laborers, whereas in America what happened is that
there was a period of time where virtually all white families were capital owners. In
Europe capital ownership started out highly concentrated under feudalism and
then became slightly less concentrated under democratic industrialized
capitalism, whereas in America capital ownership started out highly
distributed, and became more concentrated under industrialized capitalism.
The difference in capital distribution between Europe and America prior
to industrialization is key to understanding the differences in the
development of European and American economic systems and political
cultures. Indeed America is unlike any other country on earth in regard to
its transition from an agricultural economy to an industrialized economy
(which is sometimes used as the basis for the idea of "American
Exceptionalism"). America is
essentially the only country on earth that had an egalitarian society with
widespread capital ownership prior to industrialization. Every other
country, from European countries to Japan to China to India to Russia to the
South American countries, already had highly concentrated wealth with all of
the capital concentrated in the hands of a few at the time that they began
developing industrialized economies (the Dutch being somewhat of an
exception to this).
In Russia and China, obviously, industrialization was preceded by
"Communist" revolutions. What the so-called "Communist" regimes did in these
countries was they stripped the feudal property owners of their ownership and
essentially made the state the owner of everything. Various types of
collective farming systems were implemented with major land redistribution
schemes. This had the impact of
reducing economic inequality and creating more equal wealth distribution
than had previously existed in those countries, but the basis for
industrialization was radically different than in America. In these
countries industrialization was a top down process.
In places like Japan industrialization proceeded again via a top down
process, but in the case of Japan the process of industrialization was
administered by the hierarchy of the imperial Japanese state, with the
property rights of the aristocracy largely intact prior to World War II.
Capital ownership in Japan became more widely distributed after World War
II, but still never went through a phase of widespread individual capital
ownership.
In Europe the process of industrialization was not as top down as it was
in Japan, Russia or China, but it was also not as bottom up as it was in
America either. Different countries industrialized at different rates in
Europe. Obviously Britain was the first country to industrialize. Following
the Napoleonic Wars and the series of political changes that took place in
their wake, there was some redistribution of land and wealth that took place
with the rise of democracies across Europe. France, Britain, and the
Dutch industrialized in the 19th century / early 20th century
through a more bottom-up process than, for example, Germany and certainly the
Austro-Hungarians.
Prior to industrialization land was far and away the most important form
of capital, with slaves being the second most important form of "capital" in
the Americas, and indirectly in Europe, where there was little actual
slavery, but where many of the products of slave labor in the Americas were
destined. The radical shift with industrialization was that land ceased to
be the most important type of capital, being replaced by "intellectual
property" (patents, copyrights) and machinery. The whole feudal
hierarchy was built on land ownership rights, so when land ceased to be the
most important form of capital, and new types of capital, which the feudal
lords did not own, came to create more revenue than land, the power of the
feudal system and the old nobility was broken. This is not to say that land
became worthless or that the feudal aristocracies were cast off and became
nothing, they certainly did not, but industrialization provided the avenue
for the development of a new political class which gained its wealth and
power not from inheritance and taxes, but rather from the creation of new
systems of manufacturing and new technologies.
With industrialization in Europe non-propertied peasants became
non-propertied wage-laborers in the mines and factories. Some craftsmen
became capitalists, but most craftsmen struggled to hold on to their
livelihoods as they competed against the output of factories. In England,
where industrialization began, the new capitalists, i.e. factory and mine
owners, originated from a mix of feudal aristocrats, small merchants, and
poor laborers. Aristocrats had obvious advantages in terms of capital
ownership and the ability to back or start new commercial endeavors, however
the aristocracy was more threatened by the rise of industrialization than they
benefited from it. Small merchants, which had made up a small middle-class
in feudal times, were able to use their modest property to build small
factories, and then, in some cases, to expand these small factories into
larger factories and to develop entire supply-chains, acquiring rights to
resources such as coal, water power, cotton plantations, etc. Among the poor
who became capitalists, most of them got their start by making machines and
then developing patents for new machines. The patents then provided them with
enough revenue to become factory owners themselves.
While the living conditions of the poor in industrializing nations
arguably got worse, the increased productivity of industrialization meant
that the percentage of the population that was poor was reduced and the size
of the middle-class grew significantly. Living standards for the growing
middle-class, in America and Europe, grew significantly during the early
stages of the industrial revolution as the increased productive capacity
produced many more goods at lower costs, making much more material wealth
acquirable for average people.
But while industrialization appeared superficially the same in both
America and Europe, there were significant differences beneath the surface.
In Europe the majority of the population prior to industrialization were
unpropertied peasants, and most of the farming was performed on land owned
by feudal lords. The manufacturing that took place in feudal Europe was
dominated by large guilds; the middle-class was small and few people owned
their own capital. Thus, with the rise of industrialization, capitalism, and
democracy, European society was already largely divided into "haves" and
"have-nots", already largely divided into the propertied and the propertyless.
In America, however, virtually every white family owned their own capital
at the onset of industrialization. America was a nation of many small
capital owners, mostly farmers, and America had a system of democracy prior
to industrialization. Thus the political and ideological dynamic was
radically different in American than it was in Europe. In America capital
ownership was associated with economic enfranchisement; ownership of one's
own capital was the means by which most of the citizens ensured that they
kept the fruits of their own labor. In Europe the opposite was the case. In
Europe, and most every other country, capital ownership was the means of
disenfranchisement. Because capital ownership was concentrated in these
places under feudalism, ownership of capital was the means by which the wealthy minority
economically disenfranchised the non-propertied laboring majority. So with
the onset of industrialization in America political power and ideological
persuasion were divided primarily between wealthy large
capital owners and populist small capital owners, slaves and unpropertied
laborers were politically insignificant. In Europe and elsewhere the political power was divided
primarily between the large capital owners and the laborers who did not own
capital at the onset of industrialization, since the "small capital owners"
outside of America were only a minor group representing neither a large
segment of the population nor a large amount of wealth and power. In America
during early industrialization wage-laborers were disproportionately women,
blacks, and "fresh off the boat" immigrants, while almost all native born white men
were capital owners. In Europe wage-laborers and capital
owners were of course more homogenous within a given country, so there were
fewer inherent divisions between wage-laborers and capital owners other than
class. This meant that class interests were in sharp focus in Europe, while
class interests were heavily conflated with racial, ethnic, and gender
issues in America.
With the conclusion of the Civil
War roughly 15% of America's population changed overnight from being a legal
form of capital to being citizens. Virtually all of the freed slaves
immediately became unpropertied laborers, and they and their descendents
would largely remain so for generations. This significantly increased the
number of citizens who were non-capital owning workers, but due to the continued
political repressions of blacks and conflicts between white workers and
black workers, this influx of laborers failed to do much to strengthen the
political power of workers in America. In fact in some ways it made political
opposition to the rights of wage-laborers stronger due to efforts to
continue to restrict the rights of blacks by restricting the rights of wage-laborers, which virtually all blacks were.
The period immediately following the conclusion of the Civil War, from
1870 to 1880, saw the fastest rate of economic growth in American history as
industrialization and banking reforms took hold. From the end of the Civil War through to the 1920s what occurred in
America was a rapid decline of individual capital ownership. This was a de
facto consequence of industrialization, improvements in farming, and the
rise of corporations. As farming became more efficient the prices of
agricultural products dropped, in some cases dropping quite rapidly. From the end of the Civil War through the early part of the 20th century the
United States produced an excess of food due to it's heritage as a farming
nation and due to the still massive amount of land available for people to
acquire cheaply or for free. Farming was still the simplest
and most direct way for someone who didn't own their own capital to start
their own business and establish themselves as a capital owner, which
resulted in an excess of farmers, which resulted in the falling agricultural
prices.
The excess of food, which then became a major export of the United
States, also aided
the process of industrialization. As farming became more efficient, fewer
people were needed to work the farms, resulting in more and more children of
farmers leaving their family farms and going into the cities to look for
work. This produced an ample supply of wage-laborers to satisfy the
demands of growing industry. Since women and children were the least
in demand as workers on farms, a large portion of the growing number of
wage-laborers were women and children, which means that wage-laborers were comprised largely of people who were unable to
vote and had very little political power, these being women, children, and
blacks. While blacks were technically allowed to vote,
Jim Crow laws and
other means of disenfranchisement meant that blacks had limited ballot
access and were very weak politically.
With growing industrialization after the Civil War corporations became
increasingly prominent, contributing significantly to the decline of
individual capital ownership. Corporations are legal entities created by the
government through which multiple individuals can come together to combine
their capital to create a "collective individual". Over time these entities
gained virtually all of the same rights as human citizens, in addition to limited
liability and "eternal life". With the rise of industrial capitalism the
collective power of combined capital led to increases in efficiency against
which individual capital owners could not compete. This led to an increasing
collectivization of capital ownership, largely via the entities of private
corporations in capitalist countries.
The rise of modern corporations was indeed pioneered in America, despite
the fact that many Americans, including some of the nation's founders, were
highly skeptical of corporate power. As noted in a letter to George Morgan
in 1816 discussing the fall of the British aristocracy, Thomas Jefferson saw
in private corporations, which were many times weaker than they are today,
the potential for the creation of a new American feudalism.
It ends, as might have been expected, in the ruin of its people, but
this ruin will fall heaviest, as it ought to fall on that hereditary
aristocracy which has for generations been preparing the catastrophe. I
hope we shall take warning from the example and crush in it’s birth the
aristocracy of our monied corporations which dare already to challenge
our government to a trial of strength and bid defiance to the laws of
our country.
Letter to George Morgan, November 12, 1816
In
Europe corporations had existed for centuries, but their rights and duties
were much more tightly restricted; they were typically only given charters
for a finite period of time, and the issuing of a charter for incorporation
was granted only rarely. Most corporations in the 18th and early 19th
century were not-for-profit, with large numbers of them being educational
institutions, like universities. Corporations were not even allowed in
finance at all under English law, with the sole exception of the Bank of
England, which, while initially privately owned during feudal times (by the
nobility), was also highly regulated and controlled by the government.
In America, however, corporate law was left up to the states, and the
states developed very liberal laws regarding corporations in efforts to
attract capital to them. Indeed the Constitution of the United
States contains no provisions that deal with incorporation, because the
Constitution was written at a time when corporations were not very common
and the overwhelming majority of property was held by individuals, not
collective groups. The entire Constitution deals only with individual
rights, and has no provision for collective rights. In order to address this
problem, corporations came to be defined as individual persons by the mid
19th century. This was done in part because all contract law
was based on relationships between individuals, so in order to meet the
existing precedents of contract law the corporation was defined as a
distinct individual, so that the corporation itself could enter into binding
commercial contracts. What this did, however, was it essentially shielded the
actual individual people who came together to form the corporation from much
legal responsibility, putting the legal responsibilities on the corporate
entity, not real humans.
As of the early 19th century in most states corporations were barred from
making any political contributions, they were barred from owning stock in
other corporations, they were barred from engaging in any activity,
charitable or otherwise, outside of the specific purpose of their charter,
corporate officers were not protected from liability for corporate acts, and
corporations had to be accountable to the state legislators, who had to have
access to their books and could, and did, revoke the articles of
incorporations if a corporation was deemed not to be acting in the public
interest or was exceeding the bounds of its charter. The general legal trend from the mid 19th century through to
the beginning of
the 20th century was to continuously remove these types of restrictions and grant more and more power to corporations. By
the early 20th century corporations, not individuals, had become the
dominant capital owners. The intellectual justification by elected officials
and judges for granting increasingly more power to corporations and in providing
government support to foster their growth, was that these entities, by the
very nature of their size, were more efficient at production than smaller
entities. Large corporations that owned vast amounts of capital were better
able to produce more goods at lower costs, and thus, the argument went,
granting them more power and allowing them to reap massive profits was an
acceptable price to pay for the increased productivity that these
corporations produced. Of course there were other reasons why elected
officials in particular supported the interests of growing corporations,
namely the financial support provided to them by those who sought their
support, and of course ideological sympathy for the growth of powerful
private institutions.
Between the Civil War and the beginning of the 20th century numerous
powerful monopolies emerged and these monopolies were essentially given the
blessing of government, with the belief that the economies of scale created
by these monopolies would yield benefits that would exceed any negative
consequences. There were an astounding number of corporate
mergers around the turn of the 20th century. From 1895 to 1904 over 1,800
manufacturing businesses merged with rivals, with 30% of these resulting in
new corporations that controlled over 70% of market share (today's legal
definition of a monopoly). Even in cases
where mergers didn't take place, collusion was a standard practice of the
day. Because rapid industrialization resulted in business models that
involved high fixed costs and an uncertain market, the intense competition of
the early phases of industrialization made investment in capital highly
risky and often unprofitable. As a result it was common for "competitors" to
collude to fix prices in such as way as to guarantee that all of the
businesses would reap profits. Businesses at this time also colluded against
organized labor and workers in general. They colluded both on the side of
commodity price fixing and on the side of fixing the wages paid to workers
in order to keep wages down.
A significant difference between the development of private enterprise in
America and Europe at this point was that in America there were more laws
against the formation of cartels than in Europe. Because of this, in Europe
businesses tended to remain smaller and independently owned, but to form
cooperative cartels in order to reap the benefits of larger organizations.
In America however, since cartel agreements were largely illegal in private
industry, this led to more mergers and consolidations, where companies
simply merged to form larger organizations. The net result was more rapid
consolidation of capital ownership in America than in Europe.
By the 1870s there were growing political pressures to regulate large
corporations, particularly the railroads. By this time the railroad
companies were the largest companies in the country, and they were rife with
corruption and price fixing. The railroads were all technically private
enterprises, but they had been granted many public advantages, such as land
grants, rights of eminent domain, and many government
subsidies. Complaints against the railroads for price fixing, both by
passengers and shippers, were the most common, but the most effective
political and legal pressure against the railroads came from the farmers,
who had become dependent upon the railroads to ship their harvests to
market. Yet at this time very little was done in the way of federal
regulation of private enterprise. While the federal government did plenty to
subsidize and assist the development of private enterprise, little was done
to regulate it.
By the1890s there was widespread public outrage at the actions of "big
business" and widespread fear of the growing power of large corporations to
manipulate prices and to drive down wages, in addition to the growing
understanding that corporate money ruled Washington, yet little was
being done to address these concerns at the federal level.
The Bosses of the Senate 1889
In 1890 the
Sherman Antitrust Act was passed. The Sherman Antitrust Act is still one
of the most significant federal laws affecting businesses today, as it is
effectively an anti-monopoly law. The law basically prohibits a corporation
or corporations from engaging in behavior that significantly reduces
marketplace competition. In other words, this law requires that competition
exist with the exception of so-called "natural monopolies". Ironically,
however, this law was first applied against unions to bust strikes, under
the reasoning that the unions were operating a conspiracy to form a labor
monopoly, thereby reducing "competition" in the labor market. Despite the
passage of the Sherman Act, little was done to regulate private enterprise
or to enforce the Sherman Act against corporations.
This all changed with the presidency of
Theodore Roosevelt from 1901-1908, who took significant action to
regulate "big business" at the federal level. The "trust busting" activates
of Roosevelt consisted largely of breaking up large national corporations
into smaller independently owned companies and forcing them to compete
against one another. Roosevelt also presided over increased regulation of
interstate commerce, especially in regard to the railroads.
What had happened in America from the end of the Civil War up to
Roosevelt's presidency was that corporations and private enterprise had
grown well beyond their original local scope. Prior to the Civil War there
were practically no interstate businesses. There was interstate commerce,
but it was almost entirely commerce between separate local businesses. After
the Civil War, with the establishment of a
National Banking System, the rise of industrialization, and the
development of rail roads, there was
an explosion of companies that operated across multiple states, with workers
and capital and owners residing all across the country. In addition, the
prior conditions which naturally led to markets populated by many small
independent actors had given way to markets dominated by monopolies or small
numbers of large corporations. The idea that business was not originally
heavily regulated in America is a misnomer, there have always been
significant business regulations in America and things like price controls,
and the establishment of government backed monopoly enterprises for the
public good, such as public utilities, etc. were in place from the founding
of the country. The difference is that prior to the 20th century all of the
regulation took place at the state level. Since virtually all businesses
existed only at the state level prior to industrialization, and since
businesses were naturally small and less powerful than the state
governments, this wasn't a problem. When businesses expanded rapidly in size
after the Civil War and quickly became more powerful than not just state
governments, but in many ways more powerful even than the federal government
as well, this is what prompted the widespread support for federal regulation
of private enterprise.
The
economic panic of 1907 demonstrated multiple fundamental problems with
the American economy and paved the way for significant changes, including the
creation of the Federal Reserve. The panic of 1907 was brought about by
massive bank failures resulting from massively over-leveraged stock-market
trading schemes in the largely unregulated New York Stock Exchange. Traders
were borrowing astronomical sums of money in attempts to corner the market
on stocks and drive their prices. In one such case the attempt of one
borrower failed resulting in massive losses by the trader. Those losses were
all on borrowed money, and the amount of money that was borrowed was so huge
that the multiple banks which had lent the money immediately failed due to
runs on the banks.
The stock market quickly lost 50% of its value and runs on the banks
around the country led to multiple bank failures virtually overnight. This
demonstrated a clear need for greater regulation of the stock exchanges and
lending practices, as well as weaknesses with the banking system, but
additional events would demonstrate not only the weakness of the
government's ability to address these problems, but also the ways in which
America's wealthy industrialists had become more powerful than the
government.
As the crisis deepened, the government was effectively impotent to do
anything about it. J.P. Morgan and John Rockefeller stepped in to address
the problems by overseeing the liquidation of various banks, buying
companies, and depositing reserves in remaining banks (as loans). Morgan and
Rockefeller contacted other wealthy Americans and acquired pledges of
massive loans to keep the American banking system propped up. While there
was relief that these individuals did step in to avert greater crisis, it
also demonstrated how weak the government was and how disorganized and
unready the nation was to handle the realities of the modern economy.
Despite the reforms of the early Progressive era at the beginning of the
20th century, the general economic trend remained the same. While large
national corporations had been broken up into smaller companies and forced
to compete against each other, the trend was still toward larger aggregation
of capital and higher concentration of capital ownership. The percentage of
farmers and the self-employed continued to decline and the portion of the
population who were wage-laborers increased as continued industrialization
increased efficiency and made smaller business operations unable to compete
with larger national or regional corporations.
After Teddy Roosevelt's reforms, and laws passed to strengthen the
role of unions, there was a brief period prior to the end of World War I in 1918
when union membership increased and wages and working conditions
improved. During this time economic inequality was on the decline,
however after the 1917 Communist Revolution in Russia, and the
conclusion of the Great War, the tide turned against organized labor, and
along with decreasing industrial demand due to the conclusion of the war
in addition to the return of men from over seas, labor's share of the
national income began declining and economic inequality began to rise
again. By the 1920s the old American economy grounded in farming and
widespread individual capital ownership was essentially gone, with
production now dominated by corporations employing wage-laborers.
Prior to World War I the United States was a debtor nation, with the
country being in almost continuous public and private debt to foreign
countries since the day of its founding. However World War I changed this.
All of America's foreign debts were eliminated via America's contributions
to World War I and post-war pledges of reconstruction aid to Europe. This
elimination of the debt via the war paved the way for a massive explosion of
household and business credit in America, which helped to fuel the economic
excesses of the 1920s and played a significant role in creating the economic
bubble that burst in 1929, followed by the Great Depression.
The 1920s was the first time in American history that most major
purchases were made using credit. During this time 75% of cars were
purchased on credit, 70% of furniture, 75% of radios, and 80% of household
appliances were all purchased on credit. This explosion of credit enabled an
explosion of productive capacity, which allowed prices to stay fairly stable
in the face of major expansions of the money supply, both in terms of
real money supply created by the new Federal Reserve, and the virtual money
supply created by all of the credit. Even though one might expect rising
inflation, in fact inflation stayed under control due to rapidly expanding
productive capacity, as industrialization blazed ahead at break-neck speed.
During the 1920s wages did continue to rise modestly in real terms overall, but with the
decline of organized labor a larger and larger portion of the value created
by corporations went to capital owners and executives instead of the workers. Industrialization was increasing efficiency so fast that the real
economic gains were able to be shared by virtually everyone (who was white),
though this was largely due to credit.
The real gains in productivity, the massive expansions of credit, in
addition to the fact that a disproportionate share of the gains were going
to capital owners, all contributed to the rapid rise of stock prices. The
rapid rise of stock prices during the 1920s was largely a product of two
things, the growing savings of the wealthy who were looking for something to
do with their money to get a return on investment, and credit financed
speculation. As was
the case leading up to prior American stock market crashes, stocks were
highly leveraged with major amounts of credit. Low interest rates and
rapidly rising stock prices induced speculators to buy on credit amidst a
widespread faith that prices would rise indefinitely, with stock brokers and
lenders happy to facilitate the transactions for the short-term fees they
generated. In 1900 roughly 1% of the American population owned stocks, and
by 1929 over 10% of the population owned stock. Because of the fact that the
unemployment rate remained very low, prices
were stable, and wages were rising, the overwhelming majority of economists
believed that America had entered a "new era" of economics, where government
intervention had become unnecessary and prices, productivity, and profits
would rise forever.
The overwhelming majority of economists and public figures were touting
the fundamental strength and soundness of the economy right up until the
crash in late 1929, however this view was not universal. There were
economists and scholars who did warn of an impending crash. In February of
1929 the newly created Federal Reserve, feeling that credit based speculation
had gotten out of control, announced that it would no longer support bank
loans for stock purchases. Famously, Roger Babson warned that, "Sooner
or later a crash is coming, and it may be terrific ... factories will shut
down ... men will be thrown out of work ... the vicious circle will get in
full swing."
While most people focus on the stock market crash, the stock market crash
did not cause the ensuing Great Depression, the crash was a symptom of the
fundamental underlying economic problems, and the true depression did not
take hold for over a year after the crash.
The
reason for the overall economic crash, though much debated, was largely over-borrowing by
consumers, who were unable to ultimately pay back their loans resulting in spending
being unable to keep pace with productivity as the share of income going to
workers declined. Thus, productive capacity had expanded at a higher rate
than consumptive capacity. The massive expansion of credit served as a means
to bridge the gap between productive capacity and consumptive capacity, but
ultimately, since wage growth never caught up to productivity growth, the
credit bubble burst and demand rapidly plummeted. By 1929, both the consumer
markets and the stock market were highly leveraged on credit. By mid 1929
retail sales were in decline and by September stock prices had begun to
fall. In October of 1929 rapid decline of stock prices was underway.
The crash of the stock market in 1929 didn't directly cause unemployment
or factories to close. Again, the crash was a symptom not a cause. The cause
was fundamental lack of aggregate demand. The economic crash started in
America and quickly spread around the world. At the time of the economic
downturn America was the largest consumer market in the world. Europe was
still recovering from World War I, and no other countries were yet
sufficiently industrialized or had sizable middle-classes. When demand
collapsed in America due to the working-class not having enough income or
wealth to consume the goods that were being produced, there were no other
global consumers to step in to prop-up demand either, and thus sales rapidly
declined, resulting in the closing of factories, resulting in growing
unemployment, resulting in ever shrinking demand, resulting in more
factories shutting down, resulting in retail stores shutting down, resulting
in growing unemployment, resulting in people losing their homes, resulting
in more loan defaults, resulting in shrinking demand, resulting in factories
shutting down, resulting in growing unemployment, etc., etc., etc.
In the months and years following the crash of 1929 most people expected
that the economy would improve and the stock market would gradually return
to its peak levels. This was not to be. The unemployment rate went from 3.2%
in 1929 to a high of 24.9% in 1933 when Franklin D. Roosevelt entered the
presidency.
The details of the Great Depression and the New Deal are complex and much
debated. From a high level, however, what must be said is that FDR entered
office in 1933 and died in office in 1945, a span of 12 years, and during that
time Roosevelt maintained strong public support and unprecedented
legislative power, which was used by the Roosevelt administration to
significantly change the structure of the US economy and the role of the
federal government in the regulation of the economy. In the short term, the
most significant actions taken by the Roosevelt administration were the
regulation of banks, requiring citizens to return all gold coins and gold
certificates to the US Treasury, destruction of agricultural stocks in order
to raise prices, and the creation of public works programs
to provide jobs for the unemployed.
Over the long term the major impacts of the Roosevelt administration were
increased regulation of the economy by the federal government, the creation
of major social safety net programs, expansion of the federal tax base, and
the adoption of a highly progressive income tax system. What the Roosevelt
administration did not do was it did not fundamentally change the structure
of the capitalist economy. The effect of the New Deal was to regulate
capitalism, not to change its fundamental structure. FDR's policies were
seen at the time, and in retrospect, as a means of mitigating the excesses
of capitalism, while allowing the fundamentals of the system to remain
unchanged. The stock market remained in place, the relationship between
capital owners and wage-laborers remained in place, the rights of property
ownership remained in place, system of private banking remained in place,
industries were not nationalized, boards of directors stayed in place at
corporations, profit motive remained the prime driver of business,
etc. yet restrictions were placed on all of these things. Banks remained
private, but they had more rules they were required to follow. Profits from
capital gains remained in place, but they were more heavily taxed. Wages
remained largely determined by individuals within a labor market framework,
but minimum wages were implemented and collective bargaining was officially
sanctioned by the government.
It is important to note that the changes brought about by the Roosevelt
administration were broadly supported by the American public. Indeed FDR was
one of the most popular presidents of all time during his own presidency. At
the time that FDR was in office the Democratic Party, of which he was a
member, was still largely a Southern party, and it was a party heavily tied
to farmers. The political support of American farmers and Southern social
conservatives was essential in the passing of Roosevelt's New Deal agenda. Indeed this is
why many of the benefits of the Roosevelt administration's programs went to
rural Americans. Rural Americans received a disproportionate amount of the
benefits of the public works and economic development programs of the
New Deal era. Rural electrification, road building, dam
building, farm subsidies, etc. all primarily benefited rural Americans and
family farmers who, at this point in American history, while dwindling as a
percentage of the population, still represented about 25% of the American
population and were powerful politically. In 1933 only 10% of American farms
had electric service and by 1940 over 90% did, nearly all of it provided by
federal government programs.
The Roosevelt administration did make attempts at planned economy,
through various government direct-employment programs, production targets
for industries, financial incentives for targeted industries, etc., but the
problem with much of this is that while much of the fundamental planning may
have been sound, by the time these plans were implemented they had been so
distorted by political wrangling and horse-trading that priorities
were often set more by the political bargaining of special interests than by
sound economic policy.
During the 1930s there was a high degree of corporate consolidation.
Business leaders and many economists placed the blame for the depression on
excess competition, and thus sought to reduce restrictions on collusion and
anti-competitive practices. The Roosevelt administration basically went
along with this
assessment and created agencies to regulate and oversee the consolidation of
businesses and to allow greater collective bargaining among businesses, in
other words to allow forms of collusion. The result was that, both due to
the natural tendency of consolidation after an economic crash, and due to
government policies that facilitated consolidation, capital ownership
actually became much more highly concentrated during the 1930s than it was
previously.
The net effect of the Great Depression on capital ownership was that the
percentage of the population who owned stocks was dramatically reduced from
the height of 1929, the corporations that did survive the crash generally
got bigger as competitors went out of business or were consumed by mergers,
investments in capital declined significantly, startup businesses declined,
and patent applications declined, but not dramatically. The percentage of
the population working for themselves did increase, but this was out of
desperation not opportunity, and few of these self-employed people managed
to amass any capital or develop meaningful businesses. Many of those who
were "self-employed" out of desperation engaged in services or were small
time merchants, with their primary asset remaining their manual labor.
Overall, during the 1930s (and several decades beyond) both the size of
corporations and government grew. Both government and large corporations
accounted for an increasing share of employment over this period.
source: Historical Statistics, series D86; Michael Darby, Journal of
Political Economy, Feb 1976, p. 8
The various public works programs implemented by the Roosevelt
administration were programs for the unemployed, and as such, workers in
those programs were still considered to be unemployed. Roughly 5% of the
workforce was employed through public works programs throughout the duration
of their implementation. The graph above shows the official unemployment
rate in blue and the total unemployment rate when counting all those
employed through the public works programs for the unemployed as employed.
The official unemployment rate did decline from 1933 to 1937, but rose
again in 1938 after the Roosevelt administration, facing pressure from
opponents and worried about the national debt, started cutting back on
direct aid to the economy. By 1940 American production related to World War
II had already begun, even though the US would not officially enter the war
until December, 1941 after the attack on Pearl Harbor.
Income inequality fell only slightly during the 1930s and was not
significantly reduced until after World War II. One of the reasons that
unemployment remained high throughout the 1930s was that, despite
significant government expenditures and works programs, consumer demand
remained very low. Among those who were employed, the threat of losing one's
job led them to put most of their excess income into savings, to save against
the prospect of joblessness. Even though significant money was being saved,
people greatly distrusted banks so relatively little of the money was saved
in private banks, where it could have been lent out. Likewise, private banks
had become highly risk averse and since interest rates were so low, they had
little incentive to lend. The result was increased savings, but no
corresponding increases in lending or investing. Consumer demand remained low,
so there was
still nothing to significantly drive production, thus there remained little
reason to hire workers since excess productive capacity remained in the
system.
America's entry into World War II changed all of this by creating an external
driver of significant demand. The American wartime economy of World War II
can in some sense be thought of as the New Deal on steroids. The structuring
of the government's role in the economy during the 1930s provided a strong
framework through which the federal government was able to effectively take
control of the American economy during World War II and command production
through a centralized system. The wartime economy of the US during World War
II is the closest that the country has ever come to a fully centrally planned
economy.
During Word War II the Roosevelt administration created the National
Defense Advisory Commission (NDAC),
Nation Defense Research Council (NDRC),
War Production Board (WPB),
Office of Price Administration (OPA), and
Office of War Mobilization (OWM). Many of the agencies created under the
New Deal to deal with the economy were eliminated during World War II and
supplanted by these new wartime production agencies. Through these and other
agencies the federal government gained almost complete command over
the entire economy. Virtually all prices were fixed or had caps set on them.
These pricing caps were set out in huge manuals that were delivered to
businesses, covering everything from steel to mayonnaise. Practically
every material was rationed. Production and raw material extraction
facilities were either built directly by the government when needed, or the
government paid private companies to expand or modify their existing
facilities for wartime production.
source: US Bureau of Economic Analysis, National Income and Production
Accounts, Table 1.1 & Table 3.2
From 1939 to 1944 GDP practically tripled and unemployment was cut from
roughly 18% down to around 1% entirely through the massive
infusion of government spending and economic controls. What the war had
done, essentially, was provide the political will to fully engage in a
Keynesian government-directed economic stimulus program. While the New Deal
programs of the 1930s seemed large at the time, they were smaller than what
was being recommended and sought after by Roosevelt. While there was
widespread popular support for the New Deal stimulus programs, there had
also been strong and focused opposition largely from wealthy private
citizens and from politicians and economists both for ideological reasons
and out of a genuine belief that government spending and government programs
would undermine the economy and prevent a recovery. There was serious
concern during the 1930s about the federal deficit and the debt being
accumulated by the government, and this made it difficult for the Roosevelt
administration to engage in truly significant economic stimulus. What the
war economy showed, however, was that, given enough control and enough
spending, the government was capable of significantly stimulating the
economy and creating full employment, at least in the short term.
After World War II many economists wondered if the Great Depression could
have been ended much sooner had World War II level stimulus been applied in
the early 1930s. This is a difficult question. Theoretically it would seem
that the answer is yes, but it isn't quite that simple. It is not clear that
it would have been possible to engage in the level of borrowing and deficit
spending that was exercised during World War II during the 1930s, and that
even if the money could have been borrowed it may not have been as easy to
repay as it was after World War II. During the war the Europeans were
obviously willing to lend virtually unlimited sums to America. In addition,
the war made it politically possible to raise taxes to a degree that hadn't
been possible prior to the war. Taxation came to be seen as a patriotic duty
for national self defense during the war, and it was during World War II
that the tax base was significantly expanded and tax rates were
significantly increased. A significant amount of money was also raised from
war bonds, purchased by American citizens, and people just wouldn't have
bought bonds in that way for any reason other than war. Likewise, after the
war it was easier for America to pay down the national debt because of
agreements made during the conclusion of the war. Importantly, the war left
America as the sole economic super-power in the world, a position it did not
hold prior to the war, which made it much easier to repay the remaining
debts.
So what we can say is that the degree of amassing and paying down of the debt that
fueled the war time economy would not likely have been possible without the
conditions of war. If, in theory, the political will existed in 1933 to
engage in the same type of massive government effort that fueled the war
time economy, and if the same tax increases had been put in
place in 1933 that were in place in the 1940s, it is still not likely that
the government would have even been able to borrow as much money as it did
during the war because lenders wouldn't have been willing to lend it and
citizens wouldn't have bought the bonds, and even if the money could have
been borrowed, paying it back at that time would likely have been much more
difficult than it was after the war. Nevertheless, the experience of the war
economy does indicate that had significantly more government stimulus been
applied during the 1930s, based on increased taxation and deficit spending,
unemployment could have been reduced much more significantly and rapidly.
There was a very important difference between the 1930s and the war
economy of the early 1940s however, and that was the relationship between
government and the private sector. During the 1930s, while there was
certainly cooperation with the private sector and attempts to aid even
the captains of industry, by and large the relationship between government
and the private sector was antagonistic. Roosevelt portrayed corporations
and wealthy bankers and industrialists as the enemy of the people, and
economic policy of the time sought largely to regulate business, not
facilitate it.
When the war mobilization efforts ramped up, however, the opposite became
the case. Roosevelt knew that the nation needed the manufacturing capacity
and know-how that rested almost entirely in private hands in order to be
able to meet the production needs of the war. As such, captains of industry
were invited into the government and took key departmental and advisory
positions. While the government had already been contracting heavily with
private companies during the 1930s, the war effort brought about both a new
level of contracting and a new urgency to it. This resulted in less focus on
"fair" contracting and less focus on getting the best deal for the money,
and more focus on just getting the job done. Prior to World War II military
contracts were made through sealed bids, but with the war the system changed
to negotiated bids, which involved a more personal and subjective system for
awarding bids, bringing bidders and those awarding the bids into closer
personal relations.
While FDR had strenuously
denounced war profiteering and in fact enacted special taxes on war profits,
the reality was that during this time of unprecedented economic
mobilization war profits were inevitable. As Secretary of War Henry Stimson stated, "If you are going to try to go
to war, or to prepare for war, in a capitalistic country, you have got to
let business make money out of the process or business won't work."
The majority of the World War II production contracts went to large
corporations, such as General Motors, Ford, and DuPont. The rate of profit
for these companies in World War II was much less than during World War I,
where rates of profit reached over 1,000%, but they were still well above
the profits of the Depression Era. Furthermore there was little or no risk
once contracts were established. General Motors was the leading contractor
of World War II, receiving about 8% of the total value awarded.
Government contracts were awarded in a fairly concentrated manner. Two
thirds of the Research & Development contracts went to 68 companies. During
the war the US government became the largest investor in American private
business to the tune of $17 billion 1941 dollars. The business relations
between certain private corporations, indeed specific individuals in those
corporations, and the US government became very strong during this time and
huge profits were reaped at little risk for companies and businessmen.
Production of B-24 Liberators at Ford plant in Detroit
It was at this time, for example, that the aircraft industry became the
number one industry in the nation, having previously not been a major
industry at all, and to this day the aviation industry has one of the
strongest relationships with the federal government of any private industry.
Walter & Ann Beech overseeing WWII Beechcraft production line
During the war wages for average workers increased significantly, yet due
to rationing, the fact that most production was geared toward the creation
of war materials, and the fact that most of the men age 18-30 (and quite a few
women as well) were enlisted in the military, there was relatively little to
spend money on and fewer people to do the spending. The result was a massive
increase in savings. Personal savings ballooned by over 700% from a national total of
$4.5 billion in 1940 to $39 billion by 1944.
While government spending declined after the war was over, it never
returned to pre-war levels. Having brought such a large portion of the
economy under government control during the war, both inertia and the
positive results of government stimulus warranted that the role of
government in the economy would be forever changed by the World War II
experience. The single largest component of increased government spending
after the war as compared to before the war continued to be military
spending. Government spending on infrastructure projects, education,
scientific research, and various forms of economic stimulus and regulation
all increased after the war as well.
When World War II ended the United States was uniquely positioned for
massive economic growth. Because of America's role in the liberation of
Europe, and due to the American role in rebuilding post-war Europe and
Japan, much of the debt that had been accumulated prior to and during the
war was quickly either forgiven or paid off. At the same time, the economies
and societies of Europe and Asia were shattered. The United States, along
with Canada and Australia, was one of the few countries to come out of World
War II with increased productive capacity and an improved economic climate.
Compared to the United States, however, Canada's and Australia's populations
and economies were (and are) relatively small.
The rural electrification and modernization programs of the 1930s set the
stage for massive improvements in farming efficiency, so after the war the
United States was able to supply huge amounts to food to recovering Europe
and Asia, while the number of farmers as a percentage of the population
continued to decline, and domestic food prices remained low. GDP declined
slightly immediately after the war, but even during the period of declining
overall GDP, production of consumer goods exploded as production shifted from
war material to consumer goods. The massive savings that
Americans had built up during the Great Depression and the war fueled
mushrooming consumer demand and provided a solid base for business
investment.
In the 1940s and 1950s manufacturing grew significantly as a percentage
of the economy, and virtually all of the growth in manufacturing took place
through large corporations. During the 1940s and 1950s the percentage of the
American population working for large corporations grew significantly, with
most of this growth taking place in the manufacturing sector. At this time
the largest corporations in America were manufacturing, food processing, and raw materials
corporations, followed by media corporations. While there were a few large
retail corporations, such as Woolworths, Sears, and Macy's, by and large the
retail, hospitality, and food services (restaurants) industries were still
dominated by small businesses and individual proprietors. The financial
sector, heavily regulated and decentralized at this point, was relatively
small as well. With the dominance
of the manufacturing sector, manufacturers drove the markets, being able to
set prices, and determine trends and distribution channels.
The dominance of manufacturing arose because industrialization, by its
very nature, was centered on manufacturing, but also importantly, government
subsidies during the war effort were concentrated almost entirely on
manufacturing, thus it was the manufacturing sector that received almost all
of the World War II stimulus and benefits. It was also at this time,
however, that farming began its transition to an industrial basis. Prior to
World War II almost all farming was done by relatively low-tech family farmers. However, due to
the modernization programs of the 1930s, which brought power and paved roads
to the farmlands, and due to the increased need for food production during
the war effort, and due to the increased capital costs of adopting the most
modern farming equipment (which many individual farmers were unable to afford),
corporations began increasingly moving into the farm sector beginning in the
1940s.
After World War II significant consolidation took place in farming.
Corporations and wealthy families bought up and bought out many smaller
farmers, resulting in far fewer, but much larger, farm properties. This
process of consolidation and mechanization, subsidized by the federal
government through New Deal policies, led to dramatic increases in output
while the percentage of the population engaged in farming rapidly declined.
America's steel industry, which was the backbone of American industrial
production
prior to and during World War II, began its decline almost immediately after
the war. The decline of American steel was based on several instructive
factors. During the war American steel companies had become dependent on
heavy government subsidies, and when the war ended steel producers lobbied
strongly to have those subsidies continue, however, the Eisenhower
administration rejected those demands and withdrew federal subsidies from
the industry. At the same time, it was American policy to provide aid to
Europe and Japan to help them rebuild after the war, and so in fact the
American government was subsidizing the European and Japanese steel
industries during the late 1940s and 1950s.
More important, however, is the fact that the American steel industry was
heavily invested in old technology and practices. The American steel
industry was the largest and most advanced in the world prior to the war,
having developed many new technologies and practices, but having invested
heavily in those technologies it was then reluctant to adopt new ones.
American steel manufacturers did invest heavily in new equipment and
expansion after the war, but they did so by investing entirely in old
technology, with little aid from the government.
After World War II the European and Japanese steel industries were
effectively starting all over again from scratch, and with significant investment
from the American government, they invested heavily in the newest
technologies and techniques, which included new types of furnaces and new
casting methods. While the US had been the dominant steel producer in the
world from the late 19th century through to World War II, and provided
almost 50% of global steel output in 1950, by 1960 the US produced only 25%
of global stock and continued to decline after that.
This was a pattern that would play out many more times in American
manufacturing. The United States would often be the first to develop new
technologies or production systems, but would then invest heavily in them
and stick with them for long periods of time, while producers in other
countries would later adopt incremental advances over American technologies
and processes. American production had, and continues to display, a pattern
of being a leader in making big advances, followed by periods of complacency
and stagnation, as opposed to European and Asian producers who display a
pattern of more incremental and continuous advancement over time.
Nevertheless, American manufacturing and economic innovation provided the
basis for broadly shared economic growth. The broad sharing of income and
benefits enjoyed by the white middle-class during the post-war period was
heavily influenced by unionization (unions
at this time often discriminated against non-whites), which reached its peak during this time.
Unionization was most prevalent in manufacturing, and so it is no
coincidence that unionization rates peaked at around the same time that
manufacturing peaked as a percentage of the economy in America. Through a
combination of government policies, market conditions, public advocacy and union influence,
working conditions, wages, health care benefits, and retirement benefits all
became much more equitably distributed than any time in American history for
white Americans during the decades immediately following the conclusion of
World War II. While prosperity was widespread among whites, poverty remained
endemic among blacks and Hispanics, with around 50% of blacks living in
poverty as of 1950, compared to only 15% of whites. However, by the end of
the 1960s African American poverty had been significantly reduced (though it
remained high), in large part due to federal programs such as president
Lyndon Johnson's
War on
Poverty and civil rights legislation.
The period after the war through the end of the 1960s saw the rise of
robust white middle-class American consumerism. This consumerism was enabled
largely by the solid savings which Americans had built up during the
war-time economy, the increased productive capacity of the economy which was
built up during the war through government subsidies, broadly shared income, and government policies that
heavily subsidized the white middle-class. Consumerism was also heavily
driven by massive increases in corporate advertising, especially advertising
directed at women and children, largely due to the widespread acquisition of
televisions by American families after the war. Prior to the war only the
richest families owned television sets and there was very little
programming, but by the end of the 1950s virtually every white home had at least
one television set and there was a steady stream of programming provided by
the nation's three corporate broadcasters.
The post-war economic expansion was an interesting time when income
distribution was relatively egalitarian but capital ownership continued
to be consolidated. While unions and policies were able to drive equitable
sharing of the fruits of production in the short term, individual capital ownership
rates continued to decline throughout the 1950s and 60s. There was a modest
increase in the percentage of Americans owning stock during the 50s and 60s,
but many Americans remained wary of the stock market after the Great
Depression. Likewise, the portion of national income going to labor reached its
peak during the 1940s and 50s and the rise of Social Security, and generous
pension plans available to most corporate employees, provided a new level of
long-term economic security without direct capital ownership. While stock
ownership did increase modestly after the war, the decline in direct individual
capital ownership more than off-set the modest increases in stock ownership.
As mentioned earlier, this decline was most pronounced in the farm sector,
but it occurred across the economy as a whole as more people became
professionals and went to work for corporations.
While the 1950s and 60s were marked by the dominance of manufacturing
corporations, large national retail and hospitality corporations began
rising in the 1970s. The 1970s was also a time when new media and technology
corporations began their rise as well, heavily impacted by new computer and
satellite technology, much of which had been pioneered through government
funded projects (largely military and space) during the 1950s and 1960s.
Overall, however, the 1970s are most widely noted as a period of general
global economic "stagnation", particularly in America. The American economy
was heavily impacted by the oil crises of 1973 and 1979, both of which
contributed to high levels of inflation and rising unemployment. In 1973
OPEC (The Organization of Oil Exporting Countries) engaged in an oil embargo
of the United Stated and other Western countries, including Japan, due to
Western material support for Israel during the Yom Kippur War. As a result,
the Nixon administration rationed petroleum fuels across the nation to deal
with the significant shortages.
Not only did the energy crises of 1973 and 1979 have general impacts on
the economy in terms of inflation, etc., but they also highlighted problems
with American manufacturing and products. By the 1970s America faced
significant foreign competition in manufacturing, primarily from Japan, but
also from Europe. European and Japanese manufacturing processes had become
generally more advanced than American processes, particularly in the auto
industry, but also in electronics. In addition, Japanese and European car
makers produced more fuel efficient cars than American auto makers, in part
due to more stringent fuel economy standards in those countries. As a result
foreign manufacturers, particularly the Japanese, gained significant market
share in the United States during the 1970s, especially in the auto
industry.
In 1960 foreign imports only accounted for about 5% of the cars sold in
America, however by 1980 that figure had risen to almost 27%. While the
United Stated produced 49% of all cars in the world in 1960, that number had
fallen to 21% by 1980, all of which was a result of increasing foreign
production as the European and Japanese economies cemented their recoveries
from World War II, while American production levels remained relatively
unchanged throughout the 1960s and 70s.
The 1970s was a time of increasing challenges for American manufacturers,
which resulted in declining profits. The American economy remained highly
domestic. The overwhelmingly dominant consumer market for essentially all
American companies was the American market, and the majority of products
sold in America were produced in America. The challenges American
manufactures faced were increasing competition from foreign manufacturers
(primarily Japan), the increasing power of growing retail corporations which
had stronger negotiating power, significant demands from labor unions
resulting in multiple large strikes and walkouts, and of course the
challenges posed by inflation and high fuel prices, which both increased the
costs of production and reduced consumer demand.
In response to the significant challenges faced by the American economy
as a whole during the 1970s, particularly those faced by American
manufacturing which had been the backbone of the American economy since the
early 1900s, significant support grew for major economic reforms. The most
significant of these reforms were those that fall under the banner of
deregulation. Virtually all of the economic regulations which had been put
into place during the 1930s and 1940s remained in place up until the 1970s,
with new regulations being put into place during the 1950s and 1960s as
well.
Deregulation efforts began under the Nixon administration in the early
1970s, with an initial focus on the transportation sector, primarily
railroads, which had been heavily regulated since the 1880s. Deregulation
allowed railroads greater freedom to set prices and allowed railroad
corporations more freedom to acquire competitors and more freedom in
determining employee compensation. Railroad deregulation was followed by
airline and trucking deregulation under the Carter administration in the
late 1970s. The initial effect of deregulation in these industries was reduced
barriers to entry for competitors and higher pricing competition. This
initially resulted in an increase in the number of operators in these
industries and reduced profits as a result of higher competition. Generally,
however, after a period of increased competition, these industries
reconsolidated and profits rose again, often at a cost to workers, who, over
the long run, saw their incomes as a share of total revenue decline in
these industries after deregulation.
The 1970s was also a period when support for significant financial
deregulation began to build as well, though financial deregulation would not
become law until the 1980s and 1990s. The banking industry changed
dramatically during the 1970s, with these changes becoming a significant
driver for deregulation. A combination of advances in technology and
processes as well as accumulation of assets by large corporations, and the
demand for national banking by large national and international
corporations, provided significant impetus for the growth of large banks.
America had historically been a national of small banks going all the way
back to the country's founding, in large part due to popular suspicions of
banking and laws that forced banks to remain small and regional.
The development of computer technology, however, significantly changed
banking. In the 1970s business computing was dominated by large mainframe
systems, and these systems could only be afforded by large banks. Computing
became a significant driver of efficiencies through economies of scale in
banking. Prior to computing economies of scale were not significant in
banking, and thus a banking system dominated by small regional banks was
close to optimal, however as computing was adopted this made larger national
banks more competitive, but during the 1970s regulations prevented the rise
of such banks. So, this contributed to significant pressure to deregulate
the financial industry to allow larger financial corporations to take
advantage of economies of scale. Likewise, the growing corporate banking
customers wanted larger banks to be able to deal with their growing assets
as well and to make operation on a national and international level easier,
thus there was significant growing support for deregulation of the financial
industry across the business community during the 1970s.
The 1970s introduced the beginning of the decline of the pension system
as well. IRS code
401(k), which provides for tax exemption on income
deferred into retirement accounts, was introduced in 1978 becoming effective
in 1980. The 401(k) tax exemption was initially introduced specifically as a
benefit for high income receivers, however it was soon amended to encourage
inclusion of those with average incomes. By the mid 1980s many large companies had begun shifting their
retirement benefit plans from defined benefit pension plans to much less
costly 401(k) retirement plans.
The 1970s also saw significant increases in women entering the workforce.
While the women's movement of the 1960s certainly had some effect in terms
of making it more acceptable for women to enter the workplace, and improved
the working conditions and pay for women, the primary drivers of women
entering the workplace were purely economic. There are several factors that drove
women into the workplace in the 1970s, and continued to drive women into the
workplace long after that.
One of the most direct drivers in the 1970s was actually the growing
unemployment rate. Because most households had only one worker, and that
worker was male, when husbands lost their jobs in the 1970s one of the
responses to this was for wives to go to work to make ends meet while their
husbands were unemployed. In many cases, wives then remained working even
after their husbands found new employment. Even though unemployment was high
and men had difficulty finding work, women were still often able to take
part-time and lower paying positions that, while not able to fully offset
their husbands loss of employment, still clearly helped. Furthermore, women
were able to work even while their husbands drew unemployment benefits.
But there were even more fundamental drivers of the increasing rates of
women in the workforce in the 1970s as well. First of all we have to
recognize that women have always participated heavily in the "workforce",
but the "workforce" underwent a dramatic change due to industrialization and
the rise of capitalism in the 20th century. In fact, the 1950s was an
anomaly in terms of women's workforce participation, during which women's
workforce participation was unusually low. Prior to industrialization
virtually all work took place at home. During this time women were major
contributors to the work that took place at home, both in terms of domestic
chores and "business" output. In the early phases of industrialization
women were likewise major components of the employed workforce, largely
because women were not property owners, and thus they comprised a
significant portion of the wage laborers. Women who didn't work outside the
home during this time were virtually all wives who spent most of their time
doing domestic chores and raising the children, at a time when children were not yet enrolled
in full time schooling, and/or they worked at home for the remaining
home-based businesses. Women, of course, were also a huge segment of the war-time labor force in the 1940s, since huge numbers of the men were enlisted
in the military and birth rates had been low during the 1930s and 1940s,
resulting in the fact that there were few children to take care of at home
anyway.
During the 1950s, the baby boom and the widespread acquisition of
suburban single family homes, in addition to the influx of male workers, the
high accumulated savings, and the strong economy, meant that families were
economically able to prosper with only one worker and there were
significant household chores to be done, in addition to raising all of the
children of the baby boom. However, by the 1950s the home had fully ceased,
for the first time in history, to be a place of production. Home based
businesses had become virtually nonexistent by the 1950s (outside of farming,
which was in sharp decline), and so by this point essentially all production
took place outside the home.
By the end of the 1960s technological modernization meant that household
chores had been significantly reduced to the point that they no longer
required anything more than a few hours a week to fulfill, and the baby boom
was coming to an end, meaning that there were simply fewer children to take
care of. Quite simply, by the 1970s there just wasn't anything productive
to do at home anymore. Women had always been productive, there was never a
time when half the adult population was just sitting at home idly doing nothing,
but what had happened is that by the 1970s the home itself was no longer a
productive place. The home had historically been a place of productivity,
but with the rise of industrialized capitalism corporations were now the
locus of productivity. Thus, women simply had no reason to remain at home
anymore because production itself had now become external to the home.
The fact that homes were no longer productive places and that by the
1970s birth rates were in decline and all children were enrolled in full
time schooling, combined with stagnating or declining incomes for 90% of the
population, meant that there was no good reason for women to stay at home
where they were unproductive, and there were very strong economic reasons to
seek work where the work was, which was outside the home as official members
of the workforce.
As the 1970s came to a close, "stagflation" was at its peak. The 1979 oil
embargo was in full swing and unemployment, inflation, and the national debt
were on the rise while incomes remained stagnant and corporate profits
declines.
The economic and social conditions of the late 1970s brought about a
desire for change in America to which conservative presidential candidate Ronald Reagan
appealed. In addition to campaigning on a conservative social platform,
Ronald Reagan, who had a long public career campaigning against federal
programs and regulations, decried the economic conditions of the time and,
among other things, promised to balance the federal budget, reduce the
national debt, fight inflation, and deregulate the economy, all while
lowering taxes. Reagan's espoused economic platform, formally called
supply-side economics, came to be known as "Reaganomics",
famously called "voodoo economics" by his then opponent for the Republican
nomination, George H.W. Bush, who later became his Vice President.
By the time that Ronald Reagan took office in 1981 the oil crisis of 1979
was subsiding and Paul Volker, the Federal Reserve chairman appointed by
president Carter, was beginning to get inflation under control. Indeed, like
the taming of inflation, many of the economic trends associated with the
so-called Reagan Revolution were actually well under way well before Ronald
Reagan ever stepped into office.
When looking at the chart below we can see that there are definite
relationships between the rate of inflation and the unemployment rate from
the late 1960s through to the 1990s. What we see is that increases and
decreases in the rate of inflation are reflected in the unemployment rate
roughly 1 to 2 years later.
While Ronald Reagan's policies received much of the blame for rising
unemployment during the first 2 years of his presidency, and much of the
credit for the later drop, the reality is that inflation was a key driver of
unemployment rates during this time, and inflation was brought under
control both by the policies of President Carter's Federal Reserve chairman
Paul Volker and, more importantly, by the ending of the 1979 oil crisis,
both of which had very little to do with the polices of Ronald Reagan.
Something else that we notice in the chart above, however, is that the
federal deficit continued to rise under Reagan. There is, of course, a
relationship between the federal deficit as a percentage of GDP and
unemployment, in large part because increases in unemployment coincide with
decreases in GDP, thus the deficit as a percentage of GDP will naturally rise
when GDP goes down, even if the deficit in actual dollars stays the same.
Not only that, but as unemployment goes up, typically tax collections go
down, thus also contributing to the deficit, even if spending stays the
same.
Nevertheless, the chart above reflects another widely acknowledged fact
of the Reagan presidency, which is that federal deficits rose under the
Reagan presidency and remained higher, even as unemployment dropped. We can
see that the federal deficit was still significantly higher in 1989 than it
was in either 1979 or 1973, even though the unemployment rate was comparable
to those years.
Due to the extremely effective messaging of the Reagan administration,
the real impacts of Reagan's policies were often at odds with perceptions.
To this day the effects of Reagan's policies in regard to reducing
unemployment and the economic expansion of the 1980s are widely attributed to
"supply-side" policy, when in fact the real effect of Reagan's policies
was largely Keynesian. The economic expansion of the 1980s, modest as it was,
was built almost entirely on borrowing and was heavily fueled by deficit
spending on behalf of the government, in compliance with Keynesian methods.
Reagan reduced taxes through a series of tax reforms starting in 1981 and
culminating with the
Tax Reform Act of 1986. In actuality Reagan passed a
mix of both tax cuts and tax increases from 1981 through 1988, but
nevertheless the effect of all of the legislation was a net reduction in
overall taxation. The overall effect of Reagan's tax reforms was to modestly
increase taxes on the poor and to significantly reduce taxes on the wealthy.
In a televised address in 1981 Reagan stated, "tax revenues, in spite of
rate reductions, will be increasing faster than spending, which means we can
look forward to further reductions in the tax rates," claiming that tax
reductions would lead to increases in revenue as the tax reductions spurred
economic growth, and that as revenue increased this would allow for
continuing tax reductions.
The reality was that the tax reductions led to revenue losses. Tax
collections did increase under Reagan, but at the slowest pace of any post
WWII president, with the increases being largely due to population growth.
The increases did not outpace spending, and deficits consistently rose under
Reagan. Far from paying down the national debt as Reagan had promised, the
national debt rose from $900 billion when Reagan entered office to $2.9
trillion by the time he left.
When assessing the effects of the Reagan tax cuts on the economy,
virtually everyone leaves out the impact of the deficits. Economic growth
did occur during the Reagan presidency in loose association with tax cuts,
however those tax cuts were accompanied by decreasing interest rates and
increasing public and private deficit spending.
As a result of the tax cuts, middle income and wealthy Americans had more
money in their pockets than they otherwise would have, but tax revenues did
not in fact rise as predicted, though government spending rose faster under
Reagan than under prior administrations. As a result, "the pie" did indeed
grow, but it grew through borrowing. Had government spending been
constrained by revenue, in other words had the tax increases gone through
and deficits remained the same or gone down due to constraints on spending
to keep spending in line with revenues, there would likely have been no
simulative effect at all. Part of the theory behind supply-side economics was that
tax reductions in and of themselves, by allowing businesses and individual to
keep more of their money instead of having the government
spend it, would lead to economic growth. This never happened during Reagan's
presidency, because what really happened is that businesses and individuals
(except the poor) were allowed to keep more of their money, but the
government not only continued spending the money that it was no longer
collecting, it actually started spending at an even faster rate. What we
really had was tax cuts and increased government spending, not tax cuts and
decreased government spending. The immediate effects of this twin stimulus
of lower taxes and increased spending was of course generally positive in
the short term.
However, for a variety of reasons, the reality of the Reagan deficits
were not widely acknowledged. By the time Reagan left office in 1988 people
widely believed that he had balanced the budget and reduced the national
debt, after all, how could someone who made reducing the national debt a
central plank of their presidency and message have actually massively
increased the debt?
Reagan consistently talked about the importance of reducing the debt and
this message is what stuck in people's minds, even as Reagan's polices were
increasing the debt at a rate not seen since World War II. This resulted in
allowing all of the positive results of Reagan's economic policies to be
attributed to "tax cuts", creating a widespread public belief that it was
the tax cuts that resulted in the economic recovery of the 1980s, as opposed
to the Keynesian deficit spending, the taming of inflation, and all of the
borrowing facilitated by Alan Greenspan's Federal Reserve policies of
constantly lowering interest rates. The economic recovery of the 1980s was a
recovery fundamentally built on borrowing. However unlike the borrowing of
the FDR era, the borrowing of the Reagan era was widely unacknowledged and
generally kept out of mind, as if it weren't happening and as if, at any
moment, the balance-sheet would turn positive and the debt would be able to
be repaid without ever having had to acknowledge that it happened.
In addition to tax reforms, the deregulation movement which started in
the 1970s continued during the 1980s. Again, much like the taming of
inflation, many of the important acts of deregulation occurred under
president Carter in 1980, just prior to Reagan entering office, though
Reagan's presidency is popularly associated with them in part because they
were largely implemented during Reagan's time in office. Among the most
important were the
Regulatory Flexibility Act and the
Depository Institutions Deregulation and Monetary Control Act. The
stated goal of the Regulatory Flexibility Act was essentially to reduce
regulatory requirements on "small" businesses (note that a "small business"
is any business with fewer than 500 employees, regardless of revenue). The
act also brought businesses, especially "small" businesses, into the
legislative process and gave them a significant voice in developing the
regulations that they would be subject to.
The Depository Institutions Deregulation and Monetary Control Act both
gave the Federal Reserve more control over non-member banks yet also reduced other
banking regulations. The passage of this act, as well as additional
deregulation of the financial industry that occurred under Reagan, in
conjunction with the Tax Reform Acts of 1981 and 1986, contributed significantly to
the Savings and Loan Crisis of 1989. Ironically, the Tax Reform Act of 1986
contributed to the crisis by eliminating real estate investment tax
shelters which had been created in large part under the Tax Reform Act of
1981. The Tax Reform Act of 1981 contributed to a real estate bubble in the
early 1980s, and the elimination of these shelters then significantly reduced the
value of many real estate investments, which became a motivation for
manipulation of the now deregulated savings and loan industry. Because so
many real estate investments were losing money in large part due to the
loss of tax advantage of these investments, many savings and load
institutions began engaging in fraud in order to try and salvage their
investment portfolios. This fraud, among other things is what led to the
crisis and the massive tax-payer bailout of the savings and loan industry in
the early 1990s under president Bush Sr.
Many other economics trends which had their roots in the 1970s continued
into the 1980s as well.
The number of women entering the workforce continued to rise during the
1980s, largely driven, as in the 1970s, by economic necessity. This despite
the fact that president Reagan was no friend to the woman worker, having cut
funding for the Equal Employment Opportunity Commission, which investigates
matters of sex discrimination in the workplace, and not raising the minimum
wage to keep pace with inflation during his entire time as president
(minimum wage jobs were/are disproportionately filled by women). Women poured
into the workforce during the 1980s not just because they wanted to, but
because they had to.
As individual earnings for the majority of the population stagnated during
the 1980s the pressure for households to have two income earners increased.
As can be seen below, increases in household income during the Reagan era
were driven almost entirely by women entering the workforce. Once again we
have a significant component of the economic growth that did take place
during the Reagan years which has little or nothing to do with the actual
policies of Ronald Reagan. In fact Reagan and his conservative allies
lamented the increasing number of women in the workplace and at the very
least did nothing to aid the entrance of women into the workplace while at
worst perusing polices intended to counter the growing trend.
Another trend which began in the 1970s but came into full swing during
the 1980s was the growth of the American trade deficit. The trade deficit of
the 1970s was largely a product of the price of oil, but by the 1980s the
deficit was dominated by manufactured goods. While the United States had
been a net exporter of manufactured goods from the beginning of World War II
through the end of the 1970s, the 1980s marked a dramatic shift in American
manufacturing and trade.
The shift from the Unites States being a net exporter of manufactured
goods to a net importer of manufactured goods coincides with three major
things: Other countries catching up to America developmentally
after World War II, the rise of the American dollar vs. other
currencies during the mid 1980s, and importantly the rise of the financial and retail
sectors of the economy.
The growing deficits of the Reagan administration meant that the United
States government had to sell an extraordinary amount of government bonds to
finance the debt. In order to do this the yield on these bonds was
attractive, which led to a huge influx of foreign money coming into the
United States by the mid 1980s both to buy the safe and high yield
government debt and also to invest privately since at this time the United
States was seen as a safe place for investment once inflation had been
brought under control. This caused the value of the American dollar to rise
significantly against world currencies, most notably the British pound. This
made American exports very expensive and it made it much cheaper for
Americans to import foreign goods. This situation bolstered an already
emerging trend toward greater imports of foreign made goods. By the late
1980s, however, the dollar had lost some value against foreign currencies
and this, among other things, helped to boost US exports once again, but the
movement toward foreign production and the growing import of foreign made
goods was now solidly established.
Large retailers like
Wal-Mart
became hugely influential in the 1980s and this influence allowed the
retail sector to put significant pressure on manufacturers, putting
retailers in
the driver's seat now instead of the other way around. By the end of the
1980s large national and international corporations had almost entirely
taken over the retail sector, having now pushed out virtually all of the
individually owned and regional retailers. This consolidation of purchasing
power allowed large retailers to put pressure on manufactures
and begin demanding price reductions from them. This in turn put pressure on
manufacturers to increasingly focus on cost cutting. There were multiple
results from this during the 1980s. The three primary immediate impacts were
increased imports of consumer goods from foreign competitors, increased
pressure on American manufacturers to "contain costs" by downsizing and
reducing the growth of worker compensation, and off-shoring of production to
foreign countries by American companies.
Off-shoring is when a company builds facilities and/or hires workers in a
foreign country to develop goods and/or services that are consumed
domestically. Outsourcing is when a company contracts with another company
to have them produce goods or services for them. In manufacturing this
typically involves outsourcing the production of components to companies
that specialize in making those components, etc. Off-shore outsourcing is,
of course, when a company outsources to companies in foreign countries.
Limited off-shoring and off-shore outsourcing was taking place in America
prior to the 1980s, but this was largely confined to the textile and
clothing industries. While off-shoring and off-shore outsourcing were taking
place in the 1970s, at that time the vast majority of imports to the United
States were of products produced by foreign companies. By the end of the
1980s, however, a significant amount of imports in America were imports of
products being produced for and sold by American companies.
The off-shoring of production did more than move jobs to foreign
countries, it also moved capital and capital development to foreign
countries, as well as make regulation of the economy, corporations and
capital more difficult. This move to off-shore production coincided with a
shift from defined benefit retirement pension plans for corporate employees
to defined contribution only retirement plans, largely under the 401(k) tax code.
This allowed corporations to take on greater risk and to shift the priority
toward short-term goals. When corporations are bound by commitments to
long-term retirement liabilities they are forced to plan for long-term
corporate performance. As corporations shifted away from defined benefit
pensions to defined contribution only plans, rewards and objectives shifted to the
short term.
Likewise, the shift from a retirement system based on private pensions to
a retirement system based on individual asset holdings brought about an
overall shift in the nature of finance and corporate compensation. Under the
private pension system the retirement funds of workers were actually managed
in a more widely distributed way, because there were many different pensions
and each pension was managed separately. Likewise, since the pensions had an
obligation to pay out benefits for the life of the contributors, this caused
pension managers to be relatively conservative and to always have their eye
on the long-term performance of the pension fund, in addition to the fact
that pensions are more heavily regulated than the mutual funds, bonds and
stocks, which 401(k) account money is invested in.
This was not the case with defined contribution only plans, because with a
defined contribution only plan there is no long-term responsibility on the part
of the plan administrators. Essentially, pension managers have a significant
responsibility regarding the use and perforce of the funds which they manage,
however the managers of the mutual funds and other investment vehicles held
in private retirement accounts have essentially no long-term
responsibilities. Those "retirement accounts" come with no obligations
whatsoever on the part of either the employers who contribute to them or the
mangers who run them, because ultimately, all responsibility "falls on the
individual".
The shift from pension plans to individual retirement accounts did result
in a significant increase in individual stock ownership during the 1980s, as
can be seen in the graph below, and this increase in individual capital
ownership did result in a modest increase in actual stock market wealth held
by the bottom 90% of households. However this increase in stock ownership
and wealth did not represent an actual broadening of control over capital or
in fact a broadening of the return on capital or income security, because
what actually happened during the 1980s was that individual stock ownership
displaced defined benefit pension participation, such that guaranteed and
significant retirement revenue streams were replaced with less stable and
less significant individual investments.
This shift meant that while individual ownership went up, it was largely
just offsetting a loss in managed benefits promised to individuals, and thus
it represented neither an economic gain by the bottom 90% nor
a gain in control over capital by the bottom 90%. This was
especially true since almost all of the gains in "individual stock
ownership" were actually products of indirect individual ownership through
investment vehicles such as mutual funds, in which voting rights granted by
stocks went to the mutual fund managers, not the actual individual
investors. In addition, as in prior decades, gains in stock ownership were
also offset by declines in individual business ownership as capital was
consolidated by growing corporations, against which small businesses were
increasingly unable to compete.
The shift from pension systems to individual retirement accounts provided
more financial freedom to corporations, and at the same time it also played
a role in shifting away from long-term performance goals to short term
performance goals. This, in conjunction with other economic trends and
policies during the 1980s, contributed to the beginning of a trend in
significant increases in executive compensation at corporations relative to
the wages of corporate workers, a trend which would become even more
prominent in the decade to come.
On the whole, the American economy appeared quite robust during the mid
to late 1990s. There was significant economic growth as measured by GDP and
unemployment remained low at around 5%. The 1990s is known as one of the
longest periods of continuous economic expansion in US history. Deregulation
of the economy continued under the Clinton administration, culminating with
the
Financial Services Modernization Act of 1999, perhaps the most
significant and far reaching of the deregulatory actions taken since the
Great Depression.
By the early 1990s multiple conditions arose that contributed to an
explosion of globalization, led strongly by the United States. With the
collapse of the Soviet Union in 1991 the global political environment became
more open than it had been at any time since before the Great Depression.
Technological revolutions in computers and communications, punctuated by the
growth of the internet, made international communication and commerce easier
and more efficient than any prior time in human history. Industrialization
and modernization in developing economies, such as China and India, vastly
expanded the collective productive capacity of the global population.
Multiple trade trade agreements were passed during this period, the
largest and most well known of which was the
North American Free Trade Agreement, or NAFTA, between the United
States, Canada and Mexico. These agreements generally eliminated or
significantly reduced tariffs on imports and exports between
the countries, in addition to streamlining paperwork and various customs
processes for wholesale goods, etc.
America's largely domestic post World War II economy transformed rapidly
during the 1990s. Imports went from the equivalent of 5.5% of GDP in 1970 to almost 15% of GDP
by 2000. Exports increased as well, but not as rapidly as imports.
This meant that, on the whole, Americans were getting richer, at least in
the short term. When a country imports more than it exports, it means that
it is receiving more than it is giving back. As such, a net importer country
is superficially getting the better deal, because at the present time that
country is "getting" more than its "giving". This fact inflates the standard
of living beyond the means of the net importer country. It means that the
country that is a net importer is living beyond its means, enjoying a higher
standard of living than the inhabitants are actually producing, because some
portion of the material assets consumed by the population is effectively on
loan from other countries.
On an individual basis, it is as if you made 2 sandwiches and traded them
to someone for 3 equivalent sandwiches. Clearly, you are getting the better
end of the deal, at least for the moment, however if this goes on day after
day and the person who gives you 3 sandwiches for every 2 you give them is
keeping a tally and expects at some point to be paid back for all of the
extra sandwiches they have given you, that debt can accrue over time to
become problematic.
The imbalance of trade with Asian countries, such as China and Japan,
increased significantly during the 1990s and was sustained in part by Asian
countries purchasing significant quantities of US treasury bonds, a.k.a.
American debt, which acted to inflate the value of the US dollar against
their own currencies, thus favoring the American purchase of Asian made
goods (a strategy which accelerated during the 2000s) and provided the
means by which America could afford to import more than it exported. This
policy helped (and continues to help) drive export based economic growth in
developing
countries.
Unlike the rising trade deficits of the 1980s, however, the trade
deficits of the 1990s were accompanied by a much more fundamental shift in
the economy. The trade deficits of the 1980s were dominated by imports of
goods from foreign manufacturers, while by the 1990s the trade deficits had
become dominated by goods manufactured in foreign countries for or by
American corporations. Whereas 20% of American workers were employed in
manufacturing in 1992, by 2002 only 14% of American workers were employed in
the manufacturing sector.
So why would a country like China be willing to give more to America
than it gets back, why not just keep the extra goods domestically and trade
less to America? Essentially, developing countries, especially China, were
willing to give America more goods than they received back, and to support
this on-going deficit through the purchase of American bonds to prop-up
American currency to enable the on-going imbalance, in order to facilitate
the development of productive capital in their own countries. Most
specifically, what these policies did was they facilitated a transfer
of capital from America to the host producer country. What this means
is that, while there was net growth in global productive capacity during the
1990s, there was also a significant transfer of productive
capacity, such that some portion of increased productivity in developing
nations, especially China and Mexico, came at a cost to American productivity. Global
economic productivity was not an entirely zero sum game during the 1990s,
but it was also not a universal rise in the water level either. Why would
someone give you 3 sandwiches in exchange for only 2 back? It seems to make
no sense, except, in this case, what the Chinese and other developing
countries were getting in exchange for giving us more commodities in the
present, is they were luring capital away from America and inducing it to
relocate to their country, thereby increasing the capital stock, and thereby
the
long-term productive capacity, of their nations beyond what would otherwise
have been possible in a true "free-market", in part through the use of
national monetary policy. They essentially allowed their countries to be under-compensated in the short-term in order to establish a better long-term
position.
What basically happened during the 1990s was like two ranchers, one of
which (rancher A) started out with 100 horses while the other (rancher B) had
10 horses. Over a period of some years, both ranchers increased the size of
their stock, so that they had 200 horses between
them, but at this time rancher A had 120 horses and rancher B had
80 horses. Of the 80 horses that rancher B had, 30 of them had actually come
from rancher A, which rancher B had obtained by trading excess feed to
rancher A in exchange for the additional horses. So rancher B's economic
growth was a product of both production of new capital on his own ranch and
transfers of capital from rancher A. While rancher A's capital stock did
increase over time, it was actually at a lower rate than it
would otherwise have been due to the transfers of capital from A to B, in
exchange for commodities.
In the American scenario, however, we don't have a single rancher making
the exchanges, what we have is an economy of thousands of different publicly
and privately owned corporations, millions of workers, and federal and state
government all combined together. During the 1990s, American corporations
(and their executives and shareholders) benefited from the monetary and
fiscal policies of governments, which made the transfer of privately held
capital from America to foreign countries profitable. Foreign countries like
China and Mexico, etc. provided both direct incentives to American companies
for them to relocate capital there, as well as indirect incentives through
monetary policies, which the US accommodated. This, in turn, was one of the
components that fueled the sky rocketing executive compensation and stock
prices of the 1990s. Essentially governments, both foreign & domestic, bore
much of the cost of capital relocation from America to developing economies,
while executives and stock holders reaped much of the reward and American
citizens benefited as consumers from reduced commodity prices.
Another major component of the 90s economy, and the associated stock
market bubble, was of course the growth of the Information Technology
sector, and the most significant component of
this growth during the 90s was the rapid adoption of internet technology and
the growth of internet related companies.
After
decades of government research and development, and the passage of
legislation in the 1980s and 1990s to open the internet up to public and
commercial use, as well as government subsidy of internet related business
through preferential tax treatment, the late 1990s saw rapid expansion of
internet use and the rise of many internet related commercial enterprises,
from internet service providers to content providers to commercial search
engines to gaming companies to business-to-business service providers to
companies that sold tangible commodities via websites, and more.
Nevertheless, so-called e-commerce accounted for less than 1% of overall US
retail sales by the end of the 90s, and still accounts for less than 4%
today.
What effectively happened during the 1990s was that an entirely new form
of capital emerged, virtual capital, which had been created by the
government via it's development of the internet. Virtual capital is
basically web domains or web sites. Like land, a web domain is a form of
property, but unlike land web domains are virtually infinite and
inexhaustible. Historically capital has come in the form of animals and
slaves, then land as farming was adopted, then machines and intellectual
property, and most recently we now have the development of virtual capital
with the emergence of the internet. As with prior instances of the emergence
of new forms of capital, the emergence of virtual capital brought about
rapid economic change, changes in the economic order, and also coincided
with rampant financial speculation.
New forms of capital do not make old forms of capital obsolete, but they
do create new "economic environments" in which new forms of development may
occur, and the relative importance of older forms of capital in the total
economy is changed. As such, economic and social orders built on control or
dominance of old forms of capital may be challenged when new forms of
capital emerge and become dominated by different organizations, classes, or
individuals than those who dominated the older forms of capital. This is
what happened when machinery and intellectual property changed the relative
value of land as a form of capital via the industrial revolution, thus
contributing to the overthrow of the feudal systems built on land ownership.
This occurs because when new forms of capital are created there is no
established pattern of ownership, and if the dominant owners of the
traditional forms of capital do not have the means, the knowledge, or the
foresight to control the new form of capital, then that new form of capital
can become a vehicle for the entry of new individuals, organizations, or
classes into the the economy and thus a vehicle for the rise of challenges
to existing systems of economic and political power.
During the 1990s there was a rapid rise in the number of "new
millionaires", individuals who came from modest backgrounds and became
wealthy, largely through business ventures.
A significant portion of these new millionaires became wealthy directly
via internet or computer related businesses which they either started or were
involved in. Much of this wealth was a product of stock ownership in
corporations founded by such individuals. As corporations went public during
the mid to late 1990s, i.e. issued publicly tradable stocks, the founders
and principle stockholders of new technology companies received massive
wealth through their stock ownership. For example, when e-Bay went public in
1998 the company had around 30 employees and revenues of only $4.7
million a year, yet founders Pierre Omidyar and Jeffrey Skoll became
billionaires overnight as e-Bay stock hit $53.50 per share during the first day of the
IPO. These individuals became billionaires even though they had not actually
produced billions of dollars of value.
Even as the number of new millionaires increased during the 1990s,
however, overall economic inequality increased as well. The percentage of
the population who were "super-rich", and the magnitude of wealth owned by
the super-rich, increased rapidly during the late 1990s, but even though the
number of rich people was increasing, the gap between rich and average
Americans was increasing as well.
In terms of overall economic impact, "internet companies"
typically have a low ratio of workers to revenue, which generally translates
into higher incomes per employee, but relatively low "job creation" per
company. Due to the nature of the internet, and software
in general, large revenues can be supported by a relatively small number of
workers, in some cases entire companies or products were developed and
launched by single individuals or small teams of 5 or less people. Thus,
internet businesses themselves made a small number of people very rich
relatively quickly, but had very narrow impacts on total US income. Incomes from such
businesses were highly concentrated and did not account for the overall
increases in job creation during the 1990s.
Looking at revenue per employee for 2010 for a select sample of
companies, one can see that information technology companies generally have
a lower ratio of employees to revenue. Information technology companies are
much more mature today than they were in the 1990s, when their revenues and
employee counts were significantly lower than they are now. So, while
there was a significant increase in employment in the information technology
sector during the 1990s, and while a significant portion of the "new
millionaires" came from that domain, in terms of direct employment "internet
startups" accounted for a relatively small portion of direct job creation
during the 1990s. Within the IT sector there was a greater increase in job
creation within the IT departments of established entities, like banks,
hospitals, government, telecom companies, department stores, etc.
Company
Revenue
Employees
Revenue per employee
Exxon
$383,221,000,000
83,600
$4,583,983
Google
$29,321,000,000
26,316
$1,114,189
Amazon
$34,204,000,000
33,700
$1,014,955
Warner Music
$3,491,000,000
4,000
$872,750
Ford
$128,954,000,000
164,000
$786,304
Microsoft
$62,484,000,000
89,000
$702,067
General Electric
$150,211,000,000
287,000
$523,383
e-Bay
$9,156,000,000
17,700
$517,288
AT&T
$124,280,000,000
294,600
$421,860
Kraft Foods
$40,386,000,000
97,000
$416,350
Kroger
$82,189,000,000
334,000
$246,074
Home Depot
$67,997,000,000
321,000
$211,828
Wal-Mart
$421,849,000,000
2,100,000
$200,880
Sears
$44,043,000,000
355,000
$124,064
J. C. Penney
$17,759,000,000
156,000
$113,839
McDonald's
$24,075,000,000
400,000
$60,187
So, if the "internet boom" itself didn't directly account for the low
unemployment rates of the 1990s then what did? The specific industries that
accounted for the most job gains are provided below, essentially all of
which fall into the services sector, but the gains went beyond these
industries into construction, as well as some forms of manufacturing.
The real question is, why and how did the economic expansion of the mid
to late 1990s occur, thus supporting this employment growth? I believe that
the primary answer to that is inflation and interest rates, namely low
inflation and low interest rates. Why did America have low inflation in the
1990s? Because of efficiency advances, the off-shoring of manufacturing, low
energy prices, and the driving down of commodity prices by large retailers
as they engaged in fierce competition.
Here's what really happened: there was a lag effect in the relationship
between wages and inflation. Going into the 1990s wages continued to
increase at the same level they had for the past decade, which is to say not
quite keeping up with inflation. However by the mid 90s the rate of
inflation growth decreased as the effects of off-shoring and retail competition
took hold. Wage increases, however, stayed on their same trajectory, and
thus by around 1996, since inflation had dipped but wage growth didn't,
average workers were relatively "richer" than they had been in decades, even
if only a little bit. This led to increased demand, which created a cycle of
demand leading to increased job creation and thus actual wage growth, etc.
But this wasn't all that was fueling the growth, because credit, fueled
by the low interest rates, was also playing an important role, both for
average Americans as consumers and home buyers, but also for businesses and
especially in the financial industry. So we had a dual effect of inflation
briefly under-pacing wage growth coupled with a massive influx of credit.
The massive influx of credit was a product of increased savings in countries
like China and India along with Federal Reserve policy of low interest
rates, which, along with financial deregulation, contributed to growth in
the financial industry that further facilitated the expansion of credit. The
low interest rates, low inflation, and expansion of credit led to a
construction boom and increased consumer spending.
And this brings us to the investment bubble. Along with the above
mentioned economic factors, the continuing shift from pension plans to
401(k) style retirement plans resulted in a growing number of people
investing in the stock markets, in addition to increasing individual
investors and "day traders" who flooded into the stock markets in the late
90s as on-line internet based trading platforms gained popularity, making it
easier than ever before for individuals to directly buy and sell stocks. The
financial services industry saw the greatest income growth of any industry
in the late 1990s as money flooded into the financial markets. The
"internet boom" simply provided enough of a plausible explanation for
ballooning stock valuations to allow many people to believe that the stock
market gains of the late 90s were "real".
Once again, a widespread belief took hold that we had entered into a new
era of economics, and once again there was a widespread belief that
government regulation had become unnecessary or even detrimental. The
economic team of the Clinton administration was comprised heavily of strong
"free-market" advocates, such as
Robert
Rubin,
Alan
Greenspan, and
Larry Summers, who were fundamentally opposed to the concept of
financial and economic regulation. Indeed through the late 1990s the
apparent wisdom of this view gained support with each increase in the levels
of the stock markets.
However, just as in the 1920s in the midst of the industrial revolution, an economy heavily fueled by consumer credit,
highly leveraged institutional investments, and a widespread public belief that investments
were a no-lose proposition, led to the rise of investment
bubbles. Just as in the 1920s, real economic growth and technological
revolution seemed to provide a plausible explanation for rising stock
prices, yet underlying the economic growth was growing economic inequality
and unsustainable levels of consumer and financial debt.
Even though average incomes were growing marginally faster than
inflation, in fact there was also a growing separation between top and
bottom incomes, and despite gains in real income, savings continued to
decline as consumption was increasingly fueled by credit, the availability
of which expanded rapidly during the 1990s in large part due to unregulated
"financial innovation". While consumption was driven largely by household
and business debt, market prices were simultaneously driven by increasingly
leveraged speculation by institutional investors, namely the emerging and
almost entirely unregulated
hedge
funds as well as growing investment banks, through the use of
unregulated
derivatives.
Even though the percentage of Americans who owned stocks increased
dramatically during the 1990s due to the growth of 401(k) style
retirement plans and individual stock trading as millions of Americans
entered into stock market speculation for the first time, the portion of
the nation's capital owned by the bottom 90% of the population actually continued to decline.
Despite the fact that the percentage of Americans owning stock by the end of
the century had increased in just ten years to over 50% from roughly 30% as
of 1990, the portion of stock market wealth owned by the richest 10% of the
population had remained essentially unchanged over that period.
While much was made about startup companies in the press during the
1990s, in fact the rate of entrepreneurship declined during the 1990s as
wages rose and people sought employment with established organizations during the
"good"
economy. In addition, the rapid growth of multinational corporations during
the 1990s and the continued expansion of large corporations in the services
sector resulted in the continued decline of direct capital ownership and
control as small businesses were pushed out of the market by larger
corporations.
In fact what we find is that since the end of World War II
self-employment and entrepreneurship in America have had an inverse relationship to
employment rates and median incomes, meaning that when employment
and/or wages go up
self-employment goes down, and when employment and wages go down,
self-employment goes up. What this means is that entrepreneurship in
America is often not a product of opportunity, but rather of desperation.
This desperation driven entrepreneurship, just as was the case during the
Great Depression, typically involves little or no capital accumulation by
the self-employed, creates few new jobs, and relies heavily on the
manual labor of the self-employed individual. As a result, increases in
desperation driven "entrepreneurship" do little or nothing to actually
increase the rate of capital ownership in the population, and thus in good
times or bad, whether self-employment rates were increasing or decreasing,
the rate of capital ownership and control continued to decline through the
20th century, with the "economic expansion" of the 1990s being no exception.
On March 10, 2000 the NASDAQ Composite Index peaked at over 5,000, after
which it declined precipitously to around 1,200 in October of 2002. The
NASDAQ stock exchange was (and remains) heavily populated by technology
companies, with relatively few older and established companies listed on it
compared to the New York Stock Exchange, which saw a relatively smaller
decline over that same period.
The day that the NASDAQ began its fall is typically considered the day
that the "dot-com bubble" burst, and technically that is accurate, but the
bubble actually began to rupture about two years prior to that in late 1998,
when the hedge fund
Long Term Capital Management
imploded virtually overnight, requiring a bailout engineered by the Federal Reserve, shortly after
which the Federal Reserve began raising interest rates, which in turn
accelerated the inevitable bursting of the bubble.
Long Term Capital Management (LTCM) was a highly leveraged hedge fund run
by top economists, including former Federal Reserve vice-chairman David
Mullins, that operated in almost total secrecy with no regulatory oversight.
Even LTCM investors had virtually no information on how the fund operated,
they just knew two things: the historical rate of return and (they were
assured) that everything was legal. LTCM used derivatives and bond market arbitrage to generate high and, so
it's operators thought, risk-free profits through extremely high-volume low-margin exchanges. Basically, they profited from small price differences in
the bond markets, but in order to do this it required very large
transactions since the price differences were small. In order to engage in
these large transactions LTCM used highly leveraged derivates, resulting in
trillions of dollars of exposure based on only a few billion dollars of
actual assets. At its height LTCM was generating a 40% return on investment.
Virtually every major bank and Wall Street financial firm had investments
with LTCM. In mid-1998 a series of "unforeseen economic events" resulted in
massive losses in LTCM's portfolio, requiring liquidation of additional assets to cover.
The result was an almost immediate collapse of the fund. As a result, the
Federal Reserve organized a private bailout of the hedge fund by its own
investors, who collectively put up $3.5 billion to buy the fund, in
efforts to prevent a major panic and financial meltdown had the fund become
completely insolvent. The bailout worked in its fundamental intention, which
was to prevent a major financial panic, but it was also a sign of things to
come, namely greatly under-evaluated risks and highly leveraged investments
that were primed for collapse. However, the success of the bailout of LTCM,
which had gone largely unnoticed by the public, allowed the market charade to go on
a little longer.
By the end of the 1990s an estimated 7.5 million Americans had on-line
brokerage accounts, with as many as 5 million of those engaged in
day
trading. With stock markets setting new record levels each day the lure
of easy money, and the sense that if you weren't getting it you were getting
left behind, became widespread throughout the country. By late 1999 some
individual high-flying internet stocks were already starting to fall as
internet startups began to fold, but the overall market continued to grow
until early 2000.
The ensuing decline of so-called dot-com stocks was inevitable, though up
to the decline major "market analysts" and financial news outlets
were touting the soundness of stock market investment. As with LTCM, many
investors were operating in an information vacuum, but worse, large scale fraud and misinformation
was also rampant in the markets at
multiple levels. During the lax regulatory environment of the late 1990s
corporations were misleading regulators (who largely just took their word on
many issues), corporations were misleading investors and employees, and
brokers and fund managers were misleading individual investors. This was all
compounded by the fact that so-called trusted authorities were giving the
public a constant stream of reassurances in the markets and encouragement to
invest.
By 2001 it had become apparent that at least dozens of major corporations
had engaged in massive accounting and reporting fraud, having inflated their
earnings for years and engaged in all manner of market manipulations and
deceptions. The two most famous cases are
Enron
and
WorldCom. Enron was the first such corporation to have its financial
manipulations revealed, which began an outpouring of revelations about other
firms who had engaged in similar practices. As these revelations came to
light the stocks of these companies collapsed, and many of them went
completely bankrupt. The effects of these revelations, along with the
September 11th, 2001 terrorist attacks, resulted in broader stock market losses by the end
of 2002, bringing the DOW Jones industrial average under 8,000 from its peak
of almost almost 12,000 in early 2000. All-in-all over 1,500 firms ended up restating
their earnings, indicating that these firms had engaged in manipulative
accounting during the 1990s.
The rise and fall of Enron was heavily tied to deregulation and fraud on
multiple levels. During the 1990s deregulation of the energy sector took
place, enabling the sale of energy commodities, such as electricity and
natural gas, at market prices.
Enron manipulated energy markets, was responsible for the creation of
unnecessarily brown outs and blackouts, overscheduled transmission lines,
etc., all resulting in inflation of energy prices on the one hand, thus
inflating real profits, and simultaneously engaged in over-reporting of
profits through accounting gimmicks and flat out false profit statements on
the other hand. So not only were their profits inflated due to illegal and
manipulated activity in the first place, but they actually over-reported
their already inflated profits as well.
Enron was no small company; prior to its collapse it had become of the
of biggest and most influential energy companies in America. The company
also won numerous awards and its stock was heavily recommended by numerous
market analysts. Fortune had named Enron the "Most Innovative Company of the
Year" six years in a row and the company and its executives were frequently
praised by market analysts and business organizations as corporate leaders
in the new economy.
Ironically, the over-stated profits by Enron and thousands of other US
firms during the 1990s resulted in those companies paying higher corporate
taxes than they otherwise world have, had they stated their real (much
lower) profits. The primary reason that these companies over-stated profits,
despite the fact that doing so was in fact worse for the company, is that
the executives were all heavily invested in the company's stocks and
compensated with stock options. By over-stating profits this caused stock
prices to go up, thus netting millions in over-sized bonuses and stock
profits for the executives. Investors were not inclined to deeply question
the profits because the the rising stock prices benefited them as well.
But it wasn't just the corporations who were engaged in fraud and market
manipulation, brokers were as well.
Merrill Lynch was the most high-profile
broker to get caught. The problem was particularly prominent among many
recently deregulated investment banks that also operated as brokerages. The
financial deregulation of the 1990s made it easier for large financial firms
to engage in multiple lines of business, like investment baking and
brokerage and simultaneously broke down barriers between these lines of
business within companies. Corporations were the clients for the
investment banking side of the company and investors were the clients for
the brokerage side. As a result, there was an incentive for the brokerage
business to bring in money for the corporate clients in the investment
banking side. The role of the investment bankers was to raise capital for
their corporate clients, however the role of the brokerage was supposed to
be to advocate the financial interests of the investors. What became a
widespread practice by the end of the 1990s was that many of America's
largest and most prominent brokerages were knowingly and intentionally
rating stocks as good investments that they knew were in fact bad
investments, and they intentionally advised investors to buy stocks that
their own researchers believed were horrible investments. Brokerages
reserved their real analysis and advice for their largest clients and gave
bad advice to media outlets and small individual investors. As a result they
were directly benefiting their large investors as well as their corporate
investment banking clients at the direct expense of small individual
investors.
Merrill Lynch eventually paid over $100 million in a settlement to
defrauded investors, but this figure pales in comparison to the real market
effects of this type of activity, not to mention the hundreds of millions,
if not billions, of dollars that went to the investors and corporate clients
who benefited from the intentionally misleading investment advice of such
brokers. The effects of the 2000-2002 bust can be seen in the impact that it
had on the share of stock market wealth owned by the wealthiest 1% of the
population, whose percentage of total stock market ownership increased from
1999 to 2005 as a result of the losses that fell disproportionately on
smaller investors.
Following the stock market collapse of 2000 and 2001 and the revelations
of corporate accounting fraud a few new regulations were put into place
under the Bush administration, namely the
Sarbanes–Oxley Act of 2002 and the
Pattern Day Trader Rule 2520 put in place by the Securities and Exchange
Commission in 2001.
The Sarbanes-Oxley Act, also known as SOX, was one of the most
significant pieces of new business regulation introduced in decades. The act
basically increases the transparency and reliability of corporate accounting
and reporting by requiring specific standard record keeping and accounting
and auditing practices. It only affects publicly traded companies, it does
not apply to privately held companies at all. While the act does increase
regulation of "business", the beneficiaries of the act are investors, i.e.
capital holders. In essence, it is an act that increases government
responsibility for policing the practices of capital controllers for the
benefit of capital owners. So in the basic sense, what the SOX act does it
is puts the burden of ensuring that corporate executives are doing what they
are supposed to be doing and not lying to their shareholders on the back of
the government, thereby transferring the cost of capital oversight from
capital owners to the government. This reduces costs and risks for
capitalists, which is why the SOX act was heavily supported by "Wall Street"
and investment institutions. In essence, enforcement of the SOX act is
another means of subsidizing "Wall Street", or the "investor class".
The Pattern Day Trader rule only effects small traders, it does not
effect large institutional traders, and as such it has basically been seen
as a "scapegoat regulation", one that can be pointed to as having done
something while not actually having a meaningful impact. The rule restricts
the number of trades that an individual can make on margin using an account
with less than $25,000 in it. As such this rule impacts a small number of
traders and a small volume of trading, since the significant volume is
executed by institutional traders with accounts of millions or billions of
dollars.
The full picture in regard to regulation during the Bush administration
is quite complex. No significant formal deregulation took place under George
W. Bush, and in fact regulatory spending increased dramatically under Bush.
Indeed George W. Bush presided over the largest increase in regulatory
spending as well as the largest total amount of regulatory spending of any
American president in history.
But total spending and the total number of new regulations does not tell
the whole story. Much of the regulatory increase fell under the Homeland
Security Department, and dealt largely with national security issues. The
Transportation Security Agency (TSA) saw the largest increase in regulation,
and aside from SOX, most of the other financial regulations put into place
dealt with financial security and ways to track money from foreign sources,
etc. as part of efforts to track down and freeze the assets of suspected
terrorists. So while there were significant increases in total regulation
under George W. Bush, the primary focus of these regulations were national
security and protecting the interests of capital owners, unlike prior
generations of regulations which were primarily focused on labor protection,
consumer protection, banking stability, and environmental safety.
The
regulatory record of the Bush administration in other traditional areas
is even more complex however. In many cases, such as environmental and
workplace safety regulation, regulatory departments were defunded and
regulatory enforcement was lax. In other areas, however, funding and
regulations were increased and enforcement became extremely stringent. A key
example of this was the
Bush administration's approach to union regulation. Under the the Bush
administration the budget of the Office of Labor Management Standards was
significantly increased and regulatory enforcement became much more strict,
the net effect of which was to make the establishment and administration of
unions much more difficult and costly, which led to increased sanctions
against unions for regulatory failures.
The details of the contributing factors to the Bush era housing bubble
are complex, but the fact is that shortly after the bursting of the
so-called dot-com bubble housing prices began to rise precipitously, peaking
in 2006, and then declining just as quickly as they had risen. As with prior
bubbles, "leading authorities" endorsed the rising bubble as a positive
economic sign and encouraged the public to buy into the phenomenon, at least
initially. By late 2004 some talk of a housing bubble did emerge, though it
was still more common for analysts to endorse the housing market than to
advise caution. By 2005 there were growing calls for caution, though they
were matched by calls for confidence in the housing market as well. It was
widely reported in 2005 when Alan Greenspan stated that, "without
calling the overall national issue a bubble, it's pretty clear that it's an
unsustainable underlying pattern."
Nevertheless, prices continued to escalate as people both bought homes
for investment purposes and bought homes under he belief that if they didn't
buy now they would forever be priced out of the market. A frequent refrain
heard by The National Association of Realtors and others was that, "we've
never seen a national housing bubble in American history, therefore we don't
believe that national housing bubbles can exist."
What had become clear to close observers by 2005, however, was that
housing prices were rising far faster than incomes (which weren't rising at
all for 90% of the population) and were far exceeding the cost of rent for
equivalent housing.
In an interview posted on The National Association of Realtors website in
2005, which also reflects views frequently expressed by its representatives
on multiple news outlets from 2003 through 2006, they stated the following:
Should we be concerned that home prices are rising faster than
family income?
No. There are three components to housing affordability: home prices,
income, and financing costs – the latter are historically low. During
the last four-and-a-half years of record home sales, there has been a
shortage of homes available for sale. As a result, home prices during
this period have risen faster than family income. However, in much of
the 1980s and 1990s, the reverse was true – incomes rose faster than
home prices. On a national basis, according to the Housing Affordability
Index published by the National Association of Realtors, a median income
family who purchases a median-priced existing home is spending a little
over 20 percent of gross income for the mortgage principal and interest
payment. In the early 1990s, a typical mortgage payment was in the low
20s as a percent of income, and in the early 1980s it was as high as 36
percent. Overall housing affordability remains favorable in historic
terms.
What are the prospects of a housing bubble?
There is virtually no risk of a national housing price bubble, based
on the fundamental demand for housing and predictable economic factors.
It is possible for local bubbles to surface under the right
circumstances, but that also is unlikely in the current environment. -National
Association of Realtors Q & A page; 2005
Despite claims from The National Association of Realtors and others to
the contrary, housing prices were clearly not being driven by fundamentals
at all. A basic understanding of what happened is that following the
bursting of the internet bubble in 2000 investors poured money into real
estate believing that it was a "safe investment". This took place in three
primary forms, the first of which was individuals and organizations buying
investment property directly; the second of which was American individual
and institutional investors moving money into real estate investments such
as Real Estate Investment Trusts (REITs),
buy stock in real estate and construction companies, and investing in
mortgage-backed securities; the third of which was foreign banks and
investment institutions from Asia at Europe pouring money into the American
credit markets and investing in mortgage-backed securities as well.
The massive inflows of investment funds facilitated a massive expansion
of credit, but most specifically a very particular kind of credit, which was
home mortgage credit, though this also spilled into commercial real estate
as well. So the inflow of investment funds helped provide the funds for the
credit and the lowering of the federal funds rate by the federal reserve in
reaction to the economic recession of 2001-2002 helped to make credit even
cheaper, but even that wasn't fully responsible for bubble. What was really
required for the bubble were changes in lending practices, a highly flawed
securities rating system, and an unregulated and highly manipulated market
for the sale of Collateralized Debt Obligations (CDOs),
which bundled mortgage-backed securities and derivatives of mortgage-backed
securities into investment instruments.
Ultimately, a CDO is a bundle of individual mortgages, or in some cases a
bundle of bundles of fractions of mortgages. Because a mortgage is a time
sensitive financial instrument (the risk that the first portion of the loan
will be paid back is different from the risk that later portions of a loan
will be paid back), the loans were stratified, separated into different risk
pools, etc., and those risk pools were rated by rating agencies (namely
Standard & Poor's,
Moody's
and
Fitch) bundled together, pulled apart, re-bundled, etc. and sold as
investment instruments. The performance of these instruments was predicted
using predictive analysis based on the ratings, but the entire thing was a
house of cards because by this point the entire home loan process had been
broken up between multiple individual entities such as real estate agents,
appraisers, loan originators, lenders, underwriters, etc., each of which
handled only a small portion of the total overall transaction, and each of
which had a very narrow view of the process, with each of these entities
having strong short-term incentives to manipulate the system and ignore
long-term interests since responsibility for the loans was handed off at
each step of the process along the way.
Loan originators were incentivized to approve as many loans as possible
because that's where they made their fees and once the loan was handed off
to the lenders it was no longer their responsibility, so how the loan
ultimately performed made no difference to them. Competition in the loan
origination market rewarded those originators that provided the greatest
volume of loans to lenders and underwriters. Any loan originators who
sought quality over quantity were selected against in the market, and
thus most loan originators quickly learned this and adapted their practices
to the marketplace. Likewise appraisers quickly learned to give the
appraisals that the originators wanted. The lenders and underwriters were
driving the thirst for quantity over quality because via the securitization
process and the creation of CDOs, which meant that they were able to package
up the loans and "resell" them without actually holding any risk themselves,
the risk was being largely off-loaded to the investors. A major fly in the
entire ointment was the fact that everyone throughout the process was
incentivized to fudge the facts and there was no regulatory oversight to
reign any of it in.
The appraisers over-valued the houses. The originators advised clients to
overstate their incomes or at least failed to perform due diligence. The
ratings agencies took all of the data coming in to them at face value, even
if it clearly made no sense. For example, ratings agencies could easily have
determined that income levels as stated on the loans in an area far exceeded
the reported incomes for an area by the Labor Department. Indeed it became
clear that the ratings agencies weren't simply victims of bad information,
they actually engaged in further manipulation themselves and intentionally
looked the other way, because they are not actually unbiased bodies,
rather they for-profit corporations who are paid for their ratings by the consumers of the information,
and their ratings served a purpose for the consumers of their information,
who were the financial institutions that were creating the CDOs. Those
financial institutions wanted "good grades" on the loans so that they looked
better to prospective investors. The banks paid for the ratings, not the
investors, and so the banks got the ratings that benefited them. Again, in
this case market competition actually helped to drive the bad practices.
Since there are multiple rating agencies, banks would "shop around" for the
"best ratings", in other words, if one agency gave higher ratings than
another then that agency would be favored and attract more business, which
drove the ratings agencies to inflate their ratings to retain or attract
business.
Ultimately, this whole process spiraled out of control, and the result
was a credit bubble for home loans, which caused acute inflation of property
prices. It was as if the federal reserve had started printing a special kind
of money that could only be used to buy houses, and instead of keeping this
money in line with the regular dollar, they printed two "home buying
dollars" for every regular dollar. The credit bubble had grossly over
expanded the "money supply" specifically for buying homes.
By 2006 the fact that the housing market was a bubble had become
apparent, but how to get out of it wasn't. At this point all of the
different players in the home mortgage industry essentially began playing
hot potato. While most players in the industry knew that there was a bubble
and that it would crash, there was still significant market momentum and
there was still money on the table to be had, so everyone was trying to
do as many deals as they could and quickly offload the problems onto the
next entity in the chain, knowing that they didn't want to get stuck with
the bad deals.
This led to even more deceptive practices, especially among the sellers
of mortgage-backed securities who were trying to offload them onto investors as rapidly as
possible while maintaining the facade that the market was still fine. Hedge
funds also began betting against the housing market by shorting CDO
investments and the banks who had invested in them. By 2007 the housing
market began to decline and the pace of decline accelerated in 2008. Home
foreclosures began to increase and it quickly became apparent that the
mortgage-backed securities, i.e. CDOs, etc. were vastly overvalued and that
many home buyers would not be able to pay the full value of their mortgages.
This of course caused the value of mortgage-backed securities to drop, and
they dropped dramatically. It became clear that the rating agencies had been
giving extremely inflated ratings to the securities underlying the mortgage
investment instruments, etc. and many of these investments had been
themselves purchased on credit and through the use of leveraged derivates,
meaning that credit was used to buy credit instruments, essentially a
compounding of the leverage, which was of course what was largely
responsible for the credit bubble.
The overwhelming majority of the investors in mortgage-backed securities
were large institutional investors, such as "traditional" banks (which were
able to invest in these instruments due to deregulation) and investment
banks, as well as hedge funds and other financial institutions. The collapse
of the mortgage-backed security market in 2008 led to a global financial
panic as the significant mortgage-backed assets held by banks and financial
institutions around the world rapidly lost value. One of the first financial
institutions to succumb to the collapse in the mortgage market was
Lehman Brothers, the fourth largest investment bank in America at the
time.
Ultimately the federal government stepped in under the direction of the
Treasury Department and the Federal Reserve to "bail out" the financial
sector through the
Troubled Asset Relief Program (TARP), signed into law by George W. Bush
in 2008. The TARP program essentially both loaned money to financial
institutions at extremely low interest rates and "bought" "troubled assets"
from financial institutions at well above market prices.
The important thing to note here is that the primary response by the
federal government to the housing bubble and its collapse was to prop-up the
financial institutions that caused the housing bubble, and little or no
relief was provided to home buyers who purchased homes during the bubble.
This was true during the presidency of George W. Bush and remained true
under the following presidency of Barack Obama. The
Home Affordable Modification Program was included as part of the 2008
economic recovery package signed by George W. Bush and was continued and
moderately strengthened under president Obama, however this program, the
most significant federal program for assisting home buyers who bought during
the bubble, offers barely any financial relief to home buyers.
In order to be eligible for the program mortgage holders must meet the
following conditions:
Borrower is delinquent on their mortgage or faces imminent risk of
default (Note, this provision led to many mortgage holders advising home
buyers to stop paying their mortgage to qualify for the program, and to
then subsequently foreclose on their homes instead of helping them use
the program to refinance)
Property is occupied as borrower's primary residence
Mortgage was originated on or before Jan. 1, 2009 and unpaid
principal balance must be no greater than $729,750 for one-unit
properties.
If the borrower is eligible then the monthly mortgage payment will be
adjusted to a maximum of 31% of the borrower monthly income through the
following means:
Reduce the interest rate to as low as 2%
Next, if necessary, extend the loan term to 40 years
Finally, if necessary, forbear (defer) a portion of the principal
until the loan is paid off and waive interest on the deferred amount.
So the program only helps people who are facing foreclosure and only does
so by reducing the interest and extending the length of the loan. If it is
not possible to get the monthly payment below 31% of income even using the
steps above then the borrower is likewise ineligible for the program. What
no government program has done, however, is force lenders to write down
principles in line with market values after the bursting of the bubble. This
means that buyers who bought at the peak of the market face two basic
choices, to either A) continue grossly over-paying for an asset that is no
longer worth what was paid for it, and may not be again for decades or B)
default on the mortgage.
What makes this all the more troubling is the fact that lenders and
financial institutions effectively did manipulate the housing market, and
they were directly bailed out and their loses were covered by the federal
government, while home buyers received virtually nothing in the form of
assistance. It is important to note that
market manipulation is a crime in the United States, but the laws do not
apply to the housing market, only to securities such as stocks and bonds, so
even if there were any prosecutions for market manipulation, at best the
investors in mortgage-backed securities would be able to make claims, not
the actual home buyers.
As home foreclosure rates increased so followed unemployment, but it was
really much more than foreclosure rates which drove the rise in
unemployment.
The reality is that the housing bubble was just the straw that broke the
camel's back. For decades wages had been stagnant, debt levels held by the
American working class had been increasing, and the number of workers
per household had been increasing and began to plateau at a new normal of
two workers for virtually every working-age married household. The economic
"recovery" from 2003 to 2007 was essentially completely fueled by credit and
was always unsustainable. Had the housing bubble not happened from 2003 to
2007 it's certain that unemployment and GDP during that period would have
suffered as well. So the economic "recovery" of the mid 00's was largely a
product of the housing bubble itself. Thus, the Great Recession that
followed the bursting of the housing bubble was only partly caused by the
housing bubble burst, to a large extent however it is simply an unmasking of
the real 21st century American economy.
After decades of decline, wages now account for the lowest portion of
national income since World War II. What's more, wages for the bottom 95% of income recipients now account for less than 50% of gross national
income, headed toward 40%. It is an amazing figure to contemplate: Right now
only about 45% of the nation's income goes to the wages of the bottom 95% of
income receivers.
Labor's share of income typically increases during recessions because
capital income typically falls during recessions, but this has not been the
case during the recent recession. The graph below shows labor's share of
national income over time as determined by the Bureau of Labor Statistics,
which indicates an accelerating decline beginning in the 1980s.
The declining share of national income going to wages wouldn't
necessarily be a bad thing if the share of capital income going to the
bottom 95% of the population were increasing to make up the difference, in
fact that would be a good thing, but the reality is the opposite. Not only
has the share of national income going to wages been declining over the past
30 years, but the share of capital income going to the bottom 95% of the
population has been declining as well. Thus, a larger portion of national
income has been going to capital and an increasingly larger portion of that
capital income has been going to the richest 1% of the country.
During the 1970s and 1980s the financial sector accounted for no more
than 16% of domestic profits, yet so far in the 21st century the financial
sector has accounted for roughly 40% of domestic profits. In 1947 the
financial sector accounted for about 2.5% of GDP, and by 2006 that figure
had risen to 8% of GDP.
The rise of financial sector profits certainly corresponds to the decline
in labor's share of national income, however this isn't simply because the
financial sector is taking a larger share of the national income itself
(though that is part of it), it is also because of the effects of the
financial sector on the rest of the economy. While the graph above compares
financial sector profits to profits in non-financial sectors, the fact is
that the financial sector controls the non-financial sector to a large, and
increasing, degree. The financial sector plays a huge role in selecting
boards of directors, in the selection of corporate executives, in the
setting of executive pay, in off-shoring of the non-financial sector, in
corporate accounting, in corporate tax compliance, and of course a huge role
in the lobbying of government and the creation of the tax code and economic
regulations.
It is the financial sector that has most strongly driven the shift away
from wages and toward profits. The dominance of the financial sector has
grown to the degree that, in essence, all corporations now work for the
financial sector. To be more precise, the executives of publicly traded
corporations essentially work for the financial sector and to a degree even
the executives of privately held corporations do. Even the interests of
executives for privately held corporations, such as Koch Industries,
Cargill, and S.C. Johnson are often, though not always, heavily aligned with
financial sector because these corporations still have to raise investment
capital, and even when their interests aren't directly aligned they
have often had to follow the lead of publicly traded corporations in regard
to compensation practices, lobbying, and off-shoring, etc. due to market
forces.
Capital ownership has become extremely concentrated as the financial
industry has consolidated and financial wealth itself has become
concentrated. Not only that, but of the financial assets held by the bottom
90% of the country, most of those assets are held through mutual funds and
other types of administered pools which grant any voting rights to financial
institutions instead of the individual investors.
When an individual buys shares of a mutual fund, the individual is
supplying the capital, but the mutual fund manager is who gets the voting
rights, because the mutual fund manager is who uses that money to buy actual
shares, and the mutual fund manager is the holder of the shares. As such
they get the voting rights, so interestingly the working class, largely
through its investment in 401(k) style private retirement accounts,
actually increased the financial sector's control over capital, which the
financial sector has used to act against the economic interests of the
working class.
The central fact of America's economic history, however, is this: Capital
ownership has become increasingly consolidated over time, and dramatically
so.
The graphs below illustrate the consolidation of capital that has taken
place over time in the United States. Both graphs account for free citizens
only.
Both graphs are based on estimates made by me using several different
data sources, since there is no clear single data source I have found that
provides this information. Estimates from prior to the Civil War are based
on land and slave ownership rates as well as general wealth distribution.
Estimates from the end of the Civil War through the early 20th century are
based on farming and self-employment rates as well as wealth distributions.
Estimates from after World War II are based on small business ownership
rates, stock ownership and general wealth distributions.
Prior to industrialization virtually all wealth owned by individuals was
capital, whereas today most people's wealth is primarily non-capital,
meaning that today most people's wealth is tied up in non-productive
property, primarily homes, which are no longer a means of production as they
were in early America. Today the bottom 90% of the population owns roughly
15% of all financial wealth, which is comprised of stocks, bonds, business
equity, trusts, and investment real-estate (which is the most common form of
capital held by the bottom 90%).
The most significant drop in capital ownership has been in terms of
business equity, i.e. self-owned businesses, including farming. This is, of
course, primarily a product of industrialization. Prior to industrialization
the United States (and the preceding block of 13 colonies) had not only a
farming economy, but an economy based on highly distributed individual
capital ownership, where almost all white families directly owned their own
capital and worked for themselves. With the rise of industrialization and
corporations, however, individual producers were unable to compete with
collective production, so individual capital ownership rapidly
declined as collective production, controlled by corporations, out-competed individual producers.
In the early American economy total wealth ownership was heavily tied to
capital ownership, so as capital consolidation took place the share of total
wealth held by the bottom 90% of the population followed the same declining
trend. Standards of living for the bottom 90% were still increasing as the
size of the entire economic pie grew, but the portion of the
nation's total wealth going to bottom 90% was decreasing as the entire pie
got larger. (In other words if the bottom 90% received 50% of an economic
pie that was 100 units big in 1800 that would be 50 units, but by 1900 they
were receiving roughly 33% of a pie that was now 500 units, or 165 units,
so while the share shrank the standard of living was still increasing). This
trend continued essentially until the progressive reforms of the early 20th
century which resulted in a larger share of the wealth that was created
going to workers, however capital consolidation continued.
The New Deal reforms of the 1930s and 1940s significantly
increased the portion of wealth going to labor and created various social
safety nets, resulting in conditions in which the incomes and overall wealth
of the bottom 90% of the population became less dependent on capital
ownership, while the portion of capital owned by the bottom 90% of the
population continued to shrink. What the New Deal reforms did was they made
it possible for a middle-class to exist which did not own capital, but the
New Deal did not change the underlying fundamentals of the capitalist
economy.
Economic power and control remained in the hands of capital owners, and
as capital consolidation continued economic and political power was
inevitably consolidated as well. The continued consolidation of capital
resulted in increased economic inequality as consolidated capital ownership
drove profits to a shrinking portion of the population, contributing to a
cycle of increasingly concentrated wealth leading to increasingly
concentrated political power, which in turn has been used to advance the
interests of the increasingly wealthy, leading to greater concentrations of
wealth and thus ever greater concentrations of political power, which is
used to advance the interests of the wealthy, etc., etc., etc.
Through this process, over the past 30 years the mechanisms for
supporting a non-capital owning middle-class have been eroded. Over the past
30 years economic polices have swung back in greater favor of capital
owners, increasing the relationship between capital ownership and overall
wealth, while at the same time doing nothing to facilitate more widespread
capital ownership, indeed the opposite, facilitating continued and
increasing concentration of capital ownership.
The persistent decline in overall capital ownership throughout history in
America, arguably the world's leading capitalist economy, indicates that
concentration of capital ownership is an inherent quality of capitalism,
which inevitably leads to centralization of power, fundamental
disenfranchisement of the majority of the population, and economic
stagnation.
Next, then, we will take a look at economic theory which can be used to
explain these qualities of capitalism.
Sources: The primary source for this section is
American Economic History - sixth edition; Jonathan Hughes & Louis
P. Cain; 2002. Other sources are linked within the text.
Before analyzing capitalism we first have to define what capitalism is,
which may sound simple enough, but it is actually quite complicated. This is
because the very definition of capitalism is itself skewed by ideological
perspective. Definitions of capitalism are used to frame perceptions of
capitalism and to focus on specific qualities while taking attention away
from other qualities. Proponents of capitalism provide definitions of
capitalism that focus on "free-markets" and private property ownership.
These are the most commonly used types of definitions in the United States.
Examples of such definitions include:
An economic system characterized by private or corporate ownership of
capital goods, by investments that are determined by private decision,
and by prices, production, and the distribution of goods that are
determined mainly by competition in a free-market.
http://www.merriam-webster.com/dictionary/capitalism
An economic system based on a free-market, open competition, profit
motive and private ownership of the means of production. Capitalism
encourages private investment and business, compared to a
government-controlled economy. Investors in these private companies
(i.e. shareholders) also own the firms and are known as capitalists.
http://www.investopedia.com/terms/c/capitalism.asp#axzz1VxMk733J
Economic system based (to a varying degree) on private ownership of
the factors of production (capital, land, and labor) employed in
generation of profits. It is the oldest and most common of all economic
systems and, in general, is synonymous with free-market system.
http://www.businessdictionary.com/definition/capitalism.html
On a side note, capitalism is not the oldest of all economic
systems, it is widely accepted to have emerged in the late 18th to
early 19th century.
What is missing from these definitions, however, is any sense of the
inherent divisions implied by private capital ownership and the necessary
distinction between capital owners and the wage-laborers whom they employ.
The result of such definitions glosses over this relationship and leave the
impression that in a capitalist system everyone is a "capitalist" or that
there are no conflicts of interests between members of the private economy.
If anything, such definitions tend to portray a conflict of interest between
capital owners and government, which is not at all inherent, but leave no
impression of inherent conflicts of interest between capital owners and
workers or between capital owners and other capital owners.
The definition of capitalism provided by Wikipedia is a little better, it
states:
Capitalism is an economic system in which the means of production are
privately owned and operated for profit, usually in competitive markets.
Income in a capitalist system takes at least two forms, profit on the
one hand and wages on the other. There is also a tradition that treats
rent, income from the control of natural resources, as a third
phenomenon distinct from either of those. In any case, profit is what is
received, by virtue of control of the tools of production, by those who
provide the capital. Often profits are used to expand an enterprise,
thus creating more jobs and wealth. Wages are received by those who
provide a service to the enterprise, also known as workers, but do not
have an ownership stake in it, and are therefore compensated
irrespective of whether the enterprise makes a profit or a loss. In the
case of profitable enterprise, profits are therefore not translated to
workers except at the discretion of the owners, who may or may not
receive increased compensation, whereas losses are not translated to
workers except at similar discretion manifested by decreased
compensation.
There is no consensus on the precise definition of capitalism, nor on
how the term should be used as a historical category. There is, however,
little controversy that private ownership of the means of production,
creation of goods or services for profit in a market, and prices and
wages are elements of capitalism.
http://en.wikipedia.org/wiki/Capitalism
Here are the important points. Capitalism isn't simply an economic system
in which there is private property ownership. For example, if you have a
society in which everyone privately owns their property but it is a
subsistence economy where for the most part everyone creates all their own
goods, i.e. everyone is a farmer who lives on their own property, farms for
themselves, and consumes the products of their own labor and property, this
clearly is not a capitalist system. It's a system with private property
ownership, but it isn't a capitalist economy, indeed it is barely an economy
at all, since there is little or no exchange of goods and services.
So a capitalist system is one in which commodities are produced for
exchange.
As for "private property", this term is often misconstrued to mean all
property, but this is not the case; the definition of capitalism rests not
on private property rights in general, but private ownership of the "means of
production", i.e. capital, hence the term "capital-ism". Even non-capitalist
systems may retain private property rights regarding commodities and
non-productive property, like houses, cars, etc., but any economy that didn't
include private ownership of capital, i.e. property used to create value and
derive income, would not be a capitalist economy.
So a capitalist system is one in which privately owned capital is used to
produce commodities for exchange.
However, if everyone owned their own capital and worked for themselves to
create commodities then no one would be a capitalist. A capitalist is
someone who derives their income through the ownership of capital upon which
other people are employed to work. In essence, if everyone owns the capital
that they use then no one is a capitalist, since if everyone owned their own
capital everyone's income would purely be a product of their own labor, no
one would derive income from capital ownership. (We'll get into this more
later.)
So a capitalist system is one in which non-capital owners are paid wages
by private capital owners to create commodities for exchange.
So these are the core components of the definition of capitalism, an
economic system in which some people own capital and some people don't, and
the people who own capital pay wages, which are determined by markets, to
non-capital owners to use the capital that they own to create commodities
for exchange in markets.
While these are the core defining characteristics of a capitalist system,
there is always some leeway in the application of these definitions. For
example in the United States we have had a federal minimum wage for over 50
years which means that labor prices are not always determined purely by markets.
Likewise there are many price controls, taxation policies, and subsidies
which distort market prices of other commodities as well. Similarly, as has
been noted above, roughly half of Americans own some kind of share of
capital, i.e. stocks or direct business equity, etc., but owning a tiny
insignificant share of capital doesn't make one a capitalist and doesn't
qualify for the condition of everyone being a capitalist so that no one is.
Over 99% of Americans who own stock don't own enough to have any meaningful
influence over the use of capital, i.e. they have no control over capital
through their stock ownership. Likewise, the vast majority of American stock
owners own such small shares of stock that the income which is generated from
it is insignificant. Most American stock holders work for wages and receive
virtually no income from stock ownership until they retire and even then
depend on supplemental income such as Social Security or a pension in
addition to income from their stock holdings. So while the distinction
between wage-laborers and capital owners is somewhat blurry in the American
system, if we look at primary forms of income and control, the distinctions
are still quite clear.
In essence, what we are really talking about when we talk about all
modern economies are systems of collective production. Every modern economy
is a "collectivist" system of some form or another, including capitalism.
The difference in various modern economic systems is merely in how the
products of collective labor are distributed. There are no modern economic
systems dominated by individuals working in isolation or through
self-employment. The driving force behind all modern economics system is
collective production, and the defining characteristic of all modern
economies is the massive scale of collective production, not only in terms
of the size of collective entities, such as corporations that directly
employ millions of workers, but in terms of the collective integration of
separate entities. The difference between historically defined systems like
communism, socialism, fascism, and capitalism isn't in determining whether
people will work collectively or not, it is in determining how the products
of collectively produced value are distributed. Who owns the work product
that is produced by millions of people working together? That's the real
distinction between various modern economic systems.
Also notice that in my definitions of capitalism I did not use the term "free"
market. There is a reason for this, not the
least of which is that defining what "free-market" means is itself even more
difficult and controversial than defining capitalism. If we look at the definition of capitalism provided by Investopedia above
we see that it includes the phrases "free-market" and "open competition".
These are not actually defining characteristics of capitalism. Capitalist
systems can exist that operate under "free-market" conditions (of various
definitions, which we will address later) and open competition, but they don't necessarily require "free-markets" with open competition.
Indeed the American economy is not a "free-market" (by any definition of the term) nor is there 100% open competition.
The key defining characteristic of capitalism is private ownership of
capital and the employment of non-capital owning wage-laborers by capital
owners. A capitalist system is one in which capitalists profit through their
ownership of capital. Even if prices are heavily manipulated or if there is
heavy dominance by monopolies, if the capital owners still profit through
their ownership of capital then it is a capitalist system. There may need to
descriptors attached to the term capitalism in such cases, such as
state-capitalism or corporate-capitalism or monopolistic-capitalism, but
these are still a types of capitalism, types of systems in which profits are
reaped by private capital owners through the ownership of capital and the
employment of wage-laborers who produce commodities for exchange.
I consider this subject to be the single biggest point of confusion when
it comes to economics in general, but especially in regard to capitalism.
Probably the most significant subject of economics, at least from a moral
and philosophical perspective, is the issue of contribution vs. reward.
Everyone has a fundamental sense of fairness which directs us to believe
that, at base, individuals should be rewarded based on their contributions.
This is the essence of John Locke's statement that an individual has a right
to the value that they create with their own labor. Basically, if I go to
unclaimed land and dig up some clay out of the ground and fashion it into a
bowl then that bowl is mine, I have a right to it, and virtually everyone
agrees with that premise.
The problem with discussions of contribution vs. reward in a capitalist
economy, however, is that while virtually all discussions are based on that
premise, that premise is completely invalid in a capitalist economy. To
be more specific, discussions of value creation and reward within a
capitalist framework are almost always framed as if everyone in a capitalist
economy is an individual producer and receives nothing more in reward than
the value created by their own labor, when in fact no one in a
capitalist system is an individual producer who receives the true value of their
own labor.
Let's examine various modes of production outside of the context of any
given economic system, without regard to property rights or labor markets,
or any defined framework for allocating the products of production.
The most basic mode of production is simply individual production. With
the individual mode of production it is relatively easy to determine who
creates what, and what each person's reward should be. Assuming that there
are no existing property rights and a right to the products of one's own
labor as described by John Locke, each individual's reward is simply in
keeping the products of their own labor. Again, this assumes no existing
property rights, which is a fundamental requirement for the basic
functioning of John Locke's natural right to property, because if an
individual were to labor on someone else's property or using someone else's property, then the whole
picture gets far more complicated, as we will later see. So under the individual
mode of production, assuming no existing property rights, and a natural
right to the product of one's own labor, it is quite easy to determine who
creates what and what value each individual is entitled to.
Using the diagram above let us refer to the light blue diamonds as "widgets"
and for sake of argument imagine a theoretical economy where widgets are the
only commodities that exist. What we can see is that individual A creates 1 widget, B creates 2
and C creates 4. Regardless of why there is a difference between what A, B,
and C produce (maybe A is a child, maybe A is disabled, maybe A is elderly,
maybe A is simply lazy, or maybe A just isn't very good at producing
widgets) clearly there is a difference in what each of the individuals
produce.
In terms of basic fairness, assuming that all else is equal, we would say
that taking a widget from C to give to A because A has fewer widgets is
unfair. This is a position that basically every economist from John Locke
to Adam Smith to Karl Marx to Ayn Rand to Milton Friedman is in agreement
on. There is, essentially, nothing controversial about our understanding of
the individual mode of production. It might be nice for C to give a widget
to A, but to forcibly take a widget from C to give it to A would indeed be a
form of theft and would be unfair to C.
But now we move on to collective production. By collective production we
mean simply any mode of production in which multiple individuals work
together to produce goods or services. As we can see, the total number of
widgets produced by individual production is 7 and under collective
production we have 12 widgets being produced. This represents the fact that
individuals work collectively because individuals are able to create more
net value by working together than they are able to create when working
individually.
Note that for the sake of this discussion, A, B, C do not represent the
same individuals under each mode of production. The diagram for each mode of
production is separate from the rest, meaning that we aren't to imply that
individual A is less productive in the collective production diagram because
individual A is less productive in the individual production diagram.
So the interesting thing about collective production is that while it
leads to increased net productivity, determining who created what is much
more difficult, even without the complicating factor of property rights.
Assuming no property rights, how are the widgets to be divided up amongst
the individuals who created them? According to John Locke's statement on an
individual's right to possession of the value that they create with their
labor, each individual should get what they produced. But with collective
production it is essentially impossible to determine what each individual
produced, since, by virtue of the fact that collective production is more
productive than individual production, this implies that "the whole is
greater than the sum of its parts", which is to say that a certain portion
of what is produced is a product of collectivism itself, i.e. it is
not a product of the labor of any individual, it is truly a product of the
interactions between the individuals.
If you were to take a small group of people and have them work
collectively and then have them divide up the products of their collective
labor, in a neutral setting what would most likely happen is that
individuals would pay attention to who contributes what and who was working
the hardest, etc. and form opinions in their mind about what portion of
overall production each individual was responsible for. They could even go
so far as to track the exact output or the exact working time of each
individual. Accordingly people would then
divide up the proceeds of production in proportion to the relative estimated
contributions of each individual. That's not how our economic system works
and its not how hardly any economic system has ever worked. In reality,
under collective forms of production, such as existed in tribal groups, etc.
everything was highly influenced by social status, which was itself a highly
complex system based, variably, on any number of things, from family history
to individual accomplishments to intimidation to political or religious
power to bribery, etc. So all kinds of means have existed throughout
history that have distorted the ways in which individuals received rewards
from collective production, over-compensating some individuals while under-compensating others. Yet, collective production persisted for a variety of
reasons, including that fact that even individuals who were under-rewarded
based on their relative contribution may still have been better off than
they would be under an
individual mode of production. Another reason, of course, has been coercive
force, be it slavery or simple social pressure, to get under-compensated
individuals to contribute to collective production while being under-rewarded. Throughout history the "fairness" of collective production has
varied widely from one society to the next, and indeed a major aspect of
social structure in every society has been precisely how to deal with
dividing up the fruits of collective production.
Now let's move on to hierarchical collective production. Hierarchical collective
production is essentially just a form of collective production
that involves greater division of labor and specialization, within a
hierarchal structure. Fundamentally hierarchical collective production isn't
much different than basic collective production, but there are some
important distinctions. Within the hierarchical mode of collective
production the ability to determine how much value each individual creates
is complicated by two primary conditions, the first being division of labor
and specialization, the second being the nature of hierarchy itself. When
each individual is roughly equal and each individual is doing roughly the
same type of work, then evaluating how much each individual contributes is
relatively simple. However, division of labor and specialization implies
that individuals are performing significantly different tasks. The most
fundamental of these divisions may be planning vs. execution, or managers
vs. performers, which brings us to the hierarchical aspect.
Under a hierarchical system of collective production some individuals are
directly involved in the production of goods and services, while others are
only indirectly involved. Generally speaking, "managers" do not directly
create value via hierarchical collective production, they (theoretically) add
value by enhancing the productivity of the performers that they manage.
Looking at the diagram for hierarchical collective production above, we see
that all of the widgets are actually produced by individuals B and C, A
doesn't create any widgets. This means that in order for A to be
compensated some portion of the widgets produced by B and C have to be
allocated to A. Typically, of course, an individual would not manage
only two other individuals, as depicted here. This is an important note
since managers/planners/administrators, etc. don't produce commodities, all
of the compensation for such positions has to be generated by the production
of commodities by performers. This is a major reason why hierarchical systems
have pyramid type structures, because it takes many performers to support a
manager.
It is virtually impossible, however, to determine the real contribution
of "managers". Let's use a rowing team as an example. Rowing teams use
someone called a coxswain who sits in the boat with the rowers and sets the
pace, helps guide the boat, and provides encouragement, etc. Now, let's say
that a rowing team with a coxswain performs 25% better than one without a
coxswain. Does that mean that the coxswain is fully responsible for 25% of
the performance of the team? Let's say that the team has eight rowers and
they enter a race (in which all of the other teams also have eight rowers
and a coxswain). Let's say that first prize for the competition is $10,000.
How should the team divide the prize money? Should the coxswain get 25% of
the prize money because a coxswain generally improves performance by 25%?
This would result in the following compensation assuming all rowers get the
same amount: $2,500 for the coxswain and $938 for each rower. But what does
a coxswain do compared to the rowers? The coxswain is certainly an easier
job; they don't have to workout or train as intensively, they don't have to
exert themselves as much during the race. Let's say, for sake of
argument, that simply putting a metronome in the boat would increase
performance by 10%, which is less than the coxswain, but more than doing
nothing. No one would argue that the metronome or the metronome
owner should get 10% of the prize money would they?
So, when it comes to hierarchical collective production determining what
each individual actually produces is even more difficult because
"non-performers", i.e. managers, executives, administrators, etc., don't
directly produce commodities of determined value. To complicate matters even
more, hierarchical systems are heavily influenced by social pressures. There
is strong incentive to compensate managers more than the performers that
they manage, even if they contribute less to overall production than any
individual performer, because of the way that people perceive authority.
Authorities within hierarchical systems tend to have more control and
asymmetric information regarding performance, as well as the ability to
affect conditions for those under them. The very nature of the pyramid
structure of hierarchical systems means that individuals are generally
increasingly powerful the higher up in the hierarchy they are. In relative
terms, generally every individual is as powerful as the collective total of
the individuals below them in the hierarchy. In other words, in an
organization with 100 performers, which are managed in teams of 10 resulting
in 10 middle managers, who are managed in teams of 5 by 2 executives, who
report to a president, each of the middle managers is essentially as
powerful as the 10 performers that they manage, and the 2 executives are as
powerful as the 10 middle managers that they manage, and the president is as
powerful as the two executives that he manages, which means that the
president is 100 times more powerful than any individual performer, and
middle managers are 10 times more powerful than any individual performer.
Thus, in terms of determining compensation, those higher up in the hierarchy
have a disproportionate ability to influence compensation, to distort
compensation in ways that don't reflect actual contribution, which
invariably leads to distorting compensation in ways that benefit those
higher in the hierarchy. This is the basis for the formation of unions to
band individuals at the lower levels of hierarchical organizations together
so that they can act as a single individual, thus putting the workers,
acting as a single entity, on par with others higher in the hierarchy in
terms of power, which is something that I'll address in greater detail in
a later section.
And now we finally arrive at industrial collective production. Industrial
production is also inherently hierarchical, but the difference between industrial production and simple hierarchical production is that under an
industrial system of production the tools of production are far more
significant. In theoretical terms we ignore the impact of tools when
considering simple hierarchical production, but when we consider industrial
production we acknowledge that the tools themselves are a major contributor
to productivity. Indeed the term "tools" puts things very mildly, what we
are really talking about are machines, which is to say automated tools or
tools powered by something other than people or animals.
The important difference between simple hierarchical production and
industrial production is that changes to the tools of production under an
industrial system can have significant impacts on workers in the system. The
major advantage of industrial production over other forms of production is
labor efficiency, which means that industrial production reduces
the amount of labor required to generate a unit of output. Note, however,
that this doesn't necessarily mean that industrial production is more
efficient in terms of its use of resources, indeed in many cases industrial
processes waste more recourses per unit of output than non-industrial
methods. The tradeoff with industrial production is in terms of labor
efficiency, which means that if it take less human effort to produce a
widget using an industrial system, but in the process excess material is
wasted, the overall system is more efficient in terms of labor but less
efficient in terms of resources. This can still lead to an overall increase
in output and overall reduction in commodity prices when the acquisition of
raw materials itself becomes industrialized, thus reducing the amount of
human labor required per unit of output.
But let's stick to the relationship between tools and workers under the
system of industrial production. Tools increase the amount of output each
worker is capable of generating, which is a good thing. This means that in
total we can produce more goods. It also means that improvements to the
tools of production can increase productivity even more, which means that
improvements to the tools of production can result in workers going from
being able to produce 10 widgets a day to being able to produce 15 widgets a
day. But here is the big question: If improvements to the tools of
production lead to increased output, who gets the increased output?
Furthermore, how can one differentiate between increases in output due to
improvements to the tools vs. increases in output due to improvements in
worker performance? Note that in this section we are simply dealing with
modes of production, not economic models, so things like who owns the tools
or how compensation is determined are not defined. So let's move on to the
next section where we can examine how this all works within a capitalist
system of property rights and labor markets.
In the previous section we raised a lot of questions about how to
determine who actually creates what value under various modes of collective
production. It is very easy to determine who creates what value under
individual modes of production, but capitalism is inherently dominated by
collective modes of production, most specifically the industrial mode of
collective production. A "capitalist economy" may include individuals who
work for themselves, by themselves, but such individuals are not capitalists
and aren't a part of the capitalist system, they are independent individuals
who co-exist within a capitalist economy, just as
co-ops
and state run enterprises may exist within a capitalist economy even though
they are not capitalist entities.
When we are dealing with capitalism what we are really dealing with is a
particular system of laws that govern forms of collective production. And
the particular set of laws that define capitalism, as we have previously
noted, are laws defining private ownership of the means of production (i.e. tools
and raw materials) and the
use of labor markets to determine how value that is created by multiple
people working together is
distributed. To put it another way, capitalism is a form of collectivism
that allocates the fruits of labor to property owners.
We noted above that the discussion of the modes of production was going
to ignore property rights for the moment, particularly property rights in
relation to capital. This is because property rights in relation to capital
greatly complicate the issue of how value that is created by individuals'
labor is allocated. Let's go back to the most basic mode of production,
individual production. We've said that, in agreement with John Locke's
statement that an individual has a right to the products of his or her own
labor, every individual should receive the full value of what they create
with their own labor. But, what if someone exercises their labor upon
property that someone else owns? I used the example previously of someone digging up
clay and making a bowl from it, noting that of course this person
should have a right to keep the bowl that they made. But what if the person
dug up the clay on land owned by someone else? Then who has a right to the
bowl? Technically, the material the bowl is made of belongs to someone else,
and the value added to the raw clay belongs to the person who made it, but
these two "things" co-exist within the same object. Certainly the issue of
"having a right to the product of one's own labor" is complicated by
private ownership of capital. Objectively we may conclude that the value of
the raw clay belongs to the owner of the property and the value added to the
raw clay belongs to the individual who exercised their labor upon the earth
to dig it up and fashion it into a bowl, but that isn't how it works within
a capitalist system.
Here is what is important to understand about the capitalist framework.
Within the capitalist framework fundamentally everything goes back to
property rights, which means that under a capitalist system the bowl belongs
completely to the owner of the land from which the clay was drawn, even if
the value of the raw clay was five cents and the value of the bowl is fifty
dollars. So 100%
of the value belongs to the original property owner, the laborer has no
right to any value, and thus is in fact deprived of the value created by
their labor. That is, at least, the starting point of capitalism. We have,
over time, established laws that grant some rights to laborers, such as
minimum wages, guarantees of payment, etc., but fundamentally the right to
ownership of newly created value belongs completely to the owner of the
property used to create said value. Typically in a capitalist system,
however, individuals come to an employment agreement when an individual is
going to exercise their labor upon someone else's capital, in which the
laborer and the capital owner agree to a set price to be paid to the
laborer, with the capital owner keeping full ownership of the resulting work
product.
So let's move on to collective production and labor markets to see how this plays out in the big scheme of things.
Advocates of capitalism claim that "labor markets" can properly distribute the
fruits of collective production among all of those involved in the
production process, including workers and capital owners. Labor
markets effectively only play a role in hierarchical and industrial modes of
production, where workers negotiate their compensation with some
hierarchical authority. According to neo-classical labor market theory, the value
that
an individual worker creates is determined by the price they are able to
negotiate for their labor. This view is treated as common place in
neo-classical economics, as described in this passage from a paper on the
effect of minimum wages by a "libertarian" think tank.
Minimum wage laws, if meaningful, require employers to pay some
workers more than they would have earned in an unhampered market
economy. For example, whereas the federal minimum wage at this writing
is $5.15 per hour, in the absence of this minimum some employers might
pay their workers $4.50 per hour. Economic theory
suggests that in competitive markets, workers will be paid their
marginal revenue product—the amount of revenue that the worker
contributes to the firm. That is a wage consistent with the
profit-maximizing behavior of employers and the utility-maximizing
behavior of employees.
Thus, if a firm in an unregulated market economy is paying its
workers $4.50 an hour, it is probable that the marginal contribution of
the worker to the firm is about $4.50 in revenue per hour. If, in fact,
it were higher, say $5.00, it would be profitable for another firm to
offer the worker in question a higher wage than the existing $4.50.
-
Does the Minimum Wage Reduce Poverty?- Employment Policies Institute
If this were true then employees would be paid the exact full amount of
all of the value that they create. This is the way in which all discussions
of income, or value creation and reward, are popularly framed in America
today, yet it is obviously incorrect and completely contradicts classical
economics, as noted by Adam Smith's statements on wages and profits in
The Wealth of Nations and as noted by the classical economist David Ricadro.
The value which the workmen add to the materials, therefore, resolves
itself in this case into two parts, of which the one pays their wages,
the other the profits of their employer upon the whole stock of
materials and wages which he advanced. He could have no interest to
employ them, unless he expected from the sale of their work something
more than what was sufficient to replace his stock to him; - Adam Smith;
The Wealth of Nations - Book 1 Chapter 6
Thus the labour of a manufacturer adds, generally, to the value of
the materials which he works upon, that of his own maintenance, and of
his master's profit. ... Though the manufacturer has his wages advanced
to him by his master, he, in reality, costs him no expence, the value of
those wages being generally restored, together with a profit, in the
improved value of the subject upon which his labour is bestowed. - Adam Smith;
The Wealth of Nations - Book 2 Chapter 3
If the corn is to be divided between the farmer and the labourer, the
larger the proportion that is given to the latter, the less will remain
for the former. So if cloth or cotton goods be divided between the
workman and his employer, the larger the proportion given to the former,
the less remains for the latter. - David Ricardo; The Principles of Political
Economy and Taxation, 1817
The important phrase of note in the statement from the Employment
Policies Institute is "competitive markets". Given the context, this term
can only be interpreted as meaning a "perfect market", which is a subject
that we will address in detail in a later section on markets; but it is
sufficient to say here that the statement that in a perfect market "workers
will be paid their marginal revenue product" is technically true in the
theoretical sense, yet it is never true in an actual capitalist system
because perfect market conditions never exists. Under the conditions of a
"perfect market" all profits are driven to zero, under which conditions
capitalism cannot operate, which is why, as we will explore more fully,
capitalism is dependent upon imperfect, or distorted, markets.
For now let's set theory aside and look at reality. The reality is that,
as Adam Smith describes, in order for an employer to have any reason to hire
an employee, that worker has to create surplus value above and beyond what
is paid to the employee. As Adam Smith describes it, the value created by
the worker is divided between the portion that is paid to the worker in the
form of wages and the portion that is retained by the employer in the form
of profits, which is to say that profits are the value created by workers
which isn't paid to workers as compensation, but is rather retained by
capital owners.
But the reality of labor compensation is even more complex than what Adam
Smith describes, and really demonstrates why the notion that workers could
ever be paid the full amount of the value that they create within a
capitalist system, or any system, is nonsense. The reality is that in order for a worker to
contribute toward profits for a capital owner they have to not only create
enough value to cover the cost of their wages plus the profits of the
capital owner, they also have to generate enough value to cover the costs of
employing them, which is to say that in reality if a worker is paid $4.50 an hour, then
in America we also have to consider the
additional Social Security contributions of the employer, the employer's
workers' compensation insurance to cover the employee, the unemployment insurance
paid on behalf of the employee, the cost of the capital used by the
employee, the costs of training the employee, the cost to supervise the
employee, the cost of administration to process the employee's records and
pay, etc., etc.
Thus, a worker being paid $4.50 would actually costs an employer more
like $8.00 an hour to employ. So, we know that the value of the employee's
labor must actually be at least around $8 in order for an employer just to
break even, but if the value of the contribution of the employee is only $8, then
it still wouldn't be worth employing them at all either, because at a cost
of $8, there would be no benefit to the employer from employing the
employee. So, in reality we know that the value created by the employee has
to be more than $8.
Therefore, generally speaking, in order for a worker to be "worth hiring" to an
employer within a capitalist system they have to be able to create enough value to cover their
wages, the capital owner's cost of employing them, and the profits of the
capital owner or owners. The diagram below depicts a worker who creates 10
widgets, out of which 5 widgets are paid to the worker to compensate them
for their labor (light blue), one widget goes to taxes paid on behalf of the
worker (red), one widget goes toward insurance and other costs associated
with the employment of the worker (dark blue), one widget goes toward the
costs of administration and supervision of the worker (i.e. goes into a pool
of widgets used to pay managers and human resources staff, etc.) (yellow), and 2
widgets go to the capital owner and are considered "profits" (green).
In this example a worker under the industrial mode of collective
production is keeping half of the value that they create, with the other
half going to the costs of employment, managing said worker, and to the
profits of the capital owner or owners. How that value is actually split is
determined by "labor markets" within a "free-market" system.
Under the individual mode of production an individual's "reward", or
compensation, is determined purely by the market value of what they produce,
i.e. the end product. If an individual goes out into the woods, chops down
some trees, uses them to build a boat, and then sells the boat, they
receive the full value of that boat. So an individual's income in that case
is a direct representation of what they produce, i.e. their rewards are
always reflective of their contributions.
Under hierarchical and industrial modes of production however, where
individuals are paid wages, the system is split into two separate markets,
the labor market and the commodity market, that sever the relationship
between what an individual produces and what an individual receives in
compensation. What "capitalists", i.e. owners of capital, i.e. employers,
essentially do when they hire someone is they are engaging in speculation,
and what any employer is doing is they are hiring a worker at a set price on
the bet that what the worker produces will be more valuable than the price
paid to the worker. There isn't necessarily anything wrong with this, the
employer is taking on risk after all, but the real value of the worker's
contribution isn't what was paid to the worker, it is the value of the
product of the worker's labor, and given the nature of the relationship
between capital owners and workers under hierarchical and industrial modes
of production, capital owners are at inherent advantages in the deal. The
capital owner benefits from asymmetric information and lack of market
transparency, as well as hierarchical power. Indeed there are a vast number
of reasons why labor markets result in under-compensation of workers, which
we'll address in more detail after a further examination of market theory
itself.
Now to address the issue of "free-markets". The concept of a
"free-market" comes from Adam Smith, was embraced by other classical
economics such as David Ricardo, and has of course become a concept central
to neo-classical economics. But what exactly defines a "free-market"? First let's
look at one of the important descriptions given by Adam Smith:
Secondly, it supposes that there is a certain price at which corn is
likely to be forestalled, that is, bought up in order to be sold again
soon after in the same market, so as to hurt the people. But if a
merchant ever buys up corn, either going to a particular market or in a
particular market, in order to sell it again soon after in the same
market, it must be because he judges that the market cannot be so
liberally supplied through the whole season as upon that particular
occasion, and that the price, therefore, must soon rise. If he judges
wrong in this, and if the price does not rise, he not only loses the
whole profit of the stock which he employs in this manner, but a part of
the stock itself, by the expense and loss which necessarily attend the
storing and keeping of corn. He hurts himself, therefore, much more
essentially than he can hurt even the particular people whom he may
hinder from supplying themselves upon that particular market day,
because they may afterwards supply themselves just as cheap upon any
other market day. If he judges right, instead of hurting the great body
of the people, he renders them a most important service. By making them
feel the inconveniencies of a dearth somewhat earlier than they
otherwise might do, he prevents their feeling them afterwards so
severely as they certainly would do, if the cheapness of price
encouraged them to consume faster than suited the real scarcity of the
season. When the scarcity is real, the best thing that can be done for
the people is to divide the inconveniencies of it as equally as possible
through all the different months, and weeks, and days of the year. The
interest of the corn merchant makes him study to do this as exactly as
he can: and as no other person can have either the same interest, or the
same knowledge, or the same abilities to do it so exactly as he, this
most important operation of commerce ought to be trusted entirely to
him; or, in other words, the corn trade, so far at least as concerns the
supply of the home market, ought to be left perfectly free. - Adam Smith -
Wealth of Nations Book 4 Chapter 5
Here Smith is discussing the matter of buying and reselling commodities
over a short period of time, which was considered to be three months or
less, to gain a profit. As Smith had discussed prior to this, laws against
such activity had been on the books "since ancient times", as such activity
was widely viewed as callous and injurious to the public. Specifically Smith
was arguing against a law in England which set the upper limits at which
staples like corn could be bought and sold again on the same market within a
short period of time. Here Smith is arguing that such activity does the
public a service, and that therefore there should
be no such restrictions on commodity markets.
There are several key concepts to highlight here. The first of course is
to note that in the paragraphs prior to this quote Smith states that laws
against this type of speculative activity date back to "ancient times", so
Smith was arguing for market liberalization against long standing practices.
Secondly, Smith is arguing not for the "wisdom of crowds" (which is what
markets are often touted as), but for the wisdom of specialists with
in-depth knowledge to drive prices. Third, of course, is the fact that Smith
presents the activity of the specialist trader in driving prices up in the
short-term ultimately as a public service that will presumably result in
lower prices in the future. Thus Smith argues that these corn merchants
should be allowed to engage in short-term trading for profit, which can
drive up prices in the short-term, because he argues that by doing so they
perform a public service by limiting supply in times of plenty thereby
conversely preserving supply for times of scarcity, thereby more evenly
distributing the commodity supply across conditions of bounty and dearth.
Without going into any further analysis of Smith's thought experiment
quite yet, let's simply note that Smith's ideas are foundational to the
modern concept of "free-markets", so now let's look at some current
definitions of "free-market":
A market economy based on supply and demand with little or no
government control. A completely free-market is an idealized form of a
market economy where buyers and sellers are allowed to transact freely
(i.e. buy/sell/trade) based on a mutual agreement on price without state
intervention in the form of taxes, subsidies or regulation.
http://www.investopedia.com/terms/f/freemarket.asp
A free-market economy is one within which all markets are unregulated
by any parties other than market participants. In its purest form, the
government plays a neutral role in its administration and legislation of
economic activity, neither limiting it (by regulating industries or
protecting them from internal/external market pressures) nor actively
promoting it (by owning economic interests or offering subsidies to
businesses or R&D).
http://en.wikipedia.org/wiki/Free_market
So here we can see some of the immediate problems with the concept of a
so-called "free-market". The term "free-market" is largely defined simply as
a market without government regulation, however implicit in the very same
definitions is the idea that without government regulation markets would
operate according to "the laws of supply and demand", that there would be no
"subsidy", that "buyers and sellers" would be "allowed to transact freely",
and that economic activity would be otherwise unhindered.
These assumptions are not just without merit, but real world experience
demonstrates to us that such conditions don't exist in markets of any
meaningful size. Without
government interference there is nothing to prevent interference,
restriction, and subsidy by the mafia, an activity for which we have real
world examples. Without government interference there is nothing to prevent
the erection of barriers to free transaction, used either to extract rents,
to marginalize competition, or to punish groups of people based on any
number of criteria such as race, religion, gender, etc. Furthermore, there
are any number of ways in which non-governmental entities can implement
rules and regulations which distort the laws of supply and demand, a classic
example being the National Football League's imposition of salary caps and
profit sharing across organizations.
So let's look at some specific cases where private actors take action to
subvert the laws of supply and demand or prevent people from transacting
freely in the absence of government regulation. We can forgo obvious
examples like mafia interference and cite practices that are currently legal
or don't involve the use of force or threats.
Manufacturers paying retailers to eliminate competition
The classic case here is the case of Coca-Cola and Pepsi paying and
providing other incentives to retailers for them not to carry competing
products. At certain levels this practice is deemed illegal in the United
States, but it still takes place in more modest forms as well. Soft-drink
manufacturers still provide incentives to restaurants for exclusive
contracts to carry only their beverages. Though it is deemed illegal for
soft-drink companies to pay retailers not to carry competing products at all
(they have done this many, many times), they can pay retailers to heavily
promote their products and not to promote competing products. In such cases
soft-drink companies pay retailers for exclusive preferential product
placement, advertising promotion, sales, etc. In these cases the retailer is
only rewarded if they promote their product exclusively, so they are paying
not just for their own promotion, but also they are paying them not to
promote the competition. Keep in mind that this is the currently legal
version of the practice, in the past soft-drink manufactures would legally
pay retailers not to carry competing products at all, and even after that
was outlawed the practice continued leading to numerous legal cases.
So in the absence of regulation we have an example here of a practice
that clearly violates business being governed by the laws of supply and
demand, in which there is private interference and subsidy, and in which
buyers are prevented from transacting freely with retailers by the
suppliers. The practice of paying retailers not to carry competing products
is, arguably, on-par with mafia practices. Certainly such practices don't
meet Adam Smith's criteria of promoting the public interest.
So here we see a contradiction within the popular definition of a "free-market" as one in which there is both no government regulation and the
market operates according to market principles. This is a case where
regulation is required to prevent the undermining of market principles,
which creates a direct contradiction in the term "free-market".
There are of course many examples of outright monopolies throughout
American history, but a well known company that currently engages in
monopolistic practices and gets away with it is Ticketmaster. Ticketmaster's
basic approach has been to pay venues for exclusive contracts to sell
tickets for performances at those venues, then they tack on high service
fees to the price of tickets for the performances. Given that there is no
competition, and that under the terms of the agreements even the venues
themselves can't sell tickets directly in many cases, there are no alternatives for consumers. In some cases the venues
themselves do retain rights to sell tickets directly at the door, but since
Ticketmaster is their only competition their fees typically match or are
only slightly lower than Ticketmaster's fees.
Unlike Coca-Cola and Pepsi, however, which paid for exclusivity at given
locations but were never able to completely dominate the national market,
Ticketmaster's practices have led to a virtual monopoly on the national
market. This is in part due to the nature of the industry that it is in.
Whereas there are many outlets for the sale of soft-drinks, such as grocery
stores, gas stations, vending machines, restaurants, movie theaters, etc.,
for which there are hundreds or thousands of such outlets in any given city,
there are typically only a few major venues for live performances in any
given state. Whole states typically have anywhere from one to ten venues
where major live performances can be held and 10 to 50 moderate size
locations, so its much easier for Ticketmaster to monopolize the market by
obtaining exclusive contracts with a few hundred locations nation wide.
Exclusivity contracts can't possibly promote the interests of either
consumers or performers. The entity which pays the most for an exclusivity
contract, all else being equal, is the one that will get the contract with
the venue, which means that they then have to charge the most in terms of
additional fees to recoup the cost of the contract. Even if the additional
fees lead to diminished ticket sales the venue and the ticket seller can
still come out ahead, at the expense of the consumers and performers (or the
performer's manager as the case may be), whose revenue comes from the base
price of the tickets.
Live performances are forms of natural monopolies. There is a fixed
supply of available "goods", i.e. "seats", at a single location. The price
of admission for those seats will have zero impact on the supply of the
goods. Adam Smith's argument for a "free-market" in which prices are allowed
to rise was that the rising of the prices would lead to an equilibrium of
supply and demand over time, such that fewer goods would be consumed during
times of bounty if prices were elevated during times of bounty, and those
excess goods would be saved for times of scarcity, leading to lower prices
and more supply when harvests were low. Nothing of the sort can happen in
terms of live performances. The supply of available "seats" at a given venue
is always fixed, it can't go up or down. Inflating the price of tickets
serves no market function, the only thing it does is increase profits, but
with no resulting "public good" as Smith envisioned. And any possible
"public good" that could even be argued for, such as perhaps allowing the
extension of a tour by getting more venues to accept booking, would be
entirely redistributive, unlike Smith's example. In Smith's example the same
population of people "benefit" from the evening out of prices and supply
over time. Generally the same people who would have paid more for the corn
during a time of bounty would be paying less than they otherwise would
during times of scarcity. However, even if charging more for tickets in Los
Angeles led to additional venues signing onto a tour in Chicago, the effects
would be totally redistributive, where the excess fees paid by consumers in
Los Angeles would be benefiting consumers in Chicago, not themselves.
Likewise, there is no ill effect from lower prices, as in Adam Smith's
example either. In Smith's example the lower prices during times of bounty
led to waste of resources that could have been saved for times of scarcity.
In the case of live performances there is nothing to "waste". There is a
maximum number of people who can purchase the good no matter what. All that
lower prices do is shuffle who that group of people might be. If a venue of 5,000
seats will sell out at $10 a ticket and also at $50 a ticket, in either case
5,000 people are going to see the performance. At $50 a ticket it may be a
somewhat different group of 5,000 people, but nothing of substance changes.
In the case of Ticketmaster the additional cost of tickets above what
would be possible in the presence of ticket selling competition serves no
market function in terms of supply and demand, and it has no benefit for the
performers and their managers. The primary benefit goes to Ticketmaster,
with a secondary benefit going to the venue, and the cost of those benefits
are born by the consumers and performers, with no benefits. Ticketmaster is
clearly a rent seeking agent of extortion.
It's impossible to argue that a company which pays to eliminate a market
is interacting in a "free-market". Several lawsuits have been filed against
Ticketmaster on anti-trust grounds, but they have all been dismissed or
settled out of court. The most prominent lawsuit, brought by Pearl Jam in
1995, was inexplicably dropped by the Justice Department without any
explanation before ever going to trial.
It is difficult to argue that if the government were to more strongly
regulate the ticket sales industry to outlaw the practice of ticket sellers
obtaining exclusive contracts with venues that this would make the market
for live performance tickets "less free", yet at the same time this clearly
indicates a contradiction in the definition of "free-market".
The National Football League organization is technically a non-profit
association which oversees franchises of individual owners. There are no
corporations allowed in the National Football League according to the rules
of the association. Taken as a whole, the franchises of the National
Football League are the most successful and profitable of any sports league
in the world. The National Football League association is a private
governing body which enforces a strict structure of economic regulation upon
the franchises and players, which is widely considered to be the foundation
of the league's financial success. So does the economic model of the
National Football League constitute a "free-market" simply because the
regulations are being enforced by a private association instead of "the
government"? Let's take a closer look.
The NFL classifies revenue into two basic categories, shared and
non-shared revenue. The primary sources of shared revenue come from
broadcasting contracts and merchandise licensing. All shared revenue is
divided equally among all of the NFL franchises. Since this shared revenue
is also the largest form of revenue in the league, this creates a relatively
even playing field among the teams, allowing each team to be relatively
competitive. Non-shared revenue comes primarily from stadium ticket sales.
Not only is a majority of the revenue shared equality across all franchises
in the league, but in addition salary caps and floors are set based on
shared revenue, such that even if an individual franchise is able to
generate higher non-shared revenue the salary caps and floors for that
franchise are still the same as all other franchises in the league. Not only
that, but stadiums themselves, the major source of non-shared revenue, are
also highly regulated by the league with maximum seating caps.
In addition all NFL football players are members of the National Football
League Player's Association, which is a union, under which all salaries and
benefits for football players are negotiated. So there is virtually no
aspect of the economy of the National Football League that operates according
to market principles, the entire league is essentially a planned economy (in
which corporations are forbidden), and yet it is largely due to this planned
economy that the The National Football League has become the dominant sports
league in the world.
So we get back to the central question, how does the definition of "free-market" as a market that is free from government regulation, where prices,
exchanges, and compensation are determined by market forces, apply to the
National Football League? Clearly the NFL is an example of a private
organization in which prices, exchanges, and compensation are not determined
by market forces at all, nor are they regulated by "the government".
Another "free-market" paradox is the issue of discrimination. Because
markets can essentially act as a "tyranny of the majority", market forces
can lead to instances of exclusion of certain groups of individuals based on
things like race, gender, religion, or any type of characteristic. In such a
situation market forces would actually be the primary barriers to allowing
certain individuals to "transact freely" and would prevent the determination
of prices by supply and demand.
Contrary to the
recent claims of the libertarian Congressman Rand Paul, racial
segregation and discrimination in the treatment of customers in the South
would not have been solved by "the free-market", indeed it was a product of
market forces. Paul's basic claim was that due to the fact that business
owners are driven by profit motive, they would have had an incentive to
cater to African American customers in order to gain additional customers
and thus increase their revenue, so even without government intervention
"the market" would have eliminated segregation and discrimination against
blacks in the South by business owners. Paul stated in interviews that
businesses in the South which discriminated would have lost revenue due to
having fewer customers since they would have been missing out on black
customers and would have lost the business of "good" whites who would have
boycotted their businesses.
The problem with Paul's claim, however, is that it completely
misunderstands what was happening in the segregated South. Businesses
weren't spurning black customers because the business owners were racists
(though they may or may not have been), rather they were spurning black
customers because their white customers were racists. You see, Paul's logic
only works if the only reason that business owners discriminated against
blacks was because of their own racism, but that's not the case. Business
owners in the South discriminated against black customers due to market
forces, in response to the demands from their more economically important
white customers, thus, "the market" was driving the discrimination. A case
in point was the famous Woolworths' policy of not serving blacks at white-only
counters, which was a policy that the national chain only held in the South
in order to "abide by local custom". After all, when president Eisenhower
forcibly integrated Central High School in Little Rock, Arkansas in 1957
the National Guard had to be brought in to protect the black students from
angry white mobs and to escort them inside the school.
Blacks and 2 whites being taunted by white mob during Greensboro sit-in at a
Woolworths'
Elizabeth Eckford being heckled on the first day of the integration of
Central High School
So here we see the contradiction. The definition of a "free-market"
includes the idea that all buyers and sellers are allowed to "transact
freely", but in this case we have an example where, absent regulations, the
dominant market force (white customers) prevented blacks from being able to
"transact freely". So, free from government restrictions, the private
citizens imposed their own set of market restrictions. In this case the
government restrictions (preventing white business owners from
discriminating against blacks) actually brought about the condition of
allowing all buyers and sellers to transact more freely, which, again,
points to a paradox in the definition of "free-market".
What was happening in the South was that, for example, restaurants run by
white owners either refused to serve blacks at all, or if they did they
served them in separate dining areas, often with separate entrances and
separate restrooms, etc. Obviously this put an additional burden on the
restaurant owners because these separate facilities cost extra money and/or
they lost black business as a result of these practices. However, the reason
that they did this was because if they didn't they would lose almost all of their
white customers. White patrons didn't want to sit next to blacks and eat
dinner in a restaurant, they didn't want to use the same bathroom as blacks,
they didn't want to drink from a glass that had been used by blacks, etc. so
if any restaurant that relied on white business would have served blacks the
same way that they served whites they would have lost most, if not all, of
their white business, which would have been a much bigger economic loss than
any gains in black business. The same went for almost any line of business:
barber shops, clothing stores, grocery stores, movie theaters, etc., etc.
Thus, "the market" is what was actually driving the segregation and
discrimination by white-run businesses in the South.
Indeed one of the ironies of the situation was the fact that some white
business owners actually wanted to serve blacks and, due to the very reasons
cited by Paul, wanted black customers and didn't want the burden of having
to provide separate facilities, but due to "market forces" they were unable
to run their business the way that they wanted to because they were forced
by financial necessity to cater to the tyranny of the white majority. So
business owners were in fact being prevented from running their business the
way that they wanted to by market forces.
Government regulation, in this case, "freed" business owners to run their
businesses how they wanted to and allowed them to expand their customer base
without fear of white customer retaliation; so not only did the government
regulation banning racial segregation and discrimination by businesses allow
blacks to transact more freely, but it also allowed business owners greater
freedom in how they ran their own businesses. Paul's argument about how
market forces would have "eventually" ended racial segregation in the South
relies on an entirely fictional South in which the majority of people were
already opposed to racial segregation, but that wasn't the reality. The
reality was that the majority of people were in favor of racial segregation,
and continuing to cater to the interests of racial segregation in the South
wasn't only economically advantageous, it was an economic necessity.
Businesses in predominately white areas that tried to serve blacks faced the
prospect of going out of business due to market forces, because the
overwhelming majority of white customers were racists and would not
patronize businesses that didn't discriminate. Granted, the social
protests that took place in the South during the late 1950s and early 1960s
did make some progress in desegregating some individual locations, almost
entirely in the "northern South", but when the
Civil Rights Act of 1964 was passed segregation and discrimination was
still widespread and firmly entrenched in the so-called "Deep South".
A final example of "free-market" contradiction is that of toll barriers.
In an unregulated market there is nothing to prevent private individuals
from erecting barriers to trade and then charging tolls for the transport of
goods. This would, of course, be a purely rent seeking activity and in
direct contradiction to the concept of "buyers and sellers" being allowed to
"transact freely". Indeed this type of activity happens all the time if
allowed. In medieval Japan the practice was so widespread in fact that one
of the
major reforms of Oda Nobunaga in the 16th century was the abolition of
private toll barriers, which paved the way for the unification of Japan.
This abolition of toll barriers is simultaneously considered a "free-market"
reform while also being a regulation.
The toll barrier example is another good illustration of "free-market"
paradoxes. If trade is flowing freely through a mountain pass, then a
private individual acquires the land and erects a gate blocking the mountain
pass and charges everyone a fee to pass through the gate, is this to be
considered a "free-market" activity? Clearly this private individual is
preventing individuals from "transacting freely" and the erection of the
gate serves no economic purpose other than the enrichment of the individual
who charges the toll while providing no benefits to anyone else. Everyone
else was better off before the erection of the gate. Government regulation
could prevent this, either by ensuring that the mountain pass remains public
property, or by regulating the types of modifications that can be done to it
by private individuals. In either case such government regulations would
protect the ability of individuals to transact freely, thus advancing one of
the major elements of a "free-market" through government regulation, which,
according to the definition, would make it "anti-free-market".
These are just a few examples of inherent contradictions in the concept
of a "free-market". This is why there is no such thing as a true
"free-market", and can never be. The principles of a free-market are at odds
with one another. Allowing "buyers and sellers to transact freely" in many
cases requires government regulation. The whole concept of a "free-market"
is paradoxical, illogical, meaningless, and in fact harmful in that it often
confuses the conversation and is used to intentionally mislead.
That doesn't mean that the point that Adam Smith was trying to make
wasn't valid, it just means that the way that the term "free-market" has
been subsequently defined and is widely used as an axiom is not valid. If we
go back to what Adam Smith was actually saying and look at the context, what
we see is that Adam Smith is actually saying that prices should be
determined by knowledgeable individuals with a vested interest as opposed to
static rules set by lawmakers who don't have in-depth knowledge of the
market. But these same guiding principles wouldn't necessarily preclude
price-setting by government agencies. The objective laid out by Smith in the
example was to stabilize prices over time by allowing market prices in the
present to better reflect predicted future conditions. Smith says that the
best way to do this is to let those who know the most about future
conditions influence prices to the full extent of their knowledge. At the time that Smith was writing
governments didn't engage in things like monitoring crop conditions and
making crop forecasts or aggregating and analyzing data, etc. In this
situation clearly merchants and farmers on the ground had a better
assessment of future conditions than individuals in government, and could
certainly have done better than static rules which didn't even take changing
conditions into account. But that's not necessarily true today.
For example, today in the United States the
U.S. Department of Agriculture engages in crop forecasting that is among the
most accurate economic forecasting in the world. This is because the
USDA aggregates data from farmers all over the country, and has inspectors
that go out on-site all over the country to inspect conditions and get input
from farmers. They then use all of this data to make forecasts of future
yields. Given that these forecasts are arguably the most accurate picture
that we have of future crop production, by Adam Smith's logic
the USDA should be setting prices for farm commodities. Adam Smith's
argument wasn't really an argument for "the wisdom of markets", it was
really an argument for the wisdom of technocracy, set in a time when
governments were not technocratic. The point here is not to advocate
government price setting, the point here is to point out that Adam Smith's
argument was very specific and applied to a certain set of conditions, with
a defined purpose, it wasn't a broad principle, as the "free-market"
concept is often applied today.
As a broad principle the term "free-market" is a contradictory
theoretical term that has all kinds of inherent inconsistencies and
undesired implications. The purpose of Adam Smith's invocation of "free-markets" was clearly to better align the prices of commodities with current
and future supply and demand. So the objective is simply to align prices
with supply and demand fundamentals, the objective is not to have "free-markets" for "free-markets' sake".
While the term "free-market" is ill-defined and inherently problematic,
what we can talk about are regulated markets, unregulated
markets, degrees of regulation, and pro-market vs. anti-market regulations.
One of the biggest misconceptions about capitalism is the notion that
"capitalists" themselves, i.e. actual capital owners, like "free-markets".
This misconception stems from the historical development of capitalism and
the opposition of merchants and manufacturers to the economic controls of
feudal aristocracies during the 18th and 19th centuries. The economies of
Europe had been tightly controlled under the feudal system for centuries,
and were still dominated by
mercantilist policies at the onset of the industrial revolution. The
works of Adam Smith and other classical economists were in clear opposition
to the feudal system and mercantilist policy, as was the new capitalist
class that rose to power during the industrial revolution, who sought to
overthrow the control of the ruling aristocracies. As such, businessmen
during this time certainly opposed the set of rules and regulations put in
place by the feudal aristocracies, as those rules and regulations were
designed to protect the interests of the aristocracies. In other words, the
capitalists of the 18th and 19th century sought markets that were "free
from" the regulations and barriers that protected the interests of the
establishment, because at that time they were not a part of the
establishment, in fact they were a threat to it.
But here is the issue: Once so-called "democracy" and "free-market capitalism" had
overthrown the feudal aristocracies and put an end mercantilist policy, the
capitalists themselves had become a part of the establishment; they were now
the ruling class, and as such they now sought the implementation of their
own set of rules and regulations to protect their interests. This issue is
actually very similar to the issue of "States' Rights". "States' Rights" is
held out by many so-called conservatives as a cherished principle in and of
itself, but principles such as "States' Rights" and "free-markets" are
seldom really appealed to on principled grounds, they are actually appealed
to only when it suits the position of those making the appeal under a
specific set of conditions.
For example, the proponents of slavery appealed to "States' Rights" when
it became clear that the national mood was trending against slavery and the
advocates of slavery began losing power in the federal government. Yet, had
the pro-slavery position been the dominant position in the federal
government there is no doubt that the advocates of slavery would have
appealed to federal power to entrench slavery. Today we have conservatives
who appeal to the "States' Rights" argument on any number of issues, from
abortion, to immigration policy, to education, to Social Security, when
existing federal laws maintain a position that they are opposed to, yet when
those same people get into power in the federal government they immediately
advocate for federal laws to enforce their views on the whole country.
The issue is the same with capitalists and "free-markets". Capital owners
advocate for "free-markets" when there are existing rules or restrictions
that are against their interests, but they also do everything in their power
to enact rules and restrictions that benefit their interests. They don't
actually adhere to "free-markets" as a principle, they just appeal to "free-markets" when it suits them, and it really couldn't be any other way. It
would be against the self-interest of a capital owner to accept a "free-market" if competition and market forces would result in losses for them.
Thus, when faced with unfavorable market conditions all capital owners are
compelled to advocate for regulations to protect their interests, and they do
so. The most fundamental example of this from the 18th and 19th centuries
was in the area of patent and copyright law. Patents and copyrights are of
course regulations, which put limits on markets and create monopoly rights
thereby inherently restricting supply. The strengthening of patent and
copyright law was instrumental to the rise of capitalism and to the fortunes
of a great many individuals. This again points to the inherent
contradictions within the "free-market" concept. In a true purely "free-market" there would be no patents or copyrights, these are clearly forms of
regulations that capitalists, and indeed non-capital owners, want, at least
in certain forms. Patent and copyright law, at least initially, was
extremely beneficial to non-capital owning individuals who had good ideas.
They helped to ensure, in many cases, that "the little guy" was able to get
the just rewards for their contributions. Indeed patents and copyrights were
among the most common ways that poor and working-class individuals were able
to become wealthy during the 18th, 19th, and even early 20th century. Patents
helped to ensure (though of course they never guaranteed) that a poor worker
with a good idea could benefit from his or her innovations without their
boss or some other established businessperson profiting from it without
giving any compensation to the inventor. Today, however, the overwhelming
majority of patents are filed by corporations, not individuals, and patent
and copyright law is more likely to be used by established capital owners
against the "little guy" upstarts than the other way around.
Furthermore, the fact that capital owners support many regulations isn't
necessarily a bad thing, in fact in many cases its a very good thing. The
point, however, is that the notion that unregulated markets are always
preferred by capitalists is completely false. Let's look at some scenarios
where capitalists seek out market regulation.
When bad actors can undermine whole industries
This is a scenario where the actions of a single or small number of
individuals or corporations can undermine an entire industry, causing losses
or reducing gains for other "good actors". This scenario is especially
common in the food industry, where food-born illnesses can lead to recalls
or customer shunning of whole categories of food, even though only one or
two manufacturers may have been the cause of the food born illnesses. A
recent example of this is the
listeria outbreak among cantaloupe, which resulted in over 20
deaths and one hundred reported illnesses, all of which originated from a
single farm in Colorado. Even though all of the tainted cantaloupe came from
a single farm, it resulted in all cantaloupe from all farms being pulled
from shelves and consumers shunning any and all cantaloupe, and its
likely that this will have impacts on consumer behavior for at least one or
two years; so while one farm was the source of the problem, the
economic impact was felt by all cantaloupe farmers.
In these situations "responsible" businesses who have a lot of
capital at risk don't want their businesses to be undermined by
irresponsible or fly-by-night businesses, so they develop best practices
and/or standards and then appeal to government to enforce those practices or
standards upon the whole industry. The classic example is H.J. Heinz's
support of the
Pure Food and Drug Act of 1906. Indeed Heinz's support for this act was
so instrumental that the Heinz food company touts the company's role in the
passage of the act and its continuing role in government food regulation on
its website under the section
Pure
Food. Pure Good.
The passage of the Pure Food and Drug Act of 1906 resulted in a massive
number of food processors going out of business due to inability to comply
with the regulations. This clearly had a beneficial impact for Heinz, as it
eliminated competition and increased the company's market share, however, it's difficult to argue that forcing
companies out of business that were unable to comply with food safety
regulations was a bad thing. The reason that the legislation was even
brought up was because it had the mutual support of consumers, public health
experts, and industry leaders like Heinz. This was because at that time
there were no regulations at all dealing with food labeling or industrial
food safety, and there were thousands of different food processing companies
engaged in things like canning and jarring at this time. There were no
standards; companies could put whatever they wanted on their labels, they
often made completely unsupported medical claims, describing things like
cocaine as a health food, and not all of them used sanitary practices. But due
to labeling practices, etc. even knowing which company's food you were
buying wasn't always clear. Even if you could tell, at this time things
were in such flux that there was little in the way of established brands
that you could rely on being in the store on a regular basis, etc. Likewise,
it was impossible for responsible food processors to compete on price with
irresponsible food processors, which enabled irresponsible food processors
to hang on to market share since their products were safe enough that people
didn't get sick from them every time.
As a result, what was happening was that unsanitary food processors were
ruining the reputation of processed food for everyone. When someone would
try canned food and then get sick from it, it would turn them off to all
canned food, etc. So Heinz and other industry leaders who did practice
quality control appealed to the government to enforce their type of quality
control practices on everyone, so that consumers would feel safe buying
processed foods so that the industry as a whole would benefit. If, in the
process, some food processors couldn't afford to adopted the practices
necessary to meet the standards, well, that was just too bad.
The act of regulation was a benefit to specific capitalists and a
detriment to others. For those capitalists who benefited, they had succeeded
in getting the cost of quality control for their industry to be paid for by
taxpayers and in erecting barriers to entry for any would-be upstart
competitors. While Heinz benefited from the regulations. The enforcement of
the regulations, which the corporation benefited from, cost Heinz nothing
other than the lobbying efforts on the bill's behalf. The cost of inspecting
individual food processors and enforcing the rules fell onto the government,
and was paid for by the entire tax paying population. This is another reason
why capitalists like government regulation, because it almost always is a
means of externalizing costs for those businesses that benefit.
When short-term incentives run counter to long-term interests
The obvious example here is the recent housing bubble. We've already gone
through the details of the housing bubble, but the thing to focus on here is
the fact that many individual mortgage brokers and loan originators did not
want to give loans to people that were obviously unqualified, and indeed
they knew that originating loans for unqualified people who were likely to
default on their loans was bad for the industry and was in fact bad for
their own business. However, the problem was that due to market competition,
if a mortgage broker or loan originator didn't issue loans to individuals
that other mortgage brokers were willing to, then they would lose business,
and in the short term market competition would drive "responsible" brokers
out of business. You can hear more about this here:
The Giant Pool of Money.
So, the lack of regulation meant that mortgage brokers were forced to
engage in business that they knew was going to eventually sabotage their own
business down the road because if they didn't do it at the time they would
go out of business immediately. Had regulations been in place at the time to
prevent the type of irresponsible lending that was taking place a lot of
mortgage brokers that have gone bankrupt over the past few years would still
be in business today.
This type of scenario is prevalent throughout the economy, and in some
cases the capital owners are smart enough and disciplined enough to
recognize the problem and they appeal for regulation to prevent markets from
being driven by short-term interests that run counter to their long-term
interests. And again, such regulations are counter to the interests of those
who are pursuing only short-term gains, so they are against the interests of
some capital owners, but in the interests of other capital owners, and these
types of regulations get passed when the capitalists with long-term
interests are more powerful than those seeking short-term gain.
When businesses interact with and depend on other businesses
Many regulations in place are the result of capital owners in some
industry seeking regulation of other industries that they depend on, for
example grocery store owners' support of food safety and labeling regulation
for food processors and farmers. Virtually all businesses support certain
regulation of banks in various ways. Property owners support regulation of
the construction industry. Auto manufacturers support regulation of the
petroleum industry, etc., etc.
A recent example of this has played out in the battle over debit card
usage fees. The regulation of debit card swipe fees, as with most
regulation, is typically presented as a case of "government vs. business",
but really the government is just a tool, which does the bidding of whomever
the most powerful groups in society are. Sure there may be some cases where
individual legislators or elected officials take a stand against some
powerful interest group in favor of doing "what's right", but generally
speaking any government is merely an instrument being wielded by interest
groups. In the case of debit card fees, the primary interest
groups are the banks and retailers, capitalists vs. capitalists, with both
sides appealing to the government to write the rules of the game in their
favor.
As it turns out the retailers won this legislative battle with the
addition of the Durbin Amendment to the
Dodd–Frank Wall Street Reform and Consumer Protection Act, which
requires that large banks only charge debit card processing fees to
retailers that are "reasonable and proportional to the actual cost". This
legislation was lobbied hard for by retailers like Wal-Mart and Target,
among others, including the Small Business Association. The retailers, which
have a long history of legal actions against MasterCard and Visa, argued
that the duopoly power of
MasterCard
and Visa,
which combined process virtually 100% of debit cards in the United States,
enabled them to charge inflated processing fees due to lack of competition.
With the passing of the legislation restricting what the processors could
charge retailers for processing fees, the processors, Visa and MasterCard,
increased the fees that they charged to banks, which some banks have then
passed on to consumers in the form of new fees for checking accounts or
debit card use.
When capital owners seek additional control over capital controllers
In many cases capital owners seek additional control and legal power over
those whom they entrust with the administration of their capital;
essentially investors seeking additional control over corporate boards and
executives. Investors have the ability to sue corporations and their
executives and officers. Such suits are typically brought by large
institutional investors, such as pension or mutual funds. In rare cases they
are also brought as class action suits by individual investors.
However, investors obviously seek ways to prevent the need for lawsuits
in the first place as well, via regulations. The most common of these types
of regulations are regulations requiring corporate transparency. Publicly
traded companies, i.e. companies which openly sell shares of their stock via
official markets, have many reporting requirements. They are required to
submit an annual report to share holders and to submit a
Form-10K
to the
Securities and Exchange Commission. The most recent major regulation put
in place on behalf of investors is the aforementioned
Sarbanes–Oxley Act of 2002, which increases transparency of
corporate accounting.
The regulatory oversight of the SEC is essentially a subsidy to
investors, who benefit from the (albeit inadequate) tax-payer funded oversight provided by the
government agency.
Licensing and certification
Milton Friedman famously campaigned against licensing and certification,
especially in the medical profession. Friedman mostly considered licensing
and certification in relation to workers, not capital owners. Friedman,
somewhat correctly, regarded the American Medical Association as a union,
and viewed government required licenses or certifications as a means by
which laborers could restrict markets and thereby reduce the supply of
laborers in their profession, thus enabling them to charge higher prices
for their labor, and that as such licensing and certification was against
the public interest.
One of the things that Friedman fails to address in his arguments against
licensing is that one of the strongest reasons for licensing is the ability
to revoke a license. As Friedman notes, it is true that having a license is
no guarantee of quality, but when an entity or individual fails to meet the
quality standards of a licensing program the ability to revoke their license
to prevent future harm is very powerful, and even the threat of that force
can serve to keep practitioners on "the straight and narrow". Sure it's
obviously not 100% effective, but there is no doubt that it has an impact.
Nevertheless, much of what Friedman says is true regarding the impact of
licensing on prices, but that doesn't necessarily mean that licensing isn't
still in the public interest. I'm not going to address Friedman's arguments
against licensing, since that is not the point here. The point here is that
while Friedman's opposition to licensing and certification focused primarily
on skilled professionals, i.e. laborers, licensing and certification applies
to corporations and capitalists as well, in multiple ways.
For one thing licensing doesn't just apply to individuals, there are
forms of licensing and certification that apply to corporations themselves,
an obvious example being liquor licenses, which are held by businesses. The
other issue is that many of the individuals most highly involved in the
ownership and allocation of capital are licensed professionals, for example
stock brokers, bankers, and financial advisors have to be licensed.
So here is the issue. Milton Friedman makes all kinds of arguments as to
why professionals support licensing and use it as a means to manipulate the
market in their favor, and all of his arguments in that regard are true, but
these arguments apply just as equally to businesses and those who are
entrusted with the holding and allocation of capital. The point here is that
whatever the merits or demerits of licensing may be, it is something that
capitalists themselves want, in part for the very reasons that Friedman is
against it. Licensing programs exist because capitalists want them to exist.
Tariffs
The very first source of revenue for the federal government of the United
States of America was tariffs. The predecessor to what would become the U.S.
Coast Guard was originally established primarily to police the waters to
enforce customs duties and facilitate the enforcement of tariffs. Indeed
tariffs remained the main source of revenue for the United States until the
establishment of the income tax in 1913. The interesting thing about tariffs
is that they are another form of economic regulation that pits capitalists
against one another. Capitalists decry or support tariffs depending on their
impact or potential impact upon their business. Tariffs, of course, are
essentially fees, or a tax, levied on goods when they are imported into a
country. Now the interesting thing about the United States and tariffs is
that the United States pursued a strongly protectionist trade policy up
until the 1940s, and a moderately protectionist trade policy up until the
1980s.
The pattern of protectionism during the phase of economic development and
then later trade liberalization as the economy matured is a familiar pattern
that many countries follow. Tariffs and protectionism encourage domestic
production. High tariffs on imported finished goods encouraged the
development of capital within the United States by encouraging manufacturers
to relocate to the United States in order to setup manufacturing here in
order to be able to sell to the American market without paying the tariffs.
This policy in fact worked and is credited with accelerating the pace of
American industrialization, much to Britain's chagrin. In fact the British
had laws against the export of industrial technology to developing nations
and against the immigration of knowledgeable individual to America.
Nevertheless, such individuals and technology made their way to America
despite the British restrictions because the opportunities were too great.
But while the United States of America levied tariffs on goods imported to
America, the British had a more open trade policy as international British
companies sought to bring goods back into Britain from around the world.
Tariffs were almost universally supported in America by all capitalists
until the later part of the 20th century, at which time America's maturing
corporations sought to go international and be able to import foreign made
goods back into the United States.
Subsidies
Last but not least I'll mention subsidies. American capitalists have long
been highly subsidized. Indeed Alexander Hamilton himself laid the
groundwork for the public subsidy of American private business. Alexander
Hamilton had a profound impact on the economic policies of the early United
States, with influences that last to this day. Hamilton's fundamental
strategy for strengthening the American economy was the use of tariffs on
imported goods and the use of a portion of tariff revenue to subsidize
domestic manufacturing. This was laid out in Hamilton's
Report on Manufacturers and these policies were officially adopted by
the federal government. The issue of subsidizing industry was one of the
central points of division between Thomas Jefferson and Alexander Hamilton,
who famously feuded with each other on many topics.
Hamilton argued that the subsidies were essential to lure capital away
from developed nations like Britain and France, while Jefferson argued that
the subsidies would lead to corruption and bring about undo influence of
private industry on the government. Jefferson also argued that the subsiding
of manufacturing would lead to concentration of capital ownership and a
disenfranchisement of the agricultural South. Jefferson believed that an
economy based on the widespread distribution of land ownership was essential
to democracy and that concentration of economic power within corporations
would lead to political corruption and the establishment of an American
aristocracy that would undermine democracy. Hamilton, on the other hand
argued that a diverse economy with a mix of agriculture, manufacturing and
finance would be more robust and lead to a more economically independent
nation. Hamilton saw the "free trade" policies of the British empire as
merely a tool of imperialism and thus argued that in order for America to
truly break free from British imperialism the United States would have to
adopt economic protectionism and subsidize its manufacturers to gain
independence from imperial European powers who had a more advanced
manufacturing base and more robust financial systems.
In reality both were right of course. Hamilton's views were right, but
Jefferson's were as well, and the corruption that Jefferson foresaw has
plagued the country since the first days of its founding.
Hamilton also oversaw the establishment of a highly subsidized industrial
center in New Jersey through the
Society for Establishing Useful Manufactures. The Society had tried and
failed on its own to establish a manufacturing center and so they appealed
to Hamilton to subsidize their efforts through various tax breaks, grants
and rights-of-way. Hamilton agreed and the industrial center was a success
in the sense that a significant manufacturing base did grow there and the
center became highly profitable. The area remained a major manufacturing
site up to the 20th century, when the waterfall driven power became
obsolete.
The subsidizing of business remained prevalent throughout America
history. The
railroad corporations of the later 19th century are a classic case of
the subsidization of capitalists by government. Arguably the government
subsidies for American railroad barons did increase the pace of
industrialization and accelerate the expansion of the nation and the growth
of the American population and the economy as a whole, yet at the same time
the interactions between the government and the railroad barons were rife
with corruption and untold billions of dollars were wasted and misallocated
and a significant portion of the wealth of the railroad barons was a product
of public subsidy.
Today well over $100 billion a year in direct subsidies are provided to
American capitalists through
local, state, and
federal government; this doesn't count things like the 401(k) tax code
which itself is essentially a subsidy for institutional investment companies
or the fact that capital gains are taxed at a lower rate than wage income.
This also doesn't count the
emergency loans of over $1.6 trillion provided to financial institutions
at below market rates and very favorable conditions by the Federal Reserve
and
TARP programs.
The point here is this: capitalists will always welcome subsidies, and in
any political system where political power is a function of wealth, as most
systems are, those with the wealth, i.e. capitalists, have the power to
appeal to government for subsidies, and they currently do so in the United
States to great effect. Capitalists have basically two forms of leverage
that they use to appeal for subsidies. The first is the most obvious, their
wealth, which they can use to "lobby" (essentially bribe) politicians who
control taxpayer funds to subsidize them. In essence government officials
are gatekeepers, so spending a few dollars "lobbying" them can result in
them providing access to many more dollars, since the money that the
government officials preside over isn't theirs, it costs government officials
nothing to provide subsidies to capitalists. If capitalists spend a few
million of dollars a year "lobbying" government officials this can result in
hundreds of millions or billions of dollars in subsidies. The second form of
leverage is perhaps even more important however, and that leverage is
capital ownership itself. Concentration of capital ownership means that a
relatively few individuals have control over vast amounts of capital, and
this control itself can be used, and is used, as a form of threat.
Capitalists threaten to lay off workers or move their capital or do this or
do that with their private capital if politicians don't give into X, Y, or Z
demand, and this is very powerful.
This is what drives many of the state and local subsidies for
corporations in America, competition between localities to attract capital
results in subsidizing capital. With increasing globalization the same
has become increasingly true at a national level in America and around the
world, with national governments around the world essentially competing to
out-subsidize capital in order to attract it. Since capital owners are
relatively few and capital is so important for economic productivity, this
puts capital owners in a powerful position, a position which only grows
increasingly more powerful as capital ownership is consolidated. The result is
increasing pressure to subsidize capital owners via resources acquired from
non-capital owners, i.e. taxation of workers and small capital owners to
provide the revenues needed to subsidize large and powerful capital owners.
The types of regulations cited above are only a small sampling of the
types of regulations favored by capitalists. Overall what we can
plainly see is that while people often associate "free-markets" with
capitalism and claim that capitalists don't like regulations, this is in
fact not true. Specific capitalists don't like specific regulations, but
they clearly favor many other regulations. In some cases regulations that
capitalists approve of are generally beneficial to consumers and society as
a whole, in other cases they are not. Many economic regulations actually pit
capitalists against capitalists, they are put into place at the request of
some capitalists because they benefit them, while the same regulations may
harm other capitalists. Governments enacting such regulations are merely
acting at the request of capitalists themselves; government regulation is
merely a tool used by capitalists to peruse their interests and increase
profits in capitalist societies.
It's not just that capitalists don't like unregulated markets, they don't
like efficient markets either. In fact, capitalism could not exist in a
so-called "perfect
market", which is a theoretical 100% efficient market. This is extremely important
to understand, because it gets at the heart of the misconceptions about
capitalism and the motives of capitalists.
When Adam Smith wrote The Wealth of Nations over 200 years ago
the economic systems of Europe were highly inefficient. Smith observed that
within an inefficient system businesses could be driven by profit motive to
increase efficiencies, i.e. that by better serving the public interest a
business would yield higher profits. This is true, but Smith was really only
dealing with one half of the equation. The reality is that the rate of profit is
determined by the relationship between business efficiency and market
efficiency. It's true that a business' profits can be increased by
increasing the efficiency of the business, or rather by the business more
efficiently meeting market demands than competitors, but that is only one way that profits
can rise; profits can also rise if the market itself becomes less efficient.
Profits are just as much a measure of market inefficiency as they are of
business efficiency. The best way to understand this is simply to look at it
in terms of a mathematical formula, as stated below.
Technically, business efficiency over market efficiency gives us the
profit factor, and by subtracting 1 and multiplying by 100 we get a true "rate of profit". We can consider "efficiency" to be a value that ranges from 1 to
100, with 100 being either a perfectly efficient business or a perfectly
efficient market. What we see is that it doesn't require a perfect market in
order for businesses to be unprofitable; if a business is less efficient
than the market then the business will be unprofitable.
Let's look at the examples above. If "the market" has an efficiency of 20
and a business has an efficiency of 25, then every dollar invested will
yield one dollar and twenty five cents, the rate of profit is 25%. If the business is equally as
efficient as the market then for every dollar invested the business will
yield one dollar in return, in other words, the actual rate of profit is
zero. If the business is less efficient than the market then for every
dollar invested less than a dollar is returned, so the actual rate of profit
is negative. So basically, a business has to be more efficient than the
market in order to be profitable, and this is true whether the market is
highly inefficient or not, but the fact is that as markets become
more efficient it of course becomes increasingly difficult to be
more efficient than the market, and under the condition of a theoretical
"perfect market" it would be impossible for any business to be more
efficient than the market. Thus under perfect market conditions profits
would always be zero or less than zero, hence it has long been predicted
that profits would decline in capitalist economies as they matured under the
assumption that markets would become increasingly efficient.
But the point is that perfect market conditions don't have to be reached
in order for profits to fall to zero or less than zero, business efficiency
just has to be less than or equal to market efficiency, even if market
efficiency is only 10 or 20, or whatever.
So let's look at the qualities of an efficient market. Market theory is
predicated on the assumption that markets work efficiently when individuals are well informed, make
rational decisions, act in their self-interest, there are low barriers to
entry, no individual has the power to set prices, everyone has access to
technology, and there are no externalities. A perfect market then, a market
with 100% efficiency, has the following qualities:
Every individual is omnipotent (knows everything about the market)
Every individual makes only rational decisions
There are no barriers to entry
All prices are determined by individuals engaged in specific
transactions (no price fixing)
Every individual has equal access to technology
There are no externalities
So basically, while those theoretical conditions may never be fully met, as
markets come closer to those conditions it becomes increasingly difficult
for businesses to maintain their rate of profit. In mathematical terms, as
markets come closer to those conditions their "market efficiency score"
(the denominator in the profit equation) gets
closer to 100.
Let's use a concrete example. Let's say that widgets can be produced and
brought to market for $10 each, meaning that when every single cost is
factored in, the cost of the machines, the materials, the labor, the
facilities, the shipping, etc., the cost is a total of $10. Now let's say
that these widgets can be sold for $15. In that case there is a profit of $5
per widget.
What market theory says is that competition will drive profits down in an
efficient market. In an efficient market someone will begin producing those
widgets for the same $10 and selling them for $14 each, netting $4 in
profits, then someone will come in and sell them for $13, then $12, then
$11, etc. Now, in order to maintain higher profits two things can be done:
either the cost of producing a widget can be reduced or market efficiency
can be reduced. If the cost of producing the widget is reduced then that can
temporarily yield profits, but market forces would again result in the same
downward pressure on prices, driving the profit margin back down toward
zero. This is considered one of the positive aspects of a capitalist market
system. Profit motive provides an incentive to find more efficient, i.e.
less costly, ways to produce commodities and it provides an incentive to
accept lower profits per unit in order to undercut competition, thus
bringing the
price of commodities closer to the cost of production.
However, instead of developing better widgets or a more efficient way to produce widgets, to get higher profits a
capitalist could externalize part of the cost by doing something like
dumping all of the waste from the process into a river instead of paying to
dispose of the waste responsibly. In addition to that, instead of trying to
lower the cost of production a capitalist could engage in a marketing
campaign that costs about 20 cents per widget which portrays the widgets as
cooler than other widgets, thus enabling them to be sold for $13 even while
others drive the price of comparable widgets down to $11. In an efficient
market there are low barriers to entry, so another thing that a capitalist
might do to maintain profits is appeal to the government to require
licensing for widget makers or appeal to the government for new safety
standards for widgets that his widgets are already designed to meet, etc.
Several widget makers may get together and agree to fix prices, i.e. agree
that none of them would sell their widgets below $13 in order to maintain a
profit margin. Patents can be used to maintain a monopoly on technology, and
on and on.
Since it becomes increasingly difficult for businesses to get a profit as markets become more efficient, capitalists are
driven by profit motive to undermine market efficiencies. It is also
important to remember that in a capitalist economy "the market" has two
underlying components, the commodity market and the labor market, so
capitalists seek to reduce efficiency in both of these markets. They do this
through secrecy or spreading misinformation, by encouraging emotional
decision making among others, by erecting barriers to entry both privately
and through government regulation, by attempting to collude and/or use
government regulation to set prices, by using patents, by using contracts to reduce access to technology, and by using the legal system and
public subsidies to engineer the externalization of costs.
The reason that profits have not actually declined in capitalist
economies around the world is that capitalists have continuously undermined
market efficiencies using these mechanisms and others in order to maintain
profits. These actions have become so ingrained in our culture that many Americans
now accept many of them as "normal". Let's look at some ways that capitalists do
some of these things.
Fostering irrational decision making
There is advertising and then there is marketing. Advertising is arguably
simply making the public aware of the products or services that a business
or other entity offers, while marketing is arguably the attempt to actively
encourage individuals to purchase or consume those goods and services. The
reality is that marketing is all about encouraging irrational decision
making. The whole objective of marketing is to get people to make irrational
decisions, to get people to become emotionally attached to brands and
commodities, or as
Kern Lewis,
director of marketing for CMG Financial Services, put it in Forbes magazine,
"[to] inspire 'loyalty beyond reason.'" This isn't to say that
marketing only involves emotional appeals, clearly objective facts are
sometimes used in marketing, but the function of marketing is to encourage
consumption and brand loyalty beyond reason.
This topic can easily be a book in itself, and many, many books have been
written on the topic, so I'm not going to go into too much detail here, but
a quick internet search brings up plenty of reading material:
Google: marketing emotional appeal.
Emotional appeals aren't only a component of the marketing of commodities
however, they are also a component of human resource management as well,
i.e. the labor market component of the equation. Employers do this through
appeals to loyalty among employees and by engaging employees in various
activates from pep-rallies to "team building" to "employee appreciation"
parties to involvement in charity events. While some of these actives may
seem benign or even good, the reality is that employers engage in them
because they appeal to emotions to encourage irrational acceptance of lower
compensation by workers. Wal-Mart famously refers to their employees as
associates, which implies that the employees are partners, though they
clearly aren't. This is another example of ways in which employers try to
make employees feel more enfranchised than they actually are.
At an even broader level, the entire American mass media fosters
irrational consumerism. All major media outlets, especially those involved
in television, are dominated by for-profit corporations, and in many cases
the media companies are owned by larger corporations, for example
NBC and
MSNBC are owned by General Electric. This isn't to say that those in
charge of running these companies have explicit goals of fostering
irrationality, but anti-consumerist programming or programming that takes a
critical look at the corporate structure of the economy, or programming that
fosters a rational and objective understanding of society and the economy, or
of economic choices, is clearly not going to be produced and aired by the
very corporations upon which the critical eye would be turned. Wacky teen
dramas with kids doing crazy things and toting around a lot of accessories
are great in the eye of the corporate media executive, teen programming that
portrays teens being responsible, shunning materialism, and critically
evaluating the problems in society, not so much... At this point all
corporate produced media is a massive marketing campaign for the status quo
of American life, of a status quo rooted in irrational consumerism and a
capitalist economy. Virtually all corporate produced media reinforces this
worldview.
The fact is, though, that market theory is predicated on rational
decision making, and the whole objective of market theory is supposedly to
facilitate the efficient use of resources. The claim (whether true or not)
that markets are the most efficient way to allocate resources is a primary
defense of market systems, yet one of the most fundamental pillars of market
theory, that individuals act in their rational self-interest, is a primary
target for being undermined by capitalists. It is a primary target
precisely because profits can be increased when consumers and wage-laborers
don't make rational decisions; which is why capital owners encourage
irrational decision making, thereby undermining market efficiency and
increasing the rate of profit. But increasing the rate of profit in the
short-term isn't the only effect of this corporate fostered irrationality,
because irrational worldviews and irrational decision making affect all
aspects of society. It undermines our democracy and it undermines the
overall economy as a whole long-term because irrational individuals are
generally also less productive individuals, at least less capable of
developing scientific advances, new technology, and processes which can lead
to increased productivity in the future. Thus, capitalists themselves, in
the pursuit of profit motive in the present, undermine the society's ability
to develop economically in the future. Capitalists have the competing
interests of wanting consumers to be irrational, ignorant and self-absorbed,
and wanting workers who are rational, well educated, and capable in order to
be productive (but still
ignorant of labor rights and the value of their own labor).
Secrecy, lack of information, and misinformation
Secrecy and misinformation are integral to profit generation within capitalist systems.
Protecting information is seen as a normal part of business operation for
maintaining a competitive advantage in the market place, and indeed that is
exactly what it can do. Secrecy reduces market efficiency, which helps to
boost profits. Secrecy is used in many ways, from protecting
trade
secrets to hiding financial information from competitors to hiding
illegal activity to hiding employee compensation from other employees to
providing one-sided information on products to consumers.
Going back to marketing, when a for-profit entity attempts to sell a good
or service, they don't lay out an objective body of information with the
pros and cons of the product; they provide a highly biased one-sided set of
claims. All marketing is essentially corporate propaganda. Thanks to the
internet it is becoming easier for consumers to find more objective reviews
of products, but even then in some cases corporations pay to have
fake reviews posted on product review sites.
There are really too many ways that secrecy, lack of information and
misinformation are used to protect profits within capitalist systems to go
over them all here, but
let's simply use the commercial food industry as an example. Despite the
fact that there are now many regulations forcing food processors and
packagers to disclose ingredients and nutritional information on products,
consumers still lack a lot of vital information about food products when
making purchasing decisions. For example, how different would individuals'
food buying choices be if people were able to watch all of the food that
they buy being made at the time of purchase? Obviously there would be many
challenges to this in a modern economy, but the food industry benefits from
this lack of information and to some degree the way that modern food supply
systems function has been engineered to purposely remove consumers from the
food production setting.
For example, meats are packaged in grocery stores in America in such a
way as to essentially remove them as much as possible from the context of
their animal origins. A century ago all meat was acquired at a butcher or on
a farm, where people witnessed the treatment of the animals and the handling
and processing of the meat. Today people simply buy fully butchered meat in
shrink-wrapped packages where the realization that it even comes from a once living and breathing animal is no longer obvious. How was the animal
treated? How was the animal slaughtered? Was the animal diseased? How was
the meat processed? Did it get dropped on the floor? Did someone sneeze on
it? Did it lie out with flies all over it? Did the butcher wash their hands?
The consumer will never know, and what's more the seller is not only happy
that they'll never know, they want to remove the product from the context of
those concerns as much as possible altogether.
Would a consumer really opt for the cheapest package of chicken breasts
as opposed to the one that is 50 cents more if they had "full knowledge of
the market", i.e. if they knew every aspect of how the animals were treated,
slaughtered, and processed by the different sellers? Would they even buy
chicken at all if they knew all of that stuff or would they opt for a
vegetarian alternative? We haven't even gotten into sausage making and
hotdogs. And don't think that the lack of information about food processing
is simply a matter of circumstance either. The fact is that animal farming,
slaughtering, and processing is one of the most secretive industries in
America, virtually on par with the military industry. Our entire food supply
chain is owned and controlled by private for-profit businesses, and as
private businesses they have a tremendous amount of control over what the
public is allowed to know about their processes and products.
Not only is it already very difficult for the public to learn anything
about how the meat we consume is raised and processed, even with very
considerable effort, but there is an on-going effort to further restrict
public access to information about animal farming and processing. Several
states are working on legislation, at the behest of the livestock industry,
to
ban and criminalize the documenting of conditions on farms without the
consent of the farm owner. Support for this type of legislation has grown
among farmers after multiple incidents where individuals, either workers or
otherwise, have recorded animal cruelty and sanitation violations on farms.
In this case farmers are essentially trying to make it illegal to document
illegal or publicly frowned upon activity at their operations. The legislation is designed to target
whistleblowers working on the farms as well as activists and outside
journalists.
The level of secrecy surrounding American livestock farming and
processing is truly astounding when you are fully aware of it. This
segment from a PBS investigative report in 2006 states that they were the
first journalists ever allowed to film inside the largest pork processing
plant in the country.
Now think about that. The largest processing plant for pork in the whole
country, which at the time was slaughtering and processing 33,000 hogs a
day, had essentially no public access, and even the access that was granted
to PBS was very limited. We are talking about a facility that produces what
we eat, arguably the most fundamental requirement of life. This is a product
that goes into our bodies and we aren't even allowed to see how it's
made!
A recent
investigation into several diseases at a Hormel hog processing facility
revealed that at that facility the pig's guts and brains go down onto the
floor where they slide into a drain through which they are caught in vats
underneath the floor. The material is later used for food products. The
pig's brains are blown out using an air compressor, after which they slide
down through the drain in the floor. In this case workers in the "brain
blasting" area developed a rare autoimmune disease due to inhaling vaporized
pig brain. And as the cases mounted the company was, of course, very secretive
about what was going on and about the operation of the plant in general.
So, owners of capital are often collectively driven by profit motive to
reduce the amount of information that consumers have about commodities, in terms of the
actual cost of production, how the commodities are made, and the true
quality of the commodities. While some producers who produce high quality
items may seek out ways to provide consumers with more information on the
quality of their products, and may even want to provide consumers with
information on how the products are made, there is a general collective
secrecy among all capitalists within the market regarding actual costs of
production and meaningful information on how products are made.
This brings us to the other major area of secrecy within capitalist
systems and that is compensation secrecy. Virtually all private businesses
tell employees not to discuss compensation with other employees, in fact
non-disclosure of compensation is often written into employment contracts
and can be grounds for termination. When a prospective employee applies for
a job in the private sector, the employee isn't given a spreadsheet with the
compensation for all of the employees at the company, nor are they told about
any compensation negotiations with other prospective job applicants. Even
more importantly, workers have no information telling them the value of what
they produce or are expected to produce. Workers may get some idea of the
value that they produce, but the estimates workers are able to formulate are
highly subjective a not likely to be well-informed. Employees basically have
no idea what the profit margin on their labor is for their employers, and
employers want to keep it that way, unless perhaps the employer is
unprofitable.
A reporting rule included in the recent Dodd–Frank Wall Street Reform and
Consumer Protection Act requires that public corporations report the ratio
between the compensation for the CEO and the median worker. This is meant to
be a point of information for investors, workers and economists, and
corporations are vigorously fighting the implementation of this regulation.
One of the roles of unions is precisely to address this market
inefficiency, this lack of information on behalf of workers. On the one hand
unions violate the efficient market principle of individually determined
prices, but this is done in order to rectify other market inefficiencies
such as lack of information by workers and disparities of power.
Many capitalist societies have implemented regulations and mechanisms
intended to increase market transparency, under the understanding that
transparency and information are essential to any reasonable operation of
markets and that capitalists themselves have incentives to undermine market
transparency. Nevertheless, capitalists have been successful in all
countries, to varying degrees, in protecting certain levels of secrecy, both
on a broad scale and on cases-by-case bases, and there are perpetual
on-going efforts by capitalists to reduce market transparency whenever
possible.
Externalities
Externalities are a huge component of profit generation.
Externalities are one of the most important phenomena in economics and are a
massive subject in and of themselves. Ultimately, externalities are one of
the key factors which undermine classical and neo-classical market theory,
which are predicated on decisions made out of individual self-interest.
There are both "negative" and "positive" externalities. Negative
externalities are those things which incur a cost or harmful effect to a
third party. Positive externalities are those things which bring about a
benefit to a third party.
A positive externality is something like the way in which improvements to
one's home can result in increased home values for surrounding neighbors.
Another example of a positive externality is the impact that using solar or
wind power has on both pollution levels and energy markets as a whole. For
example, when someone switches from using fossil fuels to something like
solar power, they are reducing demand for fossil fuels, which ultimately
makes fossil fuels cheaper than they would otherwise be, so in fact people
who do things reduce their use of fossil fuels make fossil cheaper for those
that continue to use them. Thus, users of fossil fuels benefit from positive
externalities generated by adopters of alterative energy or people who
reduce their energy consumption.
Positive externalities generally result in under-production of goods and
services or under-adoption of practices because the individual bearing the
cost pays for benefits that are received by others who don't pay.
Negative, externalities, however, tend to have the opposite effect.
Negative externalities are things like pollution and health problems.
Negative externalities tend to cause goods and services to be "overproduced"
because the full cost of goods and services are born by third
parties, neither the producers nor consumers of the goods and services.
As a result, negative externalities are major drivers of profits because
in effect they result in inherent subsidies. A polluter for example can
reduce their manufacturing costs by simply dumping waste on public property
instead of incurring the costs of properly disposing of it. Negative
externalities are most prevalent when the harm done to others is indirect,
difficult to quantify, or difficult to identify, yet negative externalities
are ubiquitous in modern economies and forcing businesses to compensate for
externalities that they benefit from in capitalist economies is often very
difficult because of the disproportionate political power wielded by capital
owners.
So now that we've examined many aspects of capital ownership
and market theory in detail, let's put it all together to get a comprehensive
understanding of how capitalist economic systems operate, their advantages
and disadvantages, and the ways in which capitalist systems inevitably lead
to concentration of capital ownership.
First let's talk about profits. Profits are essentially the spread
between the costs of commodity production and the revenue from sales of said
commodities, which goes to the owner of the capital used to produce said
commodities. Profits can also be described as the spread between the
purchase price of property and the sale price of property. Thus profits are
a form of income that is determined purely by ownership of property, not by
work done. An owner of capital may also perform work
that generates revenue, in which case the distinction between profits and
wages becomes a blurry one, but profits in the truest sense are derived
solely from capital ownership rights.
In essence, profits are a measure of market inefficiency because profits
are not a product of value creation, they are a product of price disparity
between market participants.
The more efficient a market is the smaller the disparity between costs
and revenues will be, thus capitalists, i.e. the recipients of profit
income, are driven by profit motive to undermine market efficiencies.
Capitalist business owners are inherently motivated to maximize the efficiency of their own
businesses, while minimizing the efficiency of the market. The market
inefficiency that has the biggest impact on income distribution in a
capitalist system is the inefficiency
caused by the separation between labor markets and commodity markets. In
their capacity as employers capitalists are driven by profit motive to make
businesses a form of black box that obfuscates the relationship between
labor markets and commodity markets.
Labor markets are less than optimally
efficient for a wide variety of reasons, including some that are not under
the influence of capitalists. In addition to factors such as employers' withholding of information from workers and barriers to entry imposed on job
markets by employers, factors such as workforce mobility, worker desire for
stability, worker avoidance of risk taking, etc. all play a role in reducing
labor market efficiency in ways that tend to benefit employers.
When an individual owns their own capital and works for themselves they are
neither a wage-laborer nor a capitalist, and their income is always a
product of the full market value of the commodities that they produce and sell,
i.e. 100% of net revenue goes to the individual who performs the work. Thus,
working for one's self is the only way to ensure that a worker can receive
the true value of their labor, but individual production is almost
always less efficient than collective production, thus individuals are driven
into collective production by market forces in an industrial economy. This
is a really critical point to understand in relation to capitalism and the
history of the American economy.
America's distinctive economic feature early in its history was the
almost universal rate of private capital ownership among free white
families. Private capital ownership ensured that individuals kept the fruits
of their own labor. From the colonial era up to the Civil War America's
economy was dominated by home-based production and small family businesses,
where husbands owned their own capital and worked with their wives and
children to create value and generate revenue for the family. Since
all or most of the workers in these businesses were family members, the
entirety of the income stayed within the family, and thus private capital
ownership served to ensure that workers kept all of the value that they
created since they employed their own labor on their own property, unlike
feudal societies where all of the property was owned by an aristocracy, upon
which masses of unpropertied peasants worked, with much of the fruits of
their labor going to the property owners.
This condition of family based production was excellent in terms of
ensuring that individuals kept the fruits of their own labor, and thus
excellent in terms of creating a "just" economic system for white families
(which was of course extremely unjust for Native Americans, African
American slaves, and single women), but it was also very inefficient. The
reality is that while individual capital ownership and individual production
ensures that workers keep the full value of what they
produce, collective capital ownership and collective production are far more
efficient.
Capitalism is a system for facilitating collectivization of production. After the Civil War,
with the rise of industrialization in America, individual and family-run
businesses gave way to the market efficiencies of collective capital
ownership and production. This is the real driving force of capitalism.
Profits are inherently maximized when capital ownership is concentrated and
production is highly collectivized. What the capitalist system does is it
provides a profit motive for individuals to privately collectivize production and
minimize the number of individuals who own capital. The countervailing
market force to capital ownership concentration is risk sharing. While
capitalism creates an incentive to concentrate capital ownership on the one
hand, the ability to amass capital and the risk of doing so provides an
incentive for collective capital ownership as well.
This is where corporations come in within the capitalist framework. Corporations are legal entities that
have been designed to minimize the risks of capital ownership while allowing
individuals to pool their resources to collectively share ownership of
capital, thus facilitating a more rapid collectivization of production.
Individuals and families who directly owned and operated their own capital
were at a market disadvantage against corporations through which
resources could be pooled and the risks of capital ownership could be shared
among more individuals. However, though corporations facilitate collective
capital ownership, the efficiencies of collective production and the
mechanisms of collective ownership meant that in fact collective capital
ownership through corporations facilitated a concentration of capital
ownership.
This is due in part to the fact that by pooling resources a relatively
small number of capital owners could out-compete a larger number of
independent capital owners. In other words, in a market with 100 independent
owner-operators, a corporation collectively owned by 10 people could
generate enough efficiencies to put all 100 of the independent
owner-operators out of business, and thus by pooling resources 10 capital
owners could force 100 capital owners out of positions of ownership.
Typically, the result is that many of those 100 former capital owners would
then become wage-laborers working for the 10 capital owners, while some
would pool their resources together to form larger competing corporations,
and some would simply become destitute, retire, or go into a different line
of work.
The important thing to understand is how in this manner collective
private capital ownership can actually reduce the number of individuals who own
capital.
In addition, through "public ownership" corporations are able to spread
large portions of risk across a large population by selling tiny fractional
shares of ownership to many, many people, while retaining controlling shares
of ownership among a small number of people. This works to concentrate
control of capital among a very small number of owners, while spreading risk
among a larger number of individuals. In addition to risk reduction through
collective capital ownership, controllers of capital in capitalist societies
like America have been able to further reduce their individual exposure to
risk via their disproportionate influence over legislative bodies, thus
ensuring that the laws further protect them from risk exposure.
The reduction of risk exposure among capital owners and controllers thus
further facilitates the concentration of capital, because as was previously
stated, the countervailing force to capital concentration within a
capitalist system is risk sharing. As the risks of capital ownership are
reduced via government protections for capital owners through so-called
"business friendly" legislation, the risks associated with capital
concentration are minimized, thus enabling further capital ownership
concentration. This concentration of ownership then has a snowballing
effect, leading to growing influence of the capital owners over governments
and economies, inducing governments to offer increasing protections to the
capital owner's ever-larger institutions both due to the growing influence of
their financial power and out of real fear of the impact that a failure of
their institutions could have on the overall economy. Such protections, of
course, then continue to facilitate further concentration of capital
ownership, which is further evidenced by the
large scale of corporate stock-buy backs since the beginning of the 2008
recession.
The concentration of capital has a significant impact on labor markets as
well. Today over half of the American workforce works for large companies,
i.e. businesses with more than 500 employees. These businesses represent
just 0.3% of private employers in the country. This means that 0.3% of the nation's
private employers employ over half of the American private industry workforce.
The fact that over half of the private American workforce is employed by
less than 1% of the nation's businesses provides significant wage-setting
power for those large employers and creates significant political leverage
as well.
As capital ownership is concentrated, capital owners increasingly benefit
from market inefficiencies, which is to say that the incomes of capital
owners become increasingly a product of market inefficiencies, which is to
say that the wealth of the wealthy increasingly represents graft from
society as opposed to the creation of value.
The most difficult thing to understand about this situation, however, is
that it isn't a black and white scenario. The incomes of capital owners and
the super-rich are not purely graft. Capital owners and the
super-rich typically do create real value and are often very high value
creating individuals; the issue, however, is that while they may create
large amounts of value themselves, their incomes also include large amounts
of value that they didn't create, but that is instead redistributed from
workers, taxpayers, and other property owners via various market
inefficiencies. Not only this, but there is a high degree of variability in
the ratios of real value creation to graft among the super-rich. The incomes
of some of the super-rich are almost entirely graft, while others are mostly
products of real value creation.
The diagram below is a crude representation of this concept. The blue
diamonds represent value that is both created and received by an individual
in the form of income. The red diamonds represent value that is created by
an individual, but is redistributed to capital owners, and the green
diamonds represent capital income that is received by capital owners. The
reality is that the green diamonds are the red diamonds that were created by
workers which have been transferred to the capital owners. Yet, when looking
at this diagram we see that the capital owner is actually creating value
themselves as well, in fact they are creating more value as an individual
than the others are, but the amount of additional value they are creating
relative to the others is relatively modest, yet their total income is much
greater than the others because they are receiving such large amounts of
capital income, which is value that is being redistributed from other
workers to them.
This is, to a great extent, what makes understanding this issue so
complicated; the super-rich are for the most part both the highest
value creators in our economy and the largest recipients of
redistribution. In fact, the super-rich are large recipients of both pre-tax
redistribution and after-tax redistribution, but of these the pre-tax
redistribution is by far the most important and least recognized. Pre-tax
redistribution in a capitalist economy goes overwhelmingly from workers to
capital owners. After tax redistribution in the current American system goes
primary from middle-class and high income workers to both the poor and
super-rich capital owners.
The most visible aspect of redistribution in the American economy has
long been after-tax redistribution to the poor, yet much of the need for
after-tax redistribution to the poor is a product of the pre-tax
redistribution from the poor in the first place, who typically see
the largest portion of the value that they create going to the profits of
capital owners.
This redistributive effect, then, in addition to the forces of
competition, industrialization, economies of scale, market inefficiencies,
and government subsidy of capital owners, results in increasing
concentration of capital ownership over time in capitalist economies.
The most fundamental criticism of capitalism as an economic system has
always been that over time there would be an inherent tendency toward
concentration of capital ownership, and that this concentration of capital
ownership would, in the end, undermine not only the very basis of the
economy, but the entire social and political system as well, indeed
undermining democracy itself. Concentration of capital ownership within the
capitalist framework is predicted by fundamental economic theory and this
prediction is further strengthened by social and political science in that
social and political understanding easily explain how the inherent economic
tendencies toward capital ownership concentration within a capitalist system
will be compounded by social and political institutions as a result of the
growing power and influence of capital owners as they consolidate ownership
over capital.
America's own history, as arguably the world's flagship capitalist
society, confirms this prediction of increasing capital ownership
concentration within capitalist systems. The economic reforms of the 20th
century in America and Western Europe never changed the underlying
fundamentals of capitalism, and as a result, concentration of capital
ownership continued unabated throughout the 20th century, even after the
rise of so-called welfare-state systems in America and Western Europe.
Indeed welfare-state systems enabled the continuing growth of capitalist
economies amid increasing concentration of capital ownership.
What the economic reforms of the 20th century did in capitalist economies
is they enabled the existence of a non-capital owning middle-class. The
welfare-state reforms, by ensuring that workers would receive a greater
share of revenue and by creating social safety nets, broke the very strict
relationship between capital ownership and compensation, which, while
leading to real improvements in quality of life for the working class and
sustaining economic growth over the relatively short-term (a few decades),
ultimately enabled continuing concentration of capital
ownership.
This is reflected in the chart above in the growth of non-capital wealth
owned by the bottom 90% of households in America following the New Deal
reforms. What the economic reforms did was lead the middle-class to believe,
in both America and Europe, that the fundamental structure of capitalist
economies was sound and that capitalist economies could be equitable.
This was really a facade, however, with the continued functioning of
capitalism only made possible by both the re-distributive welfare-state
reforms and massive debt, both private debt and government debt, used to
prop-up both the welfare-state and capitalists themselves.
Meanwhile, throughout the latter half of the 20th century, actual capital
ownership continued to be consolidated behind the facade. As capital
ownership became increasingly concentrated both the incomes and political
power of capital owners increased exponentially, leading to the resurgence
of economic inequality in capitalist economies. The fundamental "flaw" of
the economic reforms of the 20th century was that they did nothing to
address the underlying structure of capital ownership, hence the
equitableness of the reforms was merely superficial. It was always
inevitable that without reversing the concentration of capital
ownership, eventually capital ownership would become so concentrated that
the political and economic power of capital owners would become so
consolidated and so great that they would be able to use that power to undo
the reforms that enabled a non-capital owning middle-class to exist. In
addition, even without the intentional elimination of these reforms,
preventing on-going economic crises in capitalist economies would require
continuous expansion of the welfare-state.
Capitalist economies around the world are now faced with a battery of
internal contradictions. Both the governments and the workers/consumers in
capitalist economies are saddled with large amounts of debt, while at the
same time the portion of economic output going to workers/consumers is also
falling as the effects of concentrated capital ownership play out, thereby
reducing the ability of those entities to generate economic demand.
Therefore, despite continuous increases in productive capacity,
consumptive capacity is stagnating or falling in mature capitalist
economies, which may not be a bad thing from an environmental perspective,
but it is undeserved from an economic perspective.
The effects of highly concentrated capital ownership are not only
economic, however, they are also societal. As capital ownership is
consolidated a smaller and smaller portion of the population gains
increasing influence over culture and conversely communities lose control
over culture. As control over culture becomes consolidated, the relationship
between producers and consumers becomes increasingly predatory, because
producers are increasingly removed from the community. Producers become less
and less concerned with community standards, morals, and concerns because
they are less and less impacted by them.
In a local economy where production takes place within the community and
producers and consumers live in contact with each other, producers are a
part of the community and affected by the impacts of their own products,
both directly and indirectly via their relationships with community members.
When producers are far removed from consumers, then the impacts of their
production on the community are not felt by producers and of less interest.
As a result, the relationship between producers and consumers becomes one
driven purely by profits.
As an example, a local clothing maker with a family living in and serving
a local community market would not be very likely to make sexually
provocative clothing for young teenagers and market that clothing directly
within the community, yet that same clothing maker would be much more likely
to produce sexually provocative clothing and market it to young teenagers if
they were serving a global market of millions of consumers, because the
scale of the market and the separation from the community insulates them
from the societal impact of their own production, and the economic benefits
to themselves from increased sales outweighs any negative social reaction
since they are removed from it.
Likewise, whereas the parents of teenagers might feel empowered to
confront a local producer and have market power to effect a small local
producer, thereby putting pressure on a local producer not to make and
market sexually provocative clothing to their children, consumers feel
disempowered, and are in actual fact disempowered, in their relationships
with large multi-national corporate producers. So the parents of children
don't have the same type of control over large multi-national corporate
producers and marketers that they do over small local businesses, and
likewise, large corporate producers don't have a localized community
relationship to the markets that they serve, and are thus differently
incentivized than producers who live and produce within local communities of
which they are members.
Ultimately what this means is that as capital ownership becomes
consolidated, fewer and fewer individuals have control over capital, which
means that fewer and fewer individuals have control over production. Culture
is largely a product of production; the things that we produce define our
culture. This means that our culture becomes defined by a smaller and
smaller portion of the population as capital ownership is consolidated,
which of course means that families and communities have diminishing control
over culture.
Maintaining control over the means of production is a key part of how the
Amish preserve their culture. Amish society is a communal society in which
they forego the use of most modern technology. Foregoing the use of modern
technology preserves a pre-industrial economic structure, helps to
ensure relatively equal property distribution among the Amish, and preserves
their communal way of life. The Amish also preserve their culture by
producing the commodities that they consume themselves, within their
pre-industrial communal framework. This is what gives them control over
their culture. The entire economic system of the Amish is designed to foster
communal cohesiveness and to preserve the traditional values and way of life
of the Amish people. This is a key understanding, because the Amish
demonstrate the critical role that the means of production and the economic
system plays in determining culture.
The approach that the Amish have taken to preserving their culture and
communal economic system is a
Luddite
type of approach. Though the Amish are an extreme example of this type of
opposition to industrialized capitalism, it is also common for liberal
opponents of capitalism to view technology as a part of the
problem. It is certainly true that advances in technology can facilitate
consolidation of capital, but let's not forget that capital ownership was
highly concentrated under the feudal system, and capital ownership was
consolidating rapidly in the American South under the plantation system
prior to the Civil War as well, so concentration of capital ownership can
occur even without advances in technology.
The "traditional" approach to serving the interests of workers in
capitalist economies has been to try and protect the "jobs" and wages of
workers. Within the capitalist framework workers often view their interests
as being in opposition to technological advances because the focus is on
"preserving their jobs" and preserving the value of their labor. There is
the view that as technological advances are implemented in the workplace,
and the workplace becomes more efficient, fewer workers are needed to
produce the same or more output, and thus workers will lose their jobs,
which is their primary or only source of income. As such, there is a
tendency among workers to oppose significant labor saving efficiencies in
order to preserve their jobs, and thus their source of income. This is an
even more
common phenomenon in Europe where unions and tradition are more powerful than in America.
There is also a tendency toward "smallism" within capitalist economies,
which is favoritism of "small" or "independently owned" businesses. There is
a recognition that owner-operators truly "earn" a larger portion of their
income, and a belief that small businesses better serve the local
communities, etc. Small business have less individual power over workers and
often tend to be more concerned with community standards and community
interests.
The problem is that opposing technological advances in production in
order to preserve jobs stifles efficiency which ultimately undermines the
economy, and small businesses tend to be less efficient than larger
businesses that can take advantage of economies of scale. This ultimately
ends up leading to lower productivity and lower incomes for workers. The
central problem goes back to the distribution of capital ownership. As
businesses increase in size and market share, ownership and control over
capital is naturally consolidated, and as production processes become more
efficient fewer workers are needed to produce the same quantity of goods and
services.
Opposing technological advances and favoring small businesses (in some
cases through economic subsidies or regulations) are ways of trying to
reduce capital ownership concentration within a capitalist framework through
structural constraints, which necessarily reduce productivity and economic
efficiency. Conversely, maximizing efficiency through capital improvements
and allowing capital ownership to become concentrated not only undermines
economic fairness and invites corruption, but also ends up undermining
economic potential as well since the consumptive capacity of the working
class is reduced as they inevitably receive a diminishing share of the
wealth created by the economy as the share of wealth creation going to
capital owners increases.
This is why capital ownership has to be broadly shared in some way in
order for an economy to maximize its potential over time, and in order to
reduce economic exploitation and unfairness as well as undo influence of a
relatively small number of individuals over the economy and culture. The
question is how to achieve this? The major Communist and Socialist regimes
of the 20th century all basically sought to do this by making "the state"
the sole or major owner of capital, and thus calling the capital owned by
the state "publicly owned". These implementations are often considered "State
Capitalism" because the government essentially took on the role of
"capitalist", owning and directing the use of capital, managing labor
relations, and setting wage compensation, using the "profits" from
enterprise as a source for government funds, which were in theory intended
to be used to provide benefits to the citizens.
The problem with this is somewhat obvious, especially with historical
hindsight. Principally, capital ownership is still concentrated under such a
system and many of the same problems with private capital ownership
concentration persist, on top of additional problems created by the
politicization of essentially all employment and economic activity, and a
host of other issues that go without saying.
An alternative to this is something called
Distributionism, which essentially means ensuring that capital ownership
is widely, almost equally, distributed among all individuals in the
population. The Distributionist movement was originally started by religious
conservatives in the 19th century, and was at that time a somewhat
anti-industrial movement, however the basic principle of equal distribution
of private capital ownership can be applied within a progressive
pro-industrial framework as well, as I lay out in
A Progressive Foundation for America's Economic Future in the section
titled Implement a National Individual Investment Program.
The critical aspect of a progressive distributionist system would be that
the government, instead of owning or controlling capital, would be used
merely to ensure equal distribution of capital ownership to individuals, but capital ownership would remain private. Far more needs to be done than the
National Individual Investment Program that I described in the
aforementioned article, but the central point is that capital ownership has
to be far more equitably distributed. As technology and efficiency progress
it is imperative that everyone have significant capital income so that
capital income can become an increasing share of national income.
The traditional situation in capitalist economies pits the interests of
wage-laborers against capital owners, whereby the gains of one are
essentially the losses of the other. What we see in capitalist economies
around the world is that the share of income going to capital is increasing,
while the portion of the population receiving that income is decreasing, so
a larger and larger share of income is going to a smaller and smaller
portion of the population. The reaction to this situation by many people who
oppose growing income inequality has been to advocate for reversing this
trend by increasing labor's share of income, but this is an entirely wrong
approach. Instead of increasing labor's share of income, what needs to be done
is that capital ownership should be more broadly distributed so that the
increasing capital income goes to everyone instead of just to a small number
of people.
The problem with the traditional dynamic within capitalist economies is
that it induces workers and policy-makers to try and sustain or prop up
labor's share of income, a tactic which is ultimately unproductive. If everyone is an
equal owner of capital, however, then the share of income going to labor
becomes significantly less important. The problem with a low share of
income going to labor in a traditional capitalist economy is that labor is
the only meaningful source of income for the vast majority of the
population. The middle-class exists on labor-income and essentially only
makes use of capital income in retirement, while the poor have essentially
no capital income throughout their lives. Without the income from labor
capitalist economies would collapse, but this is only because capital
ownership is so concentrated and the fact is that in a "free-market"
capitalist economy increasing capital ownership concentration is inevitable,
as we have seen.
This puts capitalist economies in a position where "jobs" have to be
created and maintained purely for the sake of distributing income, not for
the sake of production. The purpose of an economy is not to "create jobs",
the purpose of an economy is to create wealth. Jobs are merely a means to
that end. Jobs are something that we should be working to eliminate, not
create. The only reason that there is any talk of "creating jobs" is because
jobs are the means of distributing wealth to the poor and middle-class
within capitalist economies, but if everyone actually owned meaningful
capital, i.e. if everyone were a real "capitalist" instead of
just 1%-2% of the population beings capitalists, then creating jobs would
not only become unimportant, but in fact everyone would benefit from the
elimination of jobs and the economy would be on sound footing to truly
embrace efficiency. Productive automation and maximizing efficiency can only
be fully embraced when the dependency on "jobs" as a means of distributing
wealth is eliminated.
This doesn't mean that jobs or working would be eliminated overnight;
what it means is that the share of income between labor and capital would
become far less important and eliminating jobs would become a means of
increasing everyone's income, not just the incomes of a tiny minority of
super-rich capital owners. If, in theory, capital ownership were truly
equally distributed what that would mean is that no individual would have
massive capital income, but everyone would have moderate capital income.
Even with equal distribution of capital ownership, given the current state of
technology the majority of everyone's income would still come from labor,
but instead of having some people who receive billions of dollars a year in
capital income with capital income making up 99% of their income and other
people having no capital income at all, everyone's income would be roughly
10% to 30% from capital and the rest from labor. But that means that even if
you lose your job, you would still retain 10%-30% of your prior income
automatically, which is far better than losing 100% of your income as is
the case for most poor and middle-class workers, and this in turn would
reduce the need for government-provided safety nets (unemployment benefits,
welfare programs, disability benefits, etc.).
Some people would still be paid millions of dollars a year in labor
compensation and some people would still only be paid minimum wage, so
income inequality would still exist and "reward" for an individual's
contributions would still be a part of the economic system, as it should be,
but the current massive income inequality which is a product of capital
ownership concentration would be greatly reduced.
But truly equal ownership of capital would never be achieved at any rate;
all that could ever be achieved is a "far more equal" distribution of
capital ownership. That is because the only form of capital ownership
that could easily be distributed would be shares of corporations.
Individuals would still directly own private capital even in a distributionist system, meaning that small business owners would still own
their small businesses independently and retain full ownership. There is
absolutely nothing wrong with that, because small business ownership is
actually just another means of distributionism - in fact it is the original
means by which capital ownership was widely distributed in America in the
first place.
The important aspect of a progressive distributionist system is that it
embraces industrialization, automation and economies of scale, while
ensuring universal capital ownership.
Many other reforms of capitalism are also needed, but the relatively
equal distribution of capital is key to all other reforms of capitalism,
because many of the problems inherent in capitalist economies are products
of concentrated capital ownership and the motives that concentrated capital
ownership inspire. In addition, capital ownership is a source of political
power, so if capital ownership were more equitably distributed political
power would be as well, which would in turn further facilitate democratic
reforms of capitalist systems.
The United States of America has been, in many ways, the ideal test case for
capitalism. The widespread ownership of private capital prior to
industrialization provided an advantageous base upon which to build a
so-called "free enterprise" capitalist system. It has to be recognized that
the conditions which made widespread capital ownership possible in the
United States of America were a historical anomaly - the result of a
technologically advanced civilization invading a large land mass with a
small and significantly less technologically advanced population which they
essentially exterminated, making it possible for virtually all free families
of those invaders to become property owners. In addition, the policies of
the early American government aided widespread capital distribution through
policies that subsidized individual capital acquisition and policies that
were designed to ensure that capital (primarily in the form of land) would
be at least somewhat equally distributed among individuals instead of
concentrated into the hands of a few powerful individuals.
The relatively widespread prosperity present in early American society
was a direct product of this relatively widespread capital ownership. In
addition, the slavery system present in the early United States essentially
subsidized all of white society, even non-slaveholders, by reducing the cost
of materials for everyone. So freely available land/capital, along with
"free labor", played a large role in making "white" society highly
egalitarian in early America.
The question for capitalism as an economic system was, once the "free"
capital (land) was all gone, an end was put to slavery, and
industrialization had commenced, would the "free enterprise" capitalist
system be able to continue to provide widespread economic prosperity?
By the end of the 19th century many people in America and around the world
had begun to doubt that it would, and these doubts were only strengthened
with the global economic depression of the 1930s.
Many different solutions to the economic crisis of the 1930s were
implemented in industrialized countries around the world, ranging from
socialist to fascist to welfare-state capitalist systems. What essentially
all of the major "solutions" had in common was that they increased
regulation of the economy, created social safety nets of some kind for at
least some subset of the population, and further centralized control and
ownership over capital.
In the case of ostensibly socialist systems capital was centralized under
government control, largely against the interests of existing capital
owners. In the case of fascist systems capital was centralized under
government control largely in favor of the interests of existing capital
owners, and in the case of welfare-state systems capital generally became
more centralized under the control of private capital owners, while control
of capital became more highly regulated and taxed by governments.
Arguably, the only systems under which capital control became more
widespread were some of the socialist systems that "redistributed" land
during the 1930s-1960s, but this redistribution wasn't entirely meaningful
because in most cases the redistributed land became "collectively owned", or
rather still owned by the state.
The welfare-state reforms which dominated "developed" capitalist
economies like those of the United States and Western Europe had the effect
of providing increased economic security and stability in capitalist
economies and ensuring that prosperity was more widespread by improving the
rights and protections of non-propertied workers and by increasing the share
of created value received by non-propertied workers through regulation, as
well as creating social safety nets for workers, non-workers, and capital
owners.
These welfare-state reforms, however, treated the symptomatic problems of
capitalism without curing the underlying causes of those symptoms. This
actually enabled growth of the underlying root cause of imbalance in
capitalist economies, namely concentration of capital ownership.
Ultimately what we see when looking at the economic history of the United
States is constantly increasing concentration of capital ownership over time
in the world's flagship capitalist economy, under every regulatory scheme
and set of market conditions. We have to therefore conclude that increasing
concentration of capital ownership is an inherent outcome of capitalist
economies. We must also recognize that concentrated capital ownership
undermines the very principles that the proponents of capitalism often espouse.
However, it
would be incorrect to claim, as Karl Marx did, that capitalist economies
will "destroy themselves" or that they will cease to be able to function.
That isn't true. After all, feudal economies persisted for thousands of
years. Will capitalism inherently reach a state of "crisis"? Not if by
crisis we mean a state when the economic system will completely fail and the
ruling class will lose power much like the ruling aristocracies lost power
with the end of feudal economies. No, that won't inherently happen. It might
happen, but it isn't inevitable.
What will happen, unless capital ownership itself is massively
redistributed, is that economic disparity will increase, a ruling class will
become entrenched, and the working class will receive an ever-shrinking share of
the value created in the total economy. That condition can persist for
centuries, just as feudalism persisted for centuries.
To understand the concentration of political power in America over time we have to
understand that American economic populism was originally rooted in the socially conservative
farming population. When America was founded the majority of the
population were farmers and they owned the majority of the capital. As such,
they had tremendous political power. As the farming population shrank, the
political power of populism shrank, because what made American farmers a
unique political force was the fact that they were populist capital owners.
As farmers shrank from 85% of the population when the country was founded
down to around 40% of the population at the turn of the 20th century
their political power was waning, but remained relatively strong, and it was
the political power of the farmers that made many of the populist reforms of
the early 20th century possible.
By the 1930s the political power of the farmers was growing weaker still, but
remained strong enough to help usher through the major economic reforms of
the New Deal. Without the political backing of America's farmers it is a
virtual certainty that the populist reforms of the New Deal wouldn't have
been possible. The fundamental reason that American economic populism died
shortly after World War II is the industrialization of farming. By the 1970s
farming had become an industrialized, dominated by corporations instead of individuals, and farmers had shrunk to about 5% of the population. Not only
had the population of farmers shrunk, but farming was now dominated by
corporations, so what political power was retained by the farmers became
aligned with broader corporate interests.
This I think is key to understanding the transformation of American
economic populism. American farmers were the only meaningful group of
capital-owning populists. Once their political power waned and their
interests became aligned with corporations, the only remaining populists
were non-capital-owning workers, who, inherently, by virtue of their lack of
capital ownership, had (and continue to have) relatively little political power.
The failure of American economic thought is the failure to grasp and
internalize the paradox of property rights. Yes, private capital ownership
is what made America a great country and it is what made American society
relatively egalitarian and it is what made America a land of opportunity,
but that only worked because there was a large stock of "unclaimed" freely
available capital, in an economy dominated by individual economic production. This situation, by its very nature, essentially
negated the conflict between labor rights and property rights.
However, if we take John Locke's statement on property rights to be true,
that the right to property is a product of labor, then it becomes
obvious that owning capital necessarily deprives other individuals of their
right to property. The only time that this isn't true is when every
individual owns their own capital and all production takes place on an
individual scale. Since that was largely the condition in the early American
economy (for white males), the association between private capital ownership
and retention of the products of one's own labor became ingrained in the
American psyche. But as soon as an individual exercises their labor upon
capital owned by another individual the paradox of property rights is
raised. The early American economy did not resolve the paradox of property
rights, it merely avoided the paradox (for white families) by virtue of
having access to an essentially unlimited supply of free capital in the form
of land, and American economic thought has failed to come to grips with this
situation ever since.
It is clear that the incomes of today's large capital owners are not a
product of their own labor, but rather their incomes are the result of
redistribution of value created by millions of other people, ultimately
workers all over the world. Today there are individuals, largely in the
financial industry, with
incomes of over a billion dollars in a single year,
virtually all of which is derived from capital ownership. It is impossible
to attribute these incomes to the labor of the individuals who receive them,
yet I think that most people fail to grasp just how large these incomes are. The chart below provides a scalar
comparison between 1 billion, 1 million, and 100 thousand for reference.
To claim that any individual creates billions of dollars of value in a
single year with their own labor, while the average American creates around
fifty thousand dollars a year, is a total farce, but that income has to come
from somewhere, it has to be created by someone's labor if not theirs.
The reality is that the incomes of today's large capital owners are
little different than the incomes of the feudal aristocracies. The only
difference is that today it is easier for a non-capital owner to become a
large capital owner than it was for a non-aristocrat to become aristocracy
in the past and becoming a large capital owner is more merit based, but the
incomes are still derived in essentially the same way: They are products of
private taxation, the right to which is granted through property ownership.
Property rights grant ownership of value created by other individuals to
owners of capital. The incomes of today's large capital owners are products
of concentrated property ownership taxing away value created by the majority
of the non-capital owning population, just as they were in feudal times.
There is no easy resolution to the paradox of property rights, there is
no meaningful way to determine the true "labor value" contributed by an
individual in an industrial economy because the relationships between labor
and value creation are far too complex and the collective nature of
production necessarily produces value that is greater than the sum of the
individual contributions. In addition, as technological progress continues,
assuming that it does, automation makes reliance on labor as a primary
source of income increasingly misguided anyway.
This is why the labor movement's efforts in capitalist economies to
increase the wages of workers has been largely misdirected for the past half
century. Instead of focusing on increasing wages, the focus should be on
distributing capital ownership. However, the "blame" for this focus does not
rest entirely on the labor movement, because capitalists themselves have
intentionally kept the focus on wages as opposed to capital ownership. In
other words, in capitalist economies advocating for higher wages is easier
than advocating for capital distribution, because ultimately ownership and
control of capital is what's most important to capitalists. Capitalists
know that in the long-run retaining control of capital is more important
than temporary wage concessions.
But in order to have an equitable economy that can maximize growth and
efficiency, as well as democracy, capital ownership has to be relatively
equally distributed in some way, via some mechanism. Capital distribution is
ultimately far more important than wage distribution. This is the most
important lesson that we can learn from America's economic history.
The realization that capital ownership inherently becomes more
concentrated over time in capitalist economies is nothing new and has
been theorized for over a century, but today the evidence for this has
become overwhelming.
Private capital tends to become concentrated in few hands, partly
because of competition among the capitalists, and partly because
technological development and the increasing division of labor encourage
the formation of larger units of production at the expense of smaller
ones. The result of these developments is an oligarchy of private
capital the enormous power of which cannot be effectively checked even
by a democratically organized political society. This is true since the
members of legislative bodies are selected by political parties, largely
financed or otherwise influenced by private capitalists who, for all
practical purposes, separate the electorate from the legislature. The
consequence is that the representatives of the people do not in fact
sufficiently protect the interests of the underprivileged sections of
the population. Moreover, under existing conditions, private capitalists
inevitably control, directly or indirectly, the main sources of
information (press, radio, education). It is thus extremely difficult,
and indeed in most cases quite impossible, for the individual citizen to
come to objective conclusions and to make intelligent use of his
political rights. - Albert Einstein;
Why Socialism, 1949
Recognizing and understanding the concentration of capital ownership that
has taken place over the course of America's history, and the implications
of it, is therefore of extreme importance.
America's economy has evolved over time. The conditions that existed in
America's early economic history no longer exist today, and therefore many
of the
economic principles that ensured shared prosperity in America's early
economic history no longer have the same effect today. The Communist
and Socialist movements of the 20th century may have ultimately been
failures, but the problems of capitalism that they sought to address still
remain. The failures of those movements don't vindicate capitalism, all that
they do is show that those regimes were not the solution, but the problems
inherent in capitalism still remain; they didn't go away because some
alternative approaches failed.
The primary lessons that we learn from the failed Communist and Socialist
regimes of the 20th century is that centralization failed, yet when we look
at capitalist economies today what we see is that centralization has
taken place as well. Today the global capitalist economy is as much or more
centralized than the Soviet Union ever was, the difference is that the economy is centralized under
the control of powerful private interests who exercise heavy influence over governments
around the world, as opposed to being centralized under the direct control
of government.
A
2011 study found that a mere 147 transnational corporations (less than
1% of transnational corporations) controlled 40% of global capital. The
study found, "that network control is much more unequally distributed
than wealth. In particular, the top ranked actors hold a control ten times
bigger than what could be expected based on their wealth."
While this study examined only the relationships of transnational
corporations, the findings can be broadly applied to conclude that generally
speaking, control over capital is actually more concentrated than mere
wealth distribution would indicate. This actually makes sense based on how
controlling shares of corporations work, which is what allows entities to
own less than half of the value of a corporation while retaining controlling
interest. As capital ownership and control become increasingly concentrated,
the ability of capitalists to undermine market conditions in order to
preserve profits increases.
This is the reality that we have to acknowledge and face. Ownership and
control of capital is far more concentrated today than at any time in
America's history and this fact is a product of capitalism itself.
Ultimately, attempts at economic and political reform which don't
fundamentally address the distribution of capital ownership are doomed to be
temporary and ineffectual at best. The underlying cause of economic
inequality and political disenfranchisement in capitalist economies around
the world, particularly in America, is concentration of capital ownership.
This concentration of capital ownership undermines the principles upon which
America was founded, and now creates the type of feudalistic social and
economic conditions that early Americans fought so hard against.
- March 15, 2013
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