Tuesday, January 26, 2016
In the first post in this series, I introduced the question that has perplexed worldly philosophers for centuries: Where does profit come from in a capitalist economy, or, in other words, where does growth come from? Some economic thinkers have suggested what I brought up earlier—that logically there should be no profit in an efficiently functioning market system because revenues and expenses in the aggregate should cancel each other out and market forces should pressure both prices and wages into an uneasy truce. This is generally true, but, in addition to the financial shenanigans addressed in last week’s post, there are three notable mechanisms that disrupt the normally seamless interchange of money, goods, and services that produces a profit-free system of mutually canceling expenses and revenues.
Inventory. Because most businesses use the accrual method of accounting, revenues and expenses do not line up exactly over time. To illustrate with a simple example, revenue is realized by a producer when its product is sold to another company, perhaps a retailer, who then places it in inventory. But the retailer does not recognize this purchase as an immediate expense. The cost of this product is not recorded as an expense until it is sold to a consumer. So the revenue experienced by the producer and the expense recorded by the retailer may actually happen in different years. If inventories increase over time, the natural result for an entire economy featuring such transactions is profit. This is an example of how growth and profit are dependent on each other.
Capital assets. Some purchases are significant enough that they are capitalized and then depreciated over time instead of being immediately expensed. For example, if a business purchases a new office building, it does not immediately write the new building off as an expense, although the seller may record the sale as immediate revenue. Generally, the expense for these large purchases is realized over time as the asset depreciates. Again, revenues for one company and expenses for the other party in the transaction do not align. And if asset values increase over time, the economy grows.
Purchasing with debt. Whenever purchases are made using debt—either one business from another or consumers purchasing from a business—a similar misalignment of revenues and expenses occurs. The seller recognizes the sale immediately as revenue (if the credit is provided by a third party), but the buyer doesn’t recognize the expense all at once. That expense is spread over the life of the loan and generally takes the form of installment payments. To use a familiar example, when I purchased a car a few years ago, the auto dealer received full payment the day my credit union transferred the funds. But for me, since I am not independently wealthy, this was not a one-time expense. My expense was spread out over five years and occurred in manageable monthly installments. And what about the loan from the credit union? How did the credit union experience its expenses and revenues? Well, that is another story altogether, which I will address shortly.
Money, Money, Money
The three exceptions mentioned above are helpful in explaining how a capitalist economy grows, but in no way do they come close to accounting for all the profits that are extracted from the flow of goods and services. So, what else may account for this expansion? One pivotal mechanism that makes growth possible is the expansion of the money supply. If the money supply does not expand, the economy simply cannot grow. (This, by the way, was the fatal flaw of Hannah Bell’s two-company economy: a static money supply, which made profit impossible.) So, how does the monetary supply expand? There are perhaps three ways. I say “perhaps” because one of these ways is an illusion.
First, the government prints money. If you listen to politicians and some journalists, you get the impression that when government needs more money, it simply cranks up the printing press. But printing money is actually a very minor source of new funds, primarily because so few of our financial transactions involve federal reserve notes (cash) in this digital age.
A much more fertile source of monetary growth is the financial sleight of hand that takes place whenever commercial banks lend money into existence, and this is the answer to the credit union question above. According to Herman Daly and John Cobb, “Private creation of money by banks evolved long before it was understood. Joseph Schumpeter claims that, as late as the 1920s, ninety-nine out of one hundred economists believed that banks could not create money any more than cloakrooms could create coats.”1 Although this practice was not well understood for years, today it is fairly common knowledge. Anyone who has taken an elementary economics course should understand it. Basically, if a bank is required to keep only 10 percent of its deposits on reserve, it can loan out $90 of a $100 deposit. If the recipient of the $90 loan deposits the whole amount in his bank account, that bank can loan out $81, and the process then repeats itself again and again. The potential new money from this lending practice is $1,000. This new money, in general, is used to produce products, purchase products, and generate revenues. As the revenues return to the banks to pay off the loans, the banks skim off interest, which becomes their profit. Of course, the lower the reserve ratio, the more the initial asset can be leveraged and the more interest will be charged. The key to growth, then, is for banks to keep lending money, preferably in forms that have low reserve requirements, and to make sure that aggregate net debt increases over time.
The reserve ratio for banks in the United States varies depending on the institutions’ volume of transactions and type of deposits, but it ranges between zero and 10 percent and excludes such ordinary categories as savings accounts, CDs, and time deposits from corporations and foreign governments. What this means is that financial institutions can leverage a good portion of their deposits at astronomical rates. But what about the bizarre financial instruments concocted by Wall Street? Well, they have not been regulated at all. This is how Lehman Brothers was able to leverage its assets at a 35 to 1 ratio. And, of course, as financial institutions create this inverted pyramid of debt, they charge interest or fees at every level. This is why banking is so profitable.
Daly and Cobb question the whole notion of compound interest, insisting that “money should not bear interest as a condition of its existence, but only when genuinely lent by an owner who gives up its use while it is in the possession of the borrower. When the commercial banking system lends money, it gives up nothing, creating deposits ex nihilo up to the limit set by the reserve requirement.”2 And if there is no reserve requirement, the sky is the limit, until the air gets too thin and the balloon collapses.
The third way new money is created (and at least some people subscribe to this theory) is through the bidding up of asset values by speculation. The stock market is only one element in the vast array of assets that attract speculators, but understanding a few basic concepts about the stock market can help us comprehend what is happening in the larger financial sector. Although shares of stock represent ownership of corporations, the value of those shares of stock have a very tenuous connection to the actual value of a corporation’s assets, its ability to create and sell products, and even the money in its liquid accounts. During the last few months of 2008 and the first part of 2009, we saw the stock market’s major indices lose more than half their value. Journalists and economic analysts were aghast over the vast amount of “money” that was lost. I know something about this on a personal level. I had some of my 401k funds invested in the stock market. I lost about 20 percent of the value of the 401k before I shifted everything to other types of investments. But did I really lose anything? What about everyone else? What about all those trillions of dollars of “wealth” that simply vanished into thin air during these difficult months? A lesson from not-so-distant history may help us answer these questions.
A smaller stock market crash occurred in 1987. Joel Kurtzman, in his book The Death of Money, gave the following assessment of the carnage:
If measured from the height of the full market in August 1987, investors lost a little over $1 trillion on the New York Stock Exchange in a little more than two months. That loss was equal to an eighth of the value of everything that is manmade in the United States, including all homes, factories, office buildings, roads, and improved real estate. It is a loss of such enormous magnitude that it boggles the mind. One trillion dollars could feed the entire world for two years, raise the Third World from abject poverty to the middle class. It could purchase one thousand nuclear aircraft carriers.3
In 2008, similar statements were made about the vast wealth that suddenly disappeared. But what really happened? David Korten’s response to Kurtzman’s lament is instructive:
Those who invested in the stock market did indeed lose individual buying power. Yet the homes, factories, office buildings, roads, and improved real estate to which Kurtzman refers did not change in any way. In fact, this $1 trillion could not have fed the world for even five minutes for the simple reason that people can’t eat money. They eat food, and the collapse of the stock market values did not in itself increase or decrease the world’s actual supply of food by so much as a single grain of rice. Only the price at which shares in particular companies could be bought and sold changed. There was no change in the productive capacity of any of those companies or even in the cash available in their own bank accounts.4
Consider my own 401k to illustrate what really happened. I owned a few shares of stock through an investment fund. Over time, these shares grew in value. But did I actually have more money? Well, on paper, yes. The quarterly statements I received for my 401k showed that my account was worth a certain amount, and it was expressed in U.S. dollars. But that “money” wasn’t real because it wasn’t liquid. It was merely potential money. Because someone was willing to buy those shares from me at an inflated price, my account balance ballooned. Such was the case with all investors in the stock market. But was there actually more money in the stock market? Not at all. There was only an increase in perceived value. In other words, in August 2008 did I really have any more wealth than I did ten years earlier? No (leaving aside the additional money I had earned and deposited into the 401k during those ten years). Could I buy anything with those shares of stock? No. If I had cashed them in, then I would have been able to spend the money I received from their sale on all sorts of real goods and services. But I didn’t. And when I traded those shares for some safer investments, they were worth a lot less than they had been worth a few months earlier. My account balance was at that time about 20 percent lower than it was at its peak. Other investors lost much more than I did. But did the money supply actually decrease when the stock market plunged? No. So this sort of monetary expansion is really just an illusion.
The stock market, as mentioned, is just a small segment of the financial sector. Most of the economic expansion we have seen during the past few years occurred in foreign exchange transactions, in the commodities markets, in real estate, and in the nebulous world of phantom finance that encompasses derivatives of every shape and flavor, everything from forward rate agreements to credit default swaps. To put the financial sector in some sort of useful context, consider that foreign exchange transactions alone amounted to about $5.3 trillion per day in 2013, while the world domestic product rang in at only $205 billion per day. Put another way, the total value of all final goods and services produced in the world amounts to less than 4 percent of the money that is traded every day in just the currency markets. Money did not become a commodity until 1973, but now it is the most sought-after commodity of all. And minute fluctuations in the rates of exchange between currencies yield mammoth amounts of “profit” every day. This profit is somehow extracted from the system without anything at all being produced. What allows this to happen? The accelerated flow of money. I’ll explore this phenomenon in the next post, but for today let me backtrack momentarily.
The Resource Factor
I mentioned above that the economy cannot grow if the money supply does not grow. This is true, but expanding the money supply alone does not necessarily translate into economic growth. There must also be an expansion in the total mass of products created during a given time frame. And in order to make this production possible, natural resources must enter the flow and, through the instrumentality of labor and technology, be transformed from raw materials into finished products, a process that generally involves several steps and various industries. In essence, the two-company economy of Hannah Bell can grow only if the money supply expands and if new natural resources enter the system and are transformed into widgets. With these two factors in place, the two business owners can extract a profit, and the total quantity of products for sale can increase.
If the business owners are shrewd, they will try to increase their profits by doing two things: increasing the price of the widgets and decreasing their labor costs. Increasing the price of the widgets is possible if they either improve the product or create the widespread impression that all prices must simply increase over time. Decreasing labor costs is made possible by creating a surplus of workers looking for work over jobs available. In such circumstances, desperate workers are willing to labor for less pay. A related method for decreasing labor costs is to increase productivity, either through more efficient work methods or, more commonly, through technological innovation. Productivity improvement not only enables a worker to produce more product in a given time frame, but it also allows a company to produce the same amount of product with fewer workers. In this way, productivity improvement helps create a surplus of labor, which places downward pressure on wages. The result, of course, is more profit going into the pockets of the owners and business executives. The downside is that the workforce has less disposable income with which to buy widgets. This is the Hobsonian world we have come to accept.
When an economy becomes highly productive, it requires fewer workers who actually produce the physical products people need. The result is that the surplus workers find lower-paying jobs in an expanding service sector, which creates largely superfluous products. So, what happens when we need only 10 percent of the workforce to manufacture the products we need and want? What do the rest of us do? Do we get up each morning, as Harvard business professor William Abernathy once suggested, and press each other’s pants? Or, as an economist friend of mine put it, “I’ll cut your hair, and you’ll cut my hair, and we’ll both get rich.” A nation of superfluous service workers is not an economically healthy nation and never can be. This is the dilemma of a postindustrial society.
The crux of the issue is that increased productivity, aimed at making companies competitive and profitable, is inadvertently creating a greater division between the haves and have-nots and is therefore diluting our ability to consume all that we produce. Corporate capitalism’s solution to the dilemma of a shrinking manufacturing workforce is to introduce new products—primarily services and technological gizmos—at an accelerating pace. This creates new jobs (generally at lower pay) to replace the ones we have eliminated or exported and thus curbs unemployment, though not misemployment; it also pressures us to consume more than ever before (in an expanding economy, consumption must perpetually increase) and keeps the wheels of capitalism spinning—faster and faster.
And this brings us to a good stopping point, before we tackle the idea of speed that masquerades as growth.
1. Herman E. Daly and John B. Cobb Jr., For the Common Good: Redirecting the Economy toward Community, the Environment, and a Sustainable Future (Boston: Beacon Press,  1994), 416.
2. Daly and Cobb, For the Common Good, 426.
3. Joel Kurtzman, The Death of Money (New York: Simon Schuster, 1993), 98.
4. Korten, When Corporations Rule the World (San Francisco: Berrett-Koehler; Bloomfield, Ct.: Kumarian Press, 1995), 192.
Tuesday, January 19, 2016
John Hobson, a frail little Englishman with a speech impediment and a penchant for economic heresy, argued more than a century ago that in order to grow, indeed, in order to survive, capitalism had to become imperialistic. Without exporting both production capacity and products abroad, capitalism would eventually suffocate itself. At the time, no one really took him seriously, except the Marxists, who twisted his ideas into a strange confirmation of their own misconceptions. But Hobson’s reasoning was both fascinating and deceptively simple: growth, the very engine that drives capitalism, also creates the conditions in which a nation can never consume everything it produces.1
The poor, Hobson argued—and today we would add the middle class—don’t have the means to buy their fair share of the nation’s production, and the rich have too much money to consume a proportionate piece of the productive pie. Someone with a $10 million income can’t (or won’t see any reason to) buy two hundred times more consumer goods than a person with a $50,000 income. In fact, the wealthy in every society are mindful of what they don’t spend, for if they spend all they have, they are no longer wealthy. Wealthy people, rather than spend most of their income, invest a good portion of it, directly or indirectly, in new productive capacity, which, Hobson insisted, merely compounds the problem. If society is already having difficulty consuming all it produces, then this perpetual increase in productive capacity will flood an already saturated market.
In order to grow, Hobson concluded, capitalist economies not only have to invest their capital abroad, they also have to sell their increased production abroad. They have to export more than they import. From one nation’s perspective, this provides a temporary respite, but in the long run it ruins a world economy, as more and more nations need an outlet for their excesses.
Hobson’s ideas, though largely forgotten, are nonetheless significant, especially when seen in light of today’s global economy. For many years after World War II, America was able to export more than it imported. But now the tables are turned. For decades now, America has run up huge trade deficits. In other words, we have somehow found a way to consume not only everything we produce, but billions of dollars of goods imported from other countries. How have we managed this?
It is simple, really. We have found a way around Hobson’s insistence that capitalist societies cannot consume all they produce without becoming imperialistic: debt. We are buying on credit. The problem with this solution is obvious: eventually, as the world economy reaches the point America reached a few decades ago and all nations sink deeper into debt, the global economy will bankrupt itself. Because of the principle of compound interest, debt has a tendency to grow exponentially and, in normal times, to outpace economic growth. At present, interest rates are abnormally low, so we are experiencing a brief reprieve, but, as they say, time will tell.
The root of Hobson’s dilemma, though, is the unequal distribution of wealth. If the lower and middle classes had more disposable income with which to purchase consumer goods, and if the wealthy had less excess money to invest in unneeded production, would the system avoid its inevitable demise? This is a good question, which lies beyond the scope of this series of posts. For now, we need to address the question of profit.
The Profit Problem
John Hobson’s intriguing observations hint at the underlying question introduced in the previous post: What makes the capitalist economy grow? The answer is simple: profit. But where does profit come from? Profit in a single business is, of course, the difference between revenues and expenses. It comes simply as businesses charge more for their products than the sum of their expenses. But the aggregate of all businesses should not be able to experience a profit because all revenues and expenses should cancel each other out. This is the problem that perplexed worldly philosophers for centuries. Curiously, only three reasonable answers were ever put forward: one by Karl Marx, another by Joseph Schumpeter, and a third by Thorstein Veblen. Even the venerable Adam Smith wavered on this question between two possible answers.
For a detailed explanation of the three theories, I recommend Robert Heilbroner’s classic The Worldly Philosophers, but for our purposes here, let me try to fit these three explanations into a very small nutshell. Marx concluded, as did others, that profit doesn’t occur naturally in the capitalist system. Market forces drive profit from the system whenever it rears its head, so Marx theorized that the only way capitalists can extract a profit from their operations is to steal it from the laborers by paying them less than their actual value. This theory has some merit but also some obvious limitations, since it doesn’t address the reality Hobson identified or answer the question posed by Hannah Bell (see last week’s post).
To Schumpeter, profit was not stolen into existence; rather, it came honestly from innovation. He described production and consumption as a circular flow that follows a regular and predictable course: people trading money and products with one another. Profits magically appear whenever innovation disrupts the circular flow. Those who create the innovation can charge a higher price or reduce their production costs and thus extract a profit—until their competitors match the innovation and restore equilibrium. Schumpeter’s theory offers a partial explanation, but it still does not answer Hannah Bell’s question. Innovators may be able to charge more for their products temporarily, but their revenues must still come from somewhere, and that “somewhere” is, directly or indirectly, someone else’s expense, so revenues and expenses still theoretically cancel each other out.
Veblen came at the profit problem from a different angle. He saw “the economic process itself as being basically mechanical in character. Economic meant production, and production meant the machinelike meshing of society as it turned out goods. Such a social machine would need tenders, of course—technicians and engineers to make whatever adjustments were necessary to ensure the most efficient cooperation of the parts.”2
But where, asked Veblen, does the businessman fit in? The businessman, he concluded, was basically a saboteur of the system who extracted profit by disrupting its smooth, mechanical operation. The system saw no other end except making goods. But the businessman was interested only in making money. The problem with the economic machine, however, is that if it worked efficiently, there would be no room for a man who only wanted to make a profit, because profit would be squeezed out of the regular flow of production and consumption. “So the businessman achieved his end not by working within the system, but by conspiring against it. His real purpose was not to help make goods, but to cause breakdowns in the regular flow of output so that values would fluctuate and he could capitalize on the confusion to reap a profit.”3
And how did the businessman cause these breakdowns in the production machinery? By creating the never-never-land of corporate finance. Corporate capitalism isn’t just about producing motorcycles and mushrooms and microchips. “On top of the machinelike dependability of the actual production apparatus,” writes Heilbroner, explaining Veblen’s theory, “the businessman built a superstructure of credit, loans, and make-believe capitalizations. Below, society turned over in its mechanical routine; above, the structure of finance swayed and shifted. And as the financial counterpart to the real world teetered, opportunities for profit constantly appeared, disappeared, and reappeared.”4
The Disconnected Financial System
All three of the theories about where profit comes from in the capitalist system—the theories of Marx, Schumpeter, and Veblen—have their merits, but they also have significant flaws. Indeed, none of these theories actually explains how the capitalist economy expands and produces profit. Veblen’s version, for instance, doesn’t really explain how ordinary businesses that aren’t involved in financial manipulations can turn a profit, but it certainly addresses what has been happening recently in the global economy at large. As Wall Street has concocted a variety of “make-believe capitalizations,” the financial sector has found ways to extract obscene amounts of “profit” from the economy. In 2007, for instance, just before the big financial meltdown, the top fifty private investment fund managers received an average of $588 million each in annual compensation. The top five received more than $1.5 billion each.5 And this is just the tip of the iceberg. These firms were extracting phantom profits and paying out salaries and bonuses in unheard-of quantities. Of course, when this house of cards collapsed, it became obvious that these profits and outlandish compensation packages were simply the effect of leveraging assets to the moon and back through speculative financial instruments called derivatives. And since so much money had been paid out in salaries and bonuses, there was not nearly enough left in reserve to cover the losses, which compelled government to step in with enormous bailouts to keep the entire economy from falling apart. Of course, the recent Republican claims that we shouldn’t have bailed out Wall Street are simply the blather of politicians who have no concept of what would have happened if we hadn’t.
The idea of the bailouts was to clear out toxic debt and get credit flowing again so that the economy could return to its normal course of endless growth. But the debt this debacle has added to the system will simply hasten its demise, necessary though it was. The crisis of corporate capitalism, to put it bluntly, is not something we can grow out of, because growth is funded by debt. And in order to grow the economy faster than it could possibly grow in the normal course of business, Wall Street piled up layer upon layer of debt to leverage any real assets at the bottom of the pile far beyond the point of no return. Indeed, those real assets were buried so far beneath the pile of debt that they were almost completely forgotten, and were virtually meaningless to the Wall Street Rumpelstiltskins who were busy spinning gold out of straw.
Aside from the suffocating quantities of debt the system has generated, 2008 brought the distinct possibility of “sudden death by derivative.” The world economy came closer to collapse than most people realize. And we have not corrected the systemic flaws that pushed us to the precipice. According to figures published by the only institution that tracks the derivatives market (the Bank of International Settlements), the size of that market—consisting of both over-the-counter and exchange-traded derivatives—exceeded $1.1 quadrillion in July 2008.6 Yes, quadrillion. More recent estimates put it now at about $1.2 quadrillion. By contrast, the value of the world’s financial assets—including all stock, bonds, and bank deposits—was pegged at $294 trillion” in 2014.7 In other words, the derivatives market is four times as large as the world’s combined financial assets. But these financial instruments are not like stocks or bonds, and they certainly have little similarity to bank deposits. Even though David Korten has labeled them “phantom wealth,” they are massive in quantity and frightening in their destructive potential.
The derivatives market is something akin to a global casino. It consists of bets financial speculators place in hope of winning the jackpot. These “investors” can bet on anything from the future price of crude oil to the financial solvency of the Port Authority of New York and New Jersey. Derivatives also include insurance contracts on regular financial instruments such as corporate bonds. The problem with derivatives is that they are highly leveraged, meaning that a small foundation of real assets supports an immense tower of speculation. This is the bubble that almost popped in 2008. In March of that year, Bear Stearns, with derivatives valued at $13.4 trillion (larger than the U.S. national income), almost failed. Because the financial sector is so interlinked, this would have caused a complete systemic collapse. Disaster was averted because the Fed allowed J .P. Morgan Chase to add the endangered Bear Stearns derivatives to its own $77 trillion portfolio.8 Then, in September 2008, AIG and its derivatives—called credit default swaps—almost sank the whole financial sector.9
Investment sage Warren Buffett had good reason to call derivatives “financial weapons of mass destruction.”10 “We view them as time bombs,” he wrote, “both for the parties that deal in them and the economic system.”11 This was five years before the 2008 meltdown, which would have been catastrophic without government intervention. But the derivative bubble still exists, and even though Congress enacted a little bit of financial reform, the market is still largely unregulated and highly leveraged, and the reckless Republicans want to deregulate the financial sector even more. Go figure.
When we look at the sheer size of the derivatives market, compared with the size of the world economy ($107.5 trillion), it is easy to see where so much of our profit has come from. It is phantom wealth that has been conjured into existence by leveraging real assets far beyond their ability to ever provide the necessary level of return.
What is happening on Wall Street and elsewhere is very consistent with the ideas of Veblen, who theorized that profit is the result of financial manipulations by businesspeople who sabotage the system. The problem with this method of creating profit is that it divorces the financial system from the apparatus of production and consumption and makes profit an end in itself. In Veblen’s world, most of the goods that clamor for our spare change (or remaining credit) are not an end in themselves, items that people actually need or that improve their lives. Most of the products sold in today’s market are means to an end, and that end is profit. They were created not because we need them or even want them, but so that someone could extort a profit from the flow. We are then persuaded through advertising that we do indeed need or want them. In the process, production has become a tool of finance, not the reverse.
Finance as an end in itself is a scary thing. When money becomes the most sought-after product, something is terribly amiss because money is no product at all. Money is a tool, a pure fiction we created to ease the exchange of real products and labor. According to John Stuart Mill, “It is a machine for doing quickly and commodiously, what would be done, though less quickly and commodiously, without it; and like many other kinds of machinery, it only exerts a distinct and independent influence of its own when it gets out of order.”12
Money in our day has indeed gotten out of order. Because the financial superstructure is so divorced from the practical economy, implausible profits have been reaped and impossible though imaginary financial growth has been experienced. But, as we have seen all too clearly, this incredible profit and growth was really nothing more than a bubble. It popped once. And what did we do about it? Did we put limitations in place that would prevent another crisis? No. We restored the same flawed system, slapped its wrist, and now the Republican Congress wants to turn it loose to do what it is designed to do. We have created the perfect conditions for another bubble and another collapse.
1. For a summary of Hobson’s argument, see Robert L. Heilbroner, The Worldly Philosophers: The Lives, Times, and Ideas of the Great Economic Thinkers, 6th ed. (New York: Simon & Schuster, 1986), 194–200.
2. Heilbroner, The Worldly Philosophers, 235.
3. Heilbroner, The Worldly Philosophers, 235–36.
4. Heilbroner, The Worldly Philosophers, 236.
5. Sarah Anderson et al., “Executive Excess 2008: How Average Taxpayers Subsidize Runaway Pay,” 14th Annual CEO Compensation Survey (Washington, DC: Institute for Policy Studies, 2008), 3.
6. Jutia Group, “Global Derivatives Market Now Valued at $1.14 Quadrillion!” iStockAnalyst, http://www.istockanalyst.com/article/viewarticle/articleid/2432853/. More recent estimates peg total derivatives at $1.4 quadrillion, ample proof that indeed we have not corrected the flaws that allowed the speculative bubble that almost destroyed the global corporate economy in 2008.
7. Sam Ro, “Here’s What the $294 Trillion Market of Global Financial Assets Looks Like,” http://www.businessinsider.com/global-financial-assets-2015-2.
8. Jutia Group, “Global Derivatives Market.”
9. If you’re interested in learning more about how derivatives work and why they almost brought the house down, a good place to start is Adam Davidson, “How AIG Fell Apart,” http://www.reuters.com/article/idUSMAR85972720080918.
10. Berkshire Hathaway Inc. 2002 Annual Report, 15.
11. “Introduction to Derivatives,” Global Derivatives, http://www.global-derivatives.com/index.php?option=com_content&task=view&id=185.
12. John Stuart Mill, The Principles of Political Economy, 9th ed., (London: Longmans, Green & Co., , 1886), Vol. II, Book III, Chap. VII, p. 9.
Tuesday, January 12, 2016
Corporate capitalism is a religion. You may think this a rather fantastic statement, but it is true nonetheless. Most adherents to the capitalist religion don’t view themselves as religionists, but their behavior belies this view. Corporate capitalism is an organized system with a canon of beliefs, creeds, sacraments, articles of faith, and objects of worship. Marjorie Kelly listed several fundamental beliefs of the corporate system:
• Stockholders must be paid as much as possible and employees as little as possible.
• Stockholders legally claim wealth they do little to create.
• A corporation is piece of property—not a human community—so it can be owned and sold by the propertied class (along with any human resources that belong to the corporation).
• Corporations function with an aristocratic governance structure, in which members of the propertied class alone may vote.
• Corporate capitalism embraces a predemocratic concept of liberty reserved to property holders, which thrives by restricting the liberty of employees and the community.
• Corporations are private, and the free market will self-regulate.1
The God of Corporate Capitalism
The six beliefs listed above are crucial to maintaining order in the Church of Corporate Capitalism, but Kelly overlooked several tenets that are just as important, including one idea that rises above all others. Indeed, this idea is so highly revered that we could very well say it is universally worshipped in corporate capitalism. This one ruling principle is endless economic growth.
How universal is this principle? Consider the simple fact that both major political parties are in complete agreement over this one belief: the economy must grow. The two parties may disagree over how exactly to achieve the heaven of endless growth, but they agree that this is the paradise we must strive for. If the economy does not grow, then it shrivels and begins to die: profits disappear, corporations must shed employees to cut costs, demand withers, and the cycle starts over at a lower level, descending in a downward spiral that may eventually end in depression, or worse. All mainstream economists and all politicians agree on this. This is why governments attack recessions with tax cuts or rebates, direct government investment, and bailouts of failing companies or even whole industries. Growth is not just good; it is god. We must worship it. We must sacrifice whatever is required to appease its volatile anger and fickle demands. Growth is the heart and soul of the corporate economy. Some think money is the god of capitalism, but money is just a tool. Growth is god.
But what if endless growth is a false god? What if it is actually the root of our economic troubles? What if it is a road to nowhere? What if our problem is not really figuring out how to make the current system grow faster? What if our problem is the system itself? This is heresy of the highest order, but in this series of posts we will consider exactly where our blind and perfect faith in the god of endless growth will eventually take us.
Kenneth Lux, an economic heretic, gives us a hint: “We live on a finite planet. If human beings are defined as being made up of infinite wants [the premise behind modern economics and corporate capitalism], and the task of an economic system is to fulfill that infinity, then such a system will go on endlessly churning out goods in an attempt to reach what is from the beginning an impossible goal. When the infinite production of goods meets up with a finite planet there is bound to be a collision.”2 We are experiencing the beginnings of that collision today. The end result of endlessly increasing production and consumption is a bloated system that eventually starves itself to death because it has used up many critical resources.
But there is more than this. We may never reach the physical limits Lux warns of. Are there economic limits we may reach first? The enormous debt America and other countries are accumulating suggests as much. But why can’t the national or global economy just keep on growing forever, without end? That is the question we must answer, but to understand the answer, we must delve into the notion of growth itself: how it works and what its internal limitations are.
First, however, let me make one simple observation that lies at the heart of this issue of endless growth. If we look at a typical small business, perhaps a dry-cleaning establishment, we observe that it can remain roughly the same size for the entire span of its existence without any adverse effects. As long as it is covering its costs, putting away some cash to replace aging equipment, paying its employees a living wage, and providing for the present and future needs of its proprietor, it doesn’t really need to grow.
A large corporation, however, exists in an entirely different universe, operating under different pressures and with different compulsions. If corporations don’t grow, they generally either die or are eaten whole by other businesses. Why is this so? Paul Hawken gives us a clue. He suggests that large corporations compete on a different basis than small businesses.
“They are competing against one another,” Hawken claims, “not only for the sale of products like cars, detergent, or gasoline, but also for money, because their growth is fueled by investment. With regard to both indebtedness and equity, companies attempt to give the best return on investment, securing for themselves the greatest supply of new capital at the lowest cost possible.”3 If corporations don’t provide impressive returns, they can’t access this new capital, and often they don’t survive.
The corporate growth imperative does hinge on the competitive nature of the corporate economy and the fact that corporations must compete not only for sales but also for investment, but other factors also come into play. In fact, economic growth is, ironically, a very poorly understood concept, even though it is the god that is universally worshipped in the corporate capitalist religion. Of course, that is a problem with most gods. The more mysterious they remain, the greater their allure. So let’s unveil this god of corporate capitalism.
The Profit Paradox
A few years ago, I happened upon a website called Democratic Underground. It presented the following hypothetical scenario:
Imagine a world with 2 “owners” & 20 “workers.”
Imagine each of the owners has $100 to “invest.”
Each buys $25 worth of raw materials from the other ($15 “rent” cost, $10 labor cost).
Then each one pays their 10 workers $75 to produce 20 widgets.
Imagine everyone needs some access to a widget to sustain their life.
So, at the end of the production cycle, we have:
20 workers with $170 dollars.
2 owners with $30 in cash & 40 widgets that cost $200 to produce, that they’ll now attempt to sell at a profit.
Where does the profit come from?
This little scenario, like others I’ve seen, was really asking where profit comes from in an economy. A two-company economy is just a way of simplifying things so that we can see how transactions unfold in a large and complex economy. But the question is still valid. The ensuing back-and-forth on Democratic Underground was most entertaining. The person who presented the scenario, “Hannah Bell,” was obviously playing the devil’s advocate, but most of the people posting answers didn’t understand at all what she was asking. They were stuck on the idea that profit is simply revenue minus expenses. That’s how an individual company makes a profit. But Hannah was looking at the entire economy, where, on the surface, the numbers just don’t add up.
If we look at one company—say, Ford—its employees can never earn enough money in any particular year to buy all the products they produce in that year. Their total wages represent just a fraction of the total cost of Ford vehicles produced in that year. Above and beyond Ford’s wage expense, the company must also pay for parts, raw materials, various services, and overhead, and still have enough left over to pay executive salaries and, in theory, put away a little profit. So, even if you add in executive salaries, Ford’s employees don’t make anywhere near enough money in a year to buy all the products they produce. This is rather obvious.
But if we look at all companies in an economy as if they were one giant corporation producing millions of products and employing millions of people, they would be in the same boat as Ford. The collective group of employees simply cannot earn enough money in any given time period to buy all the products they produce. It is mathematically impossible. If, however, we add in the all the profits earned by all businesses, then perhaps there is enough money available to buy all the products produced. In such a closed economy, every dollar received by any company for the sale of its products has to come from somewhere. On the surface, it appears that every dollar of revenue, directly or indirectly, comes from either another organization’s expense or from its profits. In a closed economy, then, revenues and expenses should exactly cancel each other out. This idea has been embraced by the great worldly philosophers for centuries. If this is true, however, then how do the majority of businesses make a profit? And how do some reap enormous profits? Interestingly, no one has ever satisfactorily answered this question. Yet.
But one thing about capitalism is certain: it does grow. It does produce a collective profit. As illogical as it might seem on the surface, the market economy not only does grow over time, but it must grow. If the economy does not expand, it shrivels and begins to die, as we discover anew every time we dip into recession, a period in which we experience what economists oxymoronically call “negative growth.” Endless growth is thus a requirement for the survival of the capitalist market system. But, as Kenneth Lux pointed out, and as we will explore in greater detail in a later post, endless growth is an impossibility. We live on a finite planet with finite resources. Sooner or later the endlessly growing economy will bump into physical constraints. But long before that happens, the system, at least as we have imagined it, will smother itself with debt because of certain internal conflicts.
1. Marjorie Kelly, The Divine Right of Capital: Dethroning the Corporate Aristocracy (San Francisco: Berrett-Koehler, 2001), 14.
2. Kenneth Lux, Adam Smith’s Mistake: How a Moral Philosopher Invented Economics and Ended Morality (Boston: Shambhala, 1990), 9.
3. Paul Hawken, The Ecology of Commerce: A Declaration of Sustainability (New York: HarperBusiness, 1993), 92–93.
4. Democratic Underground, http://www.democraticunderground.com/discuss/duboard.php?az=view_all&address=389x3607862.