Capitalism and the State: an abstract
By Paolo Leon
1. Introduction
The last crash and economic slump seem to have left unscathed the fundamental beliefs that sustain the economic policies of almost all the Governments in the world. The only exception was the increase in public spending by the first Obama administration, soon followed by renewed emphasis on a balanced budget and minimum public debt. True, a massive inflow of fiat (exogenous) money on the part of the Fed, first, and later the BCE, was put into place, but little reform was undertaken to moderate speculation on the financial market, so that, fuelled by that inflow of money, the price of stocks increased out of any proportion with the increase in GDP, on either side of the Atlantic. The extremist view of an “expansionary austerity” is not any longer prevalent among economists, but the strong conservative opinion in the USA and the European Union, continue to operate on that basis. The lack of a clear line of action is indicative of a deep transformation in the culture of individuals, enterprises, financial agents and Governments, that took place after the decline and fall of the type of capitalism that was formed after the Great Depression. From the ‘30s and until the late ‘70s, an entirely new capitalism was built in the US, and later expaned in the rest of the non-communist world. In the late ‘70s, this type of capitalism shrivelled, substituted by new policies enacted by Prime Minister Thatcher and President Reagan. It is rather astonishing that, while the differences between what amounts to two very different capitalisms are known and described, nobody seems to have realized that two different economic societies have existed and that, therefore, there is not one single model of capitalism. Obviously, all theories which are predicated on assumptions that allow for one sustained/able model of economic behaviour and institutions, as well as the economic policies inspired by the same model, are built on very shaky grounds.
2. On the blindness of capitalists
It is not at stake only, or even mainly, the lack of realism of the assumptions on which models are built, such as: the very idea of a general equilibrium, including the applied dynamic stochastic general equilibrium model, the process of aggregating behaviours, the idea of perfect or imperfect competition, the concept of individual and general rationality, not to mention the identification of economics with individualism (qualified as methodological: a defensive adjective, a sign of guilt), the absence of social laws, the appearance of the State out of the blue, etc. What is at stake is not realism, but the very logical foundations of much of economics.
a) Smith’s veil
Pretending to draw from Adam Smith’s seminal finding “by pursuing his own interest, he (the individual) promotes that of society”, that certainly introduced in economics individualism and the justification of the amorality of trade and exchange, many economists, maîtres-a- penser, philosophers and gurus (particularly of the financial type) have neglected continuing reading Smith: « he generally neither intends to promote the public interest, nor knows how much he is promoting it ».
This I call Smith’s veil of ignorance, and its implication is that the effects of each individual choice are known only in so far and when and where they are in each and everyone’s interest. But the effects are never entirely limited to such interests and each choice has an influence on other individuals, often innocent bystanders.
We can exemplify. A case in point regards trade. In the classic exchange between two individuals, ever since the early utilitarianists, both parties, if they carry out the trade, realize the maximum utility expected by each, otherwise they would not have traded: adding logically the two utilities, the exchange maximizes social utility. On the other hand, if social utility is maximized, it becomes unexplainable why the distribution of utility (of income and wealth) is permanently uneven. It is more reasonable to argue that, in trading, utilities (earnings) are not equally divided between partners, if not by a fluke. If we add that trade influences third parties that have not participated in it – the workers, the suppliers of each exchanger, the end users of what is traded, it becomes clearer that the first contract affects the parties to the trade, but they don’t know the consequences on everybody else.
Another example of Smith’s veil is the behaviour of entrepreneurs during times of depression or crisis. When demand slacks, firms tend to reduce production in order to reduce costs and prices, with the aim to stimulate demand. Leaving aside the consequent deflation, the reduction of costs reduces employment and the demand on the firm’s suppliers, leading to further declines in overall demand, including that for the firm’s products. So, what appears as a rational choice, common to all firms in the same circumstances, results in an unwanted further crisis of the economy as a whole. The instance of a “supply crisis”, when costs increase and firms are pushed to reduce production, is apparently different, because if firms were operating beyond capacity, such choice can reinstate a lower utilization, a reduction of costs, and the exit from the crisis. On the other hand, firms operate to maximize profits and it is difficult to imagine that they drop the drive to reduce costs, whatever the economic situation, and capacity may well, in the end, remain underutilized. In these circumstances we can aggregate entrepreneurial behaviours, whatever its results for the economy at large, but aggregation does not mean that its economic effects are known.
Firms and families behave similarly. When employment in the family declines, the principal option available is to reduce consumption, affecting negatively demand at large, and unemployment grows even more. The aggregation of family behaviour is possible, but effects are different from the expectations.
Economists have tried to solve the problem assuming it away. An important assumption, widely used as a simplification, is that of the representative agent: if the economy as a whole is personified, Smith’s veil disappears, and the lone agent knows immediately the consequences of his choices – simply because they fall on him. If the representative agent aggregates all agents, there will never be any hiatus between each individual and society. The monstrosity of this idea, too lightly accepted in many economic models, lies in the fact that there is paradoxically no room for individual choices. If the intention is to eliminate the cleavage between individual choices and social results, the assumption eliminates the individual. The temptation to aggregate what is not aggregable, is also called “fallacy of composition”, to indicate that the composition of a population of phenomena cannot be assumed as non-existent. In a number of models, the representative agent is thus split into a number of different representative groups, whose different choices are then summed up. If, for example, we distinguish between “patient” and “impatient” agents, as some models do, we can add their choices, illustrate how the first compensate the second, recreating an aggregate agent. Here, the error is to assume that each one of these behaviours is constant, and does not change if circumstances change. In addition, if the behaviours are more than just two, compensation becomes impossible, aggregation is unfounded, and only the results at the social level are observable, but cannot be derived from any aggregation. A third way out of Smith’s veil is the idea of “rational expectations”, largely used in models to simulate economic policies. In this assumption, expectations, and therefore choices, are formed on the “basis of the relevant economic theory”: if everybody accepts the same model of the economy and, consequently, all choices are made similarly, expectations will tend to be realized, barring only random errors. We are not very far from the representative agent, because if expectations are formed on the same models, there is no reason to suppose that individual choices can differ. If individuals pursue their self-interest, their choices will not depend only on a theory on how the market changes , but also on their tastes, their income, their status, etc., and even if they are formed on similar models, decisions will reflect the particular situation of the individual relative to the models.
b) The golden rule of productivity
A proof of the inconsistency of the “rational expectations” hypothesis lies in the “golden rule of productivity”, by which equilibrium in an economy can be obtained if wages and salaries increase at the same pace as productivity (output per man); if they increase less, demand will weaken, if they increase more, prices will inflate. Now, this rule is relevant for the economy as a whole, but has nothing to do with either entrepreneurs profit maximization motive or with the workers desire to improve his well-being.
The golden rule is generally extracted from a model by the workings of competition: if firms compete for a scarce labour force, will raise the salary offered, so as to reach full capacity utilization and a minimum production cost per unit of output; supposedly, the additional salary paid should equal the additional profit obtained, attributing to each party the value of his contribution to production. Unfortunately, implicit in this concept of competition is, again, a representative agent: nothing assures that all firms and all workers are in a condition similar to that just described. Not all workers are willing to leave their old job even if the pay in the new one is higher, because he is uncertain whether the new employer will in fact grant continuing employment at that salary. Nor all enterprises are willing to produce at full capacity, even if profits increase, because they may be uncertain whether they will be able to sell the new output. Uncertainty is one reason why the golden rule is not automatically realized. In addition, the profit maximization motive will push the enterprise to minimize wages and salaries, whatever the situation on the labour force market, and this alone will have a depressing influence on total demand. Even if competition succeeds in realizing full employment and the proper working of the golden rule, it can never assure equilibrium. To understand such statement, we have to recognize that the economy is dynamic and that change (quantity and quality) in goods and services demanded and supplied is continuous. In these circumstances, full capacity is an elusive concept for each enterprise.
c) Structural dynamics
We face two challenges. On the one hand, there exist social laws that determine the change in the structure of the economy that are not in the capacity of individuals (firms, workers) to know. Engel’s law, which is based on the change in the structure of consumption at the increase in income, although observed and experienced continuously, cannot be foreseen by producers or consumers. That tastes change with income is known, how they change cannot be anticipated.
Similarly, technical progress is present in any economy ever since the first stone tool, but its direction is not known ex ante, and the change it provokes in the economy is not foreseeable.
In these conditions, competition can only be immanent and operate in the short period and the golden rule cannot be considered a stable presence in any economy.
d) Macroeconomic laws
Even more generally, there exist social laws, or laws valid for the economy as a whole – which I shall call macroeconomic laws - that operate counter intuitively and thus are not the result of conscious individual choices.
More than a law, value added is a statistical (i.e. ex post) concept that adds profits and salaries (as well as other incomes), used to evaluate national income. As neither entrepreneurs nor workers maximize value added but, respectively, profits and salaries, it is clear that national income in not an objective of the individual members of society, or of their groups. Firms consider wages and salaries a deduction from their profits, while workers consider profits a deduction from their income. A proof that the encounter of both subjects does not amount to maximize national income is again visible in income distribution, whose unevenness signals that - grossly simplifying – profits deduct from wages, rather than the other way around. Standard economists imagine that national income is maximized because its subjects obtain always the right retribution for their efforts – a result of perfect competition, where the golden rule is automatically respected, but only a consequence of assuming that the exchange between entrepreneurs and workers is always satisfying the maximum utility of each.
A second, and proper, macroeconomic law is the Kahn/Keynes multiplier of autonomous expenditures, or expenditures that do not depend on income. As is well known, when a household (but for that matter also en enterprise) decides to increase spending, a chain reaction sets in: the new expenditure is new income for others, who in turn will spend part of it accruing as income to still others, giving rise, in the end, to a level of national income which is greater than its initial level by the ratio – for households – of consumption to income; while the part not spent, the savings formed in the chain, are equal to the original amount spent. The obverse chain– with a reduction in expenditure – is, also true. A perfectly rational choice in times of unemployment, such as a reduction in household expenditures, determines lower total demand, lower income, and more unemployment: this is why I call the multiplier counterintuitive. The implications for any automatic equilibrium model are devastating: aggregating individual decisions does not imply effects in line with what motivated those decisions, but determines economy wide effects; clearly, these effects are not known in advance and therefore could not be expected. In order to provide the missing knowledge, something from outside the individual psychology should be present, and this is obviously only the State. We see, here, that the State is not simply the result of individual wills, but also the agent of the society as a whole, and its economic laws are macroeconomic. In many economic models the multiplier is left aside, precisely because it rejects market self-equilibrating force and offers both a justification and an instrument for public action, considered instead a distortion by legions of economists, because in this manner the State infringes inevitably with each person freedom of choice.
There is more than just one macroeconomic law. Another, no less relevant as Keynes’ is Leontief’s multiplier, by which any increase in production or consumption (as well as exports, imports, investment, government expenditure and taxes, not to mention technical progress), causes changes in the input-output matrix that describes the transactions between the different sectors of the economy. A multiplication (and its obverse) is implied in these changes, because if a sector is already working at full capacity, it will have to invest – and increase its inputs from other sectors - in order to satisfy any new demand for its output. Both the matrix and its changes are known only ex post and each household or enterprise cannot fathom the consequences of its decisions on the matrix. The counterintuitive element in Leontief’s multiplier lies in the counter effects that each individual choice can determine, once the results of the choice retroact on the individual, unbeknownst to him.
Similar in its formulation to Kahn/Keynes’ multiplier, is the multiplier of bank deposits, by which each bank loan creates a deposit in the banking system by those that received the expenditure out of the loan. The deposit multiplier is, generally, a form of money creation and if banks compete with each other, even if the banking culture knows that it is lending that produces deposits, and not the other way around as savers believe, no bank can trust that its own lending comes back go it as a deposit. In any case, banks’ clients do not understand the money multiplier, otherwise borrowers would ask a retribution for the fact that it is their borrowing that creates the banks’ deposits. Since a tendency to increase the banks’ degree of monopoly is often present, precisely because the banks know the money multiplier, there is always the risk that money is produced only for the banks’ profits, creating dangers of inflation/deflation. Therefore, the State must regulate the multiplier, by fixing the reserve ratio that each bank should abide to. Money creation becomes exogenous, when the State intervenes, endogenous when the banks or other subjects can put the multiplier in action. These concepts are well known, but enterprises and household, as well as individual banks, are not really aware of them.
Full employment is generally considered a specific situation, possibly desired, but for standard economists it is the result of automatic market equilibrium, so that if there are people out of work, it is due to their volition or to policy mistakes on the part of Governments; for example, it is common to state that unemployment benefits, although a fraction of current wage, are the main cause of this type of voluntary unemployment. Full employment is neither an objective of enterprise policies nor the worker’s, and for many economists is considered more a figment of imagination than anything real. The more softhearted standard economists sustain the governments’ efforts to subsidize the unemployed for reasons of fairness, considered socially desirable (but Hobbes would have argued that the subsidy is needed to avoid the poor’s rebellion). But it is difficult to find, in the economic literature, recognition that full employment is a condition for the growth of an economy, although it simply reflects the golden rule of productivity. Actually, full employment is not desired by entrepreneurs, because that is a state of the world of workers where the bargaining power of workers is maximum: nor by workers who, as individuals, are not conscious of their strength/weakness; they may be made aware if organized in a Trade Union, but standard economists consider the Unions a form of monopoly, which alters the normal working of competition and produces a welfare loss. Thus, full employment becomes a macroeconomic state of the world and only the State can be made aware of its social benefits: maximum level of demand of goods and services, full utilization of productive capacity, full exploitation of the economies of scale, compliance with the golden rule, and therefore less unfair distribution of income and wealth.
e) Macroeconomic foundations of microeconomics. These instances refer to the economy as a whole, and microeconomics is conditioned by them. There are more macroeconomic laws (or concepts) than those described here, but I consider these sufficient to show that no model can pretend to reconstruct the economy as an aggregate by adding individual behaviours, nor establish a link between individual expectations and the effects of decisions. Decisions are of course made, expectations are formed and results obtained, otherwise individuals could not act at all; also, some expectations will be fulfilled and some decisions will bear fruit - but not all expectations nor all decisions, and certainly not all the times nor in the desired form and proportions. In other words, uncertainty shrouds expectations and all efforts to eschew it from economic modelling – such as the rational expectations hypothesis – hits into Smith’s veil (sometimes a wall) of ignorance. This uncertainty is structural in nature, and no amount of additional knowledge can bridge this gap between macro and microeconomics: Keynes’ uncertainty was more radical than Knight’s and no subjective probability can change microeconomics into macroeconomics.
A first conclusion out of the consideration of Smith’ veil is that capitalists are, in fact, blind and even blinder than workers, if Unions express their interest in macroeconomic terms (such as when their priority is full employment, rather than their associates’ salaries). A second conclusion is that the State cannot be superimposed on the economy as a stop-gap, a healer of possible, random, unexpected events. If this was the State’s right to exist it would not last and, even more important, it would never have been established, historically, before or together with the market. On the contrary, the market economy would not have survived the blindness of its actors, if the State did not act as the sole agent of the economy as a whole. Therefore, no economic model can design a workable economy without bringing in, as original elements, both the State and the market. In fact, however, no model incorporates the State into its mechanics, and this, disgracefully, has separated political economy from economic policies, a fracture that was absent in classical economists (Smith, Ricardo, Marx).
I am not capable of devising a new generation of models, including the macroeconomics of microeconomics or, in other words, the conflict between individual behaviours and social effects. One reason is that this conflict defines capitalism, a state of the world where capitalists do not know or are not interested in the economy-wide effects of their decisions. I prefer to speak of capitalists, rather than entrepreneurs, because we have to consider both fields of their action: income and wealth, or profits and capital, or their income statement and their balance sheet. If the conflict between capitalists and the economy was not there, then no market economy would survive, because each actor would know “everything” of the past, present and future, becoming omniscient and similar to a God – losing his free will. Also the State is no god, because it cannot foresee events coming out of individual decisions, but possesses the means both to recognize the effects of events to be remedied and to reconstruct a workable economy.
f) On Capitalism
Unless a model is built, capitalism cannot even be defined as a system, even if I shall use the word. It would be more appropriate to speak of “capitalists” whose blindness can be (not necessarily is) corrected by the State. With such uncertain and imprecise definitions, and lacking a unified theory, I try to establish what I consider a few fundamental points:
1. Each society is defined by a survival criterion.
2. This implies that the agent of the society – the State – should operate in such a way as to avoid that some of its members be left aside; society cannot exclude anybody without negating its own right to exist.
3. Capitalism, while creating income and wealth, excludes, discriminates, distributes unfairly income, wealth and wellbeing.
4. If the State is the agent of society, but capitalism conflicts with society, then capitalists are in conflict with the State.
We know that capitalism, during the crises has needed action by the State and, in those circumstances, the conflict changed into cooperation. In their cooperation, however, both partners may not necessarily respect society’s survival criterion, nor that cooperation puts them on an equal basis. During the crises, and possibly in many other occasions, the relationships between the State and the capitalists change every time, and the compromise between them may give rise to forms of hegemony of either one, sometimes strong, sometimes weak.
3. A tale of two capitalisms
I am unable to define precisely such hegemony and in any case we lack sufficient analysis to gauge the quantity and quality of the relations that give rise to it. This is probably not a new field of research for political scientists or historians, but it is for economists (there are partial exceptions: Musgrave and Buchanan, albeit on differing sides). Lacking guidance, I shall proceed by comparing two different forms of capitalism-cum-State: that created with the New Deal, that lasts, with considerable variations, from the early ‘ 30s to the early ‘80s, when, defeated by a Great Inflation, was substituted by a new form of capitalism initiated by Prime Minister Thatcher and President Reagan. The comparison is very simplified, but will also be useful to make clear the most recent changes in the second form of capitalism, at the aftermath of the 2008 crash.
a) Roosevelt’s capitalism.
The main features of the capitalism that was built after the Great Depression are the following.
i) Monetary policy. The major change in respect of the pre-depression monetary policies was the Glass-Steagall Act of 1933 – later adopted by almost all other countries. This legislation distinguished neatly between deposit banks, as an instrument of the central bank monetary policy, and financial intermediaries engaged in medium term lending and underwriting (investment banks, mutual funds, savings and loan banks, insurance companies, etc.). Deposit banks, although privately owned, performed a public service. The money market was considered a public good. Central banks, although keeping some degree of independence from the Government, mostly for inspiring confidence in fiat money, followed Keynesian-type policies, to reduce the severity of the depression and to proceed rapidly toward full employment – including financing public deficits. Monetary policies were thus based on two objectives: high employment and low inflation.
In this manner, government expenditure for full employment did not reflect itself fully in public debt sold on the market, or in an otherwise unbearable taxation. A compromise was struck between the State and the capitalists, in which the profit motive was not weakened by excessive taxation or interest charges (the war, of course, imposed entirely new terms to the compromise).
(ii) Bank policies. Lending determined deposits, limited essentially by the reserve ratio; interest rates were not considered an effective monetary instrument because bank lending was short term, while long term lending was left to the financial sector, whose power to determine interest rates was limited by the relative weak demand for funds, because enterprises were financed essentially out of profits and short term loans. A very important institution was clearing, where offsetting claims among banks were eliminated, avoiding duplication, and reducing the need for reserves. At that time, it was felt that simply increasing the quantity of money would not have important consequences on effective demand, even though Keynes’ “marginal efficiency of capital” argument was adhered to enthusiastically, and Keynes himself thought that in the depression public investment was a better solution. Keynes’ marginal efficiency argument was in fact probably wrong: investment projects are ordered on the basis of the discount rate; if the rate changes, the ordering changes, leaving undetermined the influence of interest rate. This is true with rate decreases; when interest rates increase, it is not investment at stake, but the enterprise assets: the depressive effect is direct and rapid, as the firms’ (and the households’) debt becomes more expensive, cost and expenditure cutting is a largely inevitable policy, and effective demand is reduced.
(iii) The labour force market, liberalization and the exchange rate. An important role in the New Deal compromise, was that played by labour reforms, and in particularly the official recognition of the Trade Unions. In the US, Roosevelt gave public support to labour contracts both to provide a social lever for higher wages during the depression, and to acquire an ally in his pact with the capitalists.
Of course, after the war and when military expenditures declined, the pact became unsatisfactory for capitalists, who could not limit their activities to public works or military expenditure. The New Deal, therefore, lost its anti-depression motivation at Bretton Woods, even before the end of the war. It was important to liberalize trade, reduce protectionism practices, avoid competitive devaluations, in order to grant to capitalists at the same time a new source of effective demand in international trade not dependent on government policy, and, through fixed exchange rates, a discipline in the labour force market, otherwise considered too strong in conditions of full employment. As is well known, Keynes’ plan of an international clearing union, with the monopoly of international currency, was defeated by the US, and a gold exchange standard was decided, guaranteed by the dollar.
Two main effects. The first was the impossibility to consider deficit and surplus countries as both imperiling world economic equilibrium, which implied that the surplus economies financed the deficit ones. Instead, the new institution, the IMF, was to police deficit countries, but had no power to oblige the surplus ones to contribute. Devaluation and austerity measures were invented at that time, as means to correct deficit countries, which however broke whatever compromise between capitalists and workers had been established before. Once growth resumed, the compromise could be reinstated, but obviously, it all depended on the government will. The US was not submitted to the IMF rules, because of the gold exchange standard. The rest of the world needed dollars to finance their growing external trade, and thus provided free credit to the US, that could (should) therefore show current account deficits. In this period, the Cold War and the anticommunist stance in the US had an impact on labour legislation, and on Trade Union power, possibly because the discipline of a fixed exchange rate was not effective in the US, due to the role of the dollar. It is interesting to note that, in spite of IMF rules, Trade Unions prospered in Europe, and this had certainly an influence in establishing universal welfare states, while in the US the New Deal social action was limited to social security, with minor health extensions (Medicaid, Medicare). Also, the golden rule was more effective in Europe than in the US.
The system was not stable, however, because the value of the dollar reflected inevitably its demand caused by world trade: the more it grew the smaller was the gold reserve vis-a-vis the quantity of dollars in circulation.
b) The great inflation and the birth of a new capitalism.
When the gold exchange rate faltered, exchange rates started fluctuating. In 1968 and in 1971, the US government ceased to change gold against dollars, and the dollar became fiat money. Uncertainty became prevalent in international trade and the expectation of a devaluation of the dollar pushed upward the prices of commodities in oligopolistic markets (oil, tin, etc.), rapidly transmitted to all goods and services around the world. Individual countries reacted to inflation by depressing their own economies, but the lower production provoked further inflation.
(i) Monetary policies. Most central banks thought that inflation was due to excessive quantity of money accompanying excessive wage increase. The compromise initiated with the New Deal was thus undermined: effective demand, the golden rule, income distribution suddenly became irrelevant as guidance to economic policies. President Carter preceded Reagan In calling for anti-inflationary policies and Paul Volcker adopted Milton Friedman’s monetarism, calling for fixing in advance the quantity of money, with the idea that inflationary expectations would follow. The policy determined a reduction in the quantity of money, a raise in interest rates, and a deep and long lasting recession in the world economy. Reagan and Thatcher reacted: the first increasing public expenditure, the second devaluing the pound, in both cases largely forgetting Friedman. The change in policies, however, was real and not directly caused by the inflation or the specific anti-inflationary measures. One of the most important changes concerned the international circulation of capitals, a consequence of the abandonment of the gold exchange standard, which increased the competition in the world labour force market, reducing the Union bargaining power and limiting the tax power of each State, thereby making public budgets more dependent on borrowing from the financial market. In both cases, weakening the supporting elements for keeping effective demand in line with full employment.
(ii) Bank reform. Probably the change that had the most profound influence on the nature of the new capitalism was the reform of the bank and financial systems. Entire libraries exist on globalization and finance, but most are descriptive, not explicative. Banks were intended to behave as any other private enterprise and the very essence of the banking system – its money making function – vas lost. The production of money through lending continued, of course, but that lending was the cause of deposits was considered less important than free competition among banks. Some specific structural changes did take place, such as a greater degree of independence of Central Banks, whose policy should be mainly anti-inflationary; less attention was given to the quality of issues or the higher risks in lending. Other changes were introduced, but all had the effect of pushing banks to compete with each other in order to increase the volume of their activity and their profits: one of the most relevant was the abolition of the clearing among banks, substituted by interbank lending, motivated by the need to establish competition, but which required an increase in reserves. The money multiplier continued to operate, but since the official supply of money was limited to repress inflation, it starved the demand of banks, that, to compete, needed new money to maximize the banks activities. As a result, banks started working on their balance sheets more than on their income statements. The drive to increase their capital pushed them to sell their own shares to depositors, to issue shares on the market, to securitize and sell their loans. This is the first and fundamental reason for the rise of the stock markets: with prices climbing, increasing the value of existing shares, a leveraged financial market took place. The leverage, in turn, created new capital ex nihilo, and its more liquid securities became a new money: this was the birth of exogenous money, not linked with the money multiplier and completely insulated from government and central banks policies. Banks did not stop lending, but loans were directed to clients who invested increasingly in securities, rather than in goods and services. This had a negative effect on the Keynes multiplier, reducing effective demand, but produced new financial companies, new securities, new chances for speculation, helping to continue the growth of the leverage economy. The more banks and financial companies work on their balance sheets, the less they work on their income statements, and the end result would be a crash, because of the break between profits on the one hand and financial gains on the other- if the second grows more rapidly than the first, speculation on securities is less capable of covering the debt incurred though leverage.
(iii) Hedge fund and globalization. Two powerful forces, in the meantime, have caused major structural changes. The first, which has provided insurance against variations in prices and quantities, are hedge funds. These are peculiar forms of insurance, not based on large numbers, but on a subtle ability: that of insuring both sides of a transaction, so that if the fund loses and must pay one side, it gains on the other. The effect of such activity is to stabilize the markets, reducing volatility and enlarging the number of participants. The second force is globalization, which ensures that capital accrues where labour costs per unit of output are lower. The local demand, where labour costs are low, is insufficient to work efficiently at capacity; therefore demand must come from where the labour costs are higher. Emerging economies must export to rich countries, but the process may not last long if the competition on labour reduces incomes in the rich countries. A third, decisive force came into play: the transformation of wealth into income in rich countries.
(iv) Income and Wealth. During the life of the new capitalism, income distribution worsened. Per capita income did not decline, but a skewed distribution enlarged the gulf between the ways of life of high and low incomes. Unions should have reacted, to protect the working families from the decline in their social status, but globalization, the Reagan-Thatcher policies, the competition based on labour costs led to a dramatic decline in Union’s bargaining power. Even more important in further making Union association appear uselessly costly, was the transformation of wealth into income for working families: the increase in wealth due to the leverage economy, made it possible to increase debt on the same physical property (in general, the home), and to spend part of the debt on improving the family’s way of life. The transformation must have been considered an opportunity also for enterprises, in their choice between expenditure in goods and services or in securities. Actually, all the subjects in rich countries had a similar choice to make, in the leverage economy, but if part of the new wealth was spent on goods and services and part on securities, then the demand for securities depended strictly on the distribution of income. The more skewed became the distribution, as families could not maintain their relative wealth if they tried to maintain their relative consumption (and similarly for companies), the less was the increase in the demand of securities.
(v) The crash. More than one cause must have played in the crash of the financial markets in 2008, but the worsening distribution was possibly the hidden cause that made the crash so violent.
(vi) Financial capitalists and “real” capitalists. The structure of the economy before the crash was also characterized by a distinction (or a cleavage, a chasm) between enterprises, financial or non-financial. All companies participate in the leverage bonanza, but the financial ones were not looking for profits much as they were looking for wealth. Now, profits tend to grow as capacity utilization grows, but at a decreasing rate, to decline afterwards. Not so for financial enterprises, the value of whose wealth increases as wealth accumulates, in a leverage economy. Both types of capitalists are blind, but the financial one are doubly blind, if possible. It is true the wealth and accumulation do not show diminishing returns or declining marginal utility: accumulation tends to justify itself. But if the value of capital of “real” capitalists increases, they are strongly motivated to participate in the speculation game. This may have produced a change in the structure of the different economies: the rich ones income statements became less Important, contributing decisively to their deindustrialization.
(vii) After the crash. After the crash financial indices recuperated rather rapidly their ante-crash values, while the growth of world GDP declines and in many cases plunged below zero: a growing divide between financial and economic trends means that securities and their real basis were disconnected. How could financial values grow in the absence of GDP growth, even after the transformation of wealth into incomes was not operating anymore? Possibly it was the large inflow of exogenous money by the central banks, to substitute the sudden disappearance of endogenous money, that fed the new bout of speculation. As credit demand slacked due to the recession, the new flow of funds wen to enrich the capital and reserves of banks, which used their new wealth to buy even more securities. Accumulation was the cause for which the financial system grew on itself, pushing up prices on the stock markets that restored a measure of leverage that fed new demand for securities: this is the logic of accumulation that, as already seen, never meets diminishing marginal utility. Real output and employment, however, cannot increase if effective demand is not stimulated by government expenditure, and in fact the US, in the first Obama administration, did increase expenditure and public deficit. The policy did not last, as Congress saw a rise of conservative opinion, set against the State intervention; Europe never abandoned its conservative policies, and therefore world effective demand did not rise in parallel to financial values. It is as if the blindness of capitalists continued to shroud their judgment, even after the crash and the economic slump, which should have clearly shown the failure of the new capitalism.
4) Capitalism and the State
This also means that the State, although conscious of the need to stimulate effective demand, lacked the power to convince or oblige his capitalists to dismiss their immiserizing ideologies. In part, this was probably due to the fact that workers and “real” enterprises did not have sufficient conviction as to the fact that financial enterprises and their accumulation motive were the cause of their predicament. Actually, through their central banks, the Governments did act, as we have seen, by flooding the financial market with money, hoping that lower interest rates would spur economic activity, but no reform of the financial market was enacted that could effectively avoid the capture of the new money by financial corporations: in any case, easier money does not translate into effective demand. I think that the weakness in stimulating growth and employment by quantitative easing was one of the reasons for the resurgence of conservative thinking. Balance sheet economics became again prevalent over income statement economics and accumulation more powerful than the profit motive.
It appears that hegemony rests again on capitalists, and that the State is in their service: the likelihood of a new crisis and recession is high.
5) Globalization and mercantilist capitalism
The engine of growth, in the form of wealth transformed into income and demand, once stopped, has not been reconstructed in other ways. Emerging economies are still dependent on exports to rich countries, but as here incomes increase slowly, if at all, and income distribution continues to worsen, their growth rate is lower than in the now defunct new capitalism. Even if financial indices grow comfortably, leverage is weak and the world is waiting for a new transformation of capitalism.
I cannot provide a forecast, but a few observations on the relationship between capitalists and the State may be of some interest.
Globalization is here to stay: emerging economy need it because they have great difficulties in substituting export markets with domestic demand; a change that would call for a social revolution. These countries need also the inflow of technical progress, possible only with some freedom in international capital movements. Rich countries cannot do without globalization, both in order to export technologies and to avoid depressing the financial business and its capital flows.
Thus, whatever change is needed, it will concern all the economies, rich as well as emerging. At the same time, no Government can hope to maintain its constituency if some form of more decent income and wealth distribution doe not takes place. In these conditions, only public expenditure can be used for increasing employment. But capitalists are reluctant in admitting an effective Union movement, and Governments seem obliged to stress exports as their engine of growth, even in rich countries: competitiveness has become the new target of public policies. In this case, the State continues to be in the service of capitalists, both real and financial, but the so-called competitive policies are only a different name for mercantilism: and the benefits of mercantilism cannot accrue to all countries, nor can be practiced by all Governments -someone export surplus is someone else’s deficit.
Conflict brews and the end result of mercantilist capitalism is obscure. Possibly, large monetary areas can practice mercantilism inside their membership (Germany in Europe is a good case in point), but it may be not long-lasting, because while income distribution worsens everywhere in the area, the demand of deficit countries slacks, creating strong premises for the area crisis.
If we take into account the split between “real” and financial capitalists, other problems arise. In the mercantilist version, it would be difficult to maintain the same freedom of capital movements as in the previous capitalism. The reason is that if some obstacle is created to avoid delocalizing enterprises that would reduce local production and exports, then the financial capitalists would not sustain the Governments’ actions. This shows that “real “ capitalists cannot, by themselves, express any hegemony, and the Governments remain devoided of the possibility to increase their hegemony by splitting the capitalists.
I am unwarrantly treating real and financial capitalists as two aggregates (a fallacy of composition), but capitalists are still blind and each looking at his own interest: so, neither the real ones can appreciate the benefits of mercantilism, nor the financial ones can decry its barriers to the free circulation of capital. Governments, however, are not blind. They can calculate the effects of different policies on their constituencies, and can establish hegemony of their own on both or on one of the two sections of capitalists. Once perished the previous capitalism, Governments can offer a compromise: mercantilism for the real capitalists, globalization for the financial ones. While the first would benefit directly from this policy, the second could be assuaged by encouraging speculation on internal public debt. Globalization on capital flows can continue, concentrated on the public debt of the different economies. Of course, the volume of financial business will never be the same as with a full leverage economy, but the feasibility of splitting the capitalist interests may not be ignored.
No equilibrium is, nevertheless, assured. Mercantilism does not provide safe growth in effective demand, well distributed among different countries, and the inevitable rise of public debts ma imperil the Governments stability.
We know the solution: it was proposed by Keynes at Bretton Woods.
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