Saturday, February 28, 2015

The Economic Consequences of Self-Interested Capitalism

We like to think of capitalism as an economic system different in kind, and not just degree.  It does seem to be the most efficient system to exploit its environment ever designed.  And we can conclude this because capitalism has driven its less efficient competitors out of business.

But what is capitalism’s environment?  Capitalism’s environment is two fold:  First is the physical environment.  Capitalism’s original reason was to more efficiently, and at greater scale, harvest and exploit the resources society needed from the physical environment, and provide them to society, and in a greater abundance and at a lower cost than ever before.  And this it did.

But the rest of capitalism’s environment is that same society and economy for which it provided, and still provides, and processes, resources.  However, it is becoming more difficult to extract resources from nature, and produce real goods for society.  The costs are higher.  The increase in costs is greater than the increase in society’s ability to pay, with its current infrastructure.  This means it is increasingly more difficult to extract profits.

But clearly, the capitalist will seek to go to where the profit is greatest.  When the profit is greatest exploiting the environment, by providing things society needs or wants, that is where the capitalist will go
But if the capitalist can gain a greater profit, the capitalist can be expected to do what is necessary to do so, if society is not effective in preventing him from doing this. For instance, if the capitalist can effectively reduce his costs by damaging the rest of society, he must be expected to do so.  Under these circumstances, we must expect him to damage society, because the sole duty of the capitalist is to enhance and maximize his own profits.  (We address Milton Freidman’s discussion of this for corporations at:
 The human motivating force for capitalism is not so often discussed:  It is acting according to a narrowly defined self-interest, one that excludes the interests of any larger society.)   The first is by externalizing some of the cost of producing real benefits, real goods or services, to society. For instance, one way is by discharging pollution from the production of goods or services into the environment, and not cleaning up this pollution for society, or compensating society for the damage this pollution inflicts upon it.  Also, the capitalist may manipulate government to subsidize his production, so more is produced at greater cost and at greater profit to him than is beneficial to society. The capitalist, should either opportunity arise, must also be expected to enhance his profits through monopoly or monopsony, at the expense of the larger society.

When, however, the profit is greatest exploiting society directly, that is what the capitalist can be expected to do.  Since in the process of exploiting society directly, nothing is actually produced, these methods are all aimed at manipulating demand, with the goal of maximizing one’s own share of demand, and minimizing the share of others. 

Obviously the activity of thieves does not benefit society.  They transfer demand from others, others who are often productive individuals, to themselves, who are not productive individuals, and often to the extent of damaging the productivity of the individuals they steal from.  Where theft is made legal, as through allowing and even encouraging manipulative finance, it must be expected to proceed and grow apace. Consider the selling of credit default swaps, capital appreciation bonds to municipalities, leveraged buy-outs, and other malfeasances of Wall Street and the banking sector.

Resources are expended in this process, and indeed destroyed.  This is a consequence of the nature of debt, which can only, in real terms, be repaid by productive individuals and companies.  It is thus, in the net, the laying of debt on the productive sectors of an economy.  This hampers them, reduces their profitability, and discourages investment in them, and in consequence encouraging ‘investment,’ that is the transferring of demand, to the non-productive sectors of the economy.

Clearly, this process is destructive of the economy.  As real production is increasingly replaced by fictitious ‘production,’ we should expect the economy to be less and less capable of maintaining itself.  This would first be compensated for by importing increasing quantities of goods and material factors of production.  However, we should expect increasing poverty, decreasing investment in the real economy and infrastructure, decreasing market for real production, and eventual economic collapse.

Sunday, January 11, 2015

Destruction of Production from Unbalanced Trade

Walmart promises lower prices.  But at what cost to society?  Locally, the consumer seems to benefit.  But what about the domestic producer, who may be put out of business when a foreign supplier is chosen over him?  He is also a consumer.

We further discuss the situation of unbalanced trade, where one country runs a trade deficit with another country.  For previous discussions, see:  and the pointer there.

We start with a retail outlet, which sells the product of a domestic producer.  The domestic producer (or it may be many producers)  produces quantity  Q of his product at price P, at the equilibrium point e, intersection of the supply S and demand D curves (blue and red dashed curves.)  The quantity Q goods sell at price P for total revenue to the producer, or producers, of P x Q.  This is also the price paid by the total of all consumers.

 A foreign producer produces at price P’ less than P. If the domestic producer cannot produce at P’, the retailer chooses the foreign producer.  The supply curve shifts down by the difference between the prices, P – P’, in the diagram to the solid S curve, and the new equilibrium point is at e’.  This would be an improvement for the consumer. He would get more goods, at a lower price. However, this is not the whole story, because the domestic producer is also a consumer.  The consumer is also a producer.  The revenue which formerly went to the domestic producer, P x Q, is lost to the domestic market. The new amount of revenue, P’ x Q’, the size of the market at e’, goes overseas, to the foreign producer.  Or would if e’ was the new equilibrium point.


But it is not, because the domestic producer, no longer in the market, shuts down, and the demand is shifted down by P because of the loss of revenue to the domestic producer.  This revenue the domestic producer no longer has to consume with.

Thus the new equilibrium point is really at e”, the new intersection of the shifted demand and supply curves. Since the price the original producer charges, P, is always greater than the difference between the domestic price and the foreign price, P – P’, Q” is to the left of the original Q.  That is, after the retailer changes to a foreign supplier, the new equilibrium quantity is less than the original quantity Q. However, the real situation is actually worse, because the equilibrium quantity Q” is not a true equilibrium point.

Price goes down, but income goes down further, since money goes overseas, following foreign suppliers, and does not come back to consumers, except perhaps as a loan.  But money continuously goes overseas, and does not come back.    

The true equilibrium point is at quantity Q* = 0.  That is, without balanced reciprocal trade, the equilibrium is at zero imports. It may take a long time to get there, but the net final result is merely the destruction of domestic production. The economy is no longer able to import except by selling off capital. But in this it is limited, also. There is only so much capital.  There does exist, however, the argument from debt:  The economy can be maintained by borrowing.  But this is in the long term false, and any net import must eventually be paid for by destruction of future production.  Further, because of the costs of borrowing, the amount of future productive capacity destroyed is greater than would be destroyed without borrowing.  Borrowing makes a bad situation worse.   

Let’s take a different look at the change in situation.  Consider first the domestic economy as a closed system. The flows of  money (Black) and goods (Red) stay within the domestic boundaries, and the system is in equilibrium, by which we mean that roughly the flows compensate for each other.  (The rest of the economy consists of other producers and consumers.)  There may be changes, but these are accompanied by corresponding changes in other flows.

If, however we introduce unbalanced trade, money is exported to the foreign economy and goods are imported from the foreign economy.  Since there is no flow of money into the domestic producer, the domestic producer closes down. As a result, all flows of goods and services to and from the domestic producer close down. 

We observe, like water through the drain in a sink, money continuously flows out of the domestic economy.  Goods flow in, but unless the goods are capital goods, (and they would likely not be, because the return on investment is lower in the country running the deficit,) they are consumed and need to be continually replenished.  The continual loss of money represents ever increasing demand (money is demand) by the foreign economy on the domestic economy, while the domestic producer has been eliminated.  The domestic economy is thus ever less able to pay an increasing debt. It is certainly less able to repay with production. But it is also increasingly unable to repay this debt even with capital, because the value of capital has decreased, since its return is lower due to the foreign competition.

For comparison, we draw the same diagram with balanced trade, where the domestic producer has found a foreign buyer for his production.  Note that, while the domestic economy is here balanced, the upper foreign economy in the diagram runs a deficit wrt the domestic economy, and the lower foreign economy in the diagram runs a surplus wrt the domestic economy.  In the long run, these tendencies would have to be compensated for, by trade between the two foreign countries, just as they would have to be compensated for in the domestic economy. 

So, what would be the effects of a trade deficit on the domestic economy.  We already know that the domestic producer shuts down, resulting in a shift downward in the demand curve greater than the downward shift in the supply curve.  Since the new equilibrium point e” is to the left of the original equilibrium point e, the quantity supplied at Q” is less than the original quantity supplied at Q. However, the same phenomenon happens for all imported goods. All imported goods are supplied at lower quantities than were originally produced by domestic producers.  Otherwise the domestically produced good would be preferred by domestic consumers.

On the level of the individual, the mean income decreases, and is greater than the decrease in price.  That is, in real terms, the average consumer is poorer, because of the trade deficit, than he was before there was a deficit. The decrease in price does him no good, because the decrease in his income is greater. From a social point of view, poverty increases, and income and (long term) spending of the average individual decreases.  From an economic point of view, capital investment decreases, and indeed, on average, the economy is decapitalized, that is, its capacity for production decreases.  This has the implication that the costs of capitalization increase.  Another way of putting this is that the return on investment decreases.  The economy is less able to maintain itself and its infrastructure can be expected to be under maintained, and to decline.

The results of running a trade deficit demonstrate the need for government regulation of trade. Clearly, a private entity may increase his profit while destroying a part of the domestic economy, if it is not compensated for. The free market credo would be that this is just too bad for the domestic producer.  This should be discouraged, because the damage is not restricted to the domestic producer.

It also shows some of the consequences of incompetent, or if it be, treasonous, government, allowing or even encouraging the destruction of the livelihood of many of its citizens.

Finally, it shows that it is sometimes necessary to think two steps, instead of only one, in reaching conclusions.