A Problem with Capitalism

Capitalism, as a system, is inherently unstable.

Consider a closed economy.  By closed we mean no money, and no resources, flow in or out of it.    This is more general  than it seems, since we are really talking net flow:  We are thus talking about any economy where the flow of money in and the flow of money out are equal in magnitude. And any economy where the flow of resources in and the flow of resources out are equal in magnitude.

   

The economy consists of capital and labor. Profit is required by capital, in order to invest in greater production, that is, more capital.  Thus capital must exploit labor.  But, since the economy is closed,  labor is capital's only market, except for itself.  (Capital does not give its money, its demand, away to third parties.) But, capital cannot take a profit from itself. (Well, it can. But this is called taking a loss, when the expense borne by capital is greater than the return.)  Indeed, capital  cannot even break even, selling to itself, because of the  costs of business, and  because of the depreciation of capital. 

Thus, capital must get in return more than it produces. (This is on two levels, real and financial.) So it takes a profit from labor.  But what does this mean?    The capitalist exploits labor twice.  First, less is paid for labor than that labor produces. This produces a surplus of goods. This surplus is the profit of the capitalist.  Some of this surplus is retained by the capitalist. Yachts, for instance.  But yachts are an expense to the capitalist.  And not all of this surplus can be retained. If it is, that is the break even point  for the capitalist. 

So the surplus must be sold, and it can only be sold to labor.  This requires that the capitalist takes less from labor than it gives labor. But second, the capitalist takes more from labor than it gives labor in the first place as wages.  But this results in an ever diminishing market, whereas the capitalist requires an ever expanding market. 

Capital, in maximizing its profits, minimizes the return labor gets, even to the point where labor's return is negative.  That is, each year labor is paid less, in real terms, than the year before.   But this collapses the market for capital.  This is the problem.  

Indeed, for its market to grow, the capitalist must give labor (or some third party) some of the surplus of production.  That is, capital must share its profits with labor.  That is, labor must receive more than its costs.  This will result in an expanding market, which is required for capital to grow.  

Now with a closed real economy, the money supply can be changed. Thus an economy can be closed in real terms, (this is called Autarky,) yet 'open' in terms of money supply.   That is, the money supply can be adjusted to favor either the financial or the real sector of the economy. 

 

Keeping a fixed money supply is good for finance, but death to producers of real goods and services.  Finance takes money out of the real economy.  This is finance's cost, to the real economy, of doing business.  This is its profit, as it redistributes demand in the real economy.   Thus the money supply in the real economy decreases, and the real economy experiences deflation.   But this means that, on average, the producers of real goods experience negative profit.  Roughly, this means that, each year, over half of all non-financial businesses suffer losses.  

Loaning money to the real economy does not reduce this over time, but rather increases it, because of the interest.  Thus a period of deflation may be compensated for by finance loaning sufficient money to the real economy.  However, it will subsequently be followed be an even greater period of deflation, as the loans come due.  But this is superposed on the decline in production brought about by non-financial companies making negative profits. They will make money, and perhaps grow, while the money is being lent, but their markets will subsequently suffer an even greater contraction when loans come due, and can no longer be rolled over.  Thus while there are fewer dollars, they are also pursuing fewer goods, which may even be inflationary, if production declines at a rate greater than the money supply in the real economy. Meanwhile, the supply of money in the financial sector increases, but has no outlet, except in bidding up asset prices. Of course, real assets, that is the producers of real goods, are increasingly overvalued, as their markets are increasingly undermined. Depending on the degree of indebtedness, the transition is more or less dramatic.  

Therefore, the money supply must expand so that this profit, the money finance takes out, is zero.  This requires that the money supply be expanded in the real economy, and not in the financial economy, which will merely aggravate the situation. Effectively, this means it must be done fiscally, and not monetarily.   Finance must be taxed, and the money spent in the real economy.    

Underemployment

Why are there so many underemployed college graduates in the US? 

"About 48 percent of employed U.S. college graduates are in jobs that the Bureau of Labor Statistics (BLS) suggests requires less than a four-year college education. Eleven percent of employed college graduates are in occupations requiring more than a high-school diploma but less than a bachelor’s, and 37 percent are in occupations requiring no more than a high-school diploma;" http://centerforcollegeaffordability.org/research/studies/underemployment-of-college-graduates

The surplus of college graduates  is not because labor is overcapitalized.  College graduates require more capital to justify their employment, (as college graduates, vs.  eg. as hamburger helpers.) It is because capital, that is, the economy, is undercapitalized. 

Of course, this is actually a relative thing. If the increase in human capital was greater than the increase in physical capital, then there would be a surplus of college graduates.  If the increase in physical capital was greater than the increase in human capital, there would be a shortage.  And in some fields, noticeably medicine, there are. In medicine, demand has increased due to the affordable care act, while the supply of doctors has been restricted by the AMA. The result is that doctors, at least in some specialties, command very high fees.  In some of the sciences, on the other hand, where the economy has been losing capital, that is, contracting rather than growing, labor is relatively overcapitalized.  The supply of scientists  has outpaced the demand, as the government and industry have cut back on research.  This has led to an increase in credentialism, that is, an increase in the requirements to obtain a position, and a pool of underpaid research assistants with increasingly bleak prospects.  

There are, however,  some general causes for the undercapitalization of the economy.

One is unequal trade. A country which runs a trade deficit has an increase in the consumer surplus, since things are cheaper, but a decrease in the producer surplus, since domestic companies are unable to make as much profit.  But investment in capital comes out of the producer surplus, and since that is less, capital investment is less.  The (real) economy grows slower.

 Undercapitalized infrastructure is a second. Inadequate infrastructure increases costs, reducing producer surplus and making industry less productive.  In fact, a reduction in the capitalization of infrastructure is to be expected in a mature economy under siege, since  all capitalization is out of the producer surplus. This is also a vicious cycle:  Decaying infrastructure reducing producer surplus reducing ability to maintain infrastructure, etc.

A third cause of the undercapitalization of the economy is the burden of health care.  With the costs of health care approaching 17% of the economy, fewer resources are left for the rest of the economy.  Of course, capitalization of the health care sector increases employment opportunities there, as we mentioned above.

And excessively large and costly financial sector is a fourth:  The financial sector is overhead on a nation's industry.  It does not in itself produce.  Its burden, the resources it consumes,  is proportionate to its size, and subtracts from t he resources available to the real economy.  It is also relatively immune to foreign competition, with results similar to healthcare.

A fifth cause is the inefficient use of what capital already exists:  Consider energy.  Underpriced  energy makes labor relatively overpriced, reducing its use. This increases the ratio of capital to labor in dependent industries.  Both capital and labor are thus used inefficiently. A greater burden is placed on a smaller portion, but a larger portion is left idle, of both capital and labor.  It also reduces capitalization of the infrastructure required for extracting and delivering energy, and thus harms basic industry.   Meanwhile, the labor burden is concentrated on fewer workers, often past the point of diminishing returns. (That labor expelled from production is forced into the inferior market, ie underemployed.) Producers that are less efficient energy users are excluded at the margins, even though they may have used labor more efficiently. They must compete against the(subsidized) more efficient energy users.  While at the same time underpriced energy is put to inefficient uses.  

A sixth and perhaps most important cause of an undercapitalized economy is government. On the one hand, it is overhead.  On the other, in the modern economy its policies help determine the direction of societal growth, and thus those sectors where the economy is invested in and capitalized.  For instance, by overcapitalizing the military and the security state, it detracts from the investment in basic industry required for real growth.  Government has also pursued policies that favored the growth of oligopoly and oligopsony.   Oligopoly, while it increases the producer surplus, reduces the market and thus the need to invest in productive capital.  A consequence is money hoards in the hands of a few, while the rest of the economy is starved.    Oligopsony in labor markets will result in depressed wages in needed sectors, thus shortages in those sectors while at the same time discouraging entry.  Graduates look for work elsewhere in the economy, where growth is depressed.

Seventh, increasing complexity means an increase in structural unemployment, as there will be greater mismatch of training to skills needed by the economy.  

Finally, as we have detailed previously here at http://anamecon.blogspot.com/2011/09/unemployment-average-wage-and.html the the rich pay themselves too well. If the mean wage was lower, more people would be able to be employed, although whether they would have jobs appropriate to their skills is another matter.

Are Unions Necessary?

Unions are necessary, or rather, what is necessary is an institution, or institutions, powerful enough to balance the concentrated powers of capital, in order to create a robust economy, and a robust democracy.

In the absence of this power, capital unchecked accumulates and concentrates, to the detriment of the economy and society.  As capital concentrates, the growth of the buying power of labor, (and we see with the austerian policies promoted by the Right, government, also) first slows, then stops, then starts to decline.  And we are starting to enter the period of decline, after years of stagnant income by labor.  Capital is destroying its market, and with it, opportunity for continued profit, and the incentive to invest. This leads to a gradual decapitalization of the economy, although this will first be concealed by investment bubbles in enterprises which do not produce real goods and services. That is, the economy will continue to appear to grow, even while in real terms, in terms of industry and infrastructure, it actually declines.

Government itself, and certainly after Citizens United, is not strong enough to provide this countervailing power.   Indeed, its policies show it has clearly become the captive of capital, and so aggravates the already mal-distribution of power.

So this countervailing power once, inadequately perhaps, partly provided by unions, but now largely absent, is necessary even for the survival of capital. 

Cross-posted to http://esoltas.blogspot.com/2014/02/if-not-unions-what.html

Growth, CEO Compensation, and Savings

We wish to show, that excessive CEO compensation is deleterious to an economy.  We show that excess savings is also deleterious, the so-called "Paradox of Thrift."

Prove in the case of the Universal Corporation: UC produces everything. Therefore, all it buys is labor. Thus, all revenue goes either to labor compensation or to capital. We include capital’s share in CEO compensation.  Thus, UC’s employee compensation, minus the CEO’s compensation share c, in the n^th cycle, is R_n(1- c), where R_n is UC’s revenue.  Suppose now everything UC’s employees buy is produced by UC, and UC sells nothing to the CEO. Then UC gets all its revenue by selling to its employees, 

( R_n (1- c) ) plus a portion, R_n e, selling to persons outside the corporation.. Therefore,  

R_n+1 = R_n((1- c) + e);  The growth in revenue, for a given period: DR  =  e – c.  So, where c > e, DR is negative, that is, revenue declines. The CEO of the Universal Corporation, regardless of competence, if paid to much,  is adversely effective. Done.

Now we can include the CEO as an employee, ie someone who buys from UC, if we instead interpret c just as what the CEO does not spend, but saves.  Indeed, this gives us the Paradox of Thrift, when c is interpreted instead as the sum of what all employees, CEO included, save. So, if the portion the employees of UC save is more than the portion sold to people outside of UC, ie if c > e, revenues will decline.

If instead we separate savings into components, labor savings and capital savings, (where investment is a capital expenditure,) s_l and s_c, then if s_l + s_c > e, revenues will decline. If s_c > e, then s_l must be negative, and of magnitude greater than s_c –  e, in order for the corporation to grow in revenue.  That is, labor must dissave if capital saves at a rate greater than the rate of selling outside of UC, for UC to grow.  (This can of course be forced by paying labor less than subsistence.)   

Note, if e is negative, eg if the employees also buy from outside UC, at a rate greater than persons outside of UC buy from UC, the employees of UC must dissave, (both  c and e are negative),  |c| > |e|, in order for the revenues of UC to increase.  In components:  we must have |s_l + s_c | > |e|, where if s_c is positive, s_l must be negative of magnitude greater than  s_c + |e| for there to be positive growth of revenue. 

If we include a third component, call it government, and call UC a nation’s economy, then for positive growth we must have:  s_g + s_l + s_c  > e, or  s_g > e – ( s_l + s_c  ).  If we separate e, net exports, into its components x exports and m imports, we require for growth of revenue

s_g   <  x -- m – ( s_l + s_c ). Clearly, where imports are greater than exports, the problem is exacerbated, and there must be extensive dissavings by government if there is savings by labor and capital. 

We observe, for a system with no net trade, ( x = m ),  s_{g  <} – (s_l + s_c ).  That is, for an economy with no net trade to grow, (net closed,) government expenditures must be greater than private sector savings.  In general, that is, the economy as a whole must dissave.  That is:   0 > s_l + ­ s_c + s_g .This may be made explicit:  The share of growth of revenue,

DR =  – (s_l + ­ s_c + s_g ).

What do we mean by dissave? Savings, of course, may mean putting money into mattresses.  Dissaving implies there must be an input of money, such that more money is spent, by the components of an economy, than is earned. This may be money taken out of mattresses.  This may be money lent by an entity outside of the economy. It may be money added to the supply, as with inflation. Where it is lent by an entity inside the economy, (finance, say, thus s_f) we have the same problem:  We have a change in the relative revenue collected by the components, but the revenue for the whole economy necessarily declines.

With monetary input I, as with inflation, say, we have: I > s_l + ­ s_c + s_g + s_f  as the condition for growth of revenue in a net closed economy.  And in general, allowing for imports and exports: 
I + x – m > s_l + ­ s_c + s_g + s_f  Explicitly, the share of growth of revenue is:  
 DR = – ( s_l + ­ s_c + s_g + s_f ) + I +  x –  m.

This is rather tautological.  With a fixed money supply,  total revenue cannot increase, and any quantity of money taken out of the system leads to a decrease in revenue.  Since nominal profit requires an increase in revenue, a fixed money supply will, in the best of circumstances, result in an average nominal corporate profit of zero, unless there is dissavings. Some might argue that the policy of the wealthy for the past 35 years has been a forcing of dissavings on labor, (and government,) from which they have taken their profit. This is manifest by the fact that the share of wealth of the 1% has increased from around 20% of the total economy to around 40%. The share of wealth of the rest of society has correspondingly decreased from around 80% to less than 60%, and all but 10% is concentrated in ownership by the next 19%.  80% of the population of the United States combine to own only 10% of its assets.

PS:  The diagram is actually kind of a joke.  It's really a copy of the backward bending labor supply curve for an individual worker, a janitor say, who, when 'paid to excess,' is expected to produce less, in particular, work fewer hours. (This effect somehow is not thought to apply to CEO's.) While true for the CEO of  the Universal Corporation, in an economy it is only true for the sum of all CEO's.  Any individual corporate CEO, of course, gets nowhere near the compensation necessary to have a deleterious effect on the economy, (though he still might be expected to produce less if overcompensated.)   But that the sum of all CEO compensation, the sum of all compensation to the wealthy, may be harmful lies the problem, which we discuss in my next post.