Was Marx right about capitalism destroying itself from within?

One of the core tenets of Marx’s work is that capitalism will be undone by internal contradictions that would manifest as ever-greater crises that would eventually destroy the system from within. If it turns out the current version of global capitalism is indeed unraveling due to its internal contradictions, it would be valuable to understand this now rather than later.

Read more:

https://www.oftwominds.com/blogjan20/marx1-20.html

Since the failure of communism Marx has been politically incorrect even though what he had to say about capitalism could be of great value.

There are two trends within capitalism, which are wealth creation and wealth concentration. Wealth concentration at some point may hamper wealth creation if the people at the bottom have not enough money to spend to make capital profitable.

The oversupply of capital or the lack of demand caused by lagging wages Marx foresaw may be the primary cause of the low and negative interest rates we have now. After the next recession we may never see positive interest rates again.

Read more:

https://www.naturalmoney.org/blog/190817.html

 

Beautiful countryside in southern California

Capital for the future

Making the economy sustainable may require an unprecedented amount of capital in the form of knowledge and outfits like solar panels, sustainable farms and energy-efficient transportation systems. It is hard to imagine that it can be done. And imagining it is still a lot easier than really doing it. It is going to require some economic magic to divert investment capital from destructive activities to the future of humanity. We may need more useful capital and less consumption.

Perhaps the invisible hand can be of some help. It is easier to finance a great endeavour from investments than from taxation because nobody wants to pay taxes but everybody is happy to invest. It is the secret of the success of the European empires that conquered the world after the Middle Ages. England, France, Spain and the Netherlands were much poorer and smaller than China, India or the Ottoman Empire, but they didn’t finance their conquests with taxation, but with the use of investment capital.1

Europe won out because European conquerors took loans from banks and investors to buy ships, cannons, and to pay soldiers. Profits from the new trade routes and colonies enabled them to repay the loans and build trust so they could receive more credit next time.1 The same logic may need to be applied to making the economy sustainable. The challenge is so enormous that it may never be possible to finance it by taxes. Nowadays interest rates are so low because there is plenty of investment capital.

It’s the economy stupid!

It is often argued that the economy is unsustainable because of short-term thinking. The economy must grow in order to have positive returns on investments. And it is believed that returns on investments need to be positive otherwise the economy would collapse. The economic time horizons of individuals are reflected in their time preferences. The time horizon of the economy as a whole is reflected in the interest rate.

The lower the interest rate, the longer the time horizon of the economy could be. The following example from the Strohalm Foundation can illustrate this:

Suppose that a cheap house will last 33 years and costs € 200,000 to build. The yearly cost of the house will be € 6,060 (€ 200,000 divided by 33). A more expensive house costs € 400,000 but will last a hundred years. It will cost only € 4,000 per year. For € 2,060 per year less, you can build a house that lasts three times as long.

After applying for a mortgage the math changes. If the interest rate is 10%, the expensive house will not only cost € 4,000 per year in write-offs, but during the first year there will be an additional interest charge of € 40,000 (10% of € 400,000).

The long-lasting house now costs € 44,000 in the first year. The cheaper house now appears less expensive again. There is a yearly write off of € 6,060 but during the first year there is only € 20,000 in interest charges. Total costs for the first year are only € 26,060. Interest charges make the less durable house cheaper.2

Without interest there is a tendency to select long-term solutions. Interest charges make long-term solutions less economical. Interest promotes a short-term bias in the economy. It may explain why natural resources like rainforests are squandered for short term profits. If interest rates are high, it may be more profitable to cut down a rainforest and to put the proceeds at interest rather than to manage the forest in a sustainable way.

Only, things are not as simple as the example suggests. For example, the building materials of the cheap house might be recycled to build a new house. And technology changes. For example, if cars had been built to last 100 years, most old cars would still be around. This could be a problem as old cars are more polluting and use more fuel. Nevertheless, the example shows that long-term investments can be more attractive when interest rates are lower.

This also applies to investments in renewable energy. For instance, a solar panel that costs € 100, lasts 15 years, and generates € 150 worth in electricity in the course of these 15 years, is feasible at an interest rate of 5% but not at an interest rate of 10%. Many investments in making the economy sustainable may have low returns and are only feasible when interest rates are low. Low and negative interest rates can also deal with low economic growth. That may be needed for living within the limits of the planet.

Living within the limits of the planet

When interest rates are negative, the time horizon of the economy could go to eternity so that it makes sense to invest in making the economy sustainable. A few examples from history can illustrate this. In the Middle Ages some areas in Europe had currencies with a holding fee like Natural Money. As there hardly was economic growth, interest rates were negative. It was the era of Europe’s great cathedrals. These cathedrals were built for eternity. As better investment opportunities were absent, wealthy towns people spent their excess money on cathedrals.3 For similar reasons, the people of Wörgl planted trees as the proceeds of the wood were expected to occur in the distant future.3

A bit of calculus shows why. At an interest rate of 5%, putting € 1 in a bank account turns into € 1,05 after a year, so you would rather have € 1 now than in one year’s time, even when you need the money in one year’s time. That’s because you can put the money on a bank account at interest. At an interest rate of 5%, € 100 in one year’s time is worth € 95.25 now. The distant future has even less value. The same € 100 in one hundred year’s time is worth only € 0.59. And € 100 after 1000 years has no value at all in the present.

At an interest rate of -5%, you would prefer to have the money when you need it, otherwise you would end up with less. At an interest rate of -5%, € 100 in one year’s time would be worth € 105. The same € 100 in one hundred year’s time would be worth € 13,501 now. And € 100 after 1000 years would be worth more than everything there is in the present. Income in the distant future is also very uncertain, so it is unlikely that investors will shift their time horizon to 1,000 years, but this logic may help us to come into terms with the limits our planet poses on human activities.

Living within the limits of the planet may require unprecedented investments in the future. These investments may require low or even negative interest rates as their returns may be low. Only low and negative interest rates can make these investments economical. Everyone who has money to save can help by shifting money from consumption to saving and investing. The more people act like capitalists, the lower interest rates may go, and the more sustainable the economy may become.

Capitalists think that money spent on a frivolous item is money wasted, because when you invest your money, you will have more money that you can invest again. Capitalists hardly care about interest rates. They will save and invest anyway because of their capitalist spirit. Rich people may be encouraged to save even more if luxuries that use a lot of natural resources and energy aren’t available any more. One can think of luxury yachts, private jets, but also of travel by airplane for holidays. When energy becomes a constraint, local products may replace long-distance trade.

Featured image: Beautiful countryside in southern California. James McCauley (2005). Wikimedia Commons. Public Domain.

1. A Brief History Of Humankind. Yuval Noah Harari (2014). Harvil Secker.
2. Poor Because of Money. Henk van Arkel and Camilo Ramada (2001). Strohalm.

Amazon Blue Front Economist

Supply and demand

There is a saying, teach a parrot to say ‘supply and demand’ and you have an economist. Economics is about supply and demand. In order to understand how the invisible hand of a market economy operates, you should be familiar with the law of supply and demand. Not surprisingly, this is one of the most important laws in economics. This law states that the price is where supply and demand are equal. An example about the market for coffee can clarify the magic of the invisible hand.

If coffee would be free people might like to drink lots of coffee but producers can’t make coffee for free. Producers go bankrupt if the price is zero because they have costs, for instance employees and equipment. If the price of coffee is low, for instance € 3 per kilogram, that may not cover all the costs. Some producers can produce cheaper than others because they have more efficient production facilities, so when the price is € 5 a few producers might start producing coffee because they can make a profit.

That may not be enough to satisfy all the demand that is out there. The low-cost producers have a limited production capacity so they may be able to come up with 650 kilograms of coffee. Consumers might want to indulge themselves in 1,700 kilograms if the price is only € 5 per kilogram. In that case there would be a shortage of coffee of 1,050 kilograms. Consumers who fear that they are going to be left out of the action might then offer more money so that the price of coffee rises.

When coffee becomes more expensive some consumers might not be able to afford coffee. Others may buy less because they have other expenses like beer and milk. On the other hand, some producers might start making coffee because they can make a profit at these prices. So when the price goes up, supply goes up and demand goes down.

At € 10 per kilogram every producer may be able to make a profit, even those who have high costs, and producers may come up with 2,000 kilograms. However, consumers may only buy 600 kilograms if coffee costs € 10 per kilogram so there may be a surplus of 1,400 kilograms. Producers may then try to sell off their surplus at lower prices before it gets spoiled in order to recover some of their costs. When prices are lower, consumers are willing to buy more, but high-cost producers can’t make a profit and may stop making coffee. So when the price goes down, demand goes up and supply goes down.

The price may settle where supply equals demand. When the price is € 7 producers may make 1,200 kilograms and consumers may gobble up 1,200 kilograms. So € 7 per kilogram could be the price of coffee according to the law supply and demand. Of course, things in reality are a lot more complicated than that, but the law suffices for a basic understanding of markets. A graph can illuminate what has been discussed so far.

supplydemand2

The graph shows the quantities of coffee demanded and supplied at different prices. When the price goes up, demand goes down and supply goes up. The downward sloping black dashed line represents demand. The upward sloping black line represents supply. If the price is low the supplied quantity is low and the demanded quantity is high, leading to a shortage. At a price of € 5 there will be a shortage of 1,050 kilograms as demand is 1,700 kilograms while supply is only 650 kilograms.

If the price is high, demand is low and supply is high, leading to a surplus. If the price is € 10, there will be a surplus of 1,400 kilograms as supply is 2,000 kilograms and demand is only 600 kilograms. The lines of demand and supply cross at 1,200 kilograms and a price of € 7. Supply and demand are both 1,200 kilograms at a price of € 7, which must be the price according to the law of supply and demand.

In reality things often differ a lot from the simple model. There may be different qualities of coffee and each may have its own price. In some markets there is a lot of competition and corporations hardly make a profit. In other markets there is little or no competition and corporations make huge profits. And there hardly ever is an equilibrium as there are many factors that influence supply, demand and price, and they constantly change. Nevertheless, simple examples like this one are useful because they help to explain how a market economy works.

Featured image: Ara Economicus. Beverly Lussier (2004). Wikimedia Commons. Public Domain.

Picture of my invisible friend taken near Nijverdal

Our invisible friend

Market economy

To understand market economies, you need to know about our invisible friend, the invisible hand. Somehow market economies can distribute goods efficiently without anyone planning this. According to the economist Adam Smith it is as if an invisible hand makes this miracle happen. His critics like Karl Marx didn’t believe in invisible friends. Not surprisingly Marx also didn’t believe in God. Smith claimed that if everyone pursues his own personal interest, the interest of society is often best served.

I’m the invisible man
Incredible how you can
See right through me

– Queen, The Invisible Man

The following tale demonstrates how the invisible hand does its magic. Whether or not it is actually true doesn’t really matter. The story goes that the mayor of Moscow once visited London in the 1980s. Back then Russia didn’t have a market economy. The mayor received a tour around the city and noticed that no one had to queue up for bread like everyone did in Moscow. There was an ample supply of bread at cheap prices while no bread was thrown away. Somehow bread was produced in the right quantities in the preferred tastes and supplied at the right places.

The mayor was truly amazed about this feat so he said to his hosts: “Back in Moscow our finest minds work day and night on the bread supply and yet there are long queues everywhere. Who is in charge of the supply of bread in London? I want to meet him!” Of course, no-one was in charge. That’s the secret of the market economy. Every baker decided for himself or herself how much he or she was planning to make and sell and at what price. A few years later Russia switched to a market economy.

It is the individual decisions of bakers and the businesses working in the supply chain, for instance farmers and flour mills, that make this miracle happen. They all decide for themselves. If a baker could sell more than is produced he or she would miss out on profits. The same is true when bread is thrown away. And people are willing to pay more if the bread tastes better. Hence, every individual baker will do his or her best to make exactly the right amount of bread in the tastes people desire. It is in their best interest.

In Russia the state planned how much of every item was produced, where these items were shipped and what prices they were sold. Corporations couldn’t decide about prices. They received a compensation for their costs but they weren’t allowed to make a profit. Employees received a fixed salary. If a corporation produced more or better products, it still didn’t make a profit nor did the employees receive higher wages. Corporations also couldn’t go bankrupt when they did a bad job. This resulted in poor quality products, a shortage of nearly everything and even outright famine from time to time.

It doesn’t always work out well

There are instances where a market economy doesn’t produce the best outcome for society as a whole. Economists call them market failures. One can think of the following situations:

  • People may have far more desires than the planet can support and the market economy may fulfil those desires at the expense of future life on the planet.
  • Some people are not able to make in a living in the market economy, for instance because they lack the skills or have little bargaining power.
  • Corporations use lobbyists and bribe politicians to pass legislation that favours them.
  • A government may be a more efficient producer of products that do not benefit from competition, for instance roads and the power grid.
  • Corporations may abuse their power to charge higher prices, most notably if it is hard for competitors to enter the market.
  • Some products cause harm to people or the environment but these costs are not paid for by the producers. For example, cigarettes cause health costs.

In most countries governments interfere with the economy in order to deal with market failures. These are situations where pursuing personal interests doesn’t bring the best outcome for society as a whole. What the best outcome is, is sometimes a matter of taste, but often it is obvious. Government intervention can make things even worse, so decisions about interfering are made after weighing benefits and drawbacks. In many democratic countries public expenses are about 50% of national income. People in these countries probably believe that market economy doesn’t always work best.

An example can demonstrate why. People in the United States live as long as people in Cuba.1 Cuba is a poor country without a market economy. The United States spends more on health care than any other country in the world. Every possible treatment is available in the United States. Still, in more than 40 countries people live longer than the United States and Cuba.1 Cuba doesn’t spend a lot on health care, only 10% of what the United States spends per person. Healthcare in Cuba therefore appears extremely efficient compared to healthcare in the United States. How can this be?

The available treatments in Cuba are free for everyone. In the United States people may not receive treatment when they can’t afford it because the United States has a market economy. There may be other causes too, for example differences in the diets in Cuba and the United States. There is no fast food in Cuba because Cuba has no market economy. Still, Cuba isn’t a great country to live in. People have been fleeing Cuba for decades and many Cubans moved to the United States. Cuba is a dictatorship and most Cubans are poor. Healthcare is one of the few things that Cuba has organised well.

The story about the visit of the mayor of Moscow demonstrates that the invisible hand of the market shouldn’t be ignored. Successful societies have market economies. Many public expenses are paid for by taxes on income generated in market economies. A market economy still needs a government to set the rules and to enforce them. Governments of successful societies aim at making the market economy work better where it is beneficial for society and constraining it where it does more harm than good.

Capital

Market economy and capitalism are so closely related that many people believe them to be the same. Capitalism is about capital. Capital consists of the buildings and the machines corporations own, but also the knowledge of how to make products and how to bring them to the market. Knowledge of how to make a film entertaining might be capital for a film company. Networks of customers and suppliers can be capital too if they contribute to the success of a business. The same applies to contracts and brands. For instance, the brand Coca Cola has a lot of value because people are willing to pay more for cola when the logo of Coca Cola is printed on the bottle.

Building capital can be costly but in a market economy the value of capital doesn’t depend on the cost to build it but on the future income it is expected to produce. This can lead to peculiar situations. When investors have no faith in the future of a corporation because it is expected to make losses, the buildings and the machines on their own may be worth more than the corporation as a whole as those buildings and machines could be used by other corporations for more profitable purposes.

In most cases more capital means more wealth because capital produces the things people need or desire. Corporations tend to be more profitable if they fulfil those needs and desires better. Therefore, the value of capital in a market economy often depends on how good it can fulfil the desires of consumers. Investors are willing to invest in corporations that fulfil those needs and desires because they expect to make money by doing so.

It is sometimes argued that when investors are free to invest in the corporations of their choosing, the invisible hand channels investment capital to the most useful corporations because they are the most profitable. That’s why the value of corporations is important in a market economy. Businesses ‘create value’ for investors by making consumers happy. Still, the value of a corporation might not reflect the benefits for society as a whole. For instance, if the profitability of a corporation comes from exploiting people or harming life on the planet, a high value could be a bad sign.

And capital can be useful without being profitable, for instance in the public sector. A hospital in the public sector may have no market value because it doesn’t make a profit but it can be useful nonetheless. Capital in the public sector might even be more valuable than in a market economy. For instance, making hospitals private enterprises for profit might not benefit society as a whole. Hospital care may not improve from competition as it is often best to have one hospital serving a particular area. And patients might receive unnecessary treatments when hospitals can make a profit. Healthcare in the United States may create a lot of value for investors but it doesn’t always benefit the patients.

As there are basically two types of people, capitalists who save and invest and ordinary people who borrow and spend, it is hardly surprising that capitalists tend to be wealthier than ordinary people. Capitalism can create wealth because it is the capitalists who finance the investments in the corporations that make the items ordinary people enjoy, but this wealth is often unevenly distributed. From a moral perspective, it is a problem that poverty still exists while there could be enough for everyone. So the question that still remains is how to make the economy work better for the benefit of all?

Featured image: Our invisible friend photographed in the moorlands near Nijverdal. Jürgen Eissink (2018). Wikimedia Commons. Public Domain.

1. Life expectancy per country 2017. World Population Review. [link]