economy

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Will Robots Drive Us To Socialism?

robots-out-to-get-me

I read recently that Rio Tinto has already replaced 30% of their mining machinery operators and drivers with robots.

The future of work in an age of increasing automation is a topic that a lot of economic thinkers have considered. Frances Coppola ponders the question of how the future may look in a world in which automation is driving people out of the labour market:

Automation only happens when machines are cheaper to run than people, and it is probably fair to say that in the last few decades automation has not happened quite as fast as one might have anticipated because companies have discovered that labour in emerging markets is cheaper than the cost of investing in machinery. But as the standard of living rises in emerging markets, and the cost of technology falls, that will not remain the case. Hazlitt, writing in 1952, pointed out that it was automation of production that enabled families to survive without children’s labour, because the price of goods produced with the new machinery was so much lower than those produced in a more labour-intensive way. In the short term automation caused hardship, as people whose livelihoods depended on the old way of doing things lost their jobs: but in the longer term there was benefit to society in the reduced cost of goods that enabled many people to work less, and in the development of new industries to employ those people no longer needed in the old ones. The change we are seeing today is every bit as great, and the short-term consequences are the same – high unemployment, particularly among those with poor or irrelevant skills.

Automation should both require fewer people to work AND enable people to work less, since the whole point of automation is to reduce the cost of production, which in a competitive system would result in falling prices. Unfortunately this isn’t always the case: the owners of automated industry may use reduced production cost as an opportunity to take more profit, and they may use political influence to create barriers to entry and trade tariffs to prevent competition driving down prices. But assuming that governments don’t use subsidies and protections to keep inefficient companies alive and prices artificially high, where does that leave us in terms of employment and incomes in the future?

Where it leaves us is with increasing inequality, which of course is something that we have seen in recent years, alongside increased unemployment, which is another thing we have seen. And in a world where a minority, historically known as the capitalists own the physical means of production like factories, robots and patents this will result in greater inequality as labour becomes less and less important as an economic factor. The owners of capital will be able to produce to satisfy market demand with little labour input. This will result in more former labourers leaving that field and either becoming entrepreneurs themselves, or becoming dependent on welfare. I think this transformational phenomenon is already well under way in the West — and I only expect it to become more pronounced globally as automation becomes ubiquitous.

In theory, physical labour may become totally obsolete. If every house has a decentralised energy source like solar panels and reliable energy storage, as well as an advanced 3-D printer or molecular assembler that can produce almost physical object imaginable from a few basic recyclable chemicals then human poverty will essentially have been abolished. We can just spend the vast majority of our time doing things that we enjoy, while spending only a few minutes or at most hours a day programming our machines to fulfil our material desires.

That is the more optimistic vision. In a less optimistic vision, only a small minority of people will have access to such technologies as while the technology may exist, the costs of mass distribution remain too high (at least for a time). The vast masses, will be stuck in impoverished material conditions — dependent on welfare, and charity — without any real prospect being able to climb the ladder through selling their labour. Only a lucky few — who have an inimitably good idea, or a creative skill that cannot be replicated by a robot — will have a prospect of joining the capital-owning upper class. And for the others who are left out in the cold, political action may look attractive. Simply have the government take a larger chunk of the capital-owning class’s income or wealth, and redistribute it to the poor. Ideally, this would be done with the intent of abolishing poverty through making cheap electricity, internet access and molecular assemblers available to all. Less ideally, rather than giving the poor the means to fish (so to speak), it might instead take the shape of a giant welfare net, keeping the means of production in limited hands and simply confiscating and redistributing some wealth. These issues unresolved could create a lot of tension between the two classes. In a worst-case scenario, that could lead to social breakdown or even revolution.

Fortunately, I think that this can be avoided through voluntary charity. The billionaire class today is split between those on one hand determined to give it all away with the intent of improving the material conditions of the very poor — Bill Gates, Warren Buffett — and those on the other determined to create new futuristic technologies and systems — Elon Musk — that can improve the material conditions of the masses. As we proceed through the 21st Century and as the technologies of superabundance — solar energy, nuclear energy, wind energy, cybernetics, genomics, the internet, 3-D printing, molecular manufacturing, desalination, etc — create more and more wealth and more and more billionaires, this trend may accelerate. Simply, the wealthy may have so much wealth that eliminating material poverty through voluntary charity may in the long run be an obvious and inevitable move.

As Brian Caplan notes:

At first glance, I admit, a vision of a superabundant world where people who own only their labor eke out a meager existence seems frightening.  But put your fears aside.  In an ultra-productive world, a relatively tiny amount of non-labor resources would make your rich by current standards.  Labor + zero non-labor assets = poverty; labor + token non-labor assets = riches.  In any case, a slight charitable impulse in the better-off is all you need to ensure fabulous riches for every human on earth.

Once you’ve got a world this wonderful, the last thing you’d want to do is start down a potentially slippery slope with a high tech Russian Civil War at the bottom.  Indeed, a more sensible reaction would be abolish the welfare state as obsolete.  If half of us were billionaires, mopping up any residual human poverty with voluntary charity would be child’s play.

Ironically, this kind of world could be strangely like the decentralised and classless society that Marx originally envisaged. The route to which we appear to be travelling toward it on, though, is totally and completely different to the one Marx envisaged. Instead of violent revolution, the road to superabundance may be paved by technological progress made by the capital-owners.

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Stocks Priced in Real GDP

Since the 1990s, priced in Real GDP the Dow Jones Industrial Average (as well as the S&P500) has been far above their 20th-century norm:

STockspricedinRealGDP

There is an unsurprising coincidence — as stock prices (and corporate profits) have soared above their historical norm, wage growth has been very stagnant. The economy has come to be tilted toward bankers, financiers, insurance brokers and away from wage-earners, manufacturers and artisans. 

Does that mean that as Hassett and Glassman projected in Dow 36,000, stock prices have climbed to a new plateau? Well, while it is impossible to say exactly what prices will do in future (nominal, or otherwise) the “new plateau” has been very much supported by the Federal Reserve, first by lowering rates and keeping them low:

DJIAFederalFunds

And second through expanding the monetary base by buying securities directly (Bernanke estimates a simulated interest rate decrease of 0.25% for each 250 billion dollars of quantitative easing):

DJIABASE

Each time stocks have turned cheaper, the Fed has stepped in and eased, and stocks have reversed upward.

Some might take that as a sign that stocks aren’t going to get much cheaper, because the Fed won’t let them get much cheaper. First under Greenspan, and second under Bernanke the Fed has succeeded at reinflating the bubble. But the secular trend is back toward the pre-1990s norm. Gravity is against the Fed. The Fed (to use a tired old metaphor) is Atlas, holding stock prices up on its shoulders. Will it be third-time unlucky for the Fed, hell-bent on wealth-effecting and financialising the US economy to prosperity?

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Do Wages Benefit From A Shrinking Labour Force?

Dean Baker says yes:

The retirement of the baby boom cohorts means that the country’s labor force is likely to be growing far more slowly in the decades ahead than it did in prior decades. The United States is not alone in facing this situation. The rate of growth of the workforce has slowed or even turned negative in almost every wealthy country. Japan leads the way, with a workforce that has been shrinking in size for more than a decade.

Baker concludes:

With a stagnant or declining labor force, workers will have their choice of jobs. It is unlikely that they will want to work as custodians or dishwashers for $7.25 an hour. They will either take jobs that offer higher pay or these jobs will have to substantially increase their pay in order to compete.

This means that the people who hire low-paid workers to clean their houses, serve their meals, or tend their lawns and gardens will likely have to pay higher wages. That prospect may sound like a disaster scenario for this small group of affluent people, but it sounds like great news for the tens of millions of people who hold these sorts of jobs. It should mean rapidly rising living standards for those who have been left behind over the last three decades.

Of course, Baker could just look at the data from Japan. Real wages there have been depressed in recent years, even while the labour force has shrunk:

Japanwages

Even more damningly, labour’s share of income in Japan has declined even more considerably than the United States, and other nations with a growing working-age population:

ShareofLabourincome

Matthew C. Klein asks an important question:

Perhaps Mr Baker was thinking of an older example: the Black Death, which killed about half the people in Europe. Many (including me until I looked it up) believe that the resulting shortage in agricultural labour led to soaring real wages for peasants and a redistribution of economic power away from landowners. Recent evidence, however, casts doubt on this hypothesis. While nominal peasant wages did indeed increase in the aftermath of the Black Death, real wages may have actually fallen for decades. That may have helped heavily indebted peasants, but everyone else had to endure punishing declines in their standard of living, not to mention the psychological trauma of surviving such a devastating plague.

And the evidence on the Black Death seems conclusive:

In southern England, real wages of building craftsmen (rural and urban), having plummeted with the natural disaster of the Great Famine (1315-21), thereafter rose to a new peak in 1336-40. But then their real wages fell during the 1340s, and continued their decline after the onslaught of the Black Death, indeed into the 1360s. Not until the later 1370s – almost thirty years after the Black Death – did real wages finally recover and then rapidly surpass the peak achieved in the late 1330s.

And if we look at China — a country which has seen stunning real wage growth in recent years — it is clear that that growth has come in the context of a growth in the working-age population. China’s working-age population hit one billion for the first time in 2011.

To me at least, this seems to suggest that while all else being equal, a shrinking working age population might lead to a more competitive labour market, all else is not equal. Employers invest in more capital-intensive processes like automation and robots to compensate for a lack of workers, or in our globalised world they shift operations to somewhere with a stronger labour force (like China today, or perhaps like Africa further into the future). Even more simply, a falling population as a result of a natural disaster like the Black Death, or even just as a result of demographic trends like Japan, may lead to an economic depression due to falling demand.

This suggests that Baker’s conclusions are extremely optimistic for labour, and that shrinking populations may be bad news for wages.

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Of Wages and Robots

There is a popular meme going around, popularised by the likes of Tyler Cowen, Paul Krugman and Noah Smith that suggests that recent falls in worker compensation as a percentage of GDP is mostly due to the so-called “rise of the robots”:

For most of modern history, two-thirds of the income of most rich nations has gone to pay salaries and wages for people who work, while one-third has gone to pay dividends, capital gains, interest, rent, etc. to the people who own capital. This two-thirds/one-third division was so stable that people began to believe it would last forever. But in the past ten years, something has changed. Labor’s share of income has steadily declined, falling by several percentage points since 2000. It now sits at around 60% or lower. The fall of labor income, and the rise of capital income, has contributed to America’s growing inequality.

…

In past times, technological change always augmented the abilities of human beings. A worker with a machine saw was much more productive than a worker with a hand saw. The fears of “Luddites,” who tried to prevent the spread of technology out of fear of losing their jobs, proved unfounded. But that was then, and this is now. Recent technological advances in the area of computers and automation have begun to do some higher cognitive tasks – think of robots building cars, stocking groceries, doing your taxes.

Once human cognition is replaced, what else have we got? For the ultimate extreme example, imagine a robot that costs $5 to manufacture and can do everything you do, only better. You would be as obsolete as a horse.

Now, humans will never be completely replaced, like horses were. Horses have no property rights or reproductive rights, nor the intelligence to enter into contracts. There will always be something for humans to do for money. But it is quite possible that workers’ share of what society produces will continue to go down and down, as our economy becomes more and more capital-intensive.

So, does the rise of the robots really explain the stagnation of wages?

This is the picture for American workers, representing wages and salaries as a percentage of GDP:

WASCURGDP

It is certainly true that wages have fallen as a percentage of economic activity (and that corporate profits as a percentage of economic activity have risen — a favourite topic of mine).

But there are two variables to wages as a percentage of GDP. Nominal wages have actually risen, and continued to rise on a moderately steep trajectory:

WASCUR_Max_630_378

And average wages continue to climb nominally, too. What has actually happened to the wages-to-GDP ratio, is not that America’s wage bill has really fallen, but that wages have just not risen as fast as other sectors of GDP (rents, interest payments, capital gains, dividends, etc). It is not as if wages are collapsing as robots and automation (as well as other factors like job migration to the Far East) ravage the American workforce.

It is more accurate to say that there has been an outgrowth in economic activity that is not yielding wages beginning around the turn of the millennium, and coinciding with the new post-Gramm-Leach-Bliley landscape of mass financialisation and the derivatives and shadow banking megabubbles, as well the multi-trillion dollar military-industrial complex spending spree that coincided with the advent of the War on Terror. Perhaps, if we want to look at why the overwhelming majority of the new economic activity is not trickling down into wages, we should look less at robots, and more at the financial and regulatory landscape where Wall Street megabanks pay million-dollar fines for billion-dollar crimes? Perhaps we should look at a monetary policy that dumps new money solely into the financial sector and which has been shown empirically to enrich the richest few far faster than everyone else?

But let’s focus specifically on jobs. The problem with the view that this is mostly a technology shock is summed up beautifully in this tweet I received from Saifedean Ammous:

The Luddite notion that technology might render humans obsolete is as old as the wheel. And again and again, humans have found new ways to employ themselves in spite of the new technology making old professions obsolete. Agriculture was once the overwhelming mainstay of US employment. It is no more:

farmjobs

This did not lead to a permanent depression and permanent and massive unemployment. True, it led to a difficult transition period, the Great Depression in the 1930s (similar in many ways, as Joe Stiglitz has pointed out, to the present day). But eventually (after a long and difficult depression) humans retrained and re-employed themselves in new avenues.

It is certainly possible that we are in a similar transition period today — manufacturing has largely been shipped overseas, and service jobs are being eliminated by improvements in efficiency and greater automation. Indeed, it may prove to be an even more difficult transition than that of the 1930s. Employment remains far below its pre-crisis peak:

EMRATIO_Max_630_378

But that doesn’t mean that human beings (and their labour) are being rendered obsolete — they just need to find new employment niches in the economic landscape. As an early example, millions of people have begun to make a living online — creating content, writing code, building platforms, endorsing and advertising products, etc. As the information universe continues to grow and develop, such employment and business opportunities will probably continue to flower — just as new work opportunities (thankfully) replaced mass agriculture. Humans still have a vast array of useful attributes that cannot be automated — creativity, lateral thinking & innovation, interpersonal communication, opinions, emotions, and so on. Noah Smith’s example of a robot that “can do everything you can do” won’t exist in the foreseeable future (let alone at a cost of $5) — and any society that could master the level of technology necessary to produce such a thing would probably not need to work (at least in the sense we use the word today) at all. Until then, luckily, finding new niches is something that humans have proven very, very good at.

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1000% Inflation?

UBS’s Larry Hatheway — who once issued some fairly sane advice when he recommended the purchase of tinned goods and small calibre firearms in the case of a Euro collapse — thinks 1000% inflation could be beneficial:

When 1000% inflation can be desirable

In fact, the costs associated with inflation (price change) are less than commonly supposed. There is the famous “sticker price cost” – the cost of constantly changing price labels – but in a world of electronic displays and web based ordering this is not a serious economic cost (in fact, it never was). To take an extreme position, one can make the economic argument that there are only limited costs in having inflation running at 1000% per year, with one caveat. 1000% inflation is perfectly acceptable, as long as the 1000% inflation rate is stable at 1000%, and it is anticipated. Of course, one can argue that high inflation tends to be associated with high inflation volatility and uncertainty (and that is true empirically), but economically it is the volatility and uncertainty that does most of the damage.

The maximum damage from inflation comes if it is unexpected or if it is unpredictable.Unexpected inflation causes damage, because the investor who holds bonds yielding 1% for a decade is going to feel cheated if inflation turns out to be 1000%. Of course, no one would voluntarily buy 1% yielding bonds if 1000% inflation was expected. Thaler’s Law comes into operation here; people dislike losing money more than they like making money. As a result episodes of unexpected inflation will lead to a significant adverse reaction on the part of consumers.

Unpredictable inflation is damaging because it causes uncertainty over an investment time horizon – and that uncertainty is a risk that will demand a compensating premium. What the inflation uncertainty risk does is raise the real cost of capital. If I think inflation will be 3% but I am not sure whether it will be 3%, 0%, or 6%, I am likely to demand compensation for the 3% inflation risk but then additional compensation for the possibility that the inflation risk is as high as 6%. The additional compensation is an addition to the real cost of capital.

Nope.

This is a fairly typical mistake for an economist. In an imaginary economic model, it is possible to assume that inflation is stable, and that it is predictable, and to draw conclusions based on those (absurd) assumptions. In the real world, inflation and the effects of inflation are never predictable, because human behaviour — the micro-level phenomena on which macro-level phenomena like “inflation” are founded — is never fully predictable or stable. This means that future rates of inflation will always be uncertain, and renders Hatheway’s point meaningless.

As Hatheway readily admits, high inflation is associated in the real world with inflation volatility and uncertainty. It is not relevant to say that the real issue is not the high rate of inflation, because there has not been a single case in history where such a high rate of inflation has resulted in stability or predictability. Getting to a 1000% inflation rate is an inherently volatile path, historically one which has resulted in panics, crashes and breakdowns.

And beyond that, such a path would completely undermine the currency and instruments denominated in the currency as a store of value. There are no empirical examples of such high rates of inflation being tolerated, because at every stage in history such effects have been intolerable; when such rates of inflation set in, nations just end up ditching the currency, as happened most recently in Zimbabwe.

That is why 1000% (or 100%, or 50%, or probably even 10%) inflation will never be “perfectly acceptable”.

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QE ∞

The Keynesians and Monetarists who have so berated the Federal Reserve and demanded more asset purchases and a nominal GDP target to get GDP level up to the long-term growth trend have essentially got their wish.

This is a radical departure:

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month.  The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities.  These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.

The Committee will closely monitor incoming information on economic and financial developments in coming months.  If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.  In determining the size, pace, and composition of its asset purchases, the Committee will, as always, take appropriate account of the likely efficacy and costs of such purchases.

I tweeted this earlier in favour of the idea that the Fed would adopt open-ended asset purchases:

Those who didn’t anticipate the possibility of open-ended asset purchases should have looked much more closely at Bernanke’s words at Jackson Hole:

If we are willing to take as a working assumption that the effects of easier financial conditions on the economy are similar to those observed historically, then econometric models can be used to estimate the effects of LSAPs on the economy. Model simulations conducted at the Federal Reserve generally find that the securities purchase programs have provided significant help for the economy. For example, a study using the Board’s FRB/US model of the economy found that, as of 2012, the first two rounds of large scale asset purchases may have raised the level of output by almost 3 percent and increased private payroll employment by more than 2 million jobs, relative to what otherwise would have occurred.

Essentially, this is nominal GDP level targeting. The reason why Bernanke has framed it in terms of lowering unemployment is that his mandate relates to price stability and unemployment, not nominal GDP level. But as Bernanke himself noted in his academic days:

Estimates based on data from more recent years give about a 2% decrease in output for every 1% increase in unemployment.

To those who accept Okun’s Law, raising nominal GDP level and lowering unemployment are effectively the same thing. Bernanke seems to believe unemployment will fall in a (roughly) linear fashion as asset purchases increase. By itself, this is a problematic assumption as the past is not an ideal guide to the future.

Yet more importantly the data shows no real job recovery in the post-2008 quantitatively-eased world. This is the prime-age employment-population ratio:

And even if unemployment falls without triggering large-scale inflation as per the Fed’s design, this is no cure for the significant long-term challenges that America faces.

As I wrote back in November 2011, when nominal GDP targeting was just appearing on the horizon America faces far greater challenges than can be solved with a monetary injection. Financial fragility, moral hazard, energy dependency, resource dependency, deindustrialisation, excessive private debt, crumbling infrastructure, fiscal uncertainty, and a world-policeman complex. The underlying problems are not ones that Bernanke really has power to address.

And how long before rising food prices cause more riots and revolutions? After, all handing over more firepower to speculators tends to result in increased speculation.

Meanwhile, US creditors and dollar-holders (particularly China) would seem from past comments to be deeply unhappy with this decision.

President Hu Jintao:

The monetary policy of the United States has a major impact on global liquidity and capital flows and therefore, the liquidity of the US dollar should be kept at a reasonable and stable level.

The dollars they accrued will lose purchasing power to every new dollar printed and handed over to the American banks in exchange for mortgage backed securities. The Chinese perspective on this will be that Bernanke is essentially engaging in theft. On the other hand, they should have considered this likelihood before they went about accruing a humungous pile of fiat dollars that can be duplicated at a press of a button. No, matter; China won’t get burnt like this again.

As PBOC official Zhang Jianhua noted:

No asset is safe now. The only choice to hedge risks is to hold hard currency — gold.

Chances of future trade and currency wars between the United States and China seem to be rising as fast as Chinese gold accruals.

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Gina Rinehart is a Bubble

Last week she said:

If you’re jealous of those with more money, don’t just sit there and complain. Do something to make more money yourself — spend less time drinking, or smoking and socializing and more time working.

Today she claimed that Australians should be willing to work for less than $2 a day:

Australian mining magnate Gina Rinehart has criticised her country’s economic performance and said Africans willing to work for $2 a day should be an inspiration.

Ms Rinehart is said to make nearly A$600 (£393) a second.

The richest woman in the world is making an increasing number of public appearances, and speaking of increasingly controversial topics.

I wonder why.

It couldn’t be that she is becoming increasingly aggressive and controversial because her core business is in trouble, could it?

Marc Faber suggests so:

There have been four mega bubbles in the past 40 years. In the 1970s it was gold; in the 1980s it was the Nikkei, and in the 1990s it was the Nasdaq. Bigger than all of them, though, has been the iron ore bubble, a tenfold increase in prices in less than a decade.

Here’s iron ore priced in dollars:

Julia Gillard’s denial seems to confirm the inevitable:

Australia’s mining boom is not over and its ‘death’ has been exaggerated.

That is her “subprime is contained” moment.

Larry Elliott explodes the myth that this time is different:

Commodity-rich countries, like Australia, have never had it so good. China takes 25% of Australia’s exports and iron ore accounts for 60% of all the goods Australia sells to China. One reason Australia avoided recession during the global downturn of 2008-09 was that it had a well-run banking system. A much bigger reason was that the country had become a giant pit from which China could extract the minerals it needed for its industrial expansion. Money flooded into the country from sovereign wealth funds and hedge funds looking for AAA investments. The Australian dollar has soared, as have property prices.

China’s economy is now slowing, and although the economic data is not particularly reliable, it seems to be slowing fast. The country has two million unsold homes, with another 30 million under construction. There is a glut of iron ore and the price is falling. Where does that leave Australia? Horribly exposed, quite obviously. It has an over-valued currency, an over-valued property market, and its major customer is now desperately pulling every available policy lever in the hope of avoiding a hard landing. Whatever happens, the Australian dollar is a sell. Just how big a sell will depend on how successful Beijing is in reflating the Chinese economy.

Perhaps Gina Rinehart should spend less time drinking, socialising and writing awful poetry and more time preparing her business for the inevitable iron ore bust?

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Competing For State Contracts is Not Competition

Here in Britain, we hear the word competition a lot. Since Margaret Thatcher, there has been a general trend — in the name of competition — toward the selling-off of utilities such as water, railway, electricity and telecoms providers. More recently, there has been a trend toward government services being provided by private companies, such as the bungled Olympic security arrangements contracted out to multinational security giant G4S, as well as work capability assessments contracted out to French IT consultancy ATOS, and the contracting-out of some medical services.

The way this works is that the government provides the funding for services, which private sector companies then bid to undertake. This is also the way in which defence contractors have historically competed for defence contracts, a sector which is renowned worldwide for its profligacy, waste and inefficiency.

This is a bizarre arrangement. Competing for government contracts is nothing like the free market. In a true market environment businesses compete for the custom of individuals based on their ability to provide the best products and services. Individuals spend their money to satisfy their needs. New businesses can generally enter the marketplace at any time, and take business away from existing competitors. Competition is beautiful, because it allows economies to quickly adjust capital, labour and resource allocation to the preferences of society based on which goods and services people choose to purchase.

Under a model where private contractors compete for government cash, this is impossible because contractors are essentially bidding for a state-backed monopoly. State bureaucrats determining which contractor will get the money is not competition; there is no market mechanism, there are no consumer preferences. Contractors are just bidding for handouts from the taxpayers’ purse based on the preferences of economic planners. Consumers cannot take their custom elsewhere, because the custom is involuntarily coming out of their taxation.

This has also been the reality of privatisation. Although I am no fan of government-controlled industry, the reality of privatisation in the UK has been the transfer of state monopolies into private hands.

One very clear example of this is telecoms infrastructure. BT Openreach, an arm of the privatised BT, has a complete state-enforced monopoly on telephone exchanges. Other telecoms providers have to lease their infrastructure in order to operate.

And the same for railways; rail lines are sold off as monopolies for ten-year periods. For travellers who want to travel by rail from one destination to another, there is no competition; there is only a state-backed monopoly operating for private profit. No competition, only endless fare hikes, delays and a complete lack of market accountability as contractors take the government cash and do whatever they want.

Ultimately, the state-backed-monopoly model seems to manifest the worst of all worlds. Costs for taxpayers remain high, budget deficits continue to grow, and utilities remain inefficient and messy. The only difference appears to be that taxpayers’ money is now being funnelled off into corporate pockets.

A free society cannot be based on economic planners allocating resources based on a bidding process. A free society is based on the state letting society allocate resources based on the market for goods and services that people want and need.

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The Origin of Money

Markets are true democracies. The allocation of resources, capital and labour is achieved through the mechanism of spending, and so based on spending preferences. As money flows through the economy the popular grows and the unpopular shrinks.  Producers receive a signal to produce more or less based on spending preferences. Markets distribute power according to demand and productivity; the more you earn, the more power you accumulate to allocate resources, capital and labour. As the power to allocate resources (i.e. money) is widely desired, markets encourage the development of skills, talents and ideas.

Planned economies have a track record of failure, in my view because they do not have this democratic dimension. The state may claim to be “scientific”, but as Hayek conclusively illustrated, the lack of any real feedback mechanism has always led planned economies into hideous misallocations of resources, the most egregious example being the collectivisation of agriculture in both Maoist China and Soviet Russia that led to mass starvation and millions of deaths. The market’s resource allocation system is a complex, multi-dimensional process that blends together the skills, knowledge, and ideas of society, and for which there is no substitute. Socialism might claim to represent the wider interests of society, but in adopting a system based on economic planning, the wider interests and desires of society and the democratic market process are ignored.

This complex process begins with the designation of money, which is why the choice of the monetary medium is critical.

Like all democracies, markets can be corrupted.

Whoever creates the money holds a position of great power — the choice of how to allocate resources is in their hands. They choose who gets the money, and for what, and when. And they do this again and again and again.

Who should create the monetary medium? Today, money is designated by a central bank and allocated through the financial system via credit creation. Historically, in the days of commodity-money, money was initially allocated by digging it up out of the ground. Anyone with a shovel or a gold pan could create money. In the days of barter, a monetary medium was created even more simply, through producing things others were happy to swap or credit.

While central banks might claim that they have the nation’s best democratic interests at heart, evidence shows that since the world exited the gold exchange standard in 1971 (thus giving banks a monopoly over the allocation of money and credit), bank assets as a percentage of GDP have exploded (this data is from the United Kingdom, but there is a similar pattern around the world).

Clearly, some pigs are more equal than others:

Giving banks a monopoly over the allocation of capital has dramatically enriched banking interests. It is also correlated with a dramatic fall in total factor productivity, and a dramatic increase in income inequality.

Very simply, I believe that the present system is inherently undemocratic. Giving banks a monopoly over the initial allocation of credit and money enriches the banks at the expense of society. Banks and bankers — who produce nothing — allocate resources to their interests. The rest of society — including all the productive sectors — get crumbs from the table. The market mechanism is perverted, and bent in favour of the financial system. The financial system can subsidise incompetence and ineptitude through bailouts and helicopter drops.

Such a system is unsustainable. The subsidisation of incompetence breeds more incompetence, and weakens the system, whether it is government handing off corporate welfare to inept corporations, or whether it is the central bank bailing out inept financial institutions. The financial system never learned the lessons of 2008; MF Global and the London Whale illustrate that. Printing money to save broken systems just makes these systems more fragile and prone to collapse. Ignoring the market mechanism, and the interests of the wider society to subsidise the financial sector and well-connected corporations just makes society angry and disaffected.

Our monopoly will eventually discredit itself through the subsidisation of graft and incompetence. It is just a matter of time.

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Whitewashing the Economic Establishment

Brad DeLong makes an odd claim:

So the big lesson is simple: trust those who work in the tradition of Walter Bagehot, Hyman Minsky, and Charles Kindleberger. That means trusting economists like Paul Krugman, Paul Romer, Gary Gorton, Carmen Reinhart, Ken Rogoff, Raghuram Rajan, Larry Summers, Barry Eichengreen, Olivier Blanchard, and their peers. Just as they got the recent past right, so they are the ones most likely to get the distribution of possible futures right.

Larry Summers? If we’re going to base our economic policy on trusting in Larry Summers, should we not reappoint Greenspan as Fed Chairman? Or — better yet — appoint Charles Ponzi as head of the SEC? Or a fox to guard the henhouse? Or a tax cheat as Treasury Secretary? Or a war criminal as a peace ambassador? (Yes — reality is more surreal than anything I could imagine).

The bigger point though, as Steve Keen and Randall Wray have alluded to, is that DeLong’s list is the left-wing of the neoclassical school of economics — all the same people who (to a greater or lesser extent) believed that we were in a Great Moderation, and that thanks to the wonders of modernity we had escaped the old world of depressions and mass unemployment. People to whom this depression — judging by their pre-2008 output — was something of a surprise.

Now the left-wing neoclassicists may have done less badly than the right-wing neoclassicists Fama, Cochrane and Greenspan, but that’s not saying much. Steve Keen pointed out:

People like Wynne Godley, Ann Pettifors, Randall Wray, Nouriel Roubini, Dean Baker, Peter Schiff and I had spent years warning that a huge crisis was coming, and had a variety of debt-based explanations as to why it was inevitable. By then, Godley, Wray and I and many other Post Keynesian economists had spent decades imbibing and developing the work of Hyman Minsky.

To my knowledge, of Delong’s motley crew, only Raghuram Rajan was in print with any warnings of an imminent crisis before it began.

DeLong is, in my view, trying to whitewash his contemporaries who did not see the crisis coming, and inaccurately trying to associate them with Hyman Minsky whose theory of debt deflation anticipated many dimensions of the crisis. Adding insult to injury, DeLong seems unwilling to credit those like Schiff and Keen (not to mention Ron Paul) who saw the housing bubble and the excessive debt mountain for what it was — a disaster waiting to happen.

The most disturbing thing about his thesis is that all of the left-neoclassicists he is trying to whitewash have not really been very right about the last four years at all, as DeLong freely admits:

But we – or at least I – have got significant components of the last four years wrong. Three things surprised me (and still do). The first is the failure of central banks to adopt a rule like nominal GDP targeting or its equivalent. Second, I expected wage inflation in the North Atlantic to fall even farther than it has – towards, even if not to, zero. Finally, the yield curve did not steepen sharply for the United States: federal funds rates at zero I expected, but 30-year US Treasury bonds at a nominal rate of 2.7% I did not.

Yet we are supposed to take seriously the widely proposed solution? Throw money at the problem, and assume that just by raising aggregate demand all the other problems will just go away?

As I wrote back in August 2011:

These troubles are non-monetary: military overspending, political and financial corruption, public indebtedness, withering infrastructure, oil dependence, deindustrialisation, the withered remains of multiple bubbles, bailout culture, systemic fragility, and so forth.

These problems won’t just go away — throwing money around may boost figures in the short term, but the underlying problems will remain.

I believe that the only real way out is to unleash the free market and the spirit of entrepreneurialism. And the only way to do that is to end corporate welfare, end the bailouts (let failed institutions fail), end American imperialism, and slash barriers to entry. Certainly, cleaning up the profligate financial sector would help too (perhaps mandatory gladiatorial sentences for financial crimes would help? No more paying £200 million for manipulating a $350 trillion market — fight a lion in the arena instead!), as would incentives to create the infrastructure people need, and move toward energy independence, green energy and reindustrialisation.

Then again, I suppose there is a silver lining to this cloud. The wronger the establishment are in the long run, the more people will look for new economic horizons.