8.0 – 8.1 Adapting to Expansion

THE aftermath of the 2007-08 financial crisis ought to have been a moment of triumph for economics. Lessons learned from the 1930s prevented the collapse of global finance and trade, and resulted in a downturn far shorter and less severe than the Depression. But even as the policy remedies were helpful, the crisis exposed the economic profession’s continued ignorance of the business cycle. That is bad news not just for the discipline, but for everyone.1“Economists still lack a proper understanding of business cycles,” The Economist (April 19, 2018), www.economist.com/finance-and-economics/2018/04/19/economists-still-lack-a-proper-understanding-of-business-cycles. Accessed May 25, 2019.

The Economist, April 19, 2018

In this section, we bring money back into the discussion.

What is an economy for? Is it not for providing a standard of living? And so, in the new economics, the usual profit motive is reversed. We ask not how to make money but what to do with money to support an economy.

Of course, by ‘economy’ we are not referring to a model or to an average but to what is happening in neighborhoods and cities, locally and globally. And so, a question arises: What monetary strategies will help ensure that a double-surge2See section 7.3, note 30. succeeds?

[D]uring a surplus expansion more money will be available for spending on basic goods and services as the production of surplus goods takes off. But … when the surplus expansion is underway purchasing increasing amounts of basic goods would prematurely curtail the surplus expansion. There would be less money available to finance the surplus expansion because money would be spent on basic goods. If people used their wages to buy basic goods during a surplus expansion the prices of basic goods would rise, and more and more money would be diverted from the surplus expansion to the basic circuit. The consequences would be inflation and the surplus expansion coming to a premature end, i.e., ending before it reached its peak of production.3Bruce Anderson, “Foreign Trade in the Light of Circulation Analysis,” Journal of Macrodynamic Analysis 1 (2001): 23. http://www.mun.ca/jmda/vol1/foreign.pdf.

Adding to the problem, there may be times when personal incomes will need to be increased and perhaps also times when they will need to be decreased.

In contemporary economies, there is no place for the idea of controlling either purchasing patterns or wages depending on phases of an economy. But, the need for such variations goes along with the double-surge structure.

Adjusting personal incomes in the surplus part of the economy means adjusting cross-over payments i2. What if such adjustments do not precisely align with a surge? To what extent is an economy sensitive to adjustments in i2? If an economy is in equilibrium and wages i2 are adjusted upward or downward, will there be problematic fluctuations in the economy?

In section 8.2, we point to a kind of stability of an economy, when there are modest changes to wages i2.  This also sheds light on debates about the pros and cons of raising minimum wages.

Section 8.3 provides a beginning toward understanding the trade cycle.

While booms and slumps do not belong in the limiting ideal of our normative economics – their avoidance is the major challenge envisaged by this analysis – obsolescence and innovative replacement certainly do. They were a major concern of the economist Joseph Schumpeter, but they are also factors intended by Lonergan’s analysis. How they are made explicit in that analysis is a complex question. Like the question of planetary disturbances, it is best left out of an introductory text.4Economics for Everyone, 3rd ed., 46. See also note 22 on that same page.

However, we do provide some evidence of the fact that the trade cycle is not a necessary feature of economic activity but a maladaptation to the productive process. We will need to include international trade. That topic is treated in section 9.

 

8.1      Adapting to a Surge in Surplus Production in a Closed Economy

8.1.1   Main Aspects of the Strategy

For now, we suppose a “closed economy,” and also one that is neither primitive nor early agricultural. That is, we suppose that the economy is an exchange economy “of notable size, complexity, and development, with property, exchange, prices, supply and demand, money. … [F]or the moment, it will be convenient to suppose that foreign trade and foreign payments do not exist.”5CWL21, 246. We discuss foreign trade in section 9.

We also suppose that, for a time, the economy has been in equilibrium6We mean the kind of equilibrium that occurs, a static phase where for a time basic and surplus are more or less constant and in sync. See section 7.3 and section 6. but that now a surge in surplus production is underway.7As discussed in section 7, a catalyst for such may be the introduction of some new technology. Note also that while a surge may be regional and short-term, as history shows, a surplus surge can result in large-scale and long-term expansion at all levels. See section 7.3. A full description of all main elements in the process would go well beyond an introductory-level presentation. Among other things, it would need to include relative prices, price spreads and patterns in prices and incomes.8See, e.g., CWL21, chs. 11 and 12 (175-183, and 184 – 195). In this section, we look to just a few elements of the process, to obtain some first indications of basic aspects of the problem.

In sections 7.2 and 7.3, we worked out that there is the possibility of a normatively structured double-surge in production. When circumstances allow, a long-term surge in surplus production can lead to a surge in basic production, and so changes also in the standard of living.9It may help to imagine a city like Leeds, England, circa 1800. Approximately 25% of the regional population was in agriculture. The population of Leeds was close to 50,000 and that of the city’s rural districts was near 17,000. The Industrial Revolution was rapidly changing the city’s infrastructure, agriculture, local industry, regional demographics and standard of living.

Since we are assuming the economy is an “exchange economy,”10See note 4. our inquiry now is into monetary strategies needed to support a double-surge11Remember that while the double-surge structure is normative, what we describe is idealized, in order to understand the dynamics. See concluding paragraphs of section 7.3; as well as CWL21: “phases may very well be simultaneous” (CWL21, 25). Accelerations and decelerations can occur simultaneously and be in different phases, at all levels, in both basic and surplus production, locally, regionally and globally.. You will notice that we are not asking about “profit.”12We will say something about the “profit motive” in section 8.3. Here, we ask a structural or “mechanical” question.

It will help to keep figure 3.4 in mind, together with figures 7.2-7.5. For the convenience of the reader, we reproduce figure 3.4 here, as figure 8.1:

Figure 8.1: (Same as figure 3.4). Five functions; two types of: income, i1 and i2; maintenance and more, m1 and m2; and expenditure d1 and d2. Basic demand is demand in the basic level. Surplus demand is for surplus goods and services at some level above the basic level. The redistributive function is for redistribution of goods, services and monies.

As happened in the Industrial Revolution, entrepreneurs may be given credit for new ideas. In this context, the first meaning of ‘credit’ is not in the financial sense, but in the sense of “We’ve got to give you credit for a great idea!” But, in an exchange economy, capital financing is needed in order to follow through with “the great idea.” It is needed to build new factories, dig canals, make railroads and bridges, provide new industrial and public infrastructure and, generally, for setting up new surplus and basic supply chains and getting new production going13Aggregate large-scale surplus expansion tends to need aggregate large-scale financial backing. In the Industrial revolution, financial backing was obtained from many sources: “As the revolution grew and more opportunities presented themselves, there was a demand for more capital. While technology costs were coming down, the infrastructure demands of large factories or canals and railways were high, and most industrial businesses needed funds to start up and get started. Entrepreneurs had several sources of finance. The domestic system, when it was still in operation, allowed for capital to be raised as it had no infrastructure costs and you could reduce or expand your workforce rapidly. Merchants provided some circulated capital, as did aristocrats, who had money from land and estates and were keen to make more money by assisting others. They could provide land, capital, and infrastructure. Banks could provide short-term loans, but have been accused of holding the industry back by the legislation on liability and joint-stock. Families could provide money, and were always a trusted source, as here the Quakers, who funded key entrepreneurs like the Darbys (who pushed forward Iron production)” (Robert Wilde, “The Development of Banking in the Industrial Revolution,” ThoughtCo., January 11, 2019, https://www.thoughtco.com/development-of-banking-the-industrial-revolution-1221645. Accessed April 15, 2019)..

In section 7, we described how an increase in surplus production rates can accelerate basic production rates. Now, we are supposing that all of this is occurring in an exchange economy. In order for, say, farmers in food production to buy new tractors, and for others in basic production to take advantage of new surplus goods and services, they will need to be able to pay for them.14As often happens, those in basic production also need loans. We will get back to this point below. Below, we will say something about strategies for ensuring that that happens.

As the expansion continues, then, basic production begins to hit the streets.

Or does it? Again, there is a requirement similar to the one just mentioned. In order for new types and quantities of basic goods and services to enter the standard of living, people will need to have enough money to pay for those new goods and services. Otherwise, before long, new basic production will not be adequately funded. If that were to happen, basic production would soon not be able to buy the new surplus goods and services on offer. Eventually, then, the new surplus production also would be underfunded.

Put another way, loans and other redistributive strategies notwithstanding, the double-surge brings the financial load of the transition first to those who would buy surplus and basic goods and services, but ultimately to those would buy newly available basic goods and services. If people do not have enough money to pay for new basic goods and services, the entire double-surge will either slow down or collapse.

This is a potential difficulty that can be handled in the two-flow structure. Prior to the surplus surge, the economy was near equilibrium.15Allowing for seasonal variations and typical turn-over periods, the surplus and basic economies were not changing much, prices and personal incomes were generally set at levels that allowed people to purchase basic goods and services emerging from basic production, at more or less steady rates. Now, though, we are envisaging a surge pattern that eventually leads to accelerations in basic production rates.

Why is there a potential difficulty? With prices, personal incomes and payment rates based on a previous equilibrium, people may not have enough money to pay for newly available types, quantities of basic goods and services.16And so, in particular, ignoring special cases where someone might have saved a lot of money for a rainy day. We are talking about monies in circulation in the economy, not monies that might here and there have been pulled out of the economy and set aside for other purposes. Why not? It is because the newly available goods and services are not accounted for in the previous equilibrium. Adding to the problem is that in early stages of such a surge, new basic goods and services are not yet readily available. This can affect prices.17See note 7.

Why is the problem solvable? As indicated in figure 8.1, there are two main sources of personal income, i1 and i2. In early stages of basic acceleration, surplus firms tend to have already increasing financial reserves. Keeping in mind there will be payments for covering anticipated maintenance and replacement, surplus firms could, if needed, increase i2 so that employees in surplus production can pay for increasingly available new types, quantities and prices of basic goods and services.

Assuming that such adjustments to incomes i2 are made, new types and quantities of basic goods and services can be purchased and will increasingly enter the standard of living. By those purchases, monies flow into the basic economy. Those monies contribute to covering new expenses in basic production as well as (possibly amortized) debts incurred by firms involved in the new quantities and types of basic production. Note also that thanks to monies entering basic production, if needed, increasing i1 also soon becomes possible. That possibility is normative. Otherwise, the community would be limiting advantages of a double-surge to employees who happen to be in surplus production. Attempting to exclude employees in basic production also would be impractical. As we have described, businesses and employees can operate in both basic and (various levels of) surplus production. The level and stage of production (of, for example, a roll of stainless steel) is usually determined long after production.18Statistical results from prior production periods could go into wage formulas, production ratios are not predictable and adjustments might need to be made in concrete situations.  On what basis, then, would an employee be given one wage for one roll of steel and another wage for another roll, for the same work at the same smelter?

We are imagining a large-scale long-term double-surge, over decades or more, that is, long enough for basic production to eventually level off toward new maxima. What were, for a time, new types of surplus goods and services continue to be produced and sold, but surplus production is increasingly for maintenance and replacement, and prices19See caveat in first paragraph of section 8.2. (for what previously were new basic goods and services) tend to normalize. Monies that during early stages of the expansion might have been needed to increase i2 (and then also i1) can again be redirected, now to meet ongoing maintenance and replacement costs for basic production.

This pattern of monies circulating through the two-flow structure would be anticipated in debt structures for large-scale surplus projects. As monies return to the surplus economy, longer-term surplus debts can then also be gradually paid off. The whole economy will be reaching a new equilibrium with, if necessary, new wages, all to support a new standard of living.

 

8.1.2  Resistance to the Strategy

The strategy described here goes against the grain of present-day norms which include, for instance, the commoditization of monies and the goal of maximizing profit.

A novel aspect of the strategy just described will be adjusting wages i2 and i1 as needed to support the productive process. But, that some kind of oscillation in wages will often be needed can be anticipated from the normative structure of the productive process. The full surge structure is a double-surge. And so it will be a matter of providing fuel (money) as needed to a massive two-flow “machine.” If wages (and prices) are more or less synchronized with surge patterns in the productive process, changes in wages won’t cause any hardship. Indeed, such adjustments will be in order to avoid hardship. For instance, increases in wages will be needed if supply tends to be low, demand is increasing and prices tend to be high20See note 18. ; and vice versa for decreasing wages21See note 18..

But, this approach to wages will be new. And so, as we have found, even if one is making progress in understanding the new economics, it may be objected that adjusting wages to meet patterns in the productive process is not part of contemporary practice and will hardly be tolerated. But, again, contemporary practice is based on fundamentally flawed economic models that need to be replaced. Over the last two centuries and more, those flawed models have been contributing to deepening economic, ecological and cultural crises on a global scale. Is it reasonable to appeal to models that have failed so miserably?

Providing details will be the work of economists on the ground22See caveat in first paragraph of section 8.2.. We are, however, drawing attention to an increasingly evident feature of normative economics: wages will need to be regularly adjusted in ways that help an economy move though a double-surge, from one equilibrium and standard of living to a new equilibrium and new standard of living.

The sketch that we have given is superficial and elementary23It is “concretely speculative” in the sense that it is based on normative relations. This is in contrast to the present-day ethos of modeling.. And, the new economics has not yet been implemented. So, we cannot draw attention to clear cut instances that confirm our results. Still, there is historical evidence. Recall the pattern of generally increasing wages that occurred throughout later stages of the Industrial Revolution.24F. W. Botham and E. H. Hunt, “Wages in Britain during the Industrial Revolution,” The Economic History Review, New Series, Vol. 40, No. 3 (Aug., 1987), 380-399. We are not commenting on living conditions (which often were terrible), nor are we suggesting that industrialists knew about two-flow economic structures. But industrialists did solve financial problems. And, as history shows, running through the second half of the Industrial Revolution was a general upward trend in wages that plateaued near the end of the 19th century.25W. London, “Did living standards improve during the Industrial Revolution? Rapid economic change had mixed effects for people,” The Economist, Economic History, September 13, 2013, https://www.economist.com/free-exchange/2013/09/13/did-living-standards-improve-during-the-industrial-revolution. Accessed April 15, 2019.

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