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4. Economic Malpractice

 

 

A group of “super-rich” constituting much less than 1% of the world’s population (that fraction is decreasing) control most of the world’s wealth (that fraction is increasing). Oxfam reported that 26 individuals are now as wealthy as half of all of humanity combined1https://beta.ctvnews.ca/national/world/2019/1/21/1_4262012.html.. In countries where there are statutory minimum wages (e.g., USA and Canada), those minimum wages often are not enough to meet the costs of living. All the while, solemn daily financial reports tell us about the rise and fall of stock market indices. When indices go up it is said that the economy is doing well and when indices go down, not well. In the meantime, income differentials continue to widen while more than half of the world’s population lives in poverty, and approximately one quarter lives in what the UN calls extreme poverty.

One doesn’t need to be an economist to know that something is wrong.

As you might expect the problem is complex. And, the emergence of economists competent in economics’ new standard model will be a future achievement. In the meantime, a few preliminary observations are possible.

 

4.1      The GDP

(Countries by GDP (PPP) per capita (Int$) in 2017 according to the IMF (Rossenne [CC BY-SA 4.0 (https://creativecommons.org/licenses/by-sa/4.0)], from Wikimedia Commons).

 

One obvious problem with the current standard model is using GDP as a measure of economic health. That there is a problem with using the GDP is not a new claim. Some leading economists, including the Nobel Laureate Joseph E. Stiglitz, are now acknowledging that the GDP is not a good way to measure how well an economy is performing2Joseph E. Stiglitz, https://www.project-syndicate.org/commentary/new-metrics-of-wellbeing-not-just-gdp-by-joseph-e-stiglitz-2018-12. His observations, however, fall short of the mark. Having worked through sections 1-3, you can probably now see that Stiglitz’s focus does not get near fundamental correlations and structural issues.. As examples clearly show, a growing GDP tells us nothing about sustainability of an economy, how individuals in a country are managing, what monies are being used for, who is receiving or is in control of monies in the economy.

With the basic-surplus structure in mind3See Section 3.2., questions can be more directed. Are goods and services being provided at rates that support a decent standard of living for particular communities? Are sufficient monies being directed to surplus production and, if needed, surplus expansion? Are wages sufficient to pay for basic goods and services? If production capacity is sufficient but personal wages remain too low then a community risks social and economic crisis. Is an economic surge on the horizon, e.g., locally, regionally or globally?4As has been occurring regularly in history, a surge can start in the surplus part of the productive process, from innovation or some new technology. In the primitive economy, the invention of baskets (and other tools) lifted their way of life. Less time needed for basic survival allowed for the development of early cultures. Later examples include the invention of the plough and the emergence of the plough culture, the invention of the steam engine and later the airplane. It is crucial to think through details. In modern times, follow-through from innovation has been undermined by flawed economic models. For instance, the airplane has enormous potential for improving human lives and cultures. But the technology has also been used as a weapon. Are financial institutions operating in ways that are mindful of and supportive of local and global needs (of both flows) of the productive process? Are transaction rates between the five functions of the basic and surplus structure suitably synchronized, locally, regionally, globally, in the short run, or in long run?

Such questions help further highlight the fact that there are two main parts of the productive process (basic and surplus) and that the “economy performing well” means that they are working well together. The GDP, however, is merely a sum of expenditures, static and blind to the double structure operative in all economies. It is a monetary sum corresponding to all final goods and services. The GDP reveals nothing about either the internal coherence or sustainability of methods and rates of production and provision of basic and surplus goods and services.

 

4.2 The Stock Market

 

To help shed light on the problem, imagine the following scenario involving ten real estate investors, after which we will say something about actual stock markets.

A person living in Owen Sound buys a home from Clancy Builders5See Section 3., for $400,000. As described in Section 3, that money helps cover the cost of building supplies, contributes to personal incomes, helps pay for operating costs of the business, and contributes to savings for anticipated maintenance costs, as well as possible expansion of the business.

The home buyer gets a mortgage with TD Canada Trust. (Recall that the home buyer is the owner of record, but the bank is the lien holder.) Meanwhile, the sale of the new home catches the interest of ten real estate investors from the city of Toronto. One of these investors makes an offer to the bank to become primary lien holder for the home, for $420,000.00. The bank accepts the offer because that way it will make a profit of $20,000.00.6As an exercise, the reader might find it helpful to identify roles of real estate agents in the productive process.

The investor takes over the lien of the home. It is said to be a “financial investment.” In what way is it an “investment”? There is a normative sense in which investment contributes to the productive process.7Clancy Builders might be doing so well that it needs to hire new people and expand its base of operations. Perhaps the business needs new premises. In such cases, Clancy Builders might need an advance, financial backing for the expansion, the results of which will be the capacity to produce more homes. In other words, that kind of investment contributes to the productive process. However, for the real estate investor in the story the meaning of “investment” is radically different.  They speculate that a second investor will eventually offer to take over the lien for a still higher price, say, $440,000.00. But why would the second investor do that? It is for the same reason as the first. In this game, one wins by anticipating successfully that one of the other ten investors will, before too long, put in a bid to take over the lien at a higher price. There might, however, be a “last investor standing” who takes over the lien at a price of say, $500,000.00, beyond which none of the other investors are willing to go. In that case, $400,000.00 will be covered by the original mortgage, monies incoming from the owner of record who is living in the home. By playing the game, the “last investor” is left with a debt of $100,000.00.8We are ignoring transaction fees and other financial service fees, as well as possible fluctuations in economies.

All is not lost. Another investor may be willing to take over the lien at a lower price of $480,000.00. The investor who bought in at $500,000.00 will be able to reduce their debt from $100,000.00 to $20,000.00. Moreover, that debt of $20,000.00 could be further offset, or perhaps eliminated, by monies won from a different bet, a side-bet with other investors to the effect that, before too long, some investor will come along who is willing to take over the lien, so long as the selling price is reduced by at least $20,000.00. In other words, the investors also can make money by betting on the selling price dropping.

In this speculative game of chance, the goal is to end up with more money than you started with. But, is it harmless?

To begin to see the harm being done, it is enough to look at what happens when the first investor takes over the lien from the bank for $420,000.00. The mortgage structure for the owner of record is still in place. By taking over the lien at the higher price, the investor has taken on a debt of (present-value) $20,000.00. At the same time, the bank has added $20,000 to its financial capital. How will the investor cover the $20,000.00 debt? The investor needs to obtain financing by, for example, drawing from a cash account or some further line of credit.

Notice that the profit for the bank, the investor’s debt and the drawing of monies to cover that debt are all established independently of the productive process. Nothing new is produced. And, neither the investor nor the bank have contributed to the process. The debts, payments and lines of credit are introduced as consequences of decisions indifferent to the needs of the process. Yet this game of chance is financed with monies taken from the financial resources generated by the process.

The investors are not going to live in Owen Sound, nor maintain the home. In the game, change of ownership occurs on the mood and whim of the “investors”. Most of the winnings enter neither the Owen Sound economy nor the Toronto economy. This is not to say that the investors don’t spend some of their winnings. But that spending is a fraction of their take. The main goal of the speculative money game is to come out ahead and to keep coming out ahead.

The reader may wish to look more closely into what happens in today’s stock markets. When are trades made? Why are they made? What functions do they serve? Whom do they serve? The real estate scenario gives a few pointers for understanding second-hand trade in the redistributive zone. Instead of a single mortgage, there are, for example, mortgage funds (although that is just one of many types of investment instrument). Instead of ten investors, there are large groups of shareholders making billions of trades per day. Instead of debts and credits of a few hundred thousand dollars, the Wall Street Stock Exchange (for example) trades more than $150 billion per day.

There are normative operations such as when investment banks raise venture capital. What has become evident however is that, in its main operations, Wall Street is parasitic to the productive process. Its activities are enormously complex, but the primary goal is simple enough, to come out ahead in the money game. In a bull market, players push prices upward. In a bear market, prices keep dropping. Either way, monies can be made.9By shorting, one wins by successfully anticipating lower selling prices (https://www.investopedia.com/terms/s/short.asp). Stock market rules include some restrictions. For instance, it is illegal to “game the game” by “insider trading.” Still, insider trading is an ongoing problem (Thomas Franck, “Insider trading is still rampant on Wall Street, two new studies suggest,” CNBC Markets, (7:21 AM ET Wed, 14 Feb 2018, updated 8:27 AM ET Wed, 14 Feb 2018), https://www.cnbc.com/2018/02/14/insider-trading-is-still-rampant-on-wall-street-two-news-studies-suggest.html.

Wins and losses in the game of speculation, however, artificially introduce massive flows of debts and credits that impact the entire economy. In fact, large percentages are returned to the betting ring for more of the same, or are removed from the game and deposited in protected accounts. Losses are covered by establishing new lines of credit.10“This economic system is one in which the financial markets exist primarily to serve themselves. In this system, capital is raised for the purpose of creating, selling and trading securities and derivative securities that do not finance industry but rather trade within markets that exist as an economy unto themselves. At the same time, those markets have profound and adverse effects on the real economy. This new economic system is Financialism” (Lawrence E. Mitchell, (2011). “Financialism,” in C. Williams & P. Zumbansen (Eds.), The Embedded Firm: Corporate Governance, Labor, and Finance Capitalism (pp. 42-59). Cambridge: Cambridge University Press. doi:10.1017/CBO9780511794537.003).

Growing inequity is a long-term consequence of how the game is played. In the short-term, market activities can be devastating to economies. Within the redistributive zone, there are normal loan structures, mortgages, financing, banking needs, wages, capital investments, retirement incomes, for both basic and surplus parts of the productive process. When market indices (average selling prices) plummet, through no fault of their own, among other consequences, businesses can go bankrupt, employees can be let go, retirees whose savings are in mutual funds can find themselves destitute. As we have seen more than once in recent history, in a prolonged decline, the entire financial system can come near to collapse.

We will need economists competent working in the basic-surplus structure. But that will not be enough. The structure is present in all cases, from primitive to modern economies, whether steady, surging, in expansion, contraction, or under the control of a dictator. We need to bring all of this together, the structural and cultural parts of the problem. That will be the topic for the next and final section of our introduction.

References   [ + ]

2 Comments

  1. Artfulhousing on February 24, 2019 at 5:52 am

    Hi John/Terry

    Above you refer to the ‘super-rich’ and extreme poverty.

    Your context is a concern about the current economics and so an example of its failure.

    But is the phenomenon of the ‘super-rich’ and extreme poverty, economic issues or political ones? They appear to be economic one because they involve money and wealth. But does that make them economic issues? What is involved here is the distribution of wealth or a standard of living, not its creation. So, in my view, they are political issues where political issues are about the ways in which we reach agreements – here, about how wealth and income will be distributed.

    I’m trying to think this through because one of the things Lonergan is also trying to do (and why his economic theory is unique) is to distinguish clearly what is economic from what is political.

    • Terrance on February 26, 2019 at 2:47 pm

      Hi “Artfulhousing,”

      Thanks for writing. Your questions are great and raise important issues.

      “But is the phenomenon of the ‘super-rich’ and extreme poverty, economic issues or political ones?”

      Observing standard practice it is, of course, both. That brings us to the edge of “the greatest of problems,” the structure of history, as it happens, taken up by another one of Lonergan’s major breakthroughs. But, that goes beyond the immediate context of our Very Brief Introduction.

      You ask about our context. The immediate context is described in the Preface. Sections 1-3, are on the (dynamic) double-structure of economies. Section 4 is on current economic malpractice. The Preface-statement regarding Section 5 relates to your broader questions and the problem of history: “Reaching a correct understanding of economic processes is only part of the problem. The dynamical structures revealed by the new theory are present in any economy, whether it is one that is controlled by a misanthropic dictator or is an economy that is more or less steadily providing goods and services needed to support some approximation to a reasonable standard of living. So, in the fifth section, “The Culture & The Economy,” we touch on the larger context which includes culture and economics, recovery and the possibility of (ongoing) progress. In a short section at the end of a brief introduction, we cannot go into any details. We describe something of the context and provide references for further reading.”

      The problem of “distribution of wealth” and “standard of living” are advanced and complex. Again, there is no attempt to speak on those issues in the Very Brief Introduction to the new standard model.

      Something that we can point to here is the difficulty of the problem of wealth distribution. There will be the problem of working out flow-mechanics of “sensible wealth-distribution,” in situations. Think of a loose parallel, a different distribution problem, the problem of water distribution in a city. Design engineers need to know a lot of applied fluid dynamics, and know it inside-out, in order to design, trouble-shoot, maintain and repair, and extend water systems to new neighborhoods. For coastal cities, also potentially included would be flood control canal systems, the design and construction of ports that work with changing tides and prevailing winds. It will be very much far more challenging to provide detailed practical counsel for flows in economics, the general structure of which is heuristically indicated by Lonergan’s diagram (a version of which we give in our Section 3.2). The “practical economist [will be] as familiar a professional figure as the doctor, the lawyer, or the engineer” (Section 5.3, note 5; source is CWL21,37).

      That will be some way into the “future.” In the meantime, there are a number of introductory writings already available. General summaries of “Lonergan’s economics” won’t do the trick, no more than talking generally about fluid dynamics will lead one to be able to solve problems in fluid dynamics. A few of the already available introductory works are listed in our bibliography. In order to get a beginner’s heuristics of global economics, one needs to aim for being up on at least the first four chapters of McShane’s Economics for Everyone. The fifth chapter there extends the context and also goes to the larger questions you ask about, and so Lonergan’s later discovery of functional collaboration. [Note that McShane has a new pedagogical series in economics, some of which is already available on his website, http://www.philipmcshane.org/ecornomics/.%5D The family bakery story in E for E is a great place to start, so to be able to identify different types and fractions of payment, payouts, incomes and expenditures in that family business.] Our forthcoming Economics for the Positive Anthropocene will have additional examples. Our book will not be a textbook, but will provide filaments toward future textbooks. As McShane writes on p. xxxi of the Preface to CWL 21, there need to be “500-page texts of empirically rich, locally oriented, normatively focused, non-truncated writing.”

      A point worth pausing over: “in my view.” For Benton and Quinn (and others), part of our “shared views” is perhaps less our views than it is our more or less compatible and developing orientations: How will our views, and anyone’s view, help and grow in being able to help? How will our growing views help us, globally, move forward out of the present negative Anthropocene Age? What, in fact, are we to do? Lonergan’s later breakthrough: There needs to be cyclic collaboration. A helpful article (also given in the Bibliography of A Very Brief Introduction) is: McShane, Philip. “Sixes and Sevens: The Need for Cyclic Thinking,” December 2018, http://www.philipmcshane.org/website-articles/. Regarding the Anthropocene, you might have a look at https://www.anthropositivecene.org/.

      Thanks again for the questions and comments. Very much appreciated.

      Terry and John.

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