Fixing the Root Bug

The Simple Hack for a Growth-Independent, Fair and Sustainable Market Economy 2.0

Why getting rid of “jobs” (a human being as the unit of labor), the zero lower bound of interest rates and private monopolies – most notably that of untaxed land ownership – would solve most of our economic, social and environmental challenges and how it could be done easily and feasibly.

Tuure Parkkinen

COMPLIMENTARY SAMPLE Fixing the Root Bug: The Simple Hack for a Growth-Independent, Fair and Sustainable Market Economy 2.0

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Cover design and graphs: Matias Piiparinen. Layout design and pagination: Tuukka Pykäläinen. For my goddaughter Tiitu who has a lot less to unlearn than most of us. PHOTO: HEINI LINDVALL

About the author Tuure Parkkinen is an institutional entrepreneur, a philosophical economic engineer and a generalist passionate about asking relevant questions. He has studied industrial engineering and strategic management at Aalto University, successfully turned around an HR company and seen many industries and types of work. At the time of publishing, he is based in Helsinki, Finland.

For requests and comments related to this book, e-mail: [email protected] | 5 Table of Contents

Chapters included in this sample are marked green. PREFACE ...... 13 ACKNOWLEDGEMENTS...... 15 INTRODUCTION AND OVERVIEW ...... 17 VIDEO LINKS ...... 27 1 A BRIEF INTRODUCTION TO ECONOMICS...... 31 1.1 VALUE, PRODUCTION AND MARKETS...... 32 1.1.1 The Division of Labor – Cooperation and Sharing Information: The Philosopher’s Stones of Mankind’s Progress...... 32 1.1.2 Societal Structures Facilitate Cooperation – Economic Systems Direct Resources...... 35 1.1.3 Value Is Subjective and Perceived – Rationality Is Largely an Illusion...... 38 Sidenote Box 113A: Objective Value Theories and Morality...... 47 1.1.4 Production Is for Consumption, i.e. Appreciation – ‘Productivity’ Has Many Units...... 49 1.1.5 We Need a Market Economy Because of the Limitedness of Understanding and Empathy...... 54 1.1.6 The ‘Market Forces’ – How Prices Balance Supply and Demand...... 57 1.1.7 Ownership as a Bundle of Rights...... 66 Sidenote Box 117A: Ownership as an Idea, Feeling, Relationship or Extension of the Self?...... 67 1.1.8 Labor and Capital (and Land?) – The Factors of Production ...... 70 Sidenote Box 118A: Keynes’s Liquidity Preference Theory is Outdated ...... 76 Sidenote Box 118B: The Trouble with Measuring Capital Financially: ‘The Cambridge Capital Controversies’ and Piketty’s ‘Capital’ .81 Sidenote Box 118C: Marx’s ‘Capital’ Is Closer to Financial Capital ...... 85 Sidenote Box 118D: Does Capital Provide Economic Security and Freedom? ...... 86 1.1.9 Companies as Competing Organizational Forms (Because Institutions Suck at Suicide) – ‘Pro-Business’ Is Not ‘Pro-Market’ ...... 89 Sidenote Box 119A: Memetic Evolution Outpaces Genetic Evolution...... 95 1.1.10 Companies as Contract Bundles – Financial Assets Allocate Risks...... 98 1.1.11 The Fundamental Imperfections of a ‘Free Market’ – Externalities and the Limitedness of Land...... 102 1.2 CREDIT, MONEY AND BANKING...... 106 1.2.1 Money Facilitates Trade Through Liquidity and Broad Acceptability ...... 106 1.2.2 Credit – Delayed Payment Granting Chronological Flexibility...... 109 1.2.3 Money as Credit – Real Wealth vs. Virtual/Fiduciary Wealth ...... 110 1.2.4 The Difference between Origin, Nature and Purpose (of Money) – ‘Metallism’ vs. ‘Chartalism’...... 116 1.2.5 The Two Denominators of Currencies and Other Financial Instruments: the Reference Resource(s) and the Collateral...... 118 Sidenote Box 125A: The Currency, the Accounting System and the Payment Interface – What We Mean by ‘Types of Money’...... 130 1.2.6 Banking: Accounting for Debts and Credits and Pricing Risks – There Is No ‘Fractional Reserve’ ...... 131 Sidenote Box 126A: The Misleading Expression That ‘Banks Lend Other People’s Money’...... 136 1.2.7 Banks Need to Be Private Because Risk Has a Market Price...... 138 1.2.8 The Supply of Money Is Infinitely Interest-Rate-Elastic – The Money Supply Is Endogenous ...... 140 Sidenote Box 128A: Additional Reading on Money, Credit and Banking...... 144 1.3 INVESTMENT, SAVING AND ECONOMIC GROWTH...... 145 1.3.1 Economic Growth Is the Increase in Produced and Traded Value – The Many Meanings of ‘Wealth’ ...... 145 1.3.2 In a Closed Economy, Net Monetary Wealth Is Zero – Total Real Wealth Depends on Future Consumption and Capital Intensity (and Monopolies)...... 148 1.3.3 The Circular Flow of Income – Consumption, Saving and Investing...... 152 6 |

1.3.4 Foreign Trade: Current Accounts Are Also a Zero-Sum Game – Comparative Advantage vs. Absolute Advantage...... 155 1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And Has Little to Do with the Quantity of Money...... 158 2 COMPARING OBJECTIVES AND MEANS – DIFFERENT ECONOMIC SCHOOLS AND THE ROOT BUG HYPOTHESIS...... 165 2.1 NORMATIVE PRINCIPLES – WHAT DO WE WANT FROM AN ECONOMIC SYSTEM?...... 167 2.1.1 The Libertarian Maxim of Freedom and the Paradox of Choice...... 171 2.1.2 Life, Diversity and Sustainability as Normative Maxims...... 174 2.1.3 Anarchist Communism: ‘Everyone According to His Ability, to Everyone According to His Needs’...... 175 2.1.4 Utilitarianism and Happiness Politics/Economics – Does Measuring Happiness Make Sense?...... 177 Sidenote Box 214A: The Neoclassical Growth Model and Utility...... 180 2.1.5 ‘Rawlsianism’ – Justice Through the Veil of Ignorance...... 181 2.1.6 Conclusions – How about a Game Design Approach?...... 186 2.2 DIFFERENT ECONOMIC SCHOOLS AND THEIR SOLUTION SUGGESTIONS...... 191 2.2.1 Overview of the Solutions and Emphases of Different Schools...... 191 2.2.2 Market-Dictated, ‘Sound’ Commodity Money – Austrian perspectives...... 194 2.2.2.1 A Single Precious-Metal-Standardized Currency...... 196 Sidenote Box 2221A: What If Scrooge Really Had a Money Bin?...... 201 2.2.2.2 The Inefficiency of Competing Currencies...... 202 2.2.3 ‘Socialist’ Solutions – Money for Free (i.e. Credit for Nothing)...... 206 2.2.3.1 Collective Bargaining – ‘Blackmail Is Solidarity’...... 207 2.2.3.2 Restricting Supply – ‘Stay out of Our Territory’...... 209 2.2.3.3 Wage Regulation by the Government – All or Nothing...... 210 2.2.3.4 Social Support and Other Transfer Payments – Robin Hood Politics...... 212 2.2.3.5 The Planned or ‘Resource-Based’ Economy – ‘We Know What We Need’...... 213 2.2.3.6 Democratic or ‘Full’ Money – ‘Power to the People from the Banks’...... 215 2.2.3.7 Participatory Economics – ‘Let’s All Decide on Things Together’...... 220 2.2.4 Ecological Economics – Putting Economics into the Eco-Box...... 223 2.2.5 Mainstream Economic Solutions – Increase Spending or Compete Harder...... 226 2.2.5.1 Keynesian Fiscal Stimulus – It’s the Government’s Job to Invest Stably...... 226 2.2.5.2 Monetary Policy – You Can Pretend It’s about the Money Supply ...... 229 Sidenote Box 2252A: The Actual Policy Tools...... 237 Sidenote Box 2252B: Is Monetary Policy Distorting the Market? – The Dollar Is Not a Commodity, but a Unit of Account for Credit Relations...... 238 2.2.5.3 Competitiveness Politics – Just Indebt Other Nations Further...... 239 2.2.6 Post-Keynesian Solutions – Ignore Hyperinflation Risks and Guarantee Jobs...... 242 2.3 THE SOLUTION OF THE ROOT BUG HYPOTHESIS ...... 247 2.3.1 The Job Creation Paradigm – Why Are We Trying to Make More Work?! ...... 247 2.3.2 The Overlooked Option – Increase Correlation of Earning Opportunities with People’s Willingness to Spend and Invest ...... 251 2.3.3 The Paralyzing Assumption: ‘Work Sharing = Work Time Restrictions’ ...... 254 2.3.4 Supply and Demand Could Best Match Earning Opportunities – Just Fix the Imperfections ...... 256 2.3.5 Structure of the Root Bug Hypothesis ...... 257 3 WHY WE NEED TO FIX THE ROOT BUG...... 261 3.1 ECONOMIC STABILITY AND PROSPERITY...... 265 3.1.1 Economic Instability, Cyclicity, ‘Keynesian’ Unemployment and Growth Dependence...... 265 Sidenote Box 311A: Other Theories of Cyclicity: ‘Debt Deflation’, ABCT and Real Estate Pull...... 270 3.1.2 Other Scapegoats for the Mystical Growth Dependence...... 275 | 7

3.1.2.1 The Perpetual Debt Hoax, a.k.a. The Fallacy of Unpayable Interest...... 276 3.1.2.2 ‘Companies Have to Grow or Die’...... 277 3.1.2.3 ‘Lack of Growth Increases Inequality’ – Piketty’s ‘r>g Dilemma’ Solved...... 279 3.1.2.4 The Welfare State Arguments – Living Standards, Jobs and Tax Revenues...... 281 3.1.3 Structural, Friction and Classical Unemployment, NAIRU and Hysteresis – Is 5 % Unemployment Really Necessary?...... 282 3.1.4 Private Credit Crises, Mass Defaults and Overleverage ...... 287 3.1.5 Too Big to Fail: The Casino Economy, ‘Financialization’ and Irresponsible Risks in Banking...... 289 3.1.6 Sovereign Debt Crises...... 295 3.1.6.1 Constantly Increasing Public Debt – A Taxation Model Based on Monopoly Profits, Charging for Services and Auctioning Resources...... 295 Sidenote Box 3161A: Who Provides the Money? The Units, the Contracts and the Transactions...... 298 Sidenote Box 3161B: Tax Avoidance and the Tax Haven Problem...... 300 3.1.6.2 Sticky Trade Imbalances...... 303 3.1.6.3 The U.S. Case – Chronic Overvaluation of the Global Reserve Currency...... 304 3.1.7 Incentive Trap for Grassroots-Level Innovation...... 306 3.1.8 Public Sector Inefficiency...... 307 3.2 LOCAL SOCIAL ISSUES...... 309 3.2.1 Maximal Economic Security with Maximal Flexibility – Flexicurity and Antifragility ...... 309 3.2.2 Unfair Income Differences and Limits to Social Mobility...... 313 Sidenote Box 322A: The Causality Conundrum of ‘Productivity’: Even the ‘Marginal Productivity Theory’ Accounts for Scarcity....315 Sidenote Box 322B: The Special Case of CEO Pay – Efficiency Wages and the Corrupting Nature of Power...... 322 3.2.3 Unionization and Strikes...... 327 3.2.4 Depression, Stress, Addictions and Fitting Work Life with Family Life...... 333 3.2.5 The Demographic Challenge of the Aging Population – Retirement as We Know It Is Outdated...... 337 Sidenote Box 325A: Are Retirement Insurances and Pension Saving Schemes or Funds Necessary? ...... 339 3.2.6 Effects on Crime...... 342 3.2.7 Encouraging and Facilitating Entrepreneurship and Creative Productivity...... 343 3.3 GLOBAL SOCIAL ISSUES...... 346 3.3.1 Solving Poverty for Good – Ending the Economy War...... 346 Sidenote Box 331A: Do Developing Countries Need Protectionist Measures to Get out of Poverty?...... 349 3.3.2 Famines and Overpopulation...... 352 Sidenote Box 332A: A Note to Vegans: The EU (or the Federal U.S. government) Eats Meat for You...... 354 3.3.3 Continuing Rampage of Curable Diseases...... 356 3.3.4 Slave-Rate Wages, Inhumane Working Conditions and Child Labor...... 357 3.3.5 Resource Wars and Sustained Political Instability...... 359 3.4 ENVIRONMENTAL SUSTAINABILITY...... 362 3.4.1 Global Warming and Dependence on Fossil Fuels ...... 363 Sidenote Box 341A: The Government’s Role in Determining Standards – Can Harmful Path Dependence Be Prevented?...... 371 3.4.2 Biodiversity Deterioration, Destruction of Scarce Habitats, Pollution and Contamination...... 373 3.4.3 Unsustainable Waste Management...... 375 3.4.4 The Nuclear Power Case Example – Are All Risks Adequately Internalizable?...... 376 3.4.5 The Irrelevance of the ‘Degrowth vs. Decoupling’ Debate ...... 378 3.5 A COMPETITIVE OPTION AND DOMINATING STRATEGY...... 382 3.5.1 The Advantage of an Extremely Flexible Labor Market...... 383 3.5.2 The Advantage of Lower Transaction Taxes and Efficient Allocation of Limited Resources...... 384 3.5.3 The Advantage of the Possibility of Negative Interest Rates...... 385 8 |

4 HOW COULD THE ROOT BUG BE FIXED...... 389 4.1 MAXIMIZING FLEXIBILITY TO ELIMINATE LABOR MARKET MISMATCHES AND INCREASE ADAPTABILITY...... 391 4.1.1 A Broader Perspective of Labor Flexibility...... 392 4.1.1.1 Forms of Employment Flexibility...... 392 Sidenote Box 4111A: The German ‘Kurzarbeit’ Scheme – Closer, but No Cigar...... 393 4.1.1.2 Mid-Term Flexibility (1-5 Years’ Scale) Is What’s Relevant...... 395 4.1.1.3 The Objectives of Sharing Incentives: Maximize Individual Flexibility and Minimize Involuntary (Demand-Related) Layoffs...... 397 4.1.2 Making Sharing Work Profitable...... 399 4.1.2.1 Why Sharing Work Is Currently Not Profitable or Otherwise Viable...... 399 4.1.2.2 Removing Legal Barriers and Policy-Created Fixed Costs...... 401 4.1.2.3 Needed: a Pigovian Tax on the Externality Costs of Piling up Work on Fewer People...... 402 4.1.2.4 Continuously Progressive Payroll Taxes...... 406 4.1.2.5 Progressive Income Taxes vs. Progressive Payroll Taxes – What Does It Matter Whom the Tax Wedge Is Officially On? ...... 408 4.1.2.6 Avoiding Tax Avoidance through ‘Entreployees’...... 409 4.1.3 Other Sharing Incentives and Troubles with Them...... 411 4.1.3.1 Would a Citizen’s Salary Be Enough to Make Sharing Work Profitable?...... 411 4.1.3.2 Other Ways of Encouraging the Sharing of Work More Evenly?...... 412 4.1.3.3 Other Ways of Encouraging Giving Work to Investors, Spenders and the Indebted?...... 413 4.1.3.4 Layoff Penalties Are Hiring Costs – The ‘Paradox’ of Reduction Restrictions...... 414 4.1.4 Subsidize, Deacademize and Re-Game-Design Education to Maximize Flexibility, Mobility and Adaptability.416 Sidenote Box 414A: Additional Reading on New (and Old) Educational Ideas...... 423 Sidenote Box 414B: Your 11 Lives: The Shackles of ‘Professional Identity’ and the Teleological Fallacy in ‘Callingism’ and the Myth of Talent...... 424 4.1.5 Guaranteeing Security While Avoiding Welfare Bumming: Economic Freedom Need Not Be Free...... 427 Sidenote Box 415A: The Analogy of Substitute Players...... 428 4.1.6 Other Factors Increasing Flexibility and Mobility...... 433 4.1.6.1 Technological Advances Increasing Flexibility...... 433 4.1.6.2 Making Sharing Work Socially Acceptable...... 434 4.2 PREVENTING EXCESSIVE MONETARY SAVING – ALLOWING MONETARY POLICY TO BALANCE AGGREGATE SUPPLY AND DEMAND...... 437 4.2.1 Eliminating the Zero Lower Bound with a Higher Inflation Target or by Eliminating Cash ...... 437 4.2.1.1 The ZLB Is the Minimum Wage of Capital, Nominally Maintained by Physical Cash ...... 438 Sidenote Box 4211A: Silvio Gesell’s Theory of ‘Basic Interest’ and ‘Free-Money’ – The Same in the ‘Medium of Exchange’ Frame ... 441 4.2.1.2 A Higher Inflation Target Leaves ‘Room to Cut’ by ‘Taxing’ Cash ...... 443 Sidenote Box 4212A: The Fisher Equation and the ‘Hausse premium’ ...... 445 4.2.1.3 …Or Just Eliminate Physical Cash (That Decreasingly Liquid and Necessary Rubbish) ...... 446 4.2.1.4 Demurrage Is Unnecessarily Costly to Implement...... 448 Sidenote Box 4214A: Additional Reading on the Zero Lower Bound Issue...... 450 4.2.2 Setting a Fee on the Government Deposit Guarantee...... 451 4.2.3 Other Benefits of Higher Inflation or Negative Nominal Interest Rates...... 455 4.2.3.1 ‘Inflation Tax’ Revenues – Negative Interest on Government Debt...... 455 4.2.3.2 Underground Market and Grey Economy Mitigation...... 456 4.2.3.3 Wage Elasticity with Nominal Rigidities...... 457 4.2.3.4 Preventing Hoarding by Foreign Investors and Central Banks...... 457 4.2.3.5 More Long-Term-Oriented Investment and Company Management...... 457 4.2.3.6 A Balancing Effect on Current Account Balances and Other Credit Relations...... 459 4.2.4 Common Concerns with and Objections to Negative Rates or Higher Inflation...... 460 | 9

4.2.4.1 Problems with Unstable and Unpredictable Inflation...... 460 4.2.4.2 ‘Higher Inflation Has Never Been Stable’...... 461 4.2.4.3 How Could Higher Inflation Be Sustained?...... 463 4.2.4.4 Menu Costs...... 464 4.2.4.5 Shoe Leather Costs...... 464 4.2.4.6 The Friedman Rule for Optimal Inflation...... 465 4.2.4.7 Higher Capital Income and Corporate Taxes Due to Higher Nominal Profits...... 466 4.2.4.8 Cash Printing Costs...... 467 4.2.4.9 Real Estate Bubbles...... 467 4.2.4.10 Other Limited Resources Such as Minerals...... 469 4.2.4.11 Austrian and Fundamentalist Libertarian Arguments...... 471 4.2.4.12 Other Illogical Attempts to Demonize Inflation...... 472 4.2.4.13 Inflation Distorts Economic Decision Making...... 473 4.2.5 Other Monetary Policy Questions...... 474 4.2.5.1 The Most Relevant Inflation – CPI Composition...... 474 4.2.5.2 Objective and Reliable Monetary Policy – Neutralize Human Judgment to Avoid Regulatory Capture...... 476 4.3 ELIMINATING PRIVATE MONOPOLIES AND (OTHER) PRIVILEGES...... 479 4.3.1 Limited, Vital Resources – Tax Land to Prevent Hoarding ...... 480 4.3.1.1 Land – One Mother of a Monopoly ...... 480 Sidenote Box 4311A: Components of Location Value ...... 481 4.3.1.2 Land Value Taxation – Preventing Underusage, Extortion and Bubbles ...... 485 4.3.1.3 Practical Challenges: Fair Valuation and Assessment of the Replacement Costs of Improvements and Other Owner-Created Value ...... 488 4.3.1.4 The Pure Lease Alternative’s Problems – Land Value Is Location Value of Real Estate...... 491 4.3.1.5 Other Objections to and Concerns with Land Value Taxation...... 493 4.3.1.6 Case: Helsinki Metropolitan Region...... 495 4.3.1.7 Central City Planning and Zoning Make Unavoidable Externalities More Predictable...... 499 Sidenote Box 4317A: Additional Reading on Land Monopoly and LVT...... 503 4.3.2 A Market Value Tax on Patents – Minimizing the Negative Externalities of Technology Monopolies...... 504 Sidenote Box 432A: Domain Names as Digital Real Estate...... 509 4.3.3 Other Natural Resources, Renewable or Non-Vital...... 510 4.3.4 Making Natural Monopoly Industries Sources of Public Revenue...... 512 5 WHY NOT BEFORE? AND HOW NOW? ...... 517 5.1 WHY WE DON’T SEE THE PROBLEMS FOR WHAT THEY ARE...... 518 5.1.1 Our Emotional Attachment to Words ...... 518 5.1.2 The Misleading Conceptual Metaphor of Money as Items or Substance ...... 521 5.1.3 Taking a Step off the Road...... 524 5.1.4 Institutional Interests – Rogue Agents without a Principal...... 525 5.2 ACADEMIC ECONOMICS IS IMPORTANT – BUT IT IS NOT AN INNOVATOR...... 535 5.2.1 The Personal Nature and Incentive Traps of Academia...... 535 5.2.2 How Would You Roll out a New Operating System?...... 542 5.2.3 The Economics Discipline at Threat? ...... 545 5.2.4 The Religious Nature of Economics and Politics...... 549 5.3 THE NEXT STEPS...... 554 5.3.1 Suggested Subjects for Future Research...... 555 5.3.2 Subjects Open for Debate in Versions of a Root-Debugged Societal Model for Different Political Ideologies...... 558 5.3.3 Join the Discussion and Inspire Others in Your ‘Language’...... 559 10 |

6 APPENDICES...... 563 6.1 APPENDICES WITH USEFUL BACKGROUND MODELS AND CONCEPTS...... 564 6.1.1 Appendix 1.1: Happiness Is Appreciating – A Framework of Happiness...... 564 6.1.2 Appendix 1.2: Different Types of Value Products Provide...... 569 6.1.3 Appendix 1.3: A Model of the Value of Helping and Cooperation: Empathy, Contribution, Image-Boosting, Shame and Guilt...... 570 6.1.3.1 Empathy Value – the Understanding and Empathy factors...... 572 6.1.3.2 The Contribution Premium...... 573 6.1.3.3 Image-Boost Factor...... 573 6.1.3.4 Guilt – the Negative Contribution Premium...... 574 6.1.3.5 Shame – the Negative Image Effect...... 575 6.1.3.6 The ‘Virtue’ of Self-Sacrifice...... 575 6.1.3.7 The Value of Specialization and Sharing...... 575 6.1.3.8 The Value of Differing Values...... 576 6.1.3.9 Gratitude Is an ‘Empathic Currency’...... 576 6.1.4 Appendix 1.4: The Conundrum of Causality – The Culprit Depends on Comparison...... 577 6.1.5 Appendix 1.5: Derivatives and Other Financial Instruments...... 582 6.2 APPENDICES GOING DEEPER INTO ISSUES...... 585 6.2.1 Appendix 2.1: All the Different Causes of Monetary Saving – and Dealing with Them...... 585 6.2.2 Appendix 2.2: One Simple Version of a Competitive Taxation Model...... 592 6.2.3 Appendix 2.3: Effects of LVT on Land Value – The Optimal Land Tax Rate? ...... 595 6.2.4 Appendix 2.4: Cognitive Biases Blocking New Perspectives...... 599 6.2.5 Appendix 2.5: The Tyranny of Jobs...... 606 6.2.5.1 Descriptive Quotes and Articles...... 606 6.2.5.2 Papers Emphasizing Jobs...... 608 6.2.5.3 Examples of Senseless Job Creation and Job Preservation Attempts...... 608 6.2.5.4 Severity of the Current Unemployment Challenge...... 608 6.3 APPENDICES WITH THOUGHT EXPERIMENTS, SPECULATION AND WILDER IDEAS...... 609 6.3.1 Appendix 3.1: The Deontological Libertarian Dream: Neofeudalism or Survival of the Fittest...... 609 6.3.2 Appendix 3.2: The Challenges with Democracy...... 611 6.3.3 Appendix 3.3: A Hypothetical Alternative to Democracy: Competing Governance Forms for Natural Resources...... 618 6.3.4 Appendix 3.4: Productive vs. Distributive Activity – How e.g. Marketing and Finance Are Productive...... 622 6.4 APPENDIX 4: READING GUIDES...... 628 7 REFERENCES AND INDEXES...... 637 7.1 ACADEMIC LITERATURE AND BOOK REFERENCES ...... 638 7.2 OTHER REFERENCES...... 658 7.3 TABLE OF GRAPHS...... 659 7.4 INDEX OF KEYWORDS AND THEMES...... 661 | 11

I ask no one who may read this book to accept my views. I ask him to think for himself. Whoever, laying aside prejudice and self-interest, will honestly and carefully make up his own mind as to “the causes and the cure of the social evils that are so apparent, does, in that, the most important thing in his power toward their removal.” … “Until there be correct thought, there cannot be right action; and when there is correct thought, right action will follow.” – Henry George, Social Problems (1883, p. 326-327)

Peter Drucker made a very fundamental distinction between doing things right and doing the right thing.” … “Doing the wrong thing right is not nearly as good as doing the right thing “wrong.” … “The difference between efficiency and effectiveness is the difference between knowledge and wisdom.” – Russ Ackoff1

Simplicity: In a world of uncertainty, complex problems do not always require complex solutions.”… “It’s basically robustness. You need something that works in an uncertain future – “not something that is optimal in the past.” – Gerd Gigerenzer 2

If you want to be a whistleblower you have to be prepared to lose your job. I’m able to do what I’m doing here because I’m nobody. I don’t have to keep any academics happy. I don’t have to think “about the possible consequences of my actions for people I might admire personally who may have based their work on this and they end up looking silly.” – Nick Brown3

If you’re not prepared to be wrong, you’ll never come up with anything original.” – Sir Ken “Robinson4

1 10:45-> & 11:42->, “If Russ Ackoff had given a TED Talk...”, a presentation in 1994, viewed 16.10.2013, http://www.youtube.com/watch?v=OqEe- IG8aPPk 2 3:20->, Gigerenzer, Gerd, “What Can Economists Know? 2/5”, lecture, viewed 20.8.2013, http://www.youtube.com/watch?v=DdEEwoKk- fMA&nomobile=1 3 Andrew, Anthony, “The British amateur who debunked the mathematics of happiness”, The Guardian, 19th Jan 2014, cited 19.1.2014, http://www. theguardian.com/science/2014/jan/19/mathematics-of-happiness-debunked-nick-brown 4 5:39->, Robinson, Ken, 2006, ”How School Kills Creativity”, TED Talk, viewed 16.5.2014, http://www.ted.com/talks/ken_robinson_says_ schools_kill_creativity | 12 13 | PREFACE

If I you asked me why I wrote this book, I might reply that for me and this book, even among many interesting and “it was an accident” – or that “I had to”. Both replies would promising answer suggestions. Below are some questions be equally truthful. this book discusses in addition to the initial one – some of them rhetorical (in italics), some less so. In the fall of 2011, I was granted the opportunity to give a talk on a subject I considered important. For some reason, —— Where does the profit requirement of capital come I decided to return to a question that had bothered me for from? How is saving productive? Why should capital almost 10 years but that I had suppressed, mostly out of make a profit, even when there is a chronic oversupply frustration: of it? —— Why do lower interest rates pump up real estate Why are we trying to create more work just to allow prices specifically? Why don’t lower rates make everyone to participate in the labor market? Why is the unit people borrow excessively for any other asset just of labor a human being? Why can’t increased productivity as well? Is there some special value component in alternatively lead to people simply working less instead real estate that we’re not seeing? of more products and services? And shouldn’t the choice between these be a matter of personal preference? How —— Is there really a (natural) conflict between labor does “creating jobs” to keep people employed make more and capital? Or maybe only between monopolies sense than creating dirty dishes just to maintain the same and everyone else? Could our “class conflicts” be amount of dishwashing shifts after getting a dishwashing artificial? machine? Regardless of whether we want economic —— Are cartels, blackmail and limiting others’ choices growth or not, shouldn’t our priority be getting rid of our really the way to make things “ fair”? Or would it dependence on such growth? maybe work better to maximize people’s options – their positive freedom? While running an HR services company, I had become slightly hooked on the creative nature and thrill of —— Can we really achieve sustainable economic security entrepreneurship – and I knew that I wanted to develop with restrictions and rigidity? Is hardness strength? and sell solutions. During the spring following the talk, Or is it maybe that flexible things are robust (and encouraged by the interested feedback from the audience, “antifragile”)? I became quite certain that the above questions and the —— Why do we want earning opportunities for ourselves, initial answers to them were the seeds of the solution that but then consider it “socially irresponsible” giving them I had to develop and “sell”. There wasn’t much else that I to people in developing countries, who are even more believed in more – and the upside potential of any mobile desperate for them? Isn’t that just selfish? Why do we app startup wasn’t even comparable. want to restrict borrowing (including consumption loans) in our own countries, but promote microloans An intended two-month project ended up being a for people in developing countries and loans part of miraculous and exciting two-year discovery venture: ‘foreign aid’? reading classics and more recent papers on economics, finance, psycholinguistics, positive psychology, sociology, —— Are positive current accounts sustainable? Can ecology, work life research etc.; debating in discussion everyone sell more than they buy at the same time? groups; interviewing experts and representatives of How do you sell without a buyer? political institutions; watching talks, panel discussions —— What are the fundamental pitfalls of a completely and interviews; making videos, drawing graphs; and “free” market? writing and rewriting. —— Why do we need a central government or state at I had newly found the state of unquenchable all? And if we do, what should its role be? And inquisitiveness that I’d had as a child – I might call is democracy (equal participation in collective it “epiphanitis”. It was like a drug – an addictive and decision making) really the fairest and most consciousness-expanding one. efficient way to run such a state? —— If the government wants more economic growth, why My studies of course lead to further questions. And asking is it taxing transactions? If it is a value-producing the relevant questions remains the most important thing 14 | Preface

entity, can’t it fund itself by charging for the valuable “action titles”) and pick what sounds interesting. It is services it provides – including the ownership of modular, so you don’t need to read all of it. It is more a natural monopolies, where private competition structured wiki-like blog than a one-topic self-help book doesn’t work – and by penalizing participants for or a Malcolm-Gladwell-style popularization. Or you imposing negative externalities on others? could think of it as an old school text adventure game! An —— Why do we need to own things and trade? Why “adventure” is how I would best describe the process of can’t we just live in empathic, cooperative harmony, writing it – and I hope I have managed to make reading all seven billion of us? How well can you measure it even more so. This book has reshaped my worldview your own and others’ needs and values without many times over. I hope it helps you polish yours and having to trade or make choices in trade-off gives it a couple of new angles. situations? You can make your own route along the cross- —— Why do we need money? And what is this “money” references. And chapters have “in short” summaries. thing anyways?! The “Introduction and Overview” and section “2.3 The —— And the purpose of (the) life (of an individual) and Solution of the Root Bug Hypothesis” might be good the existence of mankind? What makes life really places to start for an impatient reader. worthwhile? Pleasure? Satisfaction? The absence of pain? “Freedom”? (And is there really such a thing Many of the best ideas come out of personal as freedom?) Or perhaps feelings of connection and frustration.” – Richard Branson5 belonging, and a sense of control, progress and “ purpose?

And yes, it is a long book – I know. But don’t look at the 5 27:05->, 2013, “Elon Musk and Sir Richard Branson Hangout on air”, number of pages: Look at the table of content (with its viewed 1.8.2014, https://www.youtube.com/watch?v=Vy9y_YSpYxA

Acknowledgements not included in this sample 17 | INTRODUCTION AND OVERVIEW

For the past century or so, the basic dilemma of economic to demand increased consumption11 of goods and services policy has been thought to be the one between promoting and hence also increased use of natural resources – and the increase in total wealth8 (or income) and the equality the concerns for environmental sustainability, which seem or fairness of the distribution of that wealth (or income) on to call for decreased “consumption”. These tradeoffs/ the other.9 The emphasis between these is also one way to dilemmas as well as economic instability (business make the economic split into the “right” and “left” wings cycles and asset market bubbles), the seeming necessity in politics10 – the right primarily focusing on maximizing of unemployment,12 constant polarization of both income total wealth and economic freedom, the left primarily differences and the concentration of wealth into fewer and concerned with economic equality and security. fewer hands are often considered to be inherent properties of capitalism or any market economy. Towards the end of the 20th century, another dilemma crept alongside this one with the emergence and This book suggests that these dilemmas and flaws are the fortification of the “green” political movement: the result of a few simple, overlooked market imperfections dilemma between economic development – which seems and especially the resulting dependence on growth13 – not economic growth or economic activity in itself – and that fixing these “bugs” would largely solve both of these dilemmas: facilitate maximal desired economic 8 See: ”1.3.1 Economic Growth Is the Increase in Produced and Trad- growth and allow keeping that growth environmentally ed Value – The Many Meanings of ‘Wealth’”. 9 E.g. in Finnish political discourse, it is common to talk metaphor- sustainable while maximizing individual (positive) ically about ”growing the cake” and ”splitting the cake”. However, the economic freedom and almost obliterating unfair income expressions are often used quite vaguely with no clarification of wheth- differences and income insecurity. er ”the cake” refers to real income, total wealth, government tax revenues or something else – which confusingly bundles all of these things together (see: ”1.3.1 Economic Growth Is the Increase in Produced and It proposes that the normative discussion of whether Traded Value – The Many Meanings of ‘Wealth’”). Also Goldman Sachs we should attempt to maximize or minimize growth CEO Lloyd Blankfein uses this ”growing the pie” rhetoric in attempting in economic activity14 is wholly irrelevant.15 How much to voice his concern for income inequality: – 0:43->, Zeitlin, Matthew, ”Goldman Sachs CEO: ’Income Inequality Is people want to do paid work (their own specialized A Very Destabilizing Thing In The Country’”, 1t cited 12.6.2014, h t t p :// activity16) and buy goods and services produced by others www.buzzfeed.com/matthewzeitlin/goldman-sachs-ceo-income-in- should be a matter of personal preference, as long as: equality-is-a-very-destabilizing 10 There are of course many different ”right-left” splits. The term originally refers to the seating arrangements in the French parliament —— keeping others in debt against their will (usury) is after the Revolution: aristocrats and clergy (vested interests) on the right prevented (by the interest rate mechanism), and the bourgeoisie (reformers) on the left. This somewhat resembles the ”conservative-progressive” split we see in the U.S. today. Another, —— environmentally unsustainable means and more means-oriented ideological split into the economic ”left” and imposing other externalities on others is banned or ”right’ can be made according to how big a role one thinks that the state 17 should have in the economy. However, in many countries it is practically sufficiently penalized and an interest-group-political split. “[The left-right-division’s] birth and sporadic use during the French —— there are no chances of extortion through Revolution were a false start because, although it distinguished opposed monopolies and other privileges. political groupings in the legislatures (initially those for and against the King’s suspensive veto), the predominant preoccupation during this period was to abolish all political divisions.” (Lukes 2003, p. 7) “Thus sociologists have focused on the social bases of voting, such as class; psychologists on attitudes or personality traits; and political scien- 11 See: ”1.1.4 Production Is for Consumption, i.e. Appreciation – ‘Pro- tists on orientations towards policy, such as governmental intervention ductivity’ Has Many Units”. in the economy.” (Lukes 2003, p. 12) 12 See: ”3.1.3 Structural, Friction and Classical Unemployment, NAI- “Perhaps what unifies the left as a tradition across time and space is RU and Hysteresis – Is 5 % Unemployment Really Necessary?”. its very rejection of the symbolic hierarchy and the inevitability of the 13 See: ”3.1.1 Economic Instability, Cyclicity, ‘Keynesian’ Unemploy- inequalities it sanctifies.” … “Its distinctive core commitment is to a de- ment and Growth Dependence”. manding answer to the question of what equality means and implies.” 14 See: ”1.3.1 Economic Growth Is the Increase in Produced and Trad- (Lukes 2003, p. 13-14) ed Value – The Many Meanings of ‘Wealth’”. “The left is, on this account, a critical, strongly egalitarian project 15 See: ”3.4.5 The Irrelevance of the ‘Degrowth vs. Decoupling’ De- which, however, allows for successive and varying interpretations and b at e”. reinterpretations of what unjustified inequalities consist in and of how 16 See: ”1.1.1 The Division of Labor – Cooperation and Sharing Infor- – through what methods and programmes – they can be reduced or mation: The Philosopher’s Stones of Mankind’s Progress”. eliminated.” (Lukes 2003, p. 16) 17 See: “3.4 Environmental Sustainability”. 18 | Introduction and Overview

Regardless of whether we want more or less of a kind of indebting other national economies25), because interest activity, getting rid of a possible dependence on a constant rates cannot drop low enough. As the return on the risk- increase in such activity should be our first priority. We free investment options – bank deposits and government need an economy that is able to adapt to all kinds of bonds – affects the profit requirements of all other preferences people might have over spending their time investments, this “zero lower bound” of interest rates is and efforts – one that truly balances supply and demand. practically a minimum wage for capital.26 Also, the fact that the government guarantees deposits for free is a The book presents – for inspiration and critical scrutiny massive subsidy to unproductive saving, holding excess – the Root Bug hypothesis, along the analogy of a (destabilizing) liquidity and makes it profitable for banks programming “bug” (an unintended functional flaw) in to overleverage themselves.27 an otherwise efficient operating system, causing a lot of undesirable effects and “accidental complexity” resulting Negative interest rates aren’t even considered in from attempts to treat its symptoms. The hypothesis is mainstream political discussion – and very little in supported by existing research in many scientific fields economics. One reason for this is that “interest” is and it can be expressed in many different frameworks and misleadingly perceived as “rent for money”, and money models. is perceived as some kind of commodity (like a physical good) instead of a credit relation28 (as money explicitly is The actual “Root Bug” is the fact that earning in our current system). Hence, the possibility of it being opportunities (work) aren’t allocated to people (in the mid- negative can be counterintuitive. A second reason is that term) according to their willingness to spend and invest.18 recent real estate bubbles are blamed on too low interest People’s willingness to spend and invest is essentially their rates – even though it has been known for centuries desire to give others earning opportunities by consuming that land (the location value of real estate) is a natural goods and services others produce and by carrying monopoly resource and hence prone to bubble in any case. the risks of companies and other ventures and projects Lowering the profit requirements of capital (the interest involving real investments. In other words, the problem is rate) just escalates these bubbles. that supply does not meet demand in the labor market on the individual level – and this mismatch increases (in the The possibilities of extortion and reaping unearned income form of involuntary unemployment) when total demand (“economic rent”) through such private monopolies as well for labor decreases. as the resulting inefficient utilization of these resources is – together with the “actual Root Bug” – the other major This is caused by the rigid quantization of labor into flaw in our current “market economies” and the other half “jobs” and “employees”, which is fundamentally caused of the “What” part of the Root Bug hypothesis29. by the fact that it is not profitable for employer companies to share work among multiple employees – but instead Most mainstream economic theories and policies aim to always pile any work on as few people as possible. at increasing total demand to ensure that the whole Partly this is the result of “natural” overhead costs (e.g. population remains fully employed.30 But this becomes training and management),19 but it is further enforced increasingly difficult, as the marginal value of new by current labor legislation and our sticky, outdated and products and services compared to that of free time self-contradictory work ethics20 that guide management and economic security constantly decreases with the styles, company cultures and especially political decision improvement in living standards – and as people are making,21 as well as by incumbent institutions that are feeling more and more guilty about “consumption” (a dependent on this insecure and unfair labor market commonly misunderstood and strongly emotionally situation to justify their own existence.22

Additionally, aggregate supply and demand23 cannot 24 be kept in balance (without public deficit spending or 25 See: ”1.3.4 Foreign Trade: Current Accounts Are Also a Zero-Sum Game – Comparative Advantage vs. Absolute Advantage” and ”2.2.5.3 18 See: ”1.3.3 The Circular Flow of Income – Consumption, Saving Competitiveness Politics – Just Indebt Other Nations Further”. and Investing”. 26 See: ”4.2.1.1 The ZLB Is the Minimum Wage of Capital, Nominally 19 See: “4.1.2.1 Why Sharing Work Is Not Profitable or Otherwise Maintained by Physical Cash” and ”1.1.8 Labor and Capital (and Land?) Viable”. – The Factors of Production”. 20 See: “4.1.6.2 Making Sharing Work Socially Acceptable” and this 27 See: ”3.1.5 Too Big to Fail: The Casino Economy, ‘Financialization’ book’s sister, “The Guilt Economy”. and Irresponsible Risks in Banking” and ”4.2.2 Setting a Fee on the 21 See: “6.3.2 Appendix 3.2: The Challenges with Democracy”. Government Deposit Guarantee”. 22 See: “3.2.3 Unionization and Strikes” and “5.1.4 Institutional Inter- 28 See: ”1.2.3 Money as Credit – Real Wealth vs. Virtual/Fiduciary ests – Rogue Agents without a Principal”. Wealth” and ”Sidenote Box 126A: The Misleading Expression That 23 See: ”1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And ‘Banks Lend Other People’s Money’”. Has Little to Do with the Quantity of Money”. 29 See: ”2.3.5 Structure of the Root Bug Hypothesis”. 24 See: ”2.2.5.1 Keynesian Fiscal Stimulus – It’s the Government’s Job 30 See: ”2.3.1 The Job Creation Paradigm – Why Are We Trying to to Invest Stably”. Make More Work?!”. 19 |

charged economic concept31). Instead of trying to The structure of the current formulation of the Root Bug manipulate people into spending more, it would make hypothesis is presented in Graph 0 (same as Graph 25 on much more sense to look for ways to direct earning page 258). opportunities to people according to their willingness to spend and invest (see: Graph 24 on page 252). And this The Root Bug hypothesis can help achieve the normative would not require any central planning or restrictions, but ends of many different societal ideologies,41 but we also could most efficiently be achieved with simple incentives suggest a new, “game design perspective”42 (NOTE: not that would leave the difficult work of optimal “task the same as “game-theoretical”) into what an economic allocation” to fair supply and demand and competition system should facilitate. It combines some aspects of between companies.32 This includes on what “level” and the consequentialist libertarian premise of maximizing time scale the flexibility occurs: as shorter days, fewer positive freedom for individuals with the Rawlsian areas of responsibility, longer holidays or sabbaticals requirement for a “veil of ignorance” and the latest between positions.33 insights from positive psychology into what really makes a human life worthwhile, rewarding and valuable.43 The fact that sharing work is not profitable (on any time scale) is a market imperfection. This perspective – and stepping outside the box of traditional, interest-group-oriented compromise politics, The economy can be made self-stabilizing, fair, sustainable which has made a democratic44 government largely a and independent of growth – but allowing just as much “job creation” (waste) and “transfer payment” (stealing) growth as people really want – simply by: machine – suggests that a central government serves its citizens best by serving as a common ownership vehicle for —— making it legal, socially acceptable and profitable limited, vital resources and natural monopoly industries45 for employers to share work among multiple and that its revenues should largely come from profits, employees (i.e. give them the opportunity work less fees and rents from these rather than transaction taxes and rather reduce labor “within people”),34 (e.g. taxes on labor, VAT, corporate taxes, capital income taxes etc.), on which current taxation models are largely —— facilitating negative interest rates to prevent dependent.46 excessive hoarding of risk-free monetary assets (keeping others in debt against their will),35 This superiorly efficient and competitive taxation —— imposing a proper fee on the government guarantee system makes fixing the Root Bug a feasible option for of bank deposits,36 any country (or region with a sovereign currency) to implement without any broader international consensus. —— taxing land – the location value of real estate – to It would be a strategy competitive enough to almost ensure efficient use and prevent hoarding,37 force others to follow suit.47 In this aspect, it differs from —— taking natural monopoly industries into public many other, more drastic suggestions for reshaping the ownership and prevent private cartelization38 economic system, which would often require either global 48 —— and removing all unnecessary price regulations consensus or isolating the system from the rest of the – especially in the labor market39 – and other world economy and then tearing down most existing obstacles to mobility (such as limited education structures to start building a new system from scratch. opportunities40). This, however, does not mean that current structures and institutions – starting from private property, credit

31 See: ”1.1.4 Production Is for Consumption, i.e. Appreciation – ‘Pro- ductivity’ Has Many Units”. 32 See: ”1.1.8 Labor and Capital (and Land?) – The Factors of Produc- t ion”. 41 See: “2.1 Normative Principles – What Do We Want from an Eco- 33 See: ”4.1.1.2 Mid-term Flexibility (1-5 years’ Scale) Is What’s Rele- nomic System?”. vant” and ”4.1.6.1 Technological Advances Increasing Flexibility”. 42 See: “2.1.6 Conclusions – How about a Game Design Approach?”. 34 See: ”4.1 Maximizing Flexibility to Eliminate Labor Market Mis- 43 See: ”6.1.1 Appendix 1.1: Happiness Is Appreciating – A Frame- matches and Increase Adaptability”. work of Happiness”. 35 See: ”4.2.1 Eliminating the Zero Lower Bound with a Higher Infla- 44 See: ”6.3.2 Appendix 3.2: The Challenges with Democracy”. tion Target or by Eliminating Cash”. 45 See: ”4.3.4 Making Natural Monopoly Industries Sources of Public 36 See: ”4.2.2 Setting a Fee on the Government Deposit Guarantee”. Reve nue”. 37 See: ”4.3.1 Limited, Vital Resources – Tax Land to Prevent Hoard- 46 See: ”3.1.6.1 Constantly Increasing Public Debt – A Taxation Model i ng ”. Based on Monopoly Profits, Charging for Services and Auctioning Re- 38 See: ”4.3 Eliminating Private Monopolies and (Other) Privileges”. s ou r c e s”. 39 See: ”2.2.3.3 Wage Regulation by the Government – All or Noth- 47 See: ”3.5 A Competitive Option and Dominating Strategy”. i ng ”. 48 Compared to e.g. Thomas Piketty’s suggestion for a ”global wealth 40 See: ”4.1.4 Subsidize, Deacademize and Re-Game-Design Educa- tax”: ”3.1.2.3 ‘Lack of Growth Increases Inequality’ – Piketty’s ‘r>g Di- tion to Maximize Flexibility, Mobility and Adaptability”. le m m a’ S olve d”. 20 | Introduction and Overview

3. HOW 1. WHAT 2. WHY COULD IT BE FIXED? IS THE ROOT BUG? DO WE NEED TO FIX IT?

Remove xed costs per ECONOMIC Cyclicity and Unemployment INSTABILITY employee Supply does not Financial Sector Incentive Traps meet demand in Make payroll taxes the labor market Public Debt progressive because Public Sector Ineciency 1. it isn’t pro table Eliminate Adopt for employers to LOCAL SOCIAL Insecurity and Income Dierences cash O R higher target share work and ISSUES ination rate Demographic Challenges 2. interest rates Stress, Depression, Restrictions to Innovation, Crime Set a price on the cannot go negative government deposit enough guarantee GLOBAL SOCIAL Poverty and Slave-waged Labour ISSUES Famines and Curable Diseases Tax land (and patents) according to market value Armed Conicts and Regional Instability The possibility of Make natural monopoly extortion with ENVIRONMENTAL Fossil Fuel Dependence and industries publicly owned monopolies and UNSUSTAINABILITY Climate Change Threat limited, vital Auction sustainable quotas resources Pollution and Biodiversity Deterioration for other natural resources Waste and Resource Issues Volume 4 in this book Section 2.3 in this book Volume 3 in this book

GRAPH 0: THE STRUCTURE OF THE ROOT BUG HYPOTHESIS. (SAME AS GRAPH 25) relations, trade, and even human cooperation – have not bank’s policy interest rate (although outdated monetarist been questioned.49 and New Keynesian models don’t see this). But the trouble is that nominal interest rates cannot fall below 0 % (which Ways to incentivize employers to share work – make them is what currently would be needed to halt the chronic compete over employees regardless of the total demand for oversupply of capital), as this would result in hoarding labor – include removing all possible legal fixed costs and cash as a safe haven. This zero lower bound problem could liabilities per employee and implementing continuously be solved by making the central bank’s target inflation progressive labor taxation after a tax-free “hand-to-mouth rate higher, for example 6 %, which would allow making income” as a Pigovian tax on the harmful economic and real interest rates negative enough to encourage investing, social externalities of piling up work on fewer people.50 spending or sharing work and thus prevent excessive saving as money and other monetary instruments53 – i.e. “Conventional” central bank monetary policy51 is already keeping others in debt against their will.54 This would controlling the profitability of saving money (holding risk- also allow charging for the government guarantee on free credit52) and the cost of being in debt with the central bank deposits, making hoarding money (unproductive capital) even less profitable and encouraging banks to 49 See e.g.: “1.1.2 Societal Structures Facilitate Cooperation – Econom- remain transparent and solvent to receive cheaper, risk- ic Systems Direct Resources”, “1.1.7 Ownership as a Bundle of Rights” bearing credit finance.55 Alternatively, physical cash could and “1.2.2 Credit – Delayed Payment Granting Chronological Flexibili- be eliminated to allow negative interest rates nominally. t y ”. 50 See: ”4.1 Maximizing Flexibility to Eliminate Labor Market Mis- matches and Increase Adaptability”. 53 See: ”4.2 Preventing Excessive Monetary Saving – Allowing Mone- 51 See: “2.2.5.2 Monetary Policy – You Can Pretend It’s about the tary Policy to Balance Aggregate Supply and Demand”. Money Supply”. 54 See: ”1.2.3 Money as Credit – Real Wealth vs. Virtual/Fiduciary 52 See: “1.2.3 Money as Credit – Real Wealth vs. Virtual/Fiduciary We a lt h”. We a lt h”. 55 See: ”4.2.2 Setting a Fee on the Government Deposit Guarantee”. 21 |

In developed economies, the development of electronic adaptability. Also the idea that fairness could be achieved banking and payment systems has almost rendered cash through blackmail and the idea of “solidarity” in the obsolete already. meaning of joining in on your friend’s blackmail against everyone else, are strongly questioned. As an alternative There is a lot of confusion in regard to “inflation”, approach, we propose “mosh pit solidarity”. its causes,56 and its effects57. Many of the arguments demonizing inflation in general are confusing steady and Fixing the inefficiencies combined with providing predetermine inflation with unstable, unpredictable, and affordable, unlimited education opportunities would sudden inflation.58 The latter kinds are rightfully criticized maximize social mobility and obliterate a “class society” and feared, as they cause unnecessary uncertainty and within the limitations of cultural and societal factors and unjust wealth transfers. Price development stability should people’s inherent productive capabilities and preferences. not be abandoned and “anchoring” inflation expectations The simple solution to interest group conflicts is to give is important – but they don’t need to be anchored at 2 %. everyone the free choice of which group to belong to and abolishing artificial privileges.63 Economists have recognized the monopoly nature of land for centuries. Some have also been aware of the fairly Getting rid of the dependence on growth would also obvious solution of a “land value tax” (LVT), which would remove the need for nations to fight the two-faced, ensure that hoarding land is not profitable and that it mercantilist “economy war” where all of them are trying is always kept in the most productive use available. But to indebt each other by any means, just to keep their own this seems to have been forgotten completely in modern citizens employed while maintaining their God-given political debate. This book provides a slightly enhanced right to save.64 Until we can end this war, we cannot solve solution to the land taxation issue and explains how a poverty with all its nasty side effects (overpopulation, joint rollout with negative interest rates can help overcome famines, slave-waged labor etc.), as we cannot allow some of the biggest political challenges impeding the developing countries to become competitive.65 The book implementation of LVT.59 attempts to show how the current foreign aid practices of Western countries are mostly either hypocritical charity In light of economic research up until today and a or cunning neocolonialism – or both – as long as their combination of existing economic frameworks, the objective is to keep their own current accounts positive. suggested solution would be superior to any previously attempted one in providing maximal growth potential We also present some simple solutions to some of our within the limits of people’s consumption preferences and most pressing environmental sustainability challenges, productive capacity as well as environmental constraints including global warming and biodiversity deterioration.66 – while eliminating the system’s growth dependence.60 Solutions that would be fast and feasible to implement and would have minimal social and economic costs if Simultaneously, it would minimize economic insecurity our economies weren’t dependent on economic growth, and eliminate unfair income differences by diversifying having to stimulate it by any means – including the risks and maximizing social mobility.61 Current public economy war. policies are aiming to find a compromise between flexibility – which companies need – and security – which This book refuses to categorize itself into a “left-wing” employees need. However, the apparent conflict between or a “right-wing” perspective. Firstly, because there are these is largely a result of the “hardness is strength” multiple such “left-right” splits or axes67 and therefore illusion and propaganda by the self-preservation- these categories quite carelessly bundle together very focused trade union institution, which has every interest in keeping the position of employees (especially non- union-members) insecure.62 In a dynamic environment, 63 See: ”3.2.2 Unfair Income Differences and Limits to Social Mobili- t y ”. sustainable security can only be found in flexibility and 64 See: “1.3.4 Foreign Trade: Current Accounts Are Also a Zero-Sum Game – Comparative Advantage vs. Absolute Advantage” and “3.3.1 56 See: ”1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And Solving Poverty for Good – Ending the Economy War”. Has Little to Do with the Quantity of Money”. 65 See: “3.3 Global Social Issues”. 57 See: ”4.2.4 Common Concerns with and Objections to Negative 66 See: ”3.4 Environmental Sustainability”. Rates or Higher Inflation” and “4.2.3 Other Benefits of Higher Inflation 67 See footnote 10 for some different left-right divisions. This book or Negative Nominal Interest Rates”. does not prioritize between maximal prosperity and maximal eco- 58 See: ”4.2.4.1 Problems with Unstable and Unpredictable Inflation”. nomic security (see: “3.2.1 Maximal Economic Security with Maximal 59 See: ”4.3.1 Limited, Vital Resources – Tax Land to Prevent Hoard- Flexibility – Flexicurity and Antifragility”). It also opposes the whole ing” and ”6.2.3 Appendix 2.3: Effects of LVT on Land Value – The Opti- idea of interest-group politics. In the “size of the state” split, it could be mal Land Tax Rate?”. considered to be “on the right”, as a “pro-market” approach, but the state 60 See: ”3.1.2 Other Scapegoats for the Mystical Growth Dependence”. is given a new kind of role (more on this coming up). On the other hand, 61 See: ”3.2.1 Maximal Economic Security with Maximal Flexibility – in the “progressive-conservative” split it could be considered to be on Flexicurity and Antifragility”. the “left”, as it strongly questions existing institutions and the sense in 62 See: ”3.2.3 Unionization and Strikes”. focusing on maintaining achieved privileges. 22 | Introduction and Overview

different types of values and orientations. Secondly, economics, psychology, marketing70, finance, game theory, because there are arguments in this book that could system dynamics and a range of other scientific fields. surely be used by almost any political faction to criticize Neither does it stick to an ideological set of objectives, its opponents. A devoted leftist would probably consider but considers the objectives of many different normative the Root Bug perspective to be on the “far right”, as it for stances and discusses what sorts of modifications of a example strongly opposes collective bargaining in the “root-debugged” economy would best allow meeting labor market and suggests removal of minimum wages those. and other restrictions in the long run and as it doesn’t in any way demonize, punish for or limit profits made It is quite a straightforward “pro-market approach”,71 in on capital investments or individuals’ possibilities of that the suggestions could be summed up as: gathering material wealth in general. This conclusion would be omitting the fact that the suggested model —— Remove unnecessary subsidies and price strongly opposes unfair income differences and economic limitations insecurity – it just provides a completely different —— Eliminate monopolies approach to these issues than is in the left-wing tradition. It explains how many current left-wing policies are actually —— Set proper prices on externality costs. maintaining higher capital incomes and how these could be lowered much more efficiently by eliminating Where it differs from many other pro-market books, is monopolies and removing the “minimum wage” capital that it points out a few externality costs previously not currently has. We could even say that fixing the Root Bug identified as externality costs72, monopolies not recognized realizes the objectives of anarchist communism better as monopolies in today’s economic discussion73, a major than the abolition of private property would.68 price limitation that is not seen as a price limitation74 and some subsidies where we don’t see who is actually A devoted rightist would probably consider the Root Bug subsidized and on whose expense.75 perspective to be on the far left, as it suggests progressive taxation of labor (and even more controversially moving Fixing the Root Bug is to economic engineering and this progression nominally on the employer) and higher societal design what Bruce Lee’s Jeet Kune Do is to martial inflation targets allowing negative interest rates that could arts – eclectically combining different “systems” and decrease the profit requirement of all capital investments. “techniques” without being bound by them, abandoning Judging these as socialist policies would be omitting the orthodoxy and dogma, constantly evolving and focusing fact that their purpose in the suggested system is not to on simplicity and effectiveness. It is therefore an act of transfer any unearned income from people working or heresy76 – and a ‘hack’: carrying productive risks to risk-averse slackers, but to encourage giving more work to those most eager to spend 70 See: ”6.1.2 Appendix 1.2: Different Types of Value Products Pro- and invest – which would also allow more economic vide” and “6.3.4 Appendix 3.4: Productive vs. Distributive Activity – How e.g. Marketing and Finance Are Productive” and “1.1.3 Value Is growth (and work), instead of discouraging work like Subjective and Perceived – Rationality Is Largely an Illusion”. progressive taxation usually tends to do. The suggested 71 For the difference between ”pro-market” and ”pro-business”, see: policies are meant to fix the imperfections of a completely ”1.1.9 Companies as Competing Organizational Forms (Because Institu- tions Suck at Suicide) – ‘Pro-Business’ Is Not ‘Pro-Market’”. free market and get supply and demand to work even 72 Most notably the piling up of work on fewer people, which is effi- more efficiently.69 Just like overly generous social support cient for an individual company but not the whole economy. See: ”4.1.2.3 and the minimum wages on labor are keeping more Needed: a Pigovian Tax on the Externality Costs of Piling up Work on people unemployed, the “minimum wage of capital” Fewer People”. 73 Most notably the private ownership of location, land. See: ”4.3.1 and unnecessary subsidies are keeping a lot of capital Limited, Vital Resources – Tax Land to Prevent Hoarding” and ”4.3.2 A “unemployed” unnecessarily. Market Value Tax on Patents – Minimizing the Negative Externalities of Technology Monopolies”. 74 Most notably the zero lower bound of interest rates. See: ”1.1.8 This seeming contradiction is explained by the fact that Labor and Capital (and Land?) – The Factors of Production” and ”4.2.1 the proposal is not the result of an attempt to find a Eliminating the Zero Lower Bound with a Higher Inflation Target or by compromise. Rather, this book questions some deeply Eliminating Cash”. 75 E.g. how the free deposit guarantee is a subsidy to all capital or entrenched assumptions and means that have become how accommodation support is also a subsidy from all other rent payers objectives in themselves and attempts to find solutions to real estate owners. See: ”3.1.5 Too Big to Fail: The Casino Economy, to economic challenges by deducing and inducing them ‘Financialization’ and Irresponsible Risks in Banking”, ”4.2.2 Setting a as directly as possible from existing research findings in Fee on the Government Deposit Guarantee” and ”6.2.3 Appendix 2.3: Effects of LVT on Land Value – The Optimal Land Tax Rate?”. 76 “2. a : dissent or deviation from a dominant theory, opinion, or practice 68 See: ”2.1.3 Anarchist Communism: ‘Everyone According to His b : an opinion, doctrine, or practice contrary to the truth or to generally Ability, to Everyone According to His Needs”. accepted beliefs or standards” 69 See: “1.1.11 The Fundamental Imperfections of a ‘Free Market’ – – “Heresy”, definition, Merriam-Webster dictionary, cited 19.5.2014, Externalities and the Limitedness of Land”. http://www.merriam-webster.com/dictionary/heresy 23 |

“The idealised hacker combines rebellion and creation solutions of the Root Bug hypothesis are better adapted to into a seamless disruptive act, using each to power an urbanized economy and the possibilities that modern the other.” … “The Hacker Ethos often entails using technology grants for an efficient electronic credit money things in ways they’re not supposed to be used, system (while Gesell lived in the “medium of exchange” thereby disrupting them through creativity.” … world82). “Many hacker approaches attempt to blend three categories of action: The book is split into 5 “volumes” and a set of appendices. Each volume is split into 3-5 “sections” (e.g. “2.1”), 1. Exploring: Empathetically getting to know the which are split into a number of “chapters” (e.g. “1.3.1”). nuances of systems, and gaining access. Some chapters have further “subchapters” under them (e.g. “4.2.4.5”). Although the book attempts to form a 2. Jamming: Rebelliously and mischievously seeking out continuous storyline, it is also “modular” so that each the systems’ vulnerabilities and exposing them. chapter works almost as a standalone essay and chapters 3. Building: Creatively seeking to recombine the containing needed background information are cross- elements of systems to create something new.” … referenced. Therefore, instead of reading the whole thing in the printed order, you can also dig into subjects “The mark of hacking is the attempt to power each of according to your momentary interests. those impulses with the energy of the others.” (Scott 2013, p. 8-9) There are also some “sidenote boxes” presenting example cases, exceptions to a previously presented rule, If a point of comparison to previous political ideologies philosophical side trails, lists of additional readings or and societal solutions is needed, the ideas of Henry George other comments too broad for footnotes (e.g. “Sidenote would probably hit the closest.77 Similarly, Henry George Box 322B: The Special Case of CEO Pay – Efficiency Wages was seen as a laissez-faire capitalist in the eyes of socialists, and the Corrupting Nature of Power”) while to some libertarians Georgism is just another branch of communism. In the spirit of Henry George, this The book is long, but still fairly brief considering its book is strongly opposed to monopolies, cartels, (hostile) massive scope. Most individual chapters are short and protectionism, mercantilism and privileges and rejects to the point and include an “in short” summary for the the idea of an inherent conflict between labor and capital impatient right after the title. A way to swallow the book (although e.g. a cartelized labor market or a commodity in one sitting is to read only these summaries. You can money system can create and sustain such a conflict78). also skip some of the quotes at the beginnings and ends of chapters if you feel there are too many. But the ideas presented here are not of Georgist origin. Despite drawing attention to land value taxation, we are The objective of the book is not to discuss any single matter not advocating a “single tax” policy,79 for which Georgists exhaustively, but rather to put issues into perspective, have become most famous. We also assess the possibilities relate them to each other and ask the relevant questions. of private individuals and institutions to extort each other This is why all the volumes are published as one book through, not only “land”, but also contractual means, although there would be enough material for five separate like monetary systems – accounting systems of credit books: because almost everything in an economic system relationships – and legal restrictions like intellectual affects almost everything! The economy is a system, and, property rights.80 We also do not advocate a dogmatic as Russ Ackoff reminds us: distinction of “land” from “capital”.81 Dependence on individual frames and vocabularies and drawing “[i]f we have a system of improvement that is directed normative or decisive conclusions from the definitions of at improving the parts taken separately, you can be concepts are things this book seeks to avoid. Silvio Gesell’s absolutely sure that the performance of the whole will Freiwirtschaft and his idea of the “Natural Economic not be improved.”83 Order” (1916) are also related to the Root Bug hypothesis in that both focus on imperfections created by limited Taking the best parts (engine, transmission, wheels, body, natural resources and monetary systems. However, the etc.) from different cars and putting them together does not result in the best possible car. How parts function 77 See: ”4.3.1 Limited, Vital Resources – Tax Land to Prevent Hoard- together is the most defining property of a system. Some i ng ”. seemingly well-intended components are simply not 78 See: “1.1.3 Value Is Subjective and Perceived – Rationality Is Large- ly an Illusion”. 79 See: “4.3.1 Limited, Vital Resources – Tax Land to Prevent Hoard- 82 See: “Sidenote Box 4211A: Silvio Gesell’s Theory of ‘Basic Interest’ i ng ”. and ‘Free-Money’ – The Same in the ‘Medium of Exchange’ Frame”. 80 See: ”4.3.2 A Market Value Tax on Patents – Minimizing the Nega- 83 5:27->, “If Russ Ackoff had given a TED Talk...”, a presentations tive Externalities of Technology Monopolies”. in 1994, viewed 16.10.2013, http://www.youtube.com/watch?v=OqEe- 81 See: Graph 8. IG8aPPk 24 | Introduction and Overview

compatible and, put together, may behave in completely Economic Schools and The Root Bug Hypothesis“) – first unintended ways.84 discusses some normative premises for an economy. Then it introduces different economic schools by briefly The book is structured like a standard business case. summarizing their main areas of concern, some solutions Volume 1 is an analysis of the situation, the “organization” they suggest, issues they purposefully omit or downplay, and the “industry” – in this case the structures and their political or interest group orientations and some mechanisms of a market economy – volume 2 is a limiting or misleading assumptions they tend to make. comparison of strategic objectives (in this case, normative Then it presents the basic logic of the Root Bug hypothesis premises) and previous solution alternatives, volume and the questions it tackles. 3 describes the major benefits and other effects of the suggested solution, volume 4 is a more detailed description The third volume of the book – the “Why” volume (see: “3 of the solution and its implementation plan and volume Why We Need to Fix the Root Bug”) – entertains the idea of 5 deals with practical problems and risks in getting the an economy, in which total demand does not significantly solution and the plan accepted by different stakeholders, affect the correlation of earning opportunities with with possible causes of concern, change resistance and people’s willingness to spend and invest and in which other contingencies. private monopolies are minimized – and shows how achieving such a situation would solve or allow solving The book starts by presenting basic economic concepts, our economic, social, and environmental challenges. theories and phenomena questioning the necessity, purpose, and validity of each along the way (see: “1 A The fourth volume – the “How” volume (see: “4 How Brief Introduction to Economics”). This first volume Could The Root Bug be Fixed”): serves as an introduction to economics and is hopefully understandable even to those new to the subject. An —— presents a simple set of solutions for making impatient reader, wanting to skip economic theory for sharing work profitable now, might want to jump directly to “2.3.1 The Job Creation —— compares alternatives for facilitating negative real Paradigm – Why Are We Trying to Make More Work?!” interest rates and return to the underlying theory later according to cross-references or personal interest. —— assesses some additional benefits of facilitating negative real interest rates and common objections However, also a person with a background in economics to a higher target inflation rate is likely to find something new and interesting in volume —— lifts land value taxation back on the table with 1. There persist especially noteworthy misconceptions arguments from three centuries and regarding our current credit money system85 with its “fractional reserve banking” (as it is misleadingly called86). —— presents some additional innovative taxation We aim to clarify these, as well as sticky, outdated systems and incentives for an efficient public and assumptions related to the mechanics of inflation.87 private sector. Also the “1.1.11 The Fundamental Imperfections of a ‘Free Market’ – Externalities and the Limitedness of The fifth volume (see: “5 Why Not Before? And How Land” provides an important basis for the solutions and Now?”) explains why these solution options have not been arguments presented in this book. suggested before, including some significant incentive traps in our existing institutions, which our romantic The second volume of the book – the “What” volume views of these institutions prevent us from seeing. It gives (see: “2 Comparing Objectives and Means – Different brief introductions to psycholinguistics and the emotivist view of morality, explaining how our outdated ethics and the misleading conceptual metaphors in our language 84 For example, the wage mechanism, which (like any price) is meant to balance supplied and demanded amounts in the labor market (see: ” also severely mislead us. It also suggests subjects for 1.1.6 The ‘Market Forces’ – How Prices Balance Supply and Demand”), future research and ways in which the reader can further is completely incompatible with predetermined quantities of education the discussion on the presented perspectives. opportunities (see: “4.1.4 Subsidize, Deacademize and Re-Game-Design Education to Maximize Flexibility, Mobility and Adaptability”), and 88 can result in a situation where rising wages in the sector actually reduce The book (especially the appendices ) includes a number the supplied amount of labor, instead of increasing it (see: ”3.2.2 Unfair of thought exercises that one is likely to find interesting and Income Differences and Limits to Social Mobility” and ”2.2.3.2 Restrict- enlightening whether one is a natural rights libertarian89 ing Supply – ‘Stay out of Our Territory’”). 85 See: “1.2.3 Money as Credit – Real Wealth vs. Virtual/Fiduciary We a lt h”. 86 See: “1.2.6 Banking: Accounting for Debts and Credits and Pricing 88 See: “6 Appendices”. Risks – There Is No ‘Fractional Reserve’”. 89 See: ”2.1.1 The Libertarian Maxim of Freedom and the Paradox of 87 See: ”1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And Choice” and ”6.3.1 Appendix 3.1: The Deontological Libertarian Dream: Has Little to Do with the Quantity of Money”. Neofeudalism or Survival of the Fittest”. 25 |

believing in free private ownership of everything and inefficiency referred to as the Root Bug – most notably all anything, an anarchist communist90 believing in the the effort put into finding ways to “create jobs”98 and of omnipotent power of love or a devoted anti-moneyist keeping the economy growing and people spending more rooting for a new attempt at a centrally planned “resource- and more regardless of their actual preferences between based economy”91 ruled by computers. We hope to clarify leisure and additional goods and services.99 the debate between these extreme views by finding some assumptions with which such systems might result in the An economic scholar might find it disturbing that I do desired outcomes. These discussions are also colored and not always use the vocabulary of mainstream academic supported with an integrated framework of “happiness”92, economics and that all models are not copied from another of empathy93 and even an initial, hypothetical official publications or textbooks. This is partly because alternative to democracy for governing and developing the book also aims to explain economic concepts using our societal structures.94 mundane examples and vocabulary so that they are understandable to the general public. One objective is This book is primarily not a work of economic science. It to build bridges both between different fields of science is a work of economic engineering.95 The author does not and between academia and non-academics. An additional attempt or claim to be a scientist conducting academic reason for this is that seeing problems in a new way often research, but an economic entrepreneur developing requires a new language. It never fails to surprise how the solutions for a better performing economic system. And grammar, vocabulary and frameworks we use limit and similarly to how it would be constructive for physicists to guide our thinking with their embedded assumptions and listen to an electronics engineer or a quantum computing connotations.100 The late economic theorist called Jesus of entrepreneur who points out that existing theories do Nazareth put it as follows: not apply to or account for a new configuration he is developing (e.g. an electronic circuit or new kind of ”No one patches old clothes by sewing on a piece transistor), the combination of solutions presented in of new cloth. The new piece would shrink and this book has the potential to trigger significant leaps in tear a bigger hole. No one pours new wine into old academic research as well.96 wineskins. The wine would swell and burst the old skins. Then the wine would be lost, and the skins Although the claims are based on existing economic would be ruined. New wine must be put into new research and theories, many suggestions in the Root wineskins.” (The Bible, Mark 2:21-22) Bug perspective have not been studied or attempted in the form suggested, and hence, due to the complexity of This lingual issue and how our sticky, outdated morality the systems in which we live, their exact outcomes are is deceiving us into self-destructive actions is discussed impossible to predict. Thus, this book is first and foremost further in this book’s sister “The Guilt Economy – Rage a cry for more research on the presented hypotheses97 Against Our Medieval Money Morals”, which combines and perspectives, which have largely been overlooked e.g. ethics, sociology and psycholinguistics to tell an ironic in mainstream economic research as well as societal and and tragic story of how mankind is being destroyed by its political debate. good intentions – our very morality itself.

This research is direly needed to verify or falsify them In this “pioneer edition” of the book, referencing (and and develop them further. The needed research funding copy editing) is also far from perfect. The full scope would be fractions of a percent of the millions currently (though not depth) of this book would amount to dozens if allocated to treating the different symptoms of this not hundreds of PhD dissertations and therefore academic integrity has been sacrificed to bring these perspectives 90 See: ”2.1.3 Anarchist Communism: ‘Everyone According to His into broader consideration and under constructive Ability, to Everyone According to His Needs’”. criticism a few years faster. The increased attention and 91 See: ”2.2.3.5 The Planned or ‘Resource-Based’ Economy – ‘We Know What We Need’”. new participants in this quest for a fair, self-stabilizing, 92 See: ”6.1.1 Appendix 1.1: Happiness Is Appreciating – A Frame- sustainable, innovative and growth-independent work of Happiness”. economic system will hopefully allow gathering a more 93 See: ”6.1.3 Appendix 1.3: A Model of the Value of Helping and Co- operation: Empathy, Contribution, Image-Boosting, Shame and Guilt”. solid and exhaustive base of literature for later versions of 94 See: ”6.3.3 Appendix 3.3: A Hypethetical Alternative to Democra- this book and to facilitate future research. cy: Competing Governance Forms for Natural Resources”. 95 The distinction between economic science and economic engineering (as defined by e.g. Ben Bernanke) and how this innovating, 98 See: ”2.3.1 The Job Creation Paradigm – Why Are We Trying to private ”entrepreneurial sector” is largely missing in the field of societal Make More Work?!”. engineering – the absence of the ”economic solutions industry” – is 99 See: ”Sidenote Box 215A: The Neoclassical Growth Model and explained in section ”5.2 Academic Economics Is Important – But It Is Utility” and ”3.4.5 The Irrelevance of the ‘Degrowth vs. Decoupling’ Not An Innovator”. Debate”. 96 See: ”5.3.1 Suggested Subjects for Future Research”. 100 See: “5.1.1 Our Emotional Attachment to Words” and “5.1.2 The 97 See: ”2.3.5 Structure of the Root Bug Hypothesis”. Misleading Conceptual Metaphor of Money as Items or Substance”. 26 | Introduction and Overview

Science, language and our other institutional constructs development and new ideas, we might eventually get to are in a constant, chaotic state of disruptive evolution “Solving the Root Bug” and its “subbugs”102 for good! and by the time we would have had this book perfectly referenced with currently available resources, many The reader is advised to remain critical but open-minded, things would surely have changed – and we’d all very not taking anything for granted, but is also advised to possibly be dead (as Keynes is often quoted to have said avoid unnecessary cynical skepticism. Only by attempting about “the long run”). This book and the solutions it to falsify hypotheses and theories can we progress in our discusses – like life or the world – are not “ready”, as in understanding of the world and our ability to control final. And hopefully never will be. Although this book phenomena – especially in understanding and controlling suggests some major “paradigm shifts”, it believes in ourselves. We need to let go of the religious attitude103 we iterative development of ideas. As Karl Popper put it: have towards societal structures and consider them a field of innovation like any other. As Paul Romer puts it: ”No book can ever be finished. While working on it we learn just enough to find it immature the moment “When we think about ideas in that way we usually we turn away from it.” (Popper 1962, p. 5) think about technologies, but there’s another class of ideas: the rules that govern how we interact with each And this is what allows you to participate in writing it other.” … “If we can keep innovating in our space of – and possibly the future history of mankind. You can rules and particularly innovate in the sense of coming contribute to the open source development of different up with rules for changing rules, so we don’t get stuck versions of a root-debugged, sustainable economic system with bad rules, then we can keep moving progress as well as share your criticism, reference hints and art forward and truly make the world a better place.”104 work explaining the Root Bug in your own, personal “language” on the forums at www.rootbug.org. We can The book attempts to build bridges and emphasizes the always do better. strife to understand instead of looking for scapegoats to blame. In short, this book presents a new way of seeing the economic, environmental and social sustainability An increased general understanding of different problems we are facing as well as a hypothesis of how economic theories, perspectives and concepts is just one they could be fixed – easily, quickly and feasibly. part. New theoretical interfaces need to be built between different – unfortunately protectionist – academic fields Some like to distinguish between “fixing” and “solving” for cross-disciplinary utilization of research findings and problems. While “fixing” the root of the problem is better more innovative research.105 Beyond dismantling scientific than treating its symptoms, in some vocabularies, it is segregation, we also need to try our best to understand the still not the same as “solving” the problem, eliminating concerns of different interest groups and the versatility of it – but merely compensating for it.101 This book is called human values and cultures. “Fixing the Root Bug”, as it identifies some fundamental flaws in both our current systems and completely “free” Let’s catch and tame the dragon before we continue markets and suggests the simplest and most robust “fixes” running around trying to put out the fires. to them that the author has found so far. With further

101 “Thinking things: Fixing problems, not solving them”, Vanguard 102 See: ”2.3.5 Structure of the Root Bug Hypothesis”. Consulting, viewed 12.11.2013, https://www.vanguard-method.com/ 103 See: ”5.2.4 The Religious Nature of Economics and Politics” and content/2/thinking_things/#video, third video. ”5.2.2 How Would You Roll out a New Operating System?”. 104 17:20->, Romer, Paul, 2009, “Why the world needs charter cities”, TED Talk, viewed 20.10.2013, http://www.ted.com/talks/paul_romer. html 105 See: ”5.2.1 The Personal Nature and Incentive Traps of Academia”. 27 | VIDEO LINKS

The Root Bug hypothesis is also explained briefly in the following “Root Bug in a Nutshell” videos. The numbers in brackets are the sections and chapters of this book that elaborate on the subject of the video.

RB in a Nutshell 1/6: Land (1.1.11, 4.3) http://rootbug.org/Ns1

RB in a Nutshell 2/6: Money and Interest Intro (1.2, 1.3.5) http://rootbug.org/Ns2

RB in a Nutshell 3/6: The Zero Lower Bound (2.2.5.2, 4.2) http://rootbug.org/Ns3

RB in a Nutshell 4/6: The Free Deposit Guarantee (4.2.2, 3.1.5) http://rootbug.org/Ns4

RB in a Nutshell 5/6: The Work-Piling Bug (2.3, 4.1, 3.2.1, 3.2.2) http://rootbug.org/Ns5

RB in a Nutshell 6/6: Externalities and Wrap-Up (1.1.11, 3.4) http://rootbug.org/Ns6 28 |

If I had an hour to solve a problem and my life depended on the solution, I would spend the first 55 minutes determining the proper question to ask, for once I knew the “proper question, I could solve the problem in less than five minutes.” – Albert Einstein

I had learned three lessons the hard way. First, the outsider often sees things more “clearly than the insider, and should not be intimidated by his inexperience. Second, the scientist must trust her or his own imagination, even if, perhaps especially if, it runs counter to received wisdom. Third, there is no substitute for intellectual daring: if you want to rise above the pedestrian, you must be prepared to take risks.” – J. Michael Bishop, “How to Win the Nobel Prize: An Unexpected Life in Science” (2003, p. 53-54)

If you’re going to contradict the prevailing wisdom of your day, you’d better have darn “good evidence.” – Jonathan Haidt, The Happiness Hypothesis (2006, p. 115) Thomas Aquinas described heresy as ‘a species of infidelity in [people], who, having professed the faith of Christ, corrupt its dogmas’.” … “The outlook, which I believe, “most approximates this, is that of the hacker.” … “A ‘hack’ is an action that combines an act of rebellion with an act of creative re-wiring. The term is the basis of the word ‘hackaton’, referring to an on-the-fly challenge in which people collaborate to create something new from something old.” … “The idealised hacker combines rebellion and creation into a seamless disruptive act, using each to power the other.” … “The Hacker Ethos often entails using things in ways they’re not supposed to be used, thereby disrupting them through creativity.” – Brett Scott, The Heretic’s Guide to Global Finance: Hacking the Future of Money (2013, p. 8)

A lot of people think of hackers as geeky computer nerds who live in their parents’ basements and spread computer viruses. But I don’t see it that way. Hackers are “innovators. Hackers are people who challenge and change the systems to make them work differently – to make them work better. It’s just how they think – it’s a mindset. I’m growing up in a world that needs more people with a hacker mindset – and not just for technology. Everything is up for being hacked! Even skiing. Even education. So whether it’s Steve Jobs, Mark Zuckerberg or Shane McHonkey, having the hacker mindset can change the world.” – Logan LaPlante1

The most exciting phrase to hear in science, the one that heralds new discoveries, is “not ’Eureka!’ (I found it) but ’That’s funny…’” – Isaac Asimov

1 5:13->, LaPlante, Logan, 2013, “Hackschooling makes me happy”, TEDx Talk, TEDx Univeristy of Nevada, viewed 25.1.2014, http://www.youtube.com/watch?v=h11u3vtcpaY | 29

But if you ask enough questions, strange as they seem at the time, you may eventually learn something worthwhile.” … “Just because a question has never been asked does “not make it good.” … “But if you can question something people really care about and find an answer that may surprise them – that is, if you can overturn the conventional wisdom – then you may have some luck.” – Steven D. Levitt & Stephen J. Dubner, Freakonomics (2005, p. 85)

The ideas of economists and political philosophers both when they are right and when they are wrong are more powerful than is commonly understood. Indeed, the world “is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.” – John Maynard Keynes

The day is not far off when the economic problem will take the back seat where it belongs, and the arena of the heart and the head will be occupied or reoccupied, by our “real problems – the problems of life and of human relations, of creation and behavior and religion.” – John Maynard Keynes, First Annual Report of the Arts Council (1945-1946)

No book can ever be finished. While working on it we learn just enough to find it immature the moment we turn away from it.” – Karl Raimund Popper, Open Society “and Is Enemies, Preface to Second Edition (1962, p. 5)

If you knew when you began a book what you would say at the end, do you think that you would have the courage to write it? What is true for writing and for love “relationships is true also for life. The game is worthwhile insofar as we don’t know where it will end.” – Michel Foucault

We cannot, after all, judge a biography by its length, by the number of pages in it; we must judge by the richness of the contents…” ... “Sometimes the ‘unfinisheds’ are “among the most beautiful symphonies.” – Viktor E. Frankl, The Doctor And The Soul

Journalism is printing what someone else does not want printed: everything else is “public relations.” – George Orwell Nothing in life is to be feared, it is only to be understood. Now is the time to “understand more, so that we may fear less.” – Marie Curie (Bernarde 1973, p. v) 70 | Value, Production and Markets

1.1.8 Labor and Capital Chapters 1.1.1-1.1.7 not included in this sample (and Land?) – The Factors of Production In short: • The factors of production – inputs needed for production – can be reduced to capital and labor. • Anything the existence of which allows benefits (including easier production of goods) in the future can be considered capital – e.g. machines, skills, relationships, permits and biodiversity. • Some (e.g. Georgists, classical economists) separate “land” – meaning “natural resources” that cannot be created with human labor – from “capital” as a third factor of production. • It is not so that capital = “money” and labor = “people”, but rather that labor = “activity” (or ”effort”) and capital = “patience” + “risk bearing” (or “responsibility”). People supply both. • The profit requirements of individual capital investments (i.e. the “cost of capital”) depend largely on (1) the return of the most risk-free investment option, which in our current system is determined by the market interest rate – which in turn depends on people’s time-preference (impatience) – as well as (2) the costs attributed to risks regarding the outcome of an investment. And both of these can be negative! Thus, investments don’t always need to make a profit to be (sufficiently) “profitable”. • If we take all the labor (from the whole supply chain) that is needed for producing a product or service, how much beforehand on average that work is done is essentially the “capital intensity” of the production method. Labor and Capital (and Land?) – The Factors of Production | 71

Capital wealth is merely the means to the profit just by holding “capital”? Karl Marx is probably the “end called income, while capital value most famous person to ask this question. He insisted that (which is the sense in which the term capital is the value of a good is only determined by the amount of ordinarily used by interest theorists) is merely labor required to produce it.317 There is a logic behind this the capitalization of expected income.” – Irving argument, but it omits the facts that: Fisher, Theory of Interest (1930, p. 27) —— the same labor and benefits might be valued differently according to when they are executed or received, i.e. costs and benefits have a time value, [C]apital is not a self-subsistent entity and existing apart from consumption. On the “ —— the benefits resulting from work cannot always be contrary, every weakening in the propensity known for sure beforehand, i.e. production and to consume regarded as a permanent habit investments involve risks and uncertainty. must weaken the demand for capital as well as the demand for consumption.” … “When This is where “capital” steps in. Sometimes significant a man buys an investment or capital-asset, he amounts of work have to be done before a project produces 318 purchases the right to the series of prospective anything useful, enjoyable or otherwise consumable. The cliché example of this is a machine that allows more returns, which he expects to obtain from selling efficient production later, but requires lots of work to its output, after deducting the running expenses design and build it before production of the end products of obtaining that output, during the life of the can be started. asset.” – John Maynard Keynes (1936, p. 71 & 88) Now, “capital” (like many other economic terms, as we will see) is “an extremely vague term and its specific definition Interest on durable goods and interest on depends on the context in which it is used”.319 The concept “consumption-credit are like other kinds of of “financial capital” is returned to in “Sidenote Box interest an outgrowth of the higher valuation 118C: Marx’s ‘Capital’ Is Closer to Financial Capital” and of present goods as against future goods.” – “1.1.10 Companies as Contract Bundles – Financial Assets Ludwig von Mises, Human Action (1963, p. 526) Allocate Risks”. Some common definitions of capital (in the context of economics) include “a factor of production that is not wanted for itself but for its ability to help in The selling-price of an asset on the market producing other goods”320 and that it is “composed of will be the capitalized value of its expected those already produced or pre-existing resources that “future rents: the capitalization to take place at are used in production of other goods or services, but are 321 the going rate of interest. The rate of interest is not destroyed significantly in the production process”. Georgists define capital as: the price of ‘time,’ and hence future earnings are discounted back to the present at this rate.” “[w]ealth used in the process of production, which – Murray N. Rothbard, A Reply to Georgist includes wealth in the course of exchange”322 or Criticisms (1997, p. 307) “wealth used to produce more wealth, or wealth in the course of exchange”323

As explained in “1.1.3 Value Is Subjective and Perceived – (for “wealth”, see: “1.3.1 Economic Growth Is the Increase Rationality Is Largely an Illusion” appreciating things is in Produced and Traded Value – The Many Meanings of a human tendency and all value is subjective. Therefore ‘Wealth’”) and labor as: also “costs” are subjective. The cost of labor is mostly the opportunity cost of not getting to do something else with your time. Any mental or physical discomfort or distress 317 See: ”Sidenote Box 113A: Objective Value Theories and Morality”. 318 See: ”1.1.4 Production Is for Consumption, i.e. Appreciation – ‘Pro- might be considered part of the real costs – “negative ductivity’ Has Many Units”. value” – of labor (as the meaning of its adjective form 319 “Capital”, Investopedia, cited 21.5.2013, http://www.investopedia. “laborious” implies). With more arduous work, real costs com/ter m s/c/capital.asp also include health threats and other risks. 320 ”Capital”, List of Wikipedia entries, cited 21.5.2013, http://en.wikipedia.org/wiki/Capital 321 ”Capital (Economics)”, Wikipedia entry, cited 21.5.2013, h t t p :// If all “costs” are human experiences and the cost of a thing en.wikipedia.org/wiki/Capital_(economics) can be reduced to the amount of labor (trouble, nuisance 322 “’Economics’ and “Political Economy“, Henry George Institute, cited 18.6.2013, http://www.henrygeorge.org/def2.htm and lost time etc.) that the thing causes, then what right 323 Davies, Lindy, “LT Essays #3: Capitalism”, cited 19.6.2013, h t t p :// do some people have to get income without work – make a www.landreform.org/es3.htm 72 | Value, Production and Markets

“[a]ll human exertion in the production of wealth and “The perfectly just proposition that the laborer services.” 324 should receive the entire value of his product may be understood to mean either that the laborer should In this book (in the context of “factors of production”) now receive the entire present value of his product, or we define “labor” as any kind of human activity or effort should receive the entire future value of his product in (including mental effort) that is considered to produce the future. But Rodbertus and the socialists expound value (also) other than direct enjoyment from the activity it as if it means that the laborer should now receive the itself (allowing it to be “fun” or otherwise valuable for the entire future value of his product.” (Fisher 1930, p. 25) provider as well325). We take a similarly very broad version of the former two definitions of “capital”: Anything that But can we really reduce the factors of production to capital makes – or has the potential to make – future benefits and labor? What about materials and components? From possible or easier to produce can be considered capital. the perspective of one company, materials are a significant This closely follows Irving Fisher’s conception of capital: factor of production, but these materials are produced by other companies using their mix of capital and labor. “Many people think of interest as dependent directly No material has any intrinsic value – just its value in use on capital. As already suggested, it will help the (subjective value326), value in trade (market value327) and reader to proceed in the following analysis if he will the costs of the capital and labor needed in the whole try to forget capital and instead think exclusively of supply chain leading to its production. Sometimes capital income. Capital wealth is merely the means to the end and labor (and land) are called the “basic” or “primary called income, while capital value (which is the sense factors of production”, while materials and energy are in which the term capital is ordinarily used by interest called “secondary factors of production”. theorists) is merely the capitalization of expected income.” (Fisher 1930, p. 27) Along this definition of “capital” based on the capacity to facilitate or generate future income, natural resources Comparing a production process to a chemical reaction, can also be considered capital. Although no human has catalysts like enzymes and favorable conditions like ever toiled to create them, they facilitate the production temperature could be considered “capital”, while the heat of goods and services and if they are destroyed or energy consumed by an endothermic reaction (i.e. one not their quality deteriorates, our ability to produce goods producing heat) would be analogous to labor. decreases. Replacing destroyed natural assets or allowing them to regenerate can involve labor or opportunity costs Capital can take the form of any resource or other “store of having to give up using them for a while. Some natural of value”, regardless of whether it is currently employed in resources, such as biodiversity are practically irreplaceable any production. – which does not make them any less valuable as capital – on the contrary. In his Theory of Interest, Fisher writes: A company isn’t created with ownership of any natural “In attempting to prove that the laborer should resources, but it has to gather capital in some other form receive the whole product, the socialist stands on to pay for the extraction work required to extract these stronger ground than has sometimes been admitted resources – and any needed rights to extract them (e.g. by overzealous defenders of the capitalist system.” land ownership and mining licenses). When natural (Fisher 1930, p. 25) resources are freely available (such as berries, mushrooms and lake water in Finland) their market value is only This is because, in many cases (in all cases if we the cost of extracting and delivering them for use. When distinguish “land” from capital, as will be explained) their cost of extraction is non-existent (like that of air – capital is produced with human labor. But what Marxists currently) then they are called “free goods”.328 ignore is that both the labor and the produced benefits have time value! If most of the benefits of a kind of labor As mentioned under “1.1.7 Ownership as a Bundle of (like planting a tree or building a house or a machine) are Rights”, there is variance in what rights of use of natural received much later than when the required work needs to resources are included in land ownership. Normatively be done, then having to wait for those benefits might have this is a challenging question due to the above-mentioned a cost. As Fisher quotes Eugen von Böhm-Bawerk: irreplaceability. It is discussed in more detail under

326 See: ”1.1.3 Value Is Subjective and Perceived – Rationality Is Largely 324 “’Economics’ and “Political Economy“, Henry George Institute, cit- a n I l lu sion”. ed 18.6.2013, http://www.henrygeorge.org/def2.htm 327 See: ”1.1.6 The ‘Market Forces’ – How Prices Balance Supply and 325 This makes it possible, theoretically, for a kind of labor to have a D e m a nd”. “negative wage” if supply and demand so require. See: “1.1.6 The ‘Market 328 “Free goods”, entry, BusinessDictionary.com, cited 18.6.2013, h t t p :// Forces’ – How Prices Balance Supply and Demand”. www.businessdictionary.com/definition/free-good.html Labor and Capital (and Land?) – The Factors of Production | 73

“1.1.11 The Fundamental Imperfections of a ‘Free Market’ not to downplay the importance of the special nature of – Externalities and the Limitedness of Land” and “4.3.1 natural resources, but, on the contrary, (1) because we want Limited, Vital Resources – Tax Land to Prevent Hoarding”. to allow separate discussion of different kinds of natural resources (renewable/non-renewable, destructible/ This special nature of natural resources, that they cannot indestructible, vital/non-vital etc.); (2) in order to avoid be produced with human labor, is why e.g. classical confusion with the specific case of “undeveloped real economists and Georgists separate them into a third factor estate” and its “location value”; (3) because also natural of production, “land”: resources can be traded between parties and invested in just as any other form of capital (and hence they affect “The entire material universe exclusive of people and other capital investment in the market); and (4) because their products. some human made “assets” also behave much more like the classical and Georgist “land” in the sense that simply Everything physical (other than human beings) owning them allows restricting others’ possibilities. Most which is not the result of human effort is within notably this includes patents (technology monopolies), the economic definition of land. This concept thus but, in a sense, academic degrees and (other) operating includes not merely the dry surface of the earth, but licenses in certain industries (such as taxi permits333) when all natural materials, forces and opportunities. The limited in quantity are similar privileges granting windfall trees in a virgin forest are land; in a cultivated forest gains and opportunities for extortion.334 We could refer to they are wealth. this category of assets that can yield individual persons and companies higher income without actually increasing Radio and TV communications use the radio total real productivity (and that are not producible) as spectrum, a limited natural resource. Drivers of SUVs “privileges”. Land, as in owned location, could arguably and other fuel-burning machinery use the earth’s better belong to this category of “privileges” than that of atmosphere as a dump for their greenhouse-gas “natural resources” (see: Graph 8), as its value is largely wastes. To understand the meaning of land as a factor dependent on the productivity of the local human society. of production, we must conceive and define land Both natural resources and privileges create “rent- broadly, as the entire set of natural opportunities.”329 seeking” opportunities.335

The example of “trees in a virgin forest” versus “a In this book we often refer to “land-like” capital as cultivated forest” hints that the distinction of “which “limited resources” and “limited, vital resources,” which is the result of human effort” is not always so clear. are one way to make unfair profits with capital – just as The recovery of animal populations can be supported achieving a monopoly position or keeping others in debt with labor, although not from extinction (with current by not giving them the opportunity to pay their debts technology). New technologies allow making useful back (usury).336 materials out of previously useless materials and even extending land into the ocean by e.g. building dams and All productive “real” capital is not composed of physical moving soil. As some suggest, the digital age has seen assets. New technologies – in addition to facilitating new the emergence of many “new” resources that behave kinds of capital investments for more efficient production more like land (such as domain names, patents and of existing or new goods – are capital in themselves and other intellectual property rights in some cases330 331) R&D (research and development) activities producing which further makes the “landness” of different kinds of technologies and innovations are investments just like resources not quite as explicit as Georgists like to think constructing a building, a factory or a robot. And also it is. Ownership of “space” and “location” – which “land customer relationships and insight into customer needs ownership” essentially is332 – is still very different from are capital. For some companies and industries (e.g. the ownership of other kinds of scarce natural resources, consulting) they are the most important kind of capital. as land is not a homogeneous, fungible commodity. 333 Badger, Emily, “Taxi medallions have been the best investment in In this book, we do not distinguish “land”, as in natural America for years. Now Uber may be changing that”, The Washington Post, 20th Jun 2014, cited 14.8.2014, http://www.washingtonpost.com/ resources, into a factor of production of its own. This is blogs/wonkblog/wp/2014/06/20/taxi-medallions-have-been-the-best- investment-in-america-for-years-now-uber-may-be-changing-that/ 334 See: ”4.3.2 A Market Value Tax on Patents – Minimizing the Nega- 329 “’Economics’ and ‘Political Economy’“, Henry George Institute, cit- tive Externalities of Technology Monopolies”, ”2.2.3.2 Restricting Supply ed 18.6.2013, http://www.henrygeorge.org/def2.htm – ‘Stay out of Our Territory’” and ”4.1.4 Subsidize, Deacademize and Re- 330 See: “4.3.2 A Market Value Tax on Patents – Minimizing the Nega- Game-Design Education to Maximize Flexibility, Mobility and Adapt- tive Externalities of Technology Monopolies”. ab i l it y ”. 331 Yglesias, Matthew, “Newfangled Capital”, Slate.com, MoneyBox 335 See: ”6.3.4 Appendix 3.4: Productive vs. Distributive Activity – How blog, 14th Jun 2013, cited 17.6.2013, http://www.slate.com/blogs/money- e.g. Marketing and Finance Are Productive”. box/2013/06/14/new_fangled_capital.html 336 See: “4.2 Preventing Excessive Monetary Saving – Allowing Mone- 332 See: ”4.3.1.1 Land – One Mother of a Monopoly”. tary Policy to Balance Aggregate Supply and Demand”. 74 | Value, Production and Markets

PHYSICAL GOODS AND ASSETS IMMATERIAL NON-TRADEABLE GL GEORGIST “LAND” GR GEORGIST “CAPITAL”

CONSUMPTION PRODUCTION - SKILLS GOODS: GOODS: - THEORIES - STORED PRODUCTS - MACHINES - TECHNOLOGIES - MATERIALS - FACILITIES & - PRODUCT DESIGNS

- WORK-IN-PROGRESS BUILDINGS - PROCESS DESIGNS PRODUCIBLE - TOOLS & EQUIPMENT - BRAND / REPUTATION PRODUCIBLE

GC GC - PERSONAL RELATIONSHIPS

- CULTURE SEMI- - FORESTS & FISH POPULATIONS - SEXUAL CAPITAL - FRESH WATER PRODUCIBLE

ABLE - FERTILE SOIL

RENEW- GL PRIVILEGES: CREDIT: BIO- - ACAD. DEGREES - MONEY - FOSSIL FUELS (RESERVES) DIVER- - OPERATING - BONDS - URANIUM SITY LICENSES (E.G. TAXI NON- - VOUCHERS

RENEW. GL MEDALLIONS) - RADIO FREQ. PERMITS - ETC. - PATENTS

- MINERALS (ORE) AND OTHER LAND NON-PRODUCIBLE ELEMENTS (LOCATION) (NO PRICE ELASTICITY OF SUPPLY) TIBLE GL GL INDESTRUC- NON-REAL NATURAL RESOURCES (RECEIVABLES)

GRAPH 8: TYPES OF ‘CAPITAL’, IN THE BROADEST DEFINITION OF ASSETS THAT CAN GENERATE INCOME OR OTHER BENEFITS.

In some management frameworks, products are the result Some economists today separate human capital, of linking “technology competences” with “customer intellectual capital and social capital into a “fourth factor competences”. (Danneels 2002) of production”. And for example Austrian Economists like to make the “entrepreneur” or “enterprise” the fourth The competences, attributes and other capabilities of a factor of production, assuming that the entrepreneur person that increase her capacity to achieve or produce is the one providing equity investments, and hence something are referred to as human capital. In today’s making “profit”, while “capital” refers to loans of money business environment, the role of relationships, fame which receive “interest”. E.g. Georgists consider this and status as components of social capital are increasing distinction to be a purely elitist distinction with a political in importance. As one subset of human capital, “sexual agenda.337 And there is no reason why we can’t consider capital” (or “erotic capital”) refers to the social benefits a person might gain due to her attractiveness to other 337 “Deconstructing Economic Text”, Henry George Institute, cited people – which is not only limited to physical attributes. 18.6.2013, http://www.henrygeorge.org/pdfs/decons.pdf Labor and Capital (and Land?) – The Factors of Production | 75

the expertise (including market insight) and creativity of amount of profit and the capital needed, but also on the an entrepreneur to be human capital and his supervision perceived risks involved. and coordination work to be forms of labor – and this labor, when unpaid, to be “sweat equity investments” The net present value (NPV) of any asset or investment is into the company (work done beforehand, just like any the sum of the future incomes (for companies, inward cash other capital). The “entrepreneur distinction” makes the flows) and expenses (outward cash flows) it facilitates or “factors of production” sound rather like a classification of causes discounted by a discounting interest rate, r, which people into “classes”, separating them into “laborers” (who is the investment’s profit requirement, a.k.a. its “cost of supply only labor), “capitalists” (bankers, who supply only capital.” “Discounting” means adjusting each future capital) and “entrepreneurs” (who supply both). year’s incomes and expenses by multiplying it by the discounting factor (1/(1+r)), the more times the further the

But what are the costs of capital then? In other words, year is in the future. If Pi is the net income for year i (P0 is what determines the reward that owners of capital the income for the current year, P1 is income for the next, assets require? Of course, capital goods – also called P2 for the one after that and so on), then the net present production goods – can also deteriorate physically both in value of the income stream P is calculated as follows: use and with time and therefore require maintenance or replacement. (Also skills erode and require revision and updating.) However, these costs can rather be thought of as labor costs of the production process. When the wear is in direct proportion to use, replacement, repair and other The discounting interest rate (r) is practically the “break- maintenance costs are direct labor costs in terms of the even profit requirement” of an investment: Investments company’s planning process, and when the wear occurs with a positive NPV are worth making, assuming that with time regardless of use, they are fixed costs, like the expected incomes are realistic and the discounting administration overhead costs and lighting. In national interest rate is determined by taking all the risks and accounts, replacement investments can be calculated by uncertainties involved sufficiently into consideration. subtracting net investment – the increase in total real assets – from gross investments – total amount of new “The theoretical fair value of the investment is actually real assets produced. Replacement investments are also the expected cash flows, discounted by the time and referred to as “capital consumption”, 338 as in the deterioration risk. Discounting is a means to perceive the present of capital assets.339 value of an investment that will pay out in the future.” (Scott 2013, p. 138) The actual cost of capital – of the part that isn’t “consumed” – is the cost of someone having to (1) wait for future Note that the present value of a cash flow is not the same benefits and (2) carry the risk of not getting those expected as the “real value” of the cash flow in “today’s dol l a r s”. benefits despite having paid for the work done upfront – These two are easy to confuse. The “real value” is only i.e. having saved and made the investment. As mentioned, corrected for inflation (π) – changes in the purchasing these are the costs Marx ignores. power of money340 – and it is calculated by adjusting by 1/ (1+π), whereas the discount rate (r) used when calculating “Profitability” in its simple definition can refer to the present value also accounts for the costs of capital: the amount of profit an investment makes – revenues minus costs of risk and impatience (or opportunity costs of expenses. But when asking the yes-no question of whether alternative investment opportunities). an investment is “profitable” or not, this does not usually mean whether it leaves a positive or negative number “on the bottom line”. Rather, it is asking whether the investment is lucrative enough to be made – whether the 340 See: “1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And expected number on the bottom line (or, rather, the bottom Has Little to Do with the Quantity of Money”. line numbers of all future years together) meets the profit requirements (the costs of capital) set for the investment. In this sense of “profitability”, the relative “profitabilities” of two investments do not only depend on the expected

338 “Capital consumption”, About.com, cited 20.2.2013, h t t p ://e c o n o m - ics.about.com/library/glossary/bldef-capital-consumption.htm 339 Such uses of the word ”consumption” as the deterioration of something causes a lot of confusion regarding the more common meanings of ”consumption” in economics. See: ”1.1.4 Production Is for Consumption, i.e. Appreciation – ‘Productivity’ Has Many Units”. 76 | Value, Production and Markets

Sidenote Box 118A: Keynes’s Liquidity Preference Theory is Outdated

John Maynard Keynes disagrees with interest being determined by time preference and emphasizes instead “liquidity preference”:

“It should be obvious that the rate of interest cannot be a return to saving or waiting as such. For if a man hoards his savings in cash, he earns no interest, though he saves just as much as before. On the contrary, the mere definition of the rate of interest tells us in so many words that the rate of interest is the reward for parting with liquidity for a specified period. For the rate of interest is, in itself; nothing more than the inverse proportion between a sum of money and what can be obtained for parting with control over the money in exchange for a debt for a stated period of time.” (Keynes 1936, p. 107)

This conclusion seems logical in a world where cash is the most liquid form of money and with the assumption that “giving out a loan” to someone requires someone else to part with the liquidity of her credit. However, in today’s world of electronic money, total liquidity is no longer a limitation: Electronic bank account “deposits” are the most liquid form of money, these deposits also have interest paid on them341 and banks can create as much liquidity as the market demands by issuing new loans. Our current monetary system will be explained in more detail in “1.2.6 Banking: Accounting for Debts and Credits and Pricing Risks – There Is No ‘Fractional Reserve’” and “1.2.8 The Supply of Money Is Infinitely Interest-Rate-Elastic – The Money Supply Is Endogenous”.

Although people’s liquidity preference is no longer a significant determinant of the interest rate in general, it is an explaining factor between the interest rates of liquid bank account deposits and less liquid risk- free credit, such as savings account deposits or government bonds (of governments with their own sovereign currency). Uncertainty in the market – for example mistrust in the central bank’s ability to keep inflation stable342 – can significantly increase interest rates on bonds compared to deposits. This could be considered to be partly the result of an increased “liquidity preference”.

Liquidity preference becomes very significant for interest rates on debts if we use a currency of limited quantity. And this further increases the self-reinforcing feedback loops that economic insecurity causes: Insecurity increases people’s liquidity preference, which raises nominal interest rates – in addition to deflation raising the real interest rate.343 And higher interest rates further reduce aggregate demand. Suggestions for limiting the amount of liquidity available (and making banks actually “lend money”, which they currently don’t344) are discussed in “2.2.3.6 Democratic or ‘Full’ Money – ‘Power to the People from the Banks’”.

341 On how the interest paid on liquid deposits also kills ”the Friedman Rule” for optimal inflation, see: ”4.2.4.6 The Friedman Rule for Op- timal Inflation”. 342 See: “1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And Has Little to Do with the Quantity of Money”. 343 See: ”3.1.1 Economic Instability, Cyclicity, ‘Keynesian’ Unemployment and Growth Dependence”. 344 See: ”Sidenote Box 126A: The Misleading Expression That ‘Banks Lend Other People’s Money’”.

In the investment market, any (rational) individual liquid investment market,346 impatience to consume (as investor who already has savings that he is not planning to consume chooses what to invest them in by comparing 346 The service lifetime of an investment good or the time it takes to investment options with each other. Therefore, the profit build the good has little relevance for investment choices in an efficient requirement of any investment is the profit yielded by the and liquid market, where financial assets, other investments (like real available risk-free investment option plus a risk premium estate) or even an ongoing investment project (like the construction of a ship) can be sold on to other investors if the investor needs consumable determined by the uncertainty of the income from the or reinvestable income earlier. Of course, some investments are less liq- investment and the investor’s averseness to risk.345 In a uid. With e.g. startup companies (or the investment of writing a book), it takes time to achieve such a level of credibility for the business (or the book project) that other investors would be ready to value it as highly as 345 “Risk premium”, Investopedia, cited 16.4.2013 http://www.investo- someone who is strongly involved in it and who has spent a lot of time pedia.com/terms/r/riskpremium.asp investigating its potential (information is strongly asymmetric, see mar- Labor and Capital (and Land?) – The Factors of Production | 77

it is called in Fisher’s theory) has no effect on the choice a much smaller reward. In addition to total income, the between different investment options, as each investment “time shape” of one’s expected future income matters: involves the opportunity cost of investing in the risk-free option – when such an option is available.347 “The fact that a person’s income is increasing tends to make his preference for present over future income However, if the yield (expected profit) of every available high, as compared with what it would be if his income investment option, including the risk-free option, is too were flowing uniformly or at a slackening rate; for low to justify the patience and risks (i.e. the net present an increasing income means that the present income value of the investment is negative), a person might – is relatively scarce and future income relatively and should if he is acting even remotely rationally or abundant.” (Fisher 1930, p. 31) “consequentialistically” – decide not to save or invest and rather to spend off the savings for additional consumption As long as people value any security, certainty and or free time. predictability, risk in income is a cost:

What we need to understand here is that when deciding “In short, a risky income, if the risk applies evenly to between consuming and investing your income, no one all parts of the income stream, is equivalent to a low else can tell you what discounting rate you should use. income, and, since a low income, as we have seen, The “internal discounting rate” of an investor-consumer tends to create a high impatience, risk, if distributed in is a matter of subjective, personal preference. Both the time, uniformly or fairly so, tends to raise impatience.” cost one attributes to waiting for benefits and to different (Fisher 1930, p. 32) levels and types of risk are subjective, perceived costs. However, this does not make them any less real costs than If one expects a fairly certain income stream in the near e.g. the cost of one’s own labor or the value of a product. future, but one’s long-term total income is uncertain Remember that all value is perceived.348 Similarly, no one (e.g. people who have jobs with a fixed salary, but a else can tell you the lowest price you should be ready to risk of losing it at some point and not finding another), accept for a specific work gig. this is equivalent (in Fisher’s thinking) to a declining income stream, which decreases impatience. In practice, In his “The Theory of Interest, As Determined by we can see how increased uncertainty in the economic Impatience to Spend Income and the Opportunity to environment can significantly lower people’s internal rate Earn It” (1930), Irving Fisher refers to this discounting of interest (discounting rate) – even to the negative side interest simply as the “rate of interest”. His theory largely – and increase saving significantly. If long-term earning bypasses risks in individual investments and focuses on opportunities were secured, the threshold to spend off time preference, which he also calls “human impatience” savings and to take on debt, if necessary, to pass periods making a fairly good account of factors that might of temporary income volatility would be lower.349 affect the internal interest rate of an (rational) investor- consumer. The most noteworthy effects are those of One very important conclusion is that the average one’s total present income and expected future income profits made by investments (capital) in a market (not limited to the capital income from one’s savings and (with fair competition) are largely determined by the investments): A person living hand-to-mouth is unlikely market interest rate – the yield of the available risk- to sacrifice any current income for even significantly free investment option. Even Adam Smith noted this higher future benefits. If he did, he might not even survive strong connection between the interest rate and overall long enough to enjoy them. Instead, a person earning profits,350 but – treating money as a commodity of limited more than he urgently needs can be enticed to save with supply – assumed that the interest rate was determined by the profits that can be made by real investments, as this made borrowers more willing to pay high interest ket imperfections under ”1.1.6 The ‘Market Forces’ – How Prices Balance Supply and Demand”.) rates to lenders. But – at least with today’s kind of credit 347 This is why the price-to-earnings (P/E) ratio of a company whose stock is traded publicly mostly reflects the risks associated with the busi- 349 See: “4.1.5 Guaranteeing Security While Avoiding Welfare Bum- ness. Lower risk-businesses and ones expected to grow have a higher P/E ming: Economic Freedom Need Not Be Free”, “3.2.1 Maximal Economic ratio as investors are ready to pay more for stocks yielding the same ex- Security with Maximal Flexibility – Flexicurity and Antifragility” and pected profits with a lower volatility. With no changes to perceived busi- “3.1.1 Economic Instability, Cyclicity, ‘Keynesian’ Unemployment and ness risks, then the stock price of a company tends to rise approximately Growth Dependence“. in proportion with the net present value of the company’s expected fu- 350 “It may be laid down as a maxim, that wherever a great deal can be ture cash flows. As all investments are compared to the risk-free invest- made by the use of money, a great deal will commonly be given for the ment option – risk-free, government-backed credit (see: ”1.3.5 Inflation use of it; and that, wherever little can be made by it, less will commonly Is the Rise in the (Nominal) Price Level – And Has Little to Do with the be given for it. Accordingly, therefore, as the usual market rate of interest Quantity of Money”) – average P/E ratios also rise (in excess of changes varies in any country, we may be assured that the ordinary profits of in market risks) when the market interest rate is higher. stock must vary with it, must sink as it sinks, and rise as it rises. The 348 See: “1.1.3 Value Is Subjective and Perceived – Rationality Is Largely progress of interest, therefore, may lead us to form some notion of the a n I l lu sion”. progress of profit.” (Smith 1776, p. 78) 78 | Value, Production and Markets

money351 and in the absence of monopoly industries or ones – you are ready to save for your future even if you resources setting a minimum standard for returns352 353 made a loss (in real terms) by doing so, i.e. even if you – the causality354 is rather the other way around: Deposit knew you were going to get back less in that future than interest rates – the profits lost for not holding risk-free you gave up now. credit – determine the opportunity cost355 of making a risky investment. A loaf of bread in a year’s time might be worth more to you than a loaf of bread today. Especially if that guarantee The other very important conclusion here is that, in of a loaf of bread is certain while your other future income order to be “pro itable” (enough), an investment does not is uncertain. Let’t assume that crops are perishable so that necessarily need to make a pro it, i.e. give you more back they cannot be stored for over a year. If a farmer makes a than you “paid” for it – not in nominal terms (i.e. good harvest this year and fears for his next year’s crop measured in money) nor in real terms (i.e. in the quantity yield, he might exchange two sacks of grain now for a and quality of goods and services).356 Capital and its costs promise of one sack the next year – constituting a debt (profit requirements) should be just as much subject to with a -50% rate of interest. But such a “negative time supply and demand as labor and wages are. And the costs preference” might also result from simply preferring to of both capital and a kind of labor can be negative: If “first work and then play”: The farmer wants to work hard there is an oversupply of financial capital (of some risk this year to be able to go on a holiday the next year. profile) even at an expected return of zero, capital (of that risk profile) needs to make a loss. If some line of work is Irving Fisher also mentions the possibility of a negative so desirable that people are willing to pay to get to do it, interest rate in his theory of interest. the wages for it can become negative. E.g. being a supporter of a football team or paying membership fees to (or doing “Time preference may not always be a preference voluntary work for) a club to get to do a hobby (such as for present over future goods; it may, under certain singing in a choir or taking part in producing an conditions, be the opposite. Impatience may be and amateur theatrical production or lifting weights) sometimes is negative!” (Fisher 1930, p. 29) could be seen as doing “negative-wage work”. Also John Maynard Keynes notes that for an unemployed person, Unfortunately, he then ignores its implications for the having at least some work would have positive utility, market interest rate mechanism he theorizes: the problem i.e. a negative cost, compared to not having work at all. It that, when granting credit occurs by “lending” physical might feel better to do voluntary work for no pay than feel cash, nominal negative interest rates cannot be charged completely useless: by a “borrower”, i.e. debtor.357 Hence, savers would simply not lend, as they would get bigger yields by just holding “When involuntary unemployment exists, the on to their notes and coins – in Fisher’s terms, the lending marginal disutility of labour is necessarily less than market would not be “cleared”.358 the utility of the marginal product. Indeed it may be much less. For a man who has been long unemployed Ludwig von Mises, an Austrian economist who adopted some measure of labour, instead of involving Böhm-Bawerk’s time preference view of interest (the profit disutility, may have a positive utility.” (Keynes 1936, requirements of all capital),359 simply concludes (through p. 85) quite a questionable induction) that people always prefer current goods to future goods – that a negative If your internal discounting rate is negative – meaning discount rate is not possible.360 Other Austrian economists that you value future benefits more than you value current 357 The natures of money and credit is returned to in “1.2 Credit, Mon- 351 See: “1.2.6 Banking: Accounting for Debts and Credits and Pricing ey and Banking”, the problem of negative interest rates in “4.2.1 Eliminat- Risks – There Is No ‘Fractional Reserve’” and “1.2.8 The Supply of Money ing the Zero Lower Bound with a Higher Inflation Target or by Eliminat- Is Infinitely Interest-Rate-Elastic – The Money Supply Is Endogenous”. ing Cash”, why “lending” money is a misleading expression in “Sidenote 352 See: “4.3 Eliminating Private Monopolies and (Other) Privileges”. Box 126A: The Misleading Expression That ‘Banks Lend Other People’s 353 “As I have mentioned above, there have been times when it was Money’” and land as another safe haven under “4.3.1 Limited, Vital Re- probably the craving for the ownership of land, independently of its sources – Tax Land to Prevent Hoarding“.) yield, which served to keep up the rate of interest;– though under Gesell’s 358 After losing significant portions of his own property in the market system this possibility would have been eliminated by land nationalisa- collapse of the Great Depression, Fisher admitted that the assumption of tion.” (Keynes 1936, p. 221-222) “markets always clearing” is unrealistic. 354 See: ”6.1.4 Appendix 1.4: The Conundrum of Causality – The Culprit 359 “Interest is a homogeneous phenomenon. There are no different Depends on Comparison”. sources of interest. Interest on durable goods and interest on consump- 355 See: ”1.1.3 Value Is Subjective and Perceived – Rationality Is Largely tion-credit are like other kinds of interest an outgrowth of the higher val- a n I l lu sion”. uation of present goods as against future goods.” (Mises 1963, p. 526) 356 Many socialists and other anti-capitalist activists like to think so 360 “Time preference is a categorial requisite of human action. No mode and include this assumption in their arguments that a monetary econo- of action can be thought of in which satisfaction within a nearer period my is inherently flawed (see: “3.1.2.1 The Perpetual Debt Hoax, a.k.a. The of the future is not – other things being equal – preferred to that in a later Fallacy of Unpayable Interest”, “3.1.2.2 ‘Companies Have to Grow or Die’, period.” … “If he were not to prefer satisfaction in a nearer period of the and “”). future to that in a remoter period, he would never consume and so satisfy Labor and Capital (and Land?) – The Factors of Production | 79

such as Robert Murphy debunk this theory with clear undervalued, and by scarce any man, who is in case examples where people can have a negative time tolerable health and spirits, valued more than it is preference both due to inherent preferences (“exogenous worth. That the chance of gain is naturally overvalued, or ex ante”) and external conditions (“actual or ex post”), we may learn from the universal success of lotteries.” such as future income insecurity. (Murphy 2001, p. 2) (Smith 1776, p. 93) Murphy concludes that interest must be considered purely a monetary phenomenon.361 In doing so, Murphy According to John Maynard Keynes, this seemingly essentially confirms Silvio Gesell’s (1916) view that a irrational temptation of risk also applies to entrepreneurs: commodity money without “demurrage”362 is a tool for extortion and that savers and “money-lenders” are like “[T]hough, if we exclude the exploitation of natural “robber barons” taking a toll for restricting free trade.363 resources and monopolies, it is probable that the 364 This book does not exactly agree with Gesell either, as actual average results of investments, even during it suggests that the whole frame of money as “a medium of periods of progress and prosperity, have disappointed exchange” is very misleading.365 the hopes which prompted them. Business men play a mixed game of skill and chance, the average results of It is also noteworthy that not everyone attributes which to the players are not known by those who take significant cost to risk in every situation. The whole a hand. If human nature felt no temptation to take a gambling industry practically relies on the fact that in chance, no satisfaction (profit apart) in constructing some cases people attribute value to chance – i.e. risk can a factory, a railway, a mine or a farm, there might have a negative cost! The thrill yielded by the possibility not be much investment merely as a result of cold of winning and the fear of losing can have positive value. calculation.” (Keynes 1936, p. 97) Economists have noted this peculiarity since the 18th century, but there is disagreement over how much of it is The human need for uncertainty has also been studied actually value attributed to risk and how much cognitive in psychology and featured in many life coaching and biases, such as overestimation of the upside potential. As happiness frameworks. Tony Robbins’s framework for Adam Smith puts it: example states “uncertainty” as one of six basic human needs.366 “The chance of gain is by every man more or less overvalued, and the chance of loss is by most men So what would be the “productivity of capital”? “Capital productivity” is actually not a very meaningful term and it is quite carelessly used to refer to different things. wants. He would always accumulate, he would never consume and en- An increase in labor productivity means that less labor is joy. He would not consume today, but he would not consume tomorrow either, as the morrow would confront him with the same alternative.” required to produce the same output. But if less capital (Mises 1963, p. 484) is required to produce the same output, what essentially 361 “For example, it might be that a certain man does not exhibit TP in happens is that capital intensity (will be explained later sense (ii); that is, if all else were equal, he would be indifferent between a marginal present or future good. However, if in a particular scenario all in this chapter) is reduced without labor productivity else were not equal – if, e.g., he knew he would be very rich in the future decreasing. If low amounts of capital employed would compared to today – then the man quite reasonably could prefer a mar- mean “high capital productivity”, “capital productivity” ginal present good to a future good; that is, he would exhibit TP in sense (i). Thus, we could say of this man that he does in this particular situation would be the highest in nomadic hunter-gatherer societies prefer present to future goods, but not that he does so as a general rule. – where capital intensity is low. On the other hand, it might be that a certain woman does, as a general rule, prefer present to future goods; she thus exhibits TP in sense (ii). So if On the other hand, what is often meant by “the productivity she knew she would be equally wealthy in the future as she is today, she would prefer a marginal present good.” … “Suppose that she knows she of capital increasing” is an increase in the revenue (and will be much poorer in the future. This effect can completely overwhelm hence profits) that existing capital assets generate for their her exogenous preference for the present, such that she actually prefers owners. But this is a matter of income distribution (between a marginal future good. This woman would thus exhibit TP in sense (ii) but not in sense (i).” … labor and capital) and does not necessarily have anything “Austrians should reject any theory of interest that deals only with ‘real’ to do with real productivity increasing. For example, a phenomena, to the exclusion of money. A positive interest rate is simply a monopoly can raise the profits it makes simply by raising higher price for present money units versus future money units.” (Mur- phy 2001, p. 2-3 & 22-23) prices. (Contrary to common belief and some neoclassical 362 See: ”4.2.1.4 Demurrage Is Unnecessarily Costly to Implement”. theories, the distribution of income between types of 363 See: “Sidenote Box 4211A: Silvio Gesell’s Theory of ‘Basic Interest’ labor and capital are not determined by their “marginal and ‘Free-Money’ – The Same in the ‘Medium of Exchange’ Frame”. productivities”. Often their “productivities” cannot even 364 Both Murphy’s and von Mises’s agenda seems to be trying to find a 367 solid justification for positive interest, instead of questioning it’s necessity. be compared to each other. ) This is quite a typical human tendency as explained in ”1.1.3 Value Is Subjective and Perceived – Rationality Is Largely an Illusion”. 365 See: ”1.2.3 Money as Credit – Real Wealth vs. Virtual/Fiduciary 366 See: “6.1.1 Appendix 1.1: Happiness Is Appreciating – A Framework Wealth” and ”1.2.5 The Two Denominators of Currencies and Other Fi- o f H appi n e s s”. nancial Instruments: the Reference Resource(s) and the Collateral”. 367 See: ”3.2.2 Unfair Income Differences and Limits to Social Mobili- 80 | Value, Production and Markets

The cash flows that a capital asset is expected to generate These measures do not include the profit requirements of (including the “exit”: a final sales price or the face value capital and have to be compared to them (e.g. “Is the IRR received at the maturity of a bond) determine its market higher than the profit requirement?”). The profitability value. Therefore, in an efficient market with perfect index369 s(PI) i the net present value of future cash flows information, the expected profitability of different existing divided by the initial investment, which gives a more assets on the financial market with similar risk profiles all intuitive view of the relative profitability of investments converge to the same profit requirement. If an asset (like of different sizes (and different risk profiles) than just the shares of a company) is suddenly expected to generate calculating NPVs.370 higher cash flows, its market price rises immediately to a level at which its expected yield again matches the profit An interesting implication of such a definition – giving requirement. This is why changes in market interest rates additional justification for the separation of “land” from significantly affect the market prices of e.g. government “capital” – is that if we consider non-producible natural bonds with preset interest rates. resources (e.g. biodiversity or mineral ore reserves) as a type of “capital”, then their marginal efficiency (or PI) is More risky investments are of course more “profitable” for always zero – as their replacement costs would be infinite! investors with better than average risk tolerance, as such However, if the natural asset could be employed both in investors discount them by a lower rate than people (or ways that deteriorate it – “consume the capital” (e.g. razing institutions) on average and vice versa. And, of course, a a forest for mining or oil drilling) – and in ways that don’t posteriori (in hindsight), due to the risks and uncertainty (e.g. by using biodiversity to develop a new material or involved, there is significant variation in how well medicine) then we could replace the replacement cost with investments actually end up producing value and hence the (net present) value of the additional benefits that can how profitable they end up being. be accrued by permanently destroying the natural asset. This is because the net present value of future benefits But many assets can also be produced and new companies that the asset would have made possible (as capital) if established instead of purchasing existing assets or not destroyed, can be regarded as opportunity costs of company shares on the investment market. It is far more destroying the asset. This makes the marginal efficiency interesting to compare the production costs with potential of natural assets (and hence the profitability of preserving yields, as that is what affects companies’ and people’s them) much bigger – especially with lower interest rates desire to make real investments. Just as with consumption (which account more net present value for income far off goods, when the market prices of some kinds of assets in the future).371 rise above their production costs, it becomes profitable to produce more of them – the supplied amount increases There is a lot of variation in capital intensity between with rising demand.368 different types of production (different goods, and different technologies used): how much capital they “Over against the prospective yield of the investment require in proportion to labor. Nominally, capital intensity we have the supply price of the capital-asset, meaning is the capital employed per total potential output. by this, not the market-price at which an asset of However, the problem with determining “real capital the type in question can actually be purchased in intensity” using the market value of the capital employed is, the market, but the price which would just induce again, that capital is usually valued according to its profit a manufacturer newly to produce an additional generation capacity. Hence, a change in the profitability of unit of such assets, i.e. what is sometimes called its a company or industry would change its capital intensity, replacement cost.” (Keynes 1936, p. 88) which makes no sense. As with the “marginal efficiency

Keynes referred to the “relation between the prospective 369 See: ”Profitability Index”, definition, Investopedia, cited 22.10.2013, yield of a capital-asset and its supply price or replacement http://www.investopedia.com/terms/p/profitability.asp 370 “Every time Chevron decides whether to invest in a new project, cost” (Keynes 1936, p. 88) as the “marginal efficiency of such as a new tar sands operation, the managers are supposed to take capital”. Irving Fisher called this “the rate of return over into account their shareholder’s expectations, referred to in the abstract cost”. (Keynes 1936, p. 91) In finance, this is nowadays as their cost of equity, or ‘what return our shareholders expect from us’ (e.g. shareholders expect a 15% return’). Chevron managers will add that more commonly called the “internal rate of return” (IRR), together with the interest rates they owe debt investors such as banks and which tells what percentage of compound annual profit bondholders, to com up with an overall cost of capital, representing all the the investment makes, i.e. what discounting interest rate demands from those nosy shareholders and parasitic lenders. would give the investment an NPV of zero. In the context of assessing a new project, this cost of capital is sometimes called the ‘hurdle rate’. A new project may be worth taking on if it’s imag- ined future returns can jump over that hurdle rate. In the technical jar- gon, they may invest in a project if it displays a positive net present value (NPV) or, expressed in another way, if the project’s internal rate of return t y ”. (IRR) exceeds the hurdle rate.” (Scott 2013, p. 140) 368 See: ”1.1.6 The ‘Market Forces’ – How Prices Balance Supply and 371 See: ”4.2.3.5 More Long-Term-Oriented Investment and Company D e m a nd”. Management”. Labor and Capital (and Land?) – The Factors of Production | 81

of capital”, using replacement costs of the capital assets value does not erode with time and use, the capital instead of current valuations provides a solution to this intensity of producing goods and services involving dilemma. significant amounts of land and/or where location is crucial (e.g. accommodation) doesn’t exactly follow the For a company, capital intensity is often measured by its previous interpretation of “how much work has been done capital intensity ratio: beforehand”373, s but i significantly affected by interest rates. This matter and its implications are discussed in Capital Intensity Ratio = Assets / Sales further detail under “1.3.2 In a Closed Economy, Net Monetary Wealth Is Zero – Total Real Wealth Depends Now, we should note that “sales” means the company’s on Future Consumption and Capital Intensity (and sales per year or other period (a figure from the company’s Monopolies)” and “6.2.3 Appendix 2.3: Effects of LVT on income statement [$/year]), while “assets” is a value at a Land Value – The Optimal Land Tax Rate?”. point in time (a figure from the company’s balance sheet372 [$]) – or, in this case more accurately, the average value of For a company, the capital intensity ratio that its balance the assets during the period in question. Therefore the unit sheet shows of course also depends on how much of earlier of capital intensity is not a percentage, but years – time. If expenses have been capitalized into its balance sheet. For we omit assets that cannot be produced (“land”), we could example previous investments in training, marketing and say that capital intensity means how much beforehand, R&D are seldom visible in a company’s balance sheet: they on average, has all the work required to produce an end are accounted as costs instead of investments. Employee product been done, compared to when the end product is skills, product designs, brand image and client relations realized. are most definitely forms of real capital for the company – often more important forms of capital and sources of If we lived in a theoretical gatherer society without tools, competitive advantage than any buildings or machines. capital intensity would be close to zero because all food is But they are usually only capitalized on the balance received as it is gathered. In a theoretical industry where sheet in cases where they are acquired from the outside goods or services are produced completely by robots that (e.g. buying a brand or a patent from another company only need to be constructed initially (and the construction or a company merger), as their value is hard to estimate required no training or new technology development), accurately and most of their value might be impossible to requiring no maintenance services during their life liquidate in the case of a bankruptcy.374 cycle, and the robots lasted in operating condition at flat productivity for ten years, the capital intensity of such an industry would be 5 years.

Again, the case of land – non-producible, vital resources – is peculiar. As land cannot be produced and its location

372 See: ”1.1.10 Companies as Contract Bundles – Financial Assets Allo- 373 Of course, we could still say: ”How much work needs to be done to cate Risks”. acquire the needed production assets?” 374 See: ”1.1.10 Companies as Contract Bundles – Financial Assets Allo- cate Risks”.

Sidenote Box 118B: The Trouble with Measuring Capital Financially: ‘The Cambridge Capital Controversies’ and Piketty’s ‘Capital’

Intuitively, another tempting measure of “capital intensity” could be the total cost of capital in proportion to the cost of labor in the production process – “the income share of capital” – but, in this case, a decrease in profit requirements (which are the costs of capital in the case of equity) would decrease the measured capital intensity. And if the profit requirements would turn negative (due to e.g. negative interest rates), capital intensity would be negative although capital is still employed. Hence, we cannot consider the income share of capital to be a measure of capital intensity.

Continued on page 82 ► 82 | Value, Production and Markets

► John Kenneth Galbraith identifies a similar problem in measuring capital in financial terms in Thomas Piketty’s (2013) ”Capital in the 21st century”, linking it back to the ”Cambridge capital theory controversies” (Cohen & Harcourt 2003) between the ”neoclassicals” of MIT in Cambridge, Massachussets (e.g. Robert Solow and Paul Samuelson ) and the ”neo-Ricardians” at the University of Cambridge, England (e.g. Piero Sraffa and Joan Robinson):

“Symbolic mathematics begets quantification. For instance, if one is going to claim that one economy uses more capital (in relation to labor) than another, there must be some common unit for each factor. For labor it could be an hour of work time. But for capital? Once one leaves behind the ‘corn model’ in which capital (seed) and output (flour) are the same thing, one must somehow make commensurate all the diverse bits of equipment and inventory that make up the actual ‘capital stock.’ But how?” …

“Then [Piketty] estimates the market value of that wealth. His measure of capital is not physical but financial.

This, I fear, is a source of terrible confusion. Much of Piketty’s analysis turns on the ratio of capital – as he defines it – to national income: the capital/income ratio. It should be obvious that this ratio depends heavily on the flux of market value.”

“Piketty devotes just three pages to the ‘Cambridge-Cambridge’ controversies, but they are important because they are wildly misleading.”…

“In desperate summary, the case was three-fold. First: one cannot add up the values of capital objects to get a common quantity without a prior rate of interest, which (since it is prior) must come from the financial and not the physical world. Second, if the actual interest rate is a financial variable, varying for financial reasons, the physical interpretation of a dollar-valued capital stock is meaningless. Third, a more subtle point: as the rate of interest falls, there is no systematic tendency to adopt a more ‘capital- intensive’ technology, as the neoclassical model supposed.”375

Piero Sraffa and Knut Wicksell would have agreed with this criticism:

“Heterogeneous capital goods cannot be measured and aggregated in physical units; instead, capital valuation must be used, as Wicksell [(1911, p. 149)] told us long ago.” (Cohen & Harcourt 2003, p. 201)

“What is the good of a quantity of capital ... which, since it depends on the rate of interest, cannot be used for its traditional purpose ... to determine the rate of interest[?]” (Sraffa 1962, p. 479)

The previous passages in this chapter (1.1.8) should solve Galbraith’s and Sraffa’s dilemma: No, there is no common unit for measuring capital and labor – but (excluding land) their proportion is time. (More on Piketty’s theory in ”3.1.2.3 ‘Lack of Growth Increases Inequality’ – Piketty’s ‘r>g Dilemma’ Solved”.)

375 Galbraith, John K., 2014, ”Kapital for the Twenty-First Century?” Dissent Magazine, Spring 2014, cited 21.4.2014, http://www.dissent- magazine.org/article/kapital-for-the-twenty-first-century

During the early phases of industrialization, capital work than it saves.376 And even if the new machinery intensity tended to grow as technological progress decreased the need for labor, the costs of the capital (profit allowed creating new kinds of machines, which were requirements of equity and interest paid on credit) might expensive to construct, but increased the productivity of future labor significantly. However, labor productivity does not always grow with capital intensity. Sometimes 376 Even such an investment can be ”profitable” if discounting interest rates are negative! If you have ”first-work-then-play” preference, you making a machine (or learning a new skill) requires more might be willing to build a dishwashing macine, even if it required more work than it would ever save you dishwashing time. Labor and Capital (and Land?) – The Factors of Production | 83

exceed the savings the investments allow in labor, making People’s willingness to save with different returns for their the investment not worth it. savings determines the “supply curve of capital”.379 As Henry George proclaimed and as will be discussed in Technological progress – e.g. how far processes can be “4.3 Eliminating Private Monopolies and (Other) automated – is a major limitation to increasing both labor Privileges”, in a working market economy, there productivity and capital intensity. However, not all labor should be no “conflict” between labor and capital – but productivity-increasing technologies increase capital rather between monopolies and everyone else.380 intensity. Many modern technologies (like web services) allow significant labor productivity increases (which is In a fair market, also the competition (“optionality”, often hard to measure, as the old and new services are not as opposed to hostility) is rather between different directly comparable377), but are less capital-intensive than types of labor381 than between labor and capital. Some e.g. constructing and operating a steel mill. This can be neoclassical (and earlier) theories treated capital as if it due to requirements of constant updating, maintenance were some kind of homogenous, fungible “jelly” or and customer support. “putty clay” with a continuous, declining marginal productivity and which could be increased or decreased Also, it is noteworthy that high capital intensity is at will in the production function (Q = f (K, L), where Q = not a completely new phenomenon. As one example, the quantity produced, L = labor, K = capital (Cohen accommodation has for a long time been a capital- & Harcourt 2003, p 201)) with changing market interest intensive “service”. Building a house requires a lot of rates. work relative to what is needed for maintaining it. In the case of nomadic tent living, the capital intensity of “[J. B.] Clark thinks of capital as a quantum of value accommodation is smaller, as tents cost less to produce, ‘imputed’ in material goods. He strips off everything but require more constant work in putting them up and which may suggest material existence, and retains maintaining them. only a value jelly, existing eternally.” (Böhm-Bawerk 1907, p. 280) Both labor and capital should be subject to the laws of supply and demand – but unfortunately today capital This led to the “marginal productivity theory” of the has a “minimum wage” or more like an “unemployment returns on capital.382 383 But in practice, the available support” as will be explained in “4.2.1 Eliminating the Zero Lower Bound with a Higher Inflation Target or by Eliminating Cash”. When there is a lot of willingness 379 For how an oversupply of capital essentially is a momentary over- to save relative to profitable investment opportunities supply of labor, see: ”2.2.5.2 Monetary Policy – You Can Pretend It’s about , the the Money Supply”. return on risk-free capital – the interest rate on deposits 380 In our current economies, we have developed such a conflict be- and government bonds – should drop, lowering the profit tween labor and capital through cartels, see: “3.2.3 Unionization and requirements of all other, more risky investments. This Strikes” and “2.2.3.1 Collective Bargaining – ‘Blackmail Is Solidarity’”. 381 See: ”3.1.3 Structural, Friction and Classical Unemployment, NAI- might make it more profitable to choose more capital- RU and Hysteresis – Is 5 % Unemployment Really Necessary?”. intensive forms of production: making investments into 382 “With the usual assumptions, like exogenously given resources and more machines if technology allows them or e.g. allowing technology, constant returns to scale, diminishing marginal productivity and competitive equilibrium, this simple model exhibits what Samuelson bigger buffers of materials and goods (emphasizing (1962) called three key ‘parables’: 1) The real return on capital (the rate “agility” over “leanness”).378 On the other hand, lower of interest) is determined by the technical properties of the diminishing long-term interest rates (that should result when capital marginal productivity of capital; 2) a greater quantity of capital leads to a lower marginal product of additional capital and thus to a lower rate of is oversupplied) could also encourage investments into interest, and the same inverse, monotonic relation with the rate of interest bigger research and development (R&D) projects that also holds for the capital/output ratio and sustainable levels of consump- create new technologies, as long-term benefits have a tion per head; 3) the distribution of income between laborers and cap- higher present value. italists is explained by relative factor scarcities/supplies and marginal products. The price of capital services (the rate of interest) is determined by the relative scarcity and marginal productivity of aggregate capital, If there is a lot of cheap labor available and capital (in and the price of labor services (the wage rate) is determined by the relative scarcity and marginal productivity of labor (L).” (Cohen & Harcourt the form of savings and existing productive, real assets) 2003, p. 201) is scarce, it becomes more profitable to choose less 383 “Binary economics” is probably the school of though that takes the capital-intensive forms of production. (However, the misconception of the productivity of capital the furthest. Advocates conclude that, as most of the recent increases in productivity are the result substitutability in this direction – e.g. when interest rates of capital (machines, technologies, processes etc.), an increasing share of rise – is limited, as will be explained.) income will unavoidably go to capital owners. (Binaries consider both labor and capital to have their own “productiveness”.) Hence, the only way to avoid increased inequality, in their view, is to make everyone owners 377 See: ”1.3.1 Economic Growth Is the Increase in Produced and Traded of “wealth-creating capital assets”. Their suggestion – “the ownership Value – The Many Meanings of ‘Wealth’”. solution to the flaws of global capitalism” – is to increase private owner- 378 See: ”1.1.1 The Division of Labor – Cooperation and Sharing Infor- ship (distinguishing it from the Marxist suggestion of public ownership of mation: The Philosopher’s Stones of Mankind’s Progress”. the means of production) by granting people interest-free loans from the 84 | Value, Production and Markets

production technologies significantly limit the possible New choices of the labor-capital mix can often only be labor-capital mixes (i.e. possible capital intensity).384 385 made when old productive capacity comes to the end of its life cycle (the capital is almost fully “consumed”) or Also between such available mixes, the short-term demand is constantly rising, allowing for new profitable elasticity between capital and labor is often very low investments without the opportunity costs of needing – especially towards labor:386 If big investments into to abandon existing capacity. However, when the capital production machinery have been made, it might not be equipment is more generic, such as facilities, commonly worth abandoning them even if very cheap labor were to used vehicles or versatile, reprogrammable robots, they become available. In most cases, production machinery, can be liquidated more easily – by for example selling R&D and training etc. are so specialized that they can them for other uses (e.g. to sectors where labor costs or hardly be liquidated387 (i.e. divested profitably) and demand rise faster) – allowing more elasticity in the the investment costs are therefore mostly “sunk costs” “labor-capital mix” in certain industries. (costs that cannot be cancelled or redeemed) in terms of switching to another production technology. For example Distinguishing from the economic concept of “capital”, a paper machine and its components have few alternative forms of “financial capital” such as company shares and uses, and the work put into producing them cannot be corporate bonds (the ratio between which determines the undone. company’s “capital structure”) are essentially instruments for allocating the risks and the generated income streams central bank to help them make big investments in company equity. of a business or other bundle of assets to different Binary economists seem to omit completely that a big part of the compen- investors.388 sation for owning capital assets comes from carrying risks. Firstly, not everyone likes assessing and carrying risks. Secondly, people making private investments with their “future savings” through interest-free loans A common mental image seems to be that “labor” = would mean huge leverage (see: 1.1.10 Companies as Contract Bundles – “people” and “capital” = “money”. And with this view, the Financial Assets Allocate Risks”.). As a result, people who happen to be the owners of failed companies would end up with massive amounts of idea of capital (money) making a profit (more money) surely 389 debt without anything to cover for them. The result, in an evolving mar- seems perverse. This idea is strongly behind Marxism. ket economy would be extreme wealth inequality! As if our homeowner- However, it would be more descriptive to say that “labor” ship paradigm with its subsidies on low-deposit mortgages wouldn’t be = “activity” (or “effort”, which can also be fun) and bad enough already (see: 4.3.1). Also, binaries (like Marxists and many others) fail to see that, no matter “capital” = “patience + “risk bearing”. And both of these how productive capital assets would be, they can still make a loss, profit- are supplied by people – though often through companies, ably, if people are willing to save even at a loss and interest rates have no funds, foundations and other organizational forms.390 zero lower bound. The “impatience component” of the return on capital can turn negative. (Ashford 1994) Risk bearing could also be expressed as “responsibility”. –Gurland, Norman, G., 2008, “Binary Economics in a Nutshell”, Center This statement might sound hilarious in today’s world for Economic and Social Justice, cited 15.8.2014, http://www.cesj.org/ where private financial capital seems to take no learn/binary-economics/binary-economics-in-a-nutshell/ responsibility whatsoever over anything. And this 384 Take for example the process of increasing capital intensity in dishwashing. With minimal capital, you’d have to go down to the lake or river observation is quite true. Currently, companies are not to wash your dishes by hand. Getting some bowls and buckets allowing held responsible for their actions (including the you to wash them at home would be a first investment reducing needed externalities391 they cause) and many do not hold labor. Then you might get a dishwashing brush or scrub to make washing easier and more effective. Then you might build a plumbing and sewer- enough risk-bearing equity to be able to cover the risks in age system removing the need to fetch water (a fairly big investment). their ventures (especially those posed on natural Then you might build a drying cupboard. But after a couple of more of resources and ecosystems, and banks that have their such small improvements, the next step of increasing capital in the mix 392 would be buying/building a dishwashing machine. This technology has credit finance insured for free ). And that is something that only been available for a few decades and, even today, you can’t real- definitely needs to be fixed – and could be fixed much more ly invest in half-a-dishwashing-machine to save half the labor a whole easily with the Root Bug fixed first.393 machine would. And beyond the dishwasher, we might have to wait for household robot servants (filling and emptying the dishwasher) to be- 388 See: “1.1.10 Companies as Contract Bundles – Financial Assets Allo- come feasible investments to further increase capital intensity. Buying cate Risks”, “3.1.5 Too Big to Fail: The Casino Economy, ‘Financialization’ another dishwasher does not help, unless the existing capacity is in full and Irresponsible Risks in Banking” and “3.4.2 Biodiversity Deteriora- use. tion, Destruction of Scarce Habitats, Pollution and Contamination“. 385 For the marginal productivity theory in regards to wages of types 389 See: “Sidenote Box 118C: Marx’s ‘Capital’ Is Closer to Financial Cap- of labor, see: ”Sidenote Box 322A: The Causality Conundrum of ‘Produc- it a l”. tivity’: Even the ‘Marginal Productivity Theory’ Accounts for Scarcity”. 390 See: ”1.1.9 Companies as Competing Organizational Forms (Be- 386 E.g.: “[A]s the rate of interest falls, there is no systematic tendency cause Institutions Suck at Suicide) – ‘Pro-Business’ Is Not ‘Pro-Market’”. to adopt a more ‘capital-intensive’ technology, as the neoclassical model 391 See: ”1.1.11 The Fundamental Imperfections of a ‘Free Market’ – Ex- supposed.” ternalities and the Limitedness of Land”. – Galbraith, John K., 2014, ”Kapital for the Twenty-First Century?” Dis- 392 See: ”3.1.5 Too Big to Fail: The Casino Economy, ‘Financialization’ sent Magazine, Spring 2014, cited 21.4.2014, http://www.dissentmaga- and Irresponsible Risks in Banking” and ”4.2.2 Setting a Fee on the Gov- zine.org/article/kapital-for-the-twenty-first-century ernment Deposit Guarantee”. 387 See: “1.2.1 Money Facilitates Trade Through Liquidity and Broad 393 See: “1.1.10 Companies as Contract Bundles – Financial Assets Allo- Acceptability” and “1.1.9 Companies as Competing Organization- cate Risks”, “3.1.5 Too Big to Fail: The Casino Economy, ‘Financialization’ al Forms (Because Institutions Suck at Suicide) – ‘Pro-Business’ Is Not and Irresponsible Risks in Banking” and “3.4.2 Biodiversity Deteriora- ‘Pro-Market’”. tion, Destruction of Scarce Habitats, Pollution and Contamination“. Labor and Capital (and Land?) – The Factors of Production | 85

Sidenote Box 118C: Marx’s ‘Capital’ Is Closer to Financial Capital

Much of the negative taint394 to the word “capital” can probably be traced back to Karl Marx’s famous book by that same name. For a devout Marxist, reading the previous chapter might have caused excruciating emotional pain, with thoughts running along the lines of: “No! My skills and relationships can’t be capital! Capital is money looking to accumulate more money. Capital is exploitative! My skills are not exploitative.”

And that’s the way Marx defined “capital” (K). He considered money (M) to be normally used as an intermediary in selling and buying goods395 (C, commodities) to acquire other goods, describing this relationship as “C – M – C”. Capital, in Marx’s terms, is “money which is used to buy something only in order to sell it again” “for a profit” (M – C – M’).

In Marx’s view, the “social relation” of capital only exists within monetary trade and making a profit requires the “capitalist” to “exploit” the laborer by not giving him the full value of the produce of his labor.396 (Marx’s omission of time preferences and the costs of risk were discussed in the beginning of “1.1.8 Labor and Capital (and Land?) – The Factors of Production“.) But as we have explained here, “capital”, in the economic sense, is a relevant concept even for Robinson Crusoe stranded alone on an island making decisions regarding the building of shelter, the making of equipment or the sowing of seeds for the next harvest – i.e. regarding investments. His time preference and the expected yield of the investment opportunities available to him should be guiding his choices if he is acting even remotely “rationally”.397 This concept of “capital” is therefore not a “social relation”.

Marx’s definition of “capital” is very close to that often used in finance and accounting and what is referred to as “financial capital” in economics398: the funds that investors give to a company for investment purposes and other operating reserves. “Financial capital” can refer to money that is waiting to be invested and the amount of money that has been invested, or the claims to these investments (mostly their income) through financial assets like shares and corporate bonds. Classical economists also sometimes referred to money as “capital” although they didn’t consider money to be a factor of production (as didn’t Austrians399). Much, though not all, of what we call “real capital” in this book is what Marx would probably refer to as “the means of production”. (Marx 1887, p. 117-118)

But as explained in “1.1.8 Labor and Capital (and Land?) – The Factors of Production”, even financial capital only needs to make a profit if the investor considers risk to be a cost and even then only needs to make a profit compared to the less risky alternatives available, e.g. keeping one’s wealth as money (i.e. one’s capital as credit400) – which with the possibility of negative interest rates (nominal or achieved through predetermined inflation401) might also be expected to make a loss! Capitalism as such would not always require “money to accumulate more money”. Sometimes an investment can be profitable (enough) without making a profit at all and, even when investments make profits, the investor can spend more than he earns capital income.

More on how finance is essentially about allocating responsibilities and risks under “1.1.10 Companies as Contract Bundles – Financial Assets Allocate Risks”.

394 See: ”5.1.1 Our Emotional Attachment to Words”. 395 See: ”1.2.1 Money Facilitates Trade Through Liquidity and Broad Acceptability”. 396 “Capital”, Marxists.com Encyclopedia of Marxism, cited 21.5.2013, http://www.marxists.org/glossary/terms/c/a.htm 397 See: ”1.1.3 Value Is Subjective and Perceived – Rationality Is Largely an Illusion”. 398 “Borrowed sums or equity with which the firm’s assets are acquired and its operations are funded.” – “Financial Capital”, definition, BusinessDictionary.com, cited 21.5.2013, http://www.businessdictionary.com/definition/financial-capital. html 399 “It is unnecessary to demonstrate that money is not a consumption good [and i]t seems equally incorrect to call it a production good.” (Mises 1912, p. 79) 400 See: ”1.2.3 Money as Credit – Real Wealth vs. Virtual/Fiduciary Wealth”. 401 See: ”4.2.1 Eliminating the Zero Lower Bound with a Higher Inflation Target or by Eliminating Cash”. 86 | Value, Production and Markets

Sidenote Box 118D: Does Capital Provide Economic Security and Freedom?

Freedom is the by-product of economic surplus.” – Aneurin Bevan, founder of the National “Health Service The reality is that owning property does not give you security – it just gives your creditors security. Real security comes from having an income…” – Niall Ferguson, The Ascent of “ 402 Money

Undoubtably two significant motives for individuals to gather wealth are the economic security and freedom – the “option value” – that having wealth provides. These are likely to be often more significant motives than an increase in one’s living standards brought by capital income.

As explained in “1.1.4 Production Is for Consumption, i.e. Appreciation – ‘Productivity’ Has Many Units”, products and services have no value unless they are consumed – i.e. enjoyed, used, experienced or otherwise appreciated – by someone. Therefore neither capital nor labor (work) has any absolute value either. Their value, including their capacity to provide security and freedom, is derived from the expected consumption of the goods and services that are produced or could potentially be produced using them.

An example of the value of mere potential production is the existence of extra power plants that are only used in the case of an extremely cold winter or other energy shortage. Yet they produce value even when they’re not in use by providing a sense of security and reducing risks and thereby facilitating other activities even if such cold winters or shortages never actually occur. This security can produce financially measurable economic value as well by for example lowering insurance costs of things to which an energy shortage can cause significant damage and facilitating investments that would otherwise be too risky (e.g. industries, the processes of which are very expensive to start up and shut down).

You might now argue that having savings of money has value in that it provides economic security and freedom to the person in possession of the savings. We could regard economic security and freedom as added value (or even “services”) that any savings (capital) provide simply by being in one’s possession, due to their potential functional value or value in trade. Stockpiles of usable goods allow you to consume them later and assets you don’t like to consume yourself can have potential exchange value providing you with “liquidity”.403 Georg Simmel describes money as a “neutral good” that is pure opportunity to everything (Aro & Jokivuori 2010, p. 87) – and Alfred Mitchell-Innes would say that it grants the holder “credit”.404 Productive assets – like machinery and facilities – grant the owner more freedom by making it possible to produce better goods more easily in the future.

However, no asset or savings provide economic security or freedom to the owner unless: —— the asset is itself consumable to the owner (value in use, e.g. a storage of tin food), or —— the asset can be expected to be exchangeable for something valuable (value in trade, e.g. money or investment gold), or —— the asset facilitates future production of something consumable or tradeable for the owner (it is a production good, e.g. the above described reserve power plant case or a house one can live in).

402 3:54:41->, ”The Ascent of Money: A Financial History of The World by Niall Ferguson Episodes 1-5”, BBC Documentary, viewed 15.3.2013, http://www.youtube.com/watch?v=4Xx_5PuLIzc 403 See: “1.2.1 Money Facilitates Trade Through Liquidity and Broad Acceptability“. 404 See: “1.2.3 Money as Credit – Real Wealth vs. Virtual/Fiduciary Wealth”.

Continued on page 87 ► Labor and Capital (and Land?) – The Factors of Production | 87

► Along Fisher’s definition of capital, these kinds of potential to provide future benefits (Fisher’s “enjoyment income”) is what makes assets capital and determines their value.

Capital that provides additional production capacity or otherwise facilitates reacting to the realization of risks does provide security. A storage of resources that the owner deems useful himself provides economic security, but stockpiles of such capital are not productive, but rather make a loss in real terms due to their storage costs, decay and technological obsolescence, as explained under “1.1.8 Labor and Capital (and Land?) – The Factors of Production”. It is therefore important to carefully consider whether the security provided by the products or currently unemployed equipment is worth the costs of holding on to them.

The security and freedom provided by consumable goods acquired for their exchange value is similarly dependent on them maintaining their use value for others – the demand persisting – and supply not increasing too much. However, holding on to credit (including all money in our current monetary system) – others’ debt – as an asset provides economic security to the individual on the expense of the economic security of others in the economy: It does not increase total economic security, as holding onto that credit implies that someone else is that much more in debt. On the contrary, an increased amount of credit and other liabilities in an economic system often increases the system’s instability and the systemic risks therein. A lot of empirical evidence and research suggest that high amounts of debt in an economic system correlate with instability and the likelihood of economic crises.405 (Sutherland et al 2012) Also, e.g. holding gold provides security value only if someone can be expected to give something useful in exchange for it.

Therefore, the security and freedom provided by capital does not exist apart from its potential to produce other value. On the contrary, the more one has, the more one has to lose (which is also a form of “insecurity”). Total real wealth in the economy is practically determined by future consumption and the capital intensity of technologies used (natural resources and monopolies are exceptions)406.

However, gathering capital is not the only – nor the most sustainable way – of increasing one’s economic security and freedom. Sustainable economic security can be achieved for everyone without reducing it for others by ensuring that everyone has earning opportunities in the long run, as is explained in “3.2.1 Maximal Economic Security with Maximal Flexibility – Flexicurity and Antifragility”. As long as one can be expected to be able to make a living and pay back one’s debts eventually, one’s current wealth – net value of assets owned – is quite irrelevant in terms of economic security.

The determinants and limits of total wealth (capital) available to possess in the economy are discussed in “1.3.2 In a Closed Economy, Net Monetary Wealth Is Zero – Total Real Wealth Depends on Future Consumption and Capital Intensity (and Monopolies)”.

405 See also: ”2.2.6 Post-Keynesian Solutions – Ignore Hyperinflation Risks and Guarantee Jobs”. 406 See: ”1.3.2 In a Closed Economy, Net Monetary Wealth Is Zero – Total Real Wealth Depends on Future Consumption and Capital Inten- sity (and Monopolies)”. 88 | Value, Production and Markets

In the division of the product between Capital, as we have seen, consists of wealth capitalists and proletariat everything used for the procurement of more wealth, as “depends upon the ratio of demand to supply. “distinguished from wealth used for the direct The capitalist can expect interest on his means satisfaction of desire; or, as I think it may be of production only as long as demand exceeds defined, of wealth in the course of exchange. supply.” … “If employers of labour were offered Capital, therefore, increases the power of labor money-capital at half the present rate of interest, to produce wealth: (1) By enabling labor to the yield of every other class of capital would apply itself in more effective ways, as by digging soon also fall to half.” – Silvio Gesell, The up clams with a spade instead of the hand, or Natural Economic Order (1916, Part 5, Ch. 6 & moving a vessel by shoveling coal into a furnace, Introd.) instead of tugging at an oar. (2) By enabling labor to avail itself of the reproductive forces of [B]esides the primary and universal requisites nature, as to obtain corn by sowing it, or animals “of production, labour and natural agents, by breeding them. (3) By permitting the division there is another requisite without which no of labor, and thus, on the one hand, increasing productive operations, beyond the rude and the efficiency of the human factor of wealth…” scanty beginnings of primitive industry, – Henry George, Progress and Poverty (1912, p. are possible: namely, a stock, previously 56) accumulated, of the products of former labour. This accumulated stock of the produce of labour The establishment of any new manufacture, is termed Capital. The function of Capital of any new branch of commerce or of any new in production it is of the utmost importance “practice in agriculture, is always a speculation, thoroughly to understand, since a number of from which the projector promises himself the erroneous notions with which our subject is extraordinary profits. These profits sometimes infested originate in an imperfect and confused are very great, and sometimes, more frequently, apprehension of this point. perhaps, they are quite otherwise; but in general they bear no regular proportion to those of other Capital, by persons wholly unused to reflect on old trades in the neighbourhood. If the project the subject, is supposed to be synonymous with succeeds, they are commonly at first very high. money.” … “Money cannot in itself perform any When the trade or practice becomes thoroughly part of the office of capital, since it can afford established and well known, the competition no assistance to production. To do this, it must reduces them to the level of other trades.” – be exchanged for other things; and anything, Adam Smith, An Inquiry Into the Nature and which is susceptible of being exchanged for Causes of the Wealth of Nations (1776, p. 99-100) other things, is capable of contributing to production in the same degree. What capital does for production, is to afford the shelter, protection, tools and materials which the work requires, and to feed and otherwise maintain the labourers during the process.” – John Stuart Mill, Principles of Political Economy (1848, Book 1, Ch. 4, Sec. 1) Companies as Competing Organizational Forms (Because Institutions Suck at Suicide) – ‘Pro-Business’ Is Not ‘Pro-Market’ | 89

1.1.9 Companies as organizational forms out of e.g. empathy or pity. No human being or economic Competing Organizational system should be dependent on any single Forms (Because Institutions profit-seeking institution. Suck at Suicide) – ‘Pro- The essential and defining properties of any Business’ Is Not ‘Pro-Market’ “system are the properties of the whole which none of its parts have.” … “If we have a system In short: of improvement that is directed at improving the • Companies (profit-seeking corporations) parts taken separately, you can be absolutely sure are competing organizational forms for that the performance of the whole will not be achieving certain desired ends and are in improved.” – Russ Ackoff407 a constant battle of survival against each other. The fragility of every startup is necessary for the economy to be antifragile, and • This process of creative destruction mim- “ that’s what makes, among other things, ics the process of genetic evolution so that entrepreneurship work: the fragility of individual products and processes can progress with- entrepreneurs and their necessarily high failure out any people needing to starve or die. rate.” … “A natural organism is not a single, • Companies don’t exist to provide em- final unit; it is composed of subunits and itself ployment. Individual companies aim at may be the subunit of some large collective. maximizing value produced for sharehold- These subunits may be contending with ers, but the whole market “ecosystem” of each other. Take another business example. competing companies exists to maintain Restaurants are fragile; they compete with each optionality and maximize value for clients other, but the collective of local restaurants and employees. This includes reducing is antifragile for that very reason.” – Nassim disliked effort and other waste and un- Nicholas Taleb, Antifragile (2012, p. 65) necessary costs as much as possible. A lot of misunderstandings and senseless Groupishness is generally actually good! A economic policies are supported by the “lot of research in social psychology shows prevailing “fallacy of composition” that that when you divide people into teams to confuses the objectives of individual com- compete, they love their in-group members a lot panies with the functions and purposes of more and hostility towards out-group members corporate competition and other market is usually minimal.” … “But cooperation and mechanisms. competition are opposite sides of the same coin. And we’ve gotten this far because we cooperate • Companies need to be allowed to go bank- to compete.” – Jonathan Haidt408 rupt when they fail in their mission, when their products or service become redun- Of course human groups are nowhere near dant, or with the emergence of organiza- “as cohesive as beehives. Human groups tional forms better fitting the ecosystem may look like hives for brief moments, but they and consumers’ needs. They also need to tend to then break apart – we are not locked be severely punished – with bankruptcy if necessary – when they impose externalities on others (e.g. through environmentally 407 4:04-> & 5:27->, “If Russ Ackoff had given a TED Talk...”, a presenta- unsustainable activities) or when they tions in 1994, viewed 16.10.2013, http://www.youtube.com/watch?v=O- qEeIG8aPPk break the rules of fair competition. There 408 4:20-> & 26:00->, Haidt, Jonathan, 2012, “Jonathan Haidt Explains is no reason to be merciful towards Our Contentious Culture”, interview, viewed 12.12.2013, http://www. youtube.com/watch?v=jHc-yMcfAY4 90 | Value, Production and Markets

into cooperation the way bees and ants are.” – example “The Corporation” documentary) are appalled 409 Jonathan Haidt by and want to change. There is, however, a very good reason for this law: Anyone can buy the shares of listed companies and people’s values tend to differ greatly.414 As explained in “1.1.1 The Division of Labor – Cooperation The most generic way to create value for all shareholders and Sharing Information: The Philosopher’s Stones of is to transfer it to them as money – generic, liquid credit – Mankind’s Progress”, specializing and cooperation have which they can then use for whatever ends they wish. If allowed people to improve the productivity of their work the majority, say 70 %, of a listed company’s shareholders significantly and automate parts of production. There suddenly decided that the company should divert its are of course many ways in which people can cooperate attention from monetary profits to another cause they and many ways to arrange production. Companies are consider valuable, say, increasing education and general organizational forms that represent different ways of knowhow of GPS systems (they might e.g. also be owners producing goods and services and of people organizing of another company making GPS systems and hence and cooperating around that form of production (e.g. would benefit from the agenda indirectly as increased Crowston 1996; Romanelli 1991; Child & McGrath supply of skilled labor), then the rest of the shareholders, 2001). They are practically evolutionary units in a fierce who have no interest in such an agenda, would practically “natural selection” process that closely mimics the natural be robbed of their capital – the profit streams they were evolution410 of biological life forms. expecting.415 The market value of their shares would drop, and reselling the shares, which now are likely to pay An individual company’s objective is to produce maximal smaller dividends in the long run, would prove difficult, value for its shareholders.411 And mostly this happens as a majority of other investors would likely not be by making profits and transferring parts of them to their interested in the new agenda. shareholders by monetary means (i.e. as credit412), but the added value need not necessarily be money. For an This is one reason why, even in unlisted companies, it unlisted company, shareholders can also decide on other is important to determine in shareholders’ agreements values that the company should pursue as ends. However, how shares can be resold and what kind of majority of the taxation systems of many countries encourage rather shareholders is needed to change a company’s priorities establishing a non-profit organization for such purposes. and major strategic objectives. And if you only value things in the pursuit of which monetary gains cannot Some countries also allow listing companies as partly- help you (e.g. true love, as the Beatles have declared that for-profits, for example as “benefit corporations” in “money can’t buy [it]”), you really shouldn’t invest in some states in the U.S., which allow the company to shares of listed companies. legally pursue other ends than monetary profits and to discriminate between potential buyers and investors Under fair competition, companies need to compete over (when raising additional funding) on other standards (1) customers, for whom they try to provide as suitable and than their financial offer.413 This might make sense when valuable goods as possible, and (2) labor, which they try an investor wants to both make profits and make certain to utilize as efficiently as possible (including making the societal impacts, as this allows avoiding corporate and supplying of that labor as rewarding and fun as possible, capital income taxes compared to owning one for-profit i.e. less laborious for the suppliers, employees) in order to corporation and transferring (taxed) income from this to produce the maximal profits possible for capital – to be e.g. a separate charity organization. able to compete against other investment options available for that capital. Companies that are not expected to make Publicly listed companies – companies whose stock is good enough profits on their capital do not usually receive traded on a stock exchange – are, in many countries, additional financial capital investments to finance further legally required to only pursue financial profits, and real investments – and even current investments might be this is something that many activist groups (and for liquidated.416

“Profit” is one word that has achieved a very negative taint. 409 14:00->, Haidt, Jonathan, 2012, “Religion, evolution, and the ecstasy of self-transcendence”, TED Talk, viewed 13.12.2012, http://www.you- But what is it really about? The added value the company (or tube.com/watch?v=2MYsx6WArKY a project or any other activity) produces is the difference 410 As the title of a book by Brian Loasby (1991) summarizes, in a mar- between the value created for its customers – and other ket economy, the economic issues of coordination and change are issues of (a tendence towards) equilibrium and evolution, respectively. 411 A company’s mission (or mission statement) usually expresses the 414 See: “1.1.3 Value Is Subjective and Perceived – Rationality Is Largely way in which it does this – the value it aims to provide for its customers. a n I l lu sion”. 412 See: “1.2.3 Money as Credit – Real Wealth vs. Virtual/Fiduciary 415 See: ”1.1.8 Labor and Capital (and Land?) – The Factors of Produc- We a lt h”. t ion”. 413 “What is a Benefit Corporation”, Benefit Corp Information Center, 416 See: “1.1.10 Companies as Contract Bundles – Financial Assets Allo- cited 26.6.2013, http://benefitcorp.net/ cate Risks”. Companies as Competing Organizational Forms (Because Institutions Suck at Suicide) – ‘Pro-Business’ Is Not ‘Pro-Market’ | 91

stakeholders, including employees – minus the value lost or high entry barriers (i.e. costs or other thresholds for a in production. Profit is the part of this added value that new player to enter the industry).418 the company manages to “capture” for itself, i.e. for its shareholders. Profit can be measured for all of the capital An organizational form that isn’t the best at providing involved in the company’s operations, a common measure for any needs of any customer segment dies away – for which is Return on Capital Employed (ROCE)417 goes bankrupt or ceases operations in another way – as organizational forms performing better take over its share ROCE = Earnings / TotalAssets of the market. When a new industry is emerging, often tens or even hundreds of new companies (or divisions in or for the shareholders, as Return on Equity (ROE) existing companies) are established, but as the industry starts finding its form, most of them disappear: either go ROE = Earnings – InterestCosts / Equity. bankrupt, merge into other companies or move their focus to other industries or niche markets. Mature industries are More on equity and balance sheets under “1.1.10 Companies often dominated by a handful of players – either locally as Contract Bundles – Financial Assets Allocate Risks” or globally, depending on what is optimal for that specific and “1.2.6 Banking: Accounting for Debts and Credits and industry. In services, benefits of scale are usually smaller Pricing Risks – There Is No ‘Fractional Reserve’”. than in physical products, which gives less advantage from global consolidation. Of course, successful service Any competitively open industry with high profits will concepts spread globally too – often as franchises – and attract more investment and competition – similarly to capture significant market shares (e.g. McDonald’s and how plentiful energy sources and otherwise attractive Starbucks). habitats attract life forms to fill their “ecological niches” – while industries with decreasing demand see tighter As said, the ingenuity of this system of ruthless competition and lower profits, which encourage the competition is how it mimics the evolutionary process companies and investors to direct their expansionary of biological life forms to increase mankind’s collective investments to other industries and to divest capital in the abilities. Practices and structures can evolve efficiently less profitable industry if possible. Competition pushing without any human being needing to go bankrupt or down prices and raising wages moves a larger share of the starve to death. When companies go bankrupt, the created value to customers and employees. employees can start working for the better performing organizational forms or in completely new industries “The establishment of any new manufacture, of any providing for different needs.419 This is not only “humane”, new branch of commerce or of any new practice in but also more efficient, as competences and information agriculture, is always a speculation, from which the acquired by individuals in previous attempts are not lost, projector promises himself extraordinary profits. but can be leveraged to help develop other companies. These profits sometimes are very great, and sometimes, more frequently, perhaps, they are quite otherwise; It is a very popular trend to blame the world’s ills on but in general they bear no regular proportion to those profit-seeking corporations, to insist that a market of other old trades in the neighbourhood. If the project economy composed of such profit-seeking entities succeeds, they are commonly at first very high. When cannot be sustainable (and always has to grow420) and to the trade or practice becomes thoroughly established try to either eliminate this corporate structure or make and well known, the competition reduces them to the companies strive for something else instead of profits. level of other trades.” (Smith 1776, p. 99-100) Such conclusions result largely from a similar fallacy of composition as if one would conclude that natural Without fair and open competition, companies easily ecosystems where every individual and species are emphasize maximizing the share of added value that only concerned for their own survival and maximal they capture – i.e. keeping prices high or wages low (in a reproduction and expansion cannot be sustainable or monopsonistic employer position) – instead of maximizing would always need to grow as a whole. The objective of the added value they produce by e.g. developing their products, processes and working conditions. Therefore, 418 See: “4.3.4 Making Natural Monopoly Industries Sources of Public private ownership and the profit motive are not the most Reve nue”. efficient solutions in industries with natural monopolies 419 This suggests a potential incompatibility in combining this kind competitive capitalism with a strongly collectivist (Hofstede 1984) culture (typical for Asian nations), where people become strongly emotionally and socially attached and are extremely loyal to the societies and organizations they belong to. However, currently, with labor quantized into jobs and little competition over employees, many people are just as 417 “Return on Capital Employed”, definition, The Free Dictionary – Fi- dependent on their employer in Western economies as well (see: ”3.2.2 nancial Dictionray, cited 22.10.2013, http://financial-dictionary.thefreed- Unfair Income Differences and Limits to Social Mobility”). ictionary.com/ROCE 420 See: ”3.1.2.2 ‘Companies Have to Grow or Die’”. 92 | Value, Production and Markets

VALUE

TOTAL VALUE PRODUCED

CUSTOMER ADDED PRICE (VALUE CAPTURED) VALUE (AVERAGE)

EBIT COSTS (EARNINGS BEFORE INTEREST AND TAX)

SHARE- PAYMENTS CREDIT WAGES HOLDER TO SUPPLIERS COSTS PROFIT

PRICE ADDED VALUE

COSTS EBIT

PTS W ......

GRAPH 9: DISTRIBUTION OF VALUE PRODUCED BY A COMPANY. one element is not necessarily the objective, outcome or as a productive and enjoyable company culture (if there is purpose of existence of the whole system. competition over employees421).422

For example economist Ha-Joon Chang falls into this trap This also raises the importance of the distinction between when arguing that: “pro-market” policies and “pro-business” policies.423 424

“[t]he worst thing about shareholder value 421 See: “3.2.2 Unfair Income Differences and Limits to Social Mobility” maximization is that it does not even do the company and “3.1.3 Structural, Friction and Classical Unemployment, NAIRU and itself much good.” (Chang 2010, p. 19) Hysteresis – Is 5 % Unemployment Really Necessary?”. 422 Chang’s arguments for why profit seeking is bad for the economy are mostly built around the uncertainty this causes for employees (Chang From an “ecosystem perspective”, this is the best part 2010, p. 18 & 21), which is the result of the Root Bug (see: ”2.3.2 The Over- about the objective of maximizing shareholder value. The looked Option – Increase Correlation of Earning Opportunities with the ruthless competition for nourishment and reproductive Will To Spend and Invest”) and the notion that this reduces investments (Chang 2010, p. 19 & 21), but avoiding unprofitable investments (ones opportunities (as well as trying to escape predators) in for which there is insufficient demand) is a very desirable outcome. In an ecosystem is not “good for” any single rabbit or lion – his book “23 Things They Don’t Tell You About Capitalism”, Chang also but it is what keeps the species and the whole ecosystem enlighteningly explains the history of how “the principle of shareholder value maximization” partially emerged to mitigate the agent-principal developing and adaptable to changing circumstances (e.g. problem between shareholders and professional, non-owner managers a climate change). (Chang 2010, p. 17). This issues is discussed in more detail in “Sidenote Box 322B: The Special Case of CEO Pay – Efficiency Wages and the Cor- Competition is not good for companies themselves, nor rupting Nature of Power”. 423 Patterson, Sam, “’Pro-Business’ or ‘Pro-Market’? And What’s the their shareholders, but it is good for customers – resulting Difference?” Economic Freedom, 5th Feb 2013, cited 16.4.2013, h t t p :// in better and cheaper products and services – and www.economicfreedom.org/2013/02/05/pro-business-or-pro-market- employees – encouraging better working conditions, more and-whats-the-difference/ 424 Carden, Art, “’Free Market’ Doesn’t Mean ‘Pro-Business’”, motivatingly organized tasks and responsibilities as well Forbes, 20th Sep 2010, cited 10.2.2014, http://www.forbes.com/sites/art- carden/2010/09/20/free-market-doesnt-mean-pro-business/ Companies as Competing Organizational Forms (Because Institutions Suck at Suicide) – ‘Pro-Business’ Is Not ‘Pro-Market’ | 93

425 It is often in the interest of individual businesses to progress (especially non-linear, disruptive progress) can restrict competition, while competition is what makes happen efficiently without people having to die is by a market more efficient. Business schools especially institutions rendering each other unnecessary. That’s what teach managers how to avoid competitive pressures and companies are doing, by outcompeting each other into achieve lock-in positions with clients, e.g. by promoting bankruptcy. high switch costs or demand-side benefits of scale (such as network effects). Michael Porter’s “five forces” model So, ironically, companies, in a sense, do the biggest service (Porter 1979; Porter 2008) – which has been a focal part of to society by going bankrupt!431 Ok – maybe that is an business strategy 101 courses for decades – is one example overstatement in terms of individual companies, but at of a framework that allows managers and investors to least we can say that a market with very few companies assess the attractiveness of an industry or market based going bankrupt (or otherwise ending operations) is not on how little competitive and bargaining pressure current a healthy market. The fragility of individual companies players, potential entrants, suppliers, customers and makes the whole economy “antifragile” (Taleb 2012, p. 65- possible substitute products pose. This allows identifying 80)432. market gaps – currently unfulfilled customer needs – but unfortunately also allows developing strategies to limit “The problem is graver than you think: People go to competition, through e.g. developing a lock-in position. business school to learn how to do well while ensuring their survival – but what the economy, as a collective, The “pro-market” vs. “pro-business” distinction is as wants them to do to not survive, rather to take a lot, a important as the distinction between nature conservation lot of imprudent risks themselves and be blinded by and animal rights protection. When an invasive rabbit the odds.” (Taleb 2012, p. 75) population is disrupting the Australian ecosystem and threatening indigenous plant species, an animal Politicians like to boast with having profitable, long- rights activist might object to attempts of controlling standing companies in their country and laud ones that the population with the myxoma virus (a sexually provide a lot of (stable) employment. But a situation where transmitted virus resulting in painful death) or the rabbit few companies go bankrupt and a majority of companies calicivirus,426 while a nature conservationist would not make big profits (compared to the general interest rate) eschew such “cruelty” to protect the biodiversity and is a signal of a non-competitive and inefficient market433, balance of the ecosystem. In nature, individual animals which doesn’t put much pressure on companies to have no rights. It is not necessarily very constructive improve products and processes. to start empathizing with zebras that are eaten alive by hyenas. Similarly, a pro-business politician will promote Companies do not exist and are not established to provide government intervention to save big companies or protect employment. The more efficient processes are made, the local industries to e.g. preserve jobs427 or prevent losses to less companies employ labor per unit produced. And pension funds and other shareholders, but a pro-market the only reason such increases in labor productivity are politician considers it part of a “natural” and “healthy” currently deemed “bad” (by politicians and the general evolutionary processes that incumbent companies are public) is that the remaining work is not allocated “disemboweled” by competitors or asset strippers,428 that optimally, because labor is quantized into jobs, i.e. because new companies emerge to take over the markets or that the unit of labor is a human being.434 The competition some industries completely disappear from a region. between companies (the evolution of organizational forms) exists to eliminate waste435 (i.e. unnecessary work), Actually, because organizational forms and other not to create more work. institutions – just like life forms – are inherently self- preserving and hence almost incapable of rendering A very popular catchphrase nowadays in political themselves unnecessary,429 430 almost the only way demonstrations is, “X[education, medicine, housing etc.] is for people, not for profits”. But everything an 425 Carter, Stephen L., “True Capitalists Are Pro-Market, Not Pro-Busi- ness”, Bloomberg Opinion, 8th Jun 2012, cited 10.2.2014, http://www. the white rabbit, the white rabbit is all you can think about. The way to bloomberg.com/news/2012-06-07/true-capitalists-are-pro-market-not- forget it is to focus on other things of higher interest. pro-business.html 431 The Finnish word for a company or enterprise is “yritys”, which 426 “Rabbit Problems in Australia”, Animal Control Technologies (Aus- originally means “a try” or “an attempt”. tralia) Pty Ltd, cited 29.9.2013, http://www.animalcontrol.com.au/rabbit. 432 See: “3.2.1 Maximal Economic Security with Maximal Flexibility – htm Flexicurity and Antifragility”. 427 See: ”2.3.1 The Job Creation Paradigm – Why Are We Trying to 433 See: “1.1.6 The ‘Market Forces’ – How Prices Balance Supply and De- Make More Work?!”. m a nd”. 428 See: ”1.1.10 Companies as Contract Bundles – Financial Assets Allo- 434 See: “2.3.2 The Overlooked Option – Increase Correlation of Earn- cate Risks”. ing Opportunities with People’s Willingness to Spend and Invest”. 429 See: ”5.1.4 Institutional Interests – Rogue Agents without a Princi- 435 Pawlik, Greg, “Muda – What is it?” The Toyota System, 17th Mar pa l”. 2009, cited 10.2.2014, http://www.thetoyotasystem.com/lean_concepts/ 430 This is the nature of ideas in genaral: If you try not to think about muda_what_is_it.php 94 | Value, Production and Markets

economy does – all its industries and processes – should finally be for people. Even profits should be for people. In considering whether an industry should be opened to competition between profit-seeking organizational forms, the relevant question we should ask is whether such competition in the industry can work fairly so that the profit-motive makes the companies produce more added value to the customers and employees than a publicly Chapters 1.1.10-1.2.2 and Sidenote Box 119A owned industry would. High natural entry barriers436 are one aspect that might make competition work inefficiently. not included in this sample More on this in “4.3 Eliminating Private Monopolies and (Other) Privileges”.

Companies should aim to maximize profits. But it is a bit of a fallacy of composition to conclude from this that every employee – or even the top management – should have their minds on profits only. Few companies’ mission statements say, “just make money”437 – and this is not merely a matter of public relations (PR). Just like happiness is best achieved by focusing on other things than trying very hard to “be happy”,438 profits are often maximized by focusing on things like creating an encouraging and fun company culture. Focusing on “grabbing the money” easily leads to a short-termist orientation that is detrimental for things crucial for maintaining a sustainable competitive advantage, such as customer satisfaction and loyalty, a salient brand with strong values and relentless product and process development.439 440 But such factors of course depend very much on the characteristics of the industry in question.

436 Michael Porter (2008, p. 26-29) lists as the main barriers of entry (1) supply-side benefits of scale, demand-side benefits of scale (i.e. network effects), customer switch costs, capital requirements, (5) Incumbency ad- vantages independent of size, (6) unequal access to distribution channels, (7) restrictive government policy and (8) expected retaliation (by incumbent players). 437 ”Making money” is in any case a misleading expression for generating revenue or earning an income. See: ”1.2.3Money as Credit – Real Wealth vs. Virtual/Fiduciary Wealth5.1.2The Misleading Conceptual Metaphor of Money as Items or Substance”. 438 See: ”6.1.1 Appendix 1.1: Happiness Is Appreciating – A Framework of Happiness” and “2.1.4 Utilitarianism and Happiness Politics/Econom- ics – Does Measuring Happiness Make Sense?”. 439 Mukunda, Gautam, “The Price of Wall Street’s Power”, Harvard Business Review, Jun 2014, cited 5.6.2014, http://hbr.org/2014/06/the- price-of-wall-streets-power/ar/1 440 How short-term-oriented companies and investors are, also depends on the market interest rate. See: ”4.2.3.5 More Long-Term-Oriented Investment and Company Management”. 110 | Credit, Money and Banking

1.2.3 Money as Credit – Real Wealth vs. Virtual/ Fiduciary Wealth In short: • Being “in possession of money” ultimately represents expectations of future services or other payments from others – just like credit. A “medium of exchange” is a very misleading expression for money. Attempts (made throughout the past centuries) to separate money into a wholly distinct thing from other credit cause a lot of unnecessary confusion. It is much simpler and more descriptive to regard money as a liquid form of credit. • Our current dollars and euros – both as physical cash and “deposits” – are explicitly credit: liabilities mediated by retail banks and central banks and finally backed by the government, making them equally risk-free and hence interchangeable. • Even money represented by a commodity, e.g. gold coins, can be regarded as credit. If someone has promised to (or is legally required to) accept it as payment for something, that party is the de facto debtor. If trade is conducted with a commodity that no one has a responsibility to accept as payment, then such a commodity money (or any other token of relatively fixed quantity) is practically a constant speculative bubble. Its “money value” (including any “liquidity premium”) cannot be considered “real value” in the same sense as the use value of consumption and production goods. There is no such thing as a medium of “exchange. A sale and purchase is the exchange of a commodity for a credit. Credit and credit alone is money.” – Alfred Mitchell-Innes (1914) Money as Credit – Real Wealth vs. Virtual/Fiduciary Wealth | 111

The community’s wealth now has two provides very interesting insight and explanatory power components: the real goods accumulated into both the domestic price stabilities of sovereign “ currencies and their exchange rates. through past real investment and fiduciary or paper “goods” manufactured by the government In Mitchell-Innes’s terminology, when people provide paid from thin air. Of course, the nonhuman wealth services to others, they always receive ‘credit’ and buyers of such a nation “really” consists only of its always incur debt. This applies regardless of what kind of tangible capital.” – James Tobin (1965) accounting system – physical cash or paper or electronic balance sheets – is used to keep track of these credits.

Money is credit. It expresses a debt-relation, “A credit cancels a debt; this is the primitive law of “a promise or obligation, which exists commerce. By sale a credit is acquired, by purchase a between human beings and cannot be identified debt is created. Purchases, therefore, are paid for by independently of its institutional usage. It sales.” (Mitchell-Innes 1914) expresses a social relation and will, following “A sale, according to this theory, is not the exchange Keynes, Minsky and Wray be treated as a of a commodity for some intermediate commodity balance sheet operation.” – Stephanie Bell (2001, called the ‘medium of exchange,’ but the exchange of a p. 150) commodity for a credit.

[M]oney is nothing but book-keeping: It is There is absolutely no reason for assuming the existence of so clumsy a device as a medium of figures. It is a way of measuring what you “ exchange when so simple a system would do all owe the community and what the community that was required. What we have to prove is not a owes you.” … “Finally, I said: ‘The trouble strange general agreement to accept gold and silver, with you gentlemen is you still think money is but a general sense of the sanctity of an obligation.” real.’” … “It has the same relationship to real (Mitchell-Innes 1913) wealth – that is, to actual goods and services – As mentioned in “1.2.1 Money Facilitates Trade Through that words have to meaning – that words have Liquidity and Broad Acceptability”, the value of money – to the physical world. And as words are not the even when it is a commodity like gold – is only for a very physical world, money is not wealth. It only is small part based on its production costs or its demand an accounting of available energy – economic for functional uses, but instead mostly on its exchange 510 value – what it can be exchanged for – which is something energy.” – Alan Watts with which even Austrian economists would agree.511 In Mitchell-Innes’s view, gold coins are merely tokens We can view credit and money as separate institutions (as representing credit. Even when it doesn’t directly involve many of the critics of the “fractional reserve banking” as any specific person’s explicit debt liability to pay something well as both Austrians and Marxists insist) and only see specific for it (as all money in our current credit system “credit money” as one monetary option. Or, alternatively, does512), its value is based on the assumption – trust – that we can expand our conception of the word “credit” – along someone will give something for it. The “implicit its original etymology as “trust” – and see all money as debtor” (not Mitchell-Innes’s term) is whoever has credit. In 1914, Alfred Mitchell-Innes presented his “Credit promised to accept the currency as payment for the Theory of Money”, which rejects the idea that there is any services or goods she provides. “Credit” – from the such thing as a “medium of exchange” and suggests that Latin word “credo”, faith or trust – in this case refers calling gold coins “commodity money” is very misleading. to this trust that it will be accepted as payment for goods and services in the future. If all parties that sell To put things bluntly, many of the major economic goods (for the acquisition of which you have acquired the disputes and “paradoxes” can be partly traced back to currency) stop accepting the currency as payment, you the desperate, centuries-long attempt to strictly separate have suffered a “credit loss” – your expected payment is money and credit conceptually from each other. Issues left unfulfilled. would become much clearer and simpler to solve if we just treated money as a form of credit – in both economic models and everyday discussions. This perspective 511 “…money has no use-value at all, but only subjective exchange-value.” (Mises 1912, p. 97) 510 16:05-> & 21:23->, Watts, Alan, ”Money and Guilt”, lecture/speech, 512 See: “1.2.6 Banking: Accounting for Debts and Credits and Pricing viewed 16.1.2014, http://www.youtube.com/watch?v=c7tlaF3dv_M Risks – There Is No ‘Fractional Reserve’.” 112 | Credit, Money and Banking

Austrian economists insist that gold coins are “commodity “Economists err if they believe something is wrong money” and that their value as a “medium of exchange” when money is not in constant, active ‘circulation.’ is “real value” and that they are no one else’s liability. Money is only useful for exchange value, true, but it Ludwig von Mises for example refers to banknotes tied to is not only useful at the actual moment of exchange. This a gold standard as “money-substitutes” – and sees them as truth has been often overlooked. Money is just as not deserving the name “money” at all. (Mises 1912, p. 53) useful when lying ‘idle’ in somebody’s cash balance, even in a miser’s ‘hoard.’ For that money is being held Murray N. Rothbard is yet more fundamentalistic towards now in wait for possible future exchange – it supplies this framework: to its owner, right now, the usefulness of permitting exchanges at any time – present or future – the owner “A most important truth about money now emerges might desire.” (Rothbard 1963, p. 32) from our discussion: money is a commodity. Learning this simple lesson is one of the world’s most And interestingly he concludes that (in his visioned important tasks. So often have people talked about commodity money system) uncertainty is the only reason money as something much more or less than this. people wish to hold money at all and that, therefore, Money is not an abstract unit of account, divorceable without economic insecurity, the whole monetary system from a concrete good; it is not a useless token only would collapse: good for exchanging; it is not a ‘claim on society’; it is not a guarantee of a fixed price level. It is simply “Thus, ironically, if it were not for the uncertainty of a commodity. It differs from other commodities in the real world, there could be no monetary system at being demanded mainly as a medium of exchange.” all! In a certain world, no one would be willing to hold (Rothbard 1963, p. 5) cash, so the demand for money in society would fall infinitely, prices would skyrocket without end, and But as e.g. William Hutt points out: any monetary system would break down.” (Rothbard 1963, p. 32-33) “If the work of money is circulation, then money is always ‘idle’ because transactions are quasi- If we really needed a “medium of exchange” to conduct instantaneous.” … “The transfer [of money] itself trade, and money was saved just so that trade would be occupies a mere moment whilst the services which possible in the future, it wouldn’t matter who held the flow from the possession of money are continuous over money until then. Such a need for future trade to happen time. The essence of all these services is availability.” would not affect individuals’ demand for holding money. (Hutt 1975) And as the transactions themselves take very little time (especially with today’s electronic banking), the demand for Von Mises also accepts that money is not only valuable in holding money is not determined by the current amount of the transactions themselves. transactions, but by people’s desire to postpone their own purchasing power for the future. “It must be recognized that from the economic point of view there is no such thing as money being idle. … In “Smith’s definition of money as being, not wealth, but fact, since money that is surrendered in an exchange the ‘wheel which circulates wealth,’ does not explain is immediately transferred from the ownership of the the facts which we see around us, the striving after one party to that of the other, and no period of time money, the desire to accumulate money. If money were can be discovered in which it is actually in movement, but a wheel, why should we try to accumulate wheels. all money must be regarded as at rest in the cash Why should a million wheels be of more use than one, reserve of some individual or other.” … “What is or, if we are to regard money as all one wheel, why called storing money is a way of using wealth.” (Mises should a huge wheel serve better than a small one, 1912, p. 147) or at any rate a moderate one. The analogy is false.” (Mitchell-Innes 1914) And also Keynes takes note of this aspect of money: Therefore, instead of “being demanded mainly as a “One reason for holding cash, … is to bridge the medium of exchange”, money is demanded mainly as a interval between the receipt of income and its “vessel for storing purchasing power”, i.e. the holder’s disbursement.” (Keynes 1936, p. 195) claims to future goods and services. And isn’t that pretty much “credit” by definition?513 As said, if monetary tokens Rothbard himself makes it very clear that the need to were only used during individual “trading days” and they conduct transactions is not enough to maintain demand and market value for money: 513 See: ”1.2.2 Credit – Delayed Payment Granting Chronological Flex- ib i l it y ”. Money as Credit – Real Wealth vs. Virtual/Fiduciary Wealth | 113

were always redistributed evenly after the day was over, facto credit on landowners, as it facilitates paying rent for then we could contend to call such tokens “a medium of accommodation or other facilities. e xc h a n g e”. Even if a commodity currency never lost its “money status” When gold is used as money, people’s main motivation for completely, its “money value” is of a very speculative acquiring and holding gold is their trust in that someone nature. As people’s preferences for both holding savings else will give them something useful in return for it later. and especially their preference for holding liquid savings If other people then stopped taking gold as payment for – their liquidity preference – can vary quickly and wildly, goods and services and shifted to another currency (silver, it cannot be assumed that the “demand for money” would furs, grain etc.) or barter, anyone holding gold would maintain a constant or even linear proportion to the suffer a “credit loss” when the market value and liquidity amount of trade conducted or any other real economic of gold suddenly falls. factor.518

Finding one descriptive analogy or framework for a So how does this “moneyness” differ from general phenomenon does of course not rule out others. It is also liquidity or marketability? As explained in “1.2.1 possible to consider the behavior of gold coins (or any Money Facilitates Trade Through Liquidity and Broad other “money” of inelastic supply, like bitcoin514) from Acceptability”, moneyness emphasizes the broadness of its the framework of a commodity. But what does one call demand, its “acceptability”. Another difference is that the a situation where the value of a commodity is largely marketability of a money-like asset – the demand for it – dependent on the expectation that someone will be ready is not so much based on any use value.519 A good can be to give something for it because someone else can be broadly marketable simply because many people have use expected to give something for it etc.? A speculative bubble! for it or because its demand is price elastic. For example To the extent that the value of a commodity rises due to it bread is more liquid than a paper machine because more obtaining the status of a commonly accepted “medium of people have direct use for it. However, even bread is quite exchange” – with no one under a legal obligation to accept illiquid because the price elasticity of the demand520 for it as payment – that value is “speculative”, i.e. not based on bread is not very high, at least in developed economies. any real economic productive potential.515 Theoretically, (Even if people got bread for free, they wouldn’t consume the value of any such monetary savings would be wiped many times more of it.) out if something else were adopted as a currency. The prospect of competing currencies is discussed under Instead, low-risk, fungible investment assets – like “2.2.2 Market-Dictated, ‘Sound’ Commodity Money – government bonds – are liquid in this “moneyness” sense Austrian perspectives”. because they are often acquired only to be sold later. Even if real estate can be a fairly low-risk investment, it Therefore, in “commodity money terms”, we could call is often not as liquid as government bonds or financially the loss incurred by money holders in a currency switch a traded commodities, as pieces of real estate are unique “speculative loss” instead of a “credit loss”. (not fungible) and hence require more effort to evaluate accurately. In practice, such currency switches are very rare because the “entry barriers” into the “currency market” are very The Credit Theory is hence very much compatible with high. One reason for this is that usually the government von Mises’s view of money.521 Von Mises just downplays determines the currency used by accepting it for settling the importance of the “time aspect” of money (that saving taxes516. And when the government does not dictate the it is postponing purchasing power) and fails522 to see how currency, landowners can practically determine the currency used, as everyone has to pay rent, in one form of 518 Such a relationship between the amount of trade and the value of another (accommodation, work facilities etc.).517 In such a money is presumed in the Quantity Theory of Money, see: “1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And Has Little to Do with the situation – even without any legal obligation – money is de Quantity of Money”. 519 If we started considering all marketability or “value in trade” to be “credit”, we’d easily end up having to considering all human needs 514 See: ”1.2.5 The Two Denominators of Currencies and Other Finan- (potential demand) a kind of debt and productive potential a kind of cial Instruments: the Reference Resource(s) and the Collateral”. credit. This wouldn’t be a completely pointless framework, as e.g. some- 515 ”When the prices of securities or other assets rise so sharply and at one needing constant expensive medication or having other such “liabil- such a sustained rate that they exceed valuations justified by fundamen- ities” can be considered less solvent than another person with the same tals, making a sudden collapse likely – at which point the bubble ’bursts’.” amount of wealth and debt. But such a definition would make the con- – ”Definition of bubble”, definition, Financial Times Lexicon, cited cepts of “credit” and “money” even more vague and less useful. 4.4.2014, http://lexicon.ft.com/Term?term=asset-bubble 520 See: ”1.1.6 The ‘Market Forces’ – How Prices Balance Supply and 516 See: “1.2.4 The Difference between Origin, Nature and Purpose (of D e m a nd”. Money) – ‘Metallism’ vs. ‘Chartalism’”. 521 Von Mises makes it clear that money is not a “consumption good” 517 See: ”1.1.11 The Fundamental Imperfections of a ‘Free Market’ – Ex- nor a “production good” (Mises 1912, p. 79) and that “…money has no ternalities and the Limitedness of Land” and ”6.3.1 Appendix 3.1: The De- use-value at all, but only subjective exchange-value.” (Mises 1912, p. 97) ontological Libertarian Dream: Neofeudalism or Survival of the Fittest”. 522 “Money is nothing but a medium of exchange and it completely 114 | Credit, Money and Banking

this makes “a medium of exchange” a very insufficient obligation or under some other threat of punishment for description of money. failure to do so.

Many economists who have not quite fully embraced But as said, “liquidity” depends on how fast large the Credit Theory of Money still agree that money is not quantities of the asset can be “sold” (used to buy other “real wealth” in the same way that consumption goods things) without incurring a loss.525 Therefore, the (2) and production goods are. Frederick Soddy referred to stability of the currency is also strongly affected by the exchange value of money as “virtual wealth” (1926). (a) how flexible the final creditor is at providing larger James Tobin, refers to the value of money as “fiduciary” – quantities of the services it has promised (or its other dependent on trust – and puts it as follows: means of gaining credit on others, i.e. gathering back the currency) compared to (b) how much of such liquid credit “The community’s wealth now has two tokens there is out on the market. If a restaurant issues or components: the real goods accumulated through sells enough gift cards for ten years of full bookings, the past real investment and fiduciary or paper gift cards become unstable in value – even if the restaurant ‘goods’ manufactured by the government from were fully solvent. As long as people spend their gift thin air. Of course, the nonhuman wealth of cards at a steady pace, their market value remains high. such a nation ‘really’ consists only of its tangible But if more bookings suddenly occur, this might result capital. But as viewed by the inhabitants of the in everyone wanting to make their bookings for times as nation individually, wealth exceeds the tangible soon as possible, and suddenly the restaurant is booked capital stock by the size of what we might term for the next five years. A gift card that cannot be used for the fiduciary issue. This is an illusion, but only anything for five years is not worth much. But as long as one of the many fallacies of composition which such a booking rush does not occur – and holders don’t are basic to any economy or society. The illusion speculate on such a risk – their value remains fairly high. can be maintained unimpaired as long as society does not actually try to convert all its paper Now, consider such gift cards or tokens the purchasing wealth into goods.” (Tobin 1965, p. 676)523 power of which are not fixed (e.g. ten cards per dinner). When there are more tokens in the market, the price for The Credit Theory of Money allows us to assess the a dinner in these gift cards – especially dinners at highly reliability, stability and liquidity of a currency along the desired times – are bid up higher, meaning that the analogy of a company issuing coupons, vouchers, gift purchasing power of the tokens drops, regardless of the cards or other tokens that it accepts as payment for its price at which they were originally issued. goods or services. This situation is a better analogy for government issued “What is stamped on the face of a coin or printed on money, as government revenues come more from taxes the face of a note matters not at all; what does matter, than selling specific services, which makes it difficult for and this is the only thing that matters is: What is the the government to “set” the price level directly. We can see obligation which the issuer of that coin or note really how both excess public debt and increased liquidity in the undertakes, and is he able to fulfill that promise, economy increase general instability and especially risks whatever it may be?” (Mitchell-Innes 1914) of hyperinflation:526 The government’s ability to collect taxes is not very flexible (analogous to how a restaurant First of all, if the company’s solvency524 is threatened – it with a fixed number of tables is not very flexible at risks going bankrupt and no longer being able to offer increasing the amount of dinner services it can provide). the services it has promised – the gift cards or other Less liquid public debt (e.g. government bonds with long credit tokens carry this default risk, and people become maturity and public pension liabilities527) does not increase less willing to hold these. Hence, their market value instability as much as government-issued liquid money drops. Therefore, the realiability of a currency is strongly (liquid credit not backed by any private debt). Similarly, if determined by the (1) solvency of those who have explicitly the restaurant wants to issue a large quantity of tokens, it promised to accept it as payment – preferably as a legal could reduce the risk of these tokens losing their value by predetermining an allowed time frame of use for most of fulfills its function when the exchange of goods and services is carried 525 See: ”1.2.1 Money Facilitates Trade Through Liquidity and Broad on more easily with its help than would be possible by means of barter.” Acceptability”. (Mises 1912, p. 21) 526 With increased debt between private parties, the effect is not the 523 Here, I will have to disagree with Tobin in that human capital – same, as the private ”demand for money” – people’s desire to work more people’s skills etc. – is just as real capital as any “tangible capital” like and save (incl. pay off their debt) – can be increased very quickly by rais- machines if not more so. Machines alone do not do much good for the ing interest rates. See: ”2.2.5.2 Monetary Policy – You Can Pretend It’s economy’s productive capacity. about the Money Supply”. 524 See: ”1.1.9 Companies as Competing Organizational Forms (Be- 527 See: ”Sidenote Box 325A: Are Retirement Insurances and Pension cause Institutions Suck at Suicide) – ‘Pro-Business’ Is Not ‘Pro-Market’”. Saving Schemes or Funds Necessary?”. Money as Credit – Real Wealth vs. Virtual/Fiduciary Wealth | 115

as someone else’s debt) is practically a constant those tokens and limiting the number of tokens for each speculative bubble, and it is therefore not a very time period (e.g. month) below its available capacity. stable basis for savings – and especially not a safe reference point for one’s debts.531 And this instability-increasing effect of liquid government debt is not changed by how such government issued A fluctuation in the measuring rod of value money is officially marked up in accounting. When a does not alter in the least the wealth of the government issues more money and spends it, it is always “ indebting itself further – regardless of how much debt it world, the needs of the world, or the productive writes up in its own accounting systems (Mitchell-Innes capacity of the world.” – John Maynard Keynes, 1914).528 The problem with dreams of “debt-free money” A Tract on Monetary Reform (1923, p. 32) and the risks and difficulties in trying to control inflation with fiscal policies is discussed in more detail under “2.2.3.6 Democratic or ‘Full’ Money – ‘Power to the People from the Banks’” and “2.2.6 Post-Keynesian Solutions – 531 See: “1.2.5 The Two Denominators of Currencies and Other Finan- cial Instruments: the Reference Resource(s) and the Collateral” and “2.2.2 Ignore Hyperinflation Risks and Guarantee Jobs”. Market-Dictated, ‘Sound’ Commodity Money – Austrian perspectives”.

How currencies could be defined by what their purchasing power is tied to and what (or who) backs up its purchasing power is discussed under “1.2.5 The Two Denominators of Currencies and Other Financial Instruments: the Reference Resource(s) and the Collateral”.

The “medium of exchange theory” (that money is a commodity of high marketability that facilitates trade) and the Credit Theory of Money (that money is receivables – i.e. expected future favors – even when it is represented by a commodity) are two frameworks for what money is and how it functions. As explained in “1.1.2 Societal Structures Facilitate Cooperation – Economic Systems Direct Resources”, a market economy is largely determined by (1) how ownership (rights to objects529) is Chapters 1.2.4-1.2.5 not included in this sample defined and enforced and (2) how credit contracts can be formed and enforced. The “medium of exchange” theory could be said to define money in terms of property rights and the “credit theory” in terms of credit contracts.

If one insists on considering money a commodity with its own supply and demand, we can consent to using such vocabulary. But then we have to understand, that: —— in a credit money system like the one we have now, the main “demand” for such money (people’s willingness to work for it) does not come from the amount of trade, but the need to repay outstanding debts that have “emerged” as the banks have “created” that new money,530 and on the other hand that —— a “commodity currency” (the supply of which is inelastic and which is not marked explicitly

528 ”A government dollar is a promise to ’pay,’ a promise to ’satisfy,’ a promise to ’redeem,’ just as all other money is.” … ”A dollar of money is a dollar, not because of the material of which is made, but because of the dollar of tax which is imposed to redeem it.” (Mitchell-Innes 2014) 529 See: ”1.1.7 Ownership as a Bundle of Rights”. 530 See: “1.2.6 Banking: Accounting for Debts and Credits and Pricing Risks – There Is No ‘Fractional Reserve’” and “1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And Has Little to Do with the Quantity of Mo n e y “. Banking: Accounting for Debts and Credits and Pricing Risks – There Is No ‘Fractional Reserve’ | 131

1.2.6 Banking: Accounting Substance”.) for Debts and Credits and Pricing Risks – There Is No A banker is one who centralises the debts of mankind and cancels them against one ‘Fractional Reserve’ “another. Banks are the clearing houses of In short: commerce.” – Alfred Mitchell-Innes (1914) • Banks don’t “lend on other people’s The process by which banks create money is money”, but simple grant new credit. so simple that the mind is repelled.” – John Money, in our current system, is liquid, “Kenneth Galbraith government-guaranteed credit on banks. Physical cash is credit on the central bank. [I]t proved extraordinarily difficult for Whenever banks make payments to non- economists to recognise that bank loans and banks (including granting new “loans”), “bank investments do create deposits. In fact, more money is “created” – when banks throughout the period under survey they refused receive payments (including repayments of with practical unanimity to do so” – Joseph “loans”), money is “destroyed”. Schumpeter (1954) • The main business of retail banks is to price credit contracts, manage their risks [W]hen I was a student in the late 50s and and provide payment services that allow “the early 60s, it was widely understood – transferring liquid credit easily between absolutely taken for granted – that the causality parties. went from loans to deposits: loans create deposits. Now students are all taught that • The relevant limiting factor for making banks lend on deposits: that deposits create the new loans for a bank is (or should be) its ability to lend and banks respond to that – this solvency – how well it can carry the risks is a regression.” – Victoria Chick (Emeritus of the volatility and defaults of its assets Professor of Economics, University College (mainly outstanding loans) with its share- London)604 holder equity and risk-bearing credit. Especially people believing in commodity currencies like • Reserves of cash and central bank money to remind us that bank account deposits are not exactly do not limit how much money banks can the same thing as notes and coins. Although their value is grant in so-called “loans” – nor does the the same by law, the bank doesn’t hold on to even closely amount of “deposits” a bank is holding. as much physical cash as they have credit liabilities, Reserves are only needed for clearing including bank account deposits to their customers. differences in transaction between banks. This is because private banks can “expand credit”. The Banks compete over “deposits” because “traditional” and popular view of this “fractional reserve they are a cheaper form of finance (and banking” is that, if the bank has 1 000 000 e of bank possibly to attract future “borrowing” account deposits (liabilities to depositors) and matching 1 clients). 000 000 e reserves of cash (government credit), it can give out 90 % (900 000 e) of this as loans and create this money • (The reason for the quotation marks used as new deposits on the borrowers’ bank accounts. Of these new deposits, it can lend out 90 % again (810 000 e) and above are explained in: “Sidenote Box so on, until it has increased the amount of deposits to 10 126A: The Misleading Expression That times the original (10 000 000 e). ‘Banks Lend Other People’s Money’ ”

and “5.1.2 The Misleading Conceptual 604 12:22→, Chick, Victoria, ” Why don’t Economists understand mon- Metaphor of Money as Items or ey? ([Positive Money] Conference 2013)”, viewed 4.3.2014, http://www. youtube.com/watch?v=EObtwxpDSzk 132 | Credit, Money and Banking

However, this explanation is rather misleading. In today’s causing nuisance to customers due to possible delayed world of electronic money, it could be considered a payments and extra interest costs for the bank for having children’s bed time story in which, unfortunately, to take fast loans from other institutions (other banks or most adults still believe. It is based on the the central bank). ASSETS LIABILITIES PROBABILITY assumption and mental image that most transaction are “CASH” (RESERVES OF NOTES executed in cash and that banks “lend out” this cash “The ‘reserves of lawful money’ in the banks have AND COINS) CURRENT when they make loans. In such a world, it is a sensible no more importance than any other bank asset.” MARKETABLE SHORT-TERM ASSETS assumption that banks have to wait for the lent-out cash to (Mitchell-Innes 1914) INVESTMENTS be redeposited before more loans can be made. This renders for example the Diamond-Dybvig (1983) CHECKING ACCOUNT In practice today, a bank’s ability to issue new loans has model – modeling the threat of bank runs607 – quite DEPOSITS very little to do with existing “deposits” at the bank or useless in an era where electronic deposits are the most CREDIT the amounts of reserves it is holding. When a bank liquid form of money. The main reason banks compete over deposits from bank depositors (note, not the same as LOANS makes a new loan, it creates new “deposits” – entries (E.G. MORTGAGES, in the “borrower’s” account – for the full worth of the reserves) with one another is that bank deposits – liquid PORTION OF RISK BUSINESS LOANS...) LONG- loan. It does not withhold anything from existing deposits checking account liabilities – are cheaper (financial) CARRIED BY TERM DOLLARS capital608 than central bank money and therefore allow CREDIT FINANCE (from other people’s accounts) in any way, but both old and ASSETS new deposits remain fully liquidly available for more profits on shareholder equity. Another incentive to transactions to other accounts and withdrawal in cash – compete over depositors is to attract clients that can be LONG-TERM SAVINGS DEPOSITS government backed credit. (Ryan-Collins et al 2012) profited from by selling them other services, like LOANS FROM CENTRAL BANK mortgages or insurances. CORPORATE BONDS In terms of reserves, the bank only needs to hold: REAL ESTATE (AND OTHER More crucial than reserve requirements – which have to do REAL ASSETS) —— sufficient amounts of (physical) cash to facilitate with the assets side of the balance sheet and affect the SHAREHOLDER EQUITY withdrawal needs SHARES IN OTHER COMPANIES bank’s liquidity with other banks – are capital requirements AND FUNDS —— sufficient reserves of central bank money (also on the liabilities side, which have to do with the bank’s referred to as “deposits with the central bank”) solvency. The bank’s shareholder equity and risk-bearing FUTURE MARKET VALUE to clear transactions between other banks due to credit, i.e. corporate bonds, need to be able to cover for OF COMPANY OR ITS ASSETS e.g. deposit customers transferring unbalanced the market volatility, possible credit defaults and other amounts of money between accounts of different risks of the bank’s assets. Banks that don’t hold enough banks. equity (i.e. are overleveraged) and that are unable to collect additional equity from their shareholders should GRAPH 18: THE RISKS OF A BANK’S ASSETS DISTRIBUTED ON EQUITY AND CREDIT The government might set limits on how big these be filed bankrupt, and their assets should be nationalized FINANCE. reserves have to be. For example, in the U.S. since 2011, (although in practice this does not happen in many banks are required to hold reserves (cash or central bank cases, which is at the core of our financial crisis, as is money) of 0 %, 3 % or 10 % of their transaction accounts explained in “3.1.5 Too Big to Fail: The Casino Economy, – liquid deposits that can immediately by transferred or ‘Financialization’ and Irresponsible Risks in Banking”). withdrawn (contrasted with “term deposits” or “time deposits”) – depending on the total amount of deposits The process of “credit expansion” has been described they have outstanding.605 by many critics of the system as “creating money out of nothing”, “counterfeiting” or “making promises of money However, the amount of deposits a bank holds does not that doesn’t exist”. So why isn’t this system twisted and significantly limit its ability make new loans as it can fraudulent? Because credits and debts remain in balance always borrow more cash and central bank money from the and the bank holds assets exceeding its credit liabilities. other retail banks or the central bank, which acts a “lender of last resort”. Therefore, banks have a virtually zero risk of going bankrupt due to a liquidity crisis606 – not having enough cash to meet their short-term payment obligations 607 The logic behind the Diamond Dybvig model is that as a big part – as a result of e.g. “bank runs”, mass withdrawals from of bank’s assets (like loans with set payment schedules or otherwise long accounts. Low liquidity – small reserves – at most risks maturity) are illiquid, but a big part of their liabilities (deposits) are liquid, this would give rise to self-fulfilling panics among depositors: even healthy banks could be subject to bank runs if depositors expect others to withdraw massive amounts of funds. The whole model starts from the perception that banks channel funds from many individual deposits into loans for borrowers that banks are intermediaries between savers who 605 “Reserve Requirements, Federal Reserve, cited 2012.12.01 h t t p :// prefer to deposit in liquid accounts and borrowers who prefer to take out www.federalreserve.gov/monetarypolicy/reservereq.htm long-maturity loans. 606 See: ”1.1.10 Companies as Contract Bundles – Financial Assets Allo- 608 See: “Sidenote Box 118C: Marx’s ‘Capital’ Is Closer to Financial Cap- cate Risks”. it a l”. Banking: Accounting for Debts and Credits and Pricing Risks – There Is No ‘Fractional Reserve’ | 133

causing nuisance to customers due to possible delayed payments and extra interest costs for the bank for having to take fast loans from other institutions (other banks or the central bank). ASSETS LIABILITIES PROBABILITY

“CASH” (RESERVES OF NOTES “The ‘reserves of lawful money’ in the banks have AND COINS) CURRENT no more importance than any other bank asset.” MARKETABLE SHORT-TERM ASSETS (Mitchell-Innes 1914) INVESTMENTS

This renders for example the Diamond-Dybvig (1983) CHECKING ACCOUNT model – modeling the threat of bank runs607 – quite DEPOSITS useless in an era where electronic deposits are the most CREDIT liquid form of money. The main reason banks compete over deposits from bank depositors (note, not the same as LOANS (E.G. MORTGAGES, reserves) with one another is that bank deposits – liquid PORTION OF RISK BUSINESS LOANS...) LONG- checking account liabilities – are cheaper (financial) CARRIED BY TERM DOLLARS capital608 than central bank money and therefore allow CREDIT FINANCE ASSETS more profits on shareholder equity. Another incentive to compete over depositors is to attract clients that can be LONG-TERM SAVINGS DEPOSITS monetized by selling them other services, like mortgages LOANS FROM CENTRAL BANK or insurances. CORPORATE BONDS REAL ESTATE (AND OTHER More crucial than reserve requirements – which have to do REAL ASSETS) with the assets side of the balance sheet and affect the SHAREHOLDER EQUITY SHARES IN OTHER COMPANIES bank’s liquidity with other banks – are capital requirements AND FUNDS on the liabilities side, which have to do with the bank’s solvency. The bank’s shareholder equity and risk-bearing FUTURE MARKET VALUE credit, i.e. corporate bonds, need to be able to cover for OF COMPANY OR ITS ASSETS the market volatility, possible credit defaults and other risks of the bank’s assets. Banks that don’t hold enough equity (i.e. are overleveraged) and that are unable to collect additional equity from their shareholders should GRAPH 18: THE RISKS OF A BANK’S ASSETS DISTRIBUTED ON EQUITY AND CREDIT be filed bankrupt, and their assets should be nationalized FINANCE. (although in practice this does not happen in many cases, which is at the core of our financial crisis, as is explained in “3.1.5 Too Big to Fail: The Casino Economy, “A banker is one who centralises the debts of mankind acquired – your debt – for further trading without the ‘Financialization’ and Irresponsible Risks in Banking”). and cancels them against one another. Banks are the receivers of that credit needing to come back to check your clearing houses of commerce.” (Mitchell-Innes 1914) creditworthiness. The process of “credit expansion” has been described by many critics of the system as “creating money out of When you take out a “loan”609 from a bank, the loan In the case of buying with a credit card, the credit card nothing”, “counterfeiting” or “making promises of money contract is your liability (debt) to the bank and the sum the company carries your default risks for the seller and makes that doesn’t exist”. So why isn’t this system twisted and bank writes on your account (the “deposit”) is the bank’s the credit liquid, just as a bank would if you instead took a fraudulent? Because credits and debts remain in balance liability (debt) to you. At the moment when the “loan” has consumption loan to pay the seller with a debit card, cash and the bank holds assets exceeding its credit liabilities. been granted, you practically owe yourself through the or bank transfer. The security of individual deposits is bank. When you use the money to buy things – for example not dependent on defaults on individual debts, the risks a house or consumer goods – you transfer the money to of which are covered by banks with their shareholder the sellers’ accounts. Now, you still owe the bank through equity gathered through issuing shares and with the the loan, but the bank now owes the sellers through the profits made from the interest margins they charge. As the 607 The logic behind the Diamond Dybvig model is that as a big part of bank’s assets (like loans with set payment schedules or otherwise long entries (“deposits”) on their accounts. In this way the loan government finally guarantees all “deposits”, liquid credit maturity) are illiquid, but a big part of their liabilities (deposits) are liq- and the bank deposits form a debt relationship between on banks, your deposits are not only backed by all of your uid, this would give rise to self-fulfilling panics among depositors: even you and the sellers. The bank is just an intermediary. The bank’s assets (including all outstanding debts to it610), but healthy banks could be subject to bank runs if depositors expect others only difference between you buying on credit directly also by the government’s solvency, including its ability to to withdraw massive amounts of funds. The whole model starts from the perception that banks channel funds from many individual deposits into from the sellers is that now the bank covers the risks of collect taxes. loans for borrowers that banks are intermediaries between savers who your default and allows the sellers to use the credit they prefer to deposit in liquid accounts and borrowers who prefer to take out long-maturity loans. 608 See: “Sidenote Box 118C: Marx’s ‘Capital’ Is Closer to Financial Cap- 609 See: “Sidenote Box 126A: The Misleading Expression That ‘Banks 610 See: “Graph 18: The risks of a bank’s assets distributed on equity it a l”. Lend Other People’s Money’”. and credit finance.” 134 | Credit, Money and Banking

When the bank charges interest on the debt, this adds to the debt, the creditor can spend the money “back into the both the amount of debt of the client and to the receivable system” by buying a service from me – or from someone – credit – of the bank. You might now note that this added else who can then buy a service from me. I can then use amount of debt did not “create any new money” – liquid the same money – cash or renewed account balance – bank deposits. The debtor (or any seller he has traded with) to pay off more of the debt. In an “all-cash economy”, a did not get any more money (credit) but is still required to million euros of debt could be paid off by “circulating” a pay back more (his debt increased). Alternatively the bank single one-euro coin often enough. takes the interest payment as money from the debtor’s account, without decreasing the amount the debtor owes Additionally, what someone hasn’t told these perpetual to the bank. Now there is more debt than there is money. debt hoaxers is that, in our current credit money system That is true. A fascinatingly large number of critics say (not an all-cash economy), banks do not only “create” that this new debt caused by interest is “perpetual” – that money when they make loans, but also when they make it is “arithmetically impossible to pay it back” because the almost any other of their own payments: e.g. when money to pay the interest “does not exist”.611 But looking purchasing other assets (McLeay et al 2014, p. 17)613 and at money as a credit relationship, this is a very illogical paying interest on depositor accounts, salaries and conclusion, as I’ll explain here. dividends. When a bank pays salaries to its employees or dividends to its shareholders that are banking with In short: all debt is to someone else: There’s always a that same bank, the bank simply credits their account – creditor for every cent owed. Let’s consider the simple writes a bigger number on them – “creating new money” case where I render you a favor and you thus “owe me for them. This additional liability reduces the bank’s one”. Debt is created, but no money (liquid credit) is shareholder equity. If the employees or shareholders created. And that’s the traditional way debt emerges in a have their accounts in another bank, that other bank system without banks. Why is it that these debts are still “creates new money” on their accounts, and this new payable? Because fundamentally, all debts are paid back liability is matched by a transfer of central bank money to by producing goods, services or some other form of real that bank’s account from the bank paying the salary or economy value! Money is just a way to keep account of dividends (unless these transfers are offset by transfers credits. between other accounts in the same banks in the opposite direction). No checkbook money disappears from the “Money does not pay for anything, never has, never bank making the payment. (A bank’s “own accounts” are will. It is an economic axiom as old as the hills trivial accounts, as they are essentially the bank’s debts to that goods and services can be paid for only with itself.) goods and services.” – Albert Jay Nock, Memoirs of a Superfluous Man (1943) When a “normal” (non-bank) company pays salaries, net new liquid credit is not created, as those companies’ “A credit cancels a debt; this is the primitive law of accounts are debited (i.e. the amount owed to the account commerce. By sale a credit is acquired, by purchase a holder is reduced) while the employees’ accounts are debt is created. Purchases, therefore, are paid for by credited (i.e. the amount owed to the account holder is sales.” (Mitchell-Innes 1914) increased).

There would always be more debt than money, even if Of course, if the bank’s employees and owners do not no interest was charged, simply because money is liquid spend their earnings, the debt becomes “perpetual”, but credit, but not all credit is as liquid. There are also bonds this applies to anyone providing any kinds of services and other direct loans made without an intermediary that or products (not only banking, i.e. risk management is allowed to create liquid, government-backed deposits. and transaction services) to others without giving them With no banks, no new credit would be liquid and all possibilities of returning favors. And avoiding such debts would be “created” without “creating money”. If you excessive hoarding of credit – others’ debt – beyond are opposed to creating debt without creating a matching how much others want to be in debt requires facilitating amount of money, you should definitely be most opposed negative real interest rates. This is at the heart of solving to peer-to-peer lending services,612 as these create no new the instability and growth dependence of the current liquidity. economic system, as will be discussed in “4.2.1 Eliminating the Zero Lower Bound with a Higher Inflation Target or Even if the creditor required the payment in money, this by Eliminating Cash“. is not a problem, because when I have paid off a part of 613 “Deposit creation or destruction will also occur any time 611 See: “3.1.2.1 The Perpetual Debt Hoax, a.k.a. The Fallacy of Unpay- the banking sector (including the central bank) buys or sells able Interest”. existing assets from or to consumers, or, more often, from com- 612 See: footnote 713. panies or the government.” (McLeay et al 2014, p. 17) Banking: Accounting for Debts and Credits and Pricing Risks – There Is No ‘Fractional Reserve’ | 135

Let’s return to the matter of bank liquidity. By law, more liquid than cash, which is starting to become checking account deposits – as opposed to savings relatively expensive to handle for both consumers and accounts that have limits to the amount and frequency vendors. As cash is becoming a less and less handy and of withdrawals – should be withdrawable at any time as less valued form of money, the need for cash reserves government-issued notes and coins (i.e. as “legal tender”). is further diminishing. Banks mainly need reserves Critics of the current system point out that if everyone of electronic central bank money to balance out the wanted to do that, the bank wouldn’t have even closely differences in transfers between the accounts of different enough cash available. This sort of flight of deposits is banks. called a “bank run” or a “run on the bank”. The bank wouldn’t be solvency bankrupt, because it still has enough The fact that a bank does not have enough government- assets – outstanding loans often backed by real assets – issued banknotes as reserves to allow all its depositors to to match its deposit liabilities and outstanding debts to its withdraw their savings is thus no reason to call the system other creditors, but it would be in a major liquidity crisis. a fraud. On the contrary, this credit money system, where money is backed mostly by private debt – and all possible What a bank could do in such a situation would be to sell real assets in the private economy that is used as collateral its debt contracts (or other assets) on to another bank for – is a much more robust basis for a monetary system than cash reserves. As long as such a bank run is expected to one where only government issued credit is allowed to be temporary, it makes more sense that the bank borrows be liquid.614 If anything is a fraud, it’s the claims that our the cash, setting its assets (including the obligations of its economy could be made more stable by depriving banks current debtors) as collateral for these debts. Currently, of their ability to “create money” and the demands that the central bank acts as this kind of lender of last resort if all money should to be credit directly on the government. other private banks are unwilling to make such loans of Vast amounts of this kind of liquidity unbacked by private reserves to each other (as most have been in the uncertain debt would threaten the central bank’s ability to prevent environment following the 2008 credit crunch). If large hyperinflation, as the government’s ability to tax is very bank runs occur, it might take some time for the central inflexible.615 bank to have all the needed physical cash printed at the mint, but the final outcome is that the central bank just An equally harmful scam are the claims that a gold becomes an extra middleman in the existing credit standard could work as a stable currency providing relationships. When the chain of liability used to be: sustainable economic security for the participants and allowing our economy to run smoothly. In reality, it would deposit holder ← retail bank ← mortgage debtors be almost impossible for such a currency to keep aggregate supply and demand in balance, as such limited, vital …after the bank run it is: resources are tempting targets for speculative hoarding and hence unavoidably volatile.616 cash holder ← central bank ← retail bank ← mortgage debtors

The ex-depositors (now cash holders) lose their interest We would rather be ruined than changed. We income, the bank makes losses in having to pay the “would rather die in our dread than climb the central bank higher interest rates and the central bank (the cross of the moment – and let our illusions die.” government) loses a big part – or all and more – of these – W. H. Auden extra profits as cash printing and minting costs. Everyone loses. The greatest – and most robust – The question that follows is why would people do such “contributions to knowledge consists in a massive bank run and choose to hold physical cash, removing what we think is wrong – subtractive which is much more inconvenient than having electronic epistemology.” – Nassim Nicholas Taleb, deposits? Most commonly the reason is mistrust in the Antifragile (2012, p. 303) bank’s ability to guarantee the deposits. In a completely “free market” with independent banks, this would be a serious risk. E.g. the 19th century U.S. banking system, without a central bank as a lender of last resort, saw repeated banking crises. However, when bank deposits 614 See: “2.2.3.6 Democratic or ‘Full’ Money – ‘Power to the People from are guaranteed by the government, they are not any more t h e Ba n k s’”. risky than cash – and additionally often have interest paid 615 See: “2.2.6 Post-Keynesian Solutions – Ignore Hyperinflation Risks and Guarantee Jobs”. on them. With today’s system of fluent internet banking 616 See: “2.2.2 Market-Dictated, ‘Sound’ Commodity Money – Austrian and credit card payments, bank deposits are often even perspectives”. 136 | Credit, Money and Banking

Sidenote Box 126A: The Misleading Expression That ‘Banks Lend Other People’s Money’

One factor is that there is a great fault in the language that we use – or a great bias in the “language that we use – in relation to banking. The word ‘deposit’ is a hangover from the days of the goldsmiths who took bags of gold for safekeeping.” .. “[M]uch of the neoclassical theory of banking still regards these as kinds of glorified safes, which they clearly are not.” … “And we also speak of banks ‘lending money’. Banks do not lend money! It may feel like that when you get a loan, but that’s not what they’re doing. They don’t have a pot of money, which they are passing on.” – Victoria Chick (Emeritus Professor of Economics, University College London)617

If anyone were to suggest the idea that (excessive) saving of money might be harmful economically, a common response is that saving is not a problem because “banks lend on the money of their depositors”. As mentioned already in “1.2.2 Credit – Delayed Payment Granting Chronological Flexibility”, the expressions of “borrowing” and “lending money” are in general misleading, as credit and debt are not the same as “borrowing” a physical item – like a frisbee for the weekend – from someone. Similarly, saving money on a bank account is not giving something for others to use, but simple gathering credit – expected future favors and goods – from others.

Have you ever heard that anyone would’ve had some money withheld from their accounts because the bank “lent” that money to someone else? Banks do not lend on anyone else’s money618 – they manage and create new credit relations between people. As you are not borrowing or renting anything from a bank when it has granted you a loan, the interest paid on debts is not “rent for money”.619 It is a compensation for delayed payment and credit risk.

While intuitively we think that people and businesses “make money” – as the American expression goes – when they work or make a profit and that banks would be passing that money on to others when they grant loans, the reality is the exact opposite: Banks “create” money when they make loans, and that money is passed on when people buy products and services or when companies pay wages to their employees. Although for an individual it might look like it, on the level of the whole economy, money is not work somehow magically stored into notes and coins or on bank accounts, but simply receivables from others – credit on them.

This expression that “banks lend their depositors’ money” isn’t completely false: Bank deposits are a form of finance for a bank, like all other liabilities on its balance sheet. However, “financing” (in the context of corporate finance) does not mean “giving money for something” – but carrying the risks of that something. 620 621 In this sense, it is the government that is financing banks through its (free) deposit guarantee.622

617 12:22-> & 14:54->, Chick, Victoria, 2013, “Why don’t Economists understand money? (Conference 2013)”, viewed 4.3.2014, http://www. youtube.com/watch?v=EObtwxpDSzk 618 See: “1.2.8 The Supply of Money Is Infinitely Interest-Rate-Elastic – The Money Supply Is Endogenous”. 619 E.g. Brett Scott, in his book “The Heretic’s Guide to Global Finance”, while explaining other financial tools and institutions very well, still obeys this misleading perception of money and interest. “’Interest rate’, for example, could be rephrased as ‘the price of renting money’.” (Scott 2013, p. 29) Also Khan Academy (which is otherwise a very reliable source of good education material) explains, misleadingly, the interest rate as ”rent” for money: – ”Money Supply and Demand Impacting Interest Rates”, educational video, Khan Academy, viewed 25.10.2013, https://www. khanacademy.org/economics-finance-domain/macroeconomics/monetary-system-topic/interest-price-of-money-tutorial/v/money-supply-and-demand-impacting-interest-rates 620 See: “1.1.10 Companies as Contract Bundles – Financial Assets Allocate Risks.” 621 In some cases, “financing” a project can also be used to refer to paying for its expenses, without getting any claims to any future revenus it might generate, e.g. in asking how a public development project or an electoral campaign should be “financed”. 622 See: “4.2.2 Setting a Fee on the Government Deposit Guarantee.”

Continued on page 137 ► Banking: Accounting for Debts and Credits and Pricing Risks – There Is No ‘Fractional Reserve’ | 137

► As a comparable example of a misleading, partly true expression, let’s consider the following: “The sun and the stars revolve around the Earth”. Standing on the Earth’s surface, that’s what it looks like and from that point of view it can be said to be so. However, a more descriptive expression is that the Earth revolves around its own axis and that is why we see the stars in different directions at different times of the night. The previous “Pre-Copernican”, geocentric framework might have for example allowed one star to stop revolving around the Earth or slow down its “orbit”. In the “Earth-spinning-around-its-axis” model, we know that such a case would mean that such a “star” cannot be a star (light-years away from us like the others), as it would have to be moving light-years per minute to do so.

Similarly, it is far more descriptive to say that bank “deposits” (and money in general) are liquid credit: Credit that banks grant, that they make liquid with their payment services and that is made risk-free (as risk-free as cash and the liquid credit of all other banks) by the fact that it is guaranteed by the government. In this way we see that for saving to be compensated (in terms of economic activity) with bank “lending”, someone has to take that “loan” and the result is a decrease in money velocity and an increase in the quantity of money623 – i.e. the amount of debt and credit in the system. With this framework, we can boldly conclude that saving money excessively – on a bank account or as cash – without intent to use it is “keeping others in debt” (though not necessarily involuntarily if the market interest rate is right624). Unfortunately, our centuries old protestant work ethic that virtues hard work, frugality and saving does not allow us to consider such a clarifying expression.625 Instead it allows us to maintain this illusion of money being work somehow magically done into storage. But you can’t send a $100 bill on your behalf to work tomorrow or make it do your laundry, can you?

Even when a retail bank engages in “proprietary trading” – buys e.g. shares or other investment products on its own risk – it “creates” the new deposits on the account of the previous owner of the shares. The bank does not exchange any existing asset it has for the shares, but simply credits the seller’s account and the new asset (share) and liability (deposit) expand the bank’s balance sheet.626 The expression that “bank’s invest or channel on other people’s savings/surpluses to productive use” (e.g. Korkman 2012, p. 54)627 is an extremely misleading expression – a “children’s bedtime story” comparable to that of storks bringing babies to married couples. But, unfortunately, it is a story that over 90 % of people (and a majority of economists) still believe literally. Arguing that, in a recession, we need (higher interest rates to encourage) more monetary saving to facilitate real investments makes about as much sense as arguing that we need to tighten the protection of storks to increase human fertility.

Savings held on bank accounts are in no way “in circulation” or “in productive use”. This might be a truthful expression in a fictional world where most transactions are made with physical cash, which people actually physically deposit by bringing the cash to a bank teller only for long-term savings purposes and have to withdraw as cash to be able to make any payments to anyone else. This has not been a descriptive model of the real world for over a hundred years.

Misleading expressions and how emotional associations we have with words affect our thinking are discussed in more detail under “5.1.1 Our Emotional Attachment to Words” and “5.1.2 The Misleading Conceptual Metaphor of Money as Items or Substance”.

623 See: “1.3.3 The Circular Flow of Income – Consumption, Saving and Investing” and “1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And Has Little to Do with the Quantity of Money”. 624 See: ”2.2.5.2 Monetary Policy – You Can Pretend It’s about the Money Supply”. 625 This is discussed in more detail in this book’s sister, ”The Guilt Economy.” 626 See: Graph 18. 627 “Firstly, the financial system channels saving into investments or assets from finance-surplused economy units to finance-deficited economy units. It is beneficial for everyone that money can move as a loan or share investment from the former to the latter. Like this, wealth is allocated in a way that supports the efficiency and growth of the economy.” (Korkman 2012, p. 54, translated from Finnish) 140 | Credit, Money and Banking Chapter 1.2.7 not included in this sample

1.2.8 The Supply of Money bank) and commercial bank lending/deposits Is Infinitely Interest-Rate- can break down entirely.” – Charles A. E. Elastic – The Money Supply Is Goodhart, Foreword to “Where does money Endogenous come from?” (Ryan-Collins et al 2012, p. 3) In short: [T]here is no way for the central bank to simply ‘increase the supply of money’ to • In today’s monetary system, the quantity “raise aggregate demand. This is why those who of money (the “money supply”) is deter- adopt the endogenous money approach reject mined by how much people and companies ISLM-type analysis in which the authorities can are willing to be in debt (“borrow”). The eliminate recession simply by expanding the central bank has hardly any control over money supply and shifting the LM curve out.” – the total quantity of money in the market L. Randall Wray (2001, p. 3) – i.e. the money supply is “endogenous” in terms of monetary policy. So the conventional wisdom in Galbraith’s • The amount of loans made does not affect “view must be simple, convenient, the price (interest rate) of future loans, comfortable – though not necessarily true. It meaning that the “supply of money” is would be silly to argue that the conventional infinitely interest-rate-elastic – the supply wisdom is never true, but noticing, perhaps curve is flat horizontal. In this sense, the where the conventional wisdom may be false central bank can be said to control the – noticing, perhaps, the contrails of sloppy or “supply of money”, as it sets the price of self-interested thinking – is a nice place to start risk-free credit. asking questions.” – Steven D. Levitt & Stephen J. Dubner, Freakonomics (2005, p. 86). • Many economists and economic theories have assumed (and still do) the short-term interest rate elasticity of the supply of One of the most sticky, faulty assumptions in many schools of economic thought is that the short-run price money to be close to zero – like that of an (i.e. interest rate) elasticity of money would be close to exogenously controlled or fixed-quantity zero. This assumption is behind the market mechanism commodity. This e.g. leads many to believe that should bring interest rates and the credit market to that increased saving would lower the equilibrium in neoclassical economic models (e.g. Fisher market interest rate – when, in reality, it 1930, p. 44) and e.g. the LM curve in the IS/LM model. (Krugman 1999-2)639 It is also assumed by monetarist does not.

• The “supply and demand of money” can 639 “Since the classic 1937 paper by Hicks, it has been usual to summa- rize short-run equilibrium in such an economy by looking at two curves: mean many things in many contexts a downward sloping IS that shows how lower interest rates increase the and should probably be abandoned demand for goods and hence real output y; and an upward-sloping LM 638 curve that shows how increased output, by increasing the demand for altogether. money (whatever exactly that means in the modern world), drives up the interest rate. Monetary policy shifts LM, fiscal policy shifts IS.” (Krug- In practice however, the central bank has man 1999-2) The LM curve (L = liquidity preference, M = money supply) in the IS/ “always sought to control the level of interest LM model shows possible points of balances in terms of the of total economic activity (Y) and the interest rate (i) as determined by the money rates, rather than the monetary base.” … supply and people’s liquidity preference. The curve is rising, suggesting “[T]he supply of money is actually determined that if the economy grows or people’s liquidity preference grows, but the money supply doesn’t, this would mean rising interest rates (or require primarily by the demand of borrowers to take them to prevent hoarding of cash). As bank deposits are nowadays the out bank loans.” … “[T]he relationship between most liquid form of money, the fear of an increased liquidity preference drawing money out of banks’ balance sheets no longer applies. As banks available bank reserves (deposits at the central can extend liquid credit without any limitation and can borrow more reserves (that are only needed for clearing transactions to other banks), 638 See footnote 654. the assumption of an exogenously determined money supply no longer The Supply of Money Is Infinitely Interest-Rate-Elastic – The Money Supply Is Endogenous | 141

theories, which emphasize the importance of the quantity an inconvertible managed currency this condition is of money in determining the price level640 and assume that strictly satisfied.” (Keynes 1936, p. 145) the central bank has control over this quantity (that the money supply would be “exogenous”). “For the amount of hoarding must be equal to the quantity of money … and the quantity of money is not The mental image that money is some kind of substance determined by the public.” (Keynes 1936, p. 111) of fixed quantity, which is accumulated in banks when agents “save” and then “used up” in making loans, and “The quantity of money as determined by the action that the amount of saving hence restricts the amount of of the central bank…” (Keynes 1936, p. 156) “loans” that can be made, and that increased borrowing or reduced saving will automatically raise the interest rate For example Keynes’s emphasis on “liquidity preference” to bring these two into balance, is prevalent even in the in determining the interest rate643 draws from this theories used to guide monetary policy641: assumption – that “making a loan” requires someone else having to part with the liquidity of her credit. “[R]eal interest rates will rise to the point that private borrowing is reduced sufficiently to allow the entire There might have been some truth to this assumption requirements of the federal … deficit … to be met.” … before electronic banking, when cash was the most liquid “Even if private investment were not as interest-elastic form of credit, but even then the central bank had no direct as it appears to be, crowding out of private spending control over retail banks’ “expansion of credit”. In today’s by the budget deficit would occur dollar-for-dollar world, the situation is quite the opposite: Electronic bank if the total supply of saving were fixed.” (Greenspan account deposits are far more liquid than cash and money 1989, p. 52-53) is completely endogenous – meaning that the central bank has little control over its quantity. The interest rate “Government spending and transfers shift toward elasticity of the “supply of money” is practically infinite: consumption some resources that the private sector The interest rates on new loans are not affected by the might otherwise invest. Government spending total amount of loans made by the banking sector so far. financed by borrowing absorbs private savings unless the private sector acts to offset the saving reduction.” Of course interest rates start rising on loans to debtors (Council of Economic Advisors 1989, p. 124) who start accumulating significant debts beyond the market value of their assets and their credible future “In this view (henceforth, the orthodox view), ability to earn income, as their default risks rise. But the unless saving rises as government deficits increase, price of risk-free credit is quite directly determined by investment will be crowded out because of price or deposit interest rates and the central bank’s policy interest quantity constraints on finance.” (Wray 1989, p. 978) rate (which finally also determines the overall level of deposit interest rates644). While Post-Keynesians642 are nowadays the most prominent preachers of Modern Monetary Theory, which In 1898, Knut Wicksell, who accepted the Quantity well explains the credit nature of our current monetary Theory of Money (the assumption of a stable long- system, the assumption of an exogenously determined term circulation velocity of money645 646) in a “pure cash money supply was strongly present also in John Maynard economy,”647 pointed out how the dynamics of the system Keynes’s General Theory: change significantly when transactions can be made directly between bank accounts, and theorized a “pure “(i) [M]oney has, both in the long and in the short period, a zero, or at any rate a very small, elasticity of production, so far as the power of private enterprise 643 See: ”Sidenote Box 118A: Keynes’s Liquidity Preference Theory is Outdated”. is concerned, as distinct from the monetary authority 644 See: “1.2.6 Banking: Accounting for Debts and Credits and Pricing ... Money, that is to say, cannot be readily produced;– Risks – There Is No ‘Fractional Reserve’”. labor cannot be turned on at will by entrepreneurs 645 See: “1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And Has Little to Do with the Quantity of Money”. to produce money in increasing quantities as its 646 “Wicksell, from the outset, regards the problem as concerning ex- price rises in terms of the wage-unit. In the case of plicitly the average change in the price of goods, which from the theoretical standpoint is quite irrelevant. He starts from the hypothesis that, in the absence of disturbing monetary influences, the average price level applies. must remain unchanged.” (Hayek 200, p. 57-58) 640 See: “1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And 647 “From Ricardo, he took the Quantity Theory which he regarded Has Little to Do with the Quantity of Money”. as a ‘completely sound and correct’ (Wicksell, 1898a, p. 49) theory of the 641 See: “2.2.5.2 Monetary Policy – You Can Pretend It’s about the Mon- price level – for a pure ‘cash economy’. The demand for cash, Wicksell e y Supply ”. noted, varies only ‘within fairly narrow limits’ and cash money ‘cannot 642 See: “2.2.6 Post-Keynesian Solutions – Ignore Hyperinflation Risks circulate ... faster than a messenger boy can run’ (Wicksell, 1936, p. 54).” and Guarantee Jobs”. (Leijonhufvud, p. 1) 142 | Credit, Money and Banking

credit economy”, without any “money”. Today, developed Regardless of for example Post-Keynesian economists countries practically are such “Wicksellian” “pure credit and other Modern Monetary Theory researchers650 clearly PRICE (INTEREST RATE ON RISK-FREE DEBT [%]) economies,” where “all payments are made by transfers analyzing and presenting this explicit credit nature of between bank accounts, and in which all deposits earn euros and dollars, the assumptions inherited from a interest” and “[l]oans make deposits whose volume is not world of notes and coins still stickily persist in many limited by any cash constraint”. (Boianovsky & Trautwein, economic models used in modern research.651 This serves DEMAND p. 3; Wicksell 1936, p. 70-76) as one example of how slow a discipline economics is at evolving – probably partly due to its highly segregated SUPPLY “With today’s technology, you could buy a cup of and fundamentalist nature.652 coffee by swiping a card or tapping a cell phone, selling two dollars and fifty cents of an S&P 500 Two terms that are easy to misunderstand and confuse fund, and crediting the coffee seller’s two dollars and – and which economists also use very sloppily653 – are fifty cents mortgage-backed security fund. If money “money supply” and “the supply of money”. The “money (reserves) are involved at all – if the transaction is not supply” usually refers to the “quantity of money”. In QUANTITY

simply netted among intermediaries – reserves are today’s money system, this is not a self-explanatory (VALUE OF EXISTING DEBTS [$]) held for milliseconds.” (Cochrane 2014, p. 3-4) expression either, as we could be talking about any of the different “monetary aggregates” such as MB, M1, M2, In today’s system, contrary to what Keynes insisted, the M3 and M4, which are measures for the total amount of GRAPH 19: THE SUPPLY OF RISK-FREE CREDIT – MONEY – quantity of money is determined by the public. Although credit in the market meeting specific liquidity (and other) IS INFINITELY INTEREST-RATE-ELASTIC IN OUR CURRENT many activist groups opposing our current banking specification. CREDIT MONEY SYSTEM. system648 like to say that private banks control our money supply, the banks only evaluate risks of loans and set the In this sense it is a false statement to say that the central risk premiums for which they are ready to carry those bank controls “the money supply”. However, the central risks. Finally, it is people and companies who decide how bank can be said to control “the supply of money”. As much they want to take on debt at the rates offered to explained in “1.1.6 The ‘Market Forces’ – How Prices them. As banks aim to maximize their profits, they will Balance Supply and Demand”, supply is the supplied make any loans the margins of which are worth the risks amount of something as a function of price. An “increase involved. If one bank doesn’t, its competitors will. in supply” can be interpreted as the supply curve either shifting “right” or “down”. When the price elasticity of The central bank can, theoretically, set an upper limit to the supply of something (in this case money, i.e. credit) is amount of “loans” granted (and hence “money created”) infinite, the supply curve is practically flat horizontal – i.e. by private banks by setting reserve requirements (e.g. as the price (in this case the interest rate for new credit) is a minimum percentage of liquid deposits, as it has in the the same regardless of quantity (the total value of existing U.S.649) and refraining from granting banks new loans of debt contracts). In such a case, “increasing the supply of central bank money. This could force a bank to borrow money” just means lowering its price – shifting the supply reserves from other retail banks if it wishes to continue curve downwards. As economists are not very careful lending after it has reached its reserve limit. In such a case, to avoid such double-meanings, the “supply of money” a high demand for loans might push interest rates up. But is often used synonymously with “money supply” (its as long as the central bank is willing to lend to banks quantity), and when John Taylor writes that “using an directly, this lending rate is what determines the risk-free interest rate rule does not eliminate the concept of money market rates. During the 1990s, reserve requirements were demand and money supply; it simply makes money either eliminated completely (Belgium, Denmark, Sweden, endogenous”, (Taylor 1999, p. 9) by “money supply” he Canada and New Zealand) or significantly lowered (UK seems to be meaning “the supply of money”.654 and the Netherlands) or regulation thereof slackened (USA, Italy, Germany, France and Spain). (Di Giorgio 650 See: “2.2.6 Post-Keynesian Solutions – Ignore Hyperinflation Risks 1999, p. 1032) After the financial crisis of 2008, as a part and Guarantee Jobs”. of attempts to stabilize the financial sector and ensure its 651 E.g. ”We assume that money demand arises from the need to carry liquidity, reserve requirements have been tightened, but, out transactions and depends positively on aggregate output and nega- tively on the interest rate. The supply of money is determined by the bal- on the other hand, the central bank has opened its loan ance sheet of the central bank and is exogenous.” (McKibbin & Wilcoxen taps to banks directly and started paying interest on 2009, p.10) central bank deposits, making the money supply, again, 652 See: ”5.2.4 The Religious Nature of Economics and Politics” and completely endogenous. ”5.2.1 The Personal Nature and Incentive Traps of Academia”. 653 E.g. ”[U]sing an interest rate rule does not eliminate the concept of money demand and money supply; it simply makes money endogenous.” (Taylor 1999) 648 See: “2.2.3.6 Democratic or ‘Full’ Money – ‘Power to the People from 654 There would be good reason to abandon the concepts of the “supply t h e Ba n k s’”. and demand for money” altogether, as they can mean many, very differ- 649 See: ”1.2.6 Banking: Accounting for Debts and Credits and Pricing ent things. Essentially the “supply” of something is its “supplied quantity Risks – There Is No ‘Fractional Reserve’”. as a function of its price” (see: “1.1.6 The ‘Market Forces’ – How Prices The Supply of Money Is Infinitely Interest-Rate-Elastic – The Money Supply Is Endogenous | 143

Regardless of for example Post-Keynesian economists and other Modern Monetary Theory researchers650 clearly PRICE INTEREST (INTEREST RATE ON RISK-FREE DEBT [%]) RATE analyzing and presenting this explicit credit nature of euros and dollars, the assumptions inherited from a world of notes and coins still stickily persist in many economic models used in modern research.651 This serves DEMAND as one example of how slow a discipline economics is at evolving – probably partly due to its highly segregated SUPPLY and fundamentalist nature.652 DEMAND FOR HOLDING CREDIT

DEMAND FOR BEING IN DEBT Two terms that are easy to misunderstand and confuse – and which economists also use very sloppily653 – are “money supply” and “the supply of money”. The “money supply” usually refers to the “quantity of money”. In QUANTITY today’s money system, this is not a self-explanatory (VALUE OF EXISTING DEBTS [$]) QUANTITY (VALUE OF DESIRED expression either, as we could be talking about any of CREDIT/DEBT BALANCES [$]) the different “monetary aggregates” such as MB, M1, M2, M3 and M4, which are measures for the total amount of GRAPH 19: THE SUPPLY OF RISK-FREE CREDIT – MONEY – GRAPH 20: THE (VOLUNTARY) ‘DEMAND FOR BEING IN DEBT’ credit in the market meeting specific liquidity (and other) IS INFINITELY INTEREST-RATE-ELASTIC IN OUR CURRENT AND THE ‘DEMAND FOR HOLDING CREDIT’. specification. CREDIT MONEY SYSTEM.

In this sense it is a false statement to say that the central bank controls “the money supply”. However, the central It is easy to assume that lowered interest rates always cause longer run by a lowered interest rate. Lower interest rates bank can be said to control “the supply of money”. As more loans to be taken655, but this is a rather misleading can help deleverage an economy with massive amounts of explained in “1.1.6 The ‘Market Forces’ – How Prices conclusion. In addition to making it cheaper to be in debt, debt. Balance Supply and Demand”, supply is the supplied lowering interest rates also makes it less profitable to hold amount of something as a function of price. An “increase on to credit and the resulting spending can also facilitate The other way to see this is that we only take the voluntary in supply” can be interpreted as the supply curve either paying debts back faster for debtors (as will be discussed component of the above “demand for credit” and call it shifting “right” or “down”. When the price elasticity of in more detail in “4.2.1 Eliminating the Zero Lower (more descriptively) the “demand for being in debt” and supply of something (in this case money, i.e. credit) is Bound with a Higher Inflation Target or by Eliminating add to the picture the “demand for holding credit”. The infinite, the supply curve is practically flat horizontal – i.e. Cash“). This practically shifts the demand curve for credit central bank is then simply keeping these in balance by the price (in this case the interest rate for new credit) is (loans) – which might not be very short-run-price-elastic controlling the cost of “being in debt” and the profitability the same regardless of quantity (the total value of existing in the first place – left (or down) by reducing involuntary of “holding credit”, by controlling the interest paid on debt contracts). In such a case, “increasing the supply of indebtedness (such as an unemployed person being stuck risk-free credit and charged for having risk-free debt – the money” just means lowering its price – shifting the supply with a student loan she would really want to pay back) market interest rate. curve downwards. As economists are not very careful and hence the quantity of credit might be decreased in the to avoid such double-meanings, the “supply of money” And we need the central bank to do this because there is often used synonymously with “money supply” (its Balance Supply and Demand”). In the case of the “supply of money”, the is no working market mechanism (thus far discovered “supplied quantity” can mean: quantity), and when John Taylor writes that “using an a) the quantity in existence (which, as mentioned, can be defined as that the author knows of) for keeping the credit market interest rate rule does not eliminate the concept of money many monetary aggregates) in balance.656 How this can influence the general price demand and money supply; it simply makes money b) the quantity currently offered for trade (i.e. the demand for other level (and changes thereof, i.e. “inflation”) by affecting endogenous”, (Taylor 1999, p. 9) by “money supply” he goods in money (Gesell 1916, Part 3, Ch. 10)) the aggregate supply and demand for labor and other real c) the quantity of new credit (“loans”) that can be granted 654 seems to be meaning “the supply of money”. and the “price” can be: resources, is explained in “1.3.5 Inflation Is the Rise in the 1) the interest rate of risk-free credit (Nominal) Price Level – And Has Little to Do with the 2) the purchasing power of the unit of credit (e.g. the dollar or the Quantity of Money”. 650 See: “2.2.6 Post-Keynesian Solutions – Ignore Hyperinflation Risks euro), the change in which is “inflation” (see: ”1.3.5 Inflation Is the and Guarantee Jobs”. Rise in the (Nominal) Price Level – And Has Little to Do with the 651 E.g. ”We assume that money demand arises from the need to carry Quantity of Money”). How our lingual expressions relating to money – out transactions and depends positively on aggregate output and nega- In this chapter, we have mostly meant “c-1” when talking about “the sup- especially the “conceptual metaphor” we use for it – tively on the interest rate. The supply of money is determined by the bal- ply of money being infinitely interest-rate-elastic”. In chapter 1.3.5, we ance sheet of the central bank and is exogenous.” (McKibbin & Wilcoxen will also talk about ”the supply and demand for money” in the sense of are strongly reinforcing and helping maintain these 2009, p.10) the relation between its quantity and its purchasing power (a-2) – one misunderstandings, is discussed further under “5.1.2 The 652 See: ”5.2.4 The Religious Nature of Economics and Politics” and of the most mistaken and blindly assumed causalities in the history of Misleading Conceptual Metaphor of Money as Items or ”5.2.1 The Personal Nature and Incentive Traps of Academia”. economics. Sub s t a n c e”. 653 E.g. ”[U]sing an interest rate rule does not eliminate the concept of 655 E.g. Paul Krugman (along other New Keynesians and mon- money demand and money supply; it simply makes money endogenous.” etarists) still likes to draw this connection between the inter- (Taylor 1999) est rate and the money supply, maintaining the illusion that 654 There would be good reason to abandon the concepts of the “supply the central bank has a strong influence over the money supply: and demand for money” altogether, as they can mean many, very differ- – ”A Teachable Money Moment”, NY Times, The Opinion Pages, 2nd Apr 656 See: “2.2.3.6 Democratic or ‘Full’ Money – ‘Power to the People from ent things. Essentially the “supply” of something is its “supplied quantity 2012, cited 5.4.2013, http://krugman.blogs.nytimes.com/2012/04/02/a- the Banks’” and “2.2.2.1 A Single Precious-Metal-Standardized Curren- as a function of its price” (see: “1.1.6 The ‘Market Forces’ – How Prices teachable-money-moment/ c y ”. 144 | Credit, Money and Banking

Sidenote Box 128A: Additional Reading on Money, Credit and Banking

—— “Banking 101, Root-Debugged”, https://www.youtube.com/watch?v=KLqYnW1RmDE (if the url has changed due to updates, refer to rootbug.org) —— Mitchell-Innes, Alfred, 1914, “The Credit Theory of Money”, From The Banking Law Journal, vol. 31, Dec./Jan., pp. 151-168, retrieved 23.5.2013, http://www.ces.org.za/docs/The%20Credit%20Theoriy%20 of%20Money.htm —— Mitchell-Innes, Alfred, 1913, “What is Money”, The Banking Law Journal, retrieved 23.5.2013, http:// www.ces.org.za/docs/what%20is%20money.htm —— Wray, L. Randall, 1993, “The Origins of Money and the Development of the Modern Financial System”, Working Paper No. 86, retrieved 23.5.2013, http://www.levyinstitute.org/pubs/wp86.pdf —— Wray, L. Randall, 2001, “The Endogenous Money Approach”, Working Paper 17, retrieved 9.9.2013, http://www.cfeps.org/pubs/wp-pdf/wp17-wray.pdf —— Zazzaro, Alberto, “How Heterodox Is the Heterodoxy of the Monetary Circuit Theory? The Nature of Money and the Microeconomy of the Circuit”, retrieved 8.1.2014, http://docs.dises.univpm.it/web/ quaderni/pdf/163.pdf —— Parguez, Alain & Seccareccia, Mario, 2000, “The Credit Theory of Money: The Monetary Circuit Approach”, In: Smithin, John, “What is money? Routledge Internatonal Studies in Money and Banking”, Routledge, ISBN: 0-203-07269-3, p. 101-124, retrieved 9.1.2014, http://cas.umkc.edu/econ/ economics/faculty/wray/631Wray/Week%205/Parguez%20and%20Seccareccia.pdf —— Hummel, William F., “Money: What it is, how it works”, cited 9.1.2014, http://wfhummel.cnchost.com/ —— Bill Mitchell’s blog on MMT, http://bilbo.economicoutlook.net/blog/?p=20091 —— Roche, Cullen O., 2011, “Understanding the Modern Monetary System”, retrieved 2.4.2015, http:// nowandfutures.com/large/UnderstandingTheModernMonetarySystem(cullen_roche)SSRN- id1905625.pdf —— “Pragmatic Capitalism: Monetary Realism Recommended Reading”, cited 23.5.2013, http://pragcap. com/understanding-modern-monetary-system —— Lavoie, Marc, 2011, “The monetary and fiscal nexus of neo-chartalism: A friendly critical look”, Department of Economics, University of Ottawa, retrieved 25.2.2013, http://www.boeckler.de/ pdf/v_2011_10_27_lavoie.pdf —— Schenk, Robert, “Cybereconomics” – “Monetary Policy and Balance Sheets”, cited 7.11.2013, http:// ingrimayne.com/econ/Banking/MonBalSheet.html —— “How is money really made by banks? - Banking 101 (Part 3 of 6)”, video, Positive Money, viewed 19.2.2014, http://www.youtube.com/watch?v=KvpbQlQwl0A (The descriptive part is very insightful, but why the conclusions make little sense is explained in “2.2.3.6 Democratic or ‘Full’ Money – ‘Power to the People from the Banks’”.) —— Werner, Richard A., 2012, ”The Quantity Theory of Credit and Some of its Applications”, PowerPoint presentation, University of Southampton Management School, Centre for Banking, Finance & Sustainable Development, retrieved 10.7.2013, http://www.postkeynesian.net/downloads/Werner/ RW301012PPT.pdf (The “money creation” part until p. 18 is enlightening. The “Quantity Theory of Credit” itself is highly questionable.657) —— “Eurokampus – The Bank of Finland promoting financial and economic know-how”, cited 19.2.2014, http://www.euro.fi/en/

657 There are little grounds for the assumption that the circulation velocity of credit granted for other than speculative purposes would be constant in the long run. See: ”1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And Has Little to Do with the Quantity of Money”. Economic Growth Is the Increase in Produced and Traded Value – The Many Meanings of ‘Wealth’ | 145

1.3 INVESTMENT, SAVING AND ECONOMIC GROWTH

1.3.1 Economic Growth The wealth of a nation can scarcely be Is the Increase in Produced “inferred from its national income.” – Simon and Traded Value – The Many Kuznets Meanings of ‘Wealth’ That is prosperity: The saving of time in In short: satisfying your needs. Ask yourself how long “you would have to work to provide for an hour of • Economic growth is the increase in (the reading light this evening to read a book by?” – value of) the production of paid products Matt Ridley, When Ideas Have Sex658 and services. It does not necessarily involve an increase in wealth (material nor I’m fascinated by a question and I know I’m monetary) nor the growth of anything not the only one. What should economies physical. “be aimed at? … Well, I studied economics at • As nothing is produced for long if it isn’t university twenty years and we never actually consumed, economic growth – in today’s asked that question, even though it seems like world – is largely determined by con- a very fundamental one, because the answer sumption. Also real investments increase was a given. It was economic growth.” – Kate demand – grow the economy – but the Raworth659 need for real investments is determined by expected future consumption (and the The most common definition of “economic growth”, in capital intensity allowed by technological economics, is an increase in production of valuable progress). goods. A lot of confusion is caused by the fact that economic growth is also sometimes defined as “the • When a fixed amount of work per person process by which a nation’s wealth increases over time”, as (and a matching consumption) is assumed, e.g. Encyclopaedia Britannica does.660 These are conflicting it is easy to think that economic growth is definitions, as “wealth” usually means an increase in “caused” by population growth and labor the value of the assets a person holds (or in the case of a nation, is held in net by everyone). E.g. the Merriam- productivity growth, as (with those as- Webster dictionary defines wealth as: sumptions) labor is the bottleneck resource for how much can be produced. “a : all property that has a money value or an exchangeable value Not only is it requisite in economic reasoning to give to such words as ‘wealth,’ b : all material objects that have economic utility; “ especially : the stock of useful goods having economic ‘capital,’ ‘rent,’ ‘wages,’ and the like, a much value in existence at any one time ”661 more definite sense than they bear in common discourse, but, unfortunately, even in political 658 5:55->, Ridley, Matt, 2010, “When Ideas Have Sex”, TED Talk, viewed economy there is, as to some of these terms, 12.12.2012, http://www.ted.com/talks/matt_ridley_when_ideas_have_ sex.html no certain meaning assigned by common 659 0:27->, Raworth, Kate, “Doughnut Economics: Creating a safe and consent, different writers giving to the same just space for humanity”, viewed 18.6.2013, http://www.youtube.com/ watch?v=CqJL-cM8gb4# term different meanings, and the same writers 660 “Economic growth”, entry, Encyclopaedia Britannica, cited often using a term in different senses.” – Henry 10.9.2013, http://global.britannica.com/EBchecked/topic/178400/economic-growth George, Progress and Poverty (1912, p. 30) 661 “Wealth”, entry, Merriam-Webster Dictionary, cited 10.9.2013, 146 | Investment, Saving and Economic Growth

Georgists define “wealth” as: And this is not the same as an increase in “wealth” – by which we mean (along the modern meaning of the word) “[a]ll material things produced by labor for the “net market value of assets.” Of course, increased expected satisfaction of human desires and having exchange demand in the future can, and often significantly does, value.”662 increase the value of productive capital assets and the market values of companies’ shares, as the value of capital On the other hand, what Adam Smith talked about assets is determined by its potential future profit yields.670 as the “wealth of nations” was the nations’ (material) However, this increase in value is not directly a function of living standard – its total real income.663 This definition current production, but of expected future production.671 of “wealth” is more understandable in the, nowadays obsolete, meaning of the word “wealth” as “well-being” The most common measure of the size of the economy or “weal”, which means “a sound, healthy, or prosperous and economic growth is the real gross domestic product state”664. Misunderstandings are often further enforced (GDP) – the real value of goods and services produced when translating between different languages.665 No annually within a country – an increase in which is what wonder Tim Jackson (2009) had to write a whole book is usually meant by “economic growth” (e.g. when news about questioning the assumed unbreakable connection articles say that, “the U.S. economy is expected to grow by between “prosperity” and “growth”. 2 %”). Nominal GDP (NGDP) is the monetary value of the goods and services produced and when this is corrected Further confusion is caused by the fact that even in the for inflation672 we get “real GDP”. context of economics, “economic growth” is sometimes defined as “an increase in the capacity of an economy to “Gross national product” (GNP) focuses on the things produce goods and services” (italics added)666 667. This produced by a nation’s citizens (rather than within its is, however, slightly contradictory with the fact that, borders) taking into account income from labor done in mainstream economics, economic growth is usually abroad. “Gross national income” (GNI) additionally takes pursued in order to “close output gaps” – differences into account factor income balances:673 how much interest between actual production and potential production (i.e. and dividends are paid out of the country and how much the capacity to produce).668 into it from other countries674.

In this book, by “economic growth”, we mean an increase GDP does not include the goods or services that are not in the market value of annually produced and sold paid for, such as household chores or voluntary work. goods and services. The value of production is “the size Hence it does not fully encompass the (development of) of the economy.”669 all value produced and experienced in the economy. Interestingly, if some kind of service has previously been http://www.merriam-webster.com/dictionary/wealth paid for and that specific service then becomes cheaper 662 “’Economics’ and “Political Economy“, Henry George Institute, cit- (e.g. as a result of increased productivity), it remains ed 18.6.2013, http://www.henrygeorge.org/def2.htm 663 The book starts by the words: with the same value in real GDP. If, instead, it is offset or “The annual labour of every nation is the fund which originally supplies replaced by some other free service (like Google Translate it with all the necessaries and conveniencies of life which it annually con- might eat some of the market of professional translation sumes, and which consist always either in the immediate produce of that labour, or in what is purchased with that produce from other nations. services), it is no longer visible in GDP. Such invisible According, therefore, as this produce, or what is purchased with it, bears increases in value are one factor that significantly distorts a greater or smaller proportion to the number of those who are to con- measurements of productivity increases – especially in sume it, the nation will be better or worse supplied with all the necessaries and conveniencies for which it has occasion.” (Smith 1776, p. 8) 664 “Weal”, entry, Merriam-Webster Dictionary, cited 10.9.2013, h t t p :// www.merriam-webster.com/dictionary/weal only those implying production of new consumable goods or new assets. 665 E.g. “(economic) prosperity” is often translated into Finnish “vau- For example investments that are divestments of others and vice versa – raus”, which is closer to “wealth”. A more direct translation of “prosper- i.e. buying and selling of existing assets produced earlier, e.g. financial ity” would be “menestys”, which in turn is more often equated with a assets, real estate or secondhand goods – are not regarded as a part of the more general “successfulness”. The name of the Finnish translation of the “size of the economy” in this sense, nor are loans made and paid back. “The Wealth of Nations”, “Kansojen varallisuus”, is not just misleading 670 See: “1.1.8 Labor and Capital (and Land?) – The Factors of Produc- but plain wrong. “Varallisuus” rather explicitly refers to one’s property. t ion”. E.g. “net assets” is “nettovarallisuus”. “Vauraus” could have been inter- 671 The relation between total consumption and total wealth is dis- preted also as living standards and is the most common translation for cussed in: “1.3.2 In a Closed Economy, Net Monetary Wealth Is Zero – To- “wealth” also in the modern meaning. tal Real Wealth Depends on Future Consumption and Capital Intensity 666 “Economic growth“, Investopedia, definition, cited 10.9.2013, h t t p :// (and Monopolies)”. www.investopedia.com/terms/e/economicgrowth.asp 672 See: “1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And 667 “Economic growth“, Business Dictionary, definition, cited 10.9.2013, Has Little to Do with the Quantity of Money”. http://www.businessdictionary.com/definition/economic-growth.html 673 See: ”1.3.4 Foreign Trade: Current Accounts Are Also a Zero-Sum 668 See: ”2.2.5.1 Keynesian Fiscal Stimulus – It’s the Government’s Job to Game – Comparative Advantage vs. Absolute Advantage”. Invest Stably”. 674 See: “Gross National Income”, definition InvestorDictionary. 669 We could also see it as an increase in the amount and value of trade, com, cited 24.10.2013, http://www.investordictionary.com/definition/ economic transactions – except that not all transactions are included, but gross-national-income Economic Growth Is the Increase in Produced and Traded Value – The Many Meanings of ‘Wealth’ | 147

services, where it is almost impossible to compare the As explained in ”1.1.4 Production Is for Consumption, i.e. “real value” produced by two different services.675 Appreciation – ‘Productivity’ Has Many Units”, things only have value if someone consumes them, and therefore It is very likely that during the last two decades, when things are usually not produced (except by a wasteful digital services have taken over many markets, economic public sector e.g. focusing on maintaining employment,680 growth (the increase of real value produced) and labor or some other party using others’ money) unless they productivity development have actually been much are expected to be consumed by someone. Hence, higher than measured, while inflation, if we measure it global economic growth is more determined by total by the living standards achievable with the same nominal consumption than by anything else. amount of monetary income, has not been as high as suggested by consumer price indices676 – we get many new Of course the economy’s capacity (and willingness) to things relatively for almost free. produce – the availability of the factors of production – can also be a bottleneck for economic growth. As most capital On the other hand, it can be debated if some services is produced (or extracted, in the case of natural resources) that are almost purely “distributive” in nature677 actually with human labor,681 labor productivity is often the most produce real value. Distributive activities between significant bottleneck. Natural resources are limited, but companies (such as patent wars678) are reflected in their extraction becoming more difficult can practically consumer prices of the goods they produce and are be seen as a decrease labor productivity. More can only therefore accounted for in indices, but for example an be produced per person, if (a) people work more, or if (b) increase in purchased divorce lawyer services – the labor productivity increases. The supply-oriented views cliché example of a “distributive” activity – does not raise of economics focus on getting people to work more, but it the prices of other products and rather shows up as an is noteworthy that this only increases growth in a closed increase in both real and nominal GDP. Similarly, if people economy if we assume people to be willing to consume have been made more dependent on medicines as e.g. a more as well. result of the side effects of other medicines, we can debate whether overall value produced has increased.679 In many Western countries, the total amount of work has remained fairly stable for decades, and therefore economic Different schools of economics and even individual growth has largely followed technological progress academics have very different views of what causes that allows increases in labor productivity. So, with the economic growth – even if they agreed on the definition. assumption of a fixed amount of work per person, it is Some strongly believe it is caused by technological understandable to conclude that “economic growth (per innovation allowing productivity increases. George Solow capita) is caused by technological development”. However, of MIT is one example. Joseph Schumpeter’s expression the verb “facilitate” or “allow” would fit in better than that capitalism progresses through “creative destruction” “c au s e”. (Schumpeter 1954), can also be seen to support this view (e.g. Jackson 2009, p 63) although “progress” does not “Change the comparison set and you change the necessarily imply growth or an increase in anything, but cause.” (Pinker 2007, p. 214) rather the emergence of a “new economic order”. Some say that the cause of growth is “investments” and some For more on the conundrum of causality, see: “6.1.4 “saving” or “capital accumulation.” Some (especially Appendix 1.4: The Conundrum of Causality – The Culprit classical economists) attribute it mainly to population Depends on Comparison”. growth. And none of these are completely erroneous. Historically – especially during industrialization – new production technologies have often also been more 675 See also: “2.3.1 The Job Creation Paradigm – Why Are We Trying to capital-intensive682 than previous ones, meaning that Make More Work?!”. 676 See: “1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And they require more work upfront – i.e. investments – to Has Little to Do with the Quantity of Money”. build the required facilities, machinery and other tools 677 See: “6.3.4 Appendix 3.4: Productive vs. Distributive Activity – How used. Usually, making these investments requires savings e.g. Marketing and Finance Are Productive”. 683 678 See: ”4.3.2 A Market Value Tax on Patents – Minimizing the Nega- upfront by the investors for equity to carry the business tive Externalities of Technology Monopolies”. 679 Some go as far as to say that the fact that new “needs” are constantly created for people through marketing erodes any value produced to 680 See: ”2.3.1 The Job Creation Paradigm – Why Are We Trying to fulfill those needs (e.g. Galbraith 1958), but here “value” and “happiness” Make More Work?!”. are confused with “satisfaction”. The distinction between happiness and 681 See: “1.1.8 Labor and Capital (and Land?) – The Factors of Produc- satisfaction is discussed in “6.1.1 Appendix 1.1: Happiness Is Appreciat- t ion”. ing – A Framework of Happiness”, the trouble with GDP as an objective 682 See: “1.1.8 Labor and Capital (and Land?) – The Factors of Produc- in itself is discussed in “3.4.5 The Irrelevance of the ‘Degrowth vs. Decou- t ion”. pling’ Debate” and the ethics of “creating needs” is debated in this book’s 683 See: “1.1.10 Companies as Contract Bundles – Financial Assets Allo- sister, the Guilt Economy. cate Risks”. 148 | Investment, Saving and Economic Growth

risks because creditors are seldom willing to carry all of it (even on high interest rates).

But savings can only be considered to be the cause of economic growth if there really is a deficit of capital, i.e. an overall deficit of labor,684 which pushes up the equilibrium Chapters 1.3.2-2.2.5.1 not included in this sample interest rate and the resulting high costs of capital are the biggest obstacles to making investments that would allow increases in productivity. And that pretty much was the case in the 18th and 19th centuries. Currently, we have chronic oversupply of saving.

People somehow distinguish just one of the “necessary conditions for an event as its cause and the others as mere enablers or helpers, even when all are equally necessary. The difference does not lie in the chain of physical events or in the laws they follow, but in an implicit comparison with certain other states of affairs (similar possible worlds, if you will) that we keep in our minds as the reasonable alternatives to the status quo. Since oxygen is pretty much always around, we don’t think of its presence as a cause of a match igniting. But since we spend more time not striking matches than striking them, and feel that it is up to us at any moment whether we strike or not, we do credit the striking as a cause. Change the comparison set and you change the cause.” – Steven Pinker, The Stuff of Thought (2007, p. 214)

684 See: ”2.2.5.2 Monetary Policy – You Can Pretend It’s about the Mon- e y Supply ”. Mainstream Economic Solutions – Increase Spending or Compete Harder | 229

this is the only rate which is directly subject to the will and fiat of the central authorities, so that it is from this that induced changes in all other factors must flow.” – John Maynard Keynes, A Treatise on Money”, (1930, p. 211) 2.2.5.2 Monetary Policy – You Can Pretend It’s about the Money Supply The earning class is, therefore, better able to save when interest is falling, and the In short: “capitalistic class when interest is rising. It • The traditional monetarist view of would be a fallacy, however, to conclude from monetary policy is that the central bank this that the function of saving, as a whole, and controls the money supply to balance the increase of capital, is unaffected by the fact economic development and changes in the that interest rises or falls.” – Silvio Gesell, The price level. Natural Economic Order (1916, Part 5, Ch. 5)

• However, it would be more descriptive to [T]he multiplier model, whether viewed from say that the central bank’s policy interest “an analytical or empirical perspective, is at rate keeps aggregate supply and demand best a misleading and incomplete model and in balance by affecting the profitability of at worst a completely misspecified model.” – saving and the cost of being in debt – the Raymond Lombra (1992, p. 305) quantity of money is not a relevant causal link between the interest rate and the price An alternative to changing government spending is to level. affect consumer (and enterprise) behavior by controlling interest rates. The traditional way to describe “monetary • Quantitative easing – an “unconventional” policy” – especially by monetarists and other worshippers monetary tool – mainly affects liquidity in of the Quantity Theory of Money – is that the central bank the market (and the prices of the financial keeps inflation stable by controlling the money supply. assets purchased) and has a much less However, this view is entirely misleading because, firstly, the central bank has little control over the money supply.1099 linear effect (i.e. a more speculative, unpre- The total quantity of credit – and also of liquid credit – in dictable, destabilizing effect) on the price the system is endogenously determined by them market. level than policy interest rate changes. Secondly, because the direct causal relationship between the total quantity of credit (any monetary aggregates) and The banking system has no direct control the general price level (inflation) is very weak in today’s “over the prices of individual commodities credit money system. or over the rates of money-earnings of the Nevertheless, Western central banks have been very factors of production. Nor has it, in reality successful at keeping inflation stable during the past any direct control over the quantity of money two decades. Their policy interest rates (e.g. the Federal ; for it is characteristic of modern systems that Funds Rate of the FED) can still affect inflation although The Central Bank is ready to buy for money the causal mechanism does not run through the “money 1100 at a stipulate rate of discount any quantity of supply” variable. As explained in “1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And Has Little securities of certain approved types.

1099 It can theoretically set an upper limit to the amount of credit that Thus … it is broadly true to say that the governor banks can extend by setting reserve requirements and refraining from of the whole system is the rate of discount. For lending new reserves (see: ”Sidenote Box 2252A: The Actual Policy Tools”), but the reliability of such limits are questionable (it can be avoided e.g. by encouraging savings accounts, as they usually don’t have simi- 1097 See: “2.2.3.3 Wage Regulation by the Government – All or Nothing”, lar reserve requirements) and their point even more so, as the quantity of “2.2.3.4 Social Support and Other Transfer Payments – Robin Hood Poli- money is not the main driver of the price level. tics” and “3.1.3 Structural, Friction and Classical Unemployment, NAIRU 1100 For how the Quantity Theory in the context of monetary policy is and Hysteresis – Is 5 % Unemployment Really Necessary?”. analogous to the “equal transit” theory in functioning of airplane wings 1098 See: “1.1.8 Labor and Capital (and Land?) – The Factors of Produc- and sails on boats, see: “6.1.4 Appendix 1.4: The Conundrum of Causality t ion”. – The Culprit Depends on Comparison”. 230 | Different Economic Schools and Their Solution Suggestions too D with the Quantity of Money”, the changes in the overall price level are determined by aggregate INTEREST supply and demand (and any possible wage RATE regulations). And as explained in “1.2.8 The Supply of Money Is Infinitely Interest-Rate-Elastic – The Money Supply Is Endogenous“, the central bank policy interest rate is practically the cost of risk-free credit and determines the cost of being in debt and the SUPPLY OF LABOR / DEMAND FOR EARNING OPPORTUNITIES profitability of holding credit. Therefore the central bank’s “conventional monetary policy” (adjusting DEMAND FOR LABOR / the interest rate) is rather keeping the “demand for SUPPLY OF EARNING OPPORTUNITIES being in debt” and “the demand for holding credit” in balance – just like a market interest rate should.1101

How does this translate into aggregate demand and QUANTITY (WORK HOURS OR REAL VALUE OF CONSUMPTION) supply for labor? Let’s remember that companies are mere intermediaries in a process where people GRAPH 22: AGGREGATE SUPPLY AND DEMAND FOR LABOR. practically buy work (and “risk-carrying services” in the form of finance) from each other through products and services produced with that labor (and finance).1102 When a person is saving as money (or other 1930, p. 203-207)1106 and also Henry George points out that, monetary assets), he is practically supplying more labor in fact, “interest is high where and when wages are high” than he is demanding. On the other hand, when a loan and vice versa. (George 1912, p. 23) Hence, the concept is taken – or savings reserves are depleted – to finance of “aggregate demand” (or supply), without having to new real investment, more labor is demanded than is specify it as the aggregate demand for (or supply of) labor, supplied.1103 Hence, people saving more than others want is justified. to be in debt practically results in an oversupply of labor, which leads to falling wages and, hence, falling prices of Mathematically we could express this roughly as follows: products and services. AdditionalDesireToBeInDebt – AdditionalDesireToHoldCredit One important conclusion is that an oversupply of = ExcessDesiredIncreaseInDebt capital (saving) practically is an oversupply of present labor! When people want to save more than is needed for = ExcessDemand(forLabor) investments (capital is oversupplied), it can just as well be = AggregateDemand – AggregateSupply said that people want to sell more work than they want to buy work (through spending and real investments), i.e. To avoid a chain reaction of accelerating inflation due to more labor is supplied than demanded.1104 Therefore the excessive aggregate demand (so-called “overheating” view of the classical economists that the cost of “factor of the economy) interest rates are raised to make saving prices” would be complementary – that interest rates rise upfront for investments and paying off loans more when there is a deficit of capital relative to labor and vice profitable compared to borrowing to make investments versa – is completely on the wrong tracks.1105 The empirical earlier. When economic growth (the increase in total evidence against this theory was already demonstrated by demand1107) slows down – as a result of reduced spending John Maynard Keynes and “Gibson’s paradox” (Keynes and reduced investment – below the increase in labor productivity (and/or supply of labor), excessive saving as money is discouraged and taking on debt encouraged by lowering interest rates. 1101 See: “Graph 20: The (voluntary) ‘demand for being in debt’ and the ‘demand for holding credit’.” 1102 See: “1.1.9 Companies as Competing Organizational Forms (Be- The model we suggest for the economic effects of cause Institutions Suck at Suicide) – ‘Pro-Business’ Is Not ‘Pro-Market’”. “conventional” monetary policy – adjusting the market 1103 Note: Receiving unemployment support or any other transfer payment could be seen as providing completely unproductive labor. interest rate – is meant to be as broad as possible, while 1104 See: ”1.3.3 The Circular Flow of Income – Consumption, Saving and remaining simple and clear. This model (lower half of Investing”. the graph, in lighter shades) and its differences with the 1105 This view point is likely to have been strongly affected by the fact monetarist perception (and other Quantity Theory views, that classical economists (such as David Ricardo and Thomas Malthus) liked to separate people into the classes of ”workers”, ”capitalists” and ”landlords”, and the assumption that only capitalists invest their savings productively – and always do invest. (Chang 201, p. 140-141) In such a the- 1106 See: ”2.2.3.6 Democratic or ‘Full’ Money – ‘Power to the People from oretical situation, ”an oversupply of labor” might mean laborers wanting t h e Ba n k s’”. to save too much and ”an oversupply of capital” would mean capitalists 1107 See: ”1.3.1 Economic Growth Is the Increase in Produced and Traded wanting to save too much. Value – The Many Meanings of ‘Wealth’”. Mainstream Economic Solutions – Increase Spending or Compete Harder | 231

CAUSALITY IN “CONVENTIONAL” MONETARY POLICY? INCREASED (INFLATION TARGETING BY POLICY INTEREST RATE) ASSET PRICES

MORE MORE DEMAND FOR LOWER COST OF MORE MONEY IN THE CONSUMPTION AND BEING IN DEBT BORROWING ECONOMY INVESTMENT GOODS MONETARIST VIEW MONETARIST

INCREASED INCREASED INCREASED LOWER MARKET DESIRE TO TAKE DEMAND FOR AGGREGATE INFLATIONARY INTEREST RATES ON MORE DEBT CURRENT DEMAND FOR PRESSURES ON (FOR CONSUMPTION) GOODS AND LABOR PRICES OF GOODS SERVICES (CONSUMPTION)

LOWER LOWER DESIRE COST OF TO SAVE PRESSURE BEING IN REDUCED TO RAISE DEBT AGGREGATE WAGES ON LOWER COST INCREASED SUPPLY OF AVERAGE OF CREDIT DEMAND FOR LABOR FINANACE REAL ASSETS (FOR INVESTMENT) LOWER (REAL INVESTMENTS) RETURN ON HOLDING RISING MARKET PRICES OF LOWER PROFIT NON-PRODUCIBLE (AND CREDIT REQUIREMENT ROOT ROOT BUG VIEW OTHER MONOPOLY) ASSETS FOR EQUITY (COST OF CAPITAL)

NEW KEYNESIAN / MARKET J.M. KEYNES’S VIEW MONETARIST VIEW (THE GENERAL THEORY)

GRAPH 23: A MODEL OF THE EFFECTS OF THE MARKET INTEREST RATE, WHICH THE CENTRAL BANK SETS IN “CONVENTIONAL” MONETARY POLICY.

in a darker shade) of the causalities between the interest a 2 B$/year willingness to take on new consumption or rate and inflation pressures are presented in Graph 23. investment loans. This would mean a fierce competition over resources – especially labor – as more would be If e.g. the currently demanded amount of consumption needed than is available. This causes more upwards goods and services is at a level requiring 10 B$/year worth pressure (in some professions) than downwards pressure of labor for their production and the needed additional (in other professions) on wages1108 and would hence lead to investments, i.e. the demand for production goods (with accelerating inflation.1109 To avoid this inflation, the central current expectations of future demand) would need 2 bank can raise the interest rate until the aggregate supply B$/year worth of labor, but the amount of labor supplied and demand for labor are in balance – and therefore also is only 11 B$/year, this means that the desired amount of consumption and investment exceeds the desired amount of work by 1 B$/year. There is therefore a desire 1108 See: “3.1.3 Structural, Friction and Classical Unemployment, NAI- to borrow 1 B$/year more than there is to save monetarily. RU and Hysteresis – Is 5 % Unemployment Really Necessary?”. 1109 Of course, with wage regulation, both the interest rate and the over- For example, there might be an overall desire to save supplyf o labor are higher in the state of non-accelerating inflation. See: up 1 B$/year as additional financial assets by some, but ”2.2.3.3 Wage Regulation by the Government – All or Nothing”. 232 | Different Economic Schools and Their Solution Suggestions

the demand for being in debt and for holding credit are in John Maynard Keynes – as early as 1930 – emphasized that balance. the central bank’s interest rate primarily affects the rate of investment and that most other effects follow from this: Firstly, the higher rate might for example encourage people to save more and hence (a) spend less to reduce “[I]t is broadly true to say that the governor of the demand for consumption goods and services by an whole system is the rate of discount. For this is the amount that reduces the demand for labor by 0.3 B$ and only rate which is directly subject to the will and fiat (b) work more (e.g. people willing to work overtime for of the central authorities, so that it is from this that cheaper or getting some employees to return from their induced changes in all other factors must flow. sabbatical) to increase the supply of labor by 0.1 B$. Then the reduced expected future spending and the higher This means, in substance, that the control of prices discounting rate1110 together might reduce the amount of is exercised in the contemporary world through the profitable looking real investment opportunities by an control of the rate of investment. There is nothing that the amount that would reduce the demand for labor further central authority can do, whether it operates by means by 0.6 B$. The balanced aggregate demand and supply of of the bank-rate or by means of open-market dealings, labor would then stand at 11.9 B$/year and the market for except to influence the rate of investment.” (Keynes additional credit would stand at 1.6 B$/year. 1930, p. 211, italics in original)

Of course the actual rates at which labor supply decreases And turning monetary savings into real or risk-bearing and consumption and investments increase (in proportion investments is likely to be the most significant short- to one another or in response to a specific interest rate term effect of interest rate changes, as this can happen change) – their “interest rate elasticities” – are impossible relatively quickly compared to changes in people’s total to predict: They are matters of supply and demand and savings. However, Keynes is omitting the fact that the rate a result of individual investors’, workers’ and consumers’ of interest – especially in the long-term – can also affect assessments and the opportunities available to them. But, consumption and people’s willingness to work (the supply of most importantly, all of these effects of the interest rate on labor). When people can expect a bigger return on their inflationary pressures are in the same direction!1111 And savings – whether they prefer keeping their savings as this explains why “conventional monetary policy” is so risk-free credit or productive investments – they will be effective – why it is enough that the central bank raises its more inclined to save, i.e. inclined to work more relative interest rate to react to inflationary pressures and lowers it to their consumption (work more or consume less) and to react to deflationary pressures. Conventional monetary vice versa. An oversupply of capital essentially is an policy is practically just replacing the market mechanism oversupply of labor. Individuals attempt to accumulate for the interest rate, which does not work naturally with capital by saving money, but unless net real investments any commodity money or other currency of inelastic occur at the same rate as net saving1114, there won’t be supply.1112 enough earning opportunities and the competition over them will push wages and prices down. However, in this model, both the amount of money and debt and the total amount of production and consumption Some New Keynesians and e.g. “market monetarist” Scott (the change in which is “economic growth”1113) are Sumner point out the effect of interest rates on aggregate “endogenous”. The central bank cannot affect these demand: The more there is aggregate demand relative directly, as they depend on the “interest rate elasticities” to aggregate supply, the more prices rise. This is how of people’s desire to save and to hold debt as well as their they explain why inflation is hard to increase with high preference of free time over products and services. overall unemployment. But unfortunately, they too, miss the potential effect of the interest rate on people’s desire to save and the aggregate supply of labor: Lower expected yields on savings can affect people’s willingness to work (if they have any choice in this regard1115).1116 1110 See: “1.1.8 Labor and Capital (and Land?) – The Factors of Produc- t ion”. 1111 In the short run, there can of course be exceptions due to the irratio- 1114 See: ”1.3.3 The Circular Flow of Income – Consumption, Saving and nal nature human beings. If a person is e.g. fixated on the idea of retiring Investing”. at 60, lower returns on their retirement savings might make him want to 1115 See: “4.1 Maximizing Flexibility to Eliminate Labor Market Mis- save even more at first. But if interest rates can drop low enough, even- matches and Increase Adaptability” and the “B factors” in: “6.2.1 Appen- tually they should start considering having that freetime earlier instead dix 2.1: All the Different Causes of Monetary Saving – and Dealing with and retiring later. Them”). 1112 See: ”Sidenote Box 2252B: Is Monetary Policy Distorting the Market? 1116 We could say that lower interest rates can alleviate the ”Paradox of – The Dollar Is Not a Commodity, but a Unit of Account for Credit Rela- Toil”, which has been presented by Gauti Eggertson (2010): t ion s”. ”Suppose everyone wakes up one day and decides they want to work 1113 See: ”1.3.1 Economic Growth Is the Increase in Produced and Traded more. What happens to aggregate employment? This paper shows that, Value – The Many Meanings of ‘Wealth’”. under certain conditions, aggregate employment falls; that is, there is less Mainstream Economic Solutions – Increase Spending or Compete Harder | 233

Of course, with the assumption of a fixed amount of work The Post-Keynesian skepticism towards the effectiveness per person – a human being as the unit of labor – a fairly of monetary policy also does not take into account how fixed (or at least interest-rate-independent) supply of labor mitigating the risks of long-term unemployment can seems like a logical simplification.1117 The effects on the reduce the positive feedback mechanisms that cause supply of labor could be significantly higher if people had cyclicity1123, making the economy more “sensitive” to the realistic option of working less without this resulting interest rates. in a higher risk of long-term unemployment.1118 The model presented in Graph 23 integrates the effects L. Randall Wray (a Post-Keynesian) argues that: on real investment suggested by Keynes with possible effects on consumption, but additionally accepts that (1) —— when there are no profitable investment lower returns on savings can increase people’s desire to opportunities, no interest rate (even a negative one) spend more earlier and that (2) both the lower profitability can induce companies to invest, and that of saving and lower costs of holding debt can (in addition to increasing spending) reduce people’s willingness to —— it makes little sense to try to induce people to work (i.e. lower the supply of labor). These possibilities borrow and spend more when they’re already too are accepted for example in Irving Fisher’s “Theory of heavily indebted.1119 Interest, As Determined by Impatience to Spend Income and the Opportunity to Invest It” (1930).1124 And he is right. But he, too, omits the effects that lower rates can have on people’s willingness to save. And that So even though, officially, the function of central bank the need to induce people to save is the whole justification monetary policy is to keep inflation stable – and therefore for the (risk-free) return on capital! If we assume that reduce uncertainty in the market – it simultaneously people would still want to save excessively (more than is serves the purpose of keeping total supply and demand for needed for investments) with a -10 % interest rate, then that labor in balance (at least if wages were not regulated1125). means that capital really does not need to make a profit Therefore a “dual mandate” (like the one the FED officially and that companies and investments could be “profitable” has) of keeping inflation stable and maintaining low at a loss.1120 It is interesting how eagerly Post-Keynesians unemployment (or low underemployment) should not be want to maintain the “minimum wage of capital”.1121 1122 necessary. work in the aggregate because everyone wants to work more. The con- But as can be seen in e.g. the current situation, a stable ditions for the paradox to apply are that the short-term nominal interest inflation rate does not mean full employment. Some critics rate is zero and there are deflationary pressures and output contraction, like Paul Krugman say that the inflation stability target much as during the Great Depression in the United States and, perhaps, the 2008 financial crisis in large parts of the world.” should be abandoned (and unemployment targeting 1117 See: “2.3.2 The Overlooked Option – Increase Correlation of Earn- emphasized) and e.g. Scott Sumner suggests replacing ing Opportunities with People’s Willingness to Spend and Invest”. the dual mandate with “nominal GDP targeting”, which 1118 See: ”3.1.1 Economic Instability, Cyclicity, ‘Keynesian’ Unemploy- ment and Growth Dependence”, ”4.1.5 Guaranteeing Security While he thinks would serve both of these purposes. However, Avoiding Welfare Bumming: Economic Freedom Need Not Be Free” and the problem is that, as the Non-Accelerating Inflation ”3.2.1 Maximal Economic Security with Maximal Flexibility – Flexicurity Rate of Unemployment (NAIRU) is mainly structural, and Antifragility”. 1119 “[Keynes’s] argument is: the problem in a slump is that the marginal friction and classical unemployment, it cannot be solved efficiency of capital - which is basically profit expectations - collapse and sustainably by just increasing aggregate demand: This can easily go negative. So that if your expectation is that if you invest that would lead to a constantly accelerating inflation rate (as you’re not only not gonna get profits - you’re actually gonna incur losses, the term says) – eventually hyperinflation – that is sure to there is no interest rate that would get you to invest. Even if you could 1126 get interest rates negative.” … “You need fiscal policy…” … “The idea have even more harmful effects on the economy. How that you can get people to borrow and banks to lend by pushing interest rates down and stimulate the economy that way was always wrongheaded. Wrongheaded for two reasons: One, we don’t want people to borrow rists and macroeconomists don’t (want to) understand theories of capital. more: Households are too heavily indebted. So pushing interest rates Capital theorists and those getting the monopoly nature of land don’t down which incurs them to borrow more, was not a good strategy. But, understand money. Those who understand the evolutionary nature of in- second, if people are worried about the future, they’re not going to bor- dustries and the imperfections of information make unrealistic assump- row. So it also wouldn’t work.” tions on macro, money and capital, and so on. – 9:45->, 11:04-> & 11:30->, “Podcast with Randy Wray September 23rd”, 1123 See: ”3.1.1 Economic Instability, Cyclicity, ‘Keynesian’ Unemploy- listened 19.5.2014, http://hwcdn.libsyn.com/p/f/2/4/f2401393fdd- ment and Growth Dependence”. 5ef47/Podcast_with_Randy_Wray_Sept_23.mp3?c_id=6180483&expira- 1124 See: ”1.1.8 Labor and Capital (and Land?) – The Factors of Produc- tion=1400534887&hwt=9f4eaebeb8a830156bfcf401bc32bc96 t ion”. 1120 See: ”1.1.8 Labor and Capital (and Land?) – The Factors of Produc- 1125 See: ”2.2.3.1 Collective Bargaining – ‘Blackmail Is Solidarity’”, t ion”. ”2.2.3.3 Wage Regulation by the Government – All or Nothing” and 1121 See: ”4.2.1 Eliminating the Zero Lower Bound with a Higher Infla- ”2.2.3.4 Social Support and Other Transfer Payments – Robin Hood Poli- tion Target or by Eliminating Cash”. t ic s”. 1122 This serves as yet another example of how segregated and exces- 1126 Nominal GDP targeting is returned to in “4.2 Preventing Excessive sively specialized academia is even within economics (see: ”5.2 Academic Monetary Saving – Allowing Monetary Policy to Balance Aggregate Sup- Economics Is Important – But It Is Not An Innovator”). Monetary theo- ply and Demand”. 234 | Different Economic Schools and Their Solution Suggestions

making sharing work profitable would remove the need seriesf o asset purchases, or ‘quantitative easing’ (QE). for NAIRU unemployment (and wage regulations that QE is intended to boost the amount of money in the further raise it) is explained in “3.1.3 Structural, Friction economy directly by purchasing assets, mainly from and Classical Unemployment, NAIRU and Hysteresis – Is non-bank financial companies. 5 % Unemployment Really Necessary?” and “3.2.2 Unfair Income Differences and Limits to Social Mobility”. QE initially increases the amount of bank deposits those companies hold (in place of the assets they sell). A bigger, more relevant problem is the zero lower bound Those companies will then wish to rebalance their of interest rates. Currently, interest rates in many Western portfolios of assets by buying higher-yielding assets, economies are already close to, or at, zero, but spending raising the price of those assets and stimulating and investing in real assets still do not pick up. Nominal spending in the economy.” (McLeay et al 2014, p. 14) interest rates cannot be set much below zero because, as long as there is physical cash, this would cause depositors However, this last stated claim that purchases of assets by to withdraw their funds. In some cases, the interest rate investment companies would raise spending and therefore can be a few promilles on the minus side for institutional the aggregate demand for labor is very questionable. investors who are ready to pay this “service fee” for someone storing their funds, but these interest rates never “Whether quantitative easing can be effective in reach consumers or companies. relieving deflationary pressures, and if so, by what mechanism, remains controversial. As already noted, An economy gets stuck at the zero lower bound (often EW have provided theoretical reasons to doubt the called “falling into a liquidity trap”1127) in a situation efficacy of quantitative easing as an independent tool where the economy is not expected to grow and there is of policy. Specifically, they show that, in a world in hence little need for additional real investments. Investing which financial frictions are limited and in which a in more capacity (houses, machines, training, R&D, etc.) clear dichotomy is maintained between monetary and would just cause excess, unused capacity, which would fiscal policies, quantitative easing will have no effect, lie idle without generating any profits or revenues. In except perhaps to the extent that the extra money this situation, people choose to hold on to their monetary creation can be used to signal the central bank’s assets, as (due to the central bank’s promise to ensure intentions regarding future values of the short-term “price stability”, i.e. keep the inflation rate at 1-2 %) it interest rate. The assumptions of frictionless financial is safer and more profitable to keep one’s savings (i.e. markets and complete separation of monetary and preserved purchasing power for the future) in them than fiscal policies, to be sure, are rather strong. If these in any real assets. assumptions do not hold, we may have some basis for believing that quantitative easing will be effective.” When the increased saving by individuals, companies and (Bernanke et al 2004, p. 18) other institutions results in excessive piling up of debt (on other private sector agents or the government), this may “Flooding banks with additional liquidity, as central start increasing the credit default risks of these debtors, banks have done recently via Quantitative Easing which raises interest rates for debtors despite the central (QE), has not led to much commensurate increase bank keeping interest rates for risk-free credit at 0 %. One in bank lending or broad money.” (Charles A. E. way for the central bank to hinder this rise in interest rates Goodhart in: Ryan-Collins et al 2012, p. 3) is to intervene in the market and buy up more bonds from the market – replace non-liquid credit with liquid credit, Instead, there is evidence that quantitative easing tends money. This is called quantitative easing (QE). to raise asset prices,1128 which makes such central bank policy announcements significant targets and causes of “In exceptional circumstances, when interest rates are (unproductive) speculation. at their effective lower bound, money creation and spending in the economy may still be too low to be Quantitative easing alone does not necessarily increase consistent with the central bank’s monetary policy borrowing significantly, but it is often combined with objectives. One possible response is to undertake a government budget deficits, i.e. fiscal stimulus.1129 s QE may lower the costs of credit for those institutions whose assets are bought (most notably governments, in the 1127 A ”liquidity trap” and ”money being stuck in the banks” are quite misleading expressions based, again, on the idea of money as an item that ”is” somewhere. See: “1.2.6 Banking: Accounting for Debts and Credits 1128 Kay, John, “Quantitative easing and the curious case of the leaky and Pricing Risks – There Is No ‘Fractional Reserve’”, “Sidenote Box 126A: bucket”, The Financial Times, 9th Jul 2013, cited 15.10.2013, http://www. The Misleading Expression That ‘Banks Lend Other People’s Money’”, ft.com/intl/cms/s/0/6b0d5268-e7ba-11e2-babb-00144feabdc0.html#ax- ”1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And Has Little to zz2Z1rF5fsH Do with the Quantity of Money” and “5.1.2 The Misleading Conceptual 1129 See: ”2.2.5.1 Keynesian Fiscal Stimulus – It’s the Government’s Job to Metaphor of Money as Items or Substance”. Invest Stably”. Mainstream Economic Solutions – Increase Spending or Compete Harder | 235

case of a monetary union1130), but it doesn’t make saving inflation under control falters, this might cause investors as monetary assets less profitable – as negative interest to also expect higher nominal interest rates, as a result of rates would. Therefore, while such policies can help keep which bonds can be sold early only at a clear discount and the economy running, they aggravate the increase in the loss. Even if government bonds don’t have a default risk, amount of total debt – and especially liquid credit – in this interest rate risk makes them more risky as short-term the economy. This causes the financial sector to expand investments. further, as it has been doing now for over a decade. The equality of default risk does, of course, not apply These massive amounts of capital gathered as credit – other in the case of a monetary union where individual parties’ debt – their movements as well as the constantly governments are not responsible for the value of their increasing uncertainty and speculation over different sovereign currencies. In such cases, government defaults parties’ ability to pay back their debt are then starting are possible, and the central bank’s promises to buy – to have significant effects on the real economy as well. or not to buy – government bonds can cause significant As the size and timing of the next round of quantitative fluctuations in bond market interest rates. This has been easing and fiscal stimulus package are an uncertain seen in the turbulent policy debates over treating the (and political) matter, it further increases speculation on eurozone debt crisis. monetary assets causing fluctuation in interest rates and asset prices as well as increased uncertainty. In the case of a monetary union like the European Monetary Union (EMU), one objection to direct central When quantitative easing is targeted only at government bank funding of states is that the resulting lower interest bonds of a country with its sovereign currency – instead costs would be an unfair income transfer from other of private financial assets – it should not lower any risk nations to the funded nation.1131 (Korkman 2012, p. 200) premiums and its speculation-increasing effect is not This problem can be overcome by the central bank funding as bad. This is practically the same as the central bank all governments in the area e.g. in proportion to their GDP funding the government directly – replacing non-liquid or total monetary assets or by making corrections in how government credit (bonds) with liquid government credit it distributes its surpluses (“profits”) back to governments (central bank money). If the bonds are bought from banks, in ways that don’t discourage fiscal discipline. But the this is the only effect, as the bank has already “created” EMU is a difficult situation in many ways, as the same new deposits of “checkbook money” on the purchase of interest rates don’t always suit all areas within the union. the bond. If bonds are repurchased from private investors, This situation is discussed under “3.1.6.2 Sticky Trade the buying back of the bond also results in creation of new Imbalances”. checkbook money, as a bank now creates liquid deposits on the investors’ account to match the new central bank Attempting to control inflation with these quantitative money in its assets. easing packages when stuck at the zero lower bound (in a “liquidity trap”, as the misleading expression goes) is not When a country has its own currency, the credibility of a very effective or sustainable alternative. In addition to the currency is dependent on the government’s ability to it being ineffective in alleviating deflationary pressures, collect taxes – just like that of the government’s bonds. it results in unproductive financial speculation as well as It doesn’t make sense for there to be a risk premium for constantly increasing amounts of debt and excess liquidity government bonds (of monetarily sovereign states), and thereby risks of hyperinflation.1132 because the same risks apply to the currency in which the bonds are issued. The additional yield of interest-rate- In 2014, the ECB cut the rate it pays retail banks for indexed government bonds should therefore result only deposits on its accounts to -0.1 %. Many journalists from the opportunity cost of lost liquidity. and commenters interpreted that “the policy should encourage private-sector banks to loan more money to Of course, this lost liquidity makes it harder to “exit” businesses and households instead of holding on to it – at the bond (as investors call selling an asset) early. Buying a loss – at the central bank.”1133 1134 The logic with this is a (non-interest-rate-indexed) bond differs from holding deposits in that the investor commits himself to receiving 1131 See: ”4.2.3.1 ‘Inflation Tax’ Revenues – Negative Interest on Govern- a set nominal interest rate until the maturity of the bond. me nt D eb t ”. When nominal market interest rates – current rates or 1132 See: ”2.2.6 Post-Keynesian Solutions – Ignore Hyperinflation Risks rates expected in the future – fall, this lowers the value and Guarantee Jobs”. 1133 Blackstone, Brian, “ECB Faces Uncharted Waters With Negative De- of current (non-indexed) bonds, as their yields adjust to posit Rate”, Wall Street Journal, 26th Mar 2014, cited 6.6.2014, http://online. the interest rates by changes in their market value. For wsj.com/news/articles/SB10001424052702304418404579463780850006774 example, if the trust in the central bank’s ability to keep 1134 “The theory is that when it becomes more costly for European banks to keep money in the E.C.B., they will have incentive to do something else with it: Lend it out to consumers or businesses, for example.” 1130 See: ”3.1.6.2 Sticky Trade Imbalances”. – Irwin, Neil, “Europe Likely to Get Negative Interest Rates. What Does 236 | Different Economic Schools and Their Solution Suggestions

similarly faulty to that with QEs: Banks do not “lend on” eliminating cash and adopting a higher target inflation their central bank reserves. Central bank reserves and rate are discussed in more detail in “4.2.1 Eliminating the retail bank money are two separate, closed accounting Zero Lower Bound with a Higher Inflation Target or by systems. Banks would still only grant loans for which Eliminating Cash”. they get profitable margins. Negative rates on reserves would likely make banks pay off their excess loans from However, such an option would not even cross the mind the central bank and start optimizing their reserves of devout monetarists, because inflation (of all kinds) is to match the minimum reserve requirements. As Dr. the demon that they have been fighting against for half Andrea Terzi suggests, they might then start paying each a century and now have finally managed to bring under other for holding their excess reserves – i.e. the interbank control. lending rate would turn negative.1135 Interestingly, one logic of central banks originally starting to pay interest In order to avoid uncertainty, we only need inflation on reserves at all was that the increased holding of reserves stability – that prices can be expected to rise predictably – but would increase lending.1136 the objective has been (unnecessarily and dangerously) dogmatized more specifically into “price stability” – i.e. The only way to prevent piling up of further debt in our low inflation. (Blanchard et al 2010)1139 The important economies would be to make saving as monetary assets distinction between predetermined, predictable inflation less profitable – which in practice would require negative and unexpected, volatile inflation as well as many of the real interest rates on retail bank deposits. And not just -0.1 arguments against any kind of inflation are discussed %, but more like -3 % or -5%. in more detail in “4.2.4 Common Concerns with and Objections to Negative Rates or Higher Inflation”. Would making all money digital be necessary for negative interest rates? For nominal interest rates yes – 1139 ”There was an increasing consensus that inflation should not only because of the bank run risk – but what really matters be stable, but very low (most central banks chose a target around 2 per- for any economic agent are real interest rates – how much cent).” (Blanchard et al 2010, p. 3-4) the purchasing power of savings and debts is expected to change! And these are also affected by the expected changes in the value of money, the general price level – which is the target inflation rate! Inflation does not cause a bank run into cash, because inflation affects cash just as much as it does deposits. However, negative real interest rates due to inflation can cause a “run” into real assets, risk-carrying investments like company shares and other currencies (devauluing of the currency1137) – which is exactly what we would need in order to get rid of the excess debt in the economy!1138 The alternatives of

That Even Mean?” New York Times, 4th June 2014, cited 6.6.2014, h t t p :// www.nytimes.com/2014/06/05/upshot/europe-likely-to-get-negative- interest-rates-what-does-that-even-mean.html “As such, a negative rate would see banks charged for parking their cash at the ECB, giving them an incentive to move their money into other assets, such as loans to households and businesses.” – Bishop, Katrina, “All eyes on the ECB: Negative rate looms”, CNBC, 3rd Jun 2014, cited 6.6.2014, http://www.cnbc.com/id/101723127 “The ECB wishes that, now that retail banks have to pay for their central bank reserves, they would start moving these stored assets into loan-giving.” (translated from Finnish) – 0:56->, “EKP:n negatiivinen talletuskorko selitettynä minuutissa”, Hel- singin Sanomat, 5th Jun 2014, viewed 6.6.2014, http://www.hs.fi/hstv/ uutiset/EKPn+negatiivinen+talletuskorko+selitettyn%C3%A4+minuutissa/v1401939182060 1135 Terzi, Andrea, “What do negative interest rates do?” Credit Writ- edowns, 12th Dec 2013, cited 6.6.2014, http://www.creditwritedowns. com/2013/12/negative-interest-rates.html 1136 See: ”Sidenote Box 2252A: The Actual Policy Tools”. 1137 See: ”3.5.3 The Advantage of the Possibility of Negative Interest Rates”. 1138 The only big problem is a ”run” into land – i.e. real estate – and other natural resources. Low interest rates tend to cause a real estate bubble. This is why land needs to be taxed according to market value. See: ”4.3.1 Limited, Vital Resources – Tax Land to Prevent Hoarding”. Mainstream Economic Solutions – Increase Spending or Compete Harder | 237

Sidenote Box 2252A: The Actual Policy Tools

In practice, during the last decades, the FED has (also) controlled its policy interest rate mostly through open market operations (and “threats” thereof) to influence the rates at which retail banks lend central bank reserves to each other – instead of adjusting the discount rate it charges for loans (which was what Keynes referred to as the policy tool in his time). But the quantities of assets traded in these operations are minuscule compared to those involved in quantitative easing.

A third policy tool has been reserve requirements: retail banks being required to hold a certain quantity of reserves (central bank money) in proportion to the liquid deposits they have outstanding to their depositors. Since 2008, as a “fourth policy tool”, the FED has also been allowed to pay interest on deposits of central bank money.1140 The FED has for a long time supported such a right in order to reduce the cost for banks to hold central bank credit. (Feinman 1993, p. 1-2) The main function of this was to “eliminate effectively the implicit tax that reserve requirements used to impose on depository institutions”1141 in order to encourage banks to maintain higher reserves1142 and so to (1) ensure liquidity between financial institutions and (2) induce them to give out more loans. The latter effect has been smaller than hoped, which is understandable, as reserves do not limit “lending” (in the absence of reserve requirements) and as reserve costs are fractions of a bank’s lending costs. The amount of checkbook money essentially depends on people’s and companies’ willingness to borrow.1143

Reserve requirements can be used for multiple purposes:

—— Imposing a higher inflation tax (seigniorage) on banks (Feinman 1993, p. 570-572): When the central bank does not pay interest on its deposits, holding reserves has a cost. Higher reserve requirements increase costs for banks. The costs of “foregone interest” of course also depend on the market interest rate. 1144

—— Ensuring liquidity: When the central bank does not pay interest on its deposits, banks will want to minimize reserves in order to minimize the aforementioned costs, which might have adverse effects on liquidity between banks and delay the clearance of payments between them. However, it can be argued that, with the central bank as a lender of last resort, the impacts of low reserves are not significant. (Feinman 1993, p. 69)

—— Limiting the quantity of loans that can be made (Feinman 1993, p. 574-578): A strict reserve requirement sets an upper limit for the proportion between checkbook money and central bank money. This can work to limit the total amount of loans, i.e. the amount of checkbook money, only if the central bank is not ready to lend out new reserves on demand.

In the current situation, where interest is paid on reserves and the central bank lends to private banks without quantity limitations, reserve requirements are not very impactful.

1140 Schenk, Robert, “Cybereconomics” – “The Federal Reserve and Monetary Policy”, cited 7.11.2013, http://ingrimayne.com/econ/Bank- ing/FedMonPol.html 1141 The FED, “Interest on Required Balances and Excess Balances”, Board of Governors of the Federal Reserve System, cited 5.3.2014, h t t p :// www.federalreserve.gov/monetarypolicy/reqresbalances.htm 1142 Schenk, Robert, “Cybereconomics” – “Big changes 2008”, cited 7.11.2013, http://ingrimayne.com/econ/Banking/bigchanges.htm 1143 See: ”1.2.8 The Supply of Money Is Infinitely Interest-Rate-Elastic – The Money Supply Is Endogenous”. 1144 See: ”4.2.3.1 ‘Inflation Tax’ Revenues – Negative Interest on Government Debt”. 238 | Different Economic Schools and Their Solution Suggestions

Sidenote Box 2252B: Is Monetary Policy Distorting the Market? – The Dollar Is Not a Commodity, but a Unit of Account for Credit Relations

Nassim Taleb is right in criticizing quantitative easing by comparing it to “shorting an out-of-the-money option” – it has a hardly noticeable effect on short-term inflation, but the added liquidity significantly increases risks of hyperinflation and general volatility of the economy. However, Nassim Taleb – siding with e.g. the devoutly anti-FED Ron Paul – forcefully attacks central bank monetary policy in general, comparing it to government control of the price of any other asset:

“Another expression of domain dependence: ask a U.S. citizen if some semi-governmental agency with a great deal of independence (and no interference from Congress) should control the price of cars, morning newspapers, and Malbec wine, as its domain of specialty. He would jump in anger, as it appears to violate every principle the country stands for, and call you a Communist post-Soviet mole for even suggesting it. OK. Then ask him if that same government agency should control foreign exchange, mainly the rate of the dollar against the euro and the Mongolian tugrit. Same reaction: this is not France. Then very gently point out to him that the Federal Reserve Bank of the United States is in business of controlling and managing the price of another good, another price, called the lending rate, the interest rate in the economy (and has proved to be good at it).” (Taleb 2012, p. 39)

Here he is clearly following Friedrich A. Hayek’s criticism of central bank monetary policy:

“As has sooner or later happened everywhere, government control of the quantity of money has once again proved fatal.” (Hayek 1976, p. 14)

“All that has been contended is that the kind of full employment which can be created in this way [by means of monetary expansion] is inherently unstable, and that to create employment by these means is to perpetuate fluctuations.” (Hayek 1976, p. 11)

But, as explained, conventional monetary policy – keeping inflation stable with interest rates – has nothing to do with controlling the quantity of money.1145 As for the destabilizing effects of excess, government-backed liquidity, Hayek’s concerns are likely valid.1146

Taleb, like Hayek, is making the mistake of viewing dollars as “goods” (commodity-like assets in themselves1147) when the main function of the dollar (or euro or any national currency) is to serve as a unit of account to which credit contracts can be tied to make their purchasing power predictable. And the usefulness of such a unit is based and dependent on the fact that it is tied to the general price level. If its market value were allowed to fluctuate freely and unpredictably, it would practically lose its main purpose of existence.1148

“The convenience of use is decidedly in favour of a currency which can be expected to retain an approximately stable value.” (Hayek 1976, p. 20)

All assets have a level of “moneyness” (i.e. liquidity and acceptability1149) and we could then just as well use any financial assets as money by transferring them to others. It might become preferable to receive payments in stocks, shares in broadly diversified funds, or food commodity futures. What makes deposits denominated in dollars and euros (e.g. bank account deposits) so superbly liquid – in addition the payment services that banks provide – is that they are perceived as risk-free investment options, which allows determining prices

1145 See: ”1.2.8 The Supply of Money Is Infinitely Interest-Rate-Elastic – The Money Supply Is Endogenous” and ”2.2.5.2 Monetary Policy – You Can Pretend It’s about the Money Supply”. 1146 See: ”2.2.6 Post-Keynesian Solutions – Ignore Hyperinflation Risks and Guarantee Jobs”. 1147 See: “5.1.2 The Misleading Conceptual Metaphor of Money as Items or Substance”. 1148 See: “1.2.5 The Two Denominators of Currencies and Other Financial Instruments: the Reference Resource(s) and the Collateral”. 1149 See: “1.2.1 Money Facilitates Trade through Liquidity and Broad Acceptability”.

Continued on page 239 ► Mainstream Economic Solutions – Increase Spending or Compete Harder | 239

► long in advance and removes the need to hedge1150 the risks of any received balances. Their risk-freeness is dependent on (1) the government deposit guarantee (which eliminates the bank’s default risks for its creditors in the case of bankruptcy), and (2) the central bank promise of price stability (which eliminates market risks).

Another way to see it is that the central bank executes the role of the market interest rate mechanism, which simply does not work by itself with a “commodity money” of inelastic supply.1151 If Nassim Taleb (or anyone, really) can come up with a purely market-based mechanism for determining a market interest rate that keeps the total “demand for being in debt” and “demand for holding credit”1152 in balance, we’d be very interested in hearing more about it so that we can render central banks redundant.

But, as such, there is nothing destabilizing or “fragilizing” about having a central bank that keeps inflation – the development of the purchasing power of this unit of account – stable and predictable, as long as it only does so by controlling its policy interest rate, government debt levels are kept in check1153 and holding excessive amounts of liquid deposits is discouraged.1154

Other concerns with the power of central banks and public monetary policy, such as regulatory capture, are discussed in “4.2.5.2 Objective and Reliable Monetary Policy – Neutralize Human Judgment to Avoid Reg ulator y Capt ure”.

1150 See: ”6.1.5 Appendix 1.5: Derivatives and Other Financial Instruments”. 1151 See: “2.2.3.6 Democratic or ‘Full’ Money – ‘Power to the People from the Banks’” and “2.2.2.1 A Single Precious-Metal-Standardized Cu r r e n c y ”. 1152 See: ”1.2.8 The Supply of Money Is Infinitely Interest-Rate-Elastic – The Money Supply Is Endogenous”. 1153 See: “2.2.5.1 Keynesian Fiscal Stimulus – It’s the Government’s Job to Invest Stably”. 1154 See: “4.2.2 Setting a Fee on the Government Deposit Guarantee”.

Chapters 2.2.5.3 and 2.2.6 not included in this sample The Job Creation Paradigm – Why Are We Trying to Make More Work?! | 247

2.3 THE SOLUTION OF THE ROOT BUG HYPOTHESIS

2.3.1 The Job Creation Plant.” … “The obsessive focus, in our political Paradigm – Why Are We Trying discourse, on ‘jobs’ is a clever way of diverting to Make More Work?! our attention from our true economic problems: unused land, wasted capital, huge fat gobs of In short: monopoly privilege, and tax burdens that hinder • Creating work has become an objective in enterprise.” … “The extent to which we focus itself – though labor is essentially a cost on ‘jobs’ is a good barometer of how unjust we should be aiming to minimize. and wasteful our economy truly is.” – Lindy Davies1192 • Why do we need to create more work in order for everyone to be able to participate We keep inventing jobs because of this false in that work? Why is the unit of labor a idea that everybody has to be employed at human being? “some kind of drudgery because, according to [People/voters] equate prosperity not with Malthusian Darwinian theory he must justify his production, but with employment. I call this right to exist. So we have inspectors of inspectors “ and people making instruments for inspectors to make-work bias.” – Bryan Caplan (2007, p. 1) inspect inspectors.” – Buckminster Fuller We want food, shelter, clothing, and all the things that money buys us. But do we all “ A major function of the whole market system with its really want jobs? We’re living in an economy fiercely competing companies is finding more efficient where productivity is no longer the goal, ways of doing things – giving us more with less. This employment is.” – Douglas Rushkoff, Are Jobs includes eliminating waste, i.e. unnecessary work. Of Obsolete?1191 course people can choose to prefer “more” to “with less” – to consume more products and services to offset the increased productivity, the reduction in needed labor. But Every intelligent workman tries to cut why are we now so desperately wanting more work? down the effort necessary to accomplish his “assigned job.” … “When providing employment Futurists of a hundred years ago expected people of the 21st becomes the end, need becomes a subordinate century to hardly work at all. Buckminster Fuller referred to this process of technological advancement constantly consideration.” – Henry Hazlitt, Economics in allowing us to do more and more with less and less until One Lesson (1946, p. 38 & 18) we can do everything with nothing as “ephemeralization”. Of course, that 21st century has not come. Why? In the argot of politicians, a ‘job’ is a commodity, like a pork belly, or a widget. Every time the amount of work decreased, there suddenly “ did not seem to be enough work for everyone to get ‘We created eleventy-umpteen new jobs on to participate in it – some people were left outside the my watch,’ says the incumbent to raucous whole market, i.e. “unemployed.” And what’s even worse, applause – as though they came freshly- any unemployment seemed to easily start feeding itself stamped out from the line at the Acme Jobs resulting in depressions and economic collapses1193.

1191 See: Rushkoff, Douglas, ”Are jobs obsolete?” CNN, opinion, 7th Sep 1192 Davies, Lindy, “Jobs”, Work and Wealth, 7th Jan 2013, h t t p ://w o r - 2011, cited 7.4.2015, http://www.rushkoff.com/blog/2011/9/7/cnn- kandwealth.com/jobs/ com-are-jobs-obsolete.html 1193 See: “3.1.1 Economic Instability, Cyclicity, ‘Keynesian’ Unemploy- 248 | The Solution of the Root Bug Hypothesis

A major focus of economics and economic policy has Shouldn’t the amount of work people do be determined hence been finding ways to maintain full employment: by how much goods and services people deem they need sustaining “sufficient aggregate demand” and closing – and consider worth the effort needed to produce them? any “output gaps”, i.e. the difference between actual Compare this to household chores. Would you try to use production and potential production. In other words, more dishes just so that everyone could get a dishwashing the objective is to keep the system running at its full shift every week? If you buy a dishwashing machine that production capacity. allows washing dishes more efficiently, would you try to get your family members or roommates to eat five- In fashion terms, “jobs” is the “black” of election course meals just to maintain the previous amount of campaigns – the issue that never goes out of style. The dishwashing work? Really? You would probably, instead, politicians promising the most jobs most credibly are let people consider how many five-course meals per often the ones that get elected. Comparing presidents month are worth the additional work (of both cooking and and administrations by how many jobs they “created” or filling the dishwashing machine). “lost” is very common. In public discourse, jobs are talked about as if they were a valuable “resource” that needs to be Nor would you try to get family members or roommates produced at a cost – when fundamentally, labor is a cost that to provide additional favors to each other as “chores” by an efficiency-oriented economy should be minimizing!1194 any means to fill the time left by the reduced dishwashing The following quote is quite typical under our current job work. Of course you might allow some members to trade creation paradigm: their dishwashing shifts with others for other favors, but if no one requested such additional favors, you would let “Fracking Jobs Cost Twice as Much as Green Jobs” … everyone participate in the remaining dishwashing and “The most important is the perception that the $100 cooking work – and preferably according to how many billion green stimulus program failed to deliver the common dinners they are able (or willing) to participate jobs it promised.” … “But considering only projects in, i.e. their “willingness to consume”.1198 within the Department of Energy itself, the best estimate is that about two hundred thousand one- Henry Hazlitt had a lot of valid criticism towards this job year-long jobs (or their equivalent over longer time creation orientation. periods) were created by spending about $17 billion. This amounts to about twelve jobs per $1 million in “When providing employment becomes the end, need spending.”1195 becomes a subordinate consideration. ‘Projects’ have to be invented. Instead of thinking only where bridges For more examples of the importance and devastating must be built, the government spenders begin to ask effect of the “jobs” argument, see: “6.2.5 Appendix 2.5: The themselves where bridges can be built.” (Hazlitt 1946, Tyranny of Jobs”. p. 18)

What sense does this objective of trying to create more “Each of us is trying to save his own labor, to work make? Wasn’t the original idea to get rid of work? Of economize the means required to achieve his course it was also to give us more (products and services, ends. Every employer, small as well as large, seeks i.e. a higher “living standard”), but even the neoclassical constantly to gain his results more economically and growth model accepts that also leisure has utility1196 and efficiently – that is, by saving labor. Every intelligent that its utility can surpass that of additional products workman tries to cut down the effort necessary to and services. It is more and more likely to do so, as living accomplish his assigned job. … The technophobes, standards rise and people’s basic needs1197 are met. if they were logical and consistent, would have to dismiss all this progress and ingenuity as not only useless but vicious.” (Hazlitt 1946, p. 38) ment and Growth Dependence”. 1194 See: ”1.1.3 Value Is Subjective and Perceived – Rationality Is Large- ly an Illusion”, ”1.1.4 Production Is for Consumption, i.e. Appreciation – ‘Productivity’ Has Many Units” and ”1.1.9 Companies as Competing ly when the internet has made the information needed for intellectual Organizational Forms (Because Institutions Suck at Suicide) – ‘Pro-Busi- self-actualization very affordably available. This is not to deny that one’s ness’ Is Not ‘Pro-Market’”. own labor can also provide a sense of Belonging, improve one’s Self-Es- 1195 Pollin, Robert, “Let’s Get Serious: Fracking Jobs Cost Twice as Much teem and facilitate Self-actualization. (Maslow 1943) as Green Jobs”, Alternet, 12th Oct 2012, cited 7.1.2014, http://www.alter- – McLeod, Saul, 2007, ”Maslow’s Hierarchy of Needs”, SimplyPsychology, net.org/economy/lets-get-serious-fracking-jobs-cost-twice-much-green- cited 4.4.2014, http://www.simplypsychology.org/maslow.html jobs?page=0%2C0 1198 Of course a family often works much better as a Gemeinschaft type 1196 See: “Sidenote Box 215A: The Neoclassical Growth Model and Utili- community (see: “6.1.3 Appendix 1.3: A Model of the Value of Helping t y ”. and Cooperation: Empathy, Contribution, Image-Boosting, Shame and 1197 If we consider for example Abraham Maslow’s hierarchy of needs, Guilt”) where everyone participates purely out of their affection for oth- fulfilment of all but the first two levels (Physiological needs and Safety ers and their will to contribute, but for example among flatmates with needs) are often far more limited by the amount of (freely allocatable) less empathic ties, such trading of chores might be the fairest and most time available than access to consumption goods or services – especial- functional arrangement. The Job Creation Paradigm – Why Are We Trying to Make More Work?! | 249

“‘That may have been all very well in the past; but —— a big part of the productivity gains are not visible today conditions are fundamentally different; and in major productivity metrics and, instead, look now we simply cannot afford to develop any more like shrinking markets and inflation.1204 labor-saving machinery.’ Mrs. Eleanor Roosevelt, indeed, in a syndicated newspaper column of Erik Brynjolfsson lists such productivity measurement September 19, 1945, wrote: ‘We have reached a point issues as one potential explanation for the “productivity today where labor-saving devices are good only when paradox” of information technology. For example: they do not throw the worker out of his job.’” (Hazlitt 1946, p. 37)1199 “[T]he sorts of benefits ascribed by managers to IT – increased quality, variety, customer service, speed In his book “Arbetssamhället” (freely translated as “work and responsiveness – are precisely the aspects of society”), Ronald Paulsen points out how productivity output measurement that are poorly accounted for has increased significantly while we still work as much as in productivity statistics as well as in most firms’ before. In the “work society”, people don’t work to produce accounting numbers.” (Brynjolfsson 1993, p. 10) things but work has become an end in itself. As a result of this “work ideology”, work is emptied of content and Another factor is that new technologies often appear as meaning. (Paulsen 2010)1200 completely new services, replacing and offsetting previous services and industries or things people previously did In his TED Talks “Are droids taking our jobs?”1201 and unpaid for themselves, which does not allow them to be “What will future jobs look like?”1202 Andrew McAfee visible in price indices, but makes it instead appear as if makes the case that the development of labor productivity services of less value are being bought and produced. E.g. that technology facilitates is not decreasing, but instead Google Translate, instead of increasing the productivity about to enter a completely new era with artificial manual translation services, might rather be replacing intelligence developing and allowing both further them and providing translation services to people who automation of knowledge work and androids that can earlier had hardly any access to them.1205 take over persistently labor-intensive service sectors. (Brynjolfsson & McAfee 2011) Although statistics would In any case, it is likely that a big part of the skills required show smaller productivity gains for the past decade than (“jobs”) in our current economies will be obsolete in 20 for most of the latter half of the 20th century, it could be years’ time – unless we start restricting the development argued that: of technology and changes in people’s consumption preferences. It is going to be extremely difficult to create —— implementing new technologies that could increase new jobs at the same pace as old ones are eliminated. productivity are hindered by the difficulty of And even if that were possible, the structural adaptation reducing labor for companies (and the public sector) process of getting people to move to these new professions and the availability of cheap labor from developing is going to be really difficult (as long as the unit of labor countries1203 hindering e.g. automation investments, remains a human being1206). McAfee optimistically points and that out that this development could allow people to be freed up to do many things for which they currently don’t have 1199 However, Hazlitt – a victim of the “commodity money religion” like time, like solving global sustainability challenges. But will other Austrian economists, Marxists and many others – still assumes that it when we are trying to keep them full-time occupied in people will always be willing to spend any saved money on something paid work by any means possible? else (Hazlitt 1946, p. 39), insists on considering monetary savings “real savings” (p. 165) and is lured by the idea that “banks lend on their depositors money” (p. 168) and that increased savings hence lower interest rates The fact that earning opportunities don’t meet people’s (p. 169), which has never been exactly the truth and is an entirely false willingness to spend and invest – especially the fact assumption in our current credit money system. See: “1.2.6 ‘Fractional that decreased total demand results in an increased Reserve Banking’, Interest and the ‘Expansion of Credit’“, ”BOX: The Mis- leading Expression That ‘Banks Lend Other People’s Money”, “1.2.8 The mismatch, i.e. unemployment – is a market failure Supply of Money Is Infinitely Interest-Rate-Elastic – The Money Supply Is and trying to spur economic growth to decrease Endogenous” and “5.1.2 The Misleading Conceptual Metaphor of Money unemployment is treating the symptoms and pushing as Items or Substance”. 1200 Nesser, Johannes, “Det meningslösa arbetet”, UNT.se, 27Th Jul the problem on to the future. It is not fixing the 2010, cited 5.6.2013, http://www.unt.se/kultur/det-meningslosa-arbetet-1003128.aspx 1201 McAfee, Andrew, 2012, “Are droids taking our jobs?” TED Talk, the protectionist-mercantilist trade policies of developed countries. See: viewed 17.6.2013, http://www.ted.com/talks/andrew_mcafee_are_ “3.3.1 Solving Poverty for Good – Ending the Economy War”. droids_taking_our_jobs.html 1204 See: “1.3.1 Economic Growth Is the Increase in Produced and Traded 1202 McAfee, Andrew, 2013, “What will future jobs look like?” TED Talk, Value – The Many Meanings of ‘Wealth’”. viewed 17.6.2013, http://www.ted.com/talks/andrew_mcafee_what_ 1205 See: “1.3.1 Economic Growth Is the Increase in Produced and Traded will_future_jobs_look_like.html Value – The Many Meanings of ‘Wealth’”. 1203 The availability of cheap labor persists as developing countries 1206 See: “3.1.3 Structural, Friction and Classical Unemployment, NAI- are currently purposefully kept uncompetitive by lack of education and RU and Hysteresis – Is 5 % Unemployment Really Necessary?”. 250 | The Solution of the Root Bug Hypothesis

market failure. Just as a bottle of vodka is not a cure for jobs. They will be jobs making every kind of alcoholism, but a treatment to its symptoms, managing frippery and unnecessary contraption, and one to “create” a few jobs (with fiscal stimuli or some other will also at the same time have to beguile the policy gimmick1207) treats the symptom – unemployment public into feeling that they need more of these – of our economies’ growth dependence. It does not cure completely unnecessary things, that aren’t even the dependence. It postpones the problems caused by the chronic mismatch in the supply and demand for labor (the beautiful. And therefore an enormous amount Root Bug): Productivity continues to increase, technology of non-sense employment – bureaucratic an to evolve and people’s preferences to change, and soon otherwise – has to be created in order to keep we are going to have to, again, find new ways of creating people working. Because, we believe, as good more jobs. protestants, that the devil finds work for idle This book is essentially trying to show that this whole “job hands to do. But the basic principle of the whole creation paradigm” – together with the rhetoric focused thing has been completely overlooked: That the on national competitiveness1208 – has no clothes. purpose of the machine is to make drudgery unnecessary. And if we don’t allow it to achieve (This chapter was focused on the pointlessness of public its purpose, we live in a constant state of self- policies that attempt to create work. Some point out 1210 that our current market economy produces a lot of non- frustration.” – Alan Watts productive, purely “distributive” activity – so-called “bullshit jobs” – also in the private sector. And they have Yeah, the droids are taking our jobs, but valid points. These issues are discussed in more detail in focusing on that fact misses the point “6.3.4 Appendix 3.4: Productive vs. Distributive Activity – “entirely. The point is that then we are freed up How e.g. Marketing and Finance Are Productive”.) to do other things. And what we’re going to do Most men would feel insulted if it were – I’m very confident – what we’re going to do is proposed to employ them in throwing stones reduce poverty and drudgery and misery around “over a wall, and then in throwing them back, the world. I’m very confident we’re going to merely that they might earn their wages. But learn to live more lightly on the planet and I am many are no more worthily employed now.” – extremely confident that what we’re going to do Henry David Thoreau (Eisenstein 2011) with our digital tools is going to be so profound and so beneficial that it’s going to make a There’s also a story about Milton Friedman mockery out of everything that came before.” – 1211 “visiting a Chinese construction project and Andrew McAfee asking his host why workers were using so many shovels and so few machines. Told that this was ‘a job creation project’, Friedman said: ‘In that case, why don’t you give them spoons?’” – George Magnus1209

Now, what happens, then, when you introduce technology into production? You “produce enormous quantities of goods by technological methods. But at the same time you 1210 22:02->, Watts, Alan, ”Money and Guilt”, lecture/speech, viewed put people out of work. You can say ‘Oh, but it 16.1.2014, http://www.youtube.com/watch?v=c7tlaF3dv_M 1211 13:14->, McAfee, Andrew, 2012, “Are droids taking our jobs?” TED always creates more jobs, there will always be Talk, viewed 17.6.2013, http://www.ted.com/talks/andrew_mcafee_are_ more jobs.’ Yes, but lots of them will be futile droids_taking_our_jobs.html

1207 See: ”2.2.5.1 Keynesian Fiscal Stimulus – It’s the Government’s Job to Invest Stably”. 1208 See: ”2.2.5.3 Competitiveness Politics – Just Indebt Other Nations Fu r t h e r ”. 1209 19:10->, “’Karl Marx was right’”, panel discussion, viewed 8.1.2014, http://www.youtube.com/watch?v=QUaVeixiVLc The Overlooked Option – Increase Correlation of Earning Opportunities with People’s Willingness to Spend and Invest | 251

2.3.2 The Overlooked relative value of material consumption vis-à-vis Option – Increase Correlation leisure time is diminished, so earning a higher of Earning Opportunities with income at the cost of working longer hours People’s Willingness to Spend may reduce the quality of your life.” – Ha-Joon Chang, 23 Things They Don’t Tell You About and Invest Capitalism (2010, p. 109-110) In short: By the late twentieth century, however, the • If earning opportunities are determined by one-size-fits-all workplace that once so well total spending and investing, shouldn’t our “fulfilled the needs of American workers became focus be on getting earning opportunities profoundly mismatched to the needs of the directed to people according to their will- increasingly diverse and varied U.S. workforce.” ingness to spend and invest – to get supply – Kathleen Christensen & Barbara Schneider, to meet demand on the individual level? Workplace Flexibility: Realigning 20th-Century • By all logic, making this correlation (be- Jobs for a 21st-Century Workforce (2010, p. 1-2) tween earnings and willingness to spend and invest) independent of aggregate de- Mainstream economic policies try to prevent excessive mand should both maximize the economy’s saving as money by attempting to get people to spend and invest more. The objective is to maintain “sufficient potential for growth and eliminate its de- aggregate demand”.1212 What would be the remaining pendence on growth as well as mitigate the way of preventing the excessive monetary saving by positive feedback loops causing economic individuals that prevents others from earning their cyclicity. living?1213 To decrease earnings. If the same people that spend less would also earn less, there would be no • That supply does not meet demand on the increase in net desires to save, nor an increase in debt. individual level in the labor market when Total “economic activity” is of course reduced, but no one else’s earning and spending opportunities are affected. total demand drops, is a market imperfection. Trying to create more work to avoid The progressive taxation and transfer payments supported this (unemployment) is just pushing the by the political left could be seen as a way of directing problem forward – treating the symptoms, income to those that need it more desperately. But this is not solving the imperfection. hardly fair or encouraging anyone to be entrepreneurial in finding better ways to create value to others or to learn 1214 Procrustes was an inn-keeper in Greek skills which are in higher demand . mythology who, in order to make the travelers “ Additionally, the people earning more might also want fit in his bed, cut the limbs of those who were to spend and invest the more. This is the case with many too tall and stretched those who were too short. company managers: A lot of their wealth is in risk- But he had the bed fitting the visitor with carrying company stocks and real property and it is often total perfection.” – Nassim Nicholas Taleb, also leveraged with notable amounts of debt (and quite a few are also scorned for their lavish lifestyles). There is Antifragile (2012, p. 81) no need to prevent people from earning and spending or investing more. Now, it is perfectly reasonable for someone to argue that she wants to work longer hours if But instead of transferring income undeservedly from “that is necessary to have a higher income – she those who earn more to those who earn less, it would would rather have another TV than one more 1212 See: ”2.2.5 Mainstream Economic Solutions – Increase Spending or week of holiday. And who am I, or anyone else, Compete Harder”. to say that the person got her priority wrong?” … 1213 See: ”1.3.3 The Circular Flow of Income – Consumption, Saving and Investing”. “However, above a certain level of income, the 1214 See: “2.2.3 ‘Socialist’ Solutions – Money for Free (i.e. Credit for Nothing)” 252 | The Solution of the Root Bug Hypothesis

THE EFFECTS OF A REDUCTION IN OVERALL DEMAND

WHY SO? WHY NOT SO?

EARNING EARNING OPPORTUNITIES OPPORTUNITIES FULL-TIME EMPLOYED

UNEMPLOYED

WILLINGNESS WILLINGNESS SPUR SPENDING TO SPEND INCREASE CORRELATION TO SPEND AND INVEST AND INVEST GRAPH 24: INCREASING THE CORRELATION BETWEEN INCOME AND WILLINGNESS TO SPEND AND INVEST – VERSUS TRYING TO CREATE MORE WORK. make more sense to get earning opportunities (namely Allowing people to work (in the mid-term) as much as they work) directed to those with a more desperate need for really want to work will not only maximize the potential the income. If you want to reduce someone’s income for economic growth,1217 but also increase structural without paying him less for the same amount of work, flexibility1218 and unleash a lot of currently underutilized the other option is to buy less work from him. Unlike talent (or, rather, capabilities1219), as skilled people would price manipulation, this should not increase mismatches less often need to reject a high-skilled career just because of supply and demand between different types of work it would require devoting too much of one’s life to work. – as the prices of units of work are not restricted or influenced in any way. By all logic and most economic An arbitrary standard to which conformity is forced is theories, maximizing the correlation between people’s referred to as a “Procrustean bed”, along the mythology of earning opportunities and their willingness to spend the rogue smith (in some versions an inn-keeper, e.g. Taleb and invest should maximize the economy’s potential 2012, p. 81) called Procrustes who invited people to stay for growth and simultaneously make it independent over at his house and either stretched them or amputated of growth – eliminating the positive feedback loops part of their legs to make them fit perfectly into his iron that make reduced demand result in recessionary chain bed. The idea of a fixed amount of work per person – e.g. reactions.1215 40 h per week – is one of the most violent Procrustean beds of our era. It is only one side effect of this that people Supply does not meet demand when everyone gets often have to choose their profession based on how much the same amount of earning opportunities, but when they want to work. opportunities are distributed according to people’s need for the income.1216 1217 See: “3.1.1 Economic Instability, Cyclicity, ‘Keynesian’ Unemploy- ment and Growth Dependence”. 1215 See: “3.1.1 Economic Instability, Cyclicity, ‘Keynesian’ Unemploy- 1218 See: “3.1.3 Structural, Friction and Classical Unemployment, NAI- ment and Growth Dependence”. RU and Hysteresis – Is 5 % Unemployment Really Necessary?” and “Side- 1216 This would practically make the economy work more like the note Box 414B: Your 11 Lives: The Shackles of ‘Professional Identity’ and neo-classical growth model expects it to: the model (in addition to as- the Teleological Fallacy in ‘Callingism’ and the Myth of Talent”. suming perfectly costless structural mobility) reduces all employees into 1219 See: “Sidenote Box 414B: Your 11 Lives: The Shackles of ‘Profession- one employee, i.e. assumes a perfect correlation between earnings and al Identity’ and the Teleological Fallacy in ‘Callingism’ and the Myth of propensity to spend and invest. Talent”. The Overlooked Option – Increase Correlation of Earning Opportunities with People’s Willingness to Spend and Invest | 253

This assumption of a human being as the unit of labor this enormous waste of productive power is due, is not new, but prevalent starting from the first words of not to defects in the laws of nature, but to social Adam Smith’s “An Inquiry Into the Nature and Causes of maladjustments which deny to labor access to the Wealth of Nations”, often considered a foundational the natural opportunities of labor and rob the work of economics: laborer of his just reward. Evidently the glut of “But this proportion [of total produce to the number markets does not come from over-production of those who are to consume it] must in every nation when there are so many who want the things be regulated by two different circumstances: first, which are said to be over-produced, and would by the skill, dexterity, and judgment with which its gladly exchange their labor for them did they labour is generally applied; and, secondly, by the have opportunity. Every day passed in enforced proportion between the number of those who are employed in useful labour, and that of those who are not so employed. idleness by a laborer who would gladly be at Whatever be the soil, climate, or extent of territory of work could he find the opportunity, means so any particular nation, the abundance or scantiness of much less in the fund which creates the effective its annual supply must, in that particular situation, demand for other labor…” – Henry George, depend upon those two circumstances.” (italics added, Social Problems (1883, p. 108-110) Smith 1776, p. 8)

What about the average amount of work done by “those employed in useful labor”? Or rather – as a human being is not labor, the employable factor of production,1220 but rather she is a supplier of labor – “what about the average amount of labor employed by those who employ their labor at all?” Karl Marx actually had a valid point in how classical economists tend to confuse “the laborer” with “labor.”

“That which comes directly face to face with the possessor of money on the market, is in fact not labour, but the labourer.” (Marx 1887, p. 373)

Perhaps nothing shows more clearly the enormous forces of production constantly “going to waste than the fact that the most prosperous times in all branches of business that this country has known was during the civil war, when we were maintaining great fleets and armies, and millions of our industrial population were engaged in supplying them with wealth for unproductive consumption of for reckless destruction.” … “The waste of labor in marching and counter-marching, in digging trenches, throwing up earthworks, and fighting battles, the waste of wealth consumed or destroyed by our armies and fleets did not amount to as much as the waste constantly going on from unemployed labor and idle or partially used machinery.” … “It is evident that

1220 See: ”1.1.8 Labor and Capital (and Land?) – The Factors of Produc- t ion”. 254 | The Solution of the Root Bug Hypothesis

Jackson does vaguely mention increasing individual 2.3.3 The Paralyzing freedom to choose how much to work, but does not give any suggestions on how this could be incentivized and, on Assumption: ‘Work Sharing = the other hand, encourages increasing rigidity by creating Work Time Restrictions’ more secure “public green jobs” (Jackson 2009, p. 70-71).1221 Jackson also mentions a citizen’s wage as an example of In short: “more radical suggestions for reorganizing work”.1222 Nic Marks (2011) of the New Economics Foundation • Mainstream labor economics has a quite also suggests “helping redistribute work throughout the restricted view of labor flexibility and has economy more evenly” and that governments should made “work sharing” a synonym for “work “create good work.” time restrictions.” A shorter legal workweek has been shown to be ineffective • E.g. shortening the legal workweek has in combatting unemployment in the long run in both been shown to be ineffective in reducing simulations with different economic models and practical experiences from many countries. This makes complete unemployment in the long run. It would sense. After the shortened working hours, a human being not eliminate cyclicity or income insecuri- – “an employee” and “a job” – still remains the unit of ty nor increase demand as the de facto unit labor and thus: of labor remains a human being. —— It would not provide any more economic security, If you look up “work sharing” in almost any economics as the preferred way for a company to adjust its textbook (e.g. Layard et al 1991, p. 502), you will notice demand for labor would still be firing individuals. that this is almost directly equated with the restriction of Thus the same risk of a recessionary chain work hours – making the legal workweek shorter. In fact, reaction1223 would apply and the basic problem of, when someone mentions “sharing work” in the context growth dependence would not be solved. of economics as a way of solving unemployment, the immediate assumption is that it would require work hour —— It would not allow any flexibility according to restrictions, and that the hopes of it working to reduce individual consumption preferences or allow unemployment must be based on the “lump sum of labor short-term adjustments with structural changes in fallacy”. However, we could say that equating all “work required skills. sharing” with limiting the maximum amount individual people are allowed to work is based on the “lump sum —— It would also restrict growth – the total amount of of labor per person fallacy” – taking for granted a human economic activity – even if that was what consumers being as the unit of labor. wanted or what was needed in order to for example develop and adopt more environmentally Douglas Booth (2004) comes to the same conclusion – that sustainable production methods. work sharing means more equal sharing – in his analysis of our growth dependence in “Hooked on Growth”, and —— Also, the work time restriction is fairly easy to it is also the main option presented by Tim Jackson in his dodge, when both the employer and the employee famous book “Prosperity without Growth”. still want to trade more work. In many industries, such as consulting, it is standard to mark 40 h per “…[In Peter Victor’s model of degrowth in Canada] week into the official reports although no one really unemployment is averted by sharing the work more counts the hours and everyone spends closer to 50- equally across the available workforce. 70 h per week at the office, at the client or on the field. Thus, it would only cause income opportunities to This is an important outcome. It is possible to avoid the be shared in professions where work hours are easy damaging unemployment that follows from recession to measure – which most typically are low-skilled, by sharing work more equally amongst the population. uneducated jobs with already low incomes.

Reducing the working week is the simplest and most often cited structural solution to the challenge of maintaining full employment with non-increasing 1221 ”Public sector employment could be directed explicitly at ‘green output. And there is some precedent for it, for jobs’.” (Jackson 2009, p. 70-71) example, from labor policies in certain European 1222 For problems with this see: “4.1.5 Guaranteeing Security While Avoiding Welfare Bumming: Economic Freedom Need Not Be Free“. nations.” (italics added, Jackson 2009, p. 80) 1223 See: “3.1.1 Economic Instability, Cyclicity, ‘Keynesian’ Unemploy- ment and Growth Dependence”. The Paralyzing Assumption: ‘Work Sharing = Work Time Restrictions’ | 255

Restricting work hours would only make sense if Although mainstream economics is fixated on work hour everyone’s willingness to spend – excluding the need restrictions as the only way to “share work”, other fields to save due to economic uncertainty – had dropped have studied different flexible employment arrangements simultaneously by the same amount, which isn’t a very extensively. Individual flexibility does not have to mean realistic assumption. There are always some people who shorter workdays or workweeks, but it doesn’t require the want to spend more, accumulate more material wealth, labor market to become a “spot market” either. Nor is it invest in entrepreneurial initiatives or otherwise carry the necessary to be able to measure work in hours – which risks productive activities. And people with these kinds e.g. in specialist and leadership tasks makes little sense. of ambitions exist in professions of all income categories It could just as well take the form of longer holidays or although the propensity to save tends to be higher among sabbaticals between positions.1227 Employment flexibility those with higher income.1224 and forms thereof will be discussed further under “4.1.1.1 Forms of Employment Flexibility” and “4.1.1.2 Mid-term If we want to maximize wanted growth, we need to allow Flexibility (1-5 years’ Scale) Is What’s Relevant”. those willing to spend and invest more to also earn more, and we need to let those with a lower propensity to spend to work less. 1227 Sagmeister, Stefan, 2009, “The power of time off “, TED Talk, viewed 8.3.2013, http://www.ted.com/talks/stefan_sagmeister_the_power_of_ When higher-paid overtime work is allowed, restricting time_off.html the standard workweek does of course not completely prevent structural flexibility and growth. The higher cost of overtime hours does encourage companies to share work, but this extra pay, on the other hand, encourages employees to work more if given the opportunity – despite their immediate or long-term need for the income. Also this “progression” of labor costs is not continuous and does not encourage giving individuals the option of working less than the official full-time. On the contrary, companies will be even less willing to employ part-time workers, as full-time work is where overhead costs – and risks of labor reduction costs – per hour (or other unit of labor) are the lowest. When combined with high costs of reducing labor1225 (like in France and the Nordics) or other high fixed costs per employee, companies are reluctant to hire new employees, even as an alternative to more expensive overtime work.

But is there a way to encourage both employers and employees to share work more flexibly according to everyone’s need to spend and invest? A tax – instead of a legally required overtime raise – could make piling up work on fewer people less profitable and thus sharing a more viable option for employers, while not giving employees any extra incentive to work more to save up only for their own future, personal financial security or as a “Game”. Such a “Pigovian tax” on “overcentralizing work” could also be continuously progressive rather than “stepped” between income brackets.1226 However, even such a tax might be unnecessary if people had no fear of long-term unemployment and were in a position to demand higher marginal pay for additional tasks.

1224 See, ”permanent income hypothesis” (PIH) in: ”3.1.1 Economic Instability, Cyclicity, ‘Keynesian’ Unemployment and Growth Depen- de n c e”. 1225 See: ”4.1.3.4 Layoff Penalties Are Hiring Costs – The ‘Paradox’ of Reduction Restrictions”. 1226 See: ”4.1.2.3 Needed: a Pigovian Tax on the Externality Costs of Pil- ing up Work on Fewer People”. 256 | The Solution of the Root Bug Hypothesis

2.3.4 Supply and Demand that they want to save more than there are profitable real Could Best Match Earning investment opportunities available. Opportunities – Just Fix the Why would anyone hoard money without intent to Imperfections spend or invest it? Different possible motives for (and other causes of) monetary saving are discussed in “6.2.1 In short: Appendix 2.1: All the Different Causes of Monetary • The quantization of labor into jobs is Saving – and Dealing with Them”. essentially quite a simple market imper- In short, most of these issues can be countered sufficiently fection that causes a chronic supply and by making the holding of credit less profitable. The demand imbalance. Although centralizing trouble is that currently we don’t have the possibility of work to as few employees as possible is low enough real interest rates to be able to do so. And efficient for one company, it has negative hence, we have a chronic oversupply of capital and labor – an overall desire to hoard more credit than others are externalities for the whole economy – also willing to go into debt.1230 the companies themselves. Another significant factor is that people save money – • Additionally, aggregate supply (of labor hoard credit – for their own economic security, even if and capital) currently exceeds demand they didn’t consider saving profitable in terms of their because interest rates cannot turn negative “time preference” otherwise. This is because temporary enough – i.e. capital has a minimum wage. unemployment involves a significant risk of long-term unemployment1231 – and this risk increases as total demand When one brings up any idea of increasing such a drops. The result is a game-theoretical problem much like “correlation between people’s willingness to spend and a Prisoner’s Dilemma or a Stag Hunt1232 (with commodity invest” or otherwise influencing the way work is allocated money1233 more clearly a Prisoner’s Dilemma), resulting in the economy, a common reaction is something like this: in an inefficient outcome for almost all participants. The fundamental cause of this dilemma is the fact that it is “Wouldn’t that require a centrally planned system where not profitable for employers to share work. “Centralizing” the government or a computer program somehow dictates work to as few employees as possible is an efficient option how much everyone gets to earn? And if we did that, for any individual employer, but inefficient for the whole why do we pay people at all – why don’t we just adopt economy – i.e. it has negative externalities. communism while we are at it?” The zero lower bound – the minimum wage of capital Actually, a centrally planned system is far from efficient – needs to be removed1234 and people need to have the at these kinds of allocations, as it cannot measure people’s realistic alternative to work less, without a significant risk preferences – the relative values they attribute to goods of long-term unemployment.1235 or types of work – fairly or with any feasible accuracy.1228 The only thing that can do this fairly is a market system of supply and demand, where individuals need to make 1230 See: ”2.2.5.2 Monetary Policy – You Can Pretend It’s about the Mon- choices and are free to do so. e y Supply ”. 1231 See: “4.1.5 Guaranteeing Security While Avoiding Welfare Bum- ming: Economic Freedom Need Not Be Free”. Clearly, in our current system, the supply and demand 1232 See: ”3.1.1 Economic Instability, Cyclicity, ‘Keynesian’ Unemploy- of earning opportunities is not very well in balance and ment and Growth Dependence”. 1233 “2.2.2 Market-Dictated, ‘Sound’ Commodity Money – Austrian per- is even less so, when aggregate demand falls. Because spectives”. total available earning opportunities are determined 1234 See: ”4.2.1 Eliminating the Zero Lower Bound with a Higher Infla- by spending and investing,1229 the unemployment and tion Target or by Eliminating Cash”. involuntary indebtedness of some means that other people 1235 See: “4.1 Maximizing Flexibility to Eliminate Labor Market Mis- matches and Increase Adaptability”. are overly eager to save money – hoard risk-free credit –

1228 See: “1.1.5 We Need a Market Economy Because of the Limited- ness of Understanding and Empathy” and “2.2.3.5 The Planned or ‘Re- source-Based’ Economy – ‘We Know What We Need’”. 1229 See: “1.3.3 The Circular Flow of Income – Consumption, Saving and Investing”. Structure of the Root Bug Hypothesis | 257

2.3.5 Structure of the Root Jules Ayer, Philosophy in the Twentieth Century Bug Hypothesis (1982, p. 133) In short: • The Root Bug hypothesis is split into three The Root Bug hypothesis is not just an inspiring parts, which can be researched, simulated, story of how the world was destroyed by simple misunderstandings – it is also an actual hypothesis. falsified and developed separately from And, according to Karl Popper, a hypothesis is the more each other. valuable, the more falsifiable it is, i.e. the more specific and testable it is. The Root Bug hypothesis can be split into • The “What” part says that a sufficient cor- three layers that can be assessed separately. relation of earning opportunities and propensity to spend an invest – independent Each of these layers (or parts) can be discussed, specified, of total demand – can be achieved by facil- falsified and developed separately. itating negative interest rates and making There’s the “Why” layer, which says that most of our sharing work profitable for employers with economic, social and environmental issues would be much simple (dis)incentives. easier to solve if we created a system where (1) extortion through full private ownership of monopolies was not • The “Why” part says that achieving such a possible and (2) earning opportunities correlate better demand-independent correlation and elim- with people’s willingness to spend and invest – so that inating private monopolies would solve or reduced total demand did not decrease this correlation allow easily solving most of our economic, significantly. The arguments are discussed in the next volume, “3 Why We Need to Fix the Root Bug”. social and environmental challenges. Then there is the “What” layer, which says that such a level • The “How” part suggests a whole new of correlation can be created by making it legal, socially taxation model prototype – including labor acceptable and profitable for employers to share work and financial market policies – that could among a bigger number of employees and by allowing eliminate the ZLB, make sharing work the real interest rate to fall low enough to keep aggregate profitable and mitigate possibilities of supply and demand in balance in all situations. This basic idea has been introduced in the previous chapters, extortion with private monopoly resources starting from ”2.3.1 The Job Creation Paradigm – Why Are and industries. We Trying to Make More Work?!”. As for monopolies, it identifies private land ownership (ownership of location) Believe those who are seeking the truth. as one of the most significant local monopolies, patents “Doubt those who find it.” – André Gide similarly as technology monopolies as well as location- dependent industries (such as basic infrastructure) and For every fact there is an infinity of other central coordination systems (like central banks and “hypotheses.” – Robert M. Pirsig, Zen and the other clearing systems) as natural monopoly industries. Art of Motorcycle Maintenance (2006) And thirdly, there is the “How” layer, which is the one requiring the most innovative thinking from all of you In so far as a scientific statement speaks – players in this operating system. The “How” section of about reality, it must be falsifiable; and in so this book (“4 How Could The Root Bug be Fixed”) “far as it is not falsifiable, it does not speak about —— suggests some initial, feasible and lucrative reality.” – Karl Raimund Popper ways for increasing choice in how much to work and mitigating risks of involuntary long-term There never comes a point where a theory unemployment, can be said to be true. The most that one “can claim for any theory is that it has shared the —— discusses how a higher, stable rate of inflation or eliminating physical cash would facilitate negative successes of all its rivals and that it has passed real interest rates on monetary assets and how at least one test which they have failed.” – Alfred this allows keeping aggregate supply and demand 258 | The Solution of the Root Bug Hypothesis

3. HOW 1. WHAT 2. WHY COULD IT BE FIXED? IS THE ROOT BUG? DO WE NEED TO FIX IT?

GRAPH 25: THE STRUCTURE OF THE ROOT BUG HYPOTHESIS.

in balance without the need for significant fiscal these other subbugs would really be, we have to weigh stimuli or other policy gimmicks, and them against each other and see whether the “investment” is worth it or not. Looking at all the unfalsified claims —— investigates the potential and challenges of lying in the Why basket, it definitely looks at least worth implementing fair and predictable land value the investigation. taxation as well as ways of dealing with other monopolies. In this structure of The Hypothesis, “the actual Root Bug” is the labor market failure of the mismatch between earning Separating the three layers of the Hypothesis – Why, What opportunities and individuals’ willingness to spend and and How – eases constructive discussion significantly. invest – and especially the fact that this mismatch is When we talk about the “Why”-arguments, we assume worsened by reduced aggregate demand, which results that we can achieve a sufficient rate of correlation – match from the quantization of labor into jobs. However, as of supply and demand – in the labor market. When we explained in “1.1.11 The Fundamental Imperfections discuss the “What” section, we assume that it is possible of a ‘Free Market’ – Externalities and the Limitedness (somehow) to make sharing work legal, socially acceptable of Land”, this is not the full extent of the problems in a and profitable and to (somehow) achieve negative real free market or our current economic systems. It has other interest rates when necessary. And when we discuss the fundamental “bugs” as well. We could expand the What How section, we assume that fixing the Root Bug really is layer of the hypothesis to incorporate these imperfections useful. and split it into the following “subbugs” – imperfections:

Of course, when we have established an estimate of what —— The Non-Isolable Externalities Bug: Some things, the effects of and requirements for fixing the Root Bug and like river water, ocean ecosystems and the global Structure of the Root Bug Hypothesis | 259

climate are too tightly interconnected to allow opportunities and other artificial access restrictions preventing externality effects or charging fairly for to certain labor markets; legal fixed costs per them.1236 employee and labor reduction restrictions; wage regulation (e.g. minimum wages that make trading —— The Land Bug: Land and other natural resources work under certain prices illegal); as well as the cannot be produced with human labor. Land types of social security schemes that discourage (location) also has a local monopoly, making it small amounts of work.1241 profitable to hoard it and giving landowners a disproportionate share of any productivity The Work-Piling Bug and the Zero Lower Bound Bug are at increases in an economy. This is the root cause of the core of “the actual Root Bug” – the mismatch of supply real estate bubbles and the natural monopolies of and demand in the labor market. This labor market failure many industries. Any land use also has significant is emphasized because: (positive and negative) externalities on the value of land around it.1237 —— it hasn’t received much attention in mainstream economic discussion, which often doesn’t seem to —— The Work-Piling Bug: It is generally more even consider the possibility of a human being not profitable for an individual company to pile up being the unit of labor, and work on fewer people – even against their will – than to let every capable individual participate —— most of the problems described in the Why section in production according to their willingness to are caused by – or simple solutions to them are spend and invest. However, this is not efficient for prevented by – this labor market mismatch as the whole economy – it has externality costs. This well as the resulting growth dependence1242 and is largely a “game-theoretical” problem: A fear of “economy war” between nations.1243 long-term unemployment and a lack of alternatives significantly hamper people’s ability to demand However, this “actual Root Bug” is hard to treat without higher pay for additional units of labor.1238 removing many of the Symptom Treatment Bugs. Also for example removing the Zero Lower Bound Bug without —— The Zero Lower Bound (ZLB) Bug: In our current assessing the Land Bug would likely result in a massive monetary system with physical cash and a 1-2 % real estate bubble.1244 When we look at the big picture, inflation target (in Western countries), real interest we find that many of the dilemmas involved in solving rates cannot fall low enough to keep aggregate individual bugs actually solve each other. All is connected. supply and demand in balance – i.e. to match desires to save with available profitable investment Science must begin with myths, and the 1239 opportunities. “criticism of myths.” – Karl Raimund Popper —— The Free Deposit Guarantee Bug: The fact that the government guarantees bank deposits practically There are 2 possible outcomes: If the result for free encourages excessive leverage in banking confirms the hypothesis, then you’ve made and excess liquidity in the market as well as acts “a measurement. If the result is contrary to the as a subsidy on risk-free credit (“unemployed hypothesis, then you’ve made a discovery.” – capital”), also maintaining higher costs of equity on its part.1240 Enrico Fermi

—— Symptom Treatment Bugs: This includes all unnecessary restrictions and transfer payments 1241 See e.g.: “4.1.2.2 Removing Legal Barriers and Policy-Created Fixed Costs”, “4.1.3.4 Layoff Penalties Are Hiring Costs – The ‘Paradox’ of Re- implemented with the excuse of treating some duction Restrictions”, “4.1.4 Subsidize, Deacademize and Re-Game-De- symptoms caused by the other imperfections sign Education to Maximize Flexibility, Mobility and Adaptability”, “4.1.5 and that mainly often do further harm (at least Guaranteeing Security While Avoiding Welfare Bumming: Economic Freedom Need Not Be Free”, “3.2.1 Maximal Economic Security with in an economy where the imperfections were Maximal Flexibility – Flexicurity and Antifragility” and “3.2.2 Unfair fixed). These include limitations of education Income Differences and Limits to Social Mobility”. 1242 See: “3.1.2 Other Scapegoats for the Mystical Growth Dependence”. 1243 See: “3.3.1 Solving Poverty for Good – Ending the Economy War”. 1236 See: “3.4 Environmental Sustainability”. 1244 See: “4.2.4.9 Real Estate Bubbles”. 1237 See: “4.3 Eliminating Private Monopolies and (Other) Privileges”. 1238 See: “4.1 Maximizing Flexibility to Eliminate Labor Market Mis- matches and Increase Adaptability”. 1239 See: “4.2.1 Eliminating the Zero Lower Bound with a Higher Infla- tion Target or by Eliminating Cash”. 1240 See: “4.2.2 Setting a Fee on the Government Deposit Guarantee”.

261 | 3 WHY WE NEED TO FIX THE ROOT BUG

In short: • Different political factions (and the eco- in Finland the left-right division has more to do with serving certain interest groups than with an ideological nomic schools supporting their arguments) separation regarding the role of the state – or the original are largely focused on debating over which conservative-progressive split from the French Revolution. symptoms caused by our buggy economic But in one categorization, we could simplify that the system to treat and how. “right” wants to maximize total economic freedom and prosperity, the “left” wants avoid unfair income • Fixing the Root Bug is not a compromise differences and economic insecurity and the “green” balancing economic, social and environ- movement wants to ensure sustainability and preserve mental objectives, but would mitigate natural capital such as biodiversity. Tragically enough, no notable political faction is concerned for “developing” many economic and nation-level social is- countries – not even the Christian democrats. sues, while removing the main obstacles to solving poverty and environmental chal- Regardless of what your “political conviction” or 1246 lenges – our economies’ growth dependence fundamental values may be, considering the and the economy war between nations. possibilities that the Root Bug hypothesis and its solutions offer is hardly a waste of time – if nothing else, it is sure Simplicity: In a world of uncertainty, complex to provide inspiration for your own theories and solutions and a better understanding of the arguments with which “problems do not always require complex your “opponents” (academic, political or recreational) solutions.”… “It’s basically robustness. You need might hit you. something that works in an uncertain future – not something that is optimal in the past.” – According to the hypothesis, a “root-debugged economy” Gerd Gigerenzer 1245 would be a basis for an economic system superior to any previously suggested system in terms of:

If you want to build a ship, don’t drum up —— Facilitating maximal economic growth (though the people to gather wood, divide the work, not requiring any) within the limitations of “ individual preferences and productive capacity and give orders. Instead, teach them to yearn for the vast and endless sea.” – Antoine De Saint- as well as natural resources and also maximize positive economic freedom including available Exupery entrepreneurial and professional opportunities (except the freedom to blackmail or exploit others). So, if it were possible to fix the Root Bug – eliminate private —— Elimination of any unfair income differences and monopolies and get supply to actually meet demand on providing sustainable economic security and other the labor market – why should we do it? Is it really worth local. it? Is it feasible (in a game theoric competitiveness and foreign policy sense) for an individual nation or economic —— Our possibilities to solve environmental region? And, specifically, is it in your interests? sustainability challenges. —— Allowing the elimination of poverty and thereby The political “left”, “right” and “green” factions have their much of the resulting humanitarian despair on a special areas of interest. Of course these categories aren’t global level. very precisely and universally defined, and for example

1245 3:20->, Gigerenzer, Gerd, “What Can Economists Know? 2/5”, lecture, viewed 20.8.2013, http://www.youtube.com/watch?v=DdEEwoKk- 1246 See: “2.1 Normative Principles – What Do We Want from an Eco- fMA&nomobile=1 nomic System?”. | 262

It would not result in as much income equality as a likely to increase total future consumption, providing socialist system would, but it would almost completely profitable investment opportunities – especially in obliterate unfair income differences1247 and make it innovative new ventures with high returns.1253 impossible to extort or enslave anyone. Therefore, if you are an extreme Marxist aiming at standardizing people A few “losers” in a direct economic sense might include into clones and devaluing differences in individuals’ skills hedge funds that have specialized in speculating with and preferences, you might want to keep the Root Bug just economic cycles and collapses of national economies as it is – and this book will sure let you know how that can and governments, as these cyclical risks and public be done as well.1248 fiscal problems would be largely eliminated.1254 But on the other hand, this allows them to apply their risk It would not result in as much negative economic freedom management know-how to actually productive investment as a laissez-faire capitalist system under a “night- opportunities that emerge, as the “debugged economy” watchman state” or a completely stateless anarcho- better facilitates entrepreneurship.1255 capitalist ecosystem would – as it would for example reduce the possibilities of exploiting others by hoarding Also, professional groups that have managed to achieve limited vital resources and imposing externality costs on high income levels by limiting education opportunities1256 them. However, with these limitations it would provide or by leveraging the damage potential of their strike threat more positive freedom – opportunities – as well as higher to bargain for wages (share of added value produced in the productivity and innovative capacity than a completely economy) higher than supply and demand would dictate, “free market” would. If you want a survival-of-the-fittest would lose this advantage. If you belong to some of these “Darwinian” world, where the least productive percentile privileged interest groups, your change resistance is very of human beings starve to death every year or can be understandable. We humans are very eager to hang on to exploited as slave labor – or, even “better”, an expendable “achieved benefits,” but it is fairly likely,that even your life resource – at the will of landowners and incumbent would be made more worthwhile and rewarding in the creditors (who can determine the interest rates), then you long run by a self-stabilizing and fair economic system that might also want to keep the Root Bug just as it is.1249 better facilitates increases in productivity and eliminating wasteful work – and gives you more alternatives, making Despite apparent short-term losses to some (currently you less dependent on the specific job to which you might privileged) interest groups, in the long run it would have locked yourself for an illusion of security.1257 provide a much more worthwhile and motivating environment for everyone to operate. The solutions to many problems are much simpler and easier than one might expect – if one just asks the Investors might be worried that they would lose out relevant questions. In most of our economic, social and when we remove the “minimum wage of capital” – the environmental challenges, we are currently focused on the zero lower bound of interest rates.1250 But here, investors wrong questions. Each issue is discussed and explained in have to understand that, just like minimum wages are its own chapter in more detail, but here are some of the harmful to workers (collectively) because they leave some most crucial “question shifts” we need to make: willing workers in that area unemployed and increase the others’ income insecurity1251, the “minimum wage of —— Unemployment:1258 Currently, we are focused on capital” leaves massive amounts of capital unemployed spurring demand to create more work in order (as government-backed credit, out of productive use)1252 to allow everyone to participate in that work. But and (through the ever piling amounts of debt) makes the “how to create the most work” is not the relevant system much more unstable, causing sudden windfall question in terms of unemployment. The relevant losses and gains. The possibility of negative interest rates question is, why does reduced demand result in a – by reducing unemployment and income insecurity – is mismatch between people’s earning opportunities and their willingness to spend and invest. 1247 See: “3.2.2 Unfair Income Differences and Limits to Social Mobili- ty.” 1248 See: ”4.1.2.1 Why Sharing Work Is Currently Not Profitable or Oth- erwise Viable”. 1253 See: ”3.2.7 Encouraging and Facilitating Entrepreneurship and Cre- 1249 See: ” 6.3.1 Appendix 3.1: The Deontological Libertarian Dream: ative Productivity”. Neofeudalism or Survival of the Fittest”. 1254 See: “3.1.6 Sovereign Debt Crises”. 1250 See: “4.2.1 Eliminating the Zero Lower Bound with a Higher Infla- 1255 See: “3.2.7 Encouraging and Facilitating Entrepreneurship and Cre- tion Target or by Eliminating Cash”. ative Productivity”. 1251 See: ”2.2.3.1 Collective Bargaining – ‘Blackmail Is Solidarity’”, 1256 See: ”2.2.3.2 Restricting Supply – ‘Stay out of Our Territory’”. ”2.2.3.3 Wage Regulation by the Government – All or Nothing”, and ”3.2.1 1257 See: “3.2.1 Maximal Economic Security with Maximal Flexibility – Maximal Economic Security with Maximal Flexibility – Flexicurity and Flexicurity and Antifragility”. Antifragility”. 1258 See: ”3.1.1 Economic Instability, Cyclicity, ‘Keynesian’ Unemploy- 1252 See: ”1.1.10 Companies as Contract Bundles – Financial Assets Allo- ment and Growth Dependence”. cate Risks”. 263 |

G L C O I Y B M IT A L Famines IS L O I (3.3.2) The Real Economy Rampage S B Instability, of Curable S N “Too Big to Fail” U Credit Crises Diseases O A Dilemma E & Depressions (3.3.3) O T (3.1.5) Child S (3.1.1) C

S & Slave

C Labour I

A E N Poverty in (3.3.4)

I Developing

Countries L Sovereign (3.3.1) Irresponsible Debt Crises Risks (3.1.6) Over- in Banking Population (3.1.5) Violent Conicts (3.3.2) & Regional Instability TRADE IMBALANCES (3.3.5)

Sharing Work The Economy is Not War between Pro table Nations

Mismatch of The Dependence Earnings and on Economic Labour Will to Spend Growth Inexibility Economic (3.1.3) Insecurity & (3.2.3) Limits to Unemployment Unionization Entrepreneur- (3.2.1) & Strikes ship & Creativity Unfair Income Unsustainable Global Warming (3.2.7) Di erences Waste & Dependence Management on Fossil Fuels Ever Increasing (3.2.2) (3.4.3) (3.4.1) Workload & Growth Stress (3.2.4) of Retired Population Pollution & Deteriorating (3.2.5) Contamination Biodiversity (3.4.2) (3.4.2) A Big Part Depression & of Crime L L Marginalization (3.2.6) O (3.2.4) A T Y C T N I L A E I L M B I S N S O O A SU CIAL VIR IN E EN TA S US UNS

GRAPH 26: THE ROOT BUG WHY INFOGRAM: HOW THE ROOT BUG CAUSES (OR PREVENTS SOLVING) CHALLENGES IN MANY DIFFERENT AREAS. | 264

—— Economic security:1259 Especially labor unions are —— Poverty:1265 Currently, people concerned with focused on limiting companies’ ability to adjust poverty are mainly campaigning for more foreign to market situations and strategy changes by development aid. But foreign development aid restricting labor reductions. But short-term changes sums (total or as percentages of GDP) are irrelevant are not relevant in terms of economic security as long as rich countries’ first focus is maintaining – long-term cumulative earning opportunities their own current account surpluses.1266 For are. The relevant question is not how to prevent developing countries to be able to get rid of their change. The relevant questions are (1) why labor is foreign debt burdens and for local capital to reduced as whole people and (2) why losing one’s accumulate, the relevant question is how to get the job results in such a significant risk of long-term current account balances of developing countries unemployment. positive and, hence, those of developed countries negative. If we want living standards to rise in —— Income differences between professions:1260 developing countries, the relevant question is how Currently, the political left tries to reduce income to give their citizens access to education that would differences with higher tax progression and increase labor productivity locally and allow them transfer payments. But the function of income to compete over types of work with a higher market differences between types of work is to balance the price. supply and demand between these types of work: Higher pay is meant to attract more employees to a —— Climate change risks:1267 Currently, the focus is sector or profession from lower-paying sectors and on trying to push down annual carbon (and other professions. Hence, the relevant question is, what greenhouse gas) emissions. However, annual prevents people currently in low-paying jobs from carbon emissions are not relevant in terms of moving to labor markets with higher wages? long-term global warming potential – long-term cumulative carbon emissions are much more so. —— The income share of capital: Currently, the political If we want to mitigate climate change risks, we left is trying to raise (nominal) wages in attempts to need to get fossil fuels permanently out of use as lower profits companies are making and to impose soon as possible. This could easily be done with transfer payments through e.g. higher capital continuously and predictably rising carbon taxes. income taxes. But these do not lower the profit And the most relevant question – as with any other requirements of investments1261 and hence, under fair obvious solutions to environmental challenges competition, they are ineffective at reducing profits – is why such taxes cannot be implemented. made in the long run. The profit requirements of Unsurprisingly, we run, again, into the trinity of capital are determined by the risk-free investment “jobs”, “growth” and “competitiveness.” option. The relevant question is, how to (1) remove the minimum wage of capital (the zero lower bound of interest rates)1262, (2) the current direct subsidy to 1263 risk-free credit (the free deposit insurance) and 1265 See: ”3.3.1 Solving Poverty for Good – Ending the Economy War”. (3) the possibility to reap unfair profits through 1266 See: ”1.3.4 Foreign Trade: Current Accounts Are Also a Zero-Sum monopolies.1264 Game – Comparative Advantage vs. Absolute Advantage”. 1267 See: ”3.4.1 Global Warming and Dependence on Fossil Fuels”.

1259 See: ”3.2.1 Maximal Economic Security with Maximal Flexibility – Flexicurity and Antifragility”. 1260 See: ”3.2.2 Unfair Income Differences and Limits to Social Mobili- t y ”. 1261 See: “1.1.8 Labor and Capital (and Land?) – The Factors of Produc- t ion”. Chapters 3.1.1-3.1.8 not included in this sample 1262 See: ”4.2.1 Eliminating the Zero Lower Bound with a Higher Infla- tion Target or by Eliminating Cash”. 1263 See: ”4.2.2 Setting a Fee on the Government Deposit Guarantee”. 1264 See: ”4.3 Eliminating Private Monopolies and (Other) Privileges”. Maximal Economic Security with Maximal Flexibility – Flexicurity and Antifragility | 309

3.2 LOCAL SOCIAL ISSUES

3.2.1 Maximal Economic this is an illusion, for he has a bit more. This Security with Maximal is the central illusion in life: that randomness Flexibility – Flexicurity and is risky, that it is a bad thing – and that Antifragility eliminating randomness is done by eliminating randomness.” … “You get pseudo-order when In short: you seek order; you only get a measure of order • In policy discussion, it is often assumed and control when you embrace randomness.” – that a conflict exists between income Nassim Nicholas Taleb, Antifragile (2012, p. 84 security and labor market flexibility and & 6-7) that the task of policy makers is to find a My father could’ve been a great comedian, compromise between these. “but he didn’t believe that that was possible • However, in an economy of constant tech- for him. And so he made a conservative choice: nological evolution and changing demand, instead, he got a safe job as an accountant, and security can be maximized by maximizing when I was twelve years old, he was let go from flexibility – bringing the flexibility “with- that ‘safe job’, and our family had to do whatever in” employees, instead of employees being we could to survive. I learned many lessons from the unit of flexibility. my father – not the least of which was that you can fail at what you don’t want, so you might as • Chronological variance (especially in the well take a chance on doing what you love.” – short-term) in a person’s income is irrele- Jim Carrey1489 vant for his economic security. What matters is the “probability variance” of what In “3.1.1 Economic Instability, Cyclicity, ‘Keynesian’ he can expect to earn cumulatively in the Unemployment and Growth Dependence” and “3.1.3 long-term. A momentarily static income Structural, Friction and Classical Unemployment, NAIRU stream is an illusion of income security and Hysteresis – Is 5 % Unemployment Really Necessary?”, – especially when it increases the risk of we explained how fixing the Root Bug would eliminate most of our involuntary, long-term cyclical, structural and sudden long-term unemployment. friction unemployment. Eliminating these by making it profitable to share work would provide the best possible We should not complain about economic security that can be achieved in a dynamic and “impermanence, because without turbulent environment where people’s preferences change impermanence, nothing is possible.” – Thich and technologies evolve. Nhat Hanh Implicit contract theory was developed to explain why reduced demand for labor results in “quantity Whosoever desires constant success must adjustments”, i.e. layoffs, instead of price adjustments. “change his conduct with the times.” – It describes the formation of fixed work contracts as an Niccolo Machiavelli insurance system, where risk-averse consumers prefer to pass the risks of unemployment on to risk-neutral Because of the variability of his income, he [a companies, who get cheaper labor in return for such taxi driver] keeps moaning that he does not an insurance. And this logic works very well in an “have the job security of his brother [personnel 1489 0:31->, “Jim Carrey on how his late father inspired him to follow department clerk in a large bank] – but in fact his dreams”, speech to Maharishi University of Management class 2014, viewed 13.4.2014, https://www.youtube.com/watch?v=ajMpfPYlHi4 310 | Local Social Issues

environment where fluctuations are small and temporary and increases the amount of unnecessary bankruptcies, and whole industries wane at most at the same rate as significantly increasing economic insecurity for workers. people retire. Currently, many companies are solving this problem with The traditional approach to tackling economic insecurity “external workforce” – leased employees. These are used by left-wing parties and the labor union movement as the flexibility buffer. The value of the flexibility to has followed this same logic. They have attempted to the companies can be seen in that they are ready to pay prevent change by all possible means including making 50-100 % premiums for leased labor compared to what employment contracts hard to change and by making the they pay people on their own payroll, despite their own reduction of labor as expensive, shameful and difficult employees being more reliable, skilled and familiar with as possible. Unfortunately, in a fast-changing, turbulent the company’s processes. This buffer does somewhat environment where technologies evolve, people’s increase the economic security of the permanent staff – consumption preferences change and the lifecycles of but labor unions’ fear of the practice expanding causes industries can be less than a decade, rigidity can only them to campaign against this kind of outsourcing by all create an illusion of security and it is far more likely to possible means. The external workforce isn’t often very increase economic insecurity. happy either (with the exception of industries with very high employee deficits, where there are always well paid Hardness is not strength. Glass is fragile because it is gigs available, e.g. the IT industry in some places), as they hard. Metals are durable because they are soft: flexible have hardly any economic security at all or choice of gigs and malleable. Suppressing one’s emotions and “putting and are often at the mercy of the leasing companies. And on a brave face” no matter what only makes one more at the problem is precisely this “duality in labour markets risk of bigger nervous breakdowns and less adaptable to that separates well-protected insiders from vulnerable different social situations and dramatic life changes.1490 1491 outsiders.” (EIF-1 2013) The unions should remember A relationship where neither party is willing to be flexible Nassim Taleb’s “chief ethical rule”: “Thou shalt not have does not usually last very long – or at least isn’t a very antifragility at the expense of the fragility of others.” happy one. One of the 8 paradoxes of life listed by popular (2012, p. 5-6) psychologist Tommy Hellsten (2008) is: “If you seek safety, live dangerously”. Fenders of steel to protect your boat are In a dynamic environment, economic security for everyone as not a good idea. Even a wild mosh pit in a rock concert “security within a job” is rather unrealistic. To provide audience can work safely as long as people keep their security through lasting, “fixed-size” jobs, we would also arms up or down, bumping softly into each other on their need to prevent technological progress and limit freedom upper arms or chests. When someone lifts their elbows or of consumer choice. As roughly demonstrated in Graph goes head first into the crowd, damage starts to happen. 33, the demand for different kinds of labor depends on people’s needs and preferences and the technologies that The competition between companies exists to find more are available to meet those needs. A “product”, from one efficient ways for achieving things.1492 If companies cannot point of view, is formed as a combination of a company’s reduce the amount of labor they buy, they are unable customer competences (understanding of customer to realize the benefits of these innovations – for their needs) and technological competences. (Danneels 2002) shareholders or clients and the whole society – unless they Having full freedom of consumption choices with variable are simultaneously increasing their sales. Also, when the human needs and preferences as well as freely evolving demand for products or services decreases or more efficient technology (means available for meeting human needs), organizational forms as competing companies emerge, but a planned economy in the labor market is a utopian companies need to be able to adjust by cutting their costs vision if something is. And that’s what we seem to be if they are to retain any hope of reinventing themselves trying now, at least in Finland. to get “back into the game.” Preventing this only makes the game less even, allowing existing dominant players However, by ensuring that it is always profitable to share to reap higher profits than more equal competition would work and so spreading – “diversifying” – the need for allow. More importantly for the employees, it causes flexibility, we can achieve a sustainable “security of a job” layoffs to occur in bigger batches and on a shorter notice (or, rather, of earning opportunities and, hence, income) in the mid-to-long-term. Of course there will be variance in how much work is available in each industry and how much different types of skills are paid for according to 1490 Brown, Brené, 2010, “The Power of Vulnerability”, TEDx Talk, TEDx Houston, viewed 17.7.2013, http://www.ted.com/talks/brene_brown_ supply and demand, but no one has the fear of ending on_vulnerability.html up completely without income for long periods of time 1491 Porter, Tony, 2010, “A call to men”, TED Talk, viewed 21.5.2013, due to no fault of his own – e.g. purely out of cyclical or http://www.ted.com/talks/tony_porter_a_call_to_men.html 1492 See: ”1.1.9 Companies as Competing Organizational Forms (Be- structural reasons. cause Institutions Suck at Suicide) – ‘Pro-Business’ Is Not ‘Pro-Market’”. Maximal Economic Security with Maximal Flexibility – Flexicurity and Antifragility | 311

PEOPLE’S NEEDS TECHNOLOGIES DEMAND FOR AND PREFERENCES AVAILABLE TO TYPES OF LABOR COMPANIES (SKILLS)

PRODUCT 1 NEED 1 TECH 1 SKILL 1

NEED 2 TECH 2 SKILL 2

NEED 3 TECH 3 SKILL 3 ......

NEED N TECH N SKILL N

GRAPH 33: TECHNOLOGY TRANSLATING HUMAN NEEDS INTO DEMAND FOR KINDS OF LABOR.

“There is a certain mathematical property to this had no savings buffers, banks would be willing to grant bottom-up volatility, and to the volatility of natural you a consumption loan until you do, as long as they trust systems. It generates the kind of randomness I call in your ability to earn income in the long run.1493 Mediocristan – plenty of variations that might be scary, but tend to cancel out in the aggregate (over And what’s even more noteworthy is that when the time, or over the collection of municipalities that longer-term variance in total demand affects everyone’s constitute the larger confederation or entity) – rather earning opportunities in the industry, it encourages the than the unruly one called Extremistan, in which you full utilization of available potential flexibility to balance have mostly stability and occasionally large chaos – those structural supply and demand imbalances,1494 errors there have large consequences. One fluctuates, preventing them from causing chain reactions of income the other jumps. One has a lot of small variations, differences growing.1495 the other varies in lumps. Just like the income of the driver compared to that of bank employee. The two This shift from “security within a job” (job security) to types of randomness are qualitatively distinct. “security of a job” (employment security) is what Dutch economist Hans Adriaansens originally referred to as Mediocristan has a lot of variations, not a single one of “flexicurity”. (Philips & Eamets 2007, p. 7)1496 Flexicurity which is extreme; Extremistan has few variations, but has become a popular buzzword, especially since those that take place are extreme.” … 2004, referring quite broadly and vaguely to different policies aimed at simultaneously providing flexibility for “In Extremistan, one is prone to be fooled by the companies and income security for employees. (Philips & properties of the past and get the story exactly Eamets 2007, p. v) The two main versions are the Dutch backwards.” … “It looks like a drop in volatility – and it is not.” (Taleb 2012, p. 90-92) 1493 This game-theoretical problem – together with the Permanent In- come Hypothesis as well as habit formation – was explained in “3.1.1 Actually, short-term chronological variance in one’s income Economic Instability, Cyclicity, ‘Keynesian’ Unemployment and Growth is wholly irrelevant in terms of economic security. It is Dependence”. your total long-term cumulative income expectations and 1494 See: ”3.1.3 Structural, Friction and Classical Unemployment, NAI- RU and Hysteresis – Is 5 % Unemployment Really Necessary?”. their probability variance that are relevant. Not knowing 1495 See: “3.2.2 Unfair Income Differences and Limits to Social Mobili- whether you will earn $0 or $1000 in the next week is not t y ”. an income security issue, as long as you know you’ll be 1496 Philips, Kaia and Eamets, Raul, 2007, “Approaches to flexicurity: EU models”, European Foundation for the Improvement of Living and earning e.g. at least $150 000 during the next five years. Working Conditions, retrieved 3.5.2013, http://www.eurofound.europa. Losing your job temporarily is not a problem: Even if you eu/pubdocs/2007/84/en/1/ef0784en.pdf 312 | Local Social Issues

model – improving employment opportunities and social forms of employment”. (Philips & Eamets 2007, p. 7 & 14) security – and the Danish model – a combination of “a This implies that “permanent, full-time jobs” should remain low level of dismissal protection and high unemployment the norm. The fact that most people’s work contracts are benefits”. (Philips & Eamets 2007, p. 7) The latter has made rigid is the reason for the economic insecurity of become a common European benchmark for flexicurity “external labor” – all needed flexibility is taken out of this policies. (Fabrice & Colomb 2009, p. 12) Flexicurity was small group. (Compare this to the increased risk imposed on also commonly referred to as the ”modèle danois” in the equity of a company by high debt leverage.) In France before the popularization of frenchifications like investment portfolios, individual risks can be rendered ”frexicurité” and ”flexisécurité”. (Fabrice & Colomb 2009, insignificant by diversifying, and the risks of an individual p. 22) 1497 large asset can be made insignificant for individual investors by sharing the risk between multiple investors. Similarly, One classification of labor market flexibility (for the risks of reduced demand can be made insignificant for employers) distinguishes between four types of flexibility: an individual employee by spreading the risk among a larger number of employees. —— “external numerical flexibility”: reducing the number of people employed, by firing, hiring or In short, the reason a “free market” causes economic adjusting the use of external workforce (including insecurity is not because it allows too much flexibility, but “ent reployees”1498 and ordering work as services) – on the contrary – because the free market is not flexible enough! Even without restrictions, the natural costs of —— “internal numerical flexibility” – an employer’s sharing work and the fear of unemployment quantize labor ability to modify the number and arrangement of into jobs, making a human being the default unit of working hours without changing the number of flexibility. To get the flexibility onto a “lower level”, employees; sharing work needs to become profitable. This might need —— “functional flexibility”: changing the content a Pigovian tax on the harmful externalities of over- of an employee’s work or moving them between centralizing work or some other way of eliminating fears of departments, long-term unemployment.1499 —— “wage flexibility”: altering wages in response to changes in labor market or competitive conditions. Nassim Nicholas Taleb’s (2012) book “Antifragile: Things (Philips & Eamets 2007, p. 11) That Gain from Disorder” gives examples of how flexible, non-centralized systems and organizations can gain from Unfortunately many researchers and political entities tend uncertainty and a turbulent environment if designed to to consider flexicurity a compromise between flexibility and adapt and evolve. To get a robust or antifragile system, security. The EU Employment Guidelines for 2003 are one each component needs to be fragile or at least flexible. To example of this: achieve sustainable security – robustness – for employees and an antifragile market system that evolves and learns “‘…providing the right balance between flexibility from shocks, we need to make every work hour (or other and security will help support the competitiveness unit of labor within people) fragile. Maximal “internal of firms, increase quality and productivity at work numerical flexibility” minimizes the need for involuntary and facilitate the adaptation of firms and workers to “external numerical flexibility” – firing. economic change’ (Council of the European Union, 2003, paragraph 12).” (italics added, Philips & Eamets However, it is completely understandable that labor 2007, p. 8) unions – as self-preservation-oriented institutions – are objected to or skeptical towards such ideas (Fabrice & In reality, there is no conflict between flexibility and Colomb 2009, p. 14), as implementing them might erode the security – and therefore no need to find a “compromise”. unions’ current role in our centralized (and hence fragile) Maximized flexibility and mobility provides maximal labor “market”.1500 This incentive trap and the illusions the security and adaptability. union institution is trying to maintain will be discussed in more detail in “3.2.3 Unionization and Strikes”. Also, the focus of flexicurity policies is often on providing social protection measures for “a flexible workforce”, “atypically employed people” or people in “non-standard

1497 Barbier, Jean-Claude & Colomb, Fabrice, 2009, “Flexicurity – an 1499 See: “4.1 Maximizing Flexibility to Eliminate Labor Market Mis- open method of coordination, at the national level?” CARMA Research matches and Increase Adaptability“. Paper 2009: 3, Centre for Labour Market Research (CARMA), retrieved 1500 …if it can be called a market at all. E.g. in Finland it is more like 3.5.2013, http://www.epa.aau.dk/fileadmin/user_upload/conniek/ a system of human trafficking between unions and companies, with Dansk/Research_papers/2009-3-PKM_01.pdf planned supply. See: ”2.2.3.2 Restricting Supply – ‘Stay out of Our Terri- 1498 See: ”4.1.2.6 Avoiding Tax Avoidance through ‘Entreployees’”. t or y ’”. Unfair Income Differences and Limits to Social Mobility | 313

Concluding with an analogy, the social security net of a Nordic welfare state is often talked about as a kind of mattress on which people can fall when they drop out of the labor market. The debate is often around whether that mattress works more like a trampoline that helps people get back into the labor market (on top of the pillars) or like a warm swamp that passivates and marginalizes people further. But why not make the whole labor market a soft balloon ocean from which it is harder to fall off Chapters 3.2.2-3.3.5 not included in this sample completely – instead of it being a collection of hard pillars on which people try to balance and that shakes out huge chunks of people even in smaller earthquakes (e.g. structural shocks)? The need for a mattress below this ocean is discussed in “4.1.5 Guaranteeing Security While Avoiding Welfare Bumming: Economic Freedom Need Not Be Free”.

It is a bad plan that admits of no modification.” – Publilius Syrus, First “Century BC

Change is the law of life and those who look “only to the past or present are certain to miss the future.” – John F. Kennedy

Everything is in a process of change, nothing endures; we do not seek permanence.” – “Masatoshi Naito 362 | Environmental Sustainability

3.4 ENVIRONMENTAL SUSTAINABILITY

In short: • The main obstacles to solving environ- industry out of business, or even force major mental sustainability challenges are our retrenchments by suppressing production economies’ dependence on growth and the because, among other important reasons, given resulting “economy war” between nations. capitalism, this would just provoke recession and Fixing the Root Bug would remove these, mass unemployment – if not worse.” – Richard making many otherwise fairly obvious Smith1723 solutions economically feasible. Most environmental researchers and engineers would I said, ‘Oh really? Really, there’s a green agree that we have the needed technological capabilities to “revolution going on here?! … “Have you solve all of our environmental sustainability challenges – ever been to a revolution where no one got or that those capabilities could be developed fairly quickly hurt?” … “The ‘green revolution’ we’re having if only the right investments were made. But why don’t we make those investments and solve these problems? is a complete fraud – as far as I’m concerned. Are we just lazy, selfish or ignorantly shortsighted? No. Because in this revolution everyone’s green: It is simply an “economic reality” that we can’t “afford Yeah, Exxon’s green, BP’s green…” … “The to”. This is yet another reason for “anti-capitalists” global economy today, friends, is like a monster and “anti-moneyists”1724 to demonize money and the truck with the gas pedal stuck and we have lost market economy altogether and insist that capitalism is an inherently flawed system. And they are right in that the key. And the only way we’re going to catch our current system has a fundamental flaw. But they are that truck is with a disruptive breakthrough. throwing the baby out with the bath water by blaming And the only way we’re going to get a disruptive money and markets in general. breakthrough, is with a completely different mix of standards, regulations, incentive and taxes Now, what exactly does it mean that we “can’t afford to” solve our environmental sustainability issues? Labor that will trigger that disruption. Which is why productivity has increased significantly during the past my fundamental rule is: ‘Change your leaders, hundred years and keeps on growing at approximately not your light bulbs.’” – Thomas Friedman1722 1-2 % per year.1725 (Gomez-Salvador et al 2006) Doesn’t that mean we should be able to afford much more than we did Under capitalism, growth and jobs are more before? often than not at odds with environmental “ Yes, people’s standard of living would drop momentarily protection. There may be some win-wins as a result of stricter environmental regulations or e.g. here and there. But for the most part, given Pigovian taxes on fossil fuels, but so it should, as current capitalism, imposing big cuts in greenhouse gas production methods keep passing costs on to future emissions means imposing big job cuts across generations. The biggest trouble, however, is not the decreased purchasing power or additional work caused industrialized economies around the world. by the drop in labor productivity, but – on the contrary – That’s why, regardless of protests, no capitalist the possible decrease in earning opportunities (jobs)! Due government on the planet will accept mandatory to positive feedback mechanisms in the real economy1726, cuts in GHG emissions.” … “[N]o capitalist 1723 Smith, Richard, “Green Capitalism: The God That Failed”, Truthout, government on Earth can impose ‘green taxes’ 9th Jan 2014, cited 22.1.2014, http://www.truth-out.org/news/item/21060- that would drive the coal industry or any other green-capitalism-the-god-that-failed 1724 See: “2.2.3.5 The Planned or ‘Resource-Based’ Economy – ‘We Know What We Need’”. 1725 Possibly even more, as a lot of productivity improvements are es- 1722 41:35->, 42:54-> & 45:23->, Friedman, Thomas, “The World Is Flat caping metrics. See: “1.3.1 Economic Growth Is the Increase in Produced 3.0”, MIT Video, lecture at MIT, 28th Nov 2013, cited 8.1.2014, h t t p ://v i d e o . and Traded Value – The Many Meanings of ‘Wealth’.” mit.edu/watch/the-world-is-flat-30-9321/ 1726 See: ”3.1.1 Economic Instability, Cyclicity, ‘Keynesian’ Unemploy- Global Warming and Dependence on Fossil Fuels | 363

even a small increase in the prices of goods could result decisions is that oil can be expected to remain affordable in a drop in total demand: Higher real prices might in the future and thus not only is the development and make people consider fewer goods worth buying. And commercial roll-out of sustainable options slowed down, this could nudge our economies into a chain reaction of but there is more uncertainty regarding which standards recession and economic collapse. That is why we cannot of sustainable alternatives – if any – will become dominant, afford to let the prices of fossil fuels rise or implement any and this significantly increases the risks of investing. new environmental restrictions that would increase costs of products or slow down the launch of new ones. As Jeff The only way we can afford to solve our global Rubin writes: sustainability problems in time – if we haven’t already passed the point of no return – is to free our economies “Over the last four decades, each time oil prices have of their growth dependence by decoupling the demand spiked, the global economy has entered a recession.”1727 for employees from the demand for labor. Before that, countries cannot stop spurring economic growth by The “affordability” of solving environmental problems any possible means or stop fighting the economy war of is not a matter of limited resources, but of the system’s keeping up their own current account surpluses. fragility and the high social and economic costs of unemployment. The following chapters present simple, possible solutions to some environmental sustainability issues that we could Without these self-reinforcing mechanisms, there would implement easily and quite painlessly – if we just weren’t be no reason why we couldn’t afford to let the prices of dependent on growth. natural resources rise to levels that would keep their use sustainable. If available earning opportunities were always allocated to people according to their willingness to spend and invest1728, people not considering some products worth buying would just result in people working less – not in any depression.

However, it is possible that without the fear of long-term Chapters 3.4.1-3.4.4 not included in this sample unemployment, the environmental regulations might even increase the amount of work available. Firstly, the total demand for goods and services might not decrease as much as labor productivity decreases (i.e. as much as producing them requires more work) as a result of the environmental restrictions and Pigovian taxes.

Secondly, the aggregate demand model, which predicts that higher prices should reduce the total demanded amount, does not include expectations of future price changes. If consumers and companies know that the costs of unsustainable products will continue to rise (as a result of e.g. constantly rising carbon taxes1729), those who just want to get the most direct personal benefit will consume and make their investments sooner rather than later! Meanwhile, knowing that sustainable alternatives (e.g. renewable energy) will become increasingly affordable with the scale benefits of increased future demand and investments into them, consumers will also be less hesitant to make the investments into for example electric cars earlier on. One of the biggest obstacles for making such

ment and Growth Dependence”. 1727 Rubin, Jeff, ”How High Oil Prices Will Permanently Cap Econom- ic Growth”, Bloomberg News, 24th Sep 2014, cited 8.9.2014, http://www. bloomberg.com/news/2012-09-23/how-high-oil-prices-will-permanently-cap-economic-growth.html 1728 See: ”2.3.2 The Overlooked Option – Increase Correlation of Earn- ing Opportunities with People’s Willingness to Spend and Invest.” 1729 See: ”3.4.1 Global Warming and Dependence on Fossil Fuels”. 378 | Environmental Sustainability

3.4.5 The Irrelevance of Economic logic says that when a new good the ‘Degrowth vs. Decoupling’ “or service comes into being, the fact that Debate someone is willing to pay for it means that it must be to someone’s benefit. In a certain In short: narrow sense, this is true. If I steal your car keys, • Eternal economic growth is not a physical it may be to your benefit to buy them back from impossibility, but it does not make sense me. If I steal your land, it may be to your benefit as an objective in itself, as further special- to rent it back so you can survive. But to say that ization does not always “increase utility” money transactions are evidence of an overall (i.e. it’s not what people always prefer) or rise in utility is absurd; or rather, it assumes that make people’s lives more worthwhile. the needs they meet were originally unmet. If we are merely paying for something once provided • The debate over whether the economy through self-sufficiency or the gift economy, should grow more or less is about as rele- then the logic of economic growth is faulty.” – vant a political debate subject as debating Charles Eisenstein (2011) over whether people should have more or less sex. Shouldn’t one’s amount of special- Growth for the sake of growth is the ideology ization and trade be a matter of individual of the cancer cell.” – Edward Abbey, The preference? “Journey Home (1977, p. 183) • Most of the problems often directly linked to economic growth are rather problems Last few years have seen a heated debate between sustained by or economies’ dependence on “green growth”, which is putting hopes in “decoupling” growth. environmental unsustainability (or “material throughput” and “environmental impact”) from economic growth Anyone who believes in indefinite growth in through technological progress on one side and different “degrowth” movements that challenge the objective of anything physical, on a physically finite growth on the other side. “planet, is either mad or an economist.” – Kenneth E. Boulding “The degrowth movement” is not a coherent whole. Some like to split its branches into two distinct categories: The gross national product is a rough (1) ideas questioning economic growth as an objective in itself and (2) ideas making economic decline an objective – measure of this total throughput. It should be “ considering it an absolute necessity for environmental possible, however, to distinguish that part of the sustainability (Alaja 2011, p. 15) – demonizing growth GNP which is derived from exhaustible and that itself. The Root Bug hypothesis could be thought to which is derived from reproducible resources, belong to the former branch of “degrowth”, questioning as well as that part of consumption which the absolute value of economic growth as well as the acceptability of our economies’ growth dependence. represents effluvia and that which represents input into the productive system again. Nobody, Advocates of the latter branches like to quote Kenneth as far as I know, has ever attempted to break Boulding: down the GNP in this way, although it would be an interesting and extremely important exercise, ”A n y o n e who believes in indefinite growth in anything physical, on a physically finite planet, which is unfortunately beyond the scope of this is either mad or an economist.” (Boulding 1966, p. 160) paper.” – Kenneth E. Boulding, The Economics of the Coming Spaceship Earth (1966, p. 4) The key part of this argument is the word “anything physical” (which is often left out in many quotations). And even then it does not apply to all “physical phenomena”. A clear counter-example to such a generalization would be a microprocessor. During the past 50 years, the amount The Irrelevance of the ‘Degrowth vs. Decoupling’ Debate | 379

of computations executed by microprocessors have However, energy use does not necessary correlate with grown over billionfold, while the processors have become economic activity or the perceived quality of goods either. smaller. Similarly, economic growth is not the growth of A lot of the current value produced is in electronically anything physical,1799 but an increase in the amount and stored information and the quality of this information value of (production-related) transactions. The (real) “size does not correlate with the amount of energy used. Also of the economy” is (determined by) the market value of electronics can become far more energy efficient than they the goods and services produced and consumed – which are now – e.g. with the development of high-temperature also includes improvements in quality (as long as they are superconductors. If the amount of available energy still numerically measurable).1800 poses a limit, as a final resort, mankind could bury itself into the Earth’s crust to prevent any energy from being Even if the physical resources for producing goods and lost and use all energy captured from the surface yet more services would be limited, there is no limit to how useful efficiently. services they can be used to provide, nor how fast or well these resources can be rearranged into useful products. So thousandfold economic growth from the current Theoretically, I could buy a new electric car every day and situation (at least along some measures of growth) is not have it disassembled and recycled each night to provide a physical impossibility. But is it an economic impossibility material for the construction of a new car. This would for such growth to be environmentally sustainable? increase economic activity – and even “throughput”, i.e. The Ehrlich equation, a.k.a. the IPAT equation, states that the flow of physical material, which ecological economics environmental impact (I) is a product of population tends to want to minimize1801 – but not “use up” or tie down (P), affluence or income level (A) and the technological any more physical resources than keeping the same car for intensity (T) of economic output. 5 years. Even material throughput can be environmentally sustainable material throughput. I = P x A x T (Jackson 2009)

The amount of energy that can be produced sustainably Degrowth activists point out that a lowered T factor on Earth is limited by the amount of radiation the Earth (e.g. increased energy efficiency or other technological receives from the sun, the radioactivity under the Earth’s advances decreasing “throughput”1803 per dollar spent) crust creating more geothermal energy and the amount of usually results in a “rebound” effect of increasing A. nuclear (fusion and fission) reactions humans can safely Increased use efficiency of a resource tends to increase the generate out of materials found on the planet. But even total consumption of that resource – and even the total the energy from the sun is far from being fully harnessed. consumption of all resources. This is also referred to as Also mirrors built into space could theoretically further “Jevons’ paradox”, named after William Stanley Jevons increase our capability to capture energy, and fusion who noticed the phenomenon with coal over 100 power or extended fission energy (increasing the amount years ago. (Alcott 2005) This is because the higher of available nuclear energy by orders of magnitude) might productivity causes the resource to be adopted more not be as far-off a sci-fi utopia as we could expect.1802 widely in production of different goods and services and the lowered real costs of the end products increases their demanded amounts. On a broader scale, this can be seen in how increased energy use efficiency tends to 1799 E.g. George Monbiot makes this assumption that economic growth result in more total energy consumption, as the increased is growth in the physical size and amount of our possessions in his recent- purchasing power increases total consumption – or, if it ly published argumentation for the impossibility of perpetual exponen- doesn’t do so directly, consumption will in one way or tial growth. – Monbiot, George, ”It’s simple. If we can’t change our economic sys- another have to be increased to maintain the same amount of tem, our number’s up”, The Guardian, 27th May 2014, cited 28.5.2014, labor demand to maintain employment.1804 Therefore, http://www.theguardian.com/commentisfree/2014/may/27/if-we-cant- “relative decoupling” might decrease the chances of change-economic-system-our-number-is-up 1800 See: “1.3.1 Economic Growth Is the Increase in Produced and Traded “absolute decoupling.” (Sorrell 2007) Value – The Many Meanings of ‘Wealth’”. 1801 See: “2.2.4 Ecological Economics – Putting Economics into the Eco- On the other hand, critics of degrowth ideas note that B ox”. 1802 …although the hype announcement by the Lockheed-Martin sub- although e.g. greenhouse gas emissions tend to increase sidiary Skunk Works, promising economically viable fusion reactors at around the same rate as the economy grows, economic within a decade smells mostly like propaganda intended to scare the declines have not been shown to decrease emissions by investors and managers of renewable energy companies – already wor- the same rate. The data in the PricewaterhouseCoopers ried by the competition imposed by cheap shale gas – from making big investments. A rather classic “bait and switch” strategy, similar to how promises of affordable hydrogen fuel cell technology were used to kill 1803 “Throughput” is what ecological economists call the material flows the support for promising battery-based electric vehicles. resulting from economic activity (Costanza et al 2007, Chapter_1#gen1). – 2013, “Solve for X: Charles Chase on energy for everyone”, YouTube vid- See: “2.2.4 Ecological Economics – Putting Economics into the Eco-Box”. eo, viewed 28.3.2013, http://www.youtube.com/watch?v=JAsRFVbcyUY 1804 See: “2.3.1 The Job Creation Paradigm – Why Are We Trying to – “Who killed the electric car?” documentary, Sony Pictures Classics. Make More Work?!”. 380 | Environmental Sustainability

report “Too late for two degrees?” (PwC 2012) shows how practices and ensure that people suffering from harmful recent recessions, both that of 2002-2004 and 2008-2012 sex addiction have access to some kind of treatment. have significantly slowed down improvements in carbon Similarly, if we ban environmentally harmful practices intensity – the rate of “decarbonization” dropping to – such as the use of fossil fuels1811 – and prevent people below 1 % in the past four years. (PwC 2012, p. 3-4) This from keeping each other involuntarily in debt,1812 they phenomenon could be explained so that people afraid should be free to decide for themselves what services and for their jobs and livelihoods are not very interested in products they still consider worth buying and working cutting down on fossil fuel consumption e.g. by buying for. more energy-efficient products (e.g. hybrid cars), which also lowers companies’ (who are already squeezed more What is it that makes both degrowth and decoupling seem tightly by price competition) incentives to build their so impossible in the current state of affairs? It is always brands with such sustainability factors. dangerous to draw conclusions of unbreakable causality from historical correlations, as both the “degrowth” and So we appear to be in a gridlock here. Both economic the “green growth” factions tend to do in supporting their growth and decline seem to be environmentally claims. Regression analysis is not reliable either, unless unsustainable! data on all other possible causal factors is controlled for. If not, a seeming causal relationship might only apply in Before presenting the solution to this dilemma, let’s the presence of another factor that has not been observed remind ourselves that even if “eternal” economic growth or controlled for – or the correlating variables might both is not a physical impossibility, it still makes no sense rather be caused by such an uncontrolled parameter. The whatsoever as an objective in itself. 1805 Paid human speed of a train car might closely correlate with that of the interaction (which is what GDP figures represent) is just locomotive – but not after we open the lock connecting one part of all human interaction. Many other kinds of them. interaction can be valuable as well, and people can also find fulfillment in non-paid ambitions.1806 The assumption And one decisive factor that has been present the whole that everyone will always want to specialize and trade past century is our economic systems’ dependence on more and more1807 and always work full-time in one’s main economic growth – that we’ve had to get growth by profession1808 is ridiculous. Even the neoclassical growth any means to avoid unemployment and an economic model accepts that also free time, leisure, has utility – and collapse.1813 Similarly, severe sex addictions are likely to that the utilities of both consumption and leisure tend to lead to lots of harmful sexual activity, sexual abuse and be marginally diminishing.1809 It is almost inevitable that spreading of STDs. In such a situation, it would be rash the marginal utility of additional leisure at some point to conclude that sexual abuse would be caused by people’s starts exceeding that of additional products and services sexuality – or more precisely, to conclude that it is a as productivity increases – at least for some individuals. “sufficient cause” from the fact that it might be a “necessary cause”. 1814 Without this dependence, we could set whatever The whole debate over whether the economy should grow limits, regulations and harms taxes sustainability might more or less is about as relevant a debate topic as whether require and then let individuals decide for themselves if people should have more or less sex: Even if you could they want to “downshift” or to work harder to get those show a clear correlation or even a causal relationship (or even more) products and services sustainably. And between the total amount of sexual activity and people’s they wouldn’t need to feel guilty about “consumption”1815 happiness (the worthwhileness of their lives and their anymore either.1816 self-esteems1810 etc.), it still would not make sense for it to be the objective of government policy to get people to The idea of comparing our dependence on economic have more sex. Most people would agree that it should be growth to a human addiction is not a new one. In 2004, a matter of personal choice. At most it makes sense for the Douglas Booth published a book titled “Hooked on government to prevent sexual abuse, promote safe sexual Growth: Economic Addictions and the Environment”.

1811 See: ”3.4.1 Global Warming and Dependence on Fossil Fuels”. 1805 See: “2.1.4 Utilitarianism and Happiness Politics/Economics – Does 1812 See: ”4.2.1 Eliminating the Zero Lower Bound with a Higher Infla- Measuring Happiness Make Sense?”. tion Target or by Eliminating Cash”. 1806 See: ”6.1.1 Appendix 1.1: Happiness Is Appreciating – A Framework 1813 See: ”3.1.1 Economic Instability, Cyclicity, ‘Keynesian’ Unemploy- o f H appi n e s s”. ment and Growth Dependence” and ”3.1.2 Other Scapegoats for the Mys- 1807 See: ”1.1.1 The Division of Labor – Cooperation and Sharing Infor- tical Growth Dependence”. mation: The Philosopher’s Stones of Mankind’s Progress”. 1814 See: “6.1.4 Appendix 1.4: The Conundrum of Causality – The Culprit 1808 See: ”2.3.1 The Job Creation Paradigm – Why Are We Trying to Depends on Comparison.” Make More Work?!”. 1815 See: ”1.1.4 Production Is for Consumption, i.e. Appreciation – ‘Pro- 1809 See: ”Sidenote Box 215A: The Neoclassical Growth Model and Utili- ductivity’ Has Many Units”. t y ”. 1816 More on our outdated economic morals and emotional association 1810 See: “6.1.2 Appendix 1.1: Happiness Is Appreciating – A Framework with words like ”consumption” in this book’s sister, ”The Guilt Econo- o f H appi n e s s”. my ”. The Irrelevance of the ‘Degrowth vs. Decoupling’ Debate | 381

(Booth 2004) In the book, he refers to our growth dependence as a “social addiction” and identifies the resulting social pains of unemployment and the dissatisfaction resulting from not increasing consumption (living standards) as its withdrawal symptoms. However, Chapters 3.5.1-4.1.6 not included in this sample while discussing how to get “unhooked” from growth, he talks about getting rid of excessive growth. I.e. his aim is to limit growth, not just to get rid of the dependence.

For some reason it is hard for people to distinguish between an addiction and the object of the addiction. Although a “cured” alcoholic often needs to become completely sober in order to avoid falling back into a binge, this does not apply to all sorts of addictions. Getting rid of sex addiction does not necessarily mean being doomed to life-long celibacy. Being cured of a compulsive eating disorder does not mean having to live on a drip for the rest of your life. We could also consider an alcoholic to be “fully cured” only after he has learned to use alcohol responsibly and in moderation without falling into a binge. (A “sober” or “recovering” alcoholic is rather managing to live with his “disease”, instead of actually having been cured – like a diabetic with insulin shots or an HIV patient on antiretrovirals, with all due respect to such survivor heroes.)

Trading between people is a very useful and even necessary sort of activity.1817 There is no reason why it should be eliminated or why we should have a specific “cap” of maximum amount and value of products and services that can be traded. Also, the fact that “capital” now allows extortion – due to its “minimum wage”,1818 the untaxed private ownership of limited vital resources and other monopolies1819 – does not mean that the concept of capital itself1820 would be evil. However, many critics of capitalism (including the Zeitgeist anti-moneyists and even the World Social Forum) have “thrown the baby out with the bathwater” and drawn the conclusion that “there is no solution inside the capitalist system”.1821

1817 See: “1.1.1 The Division of Labor – Cooperation and Sharing Infor- mation: The Philosopher’s Stones of Mankind’s Progress”, “1.1.5 We Need a Market Economy Because of the Limitedness of Understanding and Empathy” and “1.1.6 The ‘Market Forces’ – How Prices Balance Supply and Demand”. 1818 See: “4.2.1 Eliminating the Zero Lower Bound with a Higher Infla- tion Target or by Eliminating Cash”. 1819 See: “4.3 Eliminating Private Monopolies and (Other) Privileges”. 1820 I.e. the idea of being compensated for carrying risks or doing work in advance when people are impatient and risk-averse, see: “1.1.8 Labor and Capital (and Land?) – The Factors of Production”. 1821 “Declaration of the Social Movements Assembly of the World Social Forum, Tunisia 2013“, International Journal of Socialist Renewal, cited 21.5.2013, http://links.org.au/node/3283 Eliminating the Zero Lower Bound with a Higher Inflation Target or by Eliminating Cash |437

4.2 PREVENTING EXCESSIVE MONETARY SAVING – ALLOWING MONETARY POLICY TO BALANCE AGGREGATE SUPPLY AND DEMAND

4.2.1 Eliminating the Zero Lower Bound with a There is, however, a second, much more “fundamental inference from our argument Higher Inflation Target or by which has a bearing on the future of inequalities Eliminating Cash of wealth; namely, our theory of the rate of interest. The justification for a moderately high In short: rate of interest has been found hitherto in the • A growth-independent, fair and antifragile necessity of providing a sufficient inducement economy needs the possibility of negative to save. But we have shown that the extent of real interest rates. effective saving is necessarily determined by the scale of investment and that the scale of • The zero lower bound of interest rates is investment is promoted by a low rate of interest, practically a (true) minimum wage for provided that we do not attempt to stimulate it capital, which prevents keeping aggregate in this way beyond the point which corresponds supply and demand in balance. Together to full employment.” … “There can be no doubt with the free guarantee of bank deposits, that this criterion will lead to a much lower risk-free credit can be said to be on a hefty rate of interest than has ruled hitherto…” – “unemployment support”. John Maynard Keynes, The General Theory of • The obstacle to negative nominal interest Employment, Interest and Money (1936, p. 236) rates is physical cash – notes and coins. So there’s something odd about ‘financial • As long as cash is deemed necessary, we normalization’ – if that’s what the whole need a notably higher target inflation “problem was – and then continued slow growth. rate, to “tax” cash and facilitate negative So what’s an explanation that would fit both enough real interest rates. of these observations? Suppose that the short- term real interest rate that was consistent with • Eliminating physical cash would allow full employment had fallen to negative two or negative nominal interest rates and is soon negative three percent sometime in the middle a feasible option in developed economies, of the last decade. Then what would happen? as electronic payment services make cash Then even with artificial stimulus to demand – less and less liquid and a relatively costly coming from all this financial imprudence – you way of conducting transactions. wouldn’t see any excess demand.” … “Then • Demurrage is another option, but costly conventional macroeconomic thinking leaves and in almost all ways inferior to a higher, us in a very serious problem. Because, we all stable and predictable inflation rate. seem to agree that, whereas you can keep the 438 | Preventing Excessive Monetary Saving – Allowing Monetary Policy to Balance Aggregate Supply and Demand

federal funds rate at a low level forever, it’s much A lot of research shows that many people would like to harder to do extraordinary measures beyond that work less if they just had the realistic option to do so.2056 forever.” – Larry Summers2054 But some might argue that there is no guarantee that this number would be high enough to keep everyone employed merely with incentives giving people the possibility to work less. Especially in an uncertain 4.2.1.1 The ZLB Is the Minimum economic environment, there would still be the game- Wage of Capital, Nominally theoretical incentive trap for people to save for their own 2057 Maintained by Physical Cash economic security, which would cause unemployment. And even in the absence of insecurity, other factors – e.g. (In short: See parent chapter.) environmental concerns demonizing “consumption”2058 or a general Protestant work ethic making them feel [I]t is time for central banks to stop responsible about working before playing2059 – might keep pretending that zero is the floor for nominal people’s “internal discounting rate” negative2060 even in “interest rates. There is no theoretical or practical the long run. Recently Larry Summers has brought this prospect into mainstream discussion with his speech at reason for not having the Federal Funds target the IMF Economic Forum in November 2013: rate and market rates at, say, minus five percent, if that is what your Taylor rule, or whatever “Suppose that the short-term real interest rate that was heuristic guides your official policy rate, consistent with full employment had fallen to negative suggests. two or negative three percent sometime in the middle of the last decade. Then what would happen? Then Economics as a science and economic reality even with artificial stimulus to demand – coming have never had problems with negative real from all this financial imprudence – you wouldn’t see (inflation-adjusted) interest rates. So what is any excess demand.”2061 the problem with nominal rates? In a word, it’s currency [i.e. physical cash].” – Willem Buiter2055 This kind of slowing down of economic growth resulting simply from excessive propensities to save and few profitable investment opportunities2062 is sometimes If the rate of interest were so governed as to referred to as “secular stagnation”.2063 maintain continuous full employment, virtue “would resume her sway;– the rate of capital If we only made it profitable for employers to share work, accumulation would depend on the weakness of we’d have to make the incentives quite strong in order to overcome the fact that companies will compete over the the propensity to consume. Thus, once again, most skilled workers even with higher amounts of work. the tribute that classical economists pay to And such very high sharing incentives will eventually her is due to their concealed assumption that start reducing individual flexibility in how much one the rate of interest always is so governed.” – can work2064 – similarly to setting an upper limit on legal John Maynard Keynes, The General Theory of working hours – which might end up doing more harm than good. Due to the irreplaceable productivity of an Employment, Interest and Money (1936, p. 76) individual expert or the added value provided to the whole organization by a skilled leader, it’s worth it for a Debt can endure forever; wealth cannot, because its physical dimension is subject to 2056 See: “3.2.4 Depression, Stress, Addictions and Fitting Work Life “ with Family Life”. the destructive force of entropy.” – Frederick 2057 See: “3.1.1 Economic Instability, Cyclicity, ‘Keynesian’ Unemploy- ment and Growth Dependence” and “4.1.5 Guaranteeing Security While Soddy (Eisenstein 2011) Avoiding Welfare Bumming: Economic Freedom Need Not Be Free”. 2058 See: ”1.1.4 Production Is for Consumption, i.e. Appreciation – ‘Pro- ductivity’ Has Many Units”. 2059 See: ”4.1.6.2 Making Sharing Work Socially Acceptable”. 2060 See: ”1.1.8 Labor and Capital (and Land?) – The Factors of Produc- t ion”. 2061 11:05->, 2013, “Larry Summers at IMF Economic Forum, Nov. 8”, 2054 10:27-> & 12:49->, 2013, “Larry Summers at IMF Economic Forum, viewed 5.6.2014, https://www.youtube.com/watch?v=KYpVzBbQIX0 Nov. 8”, viewed 5.6.2014, https://www.youtube.com/watch?v=KYpVzB- 2062 See: ”1.3.3 The Circular Flow of Income – Consumption, Saving and bQIX0 Investing”. 2055 Buiter, Willem, “Negative interest rates: when are they coming to a 2063 “Secular Stagnation”, definition, Financial Times Lexicon, cited central bank near you?” Financial Times blog, Maverecon, 7th May 2009, 10.6.2014, http://lexicon.ft.com/Term?term=secular-stagnation cited 6.6.2014, http://blogs.ft.com/maverecon/2009/05/negative-interest- 2064 See: ”4.1.1.3 The Objectives of Sharing Incentives: Maximize Indi- rates-when-are-they-coming-to-a-central-bank-near-you/ vidual Flexibility and Minimize Involuntary (Demand-Related) Layoffs”. Eliminating the Zero Lower Bound with a Higher Inflation Target or by Eliminating Cash |439

company to take the hit of higher payroll taxes2065 in order bound” of interest rates is practically caused by physical to make the expert or leader commit as much of her life as cash (“currency”), as Ben Bernanke explains: possible to the company. “The use of this instrument [the overnight federal If these top talents and people in hard-to-share types of funds rate], however, implies a potential problem: work (like management) happen to be stingy, risk-averse Because currency [i.e. physical cash] (which pays a workaholics,2066 there is nothing that would prevent them nominal interest rate of zero) can be used as a store of from saving large quantities of money (risk-free credit) value, the short-term nominal interest rate cannot be without investing it into something productive. Thus it pushed below zero. Should the nominal rate hit zero, is not enough to make it profitable for employers to share the real short-term interest rate – at that point equal to work. Even before doing that, we need to make sure the negative of prevailing inflation expectations – may that excessive saving as money and other non-business- be higher than the rate needed to ensure stable prices risk-bearing financial instruments remains unprofitable and the full utilization of resources.” (Bernanke et al enough compared to making investments into real and 2004, p. 1) risk-bearing assets – that people’s desire to save matches the need for real investments; in other words, that people’s “With inflation low and likely to remain so, industrial willingness to be in debt remains in balance with people’s countries are at risk of encountering the zero bound desire to be owed (to hold monetary savings) and that, on nominal interest rates periodically in the future.” hence, the aggregate supply of and demand for labor (Bernanke et al 2004, p. 7) remain in balance. And these are all fundamentally the same thing: An oversupply of capital is a (momentary) Although Bernanke has become more careful (probably oversupply of labor. People’s desire to save (as a function out of political reasons) about suggesting departing from of the interest rate) is the “supply of capital” and people’s the 2 % target (at which inflation expectations have been desire to invest (as a function of the interest rate) is the conveniently “anchored”)2069, he would still (in 2012) be demand for it. Net monetary saving cannot occur in a going for negative real interest rates, if they were possible: closed economy – as all debt is to someone else, a creditor. The net desire for monetary saving is the oversupply of ”It is arguable that interest rates are too high, that labor and it is the derivative (the rate of increase) of the they are being constrained by the fact that interest oversupply of capital2067 – especially when that excess rates can’t go below zero. We have an economy where private sector saving is facilitated by the public sector demand falls far short of the capacity of the economy taking on debt.2068 to produce. We have an economy where the amount of investment in durable goods spending is far less As explained in, “2.2.5.2 Monetary Policy – You Can than the capacity of the economy to produce. That Pretend It’s about the Money Supply”, this is exactly what suggests that interest rates in some sense should be “conventional monetary policy” is doing: adjusting the lower rather than higher. We can’t make interest rates profitability of saving money by controlling interest rates lower, of course. (They) only can go down to zero. And so that aggregate demand does not exceed aggregate again I would argue that a healthy economy with good supply and, hence, price levels don’t start soaring returns is the best way to get returns to savers.”2070 uncontrollably (often called “overheating” of the economy) or vice versa. As explained in “1.1.8 Labor and Capital (and Land?) – The Factors of Production”, there is nothing that says that But when the interest rate is already at zero and there capital (savings) should always make a profit. When the are still strong deflationary pressures and persistent economy is expected to decline (people are not expected unemployment (an oversupply of labor and people’s to spend more in the near future) and therefore no desire to save compared to others’ desire to be in debt), additional investments are needed and when people’s “conventional” monetary policy fails. This “zero lower average time preference is “first work, then play”, risk-free capital needs to make a loss! If, when real assets make a loss due to overcapacity, credit – others’ debt, including 2065 See: “4.1.2.4 Continuously Progressive Payroll Taxes”. cash and government bonds – remains a safe haven for 2066 See: “6.2.1 Appendix 2.1: All the Different Causes of Monetary Sav- capital, it can lead to nothing but an ever growing debt ing – and Dealing with Them”. bubble and expansion of the financial sector as a result 2067 See: “1.2.8 The Supply of Money Is Infinitely Interest-Rate-Elastic of increased monetary saving. It is mathematically – The Money Supply Is Endogenous”, “1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And Has Little to Do with the Quantity of Mon- ey” and “1.3.2 In a Closed Economy, Net Monetary Wealth Is Zero – To- tal Real Wealth Depends On Future Consumption and Capital Intensity 2069 See: ”4.2.4.2 ‘Higher Inflation Has Never Been Stable’”. (and Monopolies)”. 2070 “Highlights: Bernanke’s Q&A testimony to House panel”, Reuters 2068 See: ”2.2.5.1 Keynesian Fiscal Stimulus – It’s the Government’s Job to – Washington News Room, 29th Feb 2012, cited 20.12.2013, h t t p ://m o b i l e . Invest Stably”. reuters.com/article/topNews/idUSTRE81S1DO20120229 440 | Preventing Excessive Monetary Saving – Allowing Monetary Policy to Balance Aggregate Supply and Demand

impossible to pay off debts if creditors hold on to their banks – negative, but this is not transferred to retail credit. If no private parties want to take on more loans, the banks’ interest rates on their deposits and loans, because a government has to take on more debt2071 – i.e. to stimulate negative interest on bank deposits would cause consumers the economy fiscally2072– to prevent unemployment and a and companies to withdraw their deposits as cash because deflationary vicious circle from getting out of hand. And cash would preserve its value better. This is called a bank as the government is very inflexible in taxing credit off the run. And because banks still need to make the same market, a constant increase in such credit (especially liquid margins between the deposit (and corporate bond) rates credit) backed by government debt (instead of private they pay and the loan rates they charge in order to remain debt) soon starts increasing risks of hyperinflation.2073 The profitable, new loans cannot be granted any cheaper than far more sustainable – and obvious – solution is to lower before either. the interest rate below zero to prevent excessive private saving. Early in [the 90s], Lawrence Summers (1991) argued that, because nominal interest rates The zero lower bound of interest rates is practically “ like a “minimum wage” for capital! And, similarly to cannot fall below zero, monetary policy faces minimum wages in the labor market, it causes supply a trade-off between achieving zero average and demand mismatches – in this case, a mismatch of the inflation and macroeconomic stability, given total supply and demand for labor (and hence capital). that the latter occasionally requires negative However, this minimum wage is a “true minimum” wage, real interest rates to offset contractionary in that all capital has the option of just sitting as cash or bank deposits, unlike the minimum wages in labor disturbances. Until the past few years, this issue legislation or collective agreements, which only ban trade appeared moot in the United States and most below a price (as Post-Keynesians wittily note when they other developed economies. However, with suggest that the government should act as an employer inflation lately falling to very low levels here 2074 of last resort, ELR ). When there is too much debt in the and abroad, the proposition that policy could economy, risk-free credit (unemployed capital), needs to start making a loss. (In addition to this “minimum wage”, be constrained with interest rates stuck at zero capital also receives a direct government subsidy in the for a prolonged period of time no longer seems form of the free government-provided deposit guarantee, far-fetched. Indeed, this possibility has become which needs to have a price imposed on it.2075 So actually – reality in Japan…” – David L. Reifschneider & 2076 as risk-free credit is not productive – we could call these John C. Williams, Three Lessons for Monetary two collectively “the “unemployment support of capital”.) Policy in a Low Inflation Era (2000, p. 1) So, a working, fair, growth-independent and self- stabilizing economic system really needs the possibility The answer to our problems, however, could of negative interest rates!2077 Unfortunately, as long as well be more negativity. But I’m not talking 2078 physical cash exists (for another 10-30 years, maybe? ), “about attitude. I‘m talking about numbers.” there is no realistic way to lower nominal interest rates below zero to make saving money even less profitable. … “The idea of negative interest rates may The central bank could pay banks for holding its money strike some people as absurd, the concoction by lowering its policy rate – the interest rate it charges of some impractical theorist. Perhaps it is. But remember this: Early mathematicians thought 2071 See: ”Sidenote Box 126A: The Misleading Expression That ‘Banks that the idea of negative numbers was absurd. Lend Other People’s Money’”. 2072 See: ”2.2.5.1 Keynesian Fiscal Stimulus – It’s the Government’s Job to Today, these numbers are commonplace. Even Invest Stably”. 2073 See: ”2.2.6 Post-Keynesian Solutions – Ignore Hyperinflation Risks children can be taught that some problems (such and Guarantee Jobs” and ”2.2.3.6 Democratic or ‘Full’ Money – ‘Power to as 2x + 6 = 0) have no solution unless you are the People from the Banks’”. 2074 See: “2.2.6 Post-Keynesian Solutions – Ignore Hyperinflation Risks ready to invoke negative numbers. Maybe some and Guarantee Jobs”. economic problems require the same trick.” – N. 2075 See: “3.1.5 Too Big to Fail: The Casino Economy, ‘Financialization’ 2079 and Irresponsible Risks in Banking” and “4.2.2 Setting a Fee on the Gov- Gregory Mankiw ernment Deposit Guarantee”. 2076 See: ”1.1.10 Companies as Contract Bundles – Financial Assets Allo- cate Risks”. 2077 …unless we somehow manage to completely revers our protestant work ethic and get people to be extremely lazy, hedonic consumers and 2079 Mankiw, N. Gregory, “It May Be Time for the Fed to Go Negative”, impatient to save. More on these ethics in “The Guilt Economy”. The New York Times – Economic View, 19th Apr 2009, cited 22.12.2013, 2078 See: ”4.2.1.3 …Or Just Eliminate Physical Cash (That Decreasingly http://www.nytimes.com/2009/04/19/business/economy/19view. Liquid and Necessary Rubbish)”. html?_r=0 Eliminating the Zero Lower Bound with a Higher Inflation Target or by Eliminating Cash |441

Sidenote Box 4211A: Silvio Gesell’s Theory of ‘Basic Interest’ and ‘Free- Money’ – The Same in the ‘Medium of Exchange’ Frame

2. The physical properties of the traditional form of money (metal money and paper- “money) allow it to be withdrawn indefinitely from the market without material cost of storage; whereas producers (workers), to whom money is essential for effecting exchanges, are compelled, by the constantly increasing losses connected with the storage of wares, to create a demand for money.

3. The merchant can therefore force the possessors of wares to make him a special payment in return for the fact that he refrains from arbitrarily postponing, delaying, or, if necessary, preventing the exchange of wares by holding back his money.” …

“In the division of the product between capitalists and proletariat everything depends upon the ratio of demand to supply. The capitalist can expect interest on his means of production only as long as demand exceeds supply.” – Silvio Gesell, The Natural Economic Order (1916, Part 5, Ch. 2 & Ch. 6)

Silvio Gesell realized over a century ago that the interest rate and hence the profit requirements of all capital investments are maintained at a minimum level simply by the fact that moneylenders can refuse to lend their money – that they can demand a compensation by “obstructing free trade”, comparing them to the monopolist “robber barons” charging immense fees for using their roads to transport goods.

“But the tribute which money claims for its use follows other laws than those governing the use of land; it more resembles the tribute exacted by the robber barons of the Middle Ages. Merchants who were forced to use a road which passed the baron’s castle were thoroughly plundered; dues of 30, 40, 50% were exacted.” …

“A king stands beside the barrier; he obstructs the stream of commerce across the frontier and says ‘The tithe is mine!’ A moneylender stands beside his safe, he obstructs the exchange of commodities which requires its contents, and says ‘Interest is mine’. King and money-lender render no service, they exact a tribute simply by obstruction…” (Gesell 1916, Part 5, Ch. 2)

“Except for the traditional form of money, the road is free for loan-money without interest, as well as for houses and means of production without interest.” (Gesell 1916, Part 5, Ch. 5)

Gesell suggests that if this ability to hoard cash profitably and the resulting “basic interest” would be removed, the interest on real capital would be determined by supply and demand for those capital assets. The concept of “basic interest” is analogous to the way this book calls the ZLB the “minimum wage of capital”.2080

“Up to the introduction of Free-Money interest on real capital depends on basic interest; after the introduction of Free-Money basic interest will disappear, and interest on loans will be exactly determined by interest on real capital. Borrowers of money will no longer pay interest because money can exact a tribute from the wares, but because the demand for loans, for the time being, exceeds the supply.” …

2080 See: ”1.1.6 The ‘Market Forces’ – How Prices Balance Supply and Demand” and ”1.1.8 Labor and Capital (and Land?) – The Factors of Production” and ”1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And Has Little to Do with the Quantity of Money”.

Continued on page 442 ► 442 | Preventing Excessive Monetary Saving – Allowing Monetary Policy to Balance Aggregate Supply and Demand

► “Interest on real capital is determined by demand and supply; it is subject to the laws of competition and can be eliminated by a simple change in the ratio of demand to supply. With basic interest this would never be possible. Interest on real capital has up to the present been protected from such a change – the condition for the production of real capital being that it should be able to exact interest equal to basic interest.” …

“[L]et us assume that a costly machine is discovered with which everyone can double his present production. This would cause an unprecedented demand for loan-money to purchase the new machine. Everyone would install it and scrap the old machines. Even if interest upon loan-money had disappeared, this enormous new demand would cause its reappearance. Under these circumstances (the conversion of all existing machinery into scrap-iron) interest might even reach an unprecedented height.” (Gesell 1916, Part 5, Ch. 5)

Capital investments are work that needs to be done upfront, before the benefits are received – which is why Gesell calls them, too, “loans”.

“With the interest on real capital, on the contrary, we have, not an exchange, but a loan. The landowner lends his land to a farmer, the house-owner lends his house to a tenant, the manufacturer lends his factory to the workmen, the banker lends money to his debtor – but the merchant who exacts interest from the wares lends, nothing; he makes an exchange.” (Gesell 1916, Part 5, Ch. 5)

Also, note how Gesell focuses on “loan-money” instead of labor as the resource used. Despite dismissing the Quantity Theory (Gesell 1916, Part 3, Ch. 15), to Gesell – just like to Marxists and the Austrian school2081 – money was a “ware”2082 (a commodity) and an “instrument of exchange and nothing else.” (Gesell 1916, Part 4, Ch. 1) He assumed its supply to be inelastic2083 and – like e.g. Irving Fisher in his Theory of Interest (1930) – that “money-lenders” lend on money which they have extracted from the market,2084 omitting the possibility of banks “extending credit”.2085

In today’s credit money system, hoarding money does not obstruct trade (by raising nominal interest rates the way Gesell assumed), as new “loans” can always be made – but, nevertheless it is keeping others in debt. But at the zero lower bound, if the government does not take on the required debt to facilitate the hoarding (excess saving),2086 the unemployed will be unlikely to get additional credit from banks indefinitely.

Gesell’s solution was a currency with demurrage – a systematic nominal devaluation – imposed on cash. This alternative is discussed in “4.1.2.4 Continuously Progressive Payroll Taxes”.

2081 See: ”2.2.2 Market-Dictated, ‘Sound’ Commodity Money – Austrian perspectives”. 2082 “The demand for wares will not always coincide with the stock of money … but money is a ware and therefore sooner or later compels its possessor to offer it in exchange.” … ”Again, since money is a ware, more money will be offered in exchange, on the average, over a period of years, where the stock of money is larger than where it is smaller.” (Gesell 1916, Part 3, Ch. 10) 2083 See: “1.2.8 The Supply of Money Is Infinitely Interest-Rate-Elastic – The Money Supply Is Endogenous” and “Sidenote Box 126A: The Misleading Expression That ‘Banks Lend Other People’s Money’”. 2084 ”There is no such thing as competition between money-lenders; competition is here an impossibility. If the money offered for loan by capitalists is drawn from the existing circulation, the capitalists, by lending this money, merely fill the holes they have dug by withdrawing it. Ten, a hundred or a thousand money-lenders mean ten, a hundred or a thousand holes dug by these money-lenders in the path that money has to pursue. The greater the amount of loan-money offered, the larger are these holes.” (Silvio Gesell 1916, Part 5, Ch. 2) 2085 See: ”1.2.6 Banking: Accounting for Debts and Credits and Pricing Risks – There Is No ‘Fractional Reserve’”. 2086 See: ”2.2.5.1 Keynesian Fiscal Stimulus – It’s the Government’s Job to Invest Stably”. Eliminating the Zero Lower Bound with a Higher Inflation Target or by Eliminating Cash |443

4.2.1.2 A Higher Inflation Target interest on cash is even higher than that on bank deposits! Leaves ‘Room to Cut’ by ‘Taxing’ Unfortunately, it is very costly to physically tax cash – 2090 Cash collect a negative nominal interest on it. However, the value, purchasing power, of the cash can change, (In short: See parent chapter.) which has exactly the same practical effect – just more continuously and with less bureaucracy. The real interest We either need to run a background level of rate can be negative as a result of inflation – the rise in the inflation that’s high enough to avoid zero overall price level!2091 “bound episodes, or else shift the policy lever to N. Gregory Mankiw, referring back to Silvio Gesell’s something that’s not effected by these issues.” – suggestion of a tax on money,2092 is one to point out that 2087 Matthew Yglesias inflation can facilitate negative rates by making cash earn less. The zero lower bound is a nominal problem. However low the real interest rate, an “The problem with negative interest rates, however, is “ quickly apparent: nobody would lend on those terms. economy can keep nominal rates safely in Rather than giving your money to a borrower who positive territory by running a sufficiently high promises a negative return, it would be better to stick rate of inflation.” … “Now again, just why the the cash in your mattress. Because holding money real, natural rate of interest is currently -4% is promises a return of exactly zero, lenders cannot offer an interesting question, but it’s irrelevant to less. the challenge of closing the output gap. All Unless, that is, we figure out a way to make holding that matters there is that expected inflation is money less attractive.” … between 1% and 2% instead of near 4%. That’s the problem; that’s what’s keeping tens of “The idea of making money earn a negative return is millions of people out of work and hundreds not entirely new. In the late 19th century, the German economist Silvio Gesell argued for a tax on holding of millions languishing in a perpetually weak money.” … economy: a couple of percentage points of inflation.” – Ryan Avent2088 ”If all of this seems too outlandish, there is a more prosaic way of obtaining negative interest rates: This is not a new fear: worries about secular through inflation. Suppose that, looking ahead, the Fed commits itself to producing significant inflation. stagnation, about a persistent shortfall of “ In this case, while nominal interest rates could remain demand even at low interest rates, were very at zero, real interest rates – interest rates measured in widespread just after World War II. At the time, purchasing power – could become negative. If people those fears proved unfounded. But they weren’t were confident that they could repay their zero- irrational, and second time could be the charm.” interest loans in devalued dollars, they would have significant incentive to borrow and spend.”2093 … “One answer could be a higher inflation target, so that the real interest rate can go more Buts a can be seen (“…they would have significant negative. I’m for it!” – Paul Krugman 2089 incentive to borrow and spend.”), just like e.g. Scott Sumner who argues for nominal GDP targeting (which includes allowing higher inflation rates), Mankiw assumes So how do we overcome this problem of the zero lower that monetary policy can only affect aggregate demand, bound on nominal rates? By making sure that the negative dismissing the possibility that it could also affect the aggregate supply of labor. The most common formulations 2087 Yglesias, Matthew, “Zero Matters Because Rules Matter”, Slate, 19th Apr 2012, cited 6.6.2014, http://www.slate.com/blogs/money- 2090 See: ”4.2.1.3 …Or Just Eliminate Physical Cash (That Decreasingly box/2012/04/19/digital_currency_ends_recessions.html Liquid and Necessary Rubbish)”. 2088 Avent, Ryan, “The solution that cannot be named”, The Economist, 2091 See: ”1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And Nov 17th 2013, cited 6.6.2014, http://www.economist.com/blogs/freeex- Has Little to Do with the Quantity of Money”. change/2013/11/secular-stagnation 2092 See: ”4.2.1.4 Demurrage Is Unnecessarily Costly to Implement”. 2089 Krugman, Paul, ”Bubbles, Regulation, and Secular Stagnation”, New 2093 Mankiw, N. Gregory, “It May Be Time for the Fed to Go Negative”, York Times – The Opinion Pages, 25th Sep 2013, cited 10.6.2014, h t t p :// The New York Times – Economic View, 19th Apr 2009, cited 22.12.2013, krugman.blogs.nytimes.com/2013/09/25/bubbles-regulation-and-secu- http://www.nytimes.com/2009/04/19/business/economy/19view. lar-stagnation/ html?_r=0 444 | Preventing Excessive Monetary Saving – Allowing Monetary Policy to Balance Aggregate Supply and Demand

of “demand-pull inflation”2094 – and its very name – little guarantee that nominal GDP targeting could not lead also include this assumption that inflation accelerates to “hyperstagflation”.2100 whenever aggregate demand is increased beyond the ability of the economy to produce – its “potential output” However, the same risks would not apply to a higher, stable (O’Sullivan & Scheffrin 2003, p. 341) – omitting the and predictable inflation rate. possibility that it might also be caused by the economy’s willingness to produce (aggregate supply) decreasing below Let’s assume that the target inflation rate of the central aggregate demand. bank was 10 % (as a round-figure-example for the purposes of demonstration only – of course this is likely to be Critics of lowering interest rates and higher inflation (not unnecessarily high). During a period of economic growth, only Austrian economists2095) are even louder to argue this would make hardly any practical difference to the that this would cause increasing amounts of debt in the current situation as – according to the Fisher Effect2101 – economy and that these debts further increase instability nominal interest rates would compensate for the inflation, and risks of credit crises.2096 They fail to notice that the bringing real interest rates to where they would be in a negative returns on deposits could also encourage people similar economic situation with a lower inflation target. to spend off their savings – either by simply spending more or by working less, (see: Graph 23) which could allow If banks (wanting to remain competitive over deposits) paying off debts and decrease the amount of debt in the for example wanted to pay a 1 % real interest on deposits, economy – i.e. increase money velocity and shrink the money with a target interest rate of 2 %, they would pay a 3,02% supply! This effect could be further increased by setting a interest on deposits. With a 10 % target inflation rate, fair price on the government guarantee on deposits, which they’d pay 11,1% nominal interest to achieve the same real would make monetary saving less profitable without interest rate. If, with 2 % inflation they charged a 6,08% making borrowing cheaper.2097 However, as long as people interest on a granted loan, with 10 % inflation, they’d don’t have the realistic option of working less (i.e. as long charge 14,4 %. In both cases the real interest rate is 4 %. as “a job is a job”,2098 that you either have or you don’t), this The banks’ real margin (3 %) and the consumers’ real cost assumption of a limited effect on labor supply is not far of borrowing would be exactly the same in both cases. from the truth. Even people with big amounts of savings would not dare to quit their jobs out of fear of not being able to “jump back on the train” and ending up long-term unemployed.2099 2100 “A condition of slow economic growth and relatively high unemployment - a time of stagnation - accompanied by a rise in prices, or infla- Also, both of these hypothetical and feared suggestions tion.” – making unemployment rates a more important, direct – “Stagflation”, definition, Investopedia, cited 6.11.2013, http://www.investopedia.com/terms/s/stagflation.asp monetary policy guideline for the central bank (New 2101 See: ”Sidenote Box 4212A: The Fisher Equation and the ‘Hausse pre- Keynesians, e.g. Krugman, Chang) and adopting nominal m iu m’”. GDP targeting (market monetarists, e.g. Sumner) – involve abandoning inflation stability, i.e. allowing inflation to rise as a temporary measure. This makes future inflation unpredictable, results in unexpected (and unfair) wealth transfers and can be argued to increase uncertainty in the market and raise real interest rates. As explained under “4.2.4.1 Problems with Unstable and Unpredictable Inflation”, volatile and unpredictable inflation is a serious threat (despite the counterexample of e.g. China). There is

2094 See: “1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And Has Little to Do with the Quantity of Money. 2095 See: ”4.2.4.11 Austrian and Fundamentalist Libertarian Arguments” and ”2.2.2 Market-Dictated, ‘Sound’ Commodity Money – Austrian perspectives”. 2096 See: “Sidenote Box 311A: Other Theories of Cyclicity: ‘Debt Defla- tion’, ABCT and Real Estate Pull”. 2097 See: “4.2.2 Setting a Fee on the Government Deposit Guarantee“. 2098 See: ”2.3.1 The Job Creation Paradigm – Why Are We Trying to Make More Work?!”. 2099 See: “4.1 Maximizing Flexibility to Eliminate Labor Market Mis- matches and Increase Adaptability” and “3.1.1 Economic Instability, Cy- clicity, ‘Keynesian’ Unemployment and Growth Dependence”. Eliminating the Zero Lower Bound with a Higher Inflation Target or by Eliminating Cash |445

Sidenote Box 4212A: The Fisher Equation and the ‘Hausse premium’

The previous calculation was made with the exact formulation of the Fisher equation:

(1+i) = (1+r) (1+π) = 1 + r + π + rπ)

where “r” is the real interest rate, “i” is the nominal interest rate and “π” is the inflation rate. For simplification, this is often rounded off to:

i = r + π,

as the term rπ is usually relatively very small with low interest and inflation rates, E.g. in the previous calculation, the error is at most 0,3 percentage-points or 10 %: 14,4 % – 11,1 %= 3,3 % vs. 14 % – 11 % = 3 %).

To determine future real interest rates according to expected inflation (πe) ex-ante, we get:

r = i – πe

Silvio Gesell named the component of (nominal) interest compensating for an expected rise in the price level the “Hausse premium”, along the German word for a rise in prices. (Gesell 1916, Part 5, Ch. 7)

There are a few differences that a higher inflation target as it has and would bring the unemployment and causes. These are discussed in the subchapters of “4.2.3 inflation rates more quickly to steady-state values, but Other Benefits of Higher Inflation or Negative Nominal the zero bound precludes these actions. This inability Interest Rates” and “4.2.3 Other Benefits of Higher to lower interest rates comes at the cost of $1.7 trillion Inflation or Negative Nominal Interest Rates”. of foregone output over four years. Second, if recent events are a harbinger of a significantly more adverse Most importantly, though, when the economy declines, macroeconomic climate than experienced over the monetary policy can still be effective because real interest preceding two decades, then a 2 percent steady- rates can now become negative. state inflation rate may provide an inadequate buffer to keep the zero bound from having noticeable This idea has been suggested e.g. by Matthew Yglesias and deleterious effects on the macroeconomy assuming Ryan Avent. 2102 2103 Daniel Leigh (2010),2104 an economist the central bank follows the standard Taylor Rule.” at the Research Department of the IMF, presents one (Williams 2009, abstract) simulated case for how Japan could have avoided its “lost decade” of stagnation and deflation with such a “room to It is hard to determine exactly how much “room to cut” – cut” interest rates. the possibility of how low real interest rates – an economy might need in the future. When the economy contracts at Model simulations conducted by John C. Williams of the a rate where no additional real investments are needed, Federal Reserve Bank of San Francisco imply that the market interest rate, theoretically, depends purely on people’s time preference.2105 However, if people in “an additional 4 percentage points of rate cuts would currently poor nations2106 are given access to earning have kept the unemployment rate from rising as much opportunities and education to improve their productivity, profitable investment opportunities will exist in meeting 2102 Yglesias, Matthew, “Zero Matters Because Rules Matter”, Slate, the demand created by this growing market struggling th 19 Apr 2012, cited 6.6.2014, http://www.slate.com/blogs/money- to attain decent living standards. Also, if fossil fuels box/2012/04/19/digital_currency_ends_recessions.html 2103 Avent, Ryan, “The solution that cannot be named”, The Economist, Nov 17th 2013, cited 6.6.2014, http://www.economist.com/blogs/freeex- 2105 See: “1.1.8 Labor and Capital (and Land?) – The Factors of Produc- change/2013/11/secular-stagnation t io n“. 2104 Leigh, Daniel, 2010, “A 4% inflation target?” Column at Voxeu policy 2106 See: ”3.3.1 Solving Poverty for Good – Ending the Economy War” portal, Centre for Economic Policy Research, cited 15.1.2013, http://www. and ”3.3.4 Slave-Rate Wages, Inhumane Working Conditions and Child voxeu.org/article/4-inflation-target L ab or ”. 446 | Preventing Excessive Monetary Saving – Allowing Monetary Policy to Balance Aggregate Supply and Demand were taxed decisively out of use, there would be huge The German trauma from the hyperinflation investment opportunities in the R&D, infrastructure and was such that the Bundesbank, the West production capacity of renewable energy.2107 In a system “ German central bank after the Second World where long-term unemployment risks were mitigated,2108 it is likely that long-term real interest rates lower than -5 War, was famous for its excessive aversion of % will not be needed for decades to come. However, the loose monetary policy. Even after the birth of possibility of lower interest rates than this is needed to the European single currency, the euro, and the avoid investors speculating on deflation resulting from the consequent de facto abolition of national central system getting stuck at the new lower bound. The system banks in the Eurozone countries, Germany’s has to be antifragile to a worst-case scenario where a supply or demand shock (by suddenly lowering expected influence has made the European Central Bank future consumption) halts the need for almost all new (ECB) stick to tight monetary policy even in investments for years. For example, after the crash of 2008, the face of persistently high unemployment…” variants of the Taylor Rule would have suggested needed … “Our obsession with inflation should end. 2109 2110 interest rates of closer to -7 %. Of course the situation Inflation has become the bogeyman that has might not have become “that bad” had the rate been able to drop below zero immediately – and especially had there been used to justify policies that have mainly been no risk of long-term unemployment for consumers. benefited the holders of financial assets, at the cost of long-term stability, economic growth and Instead, in the current system with its self-reinforcing human happiness.” – Ha-Joon Chang, 23 Things labor market mechanisms (most notably the fear of long- They Don’t Tell You About Capitalism (2010, p. term unemployment) it is possible to fall into a stagflation (combined inflation and economic decline) that can 53 & 61) escalate into a world-wide economic collapse – especially when the higher inflation is always an accident (as it is in the current system) instead of a predetermined policy 4.2.1.3 …Or Just Eliminate Physical decision. Unexpected inflation does not function as a Cash (That Decreasingly Liquid and negative real interest rates (encouraging investment), Necessary Rubbish) but as an immediate wealth transfer between debtors to creditors (i.e. or a partial credit default, “robbery”), (In short: See parent chapter.) which increases economic uncertainty and thereby has paralyzing effects.2111 First, it is precisely the existence of paper currency that makes it difficult for central Thus, say, a 6-8 % target inflation rate for the central ” banks to take policy interest rates much below bank combined with the profitability of sharing work for employers would likely be enough to make the economy zero, a limitation that seems to have become self-stabilizing from most demand and supply shocks and increasingly relevant during this century.” – adaptable to any combination of long-term consumption Kenneth Rogoff, Costs and Benefits to Phasing preferences. Fiscal stimulus2112 would only be needed Out Paper Currency (2014, p. 1) to aid recovery from exceptionally big shocks. The only limitation to growth would be those consumption preferences and individual consumers’ productivity. [O]ne virtue of a cashless economy is that ”we could always cure recessions with ‘old fashioned’ monetary policy. The so-called zero lower bound is a pure artifact of the existence of physical cash.” – Matthew Yglesias2113 2107 See: “3.4.1 Global Warming and Dependence on Fossil Fuels”. 2108 See: ”3.1 Economic Stability and Prosperity” and ”3.2.1 Maximal Economic Security with Maximal Flexibility – Flexicurity and Antifra- But given the fact that e-money that can g i l it y ”. 2109 Krugman, Paul, “The madness of the inflation hawks”, blog post, pay positive or negative interest without any New York Times, 16th Nov 2009, cited 2.7.2013, http://krugman.blogs.ny- ” times.com/2009/11/16/the-madness-of-the-inflation-hawks/ additional cost can now be made available to all, 2110 “Can the Taylor rule describe the current stance of monetary pol- in the advanced (post-) industrial countries, and icy?” Federal Reserve of Atlanta, macroblog, 30th Jul 2009, cited 3.7.2013, http://macroblog.typepad.com/macroblog/2009/07/can-the-taylor-rule- given that even traditional bank accounts, credit describe-the-current-stance-of-monetary-policy.html 2111 See: ”4.2.4.1 Problems with Unstable and Unpredictable Inflation”. 2113 Yglesias, Matthew, “Less Than Zero”, Slate, 12th Dec 2011, 6.6.2014, 2112 See: ”2.2.5.1 Keynesian Fiscal Stimulus – It’s the Government’s Job to http://www.slate.com/blogs/moneybox/2011/12/12/less_than_zero. Invest Stably”. html Eliminating the Zero Lower Bound with a Higher Inflation Target or by Eliminating Cash |447

cards and debit cards can take care of most of Ryan Avent 2121 points out how the obstacle is more political the retail payment system without creating a than technical. The main objective in current politics is zero lower bound constraint on nominal interest neither to increase welfare or economic prosperity and rates, we really don’t need cash to facilitate stability, but to maintain incumbent creditors’ purchasing 2122 trade and commerce. It is a redundant, indeed power. And this protection of people’s divine right to save money profitably is also the only reason for the dominated medium of exchange and means of need for all countries to strive for an absolute competitive payment for legitimate transactions.” – Willem advantage against each other2123 – the economy war Buiter2114 between nations that is sustaining perpetual poverty. This perversion in our outdated economic morality, which gives people the justification to the usury of keeping others in Remember that the only reason we need the higher debt against their will and paying interest to them even inflation rate is to facilitate negative real interest rates. in situations of a massive oversupply of capital,2124 is If we didn’t have physical cash, negative interest rates discussed in more detail in The Guilt Economy. could be charged nominally from bank accounts and there would be no need for any inflation. For clarity of Eliminating official, government-issued cash (“legal accounting (easier to see real profits and compare prices tender”) does of course not need to prevent private and revenues of different years2115), we could shift to companies from issuing their own cash systems or some a 0 % inflation target. And this is not a very far distant kind of physical tokens to transfer credit (compare to e.g. utopia. When mobile, electronic forms of payment become traveler’s checks) with innovative depreciation solutions easier and cheaper to use and accessible for the whole for them.2125 population,2116 2117 it is possible that cash as tokens of credit can become a completely redundant accounting tool The bottom line is that all we have to do within 5-20 years. ”to give the Fed (and other central banks) Matthew Yglesias2118 is one to discuss this idea of unlimited power to lower short-term interest eliminating cash. Miles Kimball suggests introducing rates is to demote paper currency from its role as cash that is distinct from the unit of account and can hence a yardstick for prices and other economic values have different inflation rate. Willem Buiter considers – what economists call the ’unit of account’ both alternatives as well as a form of demurrage (taxing function of money.” – Miles Kimball2126 cash).2119 2120

2121 Avent, Ryan, “The buck shrinks here”, The Economist, Free Ex- change, Apr 16th 2012, cited 17.6.2013, http://www.economist.com/blogs/ freeexchange/2012/04/monetary-policy-0 2122 Another blogger, Steve Randy Waldman also notes this policy objective issue (“Depression is a choice”, 17th Apr 2012, http://www.interflu- 2114 Buiter, Willem, “Negative interest rates: when are they coming to a idity.com/v2/3212.html ), but it an earlier blog post supports the idea of central bank near you?” Financial Times blog, Maverecon, 7th May 2009, inflation-protected “starter savings accounts” to that would prevent neg- cited 6.6.2014, http://blogs.ft.com/maverecon/2009/05/negative-interest- ative interest rates to be imposed on the middle class – with the idea of rates-when-are-they-coming-to-a-central-bank-near-you/ making it politically less controversial to increase inflation risks (and hy- 2115 See: ”4.2.4.13 Inflation Distorts Economic Decision Making”. perinflation risks) with violent fiscal stimuli (“Starter Savings Accounts”, 2116 Kolakowski, Nick, “SXSW: How Mobile Devices Are Changing Af- 12th Feb 2012, http://www.interfluidity.com/v2/2874.html ). This is yet rica”, Slashdot, 9th Mar 2013, cited 22.12.2013, http://slashdot.org/topic/ another example of very shortsighted interest-group-political thinking cloud/sxsw-how-mobile-devices-are-changing-africa/ – fueled by the same protestant work ethic that justifies monetary saving 2117 E.g. http://www.izettle.com/ ; http://www.zaypay.com/overview ; as a source of economic security. If it were possibly with “non-hypothe- https://holvi.com/ cability” to prevent “the rich” from utilizing this free insurance, the in- 2118 Yglesias, Matthew, “Mo Money, Mo Problems”, Slate.com, Money- creased inflation-risk (note: not higher inflation, but risk) on their credit Box blog, blog post, 12th Dec 2011, cited 17.6.2013, http://www.slate.com/ would rather increase market interest rates significantly due to increased articles/technology/technology/2011/12/how_eliminating_paper_mon- uncertainty. And first and foremost, this would raise the risks of hyper- ey_could_end_recessions_.html inflation to the third power as any inflation would lead to bigger public 2119 See: ”4.2.1.4 Demurrage Is Unnecessarily Costly to Implement”. deficits, as a result of huge compensation payments, instead of reducing 2120 “My earlier post described three ways of removing the zero lower public debt as the negative interest on government debts (resulting from bound on nominal interest rates: inflation) would otherwise do. (1) Abolish currency 2123 See: “1.3.4 Foreign Trade: Current Accounts Are Also a Zero-Sum (2) Tax currency holdings Game – Comparative Advantage vs. Absolute Advantage”, “2.2.5.3 Com- (3) De-couple the numéraire/unit of account from the currency/medium petitiveness Politics – Just Indebt Other Nations Further” and “3.3.1 Solv- of exchange/means of payment by introducing a new currency (the ral- ing Poverty for Good – Ending the Economy War”. lod) and abolishing the dollar currency. The dollar would remain the 2124 See: “1.1.8 Labor and Capital (and Land?) – The Factors of Produc- numéraire.” t ion”. – Buiter, Willem, “Negative interest rates: when are they coming to a 2125 See: “4.2.1.4 Demurrage Is Unnecessarily Costly to Implement”. central bank near you?” Financial Times blog, Maverecon, 7th May 2009, 2126 Kimball, Miles, “How paper currency is holding the US recovery cited 6.6.2014, http://blogs.ft.com/maverecon/2009/05/negative-interest- b a c k ”, 5 th Nov 2012, cited 6.6.2014, http://qz.com/21797/the-case-for-elec- rates-when-are-they-coming-to-a-central-bank-near-you/ tric-money-the-end-of-inflation-and-recessions-as-we-know-it/ Other Monetary Policy Questions | 479 Chapters 4.2.1.4-4.2.5 not included in this sample

4.3 ELIMINATING PRIVATE MONOPOLIES AND (OTHER) PRIVILEGES

In short: As presented in “1.1.11 The Fundamental Imperfections • There is no conflict between labor and cap- of a ‘Free Market’ – Externalities and the Limitedness of Land”, laissez-faire economics and the libertarian ital. Monopolies allow extortion. ideal of full private ownership and voluntarily formed • The main role of a (democratic) govern- governments would work marvelously if everything could be isolated – the externality effects of subsystems ment should be to serve as a vessel for the on one another eliminated – and if people could always common ownership of limited, vital re- build more fertile land and other natural resources for sources and natural monopoly industries. themselves. Unfortunately, on a limited planet with a common climate and strongly interconnected ecosystems There is in reality no conflict between labor this is far more utopian than achieving the abolition of and capital; the true conflict is between labor government. “and monopoly... Abolish the monopoly that The conclusion was that the fundamental need for a forbids men to employ themselves and capital government is to serve as the common “ownership” could not possibly oppress labor... [R]emove the platform for these limited vital, resources and cause of that injustice which deprives the laborer interconnected systems. Also the need to incentivize of the capital his toil creates and the sharp sharing work and the need for central control of interest distinction between capitalist and laborer would, rates stem from the same imperfections. As explained in “2.2.2.1 A Single Precious-Metal-Standardized in fact, cease to exist.” – Henry George (1949, p. Currency”, we could see a single commodity currency 277) – even if it emerged spontaneously out of trade – as a limited, vital resource in itself due to the extremely high [T]hough, if we exclude the exploitation entry barriers2284 of the “currency market” or “monetary of natural resources and monopolies, it industry”. And what finally prevents the ones with low “ balances of such commodity money from shifting to is probable that the actual average results of another currency is land: If the government doesn’t dictate investments, even during periods of progress a currency, landlords can do so, as everyone has to pay for and prosperity, have disappointed the hopes location in one form or another. which prompted them.” – John Maynard Keynes, The General Theory of Employment, Interest The “monetary industry” with its clearing systems and interest rate controlling central bank is, however, not the and Money (1936, p. 97) only industry with an obvious natural monopoly position. Other industries, too, attain high entry barriers or such The value of natural opportunities is created benefits of scale that even a duplicated system would by the community, and belongs to it. If we cause more inefficiency than competition could decrease “collect that value for public revenue, the rent- it – especially compared to a public owner that would not have an implicit responsibility to provide employment seekers can go ahead and seek all the rent they (which the public sector currently has).2285 Such industries can seek. Occasionally they might be very clever, and why they should be publicly owned are discussed or lucky, and find some – but not at the workers’ under “4.3.4 Making Natural Monopoly Industries Sources expense.” – Lindy Davies2283 of Public Revenue”.

2283 Davies, Lindy, “LT Essays #3: Capitalism”, cited 19.6.2013, h t t p :// 2284 See: ”1.1.9 Companies as Competing Organizational Forms (Be- www.landreform.org/es3.htm cause Institutions Suck at Suicide) – ‘Pro-Business’ Is Not ‘Pro-Market’”. 2285 See: “3.1.8 Public Sector Inefficiency”. 480 | Eliminating Private Monopolies and (Other) Privileges

Hence working-men who imagine that 4.3.1 Limited, Vital “capital is the oppressor of labor are ‘barking Resources – Tax Land to up the wrong tree.’ In the first place, much that seems on the surface like oppression by capital is Prevent Hoarding in reality the result of the helplessness to which labor is reduced by being denied all right to the 4.3.1.1 Land – One Mother of a use of land.” … “In the second place, whatever Monopoly of the earnings of labor capitalistic monopolies may succeed in appropriating, they are merely In short: lesser robbers, who take what, if they were • Land – or rather “location” or “space” – is abolished, land ownership would take.” – Henry the most important limited, vital resource George, Protection and Free Trade (1949, p. 249- and the mother of many other monopolies. 250)

• Its private untaxed ownership is the root The rent is too damn high.” – Jimmy cause of real estate bubbles, rip-off high McMillan2286 rents and inefficiency of land use (includ- “ ing urban sprawl). It also hampers progress Possibly the biggest threat of negative interest rates is in the quality of architecture and construc- that they would likely cause hoarding of limited, vital tion and raises the income share of capital resources, for lack of other “retainers of value”2287 when with increasing living standards. the yield of risk-free credit – and with it the profits of industries under fair competition – fall negative or close Buy land, they don’t make it anymore.” – to zero. Most notably, this means land: the location value Mark Twain of real estate. Location cannot be produced, and, hence, “ low interest rates escalate real estate bubbles. But the same applies partly to all monopolistic industries and vital Land monopoly is not the only monopoly, but resources with limited price elasticity of supply: Because it is by far the greatest of monopolies – it is a their yields cannot drop negative, negative discounting “perpetual monopoly, and it is the mother of all rates make their market value (the net present value of other forms of monopoly. Unearned increments the cash flows they generate) theoretically infinite and practically extremely speculative and volatile.2288 in land are not the only form of unearned or undeserved profit, but they are the principal It is for a good reason that Georgists and classical form of unearned increment, and they are economists distinguish land and other non-producible derived from processes, which are not merely natural resources into a factor of production of its own 2289 not beneficial, but positively detrimental to – “l a n d”. The limitedness of land is also behind the second of the fundamental imperfections of a completely the general public.” – Winston Churchill, in a free market: everyone not having the chance to make a speech made to the House of Commons on May living self-sufficiently.2290 4, 1909 Most natural resources are to some extent non-producible The rent of the land, therefore, considered or limited in their regeneration capacity. But e.g. fossil fuels and minerals have their extraction costs, and their as the price paid for the use of the land, “is naturally a monopoly price. It is not at all 2286 “The Rent Is Too Damn High Party’s Jimmy McMillan at the NY proportioned to what the landlord may have laid Governor Debate”, debate recording, 18th Oct 2010, viewed 27.8.2013, out upon the improvement of the land, or to what http://www.youtube.com/watch?v=x4o-TeMHys0 2287 See: ”4.2.4.9 Real Estate Bubbles”. he can afford to take; but to what the farmer can 2288 See: ”1.3.2 In a Closed Economy, Net Monetary Wealth Is Zero – To- afford to give.” – Adam Smith (1776, p. 205) tal Real Wealth Depends On Future Consumption and Capital Intensity (and Monopolies)” and ”6.2.3 Appendix 2.3: Effects of LVT on Land Value – The Optimal Land Tax Rate?”. 2289 See: “1.1.8 Labor and Capital (and Land?) – The Factors of Produc- t io n“. 2290 See: “1.1.11 The Fundamental Imperfections of a ‘Free Market’ – Ex- ternalities and the Limitedness of Land”. Limited, Vital Resources – Tax Land to Prevent Hoarding | 481

supply has (long-term) price elasticity, as new reserves However, we need to distinguish the whole concept of just become more and more costly to access and extract. “land ownership” from the ownership of physical elements Also, the net cash flows on such investments into or natural resources. Land ownership is, in fact, not so extraction (mining and pumping etc.) and refining can much about the ownership of anything physical at all – the turn negative with lower prices – if subjected to fair soil with its minerals and other resources (although often competition.2291 Regenerating natural resources (fish and that too). Rather, it is the ownership of the space above it – or game populations, biodiversity etc.) can be plundered even more specifically, its location relative to other “land”. and their regeneration capacity deteriorated. In this If you buy an acre of land in Liverpool and then scoop up way, they can be made more scarce and used as a means a ten-meter layer of soil, truck it to London and spread it of extortion. This is what makes both their private out there, your “land ownership” has not moved to the ownership and non-ownership (making them unrestricted spot in London. Therefore the position of the “natural “commons”, which makes them subject to the Tragedy of rights libertarians” (i.e. deontological libertarians2293) the Commons2292) problematic. Arable land, its soil quality, that a person can claim exclusive ownership of land by can also be “destroyed” or significantly degraded through transforming it (e.g. plowing or fencing it) makes little contamination, nutritional impoverishment resulting sense. One doesn’t really transform the space or location, from e.g. monoculture or other forms of erosion. On the but the physical resources one has found on it or brought other hand, infertile land, like deserts, can theoretically be in from elsewhere.2294 transformed into arable land.

2291 Due to global cartels like OPEC, the nationalization of oil industries and the fact that many nations have no access to fossil fuels or certain minerals, competition does not really work. And non-renewable energy 2293 See: “2.1.1 The Libertarian Maxim of Freedom and the Paradox of sources (namely fossil fuels) should be taxed out of use in any case: See: C hoic e”. “3.4.1 Global Warming and Dependence on Fossil Fuels”. 2294 It is also rather difficult to conclude the ownership of space from 2292 See: “3.4.2 Biodiversity Deterioration, Destruction of Scarce Habi- “self-ownership”: the ownership of one’s body – at least not space one tats” and “1.1.11 The Fundamental Imperfections of a ‘Free Market’ – Ex- doesn’t currently occupy with one’s body (see: “Sidenote Box 117A: Own- ternalities and the Limitedness of Land”. ership as an Idea, Feeling, Relationship or Extension of the Self?”)

Sidenote Box 4311A: Components of Location Value

The market value of lots – undeveloped locations – is directly derived from the potential (future) uses available for that location and hence follow the market value of houses and other facilities. (Kanerva et al 1987, p. 34; Peltola & Väänänen 2007, p. 2)). Theoretically, the only difference between these should be the construction costs. And the market value of a piece of real estate can be derived from the rent that people are ready to pay for using it – just like the market value of any capital asset is the net present value of the cash flows it is expected to generate for the investor.2295 The valuation equation for land is explained in more detail in “6.2.3 Appendix 2.3: Effects of LVT on Land Value – The Optimal Land Tax Rate?”.

A major component of location value is proximity to, or, more accurately, the reachability of major urban centers. (Peltola & Väänänen 2007, p. 16) This does not only depend on direct geographic distance, but more on available transportation routes and services such as roads and public transport systems. In some simplified valuation models, rentees face a tradeoff between transportation costs, including travel time (which is also affected by traffic congestion), and rent cost. Hence, the rent they’re ready to pay increases as the travel costs and times to e.g. work and commercial centers drop. (Alonso 1964) Additionally, regions and areas can have more local properties that have an attractive or a repulsive effect. For example rivers, lakes and parks tend to be attractive features for residential properties, (Peltola & Väänänen 2007, p. 19) while the proximity of a major highway, an airport or other sources of noise, smell and pollution often have a repulsive affect. (Kanerva et al 1987, p. 34) Of course, the relative valuation of different locations (like anything in a market) is always very subjective and perceived,2296 and also e.g. the “status” and reputation of certain regions is a significant factor.

2295 See: ”1.1.8 Labor and Capital (and Land?) – The Factors of Production”. 2296 See: ”1.1.3 Value Is Subjective and Perceived – Rationality Is Largely an Illusion”.

Continued on page 482 ► 482 | Eliminating Private Monopolies and (Other) Privileges

► As mentioned in “1.1.8 Labor and Capital (and Land?) – The Factors of Production”, “land” could also be categorized as a “privilege” instead of a natural resource (see: Graph 8) because its value depends more on the collective productivity of the local society (and therefore people’s real income) than any pre-existing factors of nature.

Unlike buildings, location is extremely price-inelastic in supply.2297 Although the potential to build in central locations can be increased by e.g. changing zoning2298 to allow higher structures or different uses and although, in some cases, land can be extended into the sea or by digging rails and roads underground, such decisions and the implementation of such projects seldom follow directly the market prices of real estate. (Such changes in the available amount are therefore not “price elasticity”.) Therefore the market value of land (the location value of real estate) is largely determined by demand: what people and companies are ready pay for living or operating in a region.

2297 See: ”1.1.6 The ‘Market Forces’ – How Prices Balance Supply and Demand”. 2298 See: “4.3.1.7 Central City Planning and Zoning Make Unavoidable Externalities More Predictable”.

—— Most human food production requires significant Ownership of location, in terms of the market, is very areas receiving enough sunlight and rain – making different from that of physical resources (natural or non- such surface areas a vital resource, even if the natural) in that: soil could be transformed in terms of nutrition (although this “overall limitedness of land” isn’t —— It is harder to destroy (the value of) location. Its such a location-specific issue). value does not depreciate with time in the way the value of producible goods would through decay and increased productivity in those goods. Neither Looking at the ownership of location and space through does it have storage costs. the lens of “a bundle of rights”,2301 the differences with physical entities – or even intellectual property – become —— Its value is strongly dependent on the use of even more salient. adjacent land, and therefore the use of land almost always has significant externality effects (negative As the value of location does not decay with time and and positive) on the value of surrounding land. as similar competing land cannot be produced,2302 land —— It is not a homogeneous, fungible commodity – each in a growing city is valued as a growing perpetuity (an lot is special and has a “local monopoly.” endless source of cash flow) and is strongly influenced by interest rates. This is explained in more detail in “6.2.3 —— It can hardly be produced at all – e.g. habitats of Appendix 2.3: Effects of LVT on Land Value – The Optimal animal populations can be expanded, animals Land Tax Rate?”. can be bred, forests can be grown, but you cannot produce another Central Park into Manhattan Already Adam Smith noted that “the rent of the land … (without removing something else). is naturally a monopoly price” and will yield whatever —— The concentration of people into an area is people can afford to pay for it (Smith 1776, p. 205) – even fundamental for innovation and the division of in farming, which is less location-specific than urban labor,2299 the two main drivers of increasing human land use. Hence, rent tends to take up a bigger and bigger productivity – paradoxically even more so in the era of the internet and virtual presence.2300

2301 See: “1.1.7 Ownership as a Bundle of Rights”. 2302 In some cases, a city can be expanded out into the sea, but there are 2299 See: ”1.1.1 The Division of Labor – Cooperation and Sharing Infor- limits to how far this kind expansion can go – not to mention how costly mation: The Philosopher’s Stones of Mankind’s Progress”. and environmentally hazardous such projects tend to be. And it inevita- 2300 Yglesias, Matthew, “Classical Economics, Now More Than Ever”, bly has strong (also negative) externalities on the value of other real estate Slate.com, MoneyBox blog, 10th May 2013, cited 17.6.2013, http://www. – e.g. houses and apartments previously priced high due to their seaside slate.com/blogs/moneybox/2013/05/10/back_to_the_classics.html location. Limited, Vital Resources – Tax Land to Prevent Hoarding | 483

share of people’s income when living standards rise with of the candle; it will abound with all the machinery increased productivity.2303 and improvements that so enormously multiply the effective power of labor. Will in ten years, interest Winston Churchill called the private land ownership be any higher?’ He will tell you, ‘No!’ Will the wages “the greatest of monopolies” and “the mother of all other of the common labor be any higher...?’ He will tell forms of monopoly”. Although non-location-dependent you, ‘No the wages of common labor will not be any monopolies (e.g. patents) also exist, this is a deserved title, higher...’ ‘What, then, will be higher?’ ‘Rent, the value as location dependence is behind a number of other natural of land. Go, get yourself a piece of ground, and hold monopoly industries, such as basic infrastructure.2304 possession.’ And if, under such circumstances, you take his advice, you need do nothing more. You may And this monopoly is one factor keeping the yields of sit down and smoke your pipe; you may lie around all capital investments higher than they would be – even like the lazzaroni of Naples or the leperos of Mexico; you with the zero lower bound on interest rates and wage may go up in a balloon or down a hole in the ground; regulations that also keep interest rates higher than they and without doing one stroke of work, without adding would be otherwise. Ha-Joon Chang points out that the one iota of wealth to the community, in ten years you availability of land is what kept American wages in the will be rich! In the new city you may have a luxurious 19th century much higher than those in Europe, despite mansion, but among its public buildings will be an similar GDP per capita. I.e. the share of total income going almshouse.” (George 1912 p. 175) to labor (as opposed to capital and land) was higher.2305 Also John Maynard Keynes notes how the demand for Because of this irreplaceability of land, investors and land can maintain higher interest rates. (Keynes 1936, p. real estate developers will buy up all the potentially 221-222) valuable land in and around growing cities – as they already do – even when they have no intention of utilizing Of course, land is not an absolute monopoly, as there it for anything productive for years to come. If the local are usually many different land owners in an area. economy does not decline significantly, the land can be Nevertheless, it is an entry monopoly: Total supply is expected to at least maintain its value. If the economy naturally limited, and the only way to enter the market grows and the city expands and people’s incomes grow, is to buy the resource from a current owner. (Adams 2015, the value of the land can be expected to rise dramatically. p. 9) And this is nothing new. This is what has always happened with urbanization. As Henry George Jr. put it in Henry George identified the land monopoly as practically the introduction to The Twenty-Fifth Anniversary Edition the only reason why inequality keeps growing and why of Progress and Poverty (George 1912, p. 8) poverty persists despite increases in productivity and overall wealth. “Henry George perceived that land speculation locked up vast territories against labor. Everywhere he “Take now ... some hard-headed business man, who perceived an effort to ‘corner’ land; an effort to get it has no theories, but knows how to make money. Say and to hold it, not for use, but for a ‘rise.’” to him: ‘Here is a little village; in ten years it will be a great city – in ten years the railroad will have And the less is built, the more the value of all existing taken the place of the stage coach, the electric light built (developed) and unbuilt (undeveloped) property rises as well. Anyone already owning built property not only has the incentive to buy more land, but to hold back 2303 Demand for accommodation could of course decrease, but it would be required to be expected to drop forever (and at a rate faster than what development in order to ensure that the value of their the discount rate is) in order to prevent negative interest rates from turn- current investments do not drop due to additional supply ing land value theoretically infinite. And that is unlikely, as, even if peo- of apartments and facilities. ple downshifted their other expenditure, they would likely still be willing to pay for location as long as their labor earning opportunities did not decrease significantly. This incentive trap is strengthened by the low price 2304 See: ”4.3.4 Making Natural Monopoly Industries Sources of Public elasticity of the demand for apartments: It is not easy to Reve nue”. 2305 “In the early nineteenth century, US per capita income was still adjust the size of individual apartments, and therefore around the European average and something like 50 per cent lower than demand can practically mostly flex downward through that of Britain and the Netherlands. But poor Europeans still wanted to people moving to nearby municipalities or by more move there because the country had an almost unlimited supply of land people living in shared housing. Therefore, maintaining (well, if you were willing to push out a few native Americans) and an acute labour shortage, which meant wages three or four times higher even a small deficit of apartments by avoiding new than in those in Europe.” … “At the time, the existence of almost-free construction can keep housing prices on a rising track, land in the US made it necessary for American manufacturers to offer while merely a slight oversupply (or fear of it) might cause wages around four times higher than the European average, as otherwise the workers would have run away to set up farms…” (Chang 2010, p. 103 all apartment prices and rents to drop dramatically. When & 67) large companies own significant amounts of real estate, 484 | Eliminating Private Monopolies and (Other) Privileges

they have an incentive to keep some of it unoccupied in Suppose that there is a kind of income order to keep rents for the rest of the capacity higher. This “which constantly tends to increase, without arguably is the case for example with office facilities and any exertion or sacrifice on the part of the empty lots in the Helsinki metropolitan area.2306 Negative owners: those owners constituting a class in real interest rates would make such hoarding of land just the community, whom the natural course of as a retainer of value (and keeping it out of use) even more tempting – even for other investors. things progressively enriches, consistently with complete passiveness on their own part. In such It is important to point out that investing in e.g. bigger a case it would be no violation of the principles or more fancy apartments is not a problem, as more, on which private property is grounded, if bigger (at least higher) and better buildings can always the state should appropriate this increase of be produced (as long as zoning and the availability of lots allow it2307). Doing so does not limit anyone else’s ability wealth, or part of it, as it arises.” … “Now this to live in a certain place or improve their homes. As long is actually the case with rent.” … “[Landlords] as the possibility of additional construction resulting grow richer, as it were in their sleep, without from higher rents and prices exists, it will prevent the working, risking, or economizing. What claim price of accommodation and buildings (assets used have they, on the general principle of social to provide accommodation) from bubbling up. When there is more demand for better or bigger apartments or justice, to this accession of riches? In what business premises, the additional construction results in would they have been wronged if society had, more earning opportunities for others as with increased from the beginning, reserved the right of taxing demand for consumable products and services. It is the the spontaneous increase of rent, to the highest hoarding and underutilization of land – location – that is the amount required by financial exigencies?” – challenge. The rent paid for location doesn’t grant earning opportunities (employment) for anyone else, but is rather John Stuart Mill, Principles of Political Economy a big income transfer (from rent payers to real estate (1848, Book 5, Ch. 2, Sec. 5) owners) and, therefore, including it in the Gross Domestic Product (GPD)2308 can be considered very misleading. Men did not make the earth. It is the value of the improvements only, and not the In short, the private, untaxed ownership of land – the “ location value of real estate – is a natural monopoly and a earth itself, that is individual property. Every root cause of: proprietor owes to the community a ground rent for the land which he holds.” – Thomas Paine —— real estate bubbles, —— rip-off high rents (that just grow as people’s But as rich countries shift more and more incomes grow), “into a postindustrial economy, I think many —— urban sprawl and other inefficient land use in cities, of the distinctive posits of old-fashioned classical —— non-developing (implemented) quality of economics are relevant again. In particular architectural design and construction quality, the treatment of land and natural resources including housing technology, and as something important and importantly —— the increasing income share of capital with different from ‘capital’ has a new relevance economic development and ever-polarizing wealth today. Some of that is simply because thanks to distribution. the environmentalist movement we care about natural resources in a way that the public figures Lower interest rates merely escalate this bubble – serving of the high industrial revolution didn’t. But it’s as an indicator of the monopoly nature of land. also because, paradoxically, the rapid fall in transportation and communications prices has made location matter more than ever. Digital communication turns out to be more of a

2306 See: ”4.3.1.6 Case: Helsinki Metropolitan Region”. 2307 See: “4.3.1.7 Central City Planning and Zoning Make Unavoidable Externalities More Predictable”. 2308 See: ”1.3.1 Economic Growth Is the Increase in Produced and Traded Value – The Many Meanings of ‘Wealth’”. Limited, Vital Resources – Tax Land to Prevent Hoarding | 485 complement to than a substitute for face-to-face lower living expenses. communication.” – Matthew Yglesias2309 Tax something, there will be less of it – All teachers of natural law, etc., have “except land.” – Lowell C. Harriss (Cohen & unanimously declared that the differentiation Coughlin 2005, p. 364) “into income-receiving classes and propertyless classes can only take place when all fertile lands In my opinion, the least bad tax is the have been occupied. For so long as man has “property tax on the unimproved value of land, ample opportunity to take up unoccupied land, the Henry George argument of many, many 2310 ‘no one,’ says Turgot, ‘would think of entering years ago” – Milton Friedman the service of another;’ we may add, ‘at least for wages, which are not apt to be higher than the The property tax is, economically speaking, earnings of an independent peasant working an “a combination of one of the worst taxes unmortgaged and sufficiently large property;’ – the part that is assessed on real estate while mortgaging is not possible as long as land improvements… and one of the best taxes – the is yet free for the working or taking, as free as tax on land or site value.” – William Vickrey, air and water.” … “Since land could not, have ”Land-value taxation: The Equitable and acquired ‘natural scarcity,’ the scarcity must Efficient Source of Public Finance” (Wenzer have been ‘legal.’” – Franz Oppenheimer, The 1999, p. 17) State (1908, p. 9-10 & 14) [T]he existing land-tax (which in this country What we call real estate – the solid ground “unfortunately is very small) ought not to be to build a house on – is the broad foundation regarded as a tax, but as a rent-charge in favour “on which nearly all the guilt of this world rests.” of the public; a portion of the rent, reserved from – Nathaniel Hawthorne, The House of Seven the beginning by the State, which has never Gables belonged to or formed part of the income of the landlords, and should not therefore be counted Woe to you who add house to house and join to them as part of their taxation, so as to exempt field to field till no space is left and you live them from their fair share of every other tax.” “alone in the land.” – The Bible, Isaiah 5:8. … “That a person owns part of the rent, does not make the rest of it his just right, injuriously withheld from him.” – John Stuart Mill, 4.3.1.2 Land Value Taxation – Principles of Political Economy (1848, Book 5, Preventing Underusage, Extortion Ch. 2, Sec. 6) and Bubbles The obvious solution to the land monopoly issue is to tax In short: the location value of real estate at a rate notably higher than any possible negative real interest on deposits – a • Private ownership (control) of real estate land value tax (LVT). (More speculation on the optimal has its benefits, but taxing its location LVT rate in: “6.2.3 Appendix 2.3: Effects of LVT on Land value (land) heavily – over 10 % of market Value – The Optimal Land Tax Rate?”) value – is necessary to prevent unpro- Due to the monopoly nature of land ownership, Adam ductive, opportunistic hoarding and Smith himself advocated land taxation: underutilization, which sustain real estate bubbles and other market inefficiencies. “Ground-rents are a still more proper subject of Paradoxically, higher land taxation can taxation than the rent of houses. A tax upon ground-

2309 Yglesias, Matthew, “Classical Economics, Now More Than Ever”, 2310 “Milton Friedman Interviewed”, The Times Herald, 1st Dec 1978, Slate.com, MoneyBox blog, 10th May 2013, cited 17.6.2013, http://www. cited 9.7.2013, http://www.cooperativeindividualism.org/friedman-mil- slate.com/blogs/moneybox/2013/05/10/back_to_the_classics.html ton_interview-1978.html 486 | Eliminating Private Monopolies and (Other) Privileges

rents would not raise the rents of houses. It would fall that the government would have more of a “right” to tax altogether upon the owner of the ground-rent, who (except maybe the monetary system). Taxing something acts always as a monopolist, and exacts the greatest could be seen as analogous to charging a lease fee (“rent” in rent which can be got for the use of his ground.” common speech) on it and thereby implies laying a partial (Adam Smith 1776, p. 692) claim of “ownership” on the object of taxation (“right to the income of it”). In this light, the government taxing The distinction of land from other capital was a major work and consumption can be considered quite funny subject of debate among the classical economists of the – as if the government owned people’s interaction2314 or 19th century, many of whom saw land taxation as the their personal capabilities (competence capital). It makes ideal. Land taxation is also popular among 20th century much more sense to claim that the government owns the economists. Even Milton Friedman, a libertarian opposing monetary system, which justifies taxing the holding of most kinds of state intervention (including central city money itself (especially bank deposits the government planning2311) and taxation, agreed that land value taxation guarantees) instead of transactions conducted using is “the least bad tax”. (Cohen & Coughlin 2005, p. 359) money. 2315

As the most extreme case, Georgism – named after And the government, finally, “owns” all the land: Looking Henry George – suggests a “single tax policy” where land back at the classifications of different kinds of rights taxation (of almost 100 % of its unimproved value) is the that can be included in “ownership”2316, we can infer that only source of public revenue. hardly any country allows “complete” private ownership of land – or the space above it. If you really, fully owned Henry George argued that such a tax would not raise the land, you should be able to set the laws to follow on rents: It would fall entirely on the land owner. This is a that land (part of the “right to manage”). Not only are fairly obvious microeconomic conclusion: When supply you not allowed to do that, but centrally planned zoning is limited (its price elasticity is zero), demand (how much dictates what you can and cannot do with that piece of buyers are willing to pay) determines prices.2312 And an land: what you can build on it and often what businesses LVT does not increase anyone’s willingness or ability to you can operate on it. Therefore, the landowner’s “right pay higher rents. to use” is also limited. Thus, the government and municipality partly own the land in the current system as “Nor, if a tax be levied on that rent or value, this in no well – the “landowner” just possesses the right to use it wise adds to the willingness of anyone to pay more for for a limited range of purposes as well as the rights to its the land than before; nor does it in any way add to the income (crops, rents, accommodation it provides etc.) and ability of the owner to demand more. To suppose, in capital (composed of the present value of that expected fact, that such a tax could be thrown by landowners income). Thus the government could also tax this “right upon tenants is to suppose that the owners of land of use”, i.e. reduce the owner’s right to “the income of the do not now get for their land all it will bring; is to thing”. This makes in many ways far more sense than suppose that, whenever they want to, they can put up taxing the work we do and the trade we conduct, which prices as they please. should by no means belong to the government.

This is, of course, absurd. There could be no limit So, how should such a land value tax be implemented? In whatever to prices did the fixing of them rest entirely most countries, the “real estate tax” or “property tax” – it with the seller.” (George, 1887) has many names – is already based on the market value of the real estate and it is usually levied separately on This has also been observed in practice. For example, land and buildings. In many Western countries, however, property tax reliefs for “Enterprise Zones” in the UK were the tax is around the same for both land and buildings. It almost fully captured by property owners as higher rental would be worth reconsidering this policy, as the incentive income. (CE 2008; Bond, Tyler & Gardiner 2011) And the effects of taxing land versus taxing buildings is very same applies also to public accommodation subsidies paid different. As William Vickrey writes: to tenants: they mainly serve to raise rents and hence the market values of real estate.2313 “The property tax is, economically speaking, a combination of one of the worst taxes – the part that Does the government have a “right” to tax land – the is assessed on real estate improvements … and one of location of real estate? Actually, it is hard to find anything

2311 See: ”4.3.1.7 Central City Planning and Zoning Make Unavoidable 2314 See: ”3.1.6.1 Constantly Increasing Public Debt – A Taxation Model Externalities More Predictable”. Based on Monopoly Profits, Charging for Services and Auctioning Re- 2312 See: ”1.1.6 The ‘Market Forces’ – How Prices Balance Supply and s ou r c e s”. D e m a nd”. 2315 See: “4.2.2 Setting a Fee on the Government Deposit Guarantee”. 2313 See: ”4.3.1.6 Case: Helsinki Metropolitan Region”. 2316 See: “1.1.7 Ownership as a Bundle of Rights“. Limited, Vital Resources – Tax Land to Prevent Hoarding | 487

the best taxes – the tax on land or site value.” (Wenzer keep desirable lots and pieces of real estate in suboptimal 1999, p. 17) use.

As explained, taxing land can encourage building, while Although they didn’t have the concept of negative taxing buildings is likely to discourage it.2317 Taxing externalities, many classical economists such as David buildings is comparable to taxing consumption – like the Ricardo – who regarded rent as a parasitic charge upon value added tax (VAT) or goods and services tax (GST, production – suggested taxing the rental value of land, e.g. in Australia). It taxes “accommodation and facilitation disagreeing with Smith, who only suggested taxing the services”, except that it taxes the buildings (i.e. the capital actually charged rents. Smith didn’t consider it just to tax used to produce those services) regardless of whether they unoccupied houses for which the landlord didn’t receive are occupied or unoccupied.2318 Taxing land could also any rent.2321 (The difference between rental value taxation be considered a Pigovian Tax on the negative externality and actual land value taxation as well as why rental value effects of the underutilization of land and preventing taxation is not enough to prevent land from becoming others from using it. very speculative at low interest rates is explained in “6.2.3 Appendix 2.3: Effects of LVT on Land Value – The Optimal So, what are the negative externality effects of owning Land Tax Rate?”.) land? As land is a limited resource – that locally has no substitutes – keeping it out of others’ use imposes costs on Some countries, like Finland, have seen this potential of them. Roope Luhtala, a friend of mine, used the following using real estate taxation to increase land utilization, and analogy to clarify this: Consider a situation where two the government has allowed municipal authorities to tax ships approach an uninhabited island. The crew of ship undeveloped real estate (i.e. unbuilt lots) at a higher rate A intends to cover the island with toxic waste leaving it (1-3 %, compared to a general real estate tax tax rate of unusable for 20 years (though causing no permanent 0.8-1.55 %, and a tax for permanent residential buildings environmental damage), and the crew of ship B intends to of 0.37-0.8 %2322). However, this kind of incentives – like take ownership of the land on the island and only start construction orders at threat of confiscation by local selling or renting it for use in 20 years’ time. Which one municipalities – give large real estate developers and would you prefer to reach the island first? Note that if investors the incentive to underutilize the land, e.g. build it were the toxic ship you at least wouldn’t have to pay slower or construct a two-floor building, where zoning for the land in 20 years’ time. In both cases, the land is would allow a skyscraper, and such maneuvers increase unusable to you or anyone else for the next 20 years and the costs of further development.2323 (Lyytikäinen 2007) you cannot build another island in the same location to replace it or compete with it. A warning example of the harmful effects of such tax discrimination can be seen in Greece where unfinished It is excluding and depriving others of the use of land that buildings have earlier been exempted from the real estate has the biggest negative externality costs! Using the land tax for seven years after the construction permit has been efficiently according to zoning2319 more often has positive externality effects (compared to leaving it unused) in the 2321 “Houses not inhabited ought to pay no tax. A tax upon them would longer run, as the resulting higher population density fall altogether upon the proprietor, who would thus be taxed for a subject which afforded him neither convenience nor revenue. Houses inhabited facilitates more economic interaction and increases the by the proprietor ought to be rated, not according to the expense which benefits of scale for both private and public services, they might have cost in building, but according to the rent which an eq- including infrastructure investments.2320 uitable arbitration might judge them likely to bring if leased to a tenant.” (Smith 1776, p. 692) 2322 “Rakentamattoman rakennuspaikan veroprosentti”, vero.fi, 12th Currently, a real estate tax can be based on (1) market Jan 2011, cited 27.8.2013, http://www.vero.fi/fi-FI/Syventavat_verooh- value, (2) rental value or (3) land/building area. For the jeet/Kiinteistoverotus/Rakentamattoman_rakennuspaikan_veropro- purposes of avoiding hoarding, determining the tax se(12393) ”Kiinteistöveroprosentit”, vero.fi, 17th Aug 2010, cited 20.3.2015, http:// according to market value is clearly the optimal choice, www.vero.fi/fi-FI/Henkiloasiakkaat/Kiinteistovero/Kiinteistoveropro- as the market value – what others would be ready to pay sentit(9216) for it – best represents the opportunity cost (and hence the 2323 There is already some evidence of less efficient land use from Fin- land. negative externality cost) of others not being able to use ”[T]he results for all housing project starts provide some evidence that that land for something else. This makes it unprofitable to development density might have decreased attenuating the effects of faster development.” (Lyytikäinen 2007, abstract) It is also noteworthy that the tax has mostly affected single-family apart- 2317 On how property taxation can be used to influence land use and ments… development, see: OECD 2010, p. 157. ”A large share of apartment blocks and row houses are government-sub- 2318 See: “6.2.2 Appendix 2.2: One Simple Version of a Competitive Tax- sidized and are also more often built on lots rented from the municipality at ion Mo de l”. than single-family units.” (Lyytikäinen 2007, p. 32) 2319 See: ”4.3.1.7 Central City Planning and Zoning Make Unavoidable …and that the rents that the municipality charges for lots are seldom Externalities More Predictable”. based on the full value of the location (see: “4.3.1.4 The Pure Lease Alter- 2320 See: ”Sidenote Box 4311A: Components of Location Value”. native’s Problems – Land Value Is Location Value of Real Estate”). 488 | Eliminating Private Monopolies and (Other) Privileges

granted. This naturally encourages constructing buildings permanent and indestructible powers of the soil,’ that look like they are going to have yet another floor built on the one hand, and, on the other, the value due on them later. (Brown & Hepburn 2002, p. 184) to the two different kinds of improvements – that due to communal efforts and that due to the Taxing all land equally according to market value at a efforts of the individual owner – the argument sufficient rate2324 (at least offsetting any possible negative interest rates) would ensure land is kept in the most for its adoption would be very strong. Almost productive use available – including finishing buildings all the difficulties we have mentioned, however, on schedule. stem from the fact that no such distinction can be drawn with any degree of certainty.” – 4.3.1.3 Practical Challenges: Fair Friedrich A. Hayek, The Constitution of Liberty Valuation and Assessment of the (1960, pp. 352-353) Replacement Costs of Improvements and Other Owner-Created Value I admit that it would be unjust to come upon “each individual estate, and lay hold of the In short: increase which might be found to have taken place in its rental; because there would be no • The biggest practical challenge with LVT is means of distinguishing in individual cases, fair and reliable assessment of land value, between an increase owing solely to the general which requires (1) determining an up-to- circumstances of society, and one which was date market value for the whole piece of the effect of skill and expenditure on the part real estate and (2) assessment of how much of the proprietor. The only admissible mode of of this value is created by the developer. proceeding would be by a general measure.” – • Removing all subsidies on homeownership John Stuart Mill, Principles of Political Economy could make the real estate market much (1848, Book 5, Ch. 2, Sec. 5) more efficient, providing better real time market information, which would allow The biggest (valid) concerns with and objections to real much more reliable statistical methods for estate taxes are related to the fairness and reliability of the determining both of the above values. methods used to determine the value of real estate. Real estate does not exchange hands every year and therefore • Brand value is one of the most difficult valuation tends to be dependent on individual human components to discern from location value judgment. Unfair practices and cases of corruption are the and requires comparisons with surround- main factors making the real estate tax one of the most hated taxes in the U.S.. ing land prices. • Additionally, construction and renova- Also, as land is seldom sold alone from underneath buildings, the value of the land (the location value of the tion expenses as well as assessments by real estate)2325 is essentially determined by subtracting home insurance companies can be used as the estimated replacement cost of the building from the proxies in determining replacement costs, market price of the whole piece of real estate, and, in two- but there are incentive traps and rooms for rate taxation, determining the replacement costs fairly fraud in relying on them fully. and accurately is another challenge. (Cohen & Coughlin 2005, p. 360) There still exist some organized groups E.g. Austrian economists Friedrich A. Hayek (1960, pp. 352- “who contend that all these difficulties could 353) and Murray N. Rothbard emphasize the impossibility be solved by the adoption of the ‘single-tax’ of any assessor to make a fair assessment of market value. plan... If the factual assumptions on which it is based were correct, i.e., if it were possible to “How will the annual tax on land be levied? In many distinguish clearly between the value of ‘the cases, the same person owns both the site and the

2324 See: ”6.2.3 Appendix 2.3: Effects of LVT on Land Value – The Opti- 2325 See: ”4.3.1.4 The Pure Lease Alternative’s Problems – Land Value Is mal Land Tax Rate?”. Location Value of Real Estate”. Limited, Vital Resources – Tax Land to Prevent Hoarding | 489

man-made improvement, and buys and sells both transactions and outstanding offers in an area can be site and improvement together, in a single package. used to readjust the value of all real estate in that area. How, then, will the government be able to separate If there happen to be unbuilt lots in the area, the offers site value from improvement value? No doubt, the out on these give a good reference point for the value of single taxers would hire an army of tax assessors. But other land, but even in their absence, algorithms can be assessment is purely an arbitrary act and cannot be used to determine the prices of hypothetical unbuilt lots anything else. And being under the control of politics, of different building rights based on the prices of different it becomes purely a political act as well. Value can only kinds of real estate in the area. be determined in exchange on the market. It cannot be determined by outside observers.” (Rothbard 1997, p. Of course, this leaves the challenge of determining the 296) value ratio between apartments e.g. facing different directions and on different floors in the same building. Here (for once) Rothbard has a valid point. Land value Penthouses and seaside apartments tend to be valued taxation has to be based on market information with as much higher than ground floor apartments – and such little room as possible left for the consideration of any valuation differences are of course very subjective and assessor or other human judgment. This is also necessary possibly volatile. to minimize corruption and regulatory capture. But on the other hand, in a market where homeownership In Henry George’s model, the land valuation problem was isn’t unnecessarily subsidized with any tax benefits solved by letting every owner value her own real estate compared to living on rent (as it now is in many and be required to sell it at that price to any willing buyer. countries2327), a majority of real estate would likely be In theory, this solution is almost perfect: Undervaluing owned by investment companies and funds (rather than one’s real estate would increase the risk of losing that real the occupants). The competition between these over the estate and therefore such a valuation method would keep most profitable pieces of real estate would likely provide a all land in the most valuable use available. far more versatile and regularly updated range of offers on all real estate on the market, making market values follow In practice, two troubles here are the relatively high rental prices much more closely. In this situation, it would transaction costs of moving and the fact that people become likely be whole apartment buildings (or fungible shares in emotionally attached to their apartments. A wealthy them) that are traded, instead of individual apartments, enemy could – out of pure malice or to gain leverage in reducing the problem with valuing apartments on another negotiation – buy you out of your house (or different floors and facing different directions. threaten to do so), even at a loss, as this would impose an even bigger cost on you. Such fears could require some What about the replacement cost? One might expect disliked or powerful people to pay ridiculously high taxes that the case would at least be simple for recently built (beyond the actual market value) for their apartments apartments, offices and other facilities: “Just use the only to avoid losing their family home or having to move construction costs.” And for older buildings? The relevant all the time. The same applies to office premises and other replacement costs, of course, are the current replacement business and industry facilities: Companies could conduct costs. Therefore, replacement costs determined according “hostile takeovers” of their competitors’ premises just to to historical construction and renovation expenses need damage the competitors’ operations. to be adjusted with time according to (1) changes in the construction cost index, which is affected by productivity The inverse model seems much more fair in practice: development and changes in the price of construction Instead of forcing owners to sell apartments or facilities work and materials, as well as (2) the deterioration/ to any willing buyer, it would be more humane to depreciation of the building. adjust valuations according to any outstanding offers on apartments and oblige the highest bidder to buy if the However, there is a notable incentive trap when the seller agrees to sell at the offered price. construction contractor is the same company as the real estate developer – the owner of the real estate – or involved Using the resulting offers on all similar apartments in the in other business relations with it. When a construction same area, a statistical average could be set to determine company owns the real estate it is developing, it has every a minimum and maximum amount for the actual taxable incentive to exaggerate the construction costs involved value of individual apartments – eliminating the effect and include in them as much of its overhead costs (and of “hostile offers.” The value of a lot is largely dependent of the costs of other businesses it might have) as possible on (1) the attractiveness of the location2326 and (2) what to make it seem as if a bigger part of the value of the kinds of uses its zoning allows. Therefore, any real estate 2327 See: ”6.2.3 Appendix 2.3: Effects of LVT on Land Value – The Opti- 2326 See: ”Sidenote Box 4311A: Components of Location Value”. mal Land Tax Rate?” and ”4.3.1.6 Case: Helsinki Metropolitan Region”. 490 | Eliminating Private Monopolies and (Other) Privileges

developed real estate is the result of development – in redevelopment) could be subjected to an open auction, order to make the piece of real estate cheaper to hold for allowing for “recalibration” of land values in the area. potential buyers. But is there value other than location value that a building So, a first rule would be that the construction expenses can gain without physical development? Unfortunately reported by (or paid to) the construction contractor cannot yes: brand value. And this is the most difficult kind of be trusted to represent the true replacement costs if the value to discern in the case of individual pieces of real contractor might in any way be affiliated with the current estate. Accommodation and office buildings can gain owner of the real estate. The same applies to renovation a status and reputation, which increase the rents that work. With renovation work made by the owner – and not occupants are willing to pay for them, but the problem a subcontracted that can be considered impartial – the is even more salient in developments made for special increase in the value of a building can’t be trusted to equal purposes and where the service provided is strongly reported renovation expenses. dependent on the specific piece of real estate. Say, for example, that you build a spa (or theme park or casino etc.) In controlling for fraudulent reporting of construction almost in the middle of nowhere. You might pay next to and renovation expenses (to raise the official replacement nothing for the lot and then invest $10M in building the costs in order to avoid location value taxation) and errors spa. Others might consider this a risky investment and in assessing the deterioration of buildings, there might no one would make any offers on the spa for more than be some synergies with insurance companies. Home $9M. Thus the LVT for the real estate would be $0 (as land insurers should, in principle, only value and cover for value, market value minus construction costs, is negative). the buildings, as the location value of the real estate isn’t But with a $1M investment in marketing during a year destroyed when an individual building burns down or (with no further construction), the spa might become very is flooded. Technically, nothing prevents insurers from popular among wealthy people and start generating high insuring assets for more than their actual replacement profits. As the spa business is strongly dependent on the cost (as e.g. some car insurers tend to do), but if they do specific piece of real estate, competitors or other investors so, they also have to charge higher insurance payments could practically take over the business by simply buying to keep their business profitable. If replacement costs the real estate from you. (Of course, they might have to were purely determined by insured values, would it be rehire the personnel, but that could be a less critical added profitable for homeowners and real estate investors to value factor or competitive advantage than the physical pay higher insurance fees in order to avoid land value spa itself.) Hence, offers on the spa might rise to $25M. taxes? Likely yes, as insurance payments are far lower This added value of $14M is not location value created as than the suggested taxes on location value (10 % or more). a “positive externality” by the surrounding community, Therefore, blindly trusting the figures given by individual as the spa is still located “in the middle of nowhere”. It home insurers is not a bulletproof solution either. is brand value built by the spa owner.2329 It makes little sense to charge the spa owner an LVT for the $15M by However, if homeownership weren’t subsidized compared which the market value of the spa building exceeds the to living on rent2328 and we had an efficient real estate value increase during construction. The possibility of market with real estate investors constantly having offers such penalization would harmfully disincentivize the open on most properties, a third solution – and probably marketing of any businesses or real estate and hence the fairest in that it would not reward inefficiency in many kinds of productive real investment. construction work – would be to use the relative changes in these prices to determine the effect that a renovation The above case example (together with the possibility of project or greenfield real estate development project “hostile offers”) emphasizes the importance of statistical had on its value. The market prices (outstanding offers) methods and comparisons with surrounding lots in before and after the development (real investment) would determining how much of any increase in the price of a be compared and controlled for changes in the market piece of real estate is actually location value. In the case prices of similar, undeveloped apartments or buildings of the spa, the price of an adjacent lot would not have in the region, which would serve to indicate how much changed even remotely as much because of the business of the increase in value of the developed apartment was potential in the spa itself, which would show that the the result of the rise in location value and how much increase is not a matter of location. due to the real investment. Any previously empty lots or lots with buildings planned to be razed off them (for e.g. Of course, as explained in “Sidenote Box 4311A: Components of Location Value”, the reputation – “brand” – of a whole region might increase, but this can be

2328 See: ”4.1.3.3 Other Ways of Encouraging Giving Work to Investors, Spenders and the Indebted?” and ”6.2.2 Appendix 2.2: One Simple Ver- 2329 See: ”6.3.4 Appendix 3.4: Productive vs. Distributive Activity – How sion of a Competitive Taxation Model”. e.g. Marketing and Finance Are Productive”. Limited, Vital Resources – Tax Land to Prevent Hoarding | 491

considered location value. Such a status is seldom caused and charging for land value impacts of changes made to purely by an individual development. When a developer the plans.2331 can expect his investments to raise the value of adjacent land (e.g. when Disney constructs Disney World), it is probably worth it for him to buy up a larger area of land before making the investment decision and then, after his investment decision, sell off at a higher price the bits he does not intend to develop himself. A 10 % LVT would still leave almost half of any land value (and increase thereof) to the owner, but make it unprofitable to keep it out of Chapters 4.3.1.4-4.3.4 not included in this sample productive use for a longer time.

To sum up, land value should not be determined purely based on the market price of the individual piece of real estate, but as a weighted average of (or using another algorithm taking in) the highest offers on similarly zoned pieces of real estate in the same region – making considerations for special attraction features (e.g. a river, a beach or exceptionally good views). This would maintain the incentive of any individual developer and investor to maximize the market value of their own real estate, regardless of the means.

But these are only the best options this book comes up with. Land valuation (and the details of LVT in general) is surely an area in economics where lots of (pun intended) creative solutions and innovation is necessary. Competing governance forms – e.g. charter cities or mostly autonomous states within federations2330 – could allow experimenting on different alternatives and letting people choose the ones they consider most fair.

As Friedrich Hayek notes, the biggest challenge with land value taxation is the difficulty “to distinguish clearly between the value of ‘the permanent and indestructible powers of the soil,’ on the one hand, and, on the other, the value due to the two different kinds of improvements – that due to communal efforts and that due to the efforts of the individual owner”. (Hayek 1960, pp. 352-353) However, it is not necessary to distinguish between value resulting from public investments and value resulting from general economic development (or the “powers of the soil”), as long as public investments are approximately known before the land is sold to any private developers. The biggest challenge is in determining the value created by the real estate owners’ own development efforts, as explained in this chapter.

In any case, changes in both municipal investment plans and zoning can cause both windfall profits and losses to real estate owners – and they can do even more so in the current situation with no significant land value taxes. This is why zoning and public investment plans need to be predictable and there should be a system for compensating

2330 See: ”6.3.3 Appendix 3.3: A Hypothetical Alternative to Democracy: Competing Governance Forms for Natural Resources”. 518 | Why We Don’t See the Problems for What They Are

5.1 WHY WE DON’T SEE THE PROBLEMS FOR WHAT THEY ARE

The problem, as in most cases of ‘paradigm “shift,’ is that the consensus reality doesn’t 5.1.1 Our Emotional know it’s dead yet.” – Kevin A. Carson, Austrian Attachment to Words and Marxist Theories of Monopoly Capital: A Mutualist Synthesis (2004, p. 2) In short: • People usually don’t “think concepts”, but One trouble with [LVT] which makes it rather “feel words”. “almost impossible to achieve, is that it is so simple and so easy. You cannot get people to do • Words like “inflation”, “capital”, “prof- anything that is simple; they want it complex it”, “interest”, “money”, “corporation” so they can be fooled.” – Clarence Darrow, The and “productivity” have gathered strong Land Belongs to the People (1916) emotional charges, making people classify them strictly into “good things” and “bad things”. This prevents them from seeing their conceptual essence and causal relationships as well as many possibilities involving them. • The fact that “frames (including the choice of words) trump facts”, makes it very easy to get people to believe completely inco- herent bullshit by appealing to their “final vocabulary”. Words are pale shadows of forgotten names. As names have power, words have power. “Words can light fires in the minds of men. Words can wring tears from the hardest hearts.” – Patrick Rothfuss, The Name of the Wind

There is something about words. In expert hands, manipulated deftly, they take you “prisoner. Wind themselves around your limbs like spider silk, and when you are so enthralled you cannot move, they pierce your skin, enter your blood, numb your thoughts. Inside you they work their magic.” – Diane Setterfield, The Thirteenth Tale Our Emotional Attachment to Words | 519

I know nothing in the world that has as much is the feeling which is being expressed. It is clear that “power as a word. Sometimes I write one, and there is nothing said here which can be true or false.” I look at it, until it begins to shine.” – Emily (Ayer 1936, p. 110) Dickinson “It is worth mentioning that ethical terms do not serve only to express feeling. They are calculated also to Words are loaded pistols.” – Jean-Paul Sartre arouse feeling, and so to stimulate action. Indeed some “ of them are used in such a way as to give the sentences Words, a letter and a letter on a string, in which they occur the effect of commands.” (Ayer will hold forever humanity spellbound. 1936, p. 111) “Words, possession of the beggar and the king. “Good” and “right” (in their moral sense) are purely Everybody, every day you and I, we all can say emotional words, but many other words also are strongly words, regarded as a complicated tool created by emotionally charged. For example in the context of food, man, implicated by mankind. Words, obsession “calories” and “energy” mean conceptually exactly the of the genius and the fool…” – Anders Edenroth, same thing (a calorie is a unit for measuring energy), but The Real Group, Words saying that food has calories often implies a negative attitude towards the matter, whereas a food being “energetic” has a positive emotional charge to it. We don’t So what is it that has prevented us from considering have to simplify the conceptual parts much to say that: these kinds of alternatives before? One big factor is that we are blinded by words and especially our emotional —— Brainwashing is education of which we don’t associations with these words. approve. —— Arrogance is self-confidence of which we don’t A.J. Ayer and C.L. Stevenson were pioneering “emotivists” approve. noting that words have strong emotional and attitudinal charges (connotations) in addition their conceptual —— Greed is ambition of which we don’t approve. meaning (denotation). This has the biggest implications in —— Terrorism is freedom fighting of which we don’t terms of ethics: Saying that something is “good” or “bad” approve. or “wrong” or “right” doesn’t actually describe a property of the object at all, but only tells about the talker’s attitude —— Propaganda is communication of which we don’t towards it – how much he or she approves or disapproves approve. of it. Saying “stealing is bad” is essentially the same as saying “down with stealing”. “Honesty is good” means the (To be more accurate, many of these words are complex same as “yea for honesty”. In the emotivist view, ethical bundles of associations – also conceptual associations, not questions are thus completely subjective, and no final just emotional. For example, “greed” can refer to at least “good” or “bad” can be established by objective criteria. (1) chronic dissatisfaction, (2) selfishness, (3) irresponsible According to emotivists, to make a moral judgment is to shortsightedness and (4) taking inconsiderate risks – express one’s emotions and invite others to share them – either separately or all of these collectively. “Ambition” and act on them: would mainly be a type of chronic dissatisfaction, but when directed at relative things – like status – it can also “Thus if I say to someone, ‘You acted wrongly in be a kind of selfishness.) stealing that money,’ … [i]t is as if I had said, ‘You stole that money,’ in a peculiar tone of horror, or written it In addition to the fact that words can have universal with the addition of some special exclamation marks. emotional connotations (included in their commonly The tone, or the exclamation marks, adds nothing to accepted definitions), we also have our own emotional the literary meaning of the sentence. It merely serves attachments with words and the ideas they represent. to show that the expression of it is attended by certain These associations are mostly instilled into us during our feelings in the speaker. childhood and are strongly connected with the dominant morals of the society we live in. For example, we have If now I generalize my previous statement and say been taught that “work” and “saving” are virtuous things, ‘Stealing money is wrong,’ I produce a sentence while “spending”, “borrowing” and “debt” are things for which has no factual meaning – that is, expresses no which we should feel guilty. This makes “money” such proposition which can be either true or false. It is as if I a disturbing emotional contradiction for us: We get it for had written “Stealing money!!” – where the shape and working and saving, which are “good”, but on the other thickness of the exclamation marks show, by a suitable hand “money is the root of all evil”. No wonder many convention, that a special sort of moral disapproval people are emotionally confused when it comes to money. 520 | Why We Don’t See the Problems for What They Are

A f lot o these emotional and cultural fixations about and the use of value-charged terms (by e.g. politicians and the virtue of saving have their roots in ethics that have advertisers). This means using words with e.g. a negative evolved hundreds of years ago in a world where capital connotation when talking or thinking about things was scarce and people lived hand-to-mouth.2460 And one approves of (e.g. sincerely praising a nation’s public we still live by these same outdated morals and try to education system as a “the most efficient brain washing find solutions through them. This is comparable to us scheme” in the world) or vice versa (e.g. an organic food trying to solve modern health issues caused by obesity, activist referring to “genetic manipulation” as a form of like cardiovascular diseases and diabetes, by eating “advanced biohacking” or a drought-induced famine as more sugary and fatty foods, which is what medieval “natural population control”). The former are also called nutritional morals would’ve – quite wisely – suggested for dysphemisms and the latter euphemisms.2466 This is best undernourished people doing lots of physical work. practiced talking to oneself or to close friends familiar with this habit, as it involves significant risks of causing This book’s sister “The Guilt Economy – Our Medieval misunderstandings and seriously offending people. Money Morals” aims to clarify big moral conflicts and help people alleviate unnecessary guilt. The book uses Beyond individual words, whole expressions include some strong and provocative metaphors to point out the assumptions. Some are discussed next in “5.1.2 The contradictions in our economic thinking – and especially Misleading Conceptual Metaphor of Money as Items or our economic feeling. Thus reader discretion is advised. Sub s t a n c e”.

There have been examples throughout this book of both And nothing so shows the importance of 2461 emotional associations and assumptions of causality or language in thought as the spectacle of even unbreakable coexistence embedded in concepts. “Profit- “ seeking”, “asset stripping”, “corporation”, “downsizing” acute thinkers basing important conclusions and “consumption” are just a few examples of words with upon the use of the same word in varying immediate negative associations for many. Economists senses.” – Henry George, Progress and Poverty have their fixations too, “inflation” being one such popular (1912, p. 30) demon with which they like to scare each other.2462 On the other hand, “competitiveness”2463 is a popular mantra in politics (Krugman 1994, p. 29) and for example Finnish 2466 “Euphemism”, definition, Merria-Webster Dictionary, cited 16.10.2013, http://www.merriam-webster.com/dictionary/euphemism economic discourse has been built around this maxim for many decades. (Heinonen et al 1996)2464

Similarly to how we can only see outside the conceptual “boxes” of our languages (incl. theoretical frameworks)2465 by looking at these “boxes” from other “boxes” (discussing and describing them using other languages), it is hard to see past the emotional charges of words, unless we link them to words with a contradicting emotional charge. The author suggests the habitual practice of “connotation sarcasm” (or “emotivist irony”) to increase open-mindedness, facilitate tolerance and understanding towards others’ ideas and values, as well as avoiding being manipulated through choices of frames

2460 See: ”Sidenote Box 119A: Memetic Evolution Outpaces Genetic Evo- lut ion”. 2461 See: ”6.1.4 Appendix 1.4: The Conundrum of Causality – The Culprit Depends on Comparison”. 2462 It also, etymologically, includes the assumption of a causal relationship between the quantity of money and its purchasing power. See: 5.1.2 The Misleading Conceptual Metaphor of Money as Items or Substance” and “1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And Has Little to Do with the Quantity of Money”. 2463 See: “2.2.5.3 Competitiveness Politics – Just Indebt Other Nations Fu r t h e r ”. 2464 Heinonen, Visa; Mykkänen, Juri; Pantzar, Mika & Roponen, Seppo, 1996, “Suomalaisen talouspolitiikan ajattelumallit”, Helsinki, Kuluttaja- tutkimuskeskus. 2465 See: ”5.1.2 The Misleading Conceptual Metaphor of Money as Items or Substance”. The Misleading Conceptual Metaphor of Money as Items or Substance | 521

5.1.2 The Misleading your own with a cigarette, you are a f*cking Conceptual Metaphor of Money philosopher. So the power of reframing things as Items or Substance cannot be overstated. What we have is exactly the same thing, the same activity, but one of In short: them makes you feel great, and the other one, • People intuitively think about money as a with just a small change of posture, makes you “thing” or substance”: something that “is” feel terrible.” – Rory Sutherland, Perspective is somewhere and can be “moved” freely from everything2467 one place to the another and the creation and destruction of which is somehow Fantasies are cheap. Examined by themselves cheating or unnatural. they may form a closed system and so appear “acceptable to our understanding. Like miracles • A better fitting conceptual metaphor than they are above nature, they grow and thrive a “substance” would be “distance”. Money, in the brains of men. Translated into reality, as a credit contract, is not an entity or an however, they at once come into collision with element, but a relationship between two facts.” – Silvio Gesell, The Natural Economic parties. Order (1916, Part 3, Ch. 3) • “Loans”, “deposits”, “lending/borrowing money”, “creating/destroying money”, One factor is that there is a great fault “having money in the bank” etc. are as “in the language that we … in relation to misleading terms and expressions as say- banking. The word ‘deposit’ is a hangover from ing that you are “creating kilometers/dis- the days of the goldsmiths who took bags of tance” when you move further away from gold for safekeeping.” … “And we also speak your friends and family. of banks ‘lending money’. Banks do not lend money!” – Victoria Chick (Emeritus Professor of • This misleading conceptual metaphor Economics, University College London)2468 leads both economists and the general population to make intuitively appealing but People relate to and predict the behavior the complex completely misleading assumptions re- systems in the world around them through their “internal garding how money “behaves” or what can languages” and their mental models – which are most be done with it – it’s causal relationships. often metaphors of some sorts. The academic discipline of psycholinguistics studies how these models are strongly It ain’t what you don’t know that gets you into affected by the spoken languages we use, as is explained in more detail in “The Guilt Economy.” “trouble. It’s what you know for sure that just ain’t so.” – Mark Twain A metaphor that is implied in the way in which something is talked about is called a conceptual or generative metaphor. Our life is the creation of our minds, and we E.g. when, talking about a relationships, one says “we do much of that creating with metaphor.” ... came a long way together before taking our separate “ paths”, one is using the conceptual metaphor of a journey “With the wrong metaphor we are deluded; with to describe the relationship. As another example, a battle is no metaphor we are blind.” – Jonathan Haidt, a common conceptual metaphor for a debate or argument: The Happiness Hypothesis (2006, p. 201) “The ministers dug deeper into their bunkers when the opposition commenced its final assault.” The problem is, when you can’t smoke, if you stand and stair out of the window on 2467 1:04->, Sutherland, Rory, 2011, “Perspective is everything”, TED “ Talk, viewed 21.1.2014, http://www.ted.com/talks/rory_sutherland_per- your own, you’re an antisocial friendless idiot. spective_is_everything.html 2468 12:22-> & 14:54->, Chick, Victoria, 2013, “Why don’t Economists un- If you stand and stare out of the window on derstand money? (Conference 2013)”, viewed 4.3.2014, http://www.youtube.com/watch?v=EObtwxpDSzk 522 | Why We Don’t See the Problems for What They Are

One such extremely harmful conceptual metaphor This misleading conceptual metaphor of money as leading to completely misleading conclusions of causal “things”, “objects” or a “substance” that exists in itself, is relationships2469 is in the terminology and expressions we located somewhere and can be moved from place to place use in the context of money. The expression “a medium is probably a factor allowing many myths to prevail in of exchange” (in some languages, e.g. Finnish, “a tool of economics: exchange”) implies that money is some kind of substance or collection of objects. This perception is also upheld —— The assumption that increased saving lowers by the expressions of “lending money” and “borrowing banks’ lending interest rates. money”, when “borrowing” and “lending” usually refer —— The overreliance on the Quantity Theory of Money. to temporary changes in possession of items without a change in ownerships.2470 If you – having forgotten your —— The confusion between the “money supply” (the wallet at home – asked me to buy you a beer this weekend “quantity” of money) and the supply of money (the with the idea of you buying me one back next weekend, “policy interest rate”/the cost of credit/the “price” you saying “would you lend me a beer” sounds a bit odd, of money).2474 as it implies a promise to give back the same beer later —— Misleading expressions such as a “liquidity trap”. after holding on to it. And more mundane assumptions such as: Taking a loan from a bank is more like owing a friend a beer at the bar than borrowing his football for the —— That taxes can only be collected from companies weekend: It is granting credit – permission to delayed that “make” money by making profits. payment2471 – to someone. The money (entries) in our —— That wealth can (only) be increased by saving up checking accounts and cash in our wallets are only tokens money. of such credit. But yet you wouldn’t say “I have a beer in/ with Tom”, “Tom is keeping my beer” or “I’m keeping a —— That a drop in the value of money (inflation) makes beer at Tom” to imply that Tom owes you a pint of beer, people or the economy “poorer”. but you would say: “I have 100 e in the bank”, or “I’m keeping my money in the bank”. Maybe we should start Starting to see currencies – dollars and euros – as units for saying instead “Bank A owes me 100 e”, “I have 100 e of accounting for debts and credits (units of account) would credit on my bank”, “I am 100 e long”2472 or “I’m up 100 e”. be a significant step in facilitating constructive and more creative economic policy discussion. Also the concept of “inflation”, which, etymologically, assumes the Quantity Theory of Money,2473 can be seen as Just like other measuring units, you cannot keep them a part of this massive generative metaphor, emphasizing in storage. You cannot “have” 10 meters (or even 10 kg). that quantity matters, as it does with substances. Instead, you can be 10 meters ahead of or above someone (or have 10 kg of apples). Similarly, you cannot “have 10 In addition to lingual structures, this conceptual metaphor euros”, but you can have 10 euros of credit on someone is enforced by the fact that we’ve come to associate money (or you can have a house currently worth 100 000 e on the symbolically with notes and coins, which are physical market). This is also the expression used with “ownership” objects. But notes and coins are just tokens – one way of of financial securities: having a position in it. Having a accounting for credit (on the central bank). Although “long position” means you are on the “plus side” in it and the notes and coins can be located in your wallet or in a having a “short position” means that you are on the “minus piggy bank, the credit relationship they represent is not side” in it – that you have a liability the value of which is tied to a location and cannot be (physically) “moved” – tied to the value of the target asset. only transferred to other people or institutions, which is what we call “payment”. Relations are usually not located We shouldn’t be surprised if it is hard for school kids to anywhere (e.g. “I put our friendship into garage”). understand debt or negative numbers in general if we try to explain them as “minus three apples”. What the ¢#±]≠§¶* does “minus three apples” look like!?! It is much 2469 See: “6.1.4 Appendix 1.4: The Conundrum of Causality – The Culprit easier to understand them as distances: that same distance Depends on Comparison”. in the opposite direction or being “behind” a line instead 2470 See also: ”Sidenote Box 126A: The Misleading Expression That of in front of it. And that is why we rather demonstrate ‘Banks Lend Other People’s Money” and ”1.1.7 Ownership as a Bundle of integers and other real numbers as points on a line instead R ig ht s”. 2471 See: ”1.2.2 Credit – Delayed Payment Granting Chronological Flex- of e.g. using black dots (or apples) for positive numbers ib i l it y ”. 2472 ”Long (or Long Position)”, definition, Investopedia, cited 16.10.2013, http://www.investopedia.com/terms/l/long.asp 2473 See: “1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And 2474 See: ”1.2.8 The Supply of Money Is Infinitely Interest-Rate-Elastic – Has Little to Do with the Quantity of Money”. The Money Supply is Endogenous”. The Misleading Conceptual Metaphor of Money as Items or Substance | 523

and e.g. white dots or (empty apple shells) for negative all too frequently respond by becoming even more numbers. defensive.” (Barett & Cooperrider 1990, p. 220)

Another more suitable metaphor would be electric Our political and economic scenes definitely need a charges. Total money and credit in the system is like “generative metaphor intervention”. coulombs and relative credit balances of individual agents are a bit like volts. An increased positive charge implies The used vocabulary and frameworks play an even more something else increasing in negative charge. If local significant part in politics (in which economic research charges grow too big (some party becomes increasingly is the major form of artillery2480). George Lakoff suggests indebted and insolvent), this increases the risk of charges that “frames trump facts”, meaning that voters are more short-circuiting or light arching (a credit default) – causing affected by politicians’ choices of words and metaphors a lot of damage and resulting in the charge being wasted than empirical evidence or sound logical argumentation without any productive use. The most important insight of causalities. (Pinker 2007, p. 259) This of course does from this metaphor is that negative charges (debt) cannot not only apply to economics: e.g. abortion can be made to be “destroyed” or removed without positive charges being sound very different to people (especially emotionally) annihilated as well. depending on how the fetus is referred to and who is deemed the active party in the process. (Pinker 2007, p. Money is not the only thing in which economists and 243) people are deceived and misled by language. In terms of sharing income opportunities, “jobs” is probably one of When considering the confusing etymologies and multiple the most dangerous words. Its constant use in political definitions of words like “inflation”, “capital”, “economic discussion further enforces the dogma that work can growth”, “wealth” etc., the whole history of economic only exist as these quantized chunks and that higher thought starts looking like one massive victory march employment rates require there to be more work.2475 The for the theory of linguistic determinism (informally Finnish word “työvoima” is especially confusing, as referred to by the misnomer “Sapir-Whorf hypothesis”) it simultaneously refers to “labor” – work as a factor of that people are very much governed by their language. production2476 – and “the workforce”, i.e. people who supply There is significant path dependence in the way theories and labor. concepts have developed and the assumptions embedded in concepts seem to have prevented economists from The English language is not devoid of such associations seeing some solution alternatives altogether. either: Think about the concept of a “labor party”: a party for labor. Not even “laborers”. These concepts strongly A most dramatic case example of the human slavery to enforce the perception of the labor market as “trade of language is praxeology – “the Austrian method” (Hoppe humans” – a kind of “human trafficking” – where human 1995; Rothbard 1997). Praxeology starts with the “action beings are bought and sold (between companies and trade axiom” – the “fact” that people act consciously toward unions2477) instead of it being flexible trade of services goals – as an a priori truth, not requiring or even being between employees and employers according their needs subjectable to empirical evidence or falsification.2481 and preferences (supply and demand2478). “Praxeology rests on the fundamental axiom Frank Barrett and David Cooperrider have presented that individual human beings act, that is, on the (1990) how the inception of a new generative metaphor primordial fact that individuals engage in conscious can be used to foster more open and accepting dialogue actions toward chosen goals.” … “Action implies that between disagreeing parties subtly, in situations where the individual’s behavior is purposive, in short, that it direct attempts to solve the problem only escalate the is directed toward goals. Furthermore, the fact of his conflict and opposition (i.e. have a “backfire effect”).2479 action implies that he has consciously chosen certain means to reach his goals. Since he wishes to attain “When attempts are made to make people conscious these goals, they must be valuable to him; accordingly of their negative attributions towards others and he must have values that govern his choices.” their defensive attributions in relationships, they (Rothbard 1997, p. 58-59)

2475 See: “2.3.1 The Job Creation Paradigm – Why Are We Trying to “Human action is purposeful behavior. Or we may Make More Work?!”. say: Action is will put into operation and transformed 2476 See: ”1.1.8 Labor and Capital (and Land?) – The Factors of Produc- t ion”. 2477 See: ”3.2.3 Unionization and Strikes”. 2478 See: ”1.1.6 The ‘Market Forces’ – How Prices Balance Supply and 2480 See: ”5.2.4 The Religious Nature of Economics and Politics”. D e m a nd”. 2481 See: ”1.1.3 Value Is Subjective and Perceived – Rationality Is Largely 2479 See: Backfire effect, “6.2.4 Appendix 2.4: Cognitive Biases Blocking an Illusion” and ”2.2.2 Market-Dictated, ‘Sound’ Commodity Money – Ne w Pe r s p e c t ive s”. Austrian perspectives”. 524 | Why We Don’t See the Problems for What They Are

into an agency, is aiming at ends and goals, is the ego’s meaningful response to stimuli and to the conditions of its environment…” (Mises 1963, p. 11) Chapters 5.1.3-6.3.4 not included in this sample “The economist does not ‘assume’; he knows. He concludes on the basis of logical deduction from self- evident axioms, i.e., axioms that are either logically or empirically incontrovertible.” (Rothbard 1962, p. 582)

Essentially Austrian economists (especially von Mises, Rothbard and Hoppe) take two different definitions of the word “action” (1. doing things, 2. consciously striving towards goals) and then take it as an a priori truth that one must always be the other. If economics was just a study of language, with no attempts to draw conclusions about the real world or predict its behavior, this would be fine. Statements and “proofs” in mathematics (another language) need no empirical evidence either.

But, unfortunately, economics is “the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.” (Robbins 1945, p. 16)2482 And these Austrian economists make tons of allegedly “irrefutable” deductions regarding human behavior from this action axiom. This reasoning is comparable in validity to how some Christians might take the fact that “things exist” as irrefutable proof that these things have to have been created at some point and that, therefore, a creator must exist. Hans-Herman Hoppe, the high priest of this praxeological religion (and “apriorism” and “extreme rationalism”), goes further by not only deducing truths about how people behave but also a whole ethical system (how a society should work) from this action axiom and the non-aggression-principle, as well as the “argumentation axiom” he claims to be able to derive from them. Along “Hume’s Guillotine”2483 – “there is no ought from is” – “Hoppe’s Guillotine” could be something as follows: “is and ought are, unquestionably, unchangeable and have always been because that’s the way we talk”.2484

2482 See: ”1.1.2 Societal Structures Facilitate Cooperation – Economic Systems Direct Resources”. 2483 See: ”1.2.4 The Difference between Origin, Nature and Purpose (of Money) – ‘Metallism’ vs. ‘Chartalism’”. 2484 And if one is trying to be extremely “rationalist”, refute the importance of evidence and form a perfectly “logical” (1) model of human behavior, (2) economic system and (3) values structure, one could expect one to be at least internally coherent about it. “As a matter of fact, a situation in which these categories of action would cease to have a real existence could itself never be observed, for making an observation, too, is an action.” (Hoppe 1995, p. 24-25) “Praxeology is for the field of action what Euclidean geometry is for the field of observations (non-actions).” (Hoppe 1995, p. 82) 628 | Appendix 4: Reading Guides

6.4 APPENDIX 4: READING GUIDES

This book is not one for a single sitting – at least not reading through the table of contents will allow anyone the whole of it. It is intended to put matters into context to mark the bits one finds most interesting. After that, the and perspective. Because everything is related and cross-references will help in proceeding to the next matter interconnected (the cross-referencing is quite heavy), of interest. In some cases, the “in short” summaries might the six parts of this book would not work very well as be enough to clarify the main points. If not or if you need standalone books. more profound argumentation and references to believe the points, read the whole chapter. But fortunately the book is modular in structure and each reader can pick the sections and chapters she finds most Following are some recommended chapters for people interesting. As chapter titles are mostly “action titles” with different backgrounds and areas of interest. (they attempt to include the main message of the chapter),

A person wanting to revolutionize her worldview and conceptions of life and humanity:

–– 1.1.3 Value Is Subjective and Perceived – Rationality Is Largely an Illusion –– 1.1.9 Companies as Competing Organizational Forms (Because Institutions Suck at Suicide) – ‘Pro-Business’ Is Not ‘Pro-Market’ –– 2.1 Normative Principles – What Do We Want from an Economic System? –– 2.3.1 The Job Creation Paradigm – Why Are We Trying to Make More Work?! –– 3.2.1 Maximal Economic Security with Maximal Flexibility – Flexicurity and Antifragility –– 5.1.2 The Misleading Conceptual Metaphor of Money as Items or Substance –– 5.1.4 Institutional Interests – Rogue Agents without a Principal –– 6.1.1 Appendix 1.1: Happiness Is Appreciating – A Framework of Happiness –– 6.1.3 Appendix 1.3: A Model of the Value of Helping and Cooperation: Empathy, Contribution, Image-Boosting, Shame and Guilt –– 6.1.4 Appendix 1.4: The Conundrum of Causality – The Culprit Depends on Comparison –– 6.3.2 Appendix 3.2: The Challenges with Democracy

A welfare state advocate:

–– 1.1.3 Value Is Subjective and Perceived – Rationality Is Largely an Illusion –– 1.1.5 We Need a Market Economy Because of the Limitedness of Understanding and Empathy –– 1.1.6 The ‘Market Forces’ – How Prices Balance Supply and Demand –– 1.1.8 Labor and Capital (and Land?) – The Factors of Production –– 1.1.9 Companies as Competing Organizational Forms (Because Institutions Suck at Suicide) – ‘Pro-Business’ Is Not ‘Pro-Market’ –– 1.3.4 Foreign Trade: Current Accounts Are Also a Zero-Sum Game – Comparative Advantage vs. Absolute Advantage –– 2.1 Normative Principles – What Do We Want from an Economic System? –– 2.2.3 ‘Socialist’ Solutions – Money for Free (i.e. Credit for Nothing) –– 2.3.1 The Job Creation Paradigm – Why Are We Trying to Make More Work?! –– 3.1.3 Structural, Friction and Classical Unemployment, NAIRU and Hysteresis – Is 5 % Unemployment Really Necessary? –– 3.2 Local Social Issues –– 4.1.1.1 Forms of Employment Flexibility –– 4.1.3.4 Layoff Penalties Are Hiring Costs – The ‘Paradox’ of Reduction Restrictions | 629

–– 4.1.4 Subsidize, Deacademize and Re-Game-Design Education to Maximize Flexibility, Mobility and Adaptability –– 4.1.5 Guaranteeing Security While Avoiding Welfare Bumming: Economic Freedom Need Not Be Free” –– 5.1.4 Institutional Interests – Rogue Agents without a Principal –– 6.1.1 Appendix 1.1: Happiness Is Appreciating – A Framework of Happiness –– 6.1.3 Appendix 1.3: A Model of the Value of Helping and Cooperation: Empathy, Contribution, Image-Boosting, Shame and Guilt –– 6.2.2 Appendix 2.2: One Simple Version of a Competitive Taxation Model –– 6.2.4 Appendix 2.4: Cognitive Biases Blocking New Perspectives –– 6.2.5 Appendix 2.5: The Tyranny of Jobs –– 6.3.2 Appendix 3.2: The Challenges with Democracy A libertarian possibly sympathizing with Austrian economics:

–– 1.1.3 Value Is Subjective and Perceived – Rationality Is Largely an Illusion –– 1.1.5 We Need a Market Economy Because of the Limitedness of Understanding and Empathy –– 1.1.7 Ownership as a Bundle of Rights –– 1.1.8 Labor and Capital (and Land?) – The Factors of Production –– 1.1.11 The Fundamental Imperfections of a ‘Free Market’ – Externalities and the Limitedness of Land –– 1.2 Credit, Money and Banking –– 1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And Has Little to Do with the Quantity of Money –– 2.1.1 The Libertarian Maxim of Freedom and the Paradox of Choice –– 2.2.2 Market-Dictated, ‘Sound’ Commodity Money – Austrian perspectives –– 2.2.3 ‘Socialist’ Solutions – Money for Free (i.e. Credit for Nothing) –– 2.3.4 Supply and Demand Could Best Match Earning Opportunities – Just Fix the Imperfections –– 3.1.1 Economic Instability, Cyclicity, ‘Keynesian’ Unemployment and Growth Dependence –– 3.1.8 Public Sector Inefficiency –– 3.2.1 Maximal Economic Security with Maximal Flexibility – Flexicurity and Antifragility –– 3.4 Environmental Sustainability –– 3.5 A Competitive Option and Dominating Strategy –– 4.3.1 Limited, Vital Resources – Tax Land to Prevent Hoarding –– 4.3.2 A Market Value Tax on Patents – Minimizing the Negative Externalities of Technology Monopolies –– 5.1.4 Institutional Interests – Rogue Agents without a Principal –– 5.2.4 The Religious Nature of Economics and Politics –– 6.1.1 Appendix 1.1: Happiness Is Appreciating – A Framework of Happiness –– 6.3.1 Appendix 3.1: The Deontological Libertarian Dream: Neofeudalism or Survival of the Fittest –– 6.3.2 Appendix 3.2: The Challenges with Democracy

An anti-capitalist who wants to know what money, capital and the “market forces” are really about:

–– 1.1 Value, Production and Markets –– 1.2.3 Money as Credit – Real Wealth vs. Virtual/Fiduciary Wealth –– 1.2.6 Banking: Accounting for Debts and Credits and Pricing Risks – There Is No ‘Fractional Reserve’ –– 1.2.7 Banks Need to Be Private Because Risk Has a Market Price –– 1.3.1 Economic Growth Is the Increase in Produced and Traded Value – The Many Meanings of ‘Wealth’ –– 2.1 Normative Principles – What Do We Want from an Economic System? –– 2.2.3 ‘Socialist’ Solutions – Money for Free (i.e. Credit for Nothing) –– 2.3.1 The Job Creation Paradigm – Why Are We Trying to Make More Work?! –– 2.3.4 Supply and Demand Could Best Match Earning Opportunities – Just Fix the Imperfections 630 | Appendix 4: Reading Guides

–– 2.3.5 Structure of the Root Bug Hypothesis –– 3.1.2 Other Scapegoats for the Mystical Growth Dependence –– 3.1.3 Structural, Friction and Classical Unemployment, NAIRU and Hysteresis – Is 5 % Unemployment Really Necessary? –– 3.1.8 Public Sector InefficiencyLocal Social Issues –– 3.2 Local Social Issues –– 3.3 Global Social Issues –– 3.4 Environmental Sustainability –– 4.1.5 Guaranteeing Security While Avoiding Welfare Bumming: Economic Freedom Need Not Be Free –– 4.3 Eliminating Private Monopolies and (Other) Privileges –– 5.1.1 Our Emotional Attachment to Words –– 5.1.2 The Misleading Conceptual Metaphor of Money as Items or Substance –– 5.1.4 Institutional Interests – Rogue Agents without a Principal –– 6.1.1 Appendix 1.1: Happiness Is Appreciating – A Framework of Happiness –– 6.1.3 Appendix 1.3: A Model of the Value of Helping and Cooperation: Empathy, Contribution, Image-Boosting, Shame and Guilt –– 6.1.4 Appendix 1.4: The Conundrum of Causality – The Culprit Depends on Comparison –– 6.3.1 Appendix 3.1: The Deontological Libertarian Dream: Neofeudalism or Survival of the Fittest –– 6.3.2 Appendix 3.2: The Challenges with Democracy –– 6.3.4 Appendix 3.4: Productive vs. Distributive Activity – How e.g. Marketing and Finance Are Productive An environmentalist wanting to stop the climate change and protect biodiversity:

–– 1.1.5 We Need a Market Economy Because of the Limitedness of Understanding and Empathy –– 1.1.6 The ‘Market Forces’ – How Prices Balance Supply and Demand –– 1.1.9 Companies as Competing Organizational Forms (Because Institutions Suck at Suicide) – ‘Pro-Business’ Is Not ‘Pro-Market’ –– 1.1.11 The Fundamental Imperfections of a ‘Free Market’ – Externalities and the Limitedness of Land –– 1.2.6 Banking: Accounting for Debts and Credits and Pricing Risks – There Is No ‘Fractional Reserve’ –– 1.2.7 Banks Need to Be Private Because Risk Has a Market Price –– 1.3.1 Economic Growth Is the Increase in Produced and Traded Value – The Many Meanings of ‘Wealth’ –– 2.1 Normative Principles – What Do We Want from an Economic System? –– 2.2.4 Ecological Economics – Putting Economics into the Eco-Box –– 2.2.5 Mainstream Economic Solutions – Increase Spending or Compete Harder –– 2.3.1 The Job Creation Paradigm – Why Are We Trying to Make More Work?! –– 2.3.5 Structure of the Root Bug Hypothesis –– 3.1.2 Other Scapegoats for the Mystical Growth Dependence –– 3.3.2 Famines and Overpopulation –– 3.3.5 Resource Wars and Sustained Political Instability –– 3.4 Environmental Sustainability –– 3.5 A Competitive Option and Dominating Strategy –– 4.3.1 Limited, Vital Resources – Tax Land to Prevent Hoarding –– 4.3.3 Other Natural Resources, Renewable or Non-Vital –– 5.2.1 The Personal Nature and Incentive Traps of Academia –– 6.1.3 Appendix 1.3: A Model of the Value of Helping and Cooperation: Empathy, Contribution, Image-Boosting, Shame and Guilt –– 6.1.5 Appendix 1.5: Derivatives and Other Financial Instruments –– 6.3.3 Appendix 3.3: A Hypothetical Alternative to Democracy: Competing Governance Forms for Natural Resources | 631

A human rights activist wanting solve global inequities and preempt future humanitarian problems:

–– 1.1.1 The Division of Labor – Cooperation and Sharing Information: The Philosopher’s Stones of Mankind’s Progress –– 1.1.3 Value Is Subjective and Perceived – Rationality Is Largely an Illusion –– 1.1.4 Production Is for Consumption, i.e. Appreciation – ‘Productivity’ Has Many Units –– 1.1.5 We Need a Market Economy Because of the Limitedness of Understanding and Empathy –– 1.1.6 The ‘Market Forces’ – How Prices Balance Supply and Demand –– 1.1.8 Labor and Capital (and Land?) – The Factors of Production –– 1.1.9 Companies as Competing Organizational Forms (Because Institutions Suck at Suicide) – ‘Pro-Business’ Is Not ‘Pro-Market’ –– 1.1.11 The Fundamental Imperfections of a ‘Free Market’ – Externalities and the Limitedness of Land –– 1.2.3 Money as Credit – Real Wealth vs. Virtual/Fiduciary Wealth –– 1.3.1 Economic Growth Is the Increase in Produced and Traded Value – The Many Meanings of ‘Wealth’ –– 1.3.2 In a Closed Economy, Net Monetary Wealth Is Zero – Total Real Wealth Depends on Future Consumption and Capital Intensity (and Monopolies) –– 1.3.4 Foreign Trade: Current Accounts Are Also a Zero-Sum Game – Comparative Advantage vs. Absolute Advantage –– 2.1.5 ‘Rawlsianism’ – Justice Through the Veil of Ignorance –– 2.1.4 Utilitarianism and Happiness Politics/Economics – Does Measuring Happiness Make Sense? –– 2.1.6 Conclusions – How about a Game Design Approach? –– 2.2.3 ‘Socialist’ Solutions – Money for Free (i.e. Credit for Nothing) –– 2.2.5.3 Competitiveness Politics – Just Indebt Other Nations Further –– 2.3.2 The Overlooked Option – Increase Correlation of Earning Opportunities with People’s Willingness to Spend and Invest –– 2.3.5 Structure of the Root Bug Hypothesis –– 3.1.6.2 Sticky Trade Imbalances –– 3.1.6.1 Constantly Increasing Public Debt – A Taxation Model Based on Monopoly Profits, Charging for Services and Auctioning Resources –– 3.3 Global Social Issues –– 3.4.1 Global Warming and Dependence on Fossil Fuels –– 3.4.2 Biodiversity Deterioration, Destruction of Scarce Habitats, Pollution and Contamination –– 3.4.3 Unsustainable Waste Management –– 3.5 A Competitive Option and Dominating Strategy –– 4.1.2.3 Needed: a Pigovian Tax on the Externality Costs of Piling up Work on Fewer People –– 4.2.3.4 Preventing Hoarding by Foreign Investors and Central Banks –– 4.3 Eliminating Private Monopolies and (Other) Privileges –– 4.1.4 Subsidize, Deacademize and Re-Game-Design Education to Maximize Flexibility, Mobility and Adaptability –– 5.1.1 Our Emotional Attachment to Words –– 5.1.4 Institutional Interests – Rogue Agents without a Principal –– 5.2.4 The Religious Nature of Economics and Politics –– 6.1.1 Appendix 1.1: Happiness Is Appreciating – A Framework of Happiness –– 6.1.3 Appendix 1.3: A Model of the Value of Helping and Cooperation: Empathy, Contribution, Image-Boosting, Shame and Guilt –– 6.3.1 Appendix 3.1: The Deontological Libertarian Dream: Neofeudalism or Survival of the Fittest

A person wanting to understand economics and finance in order to make better investment decisions:

–– 1.1.6 The ‘Market Forces’ – How Prices Balance Supply and Demand –– 1.1.8 Labor and Capital (and Land?) – The Factors of Production 632 | Appendix 4: Reading Guides

–– 1.1.9 Companies as Competing Organizational Forms (Because Institutions Suck at Suicide) – ‘Pro-Business’ Is Not ‘Pro-Market’ –– 1.1.10 Companies as Contract Bundles – Financial Assets Allocate Risks –– 1.2.2 Credit – Delayed Payment Granting Chronological Flexibility –– 1.2.5 The Two Denominators of Currencies and Other Financial Instruments: the Reference Resource(s) and the Collateral –– 1.2.8 The Supply of Money Is Infinitely Interest-Rate-Elastic – The Money Supply Is Endogenous –– 1.3.1 Economic Growth Is the Increase in Produced and Traded Value – The Many Meanings of ‘Wealth’ –– 1.3.4 Foreign Trade: Current Accounts Are Also a Zero-Sum Game – Comparative Advantage vs. Absolute Advantage –– 1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And Has Little to Do with the Quantity of Money –– 3.1.1 Economic Instability, Cyclicity, ‘Keynesian’ Unemployment and Growth Dependence –– 3.1.4 Private Credit Crises, Mass Defaults and Overleverage –– 3.1.5 Too Big to Fail: The Casino Economy, ‘Financialization’ and Irresponsible Risks in Banking –– 3.1.6.3 The U.S. Case – Chronic Overvaluation of the Global Reserve Currency –– 3.2.1 Maximal Economic Security with Maximal Flexibility – Flexicurity and Antifragility –– 4.3.1 Limited, Vital Resources – Tax Land to Prevent Hoarding –– 6.1.5 Appendix 1.5: Derivatives and Other Financial Instruments –– 6.2.3 Appendix 2.3: Effects of LVT on Land Value – The Optimal Land Tax Rate?

A business manager:

–– 6.1.3 Appendix 1.3: A Model of the Value of Helping and Cooperation: Empathy, Contribution, Image-Boosting, Shame and Guilt –– 6.3.2 Appendix 3.2: The Challenges with Democracy –– 6.1.4 Appendix 1.4: The Conundrum of Causality – The Culprit Depends on Comparison –– 6.2.4 Appendix 2.4: Cognitive Biases Blocking New Perspectives –– 6.3.4 Appendix 3.4: Productive vs. Distributive Activity – How e.g. Marketing and Finance Are Productive A game designer wanting ideas for e.g. strategy games:

–– 1.1 Value, Production and Markets –– 1.2.5 The Two Denominators of Currencies and Other Financial Instruments: the Reference Resource(s) and the Collateral –– 1.2.6 Banking: Accounting for Debts and Credits and Pricing Risks – There Is No ‘Fractional Reserve’ –– 1.2.8 The Supply of Money Is Infinitely Interest-Rate-Elastic – The Money Supply Is Endogenous –– 1.3.3 The Circular Flow of Income – Consumption, Saving and Investing –– 1.3.4 Foreign Trade: Current Accounts Are Also a Zero-Sum Game – Comparative Advantage vs. Absolute Advantage” –– 2.1.6 Conclusions – How about a Game Design Approach? –– 2.2.5 Mainstream Economic Solutions – Increase Spending or Compete Harder –– 2.3.2 The Overlooked Option – Increase Correlation of Earning Opportunities with People’s Willingness to Spend and Invest –– 3.1 Economic Stability and Prosperity –– 3.3.1 Solving Poverty for Good – Ending the Economy War –– 3.4.1 Global Warming and Dependence on Fossil Fuels –– 3.5 A Competitive Option and Dominating Strategy –– 5.1.4 Institutional Interests – Rogue Agents without a Principal –– 5.2.1 The Personal Nature and Incentive Traps of Academia –– 6.1.5 Appendix 1.5: Derivatives and Other Financial Instruments –– 6.3.1 Appendix 3.1: The Deontological Libertarian Dream: Neofeudalism or Survival of the Fittest –– 6.3.3 Appendix 3.3: A Hypothetical Alternative to Democracy: Competing Governance Forms for Natural Resources

A mainstream economic researcher wanting to expand horizons:

–– 1.1.3 Value Is Subjective and Perceived – Rationality Is Largely an Illusion –– 1.1.7 Ownership as a Bundle of Rights –– 1.1.9 Companies as Competing Organizational Forms (Because Institutions Suck at Suicide) – ‘Pro-Business’ Is Not ‘Pro-Market’ –– 1.1.11 The Fundamental Imperfections of a ‘Free Market’ – Externalities and the Limitedness of Land –– 1.2 Credit, Money and Banking –– 1.3.5 Inflation Is the Rise in the (Nominal) Price Level – And Has Little to Do with the Quantity of Money –M– OST OF PARTS 2-5. –– 6.1.3 Appendix 1.3: A Model of the Value of Helping and Cooperation: Empathy, Contribution, Image-Boosting, Shame and Guilt –– 6.1.2 Appendix 1.2: Different Types of Value Products Provide –– 6.1.4 Appendix 1.4: The Conundrum of Causality – The Culprit Depends on Comparison –– 6.2.2 Appendix 2.2: One Simple Version of a Competitive Taxation Model –– 6.2.3 Appendix 2.3: Effects of LVT on Land Value – The Optimal Land Tax Rate? –– 6.2.4 Appendix 2.4: Cognitive Biases Blocking New Perspectives –– 6.3.3 Appendix 3.3: A Hypothetical Alternative to Democracy: Competing Governance Forms for Natural Resources | 637

7 REFERENCES AND INDEXES 638 | Academic Literature and Book References

7.1 ACADEMIC LITERATURE AND BOOK REFERENCES

Below is the list of literature sources referred to in the form “(Aaker 1995, p. 5)” throughout this book. In addition to these, sources not resembling books or research articles are cited directly in footnotes.

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