bullus_hit said:
I'm referring to capitalism in it's present form, you obviously have your own notions of the 'perfect model', and to be perfectly frank, I can't stand the false dichotomy of socialism versus capitalism. China being a perfect case in point. My arguments stem from clear market failures, externalities such pollution being a case in point.
You are referring to the system in its current form, not to capitalism. I have no notions of "the perfect model" since none exist. All I have is an opinion on what system works best.
Our current system is better referred to as Crony Capitalism or Socialism Lite, it is a combination between the two. China is another example of the hybrid system although it has a far more socialist slant. If you really think there is little difference between capitalism than socialism, then how do you explain the need for the Berlin wall? How do you explain the massive difference in material well being of people living in communist countries compared to freer countries? History clearly demonstrates the failure of socialism, yet ignorance of economics still allows these ideas to persist.
You recognise the theory of the tragedy of the commons. I support this theory and you might be surprised to know that it is a fundamental aspect of free market capitalism, which advocates private property. Socialism does not. False dichotomy? The accumulation of capital and improving living standards would far better held in balance with environmental protection if we protected private property rights. The Soviet Union had extensive environmental regulation, and it did nothing to prevent the massive environmental damage there.
bullus_hit said:
In my opinion, economic growth is best described as the accumulation of capital. Capital are the goods that were produced by previous stages of production but do not directly satisfy consumer's needs; they are used in production to eventually produce consumer goods.
Consider a world without interfering central planners. In such a world, savings are simply that part of production that has not been consumed. Since investment is constrained by the amount of available savings, it follows that less consumption is the prerequisite for more investment. Every year, a certain amount of capital needs to be replaced. The amount of savings in excess of this replacement need is what is available for additional, net new capital investment. Keep in mind that I'm talking about real resources and capital, not 'money'.
Capital is however not an aggregate. It has a structure – what is often called the 'structure of production'. This structure has a complex ordering; before a consumer good hits the shelves, it goes through number of processes - the stages of production.
Consider a relatively simple good like a toaster. It has metal and plastics parts, put together in such a way as to make the toasting of bread possible. In the early stages of production, the metal needs to be mined and smelted; the oil needs to be pumped and transformed into plastic. In the next stages the metal and plastic must be shaped into the various parts that will make up the toaster. In a still later stage, the parts need to be assembled. In the final stage, wholesalers and retailers hold an inventory of toasters and organise their distribution to consumers (this is a very simplified version of the whole process). During the various stages of production involved in making this toaster, some take place earlier in time than others, and that the earlier stages in which the higher order raw and intermediate goods are produced are likely to involve very long range planning and large capital investment.
So how do entrepreneurs know how much and in which stages of the production process to invest? This depends on the amount of funds available for investment – i.e. the amount of available savings. The market signal that indicates whether a relatively large or small amount of savings is available is the prevailing interest rate. We are all producers, consumers and savers in personal union; our propensity to collectively either consume more in the present, or consume less in the present in order to save for future consumption, is called 'time preference'.
If our time preference is low, we will tend to save more of our production, which will increase the amount of savings available for investment – the interest rate in this case will fall. This allows the long range planning of consumers (saving for future consumption) to mesh with a corresponding long range planning of producers – as the larger amount of available savings as indicated by low interest rates makes very complex long range investment projects possible. Investment will then increasingly gravitate toward the earlier stages of the production structure, and these stages will then be able to outbid the later stages for labour and resources.
In addition, the production structure will tend to lengthen – a more complex and roundabout production process will evolve, adding new stages of production to the structure, improving overall productivity via increased specialisation.
At the end of this process, over time, more consumption will be possible than would otherwise have been the case, i.e. if fewer savings had been available earlier. In short, by people deciding to consume less in the present and save more for future consumption, more investment is made possible, which in turn will enable more production and consequently make possible more consumption in the future.
This is what 'sustainable' growth actually is. There is no need to interfere with this process – it will spontaneously order itself in an optimal manner if left alone – by what Adam Smith called the 'invisible hand'. The sum of all individual decisions in the market economy – individual decisions that are all aiming for one's material betterment – will spontaneously create the order that makes such betterment actually possible.
By means of rising and falling interest rates, the market informs investors and entrepreneurs about the size of the subsistence fund available to finance capital investment projects, the preference for consumption relative to saving, and will thus guide the decision-making process regarding in which stages of the production structure to predominantly invest.
This also highlights how wrong people are when they say that a collective propensity to save more and consume less is a negative development for the economy. It fails to consider that only by saving can one invest – and that a propensity to save more will only affect investment in the later stages of production.
Any interference in this process is socialist in nature, and is why we have massive distortion in market signals which results in a massive misalloction of capital which has to be wiped clean in the bust.
Consider the populist policy of artificially holding interest rates as low as possible that is employed by a central bank. Low central bank interest rates are designed to artificially inflate credit and thereby stimulate consumption.
This has two simultaneous effects that conspire to create an artificial boom that must perforce give way to a bust at a later stage. For one thing, it creates an incentive to consume rather than save – i.e. it raises time preferences. This raising of time preferences is not only due to the rising availability of credit and the lowering of returns on savings, but also due to the devaluation of money that the central bank's policies engender over time.
Normally, rising time preferences would tend to drive up the rate of interest, as fewer savings, and thus fewer funds for lending, are available. However, the rate of interest has been artificially fixed by the central bank, which then supplies as much money to the marketplace as is demanded at its prevailing administered rate. Contrary to real savings, this is however 'money out of thin air' – no production preceded its introduction to the marketplace.
At the same time, it won't fail to transmit the information to investors and entrepreneurs that there are plenty of savings available to invest. In other words, the artificially low interest rate misleads investors into assuming that the pool of available savings (the pool of real funding) is much larger than it actually is. Large long lead investment projects in the earlier stages of production will be undertaken, just as consumers are actually saving less and consuming more due to the same artificial incentive.
For a time, the central bank can 'paper over' the fact that real resources are consumed instead of saved, but this process of 'papering over' actually accelerates the decline in the pool of real funding via overconsumption, while capital is concurrently misdirected and malinvested. This process of malinvestment results in too much capital flows toward the production of early stage higher order goods production.
This combination of overconsumption and malinvestment takes place until the point in time when the actual state of the pool of real funding is suddenly revealed. Malinvestment implies that numerous investment projects were started that could not possibly be finished, respectively also that numerous economic activities were underway that would not be viable at all absent a credit boom.
Sometimes the artificial boom ends because the central bank belatedly decides to abort its artificial low interest rate due to the secondary lagged effect – rising prices – becoming 'visible in the data'. As an artificial boom-bust sequence progresses, it takes more and more credit inflation to engender the 'desired' economic effect of 'creating growth', which is really synonymous to creating economic activities that squander wealth. At the same time, it takes an ever smaller rise in the administered interest rate to actually starve the boom of the exponential credit creation it needs to survive.
The duration and amplitude of the boom-bust sequence meanwhile increases over time, as more and more of the pool of real funding is consumed. How can there be a 'boom' at all, when it consists mostly of overconsumption and malinvestment? Simply put, the artificial boom that credit and money out of thin air create draws upon the previously accumulated capital and consumes it, or part of it.
Note that there comes a point in time when no amount of additional credit out of thin air can restore the boom – this final stage is reached once the credit expansions of the past have consumed so much of the subsistence fund of real savings that it has stopped growing, respectively has actually begun to decline. The current 'credit crunch' episode is a strong sign that we may have reached that point.
Now this is just one example of the effect of interventionalism on the economy, I think this will suffice for now.
