Looking forward

Injecting the theoretical strength of the planned economy into a capitalist market economy, might make it possible to moderate the business cycle and address the problem of climate change and social inequality

 
By Shahrukh Rafi Khan
Last Updated: Sunday 07 June 2015

While even its sharpest critics like Marx conceded to its dynamic productive potential, the capitalist market economy periodically leads to chaotic and inhumane outcomes. Witness the suffering caused by regular recessions. Its many critics notwithstanding, the market system is usually considered as the best possible mechanism for organizing production and consumption. The planned economy did not prove to be a reasonable substitute and failed. Some would argue that the socialist vision that led to the planned economy is a worthy one. Certainly Marx’s original critique of capitalism as exploitative and wasteful still resonates; now more so because it leads to environmental depredations and because the world is now much closer to the limits of growth. Some would argue that socialism, while a worthy abstract vision, is simply not consistent with the average human motivation for self-improvement as applied to the individual, family, or nation states.

Thus the challenge for humanity is to devise a method for organizing production that harnesses the powerful motivation to maximize business profits and well-being of individuals or households but minimizes social suffering and environmental depredation. In other words, the challenge is to moderate the business cycle and mitigate climate change in a way that would be politically acceptable to the capitalist democracies that are currently ascendant globally. It would certainly not be politically acceptable if recommended structural changes were perceived as weakening economies and jeopardizing national security. Political acceptance of the kind of structural reforms I propose in this essay would be possible only under extreme crisis conditions.

I believe that such conditions are inevitable and scholars should be actively debating alternatives. This essay is therefore being put forward for debate. Such reforms should ideally be introduced via a gradual and globally negotiated process. The more likely outcome is that there will be a quick and wholesale adoption of some drastic reforms. No one really knows for sure how much time humanity has, but the best available climate models suggest that time may be too limited for gradual change. The alternative presented here is in the spirit of Looking Backwards by Edward Bellamy (1967).

Certain recent developments, not available to the Soviets in the 1920s and 1930s, make an alternative and more humane method of organizing production and consumption possible; the most prominent of these is information technology. However, we need to first understand why things go wrong in the capitalist market economy and why at least in theory they should not have done so in the Soviet Union. In a closed capitalist market economy, there are three main economic agents: the consumers (households or individuals), producers (businesses) and the government. Things go wrong because households and businesses make their economic decisions independently from each other, and the government cannot harmonize these decisions so that everything that is produced gets consumed and in such a manner that everyone who wants a job is fully employed. In theory, such harmonization was possible in the Soviet Union because the state determined both wages and investment. Thus, by appropriately setting wages, they could get a sense of what and how much needed to be produced consistent with those wages leading to full employment.

Even though this works in theory, in practice the state could not gather and process the necessary information and effectively coordinate production. Moreover, the state rather than consumers decided what to produce, hence limiting diversity; the lack of individual incentive to work or profit resulted in low work effort and efficiency; the infringement of individual liberty that such a mechanism for organizing production and consumption involves was not and still would not be acceptable in democratic capitalist market economies. But while the capitalist market economies harness the corporate drive for profits and the individual or household drive for well-being and hence produce more work effort and profit, they also experience production errors. Businesses decide, based on best estimates, how much and what to produce and individuals or households decide how much and what to consume and save the rest of their income. Inevitably, mismatches in these decisions cause over-production and under-production.

In general, the capitalist market economy can adjust much more efficiently to shortages and surpluses than a planned economy. Shortages result in rising prices and profits, and the necessary flow of resources increases production as needed and vice versa. These shortages and surpluses are not the only source of economic volatility in market economies. For example, other sources contributed to the financial and economic crisis that started in the US in Fall 2007, with roots going back much earlier. The drive for profits, easy credit and high leverage, deregulation, lax implementation, moral hazard and perverse banker incentives, conflict of interest in the rating agencies, among other reasons, created “bubbles” so that prices had little bearing with underlying economic fundamentals. Due to speculation stock prices had little relation with business earnings or real estate prices with incomes or rents. When over-optimistic and mistaken values were exposed and the bubbles burst, as is inevitable, stock and real estate prices collapsed rapidly wiping out much wealth.

As a consequence, households decreased consumption which decreased production and a vicious circle set in leading to a dangerous recessionary forces. The more wealth that is wiped out, the deeper and longer the recession is likely to be because of the extent of retrenchment of consumption and production. Recessions and depressions are accompanied by unemployment and the misery this entails and therefore humanity needs to find an alternative to these retrogressive outcomes of the economic system. This economic system is also retrogressive in other ways: in good times, the main agents in the economy have an incentive to consume more and produce more since that is culturally associated with household well being and economically with producer profits. Thus businesses have an incentive to reinforce this consumer culture through aggressive and sophisticated advertising.

In fact, politicians also reinforce this culture by urging the public to spend “to keep the economy going.” This was the main popular lesson derived from the Great Depression. When the economy was under threat after the 9/11/2001 terrorist attacks, President Bush essentially declared it to be the patriotic duty of Americans to go out and consume. But the more households consume and businesses produce, the more they collectively pollute and threaten the global eco-system. Another problem is the concentration of wealth and social inequality that finance capitalism leads to, now that the real sectors serve finance rather than vice versa. The world needs to find a way to continue to harness individual and corporate incentives without adding to the climate change problem or to excessive social inequality.

This problem seems so huge and insurmountable that it is difficult to know where to start. I suggest the place to start could be the theoretical strength of the planned economy. If that DNA could be successfully injected into a capitalist market economy, it might be possible to moderate the business cycle and address the problem of climate change and social inequality by using the strengths of both systems. Thus, the challenge is to continue to use a modified market system in a way that delivers a more humane social and environmental outcome, is consistent with national security, and has a reasonable chance at political acceptance at least in a serious crisis. I turn next to these issues.

Macro-organization

Simple macroeconomics revolves around the equality of aggregate demand (AD, all that is consumed or expended) and aggregate supply (AS, all that is produced by the market for a given time and place, i.e. GDP). If aggregate supply exceeds aggregate demand, there is a surplus and lay offs may result. If aggregate demand exceeds aggregate supply, shortages may result in price level increases or inflation. Sometimes, such as when oil prices increase, it may be possible for the economy to experience both inflation and unemployment simultaneously. John Maynard Keynes, who originated this way of thinking about the macro economy, noted that the market economy is much more efficient at self correcting inflation than it is at self-correcting unemployment. This can lead to persistent unemployment when the economy goes into a recession, and this is still the main macro problem confronted by market economies.

In an open macro economy, the components of AD or aggregate expenditure are expenditures by households or individuals (C), business investment (I), government expenditure (G), and what the rest of the world buys domestically (EX for exports) minus what is bought in the rest of the world (IM for imports). To rephrase the problem earlier raised, because C, I, and EX-IM are autonomous agent decisions, there is no way of assuring that AD will always equal AS such that the equality coincides with full utilization of all resources. In macroeconomics terminology, the GDP that results from operating at full capacity utilization is referred to as potential GDP (Yp). This would mean that labor is fully utilized, where one definition of the full utilization of the labor force is that it is at a level that does not generate inflationary forces. This is referred to as the natural rate of unemployment. The presumption is that higher employment or lower unemployment would increase labor’s bargaining power relative to capital which would lead to a wage-price spiral. By this definition, society has to tolerate unemployment in the millions since the natural rate of employment is conventionally defined at about 95 percent currently. Full utilization of capital is about 82-84 percent by convention because some level of non-utilization is needed for replacement, upgrading, servicing and down time of machinery.

In this calculus, there is no accounting for the sustainable use of natural resources and so the implication is that they are limitless and to be used as needed. An environmentally and socially sound level of GDP means moving away from the current macro targeting of operating at potential GDP and also redefining the concept of economic waste as operating below potential GDP. In an altered scenario, the key economic policy making organ could be an inter-disciplinary Council of Sustainability Advisors (CSA), including natural and social scientists and national security experts, with ecologists playing a prominent role. Their main task would be defining the level of GDP consistent with the economy being able to maintain or grow its natural capital. Let us say that this level of GDP is called Yc to reflect that it is employment, climate, and conservation sensitive taking into account possible trade-offs. I turn now to the re-structuring of production.

I allude only to the broad outlines to suggest that in theory such re-organization is possible. The vast amount of nitty-gritty work could be resolved with the information collection and processing capacity that is now available with advances in information technology.

Restructuring production

Production targets would have to be set at the sector level and within the industrial sector at the industry level. Essentially, such a mechanism allows firms to compete as before, but sets a limit on total revenue and profits by industry based on the natural resource and climate change constraints. Competition would determine the flow of capital across sector and industry to equalize profit rates and anti-trust would ensure adequate competition. A tried alternative to targeting production is targeting pollution and auctioning vouchers consistent with pollution targets (cap and trade). Vouchers can be bought and sold on the secondary market so that clean producers would profit from selling vouchers and the dirty producers may eventually be driven out of the market if they do not clean up their act.

Another alternative is taxing pollution at source such as a carbon tax. However, these options do not resolve the business cycle and unemployment problems that targeting production could in principle do, and so far they have been founding wanting as solutions for climate change. If experts determine that the tipping points of climate change are not as close, or in some cases already passed, as currently predicted, the option I propose in straight-jacketing production is inferior and other options for pro-active business cycle stabilization could be considered. Other macroeconomic variables One way to ensure AD is equal to Yc could be by requiring the setting of compensation limits by sector.

Thus, given saving (S) and self-employment, the aggregate wage bill would have to be set so that AD would be consistent with Yc. However, doing away with market based remuneration could lead to incentive problems. Investment (I) in this model, as explained above, would be exogenously determined. Thus, government expenditure (G) would have to be the shift variable to ensure the balance of AD and Yc. This is not unlike fiscal policy as currently practiced except that it would have to be “pro-active” rather than “reactive.” Given that millions of households will continue to make independent decisions as would hundreds of thousands of firms (given population size and the country’s economic maturity), based on defined constraints, overshooting or not achieving targets is inevitable notwithstanding the gains of information technology. However, via an iterative process, matters in this regard would improve and this alternative is likely to be much better than the existing reality of large business cycle swings and rapidly approaching climate tipping points. International trade and finance can also inject considerable volatility into the national and the global economy.

This is exacerbated by import or export dependence, debt, capital surpluses, and capital flows. If it is difficult for G to smooth excessive fluctuations, the world could move to a system of balanced trade (EX=IM) managed at the inter-country or world level. Some inefficiency could then be tolerated for more social justice. In other words, consumers will not always purchase from the cheapest source and diversity for consumers would be restricted since exports would set the limit to the amount that could be imported. However, in exchange, production could be managed such that all seeking employment would be able to work. Adoption by other nation states An environmental, economic and social system of this kind could only work in a global context since production, trade and climate change are global phenomena.

The prosperous countries would need to engage in a grand bargain with the less prosperous countries of the world to encourage them to move towards such a system. The bargain could entail the less prosperous countries agreeing to an income convergence formula under the auspices of a newly created UN agency (say the World Sustainability Organization (WSO)). The higher income countries could be locked in at a much higher standard of living. This could even increase consistent with sustainability criteria determined by the CSA in consultation with the WSO. The low and middle income countries could be assured that, over a course of time (perhaps a century or more for the lowest income countries), they would catch up with the technological assistance of high income countries provided they subject themselves to the discipline of the WSO.

This could save the world eco-system from the drive for industrial revolutions such as currently being witnessed in China and India with numerous other countries aspiring to the same. Looking at the history of income divergence over the past half century, this would be a great bargain for low income countries. But why should the more prosperous countries accept such reform measures? Projecting past trends, with business as usual, they would continue to dramatically increase their lead. However, if the estimates of the Intergovernmental Panel on Climate Change are to be believed, the limits to growth have been arrived at and very shortly, unless there is a change from business as usual, all will head downhill.

Conclusion

The Kyoto multilateral negotiations provide a template for global negotiations. What is at stake is the survival of humanity and major global economic restructuring is needed for that.

The Kyoto targets were not nearly ambitious enough and without re-structuring national economies most forecasts suggest the world will be doing too little and too late. Current generations should make possible “looking backward” with pride in humanity’s collective contributions. In this regard, they can draw hope from Bellamy’s observation that “On no other stage are the scenes shifted with a swiftness so like magic as on the great stage of history when once the hour strikes (1967, p. 312).”

Given human complexity, individuals can simultaneously manifest both drives. Refer to the latest report of the Intergovernmental Panel on Climate Change (IPCC),. Regulation and clean production resulting from technological change can ameliorate this, but it is unlikely that there is enough time to rely solely on these mechanisms. If society is not in a series crisis, more measured approaches such that those suggested by Speth (2012) or Daly (2008) are more suitable. Such approaches are supported by organizations such as The World Resources Institute, Washington and Center for Science and Environment, New Delhi.

References

Bellamy, E. Looking Backward 2000-1887 (Cambridge, Massachusetts: Harvard University Press, 1967).

Cottrell, A. and P. Cockshott, 2007, “Against Hayek,” Munich Personal RePEc Archive, Cockshott, W. P. and A. Cottrell, 1993, Towards a new socialism ( Nottingham, England : Spokesman).

Castro, C. J. “Sustainable Development: Mainstream and Critical Perspectives,” Organization and Environment, 17, no. 2, 2004: 195-225.

Daly, H., 2008, “A Steady State Economy,” Sustainable Development Commission, United Kingdom, Hayek, F. The Road to Serfdom (Chicago: University of Chicago Press, 1944).

Lange, O. “On the Economic Theory of Socialism,” in ed. B. E. Lippincott, On the Economic Theory of Socialism (Minneapolis: University of Minnesota Press, 1938).

Lange, O, “Fundamentals of Economic Planning,” in Essays in Economic Planning (London: Asia Publishing House, 1960).

Mishan, E. J. The Costs of Economic Growth (London: Staples Press, 1967).

Pollin, R. “The ‘Natural Rate’ of Unemployment: It’s All about Class Conflict,” in Real World Macro (Boston: Dollars and Sense, 2008), 25th edition.

Pritchett, L., 1997, "Divergence, Big Time," Journal of Economic Perspectives. 11, no. 3, 1997: 3-17.

Speth, J. G., 2012, America the Possible: Manifesto for a New Economy (New Haven: Yale University Press).

Notes Thanks are due to Jens Christainsen, Thomas Weisskopf and Fred Moseley for helpful comments and suggestions. All errors in logic or otherwise are mine. The presumption of self-interest in average human behavior does not negate the existence of considerable altruism.

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