[Michael Perelman on whether the economy is productive or merely
extractive... and this is an important insight. Mark]
========== Introductory
Walking along a city street, I look up at a marvelous office building.
Hundreds, perhaps thousands of people are busy manning computers, telephone,
fax machine, or copiers or maybe just shuffling paper. Great wealth flows to
some of the people who occupy these offices or to those who command the people
in the offices. What exactly do they do? What exactly do they accomplish?
In a field in the countryside, a number of immigrant laborers are working
hard amidst a toxic soup of agricultural chemicals. Without these people or
others like them, the economy would grind to a halt. What would people eat
without these workers in the field? Yet, despite their undeniable
contribution, these workers earn very little unlike the privileged workers who
occupy the more spacious offices. Certainly nothing compared to those who
give the orders to the crews in the offices.
In a market economy, everything follows the inexorable laws of the market.
Supposedly everyone earns a reward commensurate with his or her productivity.
Economists can tell you with assurance that the farm workers live in poverty
because their productivity lags far behind the average in the economy.
In contrast, the people in the more spacious offices enjoy enough rewards to
lead a life of comfort, or even luxury. Supposedly, they earn their elevated
station in life because of their high productivity, even though you may have a
hard time identifying exactly what they produce.
Economists teach that the people who in the offices who market and
distribute the goods and services must be very productive -- no, highly
productive -- since their wages are so high. These figure out ways to wrap
products in layer after layer of packaging. They devise advertising that
makes people feel a necessity to buy goods. People who get these jobs usually
have some higher education, even though their education probably has little to
do with their responsibilities on the job. This education is also supposed to
be a signal of their productivity.
Even more productive are the people that shunt money around -- sometimes in
stocks, sometimes in bonds and sometimes in directly productive investments.
These people are extraordinarily productive.
In contrast, to the successful member of the economy, the lowly farm workers
have little education. Their skills are widely available since many people
from poor countries would willingly take their jobs. How could a person like
that possibly be worth as much as a successful worker occupying a lavish
office?
Besides, the food that the farm workers grow is not worth very much, so how
could they be productive. Their meager productivity is thought to be
sufficient to explain their low salary. Of course, this conventional image
could possibly have a different interpretation. What if their low salary
explained why the food they grow is inexpensive? What if the high salaries
that some professional workers earn merely reflect the fact that they happen
to represent sectors of society that get special privileges?
========== extraction vs. production
I want to raise a basic conceptual problem about the nature of the economy:
is the economy is productive or is it merely extractive?
By productive, I mean that the economy manages to combine labor and
resources to create something over and above what initially went into the
production process. Obviously, the production process can turn out something
move useful that the original products. For example, the agricultural system
can convert petroleum, which is inedible, into nutritious food.
On the other hand, the supply of petroleum is fixed. Eventually, the time
will come when an agricultural system, dependent on petroleum will have
difficulty finding an adequate supply of fuel. In contrast, the traditional
agricultural system had the potential to run on renewable resources, although
it often operated destructively as well.
Now, if the economy is indeed productive, then those who are the most
privileged might have some legitimate grounds for counseling the most
disadvantaged that future economic growth will be the most likely or most
efficient strategy for bettering their condition. For that reason, they would
be well advised to accept their situation. If the economy is purely
extractive, then such advice has no grounds whatsoever.
========== Economic Logic
Economics consists of two distinct layers of theory. The first one
comprises self-evident propositions that are virtually unquestionable. Within
this context, economics teaches that an individual prefers more to less; that
lower prices encourage consumption and discourage an individual firm from
increasing production. All of these propositions would seem to represent
common sense rather than some scientific wisdom.
Notice that each of these propositions refers to the behavior of an
individual, acting in isolation. Economics based on such common sense
sometimes works relatively well in simple situations. For example, you can
feel fairly confident that if a large number of people move into town without
a corresponding increase in the number of housing units, rents will increase.
Problems emerge when economists move from such simple analysis to deal with
more complex situations that involve interactions with other people. In that
context, economists' conclusions become more tenuous. For instance, high
prices can actually encourage people to purchase a commodity when low prices
are taken as a signal of an inferior quality.
A number of software developers found that they were only able to sell a
large number of their products after they raised their prices. Similarly,
consumers sometimes prefer to purchase goods with higher prices because of the
snob effect -- that other people would see their display of such goods as
evidence of affluence.
Although simple economic theory depicts the actions of an isolated
individual, a modern economy consists of a complex network of interactions
among a large number of people. Economists have no way of capturing this
complexity. Instead, they base their reasoning upon highly simplified models
that, more often than not, leave out essential elements of the subject matter.
Economists rarely signal any fundamental difference when they make the leap
from the common sense level of economics to this more abstract level.
Instead, they adopt an unmerited certitude befitting their scientific
pretensions.
========== Value Theory
When pressed to explain the basis of their theory, economists do not appeal
to common sense, but to what they call value theory. Value is a strange
concept. It originally seems to have referred to an economic equivalency, but
the rhetoric of value easily slid from economic value to religious values,
family values, and back to economic value again. Fortunately, the English
language labels matters of real importance as invaluable.
Economists eschew anything but a relatively narrow conception of value. For
economists, value is supposed to convey something comparable to a scientific
framework. This "scientific" value theory has far ranging ramifications. In
fact, virtually all abstract economics rests upon an underlying theory of
value.
More than a century and a half ago, John Stuart Mill, probably the most
important British economist of the time, explained the vital importance of
value theory for economics: "Almost every speculation respecting the
economical interests of a society thus constituted, implies some theory of
Value: the smallest error on that subject infects with corresponding error
all our other conclusions; and anything vague or misty in our conception of
it, creates confusion and uncertainty in everything else" (Mill 1848, p. 456).
While Mill was correct about the importance of value theory, what came next
constituted perhaps the worst assessment ever made by an economist. Brimming
with confidence, he boldly proclaimed:
Happily, there is nothing in the laws of Value which remains for the
present
or any future writer to clear up; the theory of the subject is complete: the
only difficulty to be overcome is that of so stating it as to solve by
anticipation the chief perplexities which occur in applying it: and to do
this, some minuteness of exposition, and considerable demands on the patience
of the reader, are unavoidable. [Mill 1848, p. 456]
Despite Mill's confident optimism, efforts to build a theory of economics
around value theory floundered, in large part because of the difficulty of
comparing values over time. The complications associated with time are
especially glaring in the case of capital goods since they are bought at one
point in order to earn profits in the future. More than a century after Mill
wrote, Christopher Bliss assessed the state of the theory of capital
valuation, a core element of value theory:
When economists reach agreement on the theory of capital they will
shortly
reach agreement on everything. Happily for those who enjoy a diversity of
views and beliefs, there is little danger of this outcome. Indeed, there is
at present not even an agreement as to what the subject is about. [Bliss
1975, p. vii]
He went on to explain:
capital is many things to different men. To the rentier it is a claim
on
income now and in the future. To the entrepreneur it is some necessary
inputs. To the accountant it is entries in a valuation account. To the
theorist it is a source of production and a component of the explanation of
the division of that production. [Bliss 1975, p. 7]
Few economists took note of Bliss's pessimistic realism. Instead, each school
of economics continues to deploy its own idiosyncratic theory of value without
much concern for realism.
========== FIXValue Theory and Economic Efficiency
Economists conceptualize the economy as a network of relationships in which
each supplier is attempting to maximize profits. In so doing, the combined
effort of these suppliers turns a given allotment of resources into a maximum
output of value.
This sort of economic theory might make sense if the economy consisted of
nothing more than a small village in which people awoke each morning to take a
fresh harvest of resources and convert them into a daily output. In a real
economy, in which people invest in long-lived capital goods, such as
railroads, and in which technology can sometimes change with maddening speeds,
confidence in the efficacy of the economic process is more difficult to
maintain.
For example, part of the process of making bread consists in conveying wheat
in railroad cars. The decision of whether or not to bake another loaf of
bread to sell in the market is not very challenging, but a comparable decision
for investing in railroads involves enormous speculation. What grounds does
anyone have for believing that the investment in railroads is the ideal one?
Perhaps a revolutionary new mode of transportation will become economical in a
few years. Or the location of people or industry will move eliminating much
of the market of the railroad. Either possibility would wipe out much of the
value of the bread.
==========
For example, in the late 1990s, Motorola led a group of investors in the
creation of a $5 billion communication system. The venture filed for
bankruptcy a few months after it was ready for business.
The Wall Street Journal enthused?
Had the expectations of these investors been met, the world might have
hailed them as visionary. Instead, they had egg
========== Value Theory and Discounting
Economists still put great stock in value theory even though they are
usually discreet enough to stow it away from public view. It was expected
both to describe how the economy works as well as to show why the market works
with unparalleled efficiency. In this spirit, Gerard Debreu, wrote in his
book, Theory of Value, which won him a Nobel Prize in economics: "The two
central problems of the theory [of value] are (1) the explanation of the
prices of commodities ... and (2) the explanation of the role of prices in an
optimal state of an economy." (Debreu 1959, p. vii)
In their quest for a scientific theory of value, modern economists tried to
model their discipline after physics. In fact, they intentionally coined the
term economics in the late 19th century to make their subject matter sound
more like physics. Earlier practitioners had referred to their work as
political economy -- a much less scientific sounding term.
Given their heroic effort to model economics on physical laws, you might
expect economics to resemble natural science. But, economics differs from
natural science in two significant respects. First of all, economics has
nothing comparable to the laws of the conservation of matter and energy.
Instead, productivity is the centerpiece of economics. Presumably, the
productive system allows the economy to take a given value of inputs and
create a greater value of output.
Although economists allow that the proper functioning of the market creates
a surplus of value out of the blue, many, if not most, economists rule out the
possibility that the natural functioning of markets can destroy values through
the underutilization resources associated with depressions.
Economists sought the approval of the most important 19th century physicists
regarding their application of the physicists' mathematical techniques. Much
to the economists' chagrin, the physicists took umbrage with them on this very
issue. They insisted that economists could not legitimately pretend to have
much in common with natural science without some sort of conservation law
(Mirowski 1989).
The second difference between economics and the natural sciences is that
economists introduced the concept of discounting. Following common sense
rather than science, economists contend that a rational individual values a
good today more than the same good tomorrow. Consequently, the value of
future benefits should be discounted.
Discount rates are unknown in the natural science. A molecule of oxygen
tomorrow is identical to a molecule of oxygen today.
What then should the discount rate be? Children place very little value on
the future, presumably because their brains are incompletely formed until
maturity. In effect then children have a very high discount rate, even though
they may have no idea about what discounting means. Business, too, has a very
high discount rate. Many corporations will abstain from any investment that
does not promise an expected rate of return of 20 or 25 percent. With such a
high discount rate, whatever happens 10 or 15 or 20 years from now is
inconsequential.
Given that perspective, conservation of resources has virtually no
importance whatsoever. Obviously, discounting puts economists at a
considerable distance from environmentalists.
========== Sweeping Time Under the Rug
For the most part, economists are understandably uneasy in having to
confront the concept of time. Whenever they begin to feel confident that they
finally have a good command of their material, a deeper examination allows
disturbing questions of time to intrude causing obvious discomfort.
Economists apply great virtuosity to avoid coming to grips with the
complexity that the concept of time requires, but in doing so they make their
analysis far less realistic and even irrelevant to the real world.
Nonetheless, one cannot dismiss their work since it remains highly
influential.
Economists draw upon standard practice in speculative markets to develop
their main technique to avoid confronting the difficulties presented by the
concept of time. They manage to collapse the entire future into a single
number, known as a present value or a capitalization.
Consider the formation of a price for a piece of real estate. This
valuation process has three dimensions. First, the participants in the real
estate market have to estimate the range of possibilities for each payoff
period in the future. This number ultimately depends upon some combination of
the expectations about both the future sales price and the rents that it will
earn prior to the sale of this property to the next buyer. Then the
prospective purchasers have to apply a probability to each of these
possibilities to calculate an expected payoff for each future period.
Finally, they have to discount each of these expected payoffs.
On the basis of these calculations, speculators can come up with a figure
that represents how much a property is worth. If the market price is below
that present value, it represents a good investment. If not, a speculator
will not make a purchase.
Of course, few, if any, speculators would actually make such precise
calculations. After all, the future remains unknown. Intuition and emotion
probably exercise more influence in most deals, but economic theory
unrealistically assumes that everybody behaves in a supremely rational manner.
Such precision is essential for the theory to be able to "prove" that the
economy works efficiently.
Even if the speculators had perfect information about the future performance
of this property, the subjective influence of the discount rate would still
intrude. This present value calculation allows economists to treat long-lived
capital goods as if they were no different from a loaf of bread and would be
both baked and consumed within a few days -- in effect banishing the
complexities of time and uncertainty from their theory.
========== The Material Base of Value
The recent run-up in the NASDAQ dot.com stocks illustrates how tenuous the
capitalization process is. Investors, believing that Internet stocks had an
almost unlimited profit potential, investors bid up the prices of these stocks
to what in retrospect were ridiculous heights.
These investors seemed to be unmoved by the absence of profits. Given the
high discount rate typical of financial markets, these stock prices seemed to
make no sense whatsoever. Investors even seem to have taken the rate at which
these companies lost money as a signal of future prosperity.
Many seemingly informed people, including Alan Greenspan, the chairman of
the Federal Reserve Board, fed this stock market bubble. He proposed that the
economy was entering a new phase in which it could transcend traditional
material limitations. Greenspan himself effused about the potential of a
weightless economy in which information would be the driving force.
Shortly after the NASDAQ bubble burst, California began to experience severe
shortages in electricity. One popular culprit was the Internet -- the central
figure in the fantasy of a weightless economy -- which was accused of gulping
as much as eight percent of the national electricity load. While this
estimate was highly inflated, it stood as a reminder that even the weightless
economy depended upon substantial material inputs.
The California energy system to large extent depends upon natural gas and
hydroelectric power, which, in turn, depends upon rainfall. A lack of
rainfall was a major factor in the California electricity crisis. The
shortage of electricity also forces the state to consider shortages of natural
gas and water.
Because of the close nexus with water, the electricity system interacts
closely with both agriculture and aquatic ecologies. This complex network of
energy, agriculture, fisheries, and the rest of the environment stands in
sharp contrast to economic analysis, where the impact of an entire industry
collapses into a single price. In fact, virtually all economic models rule
out such interactions, except for price effects, in order to make the
mathematics tractable.
========== Imperialism and Extraction
The cumulative demands that the economy puts upon the economy are
incalculable, especially because the economy continues to grow. Even though
this growth may not be particularly rapid for the world as a whole, over time
the magnitude of the economy takes on huge proportions. John Robert McNeil
provided some perspective for this process. He observed:
500 years ago the world's annual GDP (converted into 1990 dollars)
amounted
to about $240 billion, slightly more than Poland's or Pakistan's today,
slightly smaller than Taiwan's or Turkey's .... By 1820, the world's GDP had
reached $695 billion (more than Canada's or Spain's, less than Brazil's in
1990s terms). [McNeill 2000, p. 3]
By the middle of the nineteenth century, William Stanley Jevons, one of the
most important figures in pushing the subjective theory of value, confronted
the challenge of trying to maintain the a growing standard of living within
the constraints of a sustainable world. He wrote:
The plains of North America and Russia are our corn fields; Chicago and
Odessa our granaries; Canada and the Baltic our timber forests; Australia
contains our sheep farms, and in Argentina and on the Western prairies of
North America are our herds of oxen; Peru sends her silver, and the gold of
South Africa and Australia flows to London; the Hindus and the Chinese grow
our tea for us, and our coffee, sugar and spice plantations are all in the
Indies. Spain and France are our vineyards and the Mediterranean our fruit
garden; and our cotton grounds, which for long have occupied the Southern
United States are being extended everywhere in the warm regions of the earth.
While other countries mostly subsist upon the annual and ceaseless
income
of the harvest, we are drawing more and more upon a capital which yields no
annual interest, but once turned to light and heat and motive power, is gone
for ever in space. [Jevons 1906, pp. 306-7]
While almost unanimously praised for his efforts to further "scientific" value
theory, this book subjected him to more than a century of ridicule by
mainstream economists. Nonetheless, the problems that he raised were real.
More practical people understood this resource dependence within a political
context. They recognized that the rest of the world was not inclined
voluntarily to cede advantageous access to the world's resources to rich
countries, such as Britain. In this spirit, Winston Churchill wrote in a
January 1914 Cabinet note:
We are not a young people with an innocent record and a scanty
inheritance.
We have engrossed to ourselves an altogether disproportionate share of the
wealth and traffic of the world. We have got all we want in territory, and
our claim to be left in the unmolested enjoyment of vast and splendid
possessions, mainly acquired by violence, largely maintained by force, often
seems less reasonable to others than to us. [cited in Ponting 1994, p. 132]
========== References
Bliss, Christopher J. 1975. Capital Theory and the Distribution of Income
(Oxford: North-Holland Publishing).
Debreu, Gerard. 1959. Theory of Value: An Axiomatic Analysis of Economic
Equilibrium (NY: Wiley).
Jevons, W. Stanley. 1865. The Coal Question: An Inquiry Concerning the
Progress of the Nation, and the Probable Exhaustion of Our Coal-Mines (London:
Macmillan).
McNeill, John Robert. 2000. Something New Under the Sun: An Environmental
History of the Twentieth-Century World (NY: W. W. Norton).
Mill, John Stuart. 1848. Principles of Political Economy with Some of Their
Applications to Social Philosophy. Vols 2-3. Collected Works, J. M. Robson,
eds. (Toronto: University of Toronto Press, 1965).
Mirowski, Philip. 1989. More Light than Heat: Economics as Social Physics,
Physics as Nature's Economics (Cambridge: Cambridge University Press).
Ponting, Clive. 1994. Churchill (London: Sinclair-Stevenson).
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