For those who, like me, prefer paper text, here is a reformatted copy of Michael's essay (separated paragraphs, quotes in quotes since in e-mail indenting doesn't identify them clearly, all short lines eliminated [I hope]). Carrol -------- Original Message -------- Subject: [CrashList] Perelman on whether economy is productive or just extractive Date: Mon, 19 Mar 2001 08:00:40 +0000 From: Mark Jones <[EMAIL PROTECTED]> [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 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). _______________________________________________ CrashList website: http://website.lineone.net/~resource_base _______________________________________________ CrashList website: http://website.lineone.net/~resource_base
