Maintaining Standards of Living

Maintaining Standards of Living and Maintaining Private Finance Capitalism are not the Same Thing

Many people before me have ranted and raved about the about the stupidity of assuming exponential growth as the normative condition of human economic activity for decades, centuries, millennia (or however long you think the human species is likely to survive) into the future. The impact of all of this heated rhetoric has not, as yet, been very great. A small minority of people exist who understand that the stock market and the banking system as they exist today cannot continue to be the dominant institutions of human society into the indefinite future, but this minority is very small indeed. Even among the so-called greens and the promoters of social justice the vast majority of people assume that their 401K funds will go on rising forever. In this post I wish to approach the concept of interest and economic growth from a perspective of concrete thinking about economic production rather than from discussing the abstract properties of the exponential function.

So let us think for a moment about the phenomenon of interest in its most legitimate form. You work hard and earn money. Ideally, your money represents the economic output that you have produced. In a modern complex economy with highly specialized kinds of labor it can be difficult to pinpoint exactly what goods and services each individual produces. You may be a tiny cog in a giant corporate machine, and that corporation buys goods and services from other corporations, so that in many cases it is very difficult for the individual worker to point to a product and say ‘That is the unique product of my work’. Nevertheless, ideally, the wage system is supposed to measure your relative contribution to the output produced by your company. In some cases, of course, people do not directly contribute to producing a product. Teachers give people the skills they need to produce economic output at some later time. Entertainers help people to relax so that they can stand to go back to work on Monday morning. In any event we will assume that your money income represents (directly or indirectly) the economic goods and services you have produced. You then take this production output and trade if for the output that other people have produced. Goods and services are traded for goods and services, and money is mere a convenience which enables those trades to be carries out more efficiently than by direct barter.

In general, people do not spend all of their income. They are not planning to work all of their lives, and they will need to consume economic output after they retire. Therefore they save money for the future. What does saving money imply in terms of economic production? No physical wealth is saved corresponding to the money that is saved. We produce economic output in order to consume it. Developers do not build houses in order to sell them to someone fifteen years from now. Computer manufacturers do build computers in order to sell them to someone ten years from now (the computer would be obsolete by that time). Lumber companies do not manufacture boards and leave them sitting around in warehouses for many years. Some amount of inventory of manufactured goods is a practical necessity for keeping the supply chain running smoothly, but anyone who has had experience with a manufacturing firm knows that the struggle to keep down inventory costs is constant. If inventories grow too large factories shut down and people lose their jobs. When you save money you are declining to complete the trade of some portion of your economic output for the economic output produced for others. So why doesn’t saving produce an economic recession? The answer is that people who have saved in the past jump into the breach and buy the economic output that you decline to accept, thereby keeping the factories running and preserving your job. Savings are merely an accounting system that keeps track of how much economic output you have produced in the past so that in the future you will be allowed to consume the economic output produced by other people.

Of course when you save money you don’t put it under your mattress. You invest it and it earns interest. Your money grows with time. If the interest rate earned by your money is above the inflation rate, then in the future when you finally complete the trade of your economic output for the output of other people, you will be able get a more favorable exchange rate than you would if you completed the trade in the present. That is to say that your money (which is symbolically your output of goods and services) will buy a larger amount of economic output in the future than in the present.

How can this be? How can it be that by delaying the exchange of your economic output to some future date you can get more in return for it than you can at the present time? Clearly such an increase in the value of labor is only possible if the labor of the future is more productive than the labor of the present. As technology advances (powered by reasonably priced energy) each worker hour, on average, produces more economic output. It is this excess economic output of the future which allows the purchasing power of your saved income to increase.

In fact in an economy in which productivity is constantly increasing interest is needed for healthy functioning. Suppose, for instance, that the current savings rate is 10%. Since money represents economic output this savings rate means that 10% of the total output is not being consumed by people who are currently employed. If the money of people who saved in the past had not grown to match the current productivity of the economy, then they would not be able to purchase the output and factories would close down and people would lose their jobs.

On the other hand, if our productivity ever stops increasing the world of financial investments and the phenomenon of money making money will come to halt. This is a simple physical fact. You cannot trade your economic output of today for a larger amount of output in the future unless the future is more productive. The fact that our current economic institutions structurally require constantly increasing productivity for ‘healthy' functioning is crucial for understanding our economic future. If fossil fuels start to run short, the economy cannot be saved merely by finding renewable substitutes which allow us to maintain a decent standard of living. The stock market and the system of money creation via interest bearing loans (which I call private finance capitalism) cannot function on maintenance. Our economic system is a gigantic inverted pyramid scheme; If the next level of productivity increases fails to materialize then a stock market and monetary collapse must inevitably follow.

Of course such a financial collapse is not the same thing as a collapse of productive capacity. If the depletion of fossil fuels constrains production, the actual physical limitation is more likely to take the form of a long slow strangulation rather than a sudden collapse. A financial collapse would, to some extent, be an artifact of our economic institutions rather than a constraint of physical reality, and a way could probably be found to get the productive machinery running again. The problem is that if the recovery we aim for is a recovery in the old sense, with the toy factories booming at full capacity and decades of exponential growth in front of us, then the recovery could only be partial and new financial disasters would loom on the horizon.

In the long run a healthy economy will require a fundamentally new goal. The goal of the current economic system is to increase the total volume of economic exchanges as rapidly as possible. The particular type of exchange which takes place is unimportant. Selling SUVs, 8,000 square foot homes, power boats, skiing vacations, etc. are ‘good for the economy’ as long as the total dollar volume of exchanges in these items is high. Consumers deciding that they do not need to buy expensive new toys, or ‘trade up’ to a better house, or take expensive high energy use vacations is ‘bad for the economy’ because it decreases the volume of exchanges. In a world in which economic production is constrained by the availability of energy and other natural resources such thinking is obviously insane. Instead our goal must be to produce a high quality of life with a minimum consumption of production resources. Private finance capitalism is a terrible tool for achieving this goal. New economic institutions must be forged to meet the needs of a post-growth world. My preliminary attempts to think about such new institutions will be found in later posts on this web site.

April 12, 2007