A presentation delivered to the joint SES GCGI Conference, September 2012
Dr. Peter Bowman, School of Economics Science
We are now almost four years on from the financial crisis of 2008. We are still a long way from the enactment of any fundamental reform. In the ensuing period there has been the slow emergence into the light of the extent of the mal-practice, corruption and criminality in the current economic system indicating the extent to which the economy has been subverted from serving the common good to benefitting a select few at the expense of everyone else. The present arrangements have also been shown to lead to massive disparities between rich and poor that are socially destructive (Wilkinson & Pickett 2009). There is obviously an ethical crisis but there is also systemic failure.
How deep is the malaise? Is the free market system inherently dysfunctional? Could we ever have a just market system that served the common good and restrained exploitation and corruption?
An analysis I have found helpful in seeking to answer these questions is that of Karl Polanyi in his well-known and recently revived work “The Great Transformation” (Polanyi, 1944). This author argued that at the heart of the free market system that evolved in the nineteenth and twentieth centuries was a deception and in that deception lie the seeds of its self-destruction. The market is an institution that has served man for millennia. Its purpose is to trade man-made goods, including raw materials, agricultural produce, intermediate goods as well as finished goods, what might collectively be called “commodities”. What has happened in the modern market system is that the primary elements of production, namely land, labour and credit which are clearly not commodities have been treated as if they were so, and under this pretence have been turned into things tradeable in the market. The fact that these primary elements are of an entirely different nature to man-made objects and so follow very different economic laws has been ignored. In the short term those who control the markets in land and credit and exploit the market in labour have been able to extract for themselves a much greater share of wealth of the community than by the honest endeavour of producing and selling commodities. In the long term however the system is not sustainable and lurches on in a series of damaging boom and bust cycles.
Why is it fundamentally wrong to have markets in land, labour and credit?
In economics the term land is applied to the part of the economy that is “the free gift of nature”. So, by definition, it is not man-made, also each part of it is unique and cannot be transferred to a different location. It does not follow the laws of supply and demand in the way that manufactured goods do. Its supply curve is inelastic. When the demand for land increase (in the upward part of the boom bust cycle) the only response is that its price goes up.
To be traded land must first be claimed. To many of the world’s cultures, for example the indigenous peoples of North America, the notion that land could be owned and hence bought and sold was incomprehensible but in the modern western culture the idea is deeply ingrained. This is despite the reasoning of philosophers such as John Locke who argued that the basis of a claim to property lies principally in the work done to produce it. On this basis, since land is not man-made, there can be no such claim to it (Mazor, 2009). Despite this reasoning the tendency to claim land is difficult to resist. Since man cannot live or work without access to land it is one of the most important and valuable of assets, growing in value the more the population of an area increases and its economy develops. Because of its scarcity the market in land can never clear, can never come to equilibrium, it is an effective monopoly situation with the price determined by the most the competing bidders can afford to pay. In the absence of restraint it becomes an irresistible object of speculation.
Credit, which is essentially about a relationship of trust is almost as fundamental to economic production as land. It is the bridge that spans the inevitable gap in time between the outset of any economic activity and its point of completion when it can provide a return for its producer in the market place. Credit provides the mechanism whereby a farmer can sustain himself between planting his crop and harvesting, the builder between acquiring his raw materials and producing the finished item and even the shopkeeper needs to acquire his goods and stock his shelves before he can sell them. The traditional function of banks is to act as trustworthy intermediaries in the extension of credit. In the present system the process of credit creation has undergone a gross distortion and this essential operation has been subverted into a method whose principal purpose it to maximize returns to the banks’ owners and a few select employees. The provision of credit is not now directed to where it is needed in the economy to serve the common good but where it can retain maximum return. Rather than financing the genuine production of wealth credit it is diverted to the purchase of assets, most commonly land based assets i.e. real estate and domestic property.
In the hands of the private banking cartel credit has been transformed from an essential economic service into the pretence of a marketable commodity with the interest rate masquerading as its price. The raw materials for this particular pseudo-commodity are non-existent and so its supply is without limit. Like the market in land the market in credit will never clear, it can never come to equilibrium it always remains under the control of the issuers who effectively have a monopoly control.
A labour market where human beings are themselves treated as commodities, a cost of production with wages being the price, is the inevitable outcome of the monopolies of land and credit. When people are denied access to what nature provides and denied credit other than on onerous terms they have little choice but to accept work on the terms of the employer. Under conditions where there is a permanent pool of unemployed they are reduced to receiving the least they are willing to accept. Their fate is worsened when they have to bear the brunt of the burden of taxation. In the developed world the worsening conditions have been ameliorated, firstly be social provision and more recently through growing indebtedness either unsecured or through using homes as collateral but this has not solved the problem.
The human consequences effects of the commoditization of labour run deep. The nature of work has changed into something that is done for what can be extracted from the system rather than for what is contributed, that is no longer fulfilling in its own right but is just a means to an end.
What is the solution?
If Polanyi’s analysis is correct then, in addition to indicating the underlying causes of the present crisis it can also point to the remedy. In simple terms what is required is that the market is limited to real commodities and the primary elements, land, labour and credit are excluded. This would require Government to enact its fundamental duty to protect these components from exploitation. This does not mean centralized state control or large government but it does require firm Government. It offers the possibility of truly free markets with greater economic freedom. The route to this requires taking the primary factors out of the market system. They need to be de-commoditized.
How can this be done?
First consider credit. To stop thinking of credit as a commodity and to return to thinking of it as an essential economic provision requires a fundamental change of attitude backed up by a change in the relative powers of banks and government. Credit needs to be directed to where it is needed to stimulate genuine and necessary economic activity and away from where it is simply being used to transfer the ownership of assets. The concept of “investment” needs to broken open and these two very different aspects need to be distinguished (Werner 2005). Different mechanisms for the de-commoditization are possible. It is questionable whether shareholder owned profit driven banks are the most appropriate institutions for credit creation. The function could be transferred to not for profit organizations such as credit unions or if the political will dictated they could become fully nationalised. At least the investment and retail components of banks could be separated and the credit creation restricted to the latter. If the commercial banks are left to continue the function of credit creation then credit guidance needs to become a tool of regulation. Controlling interest rates is ineffective in controlling the money supply. It needs to be replaced by restrictions directed, for example from the Central Bank on the amount of credit creation and what it is directed to (Ryan-Collins 2011).
The markets in credit and land are closely connected in that most of what is called “bank lending” is in fact credit creation for the purpose of changing the ownership of land-based assets. Thus the changes to the banking system described above would significantly impact on the property market and land-based speculation. The mechanism of de-commoditizing land is not so obvious but it could be achieved by changes in tax policy (Burgess, 1993). To understand how this works it must first be appreciated that the value of a plot of land, particularly in an urban environment where the most valuable land is located lies not in the plot itself but in its location. It is determined by the availability of things such as public services, markets, an environment propitious for business or domestic occupation. In the present system of privatized property all these things come free once the plot has been purchased. Public services do have to be paid for but this comes out of the tax system which is mainly levied on income. Perversely, as a community grows and the services a location receives improve, rather than landowners paying extra they effectively receive more since the value of the assets they own increase. This was illustrated vividly when the Jubilee Underground Line in South London was extended in 2000. This infrastructure project cost £3.5 billion but resulted in local property prices increasing by an estimated £13.5 billion (Riley 2001). If public revenue was based on regular payments proportional to the rental value of land instead of the monetized advantages of particular locations accruing to the owners they would be returned back to the community. This would effectively de-commoditize land. The only reason for occupying land would be to use it since there would be a charge associated with this and it would no longer be possible to use a land as a basis of speculation. An additional advantage of this reform of public revenue would be that the burden of taxation would be taken off labour, trade and profits.
Setting the economy free
The combined effect of de-commoditizing credit and so freeing it for productive purposes and de-commoditizing land by collecting land rents for public revenue would have a huge impact on the way the economy works and particularly on the labour market. The enhanced possibility of self-employment and associated meaningful work would shift the relative bargaining positions of employers and employees. An alternative to the combination of “wage slavery” for the masses and rent-seeking for the rich would become a possibility. A virtuous circle could arise with increasing prosperity replacing low wages, unemployment and burdensome social provision. In addition the reduction in the possibility of unearned incomes associated with asset ownership would lead to a reduction in the gap between rich and poor and the associated social stresses.
Polanyi’s insight offers an analysis that is both simple and profound. It is presented here as a basis for giving an overview of how we could move from the present unjust, inefficient destructive system to one which maintains the principle of the market but holds out the possibility of hope for a fairer and more just alternative.
Burgess, Ronald (1993) Public Revenue without Taxation, Shepheard-Walwyn, London.
Mazor, Joseph (2009) A Liberal Theory of Natural Resource Property Rights, PhD thesis for Harvard University
Polanyi, Karl (1944) The Great Transformation: the political and economic origins of our times Beacon Press, Boston, Ma.
Ryan-Collins, J., Greenham T., Werner R., & Jackson, A., (2011) Where does Money Come From New Economics Foundation.
Riley, Don (2001) Taken for a Ride: Trains, Taxpayers and the Treasury, Centre for Political Studies, London.
Werner, Richard (2005) A New Paradigm in Economics, Palgrave.
Wilkinson, Richard & Pickett, Kate (2009) The Spirit Level: Why More Equal Societies Almost Always Do Better, Allen Lane.