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version of Section F.
F.10 Would laissez-faire capitalism be stable?
Unsurprisingly, right-libertarians combine their support for "absolute property
rights" with a whole-hearted support for laissez-faire capitalism.
In such a system (which they maintain, to quote Ayn Rand, is an "unknown
ideal") everything would be private property and there would be
few (if any) restrictions on "voluntary exchanges." "Anarcho"-capitalists
are the most extreme of defenders of pure capitalism, urging that
the state itself be privatised and no voluntary exchange made illegal
(for example, children would be considered the property of their parents
and it would be morally right to turn them into child prostitutes
-- the child has the option of leaving home if they object).
As there have been no example of "pure" capitalism it is difficult
to say whether their claims about are true (for a discussion of a
close approximation see the section F.10.3).
This section of the FAQ is an attempt to discover whether such a system
would be stable or whether it would be subject to the usual booms
and slumps. Before starting we should note that there is some disagreement
within the right-libertarian camp itself on this subject (although
instead of stability they usually refer to "equilibrium" -- which
is an economics term meaning that all of a societies resources are
fully utilised).
In general terms, most right-Libertarians' reject the concept of
equilibrium as such and instead stress that the economy is inherently
a dynamic (this is a key aspect of the Austrian school of economics).
Such a position is correct, of course, as such noted socialists as
Karl Marx and Michal Kalecki and capitalist economists as Keynes recognised
long ago. There seems to be two main schools of thought on the nature
of disequilibrium. One, inspired by von Mises, maintains that the
actions of the entrepreneur/capitalist results in the market co-ordinating
supply and demand and another, inspired by Joseph Schumpeter, who
question whether markets co-ordinate because entrepreneurs are constantly
innovating and creating new markets, products and techniques.
Of course both actions happen and we suspect that the differences
in the two approaches are not important. The important thing to remember
is that "anarcho"-capitalists and right-libertarians in general reject
the notion of equilibrium -- but when discussing their utopia they
do not actually indicate this! For example, most "anarcho"-capitalists
will maintain that the existence of government (and/or unions) causes
unemployment by either stopping capitalists investing in new lines
of industry or forcing up the price of labour above its market clearing
level (by, perhaps, restricting immigration, minimum wages, taxing
profits). Thus, we are assured, the worker will be better off in "pure"
capitalism because of the unprecedented demand for labour it will
create. However, full employment of labour is an equilibrium in economic
terms and that, remember, is impossible due to the dynamic nature
of the system. When pressed, they will usually admit there will be
periods of unemployment as the market adjusts or that full unemployment
actually means under a certain percentage of unemployment. Thus, if
you (rightly) reject the notion of equilibrium you also reject the
idea of full employment and so the labour market becomes a buyers
market and labour is at a massive disadvantage.
The right-libertarian case is based upon logical deduction, and
the premises required to show that laissez-faire will be stable are
somewhat incredible. If banks do not set the wrong interest rate,
if companies do not extend too much trade credit, if workers are willing
to accept (real wage related) pay cuts, if workers altruistically
do not abuse their market power in a fully employed society, if interest
rates provide the correct information, if capitalists predict the
future relatively well, if banks and companies do not suffer from
isolation paradoxes, then, perhaps, laissez-faire will be stable.
So, will laissez-faire capitalism be stable? Let us see by analysing
the assumptions of right-libertarianism -- namely that there will
be full employment and that a system of private banks will stop the
business cycle. We will start on the banking system first (in section
F.10.1) followed by the effects
of the labour market on economic stability (in section F.10.2).
Then we will indicate, using the example of 19th century America,
that actually existing ("impure") laissez-faire was very unstable.
Explaining booms and busts by state action plays an ideological
convenience as it exonerates market processes as the source of instability
within capitalism. We hope to indicate in the next two sections why
the business cycle is inherent in the system (see also sections C.7,
C.8 and C.9).
It is claimed that the existence of the state (or, for minimal statists, government
policy) is the cause of the business cycle (recurring economic booms
and slumps). This is because the government either sets interest rates
too low or expands the money supply (usually by easing credit restrictions
and lending rates, sometimes by just printing fiat money). This artificially
increases investment as capitalists take advantage of the artificially
low interest rates. The real balance between savings and investment
is broken, leading to over-investment, a drop in the rate of profit
and so a slump (which is quite socialist in a way, as many socialists
also see over-investment as the key to understanding the business
cycle, although they obviously attribute the slump to different causes
-- namely the nature of capitalist production, not that the credit
system does not play its part -- see section C.7).
In the words of Austrian Economist W. Duncan Reekie, "[t]he business
cycle is generated by monetary expansion and contraction . . . When
new money is printed it appears as if the supply of savings has increased.
Interest rates fall and businessmen are misled into borrowing additional
founds to finance extra investment activity . . . This would be of
no consequence if it had been the outcome of [genuine saving] . .
. -but the change was government induced. The new money reaches factor
owners in the form of wages, rent and interest . . . the factor owners
will then spend the higher money incomes in their existing consumption:investment
proportions . . . Capital goods industries will find their expansion
has been in error and malinvestments have been inoccured." [Markets,
Entrepreneurs and Liberty, pp. 68-9]
In other words, there has been "wasteful mis-investment due to
government interference with the market." [Op. Cit., p.
69] In response to this (negative) influence in the workings of the
market, it is suggested by right-libertarians that a system of private
banks should be used and that interest rates are set by them, via
market forces. In this way an interest rate that matches the demand
and supply for savings will be reached and the business cycle will
be no more. By truly privatising the credit market, it is hoped by
the business cycle will finally stop.
Unsurprisingly, this particular argument has its weak points and
in this section of the FAQ we will try to show exactly why this theory
is wrong.
Let us start with Reckie's starting point. He states that the "main
problem" of the slump is "why is there suddenly a 'cluster'
of business errors? Businessmen and entrepreneurs are market experts
(otherwise they would not survive) and why should they all make mistakes
simultaneously?" [Op. Cit., p. 68] It is this "cluster"
of mistakes that the Austrians' take as evidence that the business
cycle comes from outside the workings of the market (i.e. is exogenous
in nature). Reekie argues that an "error cluster only occurs when
all entrepreneurs have received the wrong signals on potential profitability,
and all have received the signals simultaneously through government
interference with the money supply." [Op. Cit., p. 74]
But is this really the case?
The simple fact is that groups of (rational) individuals can act
in the same way based on the same information and this can lead to
a collective problem. For example, we do not consider it irrational
that everyone in a building leaves it when the fire alarm goes off
and that the flow of people can cause hold-ups at exits. Neither do
we think that its unusual that traffic jams occur, after all those
involved are all trying to get to work (i.e. they are reacting to
the same desire). Now, is it so strange to think that capitalists
who all see the same opportunity for profit in a specific market decide
to invest in it? Or that the aggregate outcome of these individually
rational decisions may be irrational (i.e. cause a glut in the market)?
In other words, a "cluster" of business failures may come about
because a group of capitalists, acting in isolation, over-invest in
a given market. They react to the same information (namely super profits
in market X), arrange loans, invest and produce commodities to meet
demand in that market. However, the aggregate result of these individually
rational actions is that the aggregate supply far exceeds demand,
causing a slump in that market and, perhaps, business failures. The
slump in this market (and the potential failure of some firms) has
an impact on the companies that supplied them, the companies that
are dependent on their employees wages/demand, the banks that supplied
the credit and so forth. The accumulative impact of this slump (or
failures) on the chain of financial commitments of which they are
but one link can be large and, perhaps, push an economy into general
depression. Thus the claim that it is something external to the system
that causes depression is flawed.
It could be claimed the interest rate is the problem, that it does
not accurately reflect the demand for investment or relate it to the
supply of savings. But, as we argued in section C.8,
it is not at all clear that the interest rate provides the necessary
information to capitalists. They need investment information for their
specific industry, but the interest rate is cross-industry. Thus capitalists
in market X do not know if the investment in market X is increasing
and so this lack of information can easily cause "mal-investment"
as over-investment (and so over-production) occurs. As they have no
way of knowing what the investment decisions of their competitors
are or now these decisions will affect an already unknown future,
capitalists may over-invest in certain markets and the net effects
of this aggregate mistake can expand throughout the whole economy
and cause a general slump. In other words, a cluster of business failures
can be accounted for by the workings of the market itself and not
the (existence of) government.
This is one possible reason for an internally generated business
cycle but that is not the only one. Another is the role of class struggle
which we discuss in the next section
and yet another is the endogenous nature of the money supply itself.
This account of money (proposed strongly by, among others, the post-Keynesian
school) argues that the money supply is a function of the demand for
credit, which itself is a function of the level of economic activity.
In other words, the banking system creates as much money as people
need and any attempt to control that creation will cause economic
problems and, perhaps, crisis (interestingly, this analysis has strong
parallels with mutualist and individualist anarchist theories on the
causes of capitalist exploitation and the business cycle). Money,
in other words, emerges from within the system and so the right-libertarian
attempt to "blame the state" is simply wrong.
Thus what is termed "credit money" (created by banks) is an essential
part of capitalism and would exist without a system of central banks.
This is because money is created from within the system, in response
to the needs of capitalists. In a word, money is endogenous and credit
money an essential part of capitalism.
Right-libertarians do not agree. Reekie argues that "[o]nce fractional
reserve banking is introduced, however, the supply of money substitutes
will include fiduciary media. The ingenuity of bankers, other financial
intermediaries and the endorsement and guaranteeing of their activities
by governments and central banks has ensured that the quantity
of fiat money is immense." [Op. Cit., p. 73]
Therefore, what "anarcho"-capitalists and other right-libertarians
seem to be actually complaining about when they argue that "state
action" creates the business cycle by creating excess money is that
the state allows bankers to meet the demand for credit by creating
it. This makes sense, for the first fallacy of this sort of claim
is how could the state force bankers to expand credit by loaning
more money than they have savings. And this seems to be the normal
case within capitalism -- the central banks accommodate bankers activity,
they do not force them to do it. Alan Holmes, a senior vice president
at the New York Federal Reserve, stated that:
"In the real world, banks extend credit, creating deposits in
the process, and look for the reserves later. The question then becomes
one of whether and how the Federal Reserve will accommodate the demand
for reserves. In the very short run, the Federal Reserve has little
or no choice about accommodating that demand, over time, its influence
can obviously be felt." [quoted by Doug Henwood, Wall Street,
p. 220]
(Although we must stress that central banks are not passive
and do have many tools for affecting the supply of money. For example,
central banks can operate "tight" money policies which can have significant
impact on an economy and, via creating high enough interest rates,
the demand for money.)
It could be argued that because central banks exist, the state creates
an "environment" which bankers take advantage off. By not being subject
to "free market" pressures, bankers could be tempted to make more
loans than they would otherwise in a "pure" capitalist system (i.e.
create credit money). The question arises, would "pure" capitalism
generate sufficient market controls to stop banks loaning in excess
of available savings (i.e. eliminate the creation of credit money/fiduciary
media).
It is to this question we now turn.
As noted above, the demand for credit is generated from within
the system and the comments by Holmes reinforce this. Capitalists
seek credit in order to make money and banks create it precisely because
they are also seeking profit. What right-libertarians actually object
to is the government (via the central bank) accommodating this
creation of credit. If only the banks could be forced to maintain
a savings to loans ration of one, then the business cycle would stop.
But is this likely? Could market forces ensure that bankers pursue
such a policy? We think not -- simply because the banks are profit
making institutions. As post-Keynesianist Hyman Minsky argues, "[b]ecause
bankers live in the same expectational climate as businessmen, profit-seeking
bankers will find ways of accommodating their customers. . . Banks
and bankers are not passive managers of money to lend or to invest;
they are in business to maximise profits. . ." [quoted by L. Randall
Wray, Money and Credit in Capitalist Economies, p. 85]
This is recognised by Reekie, in passing at least (he notes that
"fiduciary media could still exist if bankers offered them and
clients accepted them" [Op. Cit., p. 73]). Bankers will
tend to try and accommodate their customers and earn as much money
as possible. Thus Charles P. Kindleberger comments that monetary expansion
"is systematic and endogenous rather than random and exogenous"
seem to fit far better the reality of capitalism that the Austrian
and right-libertarian viewpoint [Manias, Panics, and Crashes,
p. 59] and post-Keynesian L. Randall Wray argues that "the money
supply . . . is more obviously endogenous in the monetary systems
which predate the development of a central bank." [Op. Cit.,
p. 150]
In other words, the money supply cannot be directly controlled by
the central bank since it is determined by private decisions to enter
into debt commitments to finance spending. Given that money is generated
from within the system, can market forces ensure the non-expansion
of credit (i.e. that the demand for loans equals the supply of savings)?
To begin to answer this question we must note that investment is "essentially
determined by expected profitability." [Philip Arestis, The
Post-Keynesian Approach to Economics, p. 103] This means that
the actions of the banks cannot be taken in isolation from the rest
of the economy. Money, credit and banks are an essential part of the
capitalist system and they cannot be artificially isolated from the
expectations, pressures and influences of that system.
Let us assume that the banks desire to maintain a loans to savings
ratio of one and try to adjust their interest rates accordingly. Firstly,
changes in the rate of interest "produce only a very small, if
any, movement in business investment" according to empirical evidence
[Op. Cit., pp. 82-83] and that "the demand for credit is
extremely inelastic with respect to interest rates." [L. Randall
Wray, Op. Cit., p. 245] Thus, to keep the supply of savings
in line with the demand for loans, interest rates would have to increase
greatly (indeed, trying to control the money supply by controlling
the monetary bases in this way will only lead to very big fluctuations
in interest rates). And increasing interest rates has a couple of
paradoxical effects.
According to economists Joseph Stiglitz and Andrew Weiss (in "Credit
Rationing in Markets with Imperfect Knowledge", American Economic
Review, no. 71, pp. 393-410) interest rates are subject to what
is called the "lemons problem" (asymmetrical information between
buyer and seller). Stiglitz and Weiss applied the "lemons problem"
to the credit market and argued (and unknowingly repeated Adam Smith)
that at a given interest rate, lenders will earn lower return by lending
to bad borrowers (because of defaults) than to good ones. If lenders
try to increase interest rates to compensate for this risk, they may
chase away good borrowers, who are unwilling to pay a higher rate,
while perversely not chasing away incompetent, criminal, or malignantly
optimistic borrowers. This means that an increase in interest rates
may actually increase the possibilities of crisis, as more loans may
end up in the hands of defaulters.
This gives banks a strong incentive to keep interest rates lower
than they otherwise could be. Moreover, "increases in interest
rates make it more difficult for economic agents to meet their debt
repayments" [Philip Arestis, Op. Cit., pp. 237-8] which
means when interest rates are raised, defaults will increase
and place pressures on the banking system. At high enough short-term
interest rates, firms find it hard to pay their interest bills, which
cause/increase cash flow problems and so "[s]harp increases in
short term interest rates . . .leads to a fall in the present value
of gross profits after taxes (quasi-rents) that capital assets are
expected to earn." [Hyman Minsky, Post-Keynesian Economic Theory,
p. 45]
In addition, "production of most investment goods is undertaken
on order and requires time for completion. A rise in interest rates
is not likely to cause firms to abandon projects in the process of
production . . . This does not mean . . . that investment is completely
unresponsive to interest rates. A large increase in interest rates
causes a 'present value reversal', forcing the marginal efficiency
of capital to fall below the interest rate. If the long term interest
rate is also pushed above the marginal efficiency of capital, the
project may be abandoned." [Wray, Op. Cit., pp. 172-3]
In other words, investment takes time and there is a lag between
investment decisions and actual fixed capital investment. So if interest
rates vary during this lag period, initially profitable investments
may become white elephants.
As Michal Kalecki argued, the rate of interest must be lower than
the rate of profit otherwise investment becomes pointless. The incentive
for a firm to own and operate capital is dependent on the prospective
rate of profit on that capital relative to the rate of interest at
which the firm can borrow at. The higher the interest rate, the less
promising investment becomes.
If investment is unresponsive to all but very high interest rates
(as we indicated above), then a privatised banking system will be
under intense pressure to keep rates low enough to maintain a boom
(by, perhaps, creating credit above the amount available as savings).
And if it does this, over-investment and crisis is the eventual outcome.
If it does not do this and increases interest rates then consumption
and investment will dry up as interest rates rise and the defaulters
(honest and dishonest) increase and a crisis will eventually occur.
This is because increasing interest rates may increase savings but
it also reduce consumption ("high interest rates also deter both
consumers and companies from spending, so that the domestic economy
is weakened and unemployment rises" [Paul Ormerod, The Death
of Economics, p. 70]). This means that firms can face a drop off
in demand, causing them problems and (perhaps) leading to a lack of
profits, debt repayment problems and failure. An increase in interest
rates also reduces demand for investment goods, which also can cause
firms problems, increase unemployment and so on. So an increase in
interest rates (particularly a sharp rise) could reduce consumption
and investment (i.e. reduce aggregate demand) and have a ripple effect
throughout the economy which could cause a slump to occur.
In other words, interest rates and the supply and demand of savings/loans
they are meant to reflect may not necessarily move an economy towards
equilibrium (if such a concept is useful). Indeed, the workings of
a "pure" banking system without credit money may increase unemployment
as demand falls in both investment and consumption in response to
high interest rates and a general shortage of money due to lack of
(credit) money resulting from the "tight" money regime implied by
such a regime (i.e. the business cycle would still exist). This was
the case of the failed Monetarist experiments on the early 1980s when
central banks in America and Britain tried to pursue a "tight" money
policy. The "tight" money policy did not, in fact, control the money
supply. All it did do was increase interest rates and lead to a serious
financial crisis and a deep recession (as Wray notes, "the central
bank uses tight money polices to raise interest rates" [Op.
Cit., p. 262]). This recession, we must note, also broke the backbone
of working class resistance and the unions in both countries due to
the high levels of unemployment it generated. As intended, we are
sure.
Such an outcome would not surprise anarchists, as this was a key
feature of the Individualist and Mutualist Anarchists' arguments against
the "money monopoly" associated with specie money. They argued that
the "money monopoly" created a "tight" money regime which reduced
the demand for labour by restricting money and credit and so allowed
the exploitation of labour (i.e. encouraged wage labour) and stopped
the development of non-capitalist forms of production. Thus Lysander
Spooner's comments that workers need "money capital to enable
them to buy the raw materials upon which to bestow their labour, the
implements and machinery with which to labour . . . Unless they get
this capital, they must all either work at a disadvantage, or not
work at all. A very large portion of them, to save themselves from
starvation, have no alternative but to sell their labour to others
. . ." [A Letter to Grover Cleveland, p. 39] It is interesting
to note that workers did do well during the 1950s and 1960s
under a "liberal" money regime than they did under the "tighter" regimes
of the 1980s and 1990s.
We should also note that an extended period of boom will encourage
banks to make loans more freely. According to Minsky's "financial
instability model" crisis (see "The Financial Instability Hypothesis"
in Post-Keynesian Economic Theory for example) is essentially
caused by risky financial practices during periods of financial tranquillity.
In other words, "stability is destabilising." In a period of
boom, banks are happy and the increased profits from companies are
flowing into their vaults. Over time, bankers note that they can use
a reserve system to increase their income and, due to the general
upward swing of the economy, consider it safe to do so (and given
that they are in competition with other banks, they may provide loans
simply because they are afraid of losing customers to more flexible
competitors). This increases the instability within the system (as
firms increase their debts due to the flexibility of the banks) and
produces the possibility of crisis if interest rates are increased
(because the ability of business to fulfil their financial commitments
embedded in debts deteriorates).
Even if we assume that interest rates do work as predicted
in theory, it is false to maintain that there is one interest rate.
This is not the case. "Concentration of capital leads to unequal
access to investment funds, which obstructs further the possibility
of smooth transitions in industrial activity. Because of their past
record of profitability, large enterprises have higher credit ratings
and easier access to credit facilities, and they are able to put up
larger collateral for a loan." [Michael A. Bernstein, The Great
Depression, p. 106] As we noted in section C.5.1,
the larger the firm, the lower the interest rate they have to pay.
Thus banks routinely lower their interest rates to their best clients
even though the future is uncertain and past performance cannot and
does not indicate future returns. Therefore it seems a bit strange
to maintain that the interest rate will bring savings and loans into
line if there are different rates being offered.
And, of course, private banks cannot affect the underlying fundamentals
that drive the economy -- like productivity, working class power and
political stability -- any more than central banks (although central
banks can influence the speed and gentleness of adjustment to a crisis).
Indeed, given a period of full employment a system of private banks
may actually speed up the coming of a slump. As we argue in the next
section, full employment results in a profits squeeze as firms
face a tight labour market (which drives up costs) and, therefore,
increased workers' power at the point of production and in their power
of exit. In a central bank system, capitalists can pass on these increasing
costs to consumers and so maintain their profit margins for longer.
This option is restricted in a private banking system as banks would
be less inclined to devalue their money. This means that firms will
face a profits squeeze sooner rather than later, which will cause
a slump as firms cannot make ends meet. As Reekie notes, inflation
"can temporarily reduce employment by postponing the time when
misdirected labour will be laid off" but as Austrian's (like Monetarists)
think "inflation is a monetary phenomenon" he does not understand
the real causes of inflation and what they imply for a "pure" capitalist
system [Op. Cit., p. 67, p. 74]. As Paul Ormerod points out
"the claim that inflation is always and everywhere purely caused
by increases in the money supply, and that there the rate of inflation
bears a stable, predictable relationship to increases in the money
supply is ridiculous." And he notes that "[i]ncreases in the
rate of inflation tend to be linked to falls in unemployment, and
vice versa" which indicates its real causes -- namely in
the balance of class power and in the class struggle. [The Death
of Economics, p. 96, p. 131]
Moreover, if we do take the Austrian theory of the business cycle
at face value we are drawn to conclusion that in order to finance
investment savings must be increased. But to maintain or increase
the stock of loanable savings, inequality must be increased. This
is because, unsurprisingly, rich people save a larger proportion of
their income than poor people and the proportion of profits saved
are higher than the proportion of wages. But increasing inequality
(as we argued in section F.3.1) makes
a mockery of right-libertarian claims that their system is based on
freedom or justice.
This means that the preferred banking system of "anarcho"-capitalism
implies increasing, not decreasing, inequality within society. Moreover,
most firms (as we indicated in section C.5.1)
fund their investments with their own savings which would make it
hard for banks to loan these savings out as they could be withdrawn
at any time. This could have serious implications for the economy,
as banks refuse to fund new investment simply because of the uncertainty
they face when accessing if their available savings can be loaned
to others (after all, they can hardly loan out the savings of a customer
who is likely to demand them at any time). And by refusing to fund
new investment, a boom could falter and turn to slump as firms do
not find the necessary orders to keep going.
So, would market forces create "sound banking"? The answer is probably
not. The pressures on banks to make profits come into conflict with
the need to maintain their savings to loans ration (and so the confidence
of their customers). As Wray argues, "as banks are profit seeking
firms, they find ways to increase their liabilities which don't entail
increases in reserve requirements" and "[i]f banks share the
profit expectations of prospective borrowers, they can create credit
to allow [projects/investments] to proceed." [Op. Cit.,
p. 295, p. 283] This can be seen from the historical record. As Kindleberger
notes, "the market will create new forms of money in periods of
boom to get around the limit" imposed on the money supply [Op.
Cit., p. 63]. Trade credit is one way, for example. Under the
Monetarist experiments of 1980s, there was "deregulation and central
bank constraints raised interest rates and created a moral hazard
-- banks made increasingly risky loans to cover rising costs of issuing
liabilities. Rising competition from nonbanks and tight money policy
forced banks to lower standards and increase rates of growth in an
attempt to 'grow their way to profitability'" [Op. Cit.,
p. 293]
Thus credit money ("fiduciary media") is an attempt to overcome
the scarcity of money within capitalism, particularly the scarcity
of specie money. The pressures that banks face within "actually existing"
capitalism would still be faced under "pure" capitalism. It is likely
(as Reekie acknowledges) that credit money would still be created
in response to the demands of business people (although not at the
same level as is currently the case, we imagine). The banks, seeking
profits themselves and in competition for customers, would be caught
between maintaining the value of their business (i.e. their money)
and the needs to maximise profits. As a boom develops, banks would
be tempted to introduce credit money to maintain it as increasing
the interest rate would be difficult and potentially dangerous (for
reasons we noted above). Thus, if credit money is not forth coming
(i.e. the banks stick to the Austrian claims that loans must equal
savings) then the rise in interest rates required will generate a
slump. If it is forthcoming, then the danger of over-investment becomes
increasingly likely. All in all, the business cycle is part of capitalism
and not caused by "external" factors like the existence of
government.
As Reekie notes, to Austrians "ignorance of the future is endemic"
[Op. Cit., p. 117] but you would be forgiven for thinking that
this is not the case when it comes to investment. An individual firm
cannot know whether its investment project will generate the stream
of returns necessary to meet the stream of payment commitments undertaken
to finance the project. And neither can the banks who fund those projects.
Even if a bank does not get tempted into providing credit money
in excess of savings, it cannot predict whether other banks will do
the same or whether the projects it funds will be successful. Firms,
looking for credit, may turn to more flexible competitors (who practice
reserve banking to some degree) and the inflexible bank may see its
market share and profits decrease. After all, commercial banks "typically
establish relations with customers to reduce the uncertainty involved
in making loans. Once a bank has entered into a relationship with
a customer, it has strong incentives to meet the demands of that customer."
[Wray, Op. Cit., p. 85]
There are example of fully privatised banks. For example, in the
United States "which was without a central bank after 1837"
"the major banks in New York were in a bind between their roles as
profit seekers, which made them contributors to the instability of
credit, and as possessors of country deposits against whose instability
they had to guard." [Kindleberger, Op. Cit., p. 85]
In Scotland, the banks were unregulated between 1772 and 1845 but
"the leading commercial banks accumulated the notes of lessor ones,
as the Second Bank of the United States did contemporaneously in [the
USA], ready to convert them to specie if they thought they were getting
out of line. They served, that is, as an informal controller of the
money supply. For the rest, as so often, historical evidence runs
against strong theory, as demonstrated by the country banks in England
from 1745 to 1835, wildcat banking in Michigan in the 1830s, and the
latest experience with bank deregulation in Latin America." [Op.
Cit., p. 82] And we should note there were a few banking "wars"
during the period of deregulation in Scotland which forced a few of
the smaller banks to fail as the bigger ones refused their money and
that there was a major bank failure in the Ayr Bank.
Kendleberger argues that central banking "arose to impose control
on the instability of credit" and did not cause the instability
which right-libertarians maintain it does. And as we note in section
F.10.3, the USA suffered massive
economic instability during its period without central banking. Thus,
if credit money is the cause of the business cycle,
it is likely that a "pure" capitalism will still suffer from it just
as much as "actually existing" capitalism (either due to high interest
rates or over-investment).
In general, as the failed Monetarist experiments of the 1980s prove,
trying to control the money supply is impossible. The demand for money
is dependent on the needs of the economy and any attempt to control
it will fail (and cause a deep depression, usually via high interest
rates). The business cycle, therefore, is an endogenous phenomenon
caused by the normal functioning of the capitalist economic system.
Austrian and right-libertarian claims that "slump flows boom, but
for a totally unnecessary reason: government inspired mal-investment"
[Reekie, Op. Cit., p. 74] are simply wrong. Over-investment
does occur, but it is not "inspired" by the government.
It is "inspired" by the banks need to make profits from loans
and from businesses need for investment funds which the banks accommodate.
In other words, by the nature of the capitalist system.
In many ways, the labour market is the one that affects capitalism the most.
The right-libertarian assumption (like that of mainstream economics)
is that markets clear and, therefore, the labour market will also
clear. As this assumption has rarely been proven to be true in actuality
(i.e. periods of full employment within capitalism are few and far
between), this leaves its supporters with a problem -- reality contradicts
the theory.
The theory predicts full employment but reality shows that this
is not the case. Since we are dealing with logical deductions from
assumptions, obviously the theory cannot be wrong and so we must identify
external factors which cause the business cycle (and so unemployment).
In this way attention is diverted away from the market and its workings
-- after all, it is assumed that the capitalist market works -- and
onto something else. This "something else" has been quite a few different
things (most ridiculously, sun spots in the case of one of the founders
of marginalist economics, William Stanley Jevons). However, these
days most pro-free market capitalist economists and right-libertarians
have now decided it is the state.
In this section of the FAQ we will present a case that maintains
that the assumption that markets clear is false at least for one,
unique, market -- namely, the market for labour. As the fundamental
assumption underlying "free market" capitalism is false, the logically
consistent superstructure built upon comes crashing down. Part of
the reason why capitalism is unstable is due to the commodification
of labour (i.e. people) and the problems this creates. The state itself
can have positive and negative impacts on the economy, but removing
it or its influence will not solve the business cycle.
Why is this? Simply due to the nature of the labour market.
Anarchists have long realised that the capitalist market is based
upon inequalities and changes in power. Proudhon argued that "[t]he
manufacturer says to the labourer, 'You are as free to go elsewhere
with your services as I am to receive them. I offer you so much.'
The merchant says to the customer, 'Take it or leave it; you are master
of your money, as I am of my goods. I want so much.' Who will yield?
The weaker." He, like all anarchists, saw that domination, oppression
and exploitation flow from inequalities of market/economic power and
that the "power of invasion lies in superior strength." [What
is Property?, p. 216, p. 215]
This applies with greatest force to the labour market. While mainstream
economics and right-libertarian variations of it refuse to acknowledge
that the capitalist market is a based upon hierarchy and power, anarchists
(and other socialists) do not share this opinion. And because they
do not share this understanding with anarchists, right-libertarians
will never be able to understand capitalism or its dynamics and development.
Thus, when it comes to the labour market, it is essential to remember
that the balance of power within it is the key to understanding the
business cycle. Thus the economy must be understood as a system of
power.
So how does the labour market effect capitalism? Let us consider
a growing economy, on that is coming out of a recession. Such a growing
economy stimulates demand for employment and as unemployment falls,
the costs of finding workers increase and wage and condition demands
of existing workers intensify. As the economy is growing and labour
is scare, the threat associated with the hardship of unemployment
is weakened. The share of profits is squeezed and in reaction to this
companies begin to cut costs (by reducing inventories, postponing
investment plans and laying off workers). As a result, the economy
moves into a downturn. Unemployment rises and wage demands are moderated.
Eventually, this enables the share of profits first of all to stabilise,
and then rise. Such an "interplay between profits and unemployment
as the key determinant of business cycles" is "observed in
the empirical data." [Paul Ormerod, The Death of Economics,
p. 188]
Thus, as an economy approaches full employment the balance of power
on the labour market changes. The sack is no longer that great a threat
as people see that they can get a job elsewhere easily. Thus wages
and working conditions increase as companies try to get new (and keep)
existing employees and output is harder to maintain. In the words
of economist William Lazonick, labour "that is able to command
a higher price than previously because of the appearance of tighter
labour markets is, by definition, labour that is highly mobile via
the market. And labour that is highly mobile via the market is labour
whose supply of effort is difficult for managers to control in the
production process. Hence, the advent of tight labour markets generally
results in more rapidly rising average costs . . .as well as upward
shifts in the average cost curve. . ." [Business Organisation
and the Myth of the Market Economy, p. 106]
In other words, under conditions of full-employment "employers
are in danger of losing the upper hand." [Juliet B. Schor, The
Overworked American, p. 75] Schor argues that "employers have
a structural advantage in the labour market, because there are typically
more candidates ready and willing to endure this work marathon [of
long hours] than jobs for them to fill." [p. 71] Thus the labour
market is usually a buyers market, and so the sellers have to compromise.
In the end, workers adapt to this inequality of power and instead
of getting what they want, they want what they get.
But under full employment this changes. As we argued in section
B.4.4 and section C.7,
in such a situation it is the bosses who have to start compromising.
And they do not like it. As Schor notes, America "has never experienced
a sustained period of full employment. The closest we have gotten
is the late 1960s, when the overall unemployment rate was under 4
percent for four years. But that experience does more to prove the
point than any other example. The trauma caused to business by those
years of a tight labour market was considerable. Since then, there
has been a powerful consensus that the nation cannot withstand such
a low rate of unemployment." [Op. Cit., pp. 75-76]
So, in other words, full employment is not good for the capitalist
system due to the power full employment provides workers. Thus unemployment
is a necessary requirement for a successful capitalist economy and
not some kind of aberration in an otherwise healthy system. Thus "anarcho"-capitalist
claims that "pure" capitalism will soon result in permanent full employment
are false. Any moves towards full employment will result in a slump
as capitalists see their profits squeezed from below by either collective
class struggle or by individual mobility in the labour market.
This was recognised by Individualist Anarchists like Benjamin Tucker,
who argued that mutual banking would "give an unheard of impetus
to business, and consequently create an unprecedented demand for labour,
-- a demand which would always be in excess of the supply, directly
contrary of the present condition of the labour market." [The
Anarchist Reader, pp. 149-150] In other words, full employment
would end capitalist exploitation, drive non-labour income to zero
and ensure the worker the full value of her labour -- in other words,
end capitalism. Thus, for most (if not all) anarchists the exploitation
of labour is only possible when unemployment exists and the supply
of labour exceeds the demand for it. Any move towards unemployment
will result in a profits squeeze and either the end of capitalism
or an economic slump.
Indeed, as we argued in the last section,
the extended periods of (approximately) full employment until the
1960s had the advantage that any profit squeeze could (in the short
run anyway) be passed onto working class people in the shape of inflation.
As prices rise, labour is made cheaper and profits margins supported.
This option is restricted under a "pure" capitalism (for reasons we
discussed in the last section) and
so "pure" capitalism will be affected by full employment faster than
"impure" capitalism.
As an economy approaches full employment, "hiring new workers
suddenly becomes much more difficult. They are harder to find, cost
more, and are less experiences. Such shortages are extremely costly
for a firm." [Schor, Op. Cit., p. 75] This encourages a
firm to pass on these rises to society in the form of price rises,
so creating inflation. Workers, in turn, try to maintain their standard
of living. "Every general increase in labour costs in recent years,"
note J. Brecher and J. Costello in the late 1970s, "has followed,
rather than preceded, an increase in consumer prices. Wage increases
have been the result of workers' efforts to catch up after their incomes
have already been eroded by inflation. Nor could it easily be otherwise.
All a businessman has to do to raise a price . . . [is to] make an
announcement. . . Wage rates . . . are primarily determined by contracts"
and so cannot be easily adjusted in the short term. [Common Sense
for Bad Times, p, 120]
These full employment pressures will still exist with "pure" capitalism
(and due to the nature of the banking system will not have the safety
value of inflation). This means that periodic profit squeezes will
occur, due to the nature of a tight labour market and the increased
power of workers this generates. This in turn means that a "pure"
capitalism will be subject to periods of unemployment (as we argued
in section C.9) and so still have a business
cycle. This is usually acknowledged by right-libertarians in passing,
although they seem to think that this is purely a "short-term" problem
(it seems a strange "short-term" problem that continually occurs).
But such an analysis is denied by right-libertarians. For them government
action, combined with the habit of many labour unions to obtain higher
than market wage rates for their members, creates and exacerbates
mass unemployment. This flows from the deductive logic of much capitalist
economics. The basic assumption of capitalism is that markets clear.
So if unemployment exists then it can only be because the price of
labour (wages) is too high (Austrian Economist W. Duncan Reekie argues
that unemployment will "disappear provided real wages are not artificially
high" [Markets, Entrepreneurs and Liberty, p. 72]).
Thus the assumption provokes the conclusion -- unemployment is caused
by an unclearing market as markets always clear. And the cause for
this is either the state or unions. But what if the labour market
cannot clear without seriously damaging the power and profits
of capitalists? What if unemployment is required to maximise profits
by weakening labours' bargaining position on the market and so maximising
the capitalists power? In that case unemployment is caused by capitalism,
not by forces external to it.
However, let us assume that the right-libertarian theory is correct.
Let us assume that unemployment is all the fault of the selfish unions
and that a job-seeker "who does not want to wait will always get
a job in the unhampered market economy." [von Mises, Human
Action, p. 595]
Would crushing the unions reduce unemployment? Let us assume that
the unions have been crushed and government has been abolished (or,
at the very least, become a minimum state). The aim of the capitalist
class is to maximise their profits and to do this they invest in labour
saving machinery and otherwise attempt to increase productivity. But
increasing productivity means that the prices of goods fall and falling
prices mean increasing real wages. It is high real wages that, according
to right-libertarians, that cause unemployment. So as a reward for
increasing productivity, workers will have to have their money wages
cut in order to stop unemployment occurring! For this reason some
employers might refrain from cutting wages in order to avoid damage
to morale - potentially an important concern.
Moreover, wage contracts involve time -- a contract will
usually agree a certain wage for a certain period. This builds in
rigidity into the market, wages cannot be adjusted as quickly as other
commodity prices. Of course, it could be argued that reducing the
period of the contract and/or allowing the wage to be adjusted could
overcome this problem. However, if we reduce the period of the contract
then workers are at a suffer disadvantage as they will not know if
they have a job tomorrow and so they will not be able to easily plan
their future (an evil situation for anyone to be in). Moreover, even
without formal contracts, wage renegotiation can be expensive. After
all, it takes time to bargain (and time is money under capitalism)
and wage cutting can involve the risk of the loss of mutual good will
between employer and employee. And would you give your boss
the power to "adjust" your wages as he/she thought was necessary?
To do so would imply an altruistic trust in others not to abuse their
power.
Thus a "pure" capitalism would be constantly seeing employment increase
and decrease as productivity levels change. There exist important
reasons why the labour market need not clear which revolve around
the avoidance/delaying of wage cuts by the actions of capitalists
themselves. Thus, given a choice between cutting wages for all workers
and laying off some workers without cutting the wages of the remaining
employees, it is unsurprising that capitalists usually go for the
later. After all, the sack is an important disciplining device and
firing workers can make the remaining employees more inclined to work
harder and be more obedient.
And, of course, many employers are not inclined to hire over-qualified
workers. This is because, once the economy picks up again, their worker
has a tendency to move elsewhere and so it can cost them time and
money finding a replacement and training them. This means that involuntary
unemployment can easily occur, so reducing tendencies towards full
employment even more. In addition, one of the assumptions of the standard
marginalist economic model is one of decreasing returns to scale.
This means that as employment increases, costs rise and so prices
also rise (and so real wages fall). But in reality many industries
have increasing returns to scale, which means that as production
increases unit costs fall, prices fall and so real wages rise. Thus
in such an economy unemployment would increase simply because of the
nature of the production process!
Moreover, as we argued in-depth in section C.9,
a cut in money wages is not a neutral act. A cut in money wages means
a reduction in demand for certain industries, which may have to reduce
the wages of its employees (or fire them) to make ends meet. This
could produce a accumulative effect and actually increase unemployment
rather than reduce it.
In addition, there are no "self-correcting" forces at work in the
labour market which will quickly bring employment back to full levels.
This is for a few reasons. Firstly, the supply of labour cannot be
reduced by cutting back production as in other markets. All we can
do is move to other areas and hope to find work there. Secondly, the
supply of labour can sometimes adjust to wage decreases in the wrong
direction. Low wages might drive workers to offer a greater amount
of labour (i.e. longer hours) to make up for any short fall (or to
keep their job). This is usually termed the "efficiency wage"
effect. Similarly, another family member may seek employment in order
to maintain a given standard of living. Falling wages may cause the
number of workers seeking employment to increase, causing a
full further fall in wages and so on (and this is ignoring the effects
of lowering wages on demand discussed in section C.9).
The paradox of piece work is an important example of this effect.
As Schor argues, "piece-rate workers were caught in a viscous downward
spiral of poverty and overwork. . . When rates were low, they found
themselves compelled to make up in extra output what they were losing
on each piece. But the extra output produced glutted the market and
drove rates down further." [Juliet C. Schor, The Overworked
American, p, 58]
Thus, in the face of reducing wages, the labour market may see an
accumulative move away from (rather than towards) full employment,
The right-libertarian argument is that unemployment is caused by real
wages being too high which in turn flows from the assumption that
markets clear. If there is unemployment, then the price of the commodity
labour is too high -- otherwise supply and demand would meet and the
market clear. But if, as we argued above, unemployment is essential
to discipline workers then the labour market cannot clear except
for short periods. If the labour market clears, profits are squeezed.
Thus the claim that unemployment is caused by "too high" real wages
is false (and as we argue in section C.9,
cutting these wages will result in deepening any slump and making
recovery longer to come about).
In other words, the assumption that the labour market must clear
is false, as is any assumption that reducing wages will tend to push
the economy quickly back to full employment. The nature of wage labour
and the "commodity" being sold (i.e. human labour/time/liberty) ensure
that it can never be the same as others. This has important implications
for economic theory and the claims of right-libertarians, implications
that they fail to see due to their vision of labour as a commodity
like any other.
The question arises, of course, of whether, during periods of full
employment, workers could not take advantage of their market power
and gain increased workers' control, create co-operatives and so reform
away capitalism. This was the argument of the Mutualist and Individualist
anarchists and it does have its merits. However, it is clear (see
section J.5.12) that bosses hate
to have their authority reduced and so combat workers' control whenever
they can. The logic is simple, if workers increase their control within
the workplace the manager and bosses may soon be out of a job and
(more importantly) they may start to control the allocation of profits.
Any increase in working class militancy may provoke capitalists to
stop/reduce investment and credit and so create the economic environment
(i.e. increasing unemployment) necessary to undercut working class
power.
In other words, a period of full unemployment is not sufficient
to reform capitalism away. Full employment (nevermind any struggle
over workers' control) will reduce profits and if profits are reduced
then firms find it hard to repay debts, fund investment and provide
profits for shareholders. This profits squeeze would be enough to
force capitalism into a slump and any attempts at gaining workers'
self-management in periods of high employment will help push it over
the edge (after all, workers' control without control over the allocation
of any surplus is distinctly phoney). Moreover, even if we ignore
the effects of full employment may not last due to problems associated
with over-investment (see section C.7.2),
credit and interest rate problems (see section F.10.1)
and realisation/aggregate demand disjoints. Full employment adds to
the problems associated with the capitalist business cycle and so,
if class struggle and workers power did not exist or cost problem,
capitalism would still not be stable.
If equilibrium is a myth, then so is full employment. It seems somewhat
ironic that "anarcho"-capitalists and other right-libertarians maintain
that there will be equilibrium (full employment) in the one market
within capitalism it can never actually exist in! This is usually
quietly acknowledged by most right-libertarians, who mention in passing
that some "temporary" unemployment will exist in their system
-- but "temporary" unemployment is not full employment. Of course,
you could maintain that all unemployment is "voluntary" and get round
the problem by denying it, but that will not get us very far.
So it is all fine and well saying that "libertarian" capitalism
would be based upon the maxim "From each as they choose, to each
as they are chosen." [Robert Nozick, Anarchy, State, and Utopia,
p. 160] But if the labour market is such that workers have little
option about what they "choose" to give and fear that they will not
be chosen, then they are at a disadvantage when compared to their
bosses and so "consent" to being treated as a resource from the capitalist
can make a profit from. And so this will result in any "free" contract
on the labour market favouring one party at the expense of the other
-- as can be seen from "actually existing capitalism".
Thus any "free exchange" on the labour market will usually not
reflect the true desires of working people (and who will make all
the "adjusting" and end up wanting what they get). Only when the economy
is approaching full employment will the labour market start to reflect
the true desires of working people and their wage start to approach
its full product. And when this happens, profits are squeezed and
capitalism goes into slump and the resulting unemployment disciplines
the working class and restores profit margins. Thus full employment
will be the exception rather than the rule within capitalism (and
that is a conclusion which the historical record indicates).
In other words, in a normally working capitalist economy any labour
contracts will not create relationships based upon freedom due to
the inequalities in power between workers and capitalists. Instead,
any contracts will be based upon domination, not freedom. Which
prompts the question, how is libertarian capitalism libertarian
if it erodes the liberty of a large class of people?
Firstly, we must state that a pure laissez-faire capitalist system has not
existed. This means that any evidence we present in this section can
be dismissed by right-libertarians for precisely this fact -- it was
not "pure" enough. Of course, if they were consistent, you would expect
them to shun all historical and current examples of capitalism or
activity within capitalism, but this they do not. The logic is simple
-- if X is good, then it is permissible to use it. If X is bad, the
system is not pure enough.
However, as right-libertarians do use historical examples
so shall we. According to Murray Rothbard, there was "quasi-laissez-faire
industrialisation [in] the nineteenth century" [The Ethics
of Liberty, p. 264] and so we will use the example of nineteenth
century America -- as this is usually taken as being the closest to
pure laissez-faire -- in order to see if laissez-faire is stable or
not.
Yes, we are well aware that 19th century USA was far from laissez-faire
-- there was a state, protectionism, government economic activity
and so on -- but as this example has been often used by right-Libertarians'
themselves (for example, Ayn Rand) we think that we can gain a lot
from looking at this imperfect approximation of "pure" capitalism
(and as we argued in section F.8, it is the
"quasi" aspects of the system that counted in industrialisation, not
the laissez-faire ones).
So, was 19th century America stable? No, it most definitely was
not.
Firstly, throughout that century there were a continual economic
booms and slumps. The last third of the 19th century (often considered
as a heyday of private enterprise) was a period of profound instability
and anxiety. Between 1867 and 1900 there were 8 complete business
cycles. Over these 396 months, the economy expanded during 199 months
and contracted during 197. Hardly a sign of great stability (since
the end of world war II, only about a fifth of the time has spent
in periods of recession or depression, by way of comparison). Overall,
the economy went into a slump, panic or crisis in 1807, 1817, 1828,
1834, 1837, 1854, 1857, 1873, 1882, and 1893 (in addition, 1903 and
1907 were also crisis years).
Part of this instability came from the eras banking system. "Lack
of a central banking system," writes Richard Du Boff, "until
the Federal Reserve act of 1913 made financial panics worse and business
cycle swings more severe" [Accumulation and Power, p. 177]
It was in response to this instability that the Federal Reserve system
was created; and as Doug Henwood notes "the campaign for a more
rational system of money and credit was not a movement of Wall Street
vs. industry or regional finance, but a broad movement of elite bankers
and the managers of the new corporations as well as academics and
business journalists. The emergence of the Fed was the culmination
of attempts to define a standard of value that began in the 1890s
with the emergence of the modern professionally managed corporation
owned not by its managers but dispersed public shareholders."
[Wall Street, p. 93] Indeed, the Bank of England was often
forced to act as lender of last resort to the US, which had no central
bank.
In the decentralised banking system of the 19th century, during
panics thousands of banks would hoard resources, so starving the system
for liquidity precisely at the moment it was most badly needed. The
creation of trusts was one way in which capitalists tried to manage
the system's instabilities (at the expense of consumers) and the corporation
was a response to the outlawing of trusts. "By internalising lots
of the competitive system's gaps -- by bring more transactions within
the same institutional walls -- corporations greatly stabilised the
economy." [Henwood, Op. Cit., p. 94]
All during the hey-day of laissez faire we also find popular protests
against the money system used, namely specie (in particular gold),
which was considered as a hindrance to economic activity and expansion
(as well as being a tool for the rich). The Individualist Anarchists,
for example, considered the money monopoly (which included the use
of specie as money) as the means by which capitalists ensured that
"the labourers . . . [are] kept in the condition of wage labourers,"
and reduced "to the conditions of servants; and subject to all
such extortions as their employers . . . may choose to practice upon
them", indeed they became the "mere tools and machines in the
hands of their employers". With the end of this monopoly, "[t]he
amount of money, capable of being furnished . . . [would assure that
all would] be under no necessity to act as a servant, or sell his
or her labour to others." [Lysander Spooner, A Letter to Grover
Cleveland, p. 47, p. 39, p. 50, p. 41] In other words, a specie
based system (as desired by many "anarcho"-capitalists) was considered
a key way of maintaining wage labour and exploitation.
Interestingly, since the end of the era of the Gold Standard (and
so commodity money) popular debate, protest and concern about money
has disappeared. The debate and protest was in response to the effects
of commodity money on the economy -- with many people correctly viewing
the seriously restrictive monetary regime of the time responsible
for economic problems and crisis as well as increasing inequalities.
Instead radicals across the political spectrum urged a more flexible
regime, one that did not cause wage slavery and crisis by reducing
the amount of money in circulation when it could be used to expand
production and reduce the impact of slumps. Needless to say, the Federal
Reserve system in the USA was far from the institution these populists
wanted (after all, it is run by and for the elite interests who desired
its creation).
That the laissez-faire system was so volatile and panic-ridden suggests
that "anarcho"-capitalist dreams of privatising everything, including
banking, and everything will be fine are very optimistic at best (and,
ironically, it was members of the capitalist class who lead the movement
towards state-managed capitalism in the name of "sound money").
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