Thursday, November 10, 2011

Capitalism and Dollar Democracy

Blog Entry: NOT The Wall Street Journal

By A. Grundrisse

November 11th, 2011

There has been a lot of discussion recently, no doubt prompted by among other things the Occupy Wall Street movement, recent Supreme Court decisions and Republican front-runner Mitt Romney’s candid comment that “Corporations are people too”, about the ubiquitous corrupting influence of corporations and money generally on the ostensibly democratic political process. That the moneyed interests dominate politics and thereby undermine what most think about how a democracy ought to work is essentially undeniable, but it misses the bigger point. The moneyed interests dominate all aspects of social and economic life in modern capitalist societies, so why should politics be any different? How could it be?

The first thing any student of introductory economics learns is the definition of economics: Economics is the study of how societies allocate scarce resources. Historically and theoretically there are many possible approaches. Societies can follow tradition, they can be subject to the fiat of an autocrat, or they can pursue a central planning process, to give just a few examples. Capitalist, free-market societies allocate scarce resources through a dynamic process driven by the autonomous spending and investment decisions of their members. As dollars are spent acquiring one particular good, money and resources flow to the development, production, marketing and distribution of that good, and away from all other goods. The summation of the independent individual purchasing decisions across all the members of the society determine what goods are produced, and where and how resources are allocated. The following illustration makes this process clear.

A new French bakery opened up on my block. I now buy my bread there fresh every day instead of at the bakery department of my local supermarket. I see many others there who have made the same choice. As a result of our individual decisions to buy bread there instead of the supermarket, money flows into the new bakery and away from the supermarket. If this trend continues, the new bakery will expand while the bakery department at the supermarket will contract. Society allocates more resources to the new bakery and fewer to the supermarket as a result of my neighbors’ and my independent purchasing decisions. This all unfolds without anyone intending it to happen, or indeed even being conscious of what is taking place. We are just trying to get fresher better bread, and responding rationally to our preferences and desires, and the alternatives available to us. The market system, and this is its genius, automatically does the rest.

This process is fundamental, intrinsic and lies at the very core of the capitalist / free market system. It dominates resource allocation decisions and does so regardless of whether or not money is deeply involved in politics as well. Two clear incontrovertible conclusions derive directly from this dynamic.

The first is that the more money you have, the greater your individual influence is on how societal resources are allocated. Every dollar expended is in effect a vote for how resources are allocated, and those with more dollars naturally cast more votes. Capitalist / free market societies are democracies to be sure, but they are democracies of dollars, not of people. All dollars spent or invested are equal, and each one has an equal vote in how resources are allocated society wide. This is not a moral, ethical or normative conclusion, but a purely analytical one based on the basic operating principals of capitalist / free market economies.

In this respect capitalist societies operate in a fashion similar to the governance of public corporations. Ostensibly, the most important corporate actions are subject to a vote of the shareholders. But this process is not one shareholder one vote but rather one share one vote, and those owning the most shares get the most votes. In fact corporate governance is even more distorted than this because shareholders who don’t vote or return their proxies in time are deemed to have voted in support of management. Since most individual shareholders own their shares through custodians or other intermediaries, absent Herculean efforts on their part, they often don’t even receive the proxy materials in time to vote. The result is that efforts to make management at public corporations more accountable to individual shareholders and the public at large, such as those led by among others Arthur Leavitt, while meaning well, are hopelessly naïve and delusional. The term “corporate governance”, unless it is meant to be simply synonymous with “rubber stamp”, is oxymoronic.

The second clear conclusion deriving from the nature of resource allocation under capitalist / free market societies is that all such societies are plutocracies, with the degree to which they are plutocracies dependent on the level of equality or inequality in their distribution of income and wealth. To see this clearly, imagine a capitalist society in which everyone has the same amount of income and wealth; then in such a society everyone has the same amount of dollar votes as well, and the same say in society’s resource allocation. At the other extreme in a society characterized by extremely unequal income and wealth distribution, a tiny minority makes a highly disproportionate amount of the decision-making about how and where a society uses resources. To place this in context let’s take a look at recent trends in income and wealth distribution in the United States.

Numerous studies using different methodologies and published by analysts from a wide range of political standpoints have all come to the same conclusion: Income and wealth distribution in the United States are currently at extreme levels, by some measures unprecedented even in the period immediately prior to the Great Depression. Consider the following four examples: (1) In 2007, the share of income captured by the top 10 % of the population (calculated including capital gains) reached an unprecedented 50 % of all income. The previous high level of 48 % had been reached in 1928. It is worth observing that immediately following 1928 came the Great Depression, and immediately following 2007 came the greatest banking and financial crisis of modern times; this is a point we will return to. (2) According to Professor of Economics at the University of California at Berkeley, and former senior economic advisor to President Clinton, Robert Reich, “America’s 400 richest people who earned an average of $ 300 million last year, have more wealth than the bottom 150 million Americans put together.” This means that these 400 richest Americans cast more “dollar votes” than the 150 million poorest ones combined. (3) The ratio of CEO pay to factory worker pay has risen from 42:1 in 1960 to 344: 1 in 2007. (4) According to the U.S. Central Intelligence Agency, as of 2010, income inequality in the U.S. significantly exceeded inequality levels in China, Russia, India and Egypt. Given these statistics, and the intrinsic way resource allocation decisions are made in capitalist free-market societies, it is clear that the degree to which the United States is currently a plutocracy is likely unprecedented in its modern history.

I am not suggesting that we need to be concerned about the degree of income inequality for any moral or ethical reasons (although those may exist as well), rather my focus is on purely practical and economic considerations. In fact, there may be reasons why a plutocracy is not such a bad thing: rich people are generally highly educated, they have the time and resources to research complex issues diligently, and clearly they have a lot to lose if society becomes dysfunctional. Certainly America’s sacred Founding Fathers favored plutocracies, they made satisfying stringent minimum property requirements a prerequisite to qualifying for voting. However, as mentioned above, extreme levels of economic inequality have historically preceded prolonged profound periods of economic contraction and collapse. Above all, it is this clear and compelling historical track record that ought to concern us.

The reason why extremely high levels of wealth and income inequality lead directly to economic slumps is quite obvious. There simply isn’t enough economic purchasing power left in the pockets of consumers to buy all of the products that are produced or capable of being produced. Ask yourself if those 400 richest people spend as much on Lamborghinis and Ferraris as the 150 million spend on Fords and Chevys. Or as much on Versace gowns and Brioni suits as the bottom 150 million spend on clothes at Wal-Mart and Target? Or on food at restaurants owned and operated by Thomas Keller and Daniel Boulud as the bottom 150 million spend at McDonalds and KFC? In fact, the very rich save and invest a far larger share of their income and wealth than poor people do, who generally spend all of their money on consumption and don’t save at all. And while savings and investment at some level are essential to support a growing economy and improved standards of living, at high levels of wealth imbalance they simply serve to increase the production of goods that no one has the money to buy. In doing so they actually exacerbate the underlying problem. These periods when excessive levels of income and wealth inequality threaten the entire economy are characterized by collapsing interest rates and corporations flush with cash because they cannot find any productive way to invest it. This is exactly the economic landscape surrounding us today.

As even beginning economics students know, all capitalist free-market societies are inherently, intrinsically plutocracies. While the ethical and moral merits of a plutocracy may be debatable, what is not is that whenever the distribution of income and wealth in a capitalist society reaches extreme levels, it threatens the fundamental functioning of the economy. Too many people have too little money to purchase the vast amount of goods produced. And, as noted above, there are innumerable studies out generated by a broad spectrum of analysts that indicate that the current distribution of wealth and income is at such a highly imbalanced level. This would create considerable economic problems even if the pernicious influence of money on politics could be completely eliminated. The historical trajectory of modern capitalism has generated a distribution of income and wealth which is no longer able to support the prodigious production levels that the modern economy is capable of generating. The result of this imbalance, unless or until it is dramatic changed, will be a protracted profound economic slump, which will manifest itself in high rates of un- and underemployment, low rates of income and economic growth, and a prolonged dismal and depressing daily decline in the quality of life and standard of living for the vast majority of Americans. This state of affairs is not merely an anomaly or accident; it is the product of a long-term historical development. To alter this historical result would require change to the free market system so fundamental that it would in fact no longer be a “free-market” system. What is required is not mere reform, but rather something far more profound, a qualitative change in the way our system functions. Absent this, we will remain petrified in a perpetual pernicious economic decline from which we may never truly emerge.


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