This paper by Muriel Strand ( LWVCA) presents a condensed history of economics, government and the market.

HISTORY OF ECONOMICS, GOVERNMENT AND THE MARKET: EXECUTIVE SUMMARY

Public and private property and money, key aspects of the social contract between governments, markets and individuals, have developed as explicit concepts and subjects of inquiry since at least Roman times. Medieval Europe’s stable world view gave way to changes brought about by the Enlightenment, the discovery of the Americas by Europeans and the exploitation of fossil fuels.

The enclosure of common public pastures by the upper classes in England is an early privatization process. Though described as the inevitable “tragedy of the commons” by Garrett Hardin, more recent theory (and exhaustive fieldwork) by Elinor Ostrom and her colleagues has outlined key factors sufficient to avoid this tragedy and to achieve sustainable stable management of key common-pool resources such as pastures.

Over time, economic theories have become increasingly sophisticated, complex, mathematical and specialized, as our economic system/s have become larger, more complex and more interconnected.

Money, too, has evolved. Although the three basic attributes are unchanged (medium of exchange, unit of account and store of value), the everyday item has evolved. It has gone from strings of shells or beads to bags of gold and jewels, then letters of credit, greenbacks, and eventually ATM cards.

Before World War II, markets and the economy were seen as automatically self-correcting. The Depression and Keynesian analysis led to the belief that government should manage and regulate the economy through fiscal policy (budgets) and monetary policy (the money supply and interest rates).

We have recently seen that the drive for monetary profits and growth has led to serious wounds in our economic goose, such that golden eggs are now few and far between.

The priority given to monetary growth and monetary profit persists. The transfer of an activity or service from government to the private sector may be accompanied by a transfer of focus from the achievement of the real task or service to a focus on the monetary profit that may be obtained as a byproduct of providing the product or service. (There’s a reason that advertising emphasizes non-functional aspects of goods and services.) While staying in the black is required for the continuing operation of a government or business, it’s the actual product or service that is the real reason for government and business operations. True competitiveness is about successfully providing the real product or service for the public, never just about making a monetary profit.

Muriel Strand


HISTORY OF ECONOMICS, GOVERNMENT AND THE MARKET

By Muriel Strand

Economics as a concept comes from the Greek words for home (eco) and management (nomos), and is akin to ecology, the study of the natural world we live in. (Home economics thus contains a redundant adjective.) Indeed, our economic system can be seen as a very large and complicated version of a small and basically self-sufficient homestead. Production and consumption of goods and services, investment of time and/or money in capital goods such as tools, and increases in real productivity from well-designed tools as well as from skills and experience—all can be identified in a traditional small farm as well as in the modern global economy.

Privatization is a current trend in the long historical relationship between governments and markets. Its beginning is marked by then-President Reagan’s first inaugural address, where he said, “In this present crisis, government is not the solution to our problem; government is the problem,” referring specifically to the Federal government.1 Arguments for privatization are often couched in terms of financial and economic concepts; the following discussion may help demystify them.

Governments and markets are peopled by both individual agents and groups, social and economic actors. Governments make the rules of market boundaries, operations and institutions through various processes and deliberations. The nature of the social contract between government, the market and citizens has varied and evolved through history.

Property, money and interest are key economic institutions relevant to privatization, whose nature and roles have evolved over time. The definition of property reflects the boundary between the government and the private sector. Money has at times been issued by governments and at other times by banks. And the rate of interest that is seen as usurious has also varied, as have government limitations on it.

The Ancient World

As societies have grown in size over history, their economic structures and processes have grown more complex and diverse, mirroring the evolution of governmental structures and processes. Leaders and commoners co-evolved strategies to manage the large populations of city-states such as ancient Rome, China, Egypt, Mexico and Peru.

Metal coinage preceded Rome, as did Aristotle’s economic concerns about the ethics of both slavery and usury. Charging interest only became respectable when it “was redefined as a payment for productive capital,” in the last few hundred years.2 Aristotle also noted the paradox of value, where water, which is essential for life, is cheap, while jewels are unnecessary and expensive. In general, the Romans weremost interested in real wealth, such as agricultural products and trade goods, and saw money as secondary.

According to John Kenneth Galbraith “Roman law...gave to property its formal identity and to its possessor the dominium, or rights, that are now assumed. … the right not only of enjoyment and use but also of misuse and abuse.” This Roman institution of private property “would be central to personal gratification, economic development and political conflict for the centuries to come.”3

However, the Romans didn’t define all property as private. “The Roman emperor Justinian decided to gather and condense all the unpublished rules and edicts handed down by his predecessors into a unified, coherent code of imperial law.” One of this code’s tenets was the “public trust doctrine” that “By the law of nature these things are common to all mankind, the air, running water, the sea and consequently the shores of the sea.”4 The ‘public trust doctrine’ means that “the trust lands belong to the public and are to be used to promote public rather than exclusively private purposes.”5

Elinor Ostrom6 has described the recent theory of the sustainable management of “common-pool resources” (CPR) where the resource stock is by nature held in common due to being practically non-excludable, as with fish in the ocean, while its fruits are excludable in that only one person can eat a particular fish.

She and others have demonstrated that stable harvesting arrangements lasting in some cases for centuries have been collectively created by harvesters themselves, whether indigenous or modern.  Such arrangements avoid the ‘tragedy of the commons’ by tailoring roles, relationships, and institutional structures to the situation on the ground. Governance happens on at least two levels: normal everyday operations of the commons, and rule-adjustment discussion and decisions.

Eight criteria are typically found in such cases of sustainable management of CPRs.

1. There are clear and accepted boundaries of the group of users and of the common resource.
2. Rules governing use of the common resource match local conditions & needs for labor/money inputs.
3. Most of those affected by the rules can participate in modifying the rules.
4. Those who monitor the health and harvest of the resource are accountable to the users or are the users.
5. Rule violations receive graduated sanctions that depend on seriousness and context.
6. Local, low-cost and prompt means are available for dispute resolution.
7. Users have long-term tenure rights, and distant centralized authorities respect the rule-making rights of the group of users.
8. For CPRs that are part of larger systems: Harvest, use, monitoring, enforcement, conflict resolution and governance are organized in multiple layers of nested institutions.7

In such nested institutions, government and business would be intertwined at each level such that the overall system may resemble fractal geometry (an irregular or fragmented geometric shape that can be repeatedly subdivided into parts, each of which is a smaller copy of the whole).

Medieval Europe

During medieval times, serfs belonged to the land, and, in a sense, the serfs and the landowners belonged to each other. Both sides had certain rights and responsibilities, even if landowners usually had the upper hand. Craft guilds in towns and the few cities were the cornerstones of that era’s market. Gradually these ties weakened, and economic relationships became increasingly free and monetized. Both the impact of the bubonic plague in reducing large populations  and the appearance in the world economy of all the gold Spain acquired in the Americas were destabilizing influences on feudal political and economic traditions.

The actual tragedy of the commons may have been the enclosure of common lands in England and elsewhere. The expropriation of peasant farmers, mostly the descendants of serfs, and the enclosure (i.e., privatization) of their former fields by the upper classes were largely due to the superior monetary profits available to the landlords from raising wool.8

The History of Money

The history of money is of generally increasing symbolism, going from strings of shells or beads to bags of gold and jewels, then letters of credit, greenbacks, and eventually ATM cards. Economic theory posits three key functions of money: a medium of exchange (an economic lubricant, reducing the friction of transactions and thus, costs); a unit of account (dollars and cents make operating statements and balance sheets possible); and a store of value (in a medium that is durable and least susceptible to decay and deterioration).9

In some sense, money itself is the kind of CPR described by Ostrom.10  It is by nature held in common because it only works if everyone agrees to use the same forms and rules, while only one person can possess any one dollar. And the benefits of having a monetary system can be shared fairly and unfairly, in ways that are more or less stable. However, unlike real physical resources where mass and energy are physically conserved, money can appear from, and disappear into, nothingness, such as in the stock market or the Federal Reserve Bank. The monetary system is always a subset of the real economy, which includes barter, gifts, and theft.

Monetary interest, profit and the discount rate are key and related variables, and identifying the real processes in the world that are their foundation is a crucial inquiry. The discount rate selected for a cost-benefit analysis that may be used to support a privatization proposal can play a decisive role in the outcome. Generally, governments lend and borrow at lower interest rates than businesses, consistent with their responsibility for long-term stability.

Modern Capitalism and Industry

The basic ingredients of mercantile capitalism – banking, stock exchanges, commodity markets, letters of credit, and so forth – had appeared by the end of the 15th century.11 These financial tools supported expansion of trade, and then the industrial revolution, as capital financed the manufacture of useful devices based on the experiments of physicists and the tinkering of engineers – and not least on the increasing use of coal.

The economic effects of cheap energy from fossil fuels are huge and underappreciated. In the U.S., the humanpower, minimum-wage price of the amount of energy available from a gallon of gas would be about 200 times more than we now pay at the pump.12

Communism and Socialism

The roots of modern socialism are in “an 18th-century intellectual and working class political movement that criticised the effects of industrialisation and private property on society.” Socialism is an economic and political theory advocating public or common ownership and cooperative management of the means of production and allocation of resources.13 In other words, socialism means the workers own and/or control in common the means of production.

The 19th century saw Karl Marx write Das Kapital14 which is popularly thought of as the origin of communism, but many, including Marx, saw hunter-gatherer societies as early communism. Marx’s phrase “From each according to his ability, to each according to his needs” is a common summary of the theory.15

Why are authoritarianism and totalitarianism so widely attributed to two philosophies that advocate cooperation between business and government? Wilhelm Reich suggested that the crucial strategic error of these movements was their failure to confront and reform the patriarchal authoritarian family tradition.16

Classical Economic Theory: The Monetary Economy and the Real Economy

The 19th century also saw the development of classical economic theory. One key concept is ‘the veil of money,’ the recognition that symbolic money clothes the real functioning of the economic system.17 The real goal of an economy is actually about real welfare and consumption of real goods and services, notably clean air and water, healthy food, and snug shelter. Obsessing about means and losing track of ends, one’s basic purpose, is a common human weak point, as we are warned in Timothy about the “love of money.”18

Prices, while denominated in currencies, are actually our collective, qualitative, relative and subjective agreement about what’s valuable and what’s not. Economic theory defines your income as the real value of your production. Transactions happen, and prices are determined, when two parties find a specific trade mutually beneficial, and the accumulation of these decisions leads to typical market prices.

However, needs and wants are distinguished in the theory only insofar as they are distinguished in individuals’ judgments of utility that underlie the selection of each individual’s optimal ‘market basket’ of goods and services that is selected in trade for one’s income.

Evidence of the strength of the private sector relative to the U.S. government surfaced in 1894. The U.S. Treasury held only enough money for a few more months of federal government operations, but an issue of Treasury bonds failed to sell. The White House appealed to J.P. Morgan, whose backing led to a successful sale, raising crucial funds for the government and a healthy commission for Morgan.19

Neoclassical Economic Theory and the Business Cycle

Shortly before the end of the 19th century, Alfred Marshall and others rephrased classical theory in mathematical terms, not a perfect match for a qualitative topic. The math’s quantitative strengths have supported a bias toward numeric monetary economic measures such as GDP (gross domestic product) rather than the real basics of welfare like food and water.

A key weakness of this mathematical body of theory is the list of unrealistic assumptions required to make the math work, such as ‘homo economicus’ (everyone is a totally rational individual), no transaction costs for purchases of products or labor, complete and totally available information about goods and services, no advertising, perfect competition everywhere, etc.

Marshall defined interest as the marginal return to capital, which Galbraith described as the actual interest rate that equals the return on the last and least rewarding unit of capital invested.  “There would be a balance between the marginal return on capital and the reward necessary to attract the marginal saver.”20  ‘Marginal’ means the effect of a specific small change in an economic quantity. Thus, the marginal return is the minimum increase in the rate of return sufficient to motivate a saver to invest just one more dollar.

At about the same time, accumulated experiences with economic ups and downs, booms and busts, in the 18th century and about every decade or so in the 19th century, led to the theory of ‘the business cycle.’21 Top economists of that era confronted the Great Depression with the idea that patience was the remedy for a recession, and it would eventually lift, as always.22

Keynesian Theory and Monetary Policy

Keynes developed the ideas that inadequate demand could lead to the kind of stubborn high unemployment seen in the 1930s, and that the economy simply needed a push to get going again.23 After the war, the Keynesian paradigm of keeping the economy at a stable dynamic equilibrium by means of monetary policy adjustments was adopted by most capitalist economies as the best way to tame the business cycle, minimize recession, and avoid another depression.24 Notably, the Keynesian revolution marked a shift in the relationship between government and the private sector. Henceforth, the government was seen as responsible for overall economic performance.25

Keynes modified Marshall’s definition of interest by noting two additional factors that affect the interest rate. The saver’s liquidity preference and time preference influence the going rate for investment of savings.26 Liquidity preference is the proportion of assets that are held in cash reserves for a rainy day. Time preference is the same concept as the real discount rate, a measure of the availability of surplus and how long before you think you might need it.

A low discount rate means low interest rates, because monetary value is stable, and perhaps also because the lender has adequate resources. Note that holding one’s savings in cash or other less liquid monetary assets can shelter them from the ravages of decay or depreciation, which can inflict real damage on necessities such as food.

GNP, GDP and Growthmania

GNP (gross national product) and GDP (gross domestic product) arose from the ‘system of national accounts,’ the estimates of productive capacity created to plan for World War II.27 Today, aggregate economic production is accounted in monetary terms, so that GNP (based on ownership of production) and GDP (based on geographical location of production) are actually estimates of monetary transaction volume rather than necessarily a measure of real welfare. In the past, monetary economic growth and higher profits were both closely correlated with increased real welfare, so people tend to think that any growth in GDP or profits will always, automatically, be beneficial.

Non-monetized goods and services are largely excluded from both GNP and GDP, which means that the transfer of much of women’s work into the monetary system over the past few decades looks like more economic growth than it really has been, and women appear more productive than before because unpaid work isn’t included in standard productivity accounting.28

Agencies such as the Bureau of Economic Analysis29 tabulate huge amounts of data about a very wide array of production and services. They calculate “real” GDP, which typically means ‘adjusted for inflation.’ But fundamentally it means real, tangible value and qualitative utility.

Return on investment is simply the ratio of money gained or lost on an investment relative to the amount invested. Real return on real investment, however, requires accurate goals and practical means. The role of banks is to invest and lend a substantial fraction of deposits for real constructive and productive projects that will pay back loans with interest.

Welfare-Centered Economics

Recent years have seen the development of more goal-oriented measures of economic health and welfare, such as Gross National Happiness,30 the Human Development Index,31 the Green GDP32 and the Genuine Progress Indicator.33 In general, these indices account for negative impacts such as resource depletion or pollution where conventional GDP/GNP treat all transactions as reflecting positive activities, all monetary growth as good. These negative impacts are often called “externalities,” which is a cost (or benefit) not transmitted through prices and incurred by a party who did not agree to the transaction. One negative impact is advertising, which has recently been described as a “private tax.”34

Another approach to optimal welfare is A. H. Maslow’s hierarchy of needs, formulated by the psychologist at the same time as the system of national accounts that grew into the GNP/GDP.35  Maslow’s diagram explicitly lists the different kinds of needs for a full human life, with basic survival needs (clean air and water, healthy food, warmth and sleep) as the most necessary – but not truly sufficient.

Evolution, Adaptation and Economic Stability

Business and economic cycles can operate in ways that are cooperative, suited to times of stability and certainty, as well as in ways that are competitive and opportunistic, suited to insecurity or rapid change.

Similarly, in an economy, some products and services are more basic and durable, while others are more fleeting, innovative or speculative. Some describe conservative investors as those who buy bonds that finance water systems and energy utilities, while those who seek a high and/or quick rate of return invest in high-risk ventures, spend all their time at their computers churning stocks.

The availability of cheap fossil fuels such as coal and oil has offered humanity a huge new source of cheap energy and work, allowing for a great deal of opportunistic behavior and physical growth that would have been otherwise impossible. In this context, it can be postulated that competition has recently worked better than cooperation might, since the energy and materials available have grown so fast and so recently.

But opportunistic competition is not suited to success in stable environments, and people generally prefer stability when it comes to the basic necessities. In fact, businesses themselves regularly emphasize how important it is for them to operate in stable, predictable and uniform markets in order to stay in the black.

The Return of the Business Cycle

A postwar combination of the New Deal, monetary oversight by the Federal Reserve, the 1933 Glass-Steagall Act and other regulation of financial markets, and (usually) cheap oil has allowed the United States to avoid, until recently, recessions as traumatic as the 1930s and before.

Congressional desire to support the Federal National Mortgage Association’s (FNMA or Fannie Mae) and the Federal Home Loan Mortgage Corporation’s (FHLMC or Freddie Mac) financing of low-income home ownership may have contributed to lax underwriting standards and overly-optimistic borrowing. Wall Street’s primary goal of more and more profit and monetary growth crowds out attention to the ongoing weakening of the industrial foundation and basic manufacturing in the United States.36

While financial market deregulation has been ongoing for several decades, the 1999 congressional repeal of the Glass-Steagall Act’s firewall between federally-guaranteed depository banking and supposedly free-market securities banking is seen by many as a key cause of the 2008 market meltdown.37 Some suggest this deregulation allowed too much market interconnection and overleveraging, where each given dollar actually deposited in an account could be creatively multiplied by derivative chains of lending and hedging in its name.

Banking’s job is to leverage deposits by lending a substantial fraction for constructive and productive projects that will pay back loans with interest. The proportion of deposits that must, by regulation, remain in the bank as reserves varies, but speculative lending requires higher reserves, otherwise risk increases.

In 2008 when confidence was waning, and the wrong margin or loan was called, it turned out there wasn’t nearly as much money in actual deposits or real collateral as had been created by leveraging. While home repossessions and evictions are probably the most noticeable effect to most people, for ordinary businesses the short-term scarcity of commercial paper (lines of credit and short-term lending for operations) was perhaps the most challenging fallout.38

Another contributing factor that played a role was the sharp increase in oil prices, which threatened to create similar problems in the financial markets in the wake of the oil crises of the 1970s.39

A variety of financial analysts, economists and journalists have researched and described various reasons for the recent financial downturn, often reflecting individual expertise and different points of view about the most important and overriding causes. Given the complexity of the financial system and the multitude of persons involved, it’s likely that most of these factors played a role, even if a particular analyst’s pet cause may not be a critical one.

Advocates of privatization may claim that more competition means more efficiency, but such claims rarely receive close scrutiny. What is meant by efficiency? By productivity? What is the goal? What are the means? Who will be competing, how, and for what?

The transfer of an activity or service from government to the private sector may be accompanied by a transfer of focus from the achievement of the real task or service to a focus on the monetary profit that may be obtained as a byproduct of providing the product or service. While staying profitable is required for the continuing operation of a government or business, it’s the actual real product or service that is the real reason for government and business operations. True competitiveness is about successfully providing the real product or service for the public, never about just making a profit.

Muriel Strand (LWVCA) is a member of the LWVEF Study Committee on Privatization of Government Services, Assets and Functions.

Produced by the Privatization of Government Services, Assets and Functions Study, 2012
© League of Women Voters

ENDNOTES

1. First Inaugural Address of Ronald Reagan, January 20, 1981; The Avalon Project, Lillian Goldman Law Library, Yale Law School  http://avalon.law.yale.edu/20th_century/reagan1.asp.

2. John Kenneth Galbraith, Economics in Perspective: A Critical History (Boston: Houghton Mifflin Co., 1987) p. 12.

3. See endnote 2, p. 19.

4. Jay Walljasper, ed., Field Guide to the Commons: How to Save the Economy, the Environment, the Internet, Democracy, Our Communities, and Everything Else that Belongs to All of Us (New York: New Press, 2010), p. 72.

5. CA State Lands Commission, The Public Trust Doctrine, www.slc.ca.gov/policy_statements/public_trust/public_trust_doctrine.pdf
presented at 9/17/01 meeting www.slc.ca.gov/Policy_Statements/Public_Trust_Home_Page.html, p. 3.

6. Elinor Ostrom, Governing the Commons: The Evolutions of Institutions for Collective Action (New York: Cambridge University Press, 1990.

7. See endnote 6, p. 90 and Elinor Ostrom, Understanding Institutional Diversity (Princeton, NJ: Princeton University Press, 2005), p. 259

8. Joseph A. Schumpeter, History of Economic Analysis, 2nd ed. (New York: Oxford University Press, 1994), pp. 149-150.

9. Any standard economics text lists these functions of money. Three mentioned by Wikipedia are: Gregory Mankiw, Macroeconomics, 6th ed. (New York: Worth Publishers, 2007) pp. 22-32; Paul Krugman, Robin Wells and Kathryn Graddy, Essentials of Economics (New York: Worth Pub NY 2006); and Andrew Abel and Ben Bernanke, Macroeconomics, 5th ed (Pearson Custom Publishing, 2005) pp. 266-9.

10. See endnote 6.

11. See endnote 8, p. 78.

12. Human power of 1/10 horsepower is a reasonable output for sustained work, according to James McCullagh, ed., Pedal Power In Work, Leisure and Transportation (Emmaus, PA: Rodale Press, 1977), p. 38, and gasoline heating values are standard information from sources such as NIST: http://webbook.nist.gov/chemistry/.  Any needed conversion factors can be found at www.onlineconversion.com/ or any handbook.

13. Frederick Engels, Socialism: Utopian and Scientific (Richmond, England: Curzon Press, 2007) via Wikipedia http://marxists.org/archive/marx/index.htm.

14. Karl Marx, Das Kapital (Washington, DC: Gateway Editions, 1996), www.bibliomania.com/2/1/261/1294/frameset.html.

16. Wilhelm Reich, The Mass Psychology of Fascism, 3rd ed. (New York: Farrar, Straus and Giroux, 1980).

17. Julio Segura and Carlos Rodriguez Braun, eds., An Eponymous Dictionary of Economics: A guide to Laws and Theorems Named after Economists (Northampton, MA: Edward Elgar, 2004) p. 121, www.scribd.com/doc/51284147/138/Hume’s-law.

18. 1Timothy 6:10, New Testament, Holy Bible, King James version.

19. Mario Dinunzio, Franklin D. Roosevelt and the Third American Revolution (Santa Barbara, CA: Praeger, 2011),
www.booktv.org/Program/12629/2011+Roosevelt+Reading+Festival+Mario+Dinunzio+Franklin+D+Roosevelt+and+the+Third+American+Revolution.aspx .

20. See endnote 2, p. 110.

21. See endnote 8, p. 688.

22. See endnote 2, p. 194-5.

23. See endnote 2, p. 222.

24. See endnote 2, p. 257.

25. See endnote 2, p.235.

26. See endnote 8, pp. 1178-1179.

27. See endnote 2, pp. 246-247.

28. Marilyn Waring, If Women Counted: A New Feminist Economics (New York: HarperCollins Publishers, 1990); Margunn Bjornholt, “Marilyn Waring,” Encyclopedia of Motherhood (Thousand Oaks, CA, Sage Publications) pp.1260-1261

29. Bureau of Economic Analysis, U.S. Department of Commerce: www.bea.gov/national/index.htm.

30. Gross National Happiness: www.grossnationalhappiness.com/.

31. The Human Development Index of the UN: http://hdr.undp.org/en/statistics/hdi/.

33. Genuine Progress Indicator: www.investopedia.com/terms/g/gpi.asp#axzz1VbMqe6uz. Index of Sustainable Economic Welfare:  www.oecd.org/dataoecd/22/2/43596167.pdf.

34. Andre Schiffrin, Words and Money (London: Verso, 2010) p. 94.

35. A.H. Maslow, “A Theory of Human Motivation,” Psychological Review 50(4) (1943) 370-396.
http://en.wikipedia.org/wiki/File:Maslow%27s_Hierarchy_of_Needs.svg

36. Paul Clemens, Punching Out: One Year in a Closing Auto Plant (New York: Doubleday, 2011) p. 14.

37. Nouriel Roubini, “‘Too Big To Fail’ Revisited,” Forbes.com, November 5, 2009.
www.forbes.com/2009/11/04/too-big-to-fail-volcker-greenspan-mervyn-king-opinions-columnists-nouriel-roubini.html

39. Andrew Scott Cooper, The Oil Kings: How the U.S., Iran, and Saudi Arabia Changed the Balance of Power in the Middle East (New York: Simon & Schuster, 2011). www.booktv.org/Program/12837/The+Oil+Kings+How+the+US+Iran+and+Saudi+Arabia+Changed+the+Balance+of+Power+in+the+Middle+East.aspx

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