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The productive elements of the US
economy are caught between powerful financial interests, e.g., banks seeking
speculative gains, political constituencies seeking entitlements and
government entities at all levels whose budgets and deficits are too large
compared to their revenues. All
three factions are competing for the same economic resources and all three
are net consumers of wealth. The
triumph of any one faction or of any combination thereof, promises to erode
capital and to encumber production and economic growth in the future. As a consequence, capital can be
expected to flow away from the United
States to other parts of the world.
If banks dominate over government, for example, ever larger shares of
tax revenues will likely flow to banks as a consequence of interest payments
and taxes will certainly rise despite inevitable austerity measures. If government triumphs at the expense of
banks, setting aside questions related to bank failures, bailouts or
sovereign defaults, there is no reason to believe that government entities
will become fiscally responsible or that the pattern of government expansion,
as a percent of GDP, will reverse in the foreseeable future. The banking and financial services
industries also represent a disproportionate share of US GDP. Political constituencies seeking
entitlements are, in part, a reaction against and a consequence of
disproportionate growth of government and of the banking and financial
services industries. In
advocating for or against any of the above factions, what seems to be ignored
is where sustainable economic growth will come from in the future.
Surrounded on all sides are entrepreneurs and private capital, which
are the historical engines of US
economic growth. As the nation
struggles to recover from the unprecedented global recession and the
financial crisis that began in 2008, the competition between banks,
government entities and political constituencies seeking entitlements
represents a diversion of wealth and future production into economically
unsustainable pursuits, such as bank profits, government stimulus or social
welfare programs. In economic
terms, the relationship of banks, government entities and political
constituencies seeking entitlements to the productive elements of the economy
can be described as one of rent seeking.
Rent seeking is a relationship where an individual,
company or other organization seeks income by capturing the production of
others through manipulation or exploitation of the financial, legal or
political environment, rather than through ordinary market participation or
the production of wealth.
Analogous to parasitism in biology, rent seeking means obtaining an
economic gain at the expense of others without any reciprocal benefit. Common examples of rent seeking
include tariffs sought by industries for no purpose other than to boost
profit margins and efforts by special interest groups to redistribute wealth
in their favor by shifting tax burdens or government spending where there is
no reciprocal benefit to any other group in society.
Businesses that produce physical goods, i.e., real production, along
with labor and existing capital derived from past production surpluses are
the targets of rent seeking strategies.
The central question for economists is whether rent seeking is
sustainable as an economic paradigm, i.e., as the dominant form of economic
relationship in an economy. If
so, spending by those who successfully gain control of wealth will stimulate
economic activity in a sustainable way and the economy will return to genuine
growth. For example, economic
growth might return as bank profits trickle down through the economy; or as
government borrowing and spending or expansion stimulate the economy and
create jobs, e.g., government jobs; or as social entitlements, such as
guaranteed retirement incomes or medical care, prove to be more efficient and
less costly to society when provided by government and funded by tax revenues
rather than by private industry.
If it turns out, however, that rent seeking is not a sustainable
economic paradigm, then the future of the US
economy will be characterized by an erosion of capital and an absence of
sustainable economic growth. One
question that might arise in the latter scenario is whether capital will stay
in the US
or migrate to other parts of the world.
The answer to this question lies in the nature of capitalism, as well
as in the historical origins of American capitalism.
Property
and Liberty
In terms of both economics and political philosophy, there are links
between rent seeking where government is involved, the fundamental relation
of individual citizens to the institution of the state, and macroeconomic
developments in the US
particularly since 1971. These
links became increasingly clear since the start of the global financial
crisis that began in 2008.
History bears out that capitalism, compared to other economic systems,
has created more wealth, raised the living standards of more people, and has
increased individual liberty to a greater extent. The reasons for the success of
capitalism lie not only in economics but also in philosophy. The historical innovation and
entrepreneurship and the immense industrial production of the United States
in the past occurred both in the context of capitalism and in a social and
legal framework established by the US Constitution. Going back to the American Revolution
and before, the ownership of an individual person of their own body and of
the labor that it can produce literally distinguished a free person from a
slave. This concept is the common
root of private property and of capitalism. The natural right of a person to the
fruits of their labor, i.e., to own property, is, therefore prerequisite to
other rights. In his seminal
book, The Road to Serfdom, F. A. Hayek explained the interdependence of
private property, the division of labor and freedom.
“... [T]he
system of private property is the most important guaranty of freedom. It is only because the control of the
means of production is divided among many people acting independently that we
as individuals can decide what to do with ourselves. When all the means of production are
vested in a single hand, whether it be nominally that of "society"
as a whole or that of a dictator, whoever exercises this control has complete
power over us. In the hands of
private individuals, what is called economic power can be an instrument of
coercion, but it is never control over the whole life of a person. But when economic power is centralized
as an instrument of political power it creates a degree of dependence
scarcely distinguishable from slavery.
It has been well said that, in a country where the sole employer is
the state, opposition means death by slow starvation.” – F. A. Hayek, The Road to
Serfdom (1944)
Of course, a human being is much more than an economic unit and the
natural rights of individuals do not end with the absence of slavery, thus
private property can be viewed as the keystone of all human rights. In fact, provisions of the American
Bill of Rights, such as the prohibition against unreasonable search and
seizure are an elaboration and enumeration of private property rights
vis-à-vis the rights of government. Interestingly, the American Bill of
Rights contains broad prohibitions against actions by government, rather than
positive rights, such as the right of an individual to a particular social
benefit. In the modern world,
private property and, therefore, other rights are not threatened directly by
violence and coercion as they were prior to the American Revolution, but they
are threatened today by excessive growth of government, by private concerns
pursuing rent seeking profit strategies and by political constituencies
seeking entitlements.
Taxes levied on privately owned businesses or on private individuals
for the purposes of social welfare programs function as a proxy for rent
seeking in that they affirm a positive right to an economic benefit for one
group at the expense of another group that receives no reciprocal
benefit. For example, the
establishment of a legal right of a person with no means to pay for it, to
obtain medical care, takes precedence over the property rights of individuals
who have the means to pay for medical care on their own behalf. In the example of medical care, it is
likely that those upon whom the financial burden falls have little or no
objection to the arrangement because a majority of individuals probably
believe that their contribution is for a worthy cause, but the precedent of
government intervention over volunteerism is a dangerous one from the
standpoint of individual rights.
While one group bears the economic cost, even if the only cost is
reduced access to medical care or reduced quality of care, there is a more
broad cost to society in terms of the erosion of individual rights. In a rent seeking economic relationship
where government is the agent of wealth transfers, it is not only exploited
groups that loose rights but, in fact, all citizens. When wealth is transferred or
redistributed by government, rights removed from exploited groups are not
transferred to groups that receive the resultant economic benefits but rather
accrue to the government itself, thus diminishing the rights of all and
expanding the power of government, i.e., the power to claim the wealth of
it’s citizens for whatever purposes are deemed worthy.
“The
preservation of freedom is the protective reason for limiting and
decentralizing governmental power.
But there is also a constructive reason. The great advances of civilization,
whether in architecture or painting, in science or in literature, in industry
or agriculture, have never come from centralized government.” – Milton Friedman, Capitalism
and Freedom (1962)
While wealth transfers may be undertaken with the best intentions,
over time, the eventual consequence is an aggregation and concentration of
power in government at the expense of individuals. Among other things, a precedent is
established whereby rights are granted by government to citizens and not the
reverse. Wealth transfers by
government, therefore, result in the expansion and centralization of economic
and legal power in the government at the expense of the rights of individual
citizens.
In the extreme, the flow of rights from individuals to government may
eventually result in a totalitarian state structure where rights per se no longer exist, or exist in
name only, replaced, in practice, by privileges granted by government at its
sole discretion. In terms of
political philosophy, a constitutional republic aims to prevent
totalitarianism (historically referred to as tyranny) by establishing that
the people are sovereign and that the limited rights of government are
granted to it at the sole discretion of the people. In contrast, an economic system, based
on government redistribution of wealth, is ultimately incompatible with a
structure where the people are sovereign, i.e., a constitutional republic,
simply because wealth redistribution requires that the rights of government
take precedence over the property rights of individuals.
There’s
been one underlying basic fallacy in this whole set of social security and
welfare measures, and that is the fallacy - this is at the bottom of it - the
fallacy that it is feasible and possible to do good with other people’s
money. That view has two
flaws. If I want to do good with
other people’s money, I first have to take it away from them. That means that the welfare state
philosophy of doing good with other people’s money, at its very bottom,
is a philosophy of violence and coercion. It’s against freedom, because I
have to use force to get the money.
In the second place, very few people spend other people’s money
as carefully as they spend their own.
The real problem with government is not the deficit. The real problem with government is
the amount of our money that it spends.
– Milton Friedman
If the basic economic rights of individuals are undermined and
government power expands, becoming more centralized, then controlling
government spending may be problematic, particularly if doling out
entitlements is central to the political goals of the regime in power, e.g.,
remaining in power. As has been
seen in Europe, government spending for the purposes of expanding
entitlements is constrained only by the capacity to borrow and to service
debt, which is a pattern that can lead to economic collapse.
“A
democracy cannot exist as a permanent form of government. It can only exist until the majority
discovers it can vote itself largess out of the public treasury. After that, the majority always votes
for the candidate promising the most benefits with the result the democracy
collapses because of the loose fiscal policy ensuing, always to be followed
by a dictatorship, then a monarchy.” – Scottish historian Alexander
Fraser Tytler, Lord Woodhouselee (1747-1813), unverified attribution
Totalitarianism:
Public or Private?
Wealth redistribution is not the exclusive domain of government. Inflationary policies by the US
Federal Reserve erode the value of money and dilute the share of wealth held
by those who depend on the monetary system while transferring wealth either
to banks or to those who first receive newly created money. The institution of central banking is
itself a form of rent seeking where governments borrow their own currencies
into existence from private banks passing the burden of repayment with
interest on to taxpayers, e.g., as a value added or income tax, rather than
maintaining the national currency as a public facility. Central banking is associated both
with economic rent seeking insofar as private interests successfully
influence the central bank in their favor, and with political philosophy
where the rights of individuals are concerned, e.g., monetary inflation
deprives savers of the right to spend tomorrow money obtained in exchange for
labor today at a value consistent with the terms of the exchange. In the latter case, the central bank
produces a de facto breach of contract that is technically legal. As John Maynard Keynes famously said, “By a continuing process of
inflation, government [or private interests that control the central bank]
can confiscate, secretly and unobserved, an important part of the wealth of their
citizens.” In this
regard, one can see the extent of the powers abdicated by governments to
central banks. Central banks have
the power to redistribute wealth and can do so either at the behest of
government or, more importantly, in the service of private concerns.
The advent of bank bailouts, amounting to roughly $4 trillion in the US officially, but perhaps as much as $23.7 trillion, during the global financial crisis that began in
2008 was remarkable for two reasons other than the danger of systemic
collapse thus averted and the amounts of money involved. First, it became apparent that large
banks, and central banks, had more influence over governments than their own
citizens. In fact, a majority of Americans opposed
bank bailouts. Second, the power of central banks to
transfer wealth was laid bare by the Federal Reserve’s purchase of
mortgage backed securities which traded newly created money for what most
observers agree was little more than worthless paper in an attempt to render
otherwise bankrupt financial institutions solvent again.
The independent actions of the US federal government and Federal
Reserve produced record profits and bonuses in the banking sector while, at
the same time, household wealth in America fell significantly, creating the
popular impression that Wall Street was somehow looting Main Street. The mechanism of wealth transfer,
however, was actually the Federal Reserve, which had then been in place for
94 years prior to the crisis and during which, arguably, a similar process of
wealth transfer had taken place gradually on a smaller scale. The arbitrary and sweeping nature of
the emergency actions taken by the federal government and Federal Reserve in
response to the financial crisis revealed the extent to which the powers of
both the federal government and Federal Reserve had quietly expanded and
become more centralized over a period of less than 100 years to a point of
near absolute control over the wealth, i.e., the property, of US citizens. The roots of these developments,
however, lay not in the economic bubbles leading up to the financial crisis
that began in 2008 but in the 1913 Federal Reserve Act and in the New Deal
that followed the resulting Great Depression.
“Legal
plunder can be committed in an infinite number of ways; hence, there are an
infinite number of plans for organizing it: tariffs, protection, bonuses,
subsidies, incentives, the progressive income tax, free education, the right
to employment, the right to profit, the right to wages, the right to relief,
the right to the tools of production, interest free credit, etc., etc. And it
is the aggregate of all these plans, in respect to what they have in common,
legal plunder, that goes under the name of socialism.” – Frederic
Bastiat, The Law (1848)
After World War II, the United States had embraced labor unions and
social programs partly in response to the ideological struggle between the US
and the Soviet Union, which was a totalitarian state, but the US, while
fighting totalitarianism, planted the seeds of totalitarianism in its own
backyard. Following decades
during which social welfare programs expanded, and during which both the
federal government and the financial sector grew dramatically as percentages
of US GDP, the centralization of power revealed in 2008 indicated a largely
unrecognized shift in political philosophy toward a totalitarian state
structure.
A
Monetary Empire in Decline
Perhaps every empire in decline witnesses a transition from surplus
production to excess consumption and that is precisely what happened in the
United States in the 1970s, marked first (after the establishment of the US
Federal Reserve and then of a welfare state by President Franklin Delano
Roosevelt) by the final abandonment of the gold standard in
1971 then by the 1975 shift from trade surplus to
trade deficit. Both events were a consequence of
spending in excess of real wealth production. These events ushered in the era of
offshoring in the 1980s and of outsourcing to foreign firms in the
1990s. The idea was simple:
exchange higher domestic costs for lower costs abroad and sell virtually the
same products to the same domestic customers at higher margins, lower prices
to gain market share, or simply hold prices at competitive levels by cutting
costs. Under the banner of free
trade, and later of globalization, the US government did virtually nothing to
curtail these trends and the US economy appeared to expand as US dollars
flooded the world in an unprecedented period of monetary expansion. As the accompanying
deindustrialization of the United States progressed, two developments, in
addition to the then accumulated capital in the US, mitigated the impact of
declining US industrial production: (1) growth in service industries and (2)
a combination of asset appreciation and increased consumer borrowing and
spending (eventually reaching an unsustainable 70% of GDP), but both were
fundamentally linked to monetary expansion and neither proved to be
sustainable.
Replacing industrial production with a service economy was a flawed
concept because as domestic production fell, it was, in fact, debt expansion
that replaced the creation of real wealth, thus the US trade deficit
soared. As factories closed and
as jobs departed US shores for Taiwan, China, India and elsewhere, the
selling of equivalent foreign-made goods and offshore services to Americans
into a domestic market that included a growing number of displaced workers,
became less and less plausible.
The idea that displaced American workers would eventually embark upon
new, service industry careers and, therefore, maintain their spending levels,
in retrospect, was plainly wrong.
While perhaps viable in a perfectly balanced global economy, it is
difficult to imagine a sustainable domestic economy, in itself, comprising a
majority of services since it would have to rely on material goods from
abroad, i.e., it would suffer a chronic trade deficit. The answer for American businesses was
to expand into global markets but this did little for the domestic economy,
thus the US service economy failed to replace declining industrial
production. What happened, in reality,
was that the percentage of the total US population in the work force simply
declined, flooding welfare roles and producing a growing political
constituency favoring wealth redistribution.
One way to characterize the sequence of events in the US is to say
that a paradigm shift took place where the US economy moved from production
to consumption; from an industrial economy to a (so-called) service economy;
from wealth creation to wealth extraction; from increasing living standards
to wealth redistribution; from a nation of citizens and workers to a nation
of “consumers,” all the while transitioning from the largest
lender in the world to the largest debtor nation in the entire history of the
world. In terms of US government
spending, unsustainable growth in entitlements and pork barrel politics
became business as usual in Washington D.C., while Wall Street shifted from
investing, in order to participate in dividends and capital gains resulting
from production and value creation, to trading based on technical indicators;
a competition where participants seek to extract wealth from investors and
other traders in what amounts to a casino game, i.e., a rent seeking
structure. Flash trading using
automated trading systems and high-frequency trading algorithms, for example,
is pure rent seeking in the garb of high technology.
Other advanced economies, in varying degrees, have followed the
American example, resulting in the emergence of rent seeking as the dominant
economic paradigm of Western countries.
To make matters worse, rent seeking by private concerns has become
confused with capitalism.
The Flight of Capital
In the past, capital and individual entrepreneurs flowed into the
United States from around the world because it represented two related
things: freedom and economic opportunity. The post bailout world is one where
large banks have, to some degree, hijacked the emergent totalitarian powers
of governments in a model where perpetual sovereign debt represents a
virtually unlimited flow of wealth from the subjects of totalitarian states
to the banks that, through the institution of central banking, exert
considerable influence over each nation’s government. The post bailout economy seems to be a
veritable frenzy of rent seeking activity by banks, governments and political
constituencies seeking entitlements.
In all three cases, individual liberty, e.g., the right to own
property is an impediment and the success of any of the three factions
promises to encumber or to prevent entirely future economic growth. It makes little difference to
individuals if the fruits of their labor are confiscated by inflation, by
taxes to fund unsustainable government expansion, or by taxes to fund social
welfare programs. In all three
cases, the impetus toward entrepreneurship and the incentives for putting
private capital, i.e., private property, at risk in new business ventures are
reduced or eliminated. Regardless
of which rent seeking faction wins, capitalism, which has created more
wealth, raised the living standards of more people and which, because of its
intrinsic compatibility with private property, has increased individual
liberty more than any other economic system in the history of the world, is
set to lose.
Capitalism, rather than ceasing to exist, will obviously adapt, thus
capital will migrate away from economies characterized by rent seeking, i.e.,
by the consumption of wealth, to parts of the world characterized by the
production of wealth. Capital may
also be driven into black markets as seen under the former Soviet Union. All other things being equal, the next
decade is likely to see a massive flight of capital from the United States to
countries where property rights are respected (or where government is simply
smaller) and where the values of investments are less vulnerable to the
ravages of excess monetary expansion, counterproductive taxation and
sovereign debt risk or redistribution by government in the service of
political constituencies seeking entitlements. Within the latter constraints, China
and emerging economies that are rich in natural resources and that produce commodities
or physical goods will surely become the new bastions of capitalism.
Ron Hera
Hera Research
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Ron Hera is the founder of Hera Research, LLC, and the principal author of the Hera Research
Monthly newsletter. Hera Research provides deeply researched analysis to help
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