Chapter 4 Problems of the Economy
at the Outset of 21st Century
-Impediments for Sustainability-
One of the basic components for civilization is “economy”. The current world economy, its theories and reality, is the basic impediments for establishing a sustainable human civilization. Several important and fundamental aspects of the today’s economy are reviewed here, in order to assess their fitness toward sustainability. The arguments here developed may not be deep enough and may also contain flaws and misunderstanding, as this writer is not an economist. It will be nice if this short essay stirs a serious debate among many people, experts and non-experts alike, as to the basic problems of the current economic system and possible sustainable economic systems.
4.1. “Need vs Demand”-Neoclassic Economic Theories-
Classic economic theory, represented by that of Adam Smith, developed in the dawn (1776) of modern industrial/postindustrial economy, was focused on the human “needs”, and was conscious of the “Finiteness of Nature”. As the industrial production had increased and exceeded the “needs”, the economics turned to create “demands” so that further production was made necessary. This whole process has become the basic engine in the economy; “production” creates “demand” and then “demand” induces more production. This neoclassicism is the basic idea of the current economy dependent on “growth”. The value of a good is not determined by its worth as a good, but determined by the supply vs demand.
The finiteness of nature has been dwarfed to the “scarcity” of resource in the neo-classicism, and has escaped the economists’ concern. Hence the entire planetary system in which the economy is embedded seems to have been outside of the people’s thoughts, until a recent time. In this economic system, “magnifying desire” is a “virtue”, as it creates more demands, and, on the contrary, “self-restraining (suppressing) one’s desire” is regarded as a “vice”, as it hampers the growth of economy. The ethic that “fulfilling of one’s desire” is a “good”, prevalent in the Western culture and others, has fostered the market economy based on the growth in demand.
4.2. Neoclassicism to Neoliberalism
The neoclassic economic theories assume that an individual is a perfect economic man capable of reasonable judgment and of competing on his own selfish interest, based on a perfect information, and also that under this condition the market is balanced through “invisible hands”. It should be pointed out that theoretical propositions based on simplified (and far from reality) premises such as this cannot reflect the reality, and the theory thus formulated, though proposed as a scientific one, is far from being scientific [1].
In 1970’s Milton Friedman proposed what is now known as “neoliberalism”; he insisted that a significant economic growth can be expected in a system in which most of the regulations be abolished so that free competitions prevail in the market. Such a system, it is further suggested, may produce a few very rich people, but the wealth thus created will trickle down to the bottom of the society, and hence everybody will win.
Many nations including the United States and Japan embraced this idea and set in place such policies that enhance the free competitive market economy called neoliberalism. Regulations of all kind have been abolished or at least weakened to remove the constraints in operating economy. Those in a position to exploit others have greedily done so using all the trickeries. Many public services have been privatized, social welfare has been cut, and worker’s privileges have been stripped off. Mortgages certificates are collected, reassembled, and securitized (as derivatives) and sold as bonds. If everything goes well, the people involved in this scheme may gain a lot of profit. It is obvious that this economic system will definitely widen the gap between “haves” and “have-nots”. Those people who schemed this would gain a lot of money (almost out of nothing) in dealer’s charge, no matter whether the scheme would work or not. However, those sucked into this scheme would lose a lot, once the securities go sour; for example, a person who bought a mortgage has become unable to pay the monthly installments, and the financial institution forecloses the house, which is now of much lower value than the mortgage. The securities associated with the mortgage are now worthless, called “toxic assets”. This is a part of the financial breakdown starting significantly since the fall of 2008, though it had started earlier.
The same greed mentality may cause other problems; for example, many milk and milk product producers in China were found to use a toxic chemical (melamin) to make their products look like to be of a high quality containing a high level of proteins. This caused a widespread health problems among babies fed with such milk products. This is due to the same profit motivation as that of the financial institutions.
In either case, human values (life itself as well as living condition of ordinary people) is sacrificed in order for a wealthy few to gain more “money”; it is a sign of degradation of humanity [2]. The neoliberalism has managed to unleash such a negative aspect of human nature.
4.3. Globalism
Economic globalization and the free trade associated with it have been advocated as an extension of neoclassical economy but have been intensified as an expression of neoliberalism. The current global organization WTO (world trade organization) is a manifestation of this ideal, removing all the restrictions in trade. Protectionism is regarded as a vice in this organization.
Under this condition, a powerful nation, even with subsidy from the government, can force the farm products cheaply onto the developing nations. The farmers in those nations cannot compete with such a powerful agent, and the farming of the developing nations become ruined as a result. On the other hands, international financial aid organizations such as International Monetary Fund and World Bank are supposed to help developing nations in their economic development, but in reality the funds are manipulated by the powerful nations to financially weaken and oblige the developing nations by debt [3].
An opposite phenomenon happens in the manufacturing sections. Corporations move their production factories overseas because they may be able to reduce drastically the labor costs and also avoid some inconvenient regulations. As a result, for example, the manufacturing section of industry in the United States has declined in its number and activity, and hence the number of employment opportunities with high wages has diminished significantly, and the average wage of the workers in the United States has decreased in the recent decades.
In either case, globalization has led to a widening of the gap between the “haves” and the “have-nots” both of individual persons and nations, all over the world. Globalization is one clear manifestation of the greed and profit motive of large multinational corporations. People need to realize its true intent, and start dismantling such a system by pressuring governments and corporations.
Globalization involves moving a large quantity of goods. As long as the energy needed for transportation is cheap, this scheme may work. But in the near future, the situation would change, as the cheap source of energy (petroleum) is depleted. Transportation cost should also be incorporating factors other than fuel, such as the cost of its environmental impact. If this is done properly, the transportation cost would soar and may constrain further development of globalization, or even reduce globalization involving long-distance transportation of material.
On the other hand, the financial globalization cannot be hampered by such a reduction of energy source. The money can travel instantaneously in the form of record in the computers thanks to the development of IT. All the financial institutions around the world have now been intimately connected through IT. This is one of the reasons that the financial failure in the big banks and investment banks in the US affected so rapidly the financial institutions around the world.
4.4. Future Discount – Mistake of regarding “money” being equivalent to “goods” (1)
The idea “future discount” is prevalent in the neoclassic theories, and presents a blockage to the establishment of a sustainable society. It is considered to be reasonable in today’s economy, and is based on a basic fallacy that “money”, an abstract entity, is equivalent to the concrete entities such as “goods and services”. The abstract entity, no matter how large, cannot sustain human lives by itself.
Here is an example. A household owns a big cedar tree on its premise. It is expected that it will grow (say by 20%) and stay healthy 100 years from now. The market value of the tree is assumed to be 1000 dollars right now. If no inflation, the tree will be worth about 1200 dollars 100 years later (assuming that the market value is dependent on the height). There are a number of ways of disposing this tree; i.e., sell it 10 years later, 50 years or 100 years later. The money obtained from selling the tree will be deposited in a bank, and the interest rate is assumed to be 7%; this may not be realistic but makes it easier to do the calculation. Let’s suppose that we would cut and sell it 10 years from now. We will get 1020 dollars at the time. Well if we deposit an amount of money now in order to get 1020 dollars 10 years later. How much do we need deposit? We need to deposit about 520 dollars. That implies that the tree is worth only about half of the current value if we well it 10 years later. If we sell it 50 years later, we need to deposit only about 37 dollars now. It is worth only 1.4 dollars now if sold 100 years. Instead, if we sell it right now for 1000 dollars and deposit in a bank, we will have about 2000 dollars 10 years later; 33000 dollars 50 years later, and a million dollars 100 years later. Hence, it makes a good economic sense to sell it and deposit the money now. The idea is called “future discount). (This illustration of the idea of future discount is taken from H. Bossel [5].)
Of course, there will be inflation and the interest rate may not be as high as 7%. No matter what, the monetary value of a commodity will be discounted if disposed of at a later date. With this spirit in mind, it is considered to be economical to cut tree in the rain forest now rather than later, exhaust the fish stock, and use as much as and deplete resources. This spirit cannot be compatible with the idea of “sustainability”. This idea is based on a wrong notion, i.e., the equivalence of money and material, but human being cannot live on money (paper, gold or otherwise). We need material to live by and with.
4.5. Financial Control of Economy – Mistake of regarding
“money” being equivalent to “goods” (2)
The current economic system is based on “money”. Money is today usually “paper” money, though it used to be convertible to gold. If money can buy goods or service at anytime under usual circumstance, “having money” can be regarded to be equivalent to having goods or service. Usually this has been the case. However, there have been a number of occasions when this was not the case. Particularly severe was the case in which the real value of money changed suddenly and rapidly, i.e., inflation under certain circumstances. The inflation in current Zimbabwe is as high as several million percent over a day; in this case money cannot buy.
Anyway, money is usually the thing people want most, because it buys anything. Money has become the purpose of life for many people, particularly those in the financial business.
Today, money cannot be converted to gold. Then what determines the value of paper money? It relies on the faith in the institution that prints the money or rather the political/economic system behind it. It is usually the governmentally controlled central bank of a nation, though that in the US, Federal Reserve, is a consortium of private banks. Today, particularly since the economic crisis in the fall of 2008, paper money seems to be printed almost arbitrarily, without any backings. If this is the case, what is the value of a paper money?
Money has become more abstract. Money used to be in the form of paper or coin and be exchanged with service or goods. But now, in many occasions, money is simply a record in your account in a bank; it is memorized in the bank computer. When you are paid a wage, it will be transferred from the accounting office of your working place and deposited in your bank account as a number. We pay telephone bill and others at the bank; they are recorded on the computer in the bank, and transferred to the payees. We often do not carry cash anymore; we pay everything by a credit card or debit card. The amount is then deducted on record from our account. This system has made it easier to deal with a large sum of money; it can be done on a computer. This technically has made it possible to collect and reassemble a large number of mortgages and other kinds of debt to produce securities (derivatives) out of these, and sell them as bonds. Indeed those involved in these kinds of dealing (securitization of mortgages) made fortunes from dealers’ fees. This kind of deal was prevalent among investment banks and other financial institutions. Mortgages used for this purpose included those falsely sold to low-income families. Many of them became unable to make the monthly payment, and besides the prices for houses have declined significantly in the last few years. Therefore, the low-income families lose houses for foreclosure, but the collateral houses are much less worth than the mortgages; that is, those are “toxic assets” for mortgage companies. But this situation soon affected all the financial institutions, as the securities created from debt have connected them through derivatives. Hence the collapse in mortgage immediately caused a collapse of the major financial institutions involved in this scheme.
Two factors contributed to the chaos. One is lack of regulation or supervision over this kind of transactions. The other is the bogusness of ratings. Those rating companies colluded with the financial institutions to make the bonds (derivatives) appear to be safe, rating them AA to AAA. The people blindly relied on these ratings. People should have known better; there is no such a thing as a free lunch.
People, particularly those in the United States, buy goods such as car with loans and often they used their houses as a collateral to borrow money. The financial collapse made it hard to borrow money; this happened not only for individual consumers but also large or small business. Hence the crisis in the financial institution has become immediately crises in all the other sectors of economy. In other words, in the current economy, the financial section has a predominantly powerful influence on the entire economy.
The current economic system, it is apparent, would not be able to sustain the human civilization. Is there any alternative [4]? In the beginning of twentieth century, an alternative politico-economic system, communism/socialism, was instituted by a revolution in Russia. It spread to the surrounding nations (and others as well) but collapsed before the turn of the century. People, in the face of the current economic crisis, may take another look at it in the hope of finding some ways to overcome the current economic crisis. The communism, in theory, is about who has the hegemony of the economy, i.e., capitalists or laborers, and the issue of “sustainability” was not even considered.
[1] Ochiai, Eiichiro: “Faults and limitations in the Scientific Methodology in the Western Science, particularly social science” (this book, Chapter 13)
[2] Ochiai, Eiichiro: “Signs of Degradation of Humanity”, www.nikkanberita.com (2008.06.11)
[3] Perkins, John: Confessions of Economic Hit Man (Plume, 2004); Ochiai, Eiichiro: this book, Chapter 9
[4] Ochiai, Eiichiro: this book, Chapter 10
[5] Bossel, Hartmut: “Earth at a Crossroads” (Oxford University Press, 1998)
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