Understanding Macro II: Post-War Prosperity

In part 1 of this article (Understanding Macro: The Great Depression (1/3), we saw that Keynes challenged classical economics on many fronts. Against the classical idea that free markets will automatically eliminate unemployment, he argued that governments needed to adopt appropriate fiscal and monetary policy in order to create full employment, as a necessary condition for high economic growth. He also argued that money is not neutral, and that there is fundamental uncertainty about the future.  Widespread acceptance of Keynesian economics was one of the two major ingredients that led to prosperity in Europe and USA after World War II. We start with a discussion of the second ingredient, which was strict regulation of financial institutions.

It was obvious to all that irresponsible lending had caused the Great Depression. The creation of the Federal Reserve Bank in 1914 allowed banks to create credit freely. Banks could provide loans to anyone who asked for it, without minimal backing in cash reserves, since the Fed would provide them with cash in case of any shortfall in reserves. This was a windfall for the private banking sector, since they could provide credit for loans at zero cost to themselves, simply by making an entry on their books. Banks capitalized on this opportunity by creating a debt-based boom in the economy. Consumers were encouraged to buy everything, especially real estate, housing, and stocks on credit. Easy availability of loans created a boom in economy, referred to as the roaring twenties. As prices of land and stocks increased, people rushed out to get loans to buy more, in order to get a share of the easy profits due to soaring values. Eventually, a stock market crash in 1929 punctured this bubble, leading to the Great Depression of 1929. About 11,000 of 25,000 banks collapsed, wiping out the life-savings of millions, since there was no deposit insurance at the time.

The Great Depression was a massive crisis, a man-made disaster of unimaginable proportions. The stock market crash of 1929 set off a worldwide chain of bankruptcies and defaults. Factories and businesses closed, workers plunged into poverty in millions, houses and farms were repossessed, crops which could not be sold were dumped into the sea. By late 1932, manufacturing output had fallen to half its 1929 level, and some 30% of workers  searched in vain throughout the country for jobs to support their families. Farmers unable to sell their produce, unable to repay their bank loans were evicted and with their families joined the human flood of misery. Keynes wrote that ‘we are living in the shadows of one of the greatest economic catastrophes of modern history’. In pattern worthy of note, the shock of the Great Depression created the possibilities of radical changes in ways of thinking, and in the structure of policies and institutions.

In the aftermath of the Great Depression, very stringent regulations on banking were passed by Roosevelt, after he was elected in 1932. It was clear that this was required, since banks have an incentive to gamble with other people’s money. When they make gains, they can pocket them. Losses are passed on to the depositors. To prevent this, the Glass-Steagall Act prohibited the banks from investing in stocks, and in many other types of speculation that had been responsible for the Great Crash. The effectiveness of banking regulations is shown by absence of large scale bank failures for nearly fifty years. Repeal of regulations in the Savings and Loan sector by Ronald Reagan let to the first massive banking crisis in the 1980s, which wiped out the profits of the entire banking sector for this fifty year period. Nonetheless, the de-regulation of banks continued, culminating in the repeal of Glass-Steagall in 1999, followed by the Commodity Futures Modernization Act of 2000, which created an unregulated financial sector. It took only seven years for the natural consequence, the Global Financial Crisis of 2007. But this is moving ahead of our story.

Going back to the post-war period, Central Banks all over the world started following Keynesian prescriptions for monetary policy. Keynesian theories suggested that if the rate of growth of money was lower than required by economic growth, it would lead to recession and unemployment. If it was higher than required, it would lead to inflation. Thus, the job of the Central Bank was to keep the money supply at just the right rate required to maintain full employment, while avoiding inflation. In conjunction with strict regulation of the financial sector, Keynesian policies worked like a charm for almost three decades following the second world war. Because of full employment everywhere, USA and Europe enjoyed a golden era of high growth which enriched the masses, and created unprecedented levels of prosperity. But there was a snake in this Garden of Eden, waiting for his chance to strike.

Two deep truths about Capitalist economies were discovered by Marx. One is that the fruits of capitalist production are distributed among classes according to their relative power. As an illustration, a recent study showed that the top 1% captured 85% of the growth over 2009 to 2013. The second truth is even deeper: capitalism works with the consent of the exploited, by persuading laborers of the justice and necessity of their exploitation (see ET1%: Blindfolds created by Economic Theories). Conventional economic theories of the labor market are ideal tools of propaganda for this purpose . These theories, proven false by Keynes and his followers, show that capital and labor both get paid what they deserve, in terms of their contribution to the economic production. Keynesian theories made the government responsible for creating full employment, empowering the masses, and enabling them to escape exploitation by the wealthy. This led to a dramatic rise in general prosperity, and equally dramatic decline in inequality and the wealth share of the top 1%.

The top 1% did not accept this loss of prestige and power, but made patient and far-sighted plans to reverse this situation. As Milton Friedman said “Only a crisis – actual or perceived – produces real change”. They prepared ideologies, theories, institutions and acolytes while waiting for the desired crisis to operationalize their plans. Naomi Klein in “The Shock Doctrine: The Rise of Disaster Capitalism”, has brilliantly described how crises around the globe were used to force free market policies down the throats of an unwilling public. These policies enriched corporations while impoverishing the people and creating massive social disturbances. In the USA, the opportunity to launch a counter-revolution against Keynes came in the 1970s, as we will discuss in the third and last part of this article. It is rather amazing that this counter-revolution was able to turn back the clock, reject all Keynesian advances, and go back to pre-Keynesian theories solidly rejected by empirical evidence.

For the last part, see: Understanding Macro III: The Rule of Corporations

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1 comment
  1. David Harold Chester said:

    To promote more employment and to reduce poverty, the government should tax land values instead of incomes, purchases and capital gains. The following essay is about Socially Just Taxation and Its Effects (17 listed)

    Our present complicated system for taxation is unfair and has many faults. The biggest problem is to arrange it on a socially just basis. Many companies employ their workers in various ways and pay them diversely. Since these companies are registered in different countries for a number of categories, the determination the criterion for a just tax system becomes impossible, particularly if based on a fair measure of human work-activity. So why try when there is a better means available, which is really a true and socially just method?

    Adam Smith (“Wealth of Nations”, 1776) says that land is one of the 3 factors of production (the other 2 being labor and durable capital goods). The usefulness of land is in the price that tenants pay as rent, for access rights to the particular site in question. Land is often considered as being a form of capital, since it is traded similarly to other durable capital goods items. However it is not actually man-made, so rightly it does not fall within this category. The land was originally a gift of nature (if not of God) for which all people should be free to share in its use. But its site-value greatly depends on location and is related to the community density in that region, as well as the natural resources such as rivers, minerals, animals or plants of specific use or beauty, when or after it is possible to reach them. Consequently, most of the land value is created by man within his society and therefore its advantage should logically and ethically be returned to the community for its general use, as explained by Martin Adams (in “LAND”, 2015).

    However, due to our existing laws, land is owned and formally registered and its value is traded, even though it can’t be moved to another place, like other kinds of capital goods. This right of ownership gives the landlord a big advantage over the rest of the community because he determines how it may be used, or if it is to be held out of use, until the city grows and the site becomes more valuable. Thus speculation in land values is encouraged by the law, in treating a site of land as personal or private property—as if it were an item of capital goods, although it is not (Mason Gaffney and Fred Harrison: “The Corruption of Economics”, 2005).

    Regarding taxation and local community spending, the municipal taxes we pay are partly used for improving the infrastructure. This means that the land becomes more useful and valuable without the landlord doing anything—he/she will always benefit from our present tax regime. This also applies when the status of unused land is upgraded and it becomes fit for community development. Then when this news is leaked, after landlords and banks corruptly pay for this information, speculation in land values is rife. There are many advantages if the land values were taxed instead of the many different kinds of production-based activities such as earnings, purchases, capital gains, home and foreign company investments, etc., (with all their regulations, complications and loop-holes). The only people due to lose from this are those who exploit the growing values of the land over the past years, when “mere” land ownership confers a financial benefit, without the owner doing a scrap of work. Consequently, for a truly socially just kind of taxation to apply there can only be one method–Land-Value Taxation.

    Consider how land becomes valuable. New settlers in a region begin to specialize and this improves their efficiency in producing specific goods. The central land is the most valuable due to easy availability and least transport needed. This distribution in land values is created by the community and (after an initial start), not by the natural resources. As the city expands, speculators in land values will deliberately hold potentially useful sites out of use, until planning and development have permitted their values to grow. Meanwhile there is fierce competition for access to the most suitable sites for housing, agriculture and manufacturing industries. The limited availability of useful land means that the high rents paid by tenants make their residence more costly and the provision of goods and services more expensive. It also creates unemployment, causing wages to be lowered by the monopolists, who control the big producing organizations, and whose land was already obtained when it was cheap. Consequently this basic structure of our current macroeconomics system, works to limit opportunity and to create poverty, see above reference.

    The most basic cause of our continuing poverty is the lack of properly paid work and the reason for this is the lack of opportunity of access to the land on which the work must be done. The useful land is monopolized by a landlord who either holds it out of use (for speculation in its rising value), or charges the tenant heavily for its right of access. In the case when the landlord is also the producer, he/she has a monopolistic control of the land and of the produce too, and can charge more for this access right than what an entrepreneur, who seeks greater opportunity, normally would be able to afford.

    A wise and sensible government would recognize that this problem derives from lack of opportunity to work and earn. It can be solved by the use of a tax system which encourages the proper use of land and which stops penalizing everything and everybody else. Such a tax system was proposed 136 years ago by Henry George, a (North) American economist, but somehow most macro-economists seem never to have heard of him, in common with a whole lot of other experts. (I would guess that they don’t want to know, which is worse!) In “Progress and Poverty” 1879, Henry George proposed a single tax on land values without other kinds of tax on produce, services, capital gains etc. This regime of land value tax (LVT) has 17 features which benefit almost everyone in the economy, except for landlords and banks, who/which do nothing productive and find that land dominance has its own reward.

    17 Aspects of LVT Affecting Government, Land Owners, Communities and Ethics

    Four Aspects for Government:

    1. LVT, adds to the national income as do other taxation systems, but it replaces them.
    2. The cost of collecting the LVT is less than for all of the production-related taxes–tax avoidance becomes impossible because the sites are visible to all.
    3. Consumers pay less for their purchases due to lower production costs (see below). This creates greater satisfaction with the management of national affairs.
    4. The national economy stabilizes—it no longer experiences the 18 year business boom/bust cycle, due to periodic speculation in land values (see below).

    Six Aspects Affecting Land Owners:
    5. LVT is progressive–owners of the most potentially productive sites pay the most tax.
    6. The land owner pays his LVT regardless of how his site is used. A large proportion of the ground-rent from tenants becomes the LVT, with the result that land has less sales-value but a significant “rental”-value (even when it is not used).
    7. LVT stops speculation in land prices and the withholding of land from proper use is not worthwhile.
    8. The introduction of LVT initially reduces the sales price of sites, even though their rental value can still grow over a longer term. As more sites become available, the competition for them is less fierce.
    9. With LVT, land owners are unable to pass the tax on to their tenants as rent hikes, due to the reduced competition for access to the additional sites that come into use.
    10. With LVT, land prices will initially drop. Speculators in land values will want to foreclose on their mortgages and withdraw their money for reinvestment. Therefore LVT should be introduced gradually, to allow these speculators sufficient time to transfer their money to company-shares etc., and simultaneously to meet the increased demand for produce (see below).

    Three Aspects Regarding Communities:
    11. With LVT, there is an incentive to use land for production or residence, rather than it being unused.
    12. With LVT, greater working opportunities exist due to cheaper land and a greater number of available sites. Consumer goods become cheaper too, because entrepreneurs have less difficulty in starting-up their businesses and because they pay less ground-rent–demand grows, unemployment decreases.
    13. Investment money is withdrawn from land and placed in durable capital goods. This means more advances in technology and cheaper goods too.

    Four Aspects About Ethics:
    14. The collection of taxes from productive effort and commerce is socially unjust. LVT replaces this extortion by gathering the surplus rental income, which comes without any exertion from the land owner or by the banks–LVT is a natural system of national income-gathering.
    15. Bribery and corruption on information about land cease. Before, this was due to the leaking of news of municipal plans for housing and industrial development, causing shock-waves in local land prices (and municipal workers’ and lawyers’ bank balances).
    16. The improved use of the more central land reduces the environmental damage due to a) unused sites being dumping-grounds, and b) the smaller amount of fossil-fuel use, when traveling between home and workplace.
    17. Because the LVT eliminates the advantage that landlords currently hold over our society, LVT provides a greater equality of opportunity to earn a living. Entrepreneurs can operate in a natural way– to provide more jobs. Then earnings will correspond to the value that the labor puts into the product or service. Consequently, after LVT has been properly introduced it will eliminate poverty and improve business ethics.

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