RG5 Evolution of Economic Systems

As discussed in previous post (RG4: History, Methodology, & Economic Theory), economic systems have changed and evolved through history. The purpose of this post is to go over, very briefly, how the economic system has changed over time, to arrive at the capitalist economic system that we all live in today.

Evolution of Economic Systems

Economic systems evolve, sometimes under external dynamic and sometimes under internal dynamics. As they evolve, economic theories co-evolve, however their can be (often are) lags in understanding – so theories relevant to one system are applied to another, with disastrous results.

Human beings started out with tribal societies, and spent the longest period of history in this form. They societes were egalitarian and communal. They were not market oriented. Production and  distribution was done by consensus of the community. Communities were self-sufficient, producing or acquiring basic needs for all members, without any markets or trade. For more details, see “Hunter-Gatherer Societies”.  An essential point to understand is that the economic system shaped the nature of the society – the need for cooperation to survive in a harsh environment shaped social norms. This is again in contrast with the story told by economists that evolution has shaped us to be greedy and competitive, as this is necessary for survival. For the opposite point of view, see “Does Altruism Exist?” by D. S. Wilson, which uses latest findings of evolutionary biology to show that the opposite is true. Evolution has shaped human beings to be cooperative and generous.

In light of these understandings, it is very important for us to study the great transformation in European societies during which traditional societies based on cooperation, social responsibility, and community, were replaced by market societies with competition, individualism, and hedonism. This is because our own identities have been shaped by living in market societies.

Industrial Revolution Allows Production of Massive Surplus: New patterns of crop rotation and livestock utilization paved the way for better crop yields, a greater diversity of wheat and vegetables and the ability to support more livestock. These changes impacted society as the population became better nourished and healthier. The Enclosure Acts, passed in Great Britain, allowed wealthy lords to purchase public fields and push out small-scale farmers, causing a migration of men looking for wage labor in cities. The availability of surplus food, surplus labor, and technological innovations, combined to create the Industrial Revolution, which permitted production of massive amounts of surplus.

The ability to produce massive amounts of surplus led to dramatic changes in economics, politics, and social systems. Some of these changes are listed below:

  1. Surplus needs to be marketed to consumers. This led to creation of a consumer economy. When domestic demand proved insufficient, colonization of the globe was done to provide more consumers for the surplus.
  2. Massive productive capacity provided the material wealth, power, and weapons to enable colonization. This process had to destroy self-sufficient societies throughout the globe, in order to create consumers. This led to the emergence of the theory of “comparative advantage”, which argued that colonized lands should only produce raw materials, while the colonizers produced manufactured goods to sell back to the colonized lands.
  3. Creation of a large labor force was required to support industrial production processes. This led to the gradual normalization of the idea the hours of our lives could be brought and sold for wages on the market. This cheapened human lives by reducing them to resources and valuing lives by what they were worth on the marketplace.
  4. Money acquired central importance as a much more efficient way to store the surplus value created by goods. Money allowed trading of goods across time, and became the means to purchase all things – human lives, entire nations and colonies, political power, and educational systems to indoctrinate masses to capitalist ways of thinking. As Karl Marx noted, capitalism exploits workers not by force, but by their willing agreement. A similar statement holds for colonization.
  5. Thinking shifted from the C-M-C’ mode, where commodities are valued and traded by using money, to the M-C-M’ mode, where money is used to produce commodities and to sell them for even more money. This shift changed social goals and markers of social status from land and property to monetary wealth. This shift was of monumental importance in changing society.
  6. One of important impacts was the change in the nature of the relationship between man and our habitat – The Mother Earth. Instead of the natural symbiotic relationship, our planet provides all resources we need for our comforts, and we protect and preserve it, land became a commodity for sale on the market.

For a large number of reasons – repeated crises, increasing inequality, environmental collapse, even the ongoing COVID crisis – the current mode of capitalism seems to be self-destructing.  Continuing rape of the planet and massive destruction of plants and animals has led to loss of habitat and increased unusual interactions between humans and animals. The process continues, making further crises like this eminently likely.  If our planet and humanity survive the death-throes, we may expect a new system to emerge out of the ashes. There are large numbers of successful alternative models which have been used to organize societies in the past, and perhaps some of these may be useful as templates for the future.

To connect this with our current study of Central Banking, it is worth noting that we are studying the evolution of the monetary system associated with Central Banks. But all realms of our lives – social, political, and environmental – are connected and changes in one sphere affect all others.

LINKS to related Materials:

  • Introduction to Reading Course: bit.ly/iw2gh
  • Readers Guide (RG1) to Goodhart on Central Banking: bit.ly/gh2rg
  • RG2: Free Market objections to Central Banks bit.ly/we0rg1
  • RG3: Macro & Micro Monetary Management by CBs bit.ly/we0rg3
  • RG4: History, Methodology, & Economic Theory bit.ly/wp0rg4
38 comments
  1. shivz said:

    “The Industrial Revolution Allows Production of Massive Surplus” which “needs to be marketed to consumers”. Query: if there is a surplus to be sold, does it mean that such surplus is costless to the capitalists, i.e., after accounting for all outlays, including wages and depreciation? and if so, how consumer purchasing power (that corresponds to such surplus) is (was) created?

    • This is good question – to which there is a shallow answer: Say’s Law — Consumers have money, Capitalists have goods, price will adjust to ensure all goods are sold. Slightly deeper, the process of production creates money in hands of consumers/laborers because they earn wages as part of the production process. Even deeper is Keynes rejection of Say’s Law, which is where the General Theory starts. The issue is complex and confusing which much work on it.

      • zshiv said:

        Appreciate your attention. Would be grateful if you took my questions one by one. First, “if there is a surplus to be sold, does it mean that such surplus is costless to the capitalists, i.e., after accounting for all outlays, including wages and depreciation?” (the question implies that wages are income-generating expenditures).

    • Dingo said:

      The answer to this is quite simple from a macro-perspective.

      As Asad, rephrased the question ‘WHERE DO PROFITS COME FROM?’

      As we are looking at the macro-picture, we will lump all owners of the means of production into one sector called the business sector (BS), therefore all B2B transactions stay in the BS. This means, the only expense of the BS is wages, and because wages are the only source of income for the BS, the question posed is very valid – where do profits come from?

      The simple answer is either:

      Exports;
      Household debt;
      Government deficits

      That is your answer.

      Now, from a global perspective, all exports equal imports and so zero-out.

      Therefore, it leaves just household and government debt as the source of profits. There is absolutely no mathematical, legal, or economic way for the BS to generate profits otherwise.

      And as the Bank of England correctly pointed out in 2014, if all debts in society were paid off, all money would vanish and all we would have left is stuff. But who would own or control this stuff?

      Economists who dispute this are bamboozled because they look at the economy as it if it based on barter and real resources only, and that money is some after-thought.

      The western system we employ today (i.e. production, distribution and consumption through the legal institutions of property and contract) is nothing more than a more palatable version of feudalism. Around 95% of the workforce work for the owners of the means of production.

      Do a google for Labour (or Labor) share of GDP, and you will see your answer. Most developed countries have around a 45-55% of labour compensation of GDP – meaning, the wages you received for producing what you produce will only allow you to purchase half of what you produced. In order to access more of what we produce, we must go into debt. This expands the money supply and at the same time expands the wealth of those who control the means of production.

      Just look at the level of both government and household debt throughout the world (look at China and the exponential growth of household debt just in the last 15 years, whilst economists like to use China as an example of how capitalism pulls people out of poverty – as if debt is not poverty), and also look at the time frames of this debt. We have not only continued to increase the levels of debt as our material lives have apparently benefited, the time horizons of this debt is also constantly increasing. What was once a 7 yr mortgage 80 to 100 years ago is now 25-30 years and even talk of 50 years. Government debt horizons are out to 30 years and there is talk of 50 and 100 yrs, not to mention corporate bonds which now include 100 yr bonds (and with the Fed buying up all this stuff too).

      That is your answer – plain and simple. No amount of increased productivity (on a real level) can change this.

      • I am impressed Dingo — I arrived at this analysis independently. Do you have a source which explains this point clearly for students – something useful for pedagogical and expository purposes? Even though this point is FUNDAMENTAL to understanding performance of economic systems, and also to Modern Monetary Theory, no one seems to know about it at least in the orthodoxy.

    • Dingo said:

      ” if there is a surplus to be sold, does it mean that such surplus is costless to the capitalists”

      Yes, because the workers paid for the surplus through their time and energy to create it..

      ” if so, how consumer purchasing power (that corresponds to such surplus) is (was) created?”

      I created this game/spreadsheet to demonstrate visually the identities which prove where the purchasing power comes from in order to answer this very question:

      https://docs.google.com/spreadsheets/d/1HptV1XB7rk2FP3MuZLjGC-54XpIgqHWxDOAWvNA9H9M/edit#gid=1339356186

      (you enter in the answers in the fields next to productivity, wages, employees, profits expected etc)

      Let me know what you think of said game/spreadsheet and its ability to demonstrate identities of where profits come from

  2. Answers are complicated because what happens at the micro level is different from what happens at the macro level – there is complexity and the sum of parts does not add up to the whole. From the micro capitalist point of view all production is costly and one can assume – approximately – that production of Q units incurs fixed costs F plus per unit cost cQ. So total cost of production C(Q) = F + cQ. Now, suppose there are N capitalists and they product NQ units total. These must be sold. The money avaialbe to buy them, generated by wage payments, is wL. The price will equilibriate to ensure full sales. But in this case, there can be no profits, because the capitalist will just recoup what they paid out in wages. So the question of WHERE DO PROFITS COME FROM becomes of central importance. What happens at the macro level, as a result of micro decsions is quite a mess to figure out. Here are two different papers which try to sort it out:
    http://www.levyinstitute.org/pubs/wp309.pdf LEVY institute: Profits: The Views of Levy and Kalecki
    Where do Profits and Jobs come from:
    https://www.ineteconomics.org/research/research-papers/where-do-profits-and-jobs-come-from-employment-and-distribution-in-the-us-economy

    • zshiv said:

      To Zaman: this was a reply to my comment, to which I responded. Have you seen my response?

      • I replied to your response [take it step by step, with first step being what does production of surplus cost producers], but apparently you did not see it. This whole thread with Dingo is a followup to my response to you.

      • zshiv said:

        There is one comment of mine that I don’t see in this whole exchange. That comment referred to your text,
        “These [product units] must be sold. The money available to buy them, generated by wage payments, is wL. The price will equilibriate to ensure full sales. But in this case, there can be no profits, because the capitalist will just recoup what they paid out in wages” – to which I said (in the unseen comment) EXACTLY!

        Now let me reconstruct my lost comment: Exactly, especially whenever, as Smith would have had it, less and less labourers perform greater and greater ‘quantity of work’, but on top of the (justifiable or unjustifiable) profit made on the back of unpaid labour, capitalists can sell their automation-induced costless surpluses without reducing prices if household purchasing power was/is created not only by wages but also by bank credit and/or government transfers.

        If you look at the goods-producing and household sectors in the last 30 years or so, you will find: (a) real value added increased by 100%; (b) about 20% falling share of compensation of employees; (c) hundreds of billions annual injections of purchasing power households by bank- and/or government-money, and (d) about 30% increase in Gross Operating Surplus.

        The gist of it is that due to technological progress and the ensuing costless surpluses, the capital owners cannot on their own (i.a., with their income generating expenditures) create the purchasing power with which their physical-surpluses could be translated into money-surpluses.

        As you said, they could sell their new product units only by price adjustments (downwards), to which I add – unless household purchasing power is fed by sources other than the goods producers. Then, theirs will be windfall profits but that is something else.

      • There is remarkable divergence betweeen labor productivity and wages, but as far as I understand the mathematics, this has nothing to do with profits. To understand why, see the discussion which followed your comments regarding WHERE DO PROFITS COME FROM — As you say “unless there is an increase in purchasing power” — in a monetary economy, there is no abstract purchasing power, it is all MONEY — we have to give consumers extra money to buy, and/or businesses extra money directly. Extra money can only come from two sources – Government Deficit – government spends money into the economy, or Trade surplus, foreigners spend more money than we buy imports, creating surplus money. (The third source can be consumer dis-saving, spending out of their accumulated assets). These are the only three possible sources of profits.

      • zshiv said:

        To Zaman: “Multifactor productivity is intended to measure the increase in output that is not attributable to either labor inputs or capital inputs”. Is it not tantamount to costless surplus?

      • surplus here is FREE production — suppose capitalists can produce among X and they get free bonus of another X costlessl – this does not go anywhere towards solving the question of WHERE profits come from — PROFITS require MONEY injections into the system. You can produce ALL YOU WANT and completely without laborers – the problem of profits remains exactly the same.

  3. Dingo said:

    “I am impressed Dingo — I arrived at this analysis independently. Do you have a source which explains this point clearly for students – something useful for pedagogical and expository purposes? Even though this point is FUNDAMENTAL to understanding performance of economic systems, and also to Modern Monetary Theory, no one seems to know about it at least in the orthodoxy.”

    Asad,
    Unfortunately, there is no such source.

    I had the advantage of studying the history of our legal institutions and feudalism, and how money began during early feudalism. Without this basis (or similar outside and non-economic sources), I don’t think it is possible for most to break free from the indoctrinated belief that our monetary economy is subordinate to the real economy (i.e. barter came first and then money), and hence why so many see monetary profits as reflecting a surplus of production over consumption, like a fruit tree or livestock might produce more than it consumes. Whilst individual business can do this, the whole concept of competitive capitalism is that it is a zero-sum game – and no true capitalist denies this.

    Here are two quotes worth mentioning:

    “Profit margins are probably the most mean-reverting series in finance, and if profit margins do not mean-revert, then something has gone badly wrong with capitalism. If high profits do not attract competition, there is something wrong with the system, and it is not functioning properly.” – Jeremy Grantham

    “Capitalism without bankruptcy is like Catholicism without Hell” – Howard Mark

    To attempt to explain this point clearly for students is to ask them to go down roads they had not initially bargained for.

    I am more than happy to begin some sort of project along these lines – nothing would excite me more, but I would need a platform, like your site to do this, as I do not have any type of following and my websites are rarely visited.

    But I will say this:

    I believe the fundamental issue at heart in our economic system is that property is competitive sourced reward that takes risk, i.e. the risk of becoming bankrupt. Today, this is completely messed up with all sorts of political manipulations. Further, property ownership is now so entrenched in our education system, that recent generations are exposed to this concept at an earlier age than ever before, and yet, they do not see it from the capitalists view, they see it is some divine right, as if it can exist, and it can appreciate in value without risk. Only if you are indoctrinated under the idea that the monetary economy is subordinate to the real economy would you believe such nonsense.

    Put simply, to understand why profits = debt, one must see that the real economy is subordinate to the monetary economy, which is underpinned by the legal institutions of property and contract, it is not the other way around. We get passed this point, I believe we can move forward.

      • Dingo said:

        Yes, that is a good start, especially by dispelling the barter mantra. Although I have taken this further in the past by showing how a barter system would inevitably break down by virtue of the fact that it would be impossible under any sort of decent sized setting that all exchanges would be ‘on-the-spot’ and that in reality most exchanges would contain at least one legally binding future promise on one side, if not, one on either side – and that legally binding promises (i.e. contractual rights which are essentially debts/obligations) are not only the basis for money anyway (because contractual rights can be sold to 3rd parties if the law allows it), but also that many contracts will be broken for all manner of reasons, such as weather, sickness, war etc, and as a result it is inevitable that people get sued and property gets seized and the gap between those who own the means of production and those who don’t, steadily gets wider. It is in fact quite laughable to have people claim we started out as a barter system when in order for such a system to operate everyone must begin by owning some of the means of production, because you can’t barter what you do not own – and yet history clearly shows we began this latest cycle (came out of the dark ages) with feudalism, not some shared common ownership, and that exchanges during feudal times were vertical not horizontal.

        I think it might help also to go further back in time to understand how early feudalism began and how it transitioned from a purely real resource fee base (i.e. fees were paid in real goods in exchange for real services like security and protection from landlords, rulers etc) to a monetary fee based system. The evidence for this is not direct because most of it, if any, lies in very old law books, but I summarize it as thus:

        Feudalism began as a system of real goods in exchange for real services. All relations were vertical, and real goods were produced by serfs and commoners and these real goods made their way up the chain of vertical relations in the form of fees, in exchange for services of protection, government, etc. A need arose quite early on for lords and Kings to access fees earlier than normal (wars, infrastructure, emergencies etc), and the only way they could do this was to issue tokens in exchange for early access which acted as proof of payment of fees when the normal collection time came due. These tokens were made valuable not by any metal content, but purely because they were accepted by rulers as payment of fees. Any metal content, or other techniques (such as tally sticks) were employed to prevent counterfeiting, and nothing more. Because these tokens had value, it enabled horizontal relations to open up, cross exchanges among commoners etc, lending, and of course, depositories who could hold them for safe keeping. These are of course what we know today as banks. Banks could take deposits and then issue bank notes which were proof of deposit, and the bank notes were the legal obligation of the bank to convert said bank notes back into said deposits. People could then use these bank notes in the same way as tokens. When the common law finally relaxed itself on the issues, first of usury, and then on the negotiations of debts, leverage finally became possible, and banks could lend out more than they held on deposit, because their bank notes had value because they reflected the value of the deposits (the proof of payment of fees, or as we know today, taxes). What we have today, is the notes and coins issued by governments are the exact same thing as the original tokens issued by Kings, and the bank money we use today are the legal obligations of the banks to convert account balances into notes and coins on demand – hence the name demand deposits. Our whole monetary system is a leveraging of these notes and coins.

        The history of the feudal periods into the commercial world we know today is a very informative lesson, but extremely heavy. It needs to be understood that the idea of buying and selling land as we do it today, was unlawful a few centuries ago except under rare exceptions. In England, land ownership by a commoner was not possible until around 1920 when rent laws forced land estate owners to sell rather than be burdened by these laws – and hence began the so-called dream of home ownership. Usury was illegal very early on. It was not until only a couple of centuries ago that common debts could be negotiated. The whole idea of ‘trade’ and ‘commerce’ was only enjoyed by the adventurous types called merchants etc and had to be finally placed under the umbrella of the common law only when it became necessary, as William Blackstone said it, that all resources capable of ownership find a legal owner. Even a hundred or so years ago, equity jurisprudence was still a huge part of every day life, whereas today (as predicted by Pomeroy) society has become all too reliant on legal rights and statutes to the expense of doing equity. Back then average people went and watched court proceedings as an everyday thing and understood the law, today, no one seems to understand it. It is sad.

        I will confess, I use these types of explanations because it is an attempt to appeal to the general person, and not just an economics student. The general public use a different language (one which involves more imagery and emotion) to more academically minded people.

      • Dingo said:

        Asad,
        Just to go back to your original request, i did manage to find something that I had found a couple of years ago which did enable me to see it far better from a formula perspective – something which may help with your goals re: students

        https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1973952

  4. Dingo said:

    Asad,
    I also have a game which I created on a spreadsheet.

    The name of the game is Impossibility, and the purpose of the game is to get your business (being the only business) to make a profit. The game allows you to set wages, productivity, hours, profit targets etc. Once you realize your one business can’t sell all its products, you move to the next stage.

    The game then moves to allowing 5 businesses, all with the same goals. Here it then shows how unemployment is created once some businesses profit but which inevitably cause others to go bankrupt.

    After this, the game then allows the introduction of government spending. The game demonstrates that no matter what you set all the elements values at, the business sector will not make a profit, nor will unemployment reach 0% until government spending is introduced. Because it is on a spreadsheet, I am not sure how to get it to you as I can’t attach it here. any ideas?

    • This is a good. A clear writeup of this could be published in many places, and the game would add some novelty to the pedagogy. The hard part would be to link it to the literature – the many papers which do discuss profits, but somehow fail to provide a CLEAR presentation – indeed, I think that this identity Profits+Savings=Deficit+Export Surplus has been arrived at in some places, but without full cognizance of its significance, which you have picked up above.

  5. zshiv said:

    I am afraid we are making identical arguments but in different language. Frankly, I do not understand what ‘free production’ means, but I guess you are talking about an increment of produced goods, attributable, say, to some process innovation, i.e., without corresponding increase in the cost of production (income-generating expenditures).

    What I said in my previous note was that the owners of such costless surplus could not translate/transform their physical-surplus (free production?) into money-surplus (profit) unless household purchasing power is increased by some exogenous source of money, like banks or governments. Otherwise, producers will have to sell their whole newly produced quantities, including of course the surplus, at reduced prices (or as you said, “the price will equilibriate to ensure full sales”).

    Indeed, in exchange economy, the function of money is not less important than production itself.

  6. ghholtham said:

    Guys, you are getting in a muddle because you have overlooked something. Go back to the Impossibility game. When you have five companies and four are making profits you don’t allow them to spend the profits. The fifth company therefore cannot sell its output. Now suppose company five is making investment goods that it sells to the other four companies. They spend their $40,000 profit on the output of company five. Voila – no unemployment and plenty of profit. Capitalists can consume too of course. You say that owners want more income than their workers but they apparently don’t want to consume any of it. Your mistake is to suppose that the only source of demand is the workers. But the capitalists spend too – either on consumption or investment. If all profits are saved you get the kind of results that you talk about.
    Kalecki could have given you the answer in his growth model: profits are created by investment. You don’t need some deus ex machina like the government.

    • Read the article “Where Do Profits Come From?” by David A. Levy, Martin P. Farnham, and Samira Raja. They explain all the issues very clearly. Business to business transactions do not alter net cash holdings within business sector.

  7. ghholtham said:

    Well of course they don’t – by definition. That is beside the point at issue. Profits have to be spent to generate the activity that provides profits. Look, Kalecki and Kaldor were socialist economists who understood accounting identities. Do you really think they didn’t? Go back and play with the spreadsheet. If you allow the capitalists to spend you can generate positive profit solutions. There are interesting issues about how the system moves through time but you can’t address those with a static spreadsheet

  8. ghholtham said:

    Perhaps this will make the point clearer: profits are not the same thing as free cash. In the little spreadsheet example that Dingo constructed, profits are made. At the end of the period four of his five firms have acquired capital goods that they didn’t have at the start. The fifth firm has inventories equal to its profit. Those are all wealth and that is the form the profits take. In fact there is no cash accounting in that little model. Presumably all the firms had free cash at the beginning of the period which enabled them to pay the workers while production was going on. At the end of the period they would have had exactly the same cash balances as at the start. To raise cash they would have to sell or mortgage the extra assets they had acquired. It is a truism that if everyone tries to cash out their assets at once you get a crisis and a slump. Don’t confuse profits and liquidity.

  9. ghholtham said:

    Actually, Dringo’s original mistake is an instructive one. In his simple case with only one firm, the firm pays out 80 units and makes 100 units of product. Because the firm cannot sell the surplus production of 20 units to the workers, Dingo assigns it zero value. That’s why he says there are zero profits. But in that case why bother to produce a 100 units?. In the simplest case the capitalist keeps the 20 units and consumes them himself. There’s no doubt he can enjoy the 20 units – that’s his profit, which gives him a much higher income than any of his workers. The above example could be a subsistence farmer employing labourers. He exchanges others’ labour for food and eats the surplus himself. No market transactions and no need for money. In a market economy the capitalist acquires a range of goods for consumption and invests in assets through market transactions, acquiring labour for cash and buying goods off other capitalists. Cash facilitates the transactions. If a single capitalist wants cash he can always acquire it by selling assets to other capitalists (eg by selling shares in his company). Then they get more assets, he gets more cash. But they cannot all liquidate their assets at once. That doesn’t work.

    Notice that the economy can grow if the capitalists invest and the extra capital enables output to rise with the same labour force. Even the workers can share in some of the growth if their higher productivity enables them to get higher wages. As long as there is enough money to facilitate transactions the stock of money need not grow at all. If transactions systems allow the economy can get wealthier with no increase in the stock of money – it just circulates faster. Money and wealth are not the same thing. Dingo makes the same mistake as some MMT theorists: he does not distinguish cash from real resources.

    • I dont have time for detailed response, but Dingo is right. You need to look at the stock of money at the start of period T M(T) and the stock at start of T+!, M(T+1). Business Profits + Consumer Savings = 0 – it does not matter how fast the money circulates. But if you cannot understand this, I wont bother to explain further.

    • Dingo said:

      Hey ghholtham,
      Thanks for taking the time to respond and play with the little spreadsheet. Granted, it is a bit basic and I do plan to expand on it somewhat. I admit that this is a bit rushed.

      Technically speaking, what you are saying is correct if we look at it from an isolated perspective. An economist (I think he is an economist) by the name of David Levy has a short 18min video on youtube which explains what you are saying quite well.

      I will also admit, I am not forthright in all my reasons for the spreadsheet, because one of the reasons I have set it up is to get people thinking about questions beyond the economics of the business sector, such as, where does the money come from to begin with (as a kid I always asked this when we played monopoly). Because most people think money is always notes and coins, that banks are simply intermediaries, and that all economies start out as barter societies, very few people seem to understand where it all comes from and what exactly it is they are using as money today, nor what economic effects can happen when they buy homes for example. For instance, if and when I tell people that the account balance you have at the bank is not notes and coins, but a legal obligation of the bank to convert the balance into notes and coins on demand (hence the name demand deposit), but a right most people most of the time never exercise, I am almost always met with a blank face. It then becomes moot to attempt to explain to them why, when we pay taxes with account balances (as opposed to paying taxes in notes and coins), the account balance is by law technically destroyed, because there is an extinguishment of the legal obligation (because the government now owns but at the same time owes, and because it owes it to itself, the legal obligation is extinguished). This part (and many others) of the reality of how money works today is missing in most people’s minds. I have studied a lot of the early feudal periods by reading a lot of old law books and if we were to go back several hundred years before the common law took commerce under it’s wings, I am quite sure the average person had a far better understanding of money and it’s roles and limitations. What is more, the economy we operate under is legal by nature (i.e. nothing can happen economically without legal rights/obligations etc and hence the real economy is subordinate to it), and yet the average person today cannot think in these terms or concepts, they mostly operate under the language of imagery and emotions – hence why most economic literature is always coming from the real economy (i.e. actual goods etc) perspective first in order to paint the picture that the monetary side is subordinate to it.

      So, to get back to your criticisms. It is probably sufficient to say, that for many people, the question of where the money comes from to begin with is of little importance (and the covid-19 stimulus packages has hardly raised this question for the average person), but for the likes of Asad and myself, it get’s to the very core of what we are trying (at least in our own ways) to get out there. I am looking for people who, after playing the game, ask me, where did the money come from to begin with; how did the business pay for the initial investment it would have had to make in order to produce it’s first products (and who produced this initial capital); if it borrowed it from whom did it borrow it, and where did the lender get it from if there were no businesses (to create profits) before this first business? Once we begin to ask (and answer) these questions, we can then expand on how money becomes leveraged, the means used to do this (which includes home ownership), the effects of these means and so forth. The feudal period holds the answers.

      The question was posed originally, and admittedly, the questioner may have been asking for an answer in a more isolated situation such as the way you and Levy have explained it, but I took the opportunity to answer it in a more broader sense.

  10. ghholtham said:

    Asad, I don’t know if you are kidding me or yourself. You don’t answer because there is no answer. Identities are identities. You seem to be confusing money and profits but if you don’t want to talk about it we can’t get any further.

    Dingo, There are several questions running together here and it might help to tease them out. The first question is to do with inventories of real goods. If production is starting at a point in time and it takes time, how are the workers fed etc while production is under way?. There must be pre-existing stocks of inventories. If there are no inventories there is nothing to buy and money is irrelevant. Second question, given inventories, if they are not held by the capitalist employer, does he have the money to pay the workers to buy the goods before he gets remunerated by the sales of his production? When you construct a model as you did, unless you collapse time and assume everything is instantaneous you must be assuming initial stocks of goods and money exist. If you don’t want to take that for granted you have to follow a historical process that will certainly take you back to feudalism and beyond. The first inventory occurred when someone did some work to produce a storable commodity and did not consume all of it or sell it. If we want to work out how an existing system works I’m not sure it is necessary to go back that far.

    It is certainly true that one cannot be a capitalist unless one has either money or access to credit . But it is important, I think, to recognise that the concept of wealth is different and broader than the concept of money. In your model, the money will always end up back in the hands of the capitalists because they are the only ones selling goods. The workers sell their labour for money and buy goods off the capitalists for money. At the end of a period the money is with the capitalists. The capitalists buy and sell from each other too but that just moves the money around within the set of capitalists. You and Asad were impressed by the fact that the capitalists did not end up with more money than they started with. That is true but they ended up richer. They acquired capital assets as well as consuming on their own account. Their own consumption plus the assets they acquired were equal to their profits.

    We have to roll the story forward now. The assets the capitalists acquired were valuable because, we suppose, they facilitate an increase in production. If the workers don’t get paid more, the capitalists have to consume more and/or invest more to keep the system working. What happens if the stock of money does not increase? Since the physical production is going up and the potential to consume is increasing because of the investment, the society is getting better off, even though the money stock is stable. That could happen in one of several ways. One the frequency of payments could rise, I need less money if I pay workers weekly and insist on advance payment than if pay monthly. and let customers defer payment. Another, the capitalists could extend each other trade credit so only the workers work for money, the capitalists pay each other in promissory notes. In other words they create their own money to finance the system. Indeed that is how capitalism worked before the creation of central banks. As the system grows, the volume of promissory notes will grow and becomes a form or money. . The system works as long as confidence persist. If people lose faith in the promissory notes and all want gold coins at the same time, there will be some sort of crash. But that is the same reason that there can be bank runs: most of a society’s wealth is tied up in illiquid assets like buildings, plant and machinery. If everyone wants to cash out at once, it can’t happen. The third theoretical possibility is that prices and wages fall so that the same stock of money buys ever more goods. That seldom happens in practice – because if money is an appreciating asset people tend to hoard it instead of investing it and then there is a slump.

    So monetary practices and the operation of credit are extremely important for the operation of the system but at the end of the day money is just like tickets to a show. It is valuable because you can’t go to the show without tickets. But their value depends entirely on there being a show. No show and the tickets are just waste paper. If the capitalists hoard the tickets they never get to see the show – and nor does anyone else. Both Marx and Kalecki understood that the system is driven by capitalist expenditure. You were right that capitalists can make money by selling to the government but that is not necessary. Capitalists were making profits long before government expenditure amounted to much.

    .

    • Dingo said:

      ghholtham,
      Everything you say is correct, and I can’t fault any of it, precisely because we are tackling it from slightly different angles. In fact, I would like to expand my spreadsheet to incorporate much of what you (and others who have done the same) are expressing. But I must be clear, I want to show a much broader perspective, including the very beginnings of money as a tool used during the very early feudal times and how it was able to be leveraged under the relaxation of the common law over many centuries. This is not as complex as it may sound, but also, my aim is to make this known to the general public, but, and this is a big but, the public are not ready at this point in time; and I can’t see them being ready until they completely lose confidence in the system. Then they will be asking many questions and that is when we need to be ready with the answers. Just when this happens, I don’t know, but I believe it will occur when the wage deflation cycle bottoms out which I also believe will co-incide with a peak in global housing ownership. This will also be a great time to demonstrate better ways to allow capitalism to thrive..more on this later. Just as an aside, I do not believe in socialism, or MMT’s policies, but my reasons are different to most that I come across.

  11. ghholtham said:

    Yes I have read it. Initially, they suppose the economy produces only consumer goods and there is no inventory building. They conclude that in that situation there will be no profits. The conclusion depends on taking definitions from one (real) situation and applying them in a model situation where they make little sense – but I won’t argue about that The point is when you allow investment and inventory building profits are generated. The profits depend on the amount of investment. And that is decided by the business sector. On p.13 they say “The flow of funds method has taken us further by revealing that investment sets in motion a flow of funds that become -indeed cause – profits”. Exactly the point I was trying to make.

    Dingo’s spreadsheet depicted the world without investment and the conclusions he was drawing apply only to a world with no investment and no capitalist consumption. Levy et al make the point that savings equal investment and Investment is financed by the saving of households and business together (also by foreigners). It follows as a matter of identity that for a given level of investment, the more household saving there is, the less profit there must be. That is just arithmetic but investment is not in practice fixed. It is the volume of investment that is the primary driver of profits. They don’t dispute that.

    As a matter of fact the investment that most household saving goes into is residences. Houses are the part of the capital stock that are largely held by households. Most business investment is financed by retained earnings i.e. profits. And money is endogenous. Both households and business can get credit when they want to invest. When they buy the investment goods, the credit becomes deposits and swells the money supply. I discussed the fixed money stock case above only to make the point that wealth is not money and can grow at a different rate from the money stock. In practice the money stock will grow along with expenditure.

    I apologise if I was rude in my earlier email. I was irritated by the assumption that I had not understood what was being said but I should have been more restrained.

    • I am really trying to understand this, but I cannot follow what you say — The argument seems trivial. Tell me where is my mistake. Let MB(T), MH(T) be money stock in hand of Business and Households at start of period T. Then MB(T+1)-MB(T) is the Money Gain over the year or BUSINESS PROFITS. MH(T+1)-MH(T) is household savings. It does not matter how the money may have circulated during the in-between time. Total money stock at time T is MB(T)+MH(T) if no money is injected into the system then this must equal MB(T+1)+MH(T+1). But if these two quantities are equal, then Business Profits+Household Savings=ZERO. Profits are only possible when money is injected into the system.

  12. ghholtham said:

    Asad, you are focusing purely on money balances but production is going on. What is being produced and who gets it? If I start the period with $100 dollars and end the period with $100 and a house am I not better off? Money is not all of wealth. In the course of a period, the capitalist consumes more than the worker and he acquires capital goods. How could he do those things if he made no profit? They are his profit. The fact that his money balance has not changed is not very relevant. How can you ignore the accumulation of capital assets?

    You imply that a firm cannot have earned profits in a year unless its cash balances have gone up.. But when firms declare profits they are saying the amount by which their assets exceed their debts has gone up. Their cash balances are just one item on the balance sheet. They could have gone up, down or sideways.

    Put it this way. Only business companies sell goods. Households sell labour. If business starts off with a given cash balance and pays it to workers it can only sell to the workers goods for the same amount of cash (unless it gives credit). That is your point and it is not disputed. But the workers produced more than the were paid. That “more” is profit. It was either consumed by the capitalists or business owners or they traded among themselves to invest and acquire capital goods.

    • This is the difference between M=C-M’ economy and C-M=C’ economy. Capitalists are driven by MONEY profits, according to Max Weber, and other analysts

  13. ghholtham said:

    An individual capitalist will want to sell out for cash eventually, it is true. But they cannot all do it at once. Marx called it the realisation of capital problem. Kalecki described the situation as: workers spend what they earn but capitalists earn what they spend. Profits dwindle unless firms invest. Anyway, I think Dingo’s problem is resolved.

Leave a Reply to Dingo Cancel reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.

%d bloggers like this: