The Origins and Evolution of Consumer Capitalism: A Veblenian-Keynesian Perspective 9781138335455, 9781138335462, 9780429443763

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“John P. Watkins’ new book constructs a coherent historical narrative of the emergence of modern mass consumer capitalism out of late nineteenth-early twentieth century capitalism. It is masterfully written, and hopefully, will be read by many economists and, most importantly, by the next generation.” William Waller, Hobart and William Smith College “In his new book, John P. Watkins has utilized the insights of two of the greatest analysts of the paradoxical nature of American economic development, Thorstein Veblen and John Maynard Keynes, to interpret the key moments of the last one hundred and fifty years of American capitalism. Thus, this volume will be useful for those teaching or researching U.S. economic history as well as those seeking texts that present an alternative perspective to economic theory.” Janet T. Knoedler, Bucknell University

The Origins and Evolution of Consumer Capitalism

Consumer capitalism arose with the second industrial revolution, the application of continuous-mass production to consumer goods during the late nineteenth and early twentieth centuries. This book adopts a Veblenian, Keynesian viewpoint, presenting an evolutionary view of consumption combined with the need to increase demand to match increases in production. The book traces the history of consumer capitalism, examining the paradox posed by applying continuous-mass production to produce armaments for dynastic ambitions versus consumer goods for the masses, manifesting itself in the world wars of the twentieth century. Multiple paradoxes at the heart of the story address booms leading to busts, over-producing countries in Asia relying on over-consuming countries in the West, and the expansion of demand depending on increasingly inventive ways of liquefying assets, in light of stagnant incomes. The book persuasively argues that these paradoxes result from capitalism’s incessant drive to accumulate capital, ­fostering conflict, crises, and depression. The latest paradox results from the impact of continuous-mass production on the environment, manifesting itself as the Darwinian dilemma. The dilemma stems from human beings largely winning the struggle for existence and, in the process, possibly making the earth uninhabitable, at least for humans. John P. Watkins is Professor of Economics at Westminster College, Salt Lake City, Utah, and adjunct Professor of Economics at the University of Utah. He has taught economics for some 40 years, teaching the history of economic thought, macroeconomic theory, economic justice, and ecological economics. He is past president of the Association for Evolutionary Economics and the Association for Institutional Thought. He is winner of the Bill and Vieve Gore Excellence in Teaching Award, twice recipient of the Manford A. and June Shaw Faculty Publication Award, and voted six times Professor of the Year. His purpose in teaching is to raise the students’ level of confusion, a purpose which he is known to have accomplished with considerable success.

Economics as Social Theory

Series edited by Tony Lawson, University of Cambridge

Social Theory is experiencing something of a revival within economics. Critical analyses of the particular nature of the subject matter of social studies and of the types of method, categories, and modes of explanation that can legitimately be endorsed for the scientific study of social objects are re-­ emerging. Economists are again addressing such issues as the relationship between agency and structure, between economy and the rest of society, and between the enquirer and the object of enquiry. There is a renewed interest in elaborating basic categories such as causation, competition, culture, discrimination, evolution, money, need, order, organization, power probability, process, rationality, technology, time, truth, uncertainty, and value. The objective of this series is to facilitate this revival further. In contemporary economics, the label “theory” has been appropriated by a group that confines itself to a largely asocial, ahistorical, mathematical “modelling.” Economics as Social Theory thus reclaims the “theory” label, offering a platform for alternative rigorous, but broader and more critical conceptions of theorizing. 47. Markets Perspectives from economic and social theory William A. Jackson 4 8. Keynes against Capitalism His economic case for liberal socialism James Crotty 49. The Nature of Social Reality Issues in social ontology Tony Lawson 50. The Evolutionary Origins of Markets How evolution, psychology and biology have shaped the economy Rojhat Avsar For more information about this series, please visit: https://www.routledge. com/Economics-as-Social-Theory/book-series/EAST

The Origins and Evolution of Consumer Capitalism A Veblenian-Keynesian Perspective

John P. Watkins

Designed cover image: © Getty Images First published 2023 by Routledge 4 Park Square, Milton Park, Abingdon, Oxon OX14 4RN and by Routledge 605 Third Avenue, New York, NY 10158 Routledge is an imprint of the Taylor & Francis Group, an informa business © 2023 John P. Watkins The right of John P. Watkins to be identified as author of this work has been asserted in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library ISBN: 978-1-138-33545-5 (hbk) ISBN: 978-1-138-33546-2 (pbk) ISBN: 978-0-429-44376-3 (ebk) DOI: 10.4324/9780429443763 Typeset in Times New Roman by codeMantra

Dedicated to Sandra and Katie and to my readers struggling to understand and resolve the paradoxes posed by our current civilization.

Contents

List of figures List of tables Preface Acknowledgments 1 The Origins and Paradoxes of Consumer Capitalism

xi xiii xv xix 1

2 Toward an Evolutionary Theory of Consumer Capitalism: Thorstein Veblen and John Maynard Keynes

18

3 Continuous-Mass Production and the Rise of the Modern Corporation

39

4 How to Absorb the Output? Consumerism versus Militarism: Veblen, Hobson, and Polanyi

55

5 Keynes and The Great Depression: “Poverty in the Midst of Plenty”

77

6 The Myopic Consumer and the Rational Economist: The Institutional Pattern of Consumption and Theories of Consumer Choice

98

7 The Liquefication of Everything: Corporate Power and the Evolution of Consumer Credit

113

8 America’s Perpetual Trade Deficit

138

9 The Great Financial Crisis—A Test of Two Models: Minsky’s Financial Instability Hypothesis and the Dynamic Stochastic General Equilibrium Model

154

x Contents

10 Overcoming the Limits of the Private-Domestic Economy: Quantitative Easing versus Modern Monetary Theory

175

11 The Darwinian Dilemma: Winning the Struggle, Making the World Uninhabitable?

190

12 The Civilization of Consumer Capitalism

204

Index

213

Figures

5.1 Keynes’ Model of Effective Demand 83 7.1 Consumer Credit as a Percentage of Disposable Income (1910–2000) 123 7.2 Revolving Credit as a Percentage of Disposable Income (1959–2000) 129 7.3 Personal Saving as a Percentage of Disposable Income (1059–2000) 129 7.4 Revolving, Non-Revolving, and Home Equity as a % of GDP (1959–2007) 130 8.1 US Current Account as a Percentage of GDP 139 8.2 US Gross Domestic Purchases as a Percentage of GDP and Consumption as a Percentage of GDP (1959–2009) Gross Domestic Purchases as a Percentage of GDP is Measured on the Left Axis, Consumption as a Percentage of GDP is Measured on the Right Axis 147 9.1 The Dynamic Stochastic General Equilibrium Model of the GFC 169 10.1 Ratio of Stock Market Capitalization to GDP (percent of GDP) 179

Tables



3.1 4.1 4.2 7.1

8.1 8.2 9.1 9.2 9.3 10.1 10.2 10.3 10.4 10.5 11.1

Advertising as a Percentage of GDP—1919–1930 49 Per-Capita GDP in 1990 International Dollars 60 Military Expenditures as a Percent of the National Budget 61 Ratio of Business Saving to Gross Private Domestic Investment Less Private Residential Fixed Investment 118 Consumption as a Percentage of GDP for China, Japan, and the United States 145 Trade Balance with Various Countries as a Percentage of US GDP 149 Evolution of Consumer Credit: 1970–2009 156 Growth of Financial Profits, Total Consumer Debt, and Asset-Backed Securities as a Percentage of GDP 156 Taxonomy Classification of Cash Flows 161 Monetary Policy and Fiscal Policy 179 Inequality in the Distribution of Income by Share of Household Income 180 Distribution of Wealth by Household Income as a 180 percentage of Total Wealth Quantitative Easing 186 Functional Finance 187 Human Population, Atmospheric Carbon, and Remaining Wilderness 197

Preface

Capitalism is an inherently ambiguous concept. Like gazing at clouds on a summer’s day, one person sees a bear, another a bison. What one sees depends on one’s point of view. Capitalism is an interpretive concept, allowing us to organize the various events that ushered in the modern world. A significant event giving rise to consumer capitalism lay in the widespread adoption of continuous-mass production, initiating the second industrial revolution. Consumer capitalism represents an evolution of capitalism generally, vastly expanding production for the masses, requiring an increase in demand. Its emergence in the late nineteenth and early twentieth centuries is reflected, in part, in two transformative books: Thorstein Veblen’s The Theory of the Leisure Class and John Maynard Keynes’ The General Theory of Employment, Interest and Money. The Theory of the Leisure Class introduced an evolutionary theory of consumption. Individuals emulate each other to achieve the pecuniary standard, a standard that advances as corporations apply continuous-mass production to new products. The General Theory reflects the increased importance of consumption in the theory of effective demand, foregoing the classical categories of wages, profits, and rents. The theory of effective demand, as taught throughout the world, depends on spending by consumers, entrepreneurs, government, and the foreign sector. Consumer spending, of course, forms the largest component. Production for the masses required a sea-change in the institutions of capitalism: the rise of the modern corporation; a change in the laws allowing corporations to go beyond the scope of their charters; a change in the concept of property from use value to exchange value, from the replacement costs of a firm’s assets to the present value of its anticipated income stream; efforts to combine production with distribution; the rise of modern advertising to sell products; and the rise of consumer credit to supplement incomes enabling people to buy the products. The ideas for this book came from various sources. The first source was an article I wrote titled “Corporate Power and the Evolution of Consumer Credit.” Viewing consumer credit from a historical perspective revealed increasing efforts to liquefy consumer assets and provide credit based on

xvi Preface those assets beginning with installment credit. Installment credit arose concomitantly with the durable-goods revolution. At the time of the article, I was unaware that the durable-goods revolution resulted from applying continuous-mass production to consumer goods. Continuous-mass production, along with numerous innovations, ushered in the second industrial revolution stemming from the application of science to production. The second source stems from a personal aversion to debt. The aversion is part of the economist’s gestalt, reinforced by the idea of economic rationality, the tendency to weigh costs and benefits at the margin. Economic rationality forms the defining characteristic of the economist’s cultural orientation, the result of the socialization that occurs in graduate school. Most economists model the world as they see themselves: rational, informed, engaged in optimizing choices. The result is a caricature of people, not people as they are in their daily life. In the real world, people emulate each other, attempting to live at the conventional standard of living, an effort, as they say, “to keep up with the Jones.” Human choice is complex, subject to habit, emotion, emulation, guilt, in addition to economic rationality. Despite claims to the contrary, economic rationality often fails to reveal the best choice. It is generally invoked to justify the choice made. In addition, the real world is fraught with uncertainty and moral dilemmas. Uncertainty undermines our efforts to measure costs and benefits. Moral dilemmas prompt us to question the choice made. Too often, economic rationality creates blinders, leading economists to mistake the model for the real world, failing to realize that models are metaphors, capturing some elements and omitting others. Most economists disregard the evolution of economic institutions, ideas, and material conditions. They take a static approach, observing the tree or perhaps a cluster of trees, unaware that the forest itself is evolving, incurious regarding the cause of that evolution or where it might lead. The third and, perhaps, most important source is my dear friend, my love, and my fellow searcher, one who transcends rationality, generous to a fault, unconcerned with balancing costs and benefits, empathetic to the extreme. Her priority is caring for others, too kind to be among “wolves.” For the “wolves,” the point, as Veblen would say, is “to get something for nothing.” People who care, who are empathetic, who are dedicated to service, who lack income or property beyond their labor power or lack understanding of how the system works, those people often become easy pickings. Consumer capitalism represents the application of continuous-mass production to produce goods for the masses. The purpose, of course, is to earn profits. The assumption that wants are infinite justifies the system, an assumption taught in principles of economics classes throughout the world. When I ask students if wants are infinite, most agree. When I ask is this sustainable, most are silent. Their silence deafens, revealing the paradox we confront, the paradox that our civilization is unsustainable.

Preface  xvii Hints of the paradox began at four or five. I would draw maps, marking a town as a dot on the riverbanks, lines representing roads connected to other dots. The town became a city, which became a metropolis. The dots grew ever larger filling the page. Then what? Of course, I had no understanding of relating the drawing to the problems at hand. The page was full, time to move on. Continuous-mass production that ushered in consumer capitalism entails mass consumption. He who wins with the most toys wins the race. But what has he won? What have we won? A world in which a few have far more than they need while many need more than they have? A world void of the diversity of life? A world growing ever warmer? I am reminded of a quote by Kenneth Boulding, “Anyone who believes exponential growth can go on forever in a finite world is either a madman or an economist.” Perhaps we are all mad.

Acknowledgments

We are all influenced by the efforts of others. In this regard, I am indebted to the insights, writings, and conversations of many people. Glenn Atkinson and Steven Paschall alerted me to the legal changes making possible the emergence of the corporation. Anne Mayhew’s writings were particularly helpful in understanding cumulative causation. Jan Knoedler alerted me to Anne Mayhew’s work on continuous-mass production, after much of my research had been completed. Other conversations, writings, and insights came from Robert Scott, William Waller, John Henry, Charles Whalen, Tim Wunder, Eric Hake, Randall Wray, Christopher Brown, Zdravka Todorova, William Redmond, James Seidelman, Michael Popich, and Geoffrey Schneider, among others. My thanks to you all. No doubt, there were others who influenced me. My apologies for not acknowledging your contributions as well. As usual, despite the help of others, all errors and omissions reside with me.

1 The Origins and Paradoxes of Consumer Capitalism

Continuous-mass production technology, widely adopted in the late nineteenth and early twentieth centuries, introduced what J. R. Commons and John Maynard Keynes called “the era of abundance.” Continuous-mass ­production enabled businesses to vastly increase output, thereby r­ educing per-unit costs, potentially increasing profitability. Thorstein Veblen was among the first to observe the business response, noting that ­continuous-mass production posed a problem: how to prevent production from exceeding what the market could profitably absorb? How to prevent losses? How to increase profits? Avoiding excessive production and increasing prices required the adoption of the corporate form of business enterprise, merging corporations to control output, and adopting various institutional innovations, particularly the holding company. Merging corporations and controlling prices further involved changing the concept of property itself and changing the laws, freeing corporations to engage in activities beyond the scope of their charter. Increasing sales and, hence, increasing demand required further institutional changes: the establishment of retail outlets in different regions of the country; systematic and rational advertising; financial innovations to extend credit to consumers; and most importantly, a change in culture from emphasizing the virtues of thrift to the pleasures of gratification. Continuous-mass production introduced consumer capitalism, applying the technology to consumer goods and creating the necessity of increasing consumer demand to keep pace with increased production. Expanding both the production and consumption of goods fuels the accumulation of capital, creating a continuous feedback loop, a circular causation. Increased production necessitates more consumption, which, in turn, necessitates more production. Continuous-mass production has accentuated a number of paradoxes: the prospect of depression or, as Keynes put it, the “paradox of poverty in the midst of plenty;” the rise of dynastic ambitions channeling the increased output into militarism; financial innovations involving identifying and liquefying consumers assets to provide consumers credit, expanding demand, and laying the foundation for the financialization of the economy toward the end of the twentieth century and the beginning of the twenty-first century.

DOI: 10.4324/9780429443763-1

2  The Origins and Paradoxes of Consumer Capitalism Financialization culminated in the Great Financial Crisis (GFC), requiring massive government intervention on behalf of financial institutions to avoid an economic meltdown. The GFC gave rise to the Modern ­Monetary Theory as a means of dealing with the GFC and, particularly, the ­Covid-19-induced recession, overcoming the limits of the market economy. And the environmental crisis resulting from the commodification of the natural world, accentuated by applying continuous-mass production to the extraction and burning of fossil fuels combined with a belief in infinite growth. Consumer capitalism originated in the late nineteenth and early twentieth centuries with the creation of a national market and the introduction of continuous-mass production technology, initiating what Alfred Chandler called “the second industrial revolution.”1 Chandler continues: In the 1880s and 1890s new mass-production technologies—those of the Second Industrial Revolution—brought a sharp reduction in costs as plants reached minimum efficient scale. In many industries the throughput of plants of that scale was so high that a small number of them could meet the existing national and even global demand. (Chandler and Hikino 1990, 26) The economies of scale and scope associated with continuous-mass production changed the nature of production itself. Railroads and telegraph spanned the continent overcoming local markets, establishing the first national market. Farmers could send their wheat, corn, and barley at reduced cost to markets back east, ranchers their cattle. New England millers sent their lumber to the Midwest. Manufacturers sent their goods from the cities on the east coast Westward. The railroads opened the West to homesteading. To foster the settlement of the West, the government forcibly removed the indigenous peoples from their traditional lands. Advances in transportation and communication initiated a manner of economic development described by Adam Smith in The Wealth of Nations. By extending the market, the railroads expanded the division of labor, thereby increasing productivity and output (see Smith [1776] 1937, Chapter 2).2 The creation of a national market proved propitious for businesses using continuous-mass production. The technology increased the speed with which goods could be produced, providing a cost advantage. The advantage enabled businesses to produce goods previously produced within the home. Attracted by lower prices and easier access, consumers began purchasing mass-produced goods instead of producing household goods. Electrification brought new products in its wake—radios, electric lighting, washing machines further attracting consumers. Henry Ford introduced the moving assembly line, the classic example of continuous-mass production, greatly reducing the price of automobiles. From 1909 to 1910, the price of a model T was $950, with 18,664 cars produced. By 1916–1917, the price had fallen to $360 with 785,432 cars produced (Ford and Crowther 1922, 145). Initially,

The Origins and Paradoxes of Consumer Capitalism  3 the demand for autos exceeded supply. Ford and his associates looked to speed up production. The moving assembly line enabled them to produce over 1,200 automobiles per day (Chandler 1964, 12). The industry’s output rose from 1.5 million cars in 1921 to 2.5 million in 1922 and 4.3 million in 1923. But from 1923 until 1929 the market leveled off, taking an average of a little under 4 million cars a year. As had happened or would happen in so many American industries, the initial demand for the new product had reached the level permitted by the existing national income. Moreover, as has also usually been the case, production potential exceeded demand. By the mid-1920s the country’s automobile plants had a productive capacity of over 6 million vehicles. (Chandler 1964, 13) A national market combined with continuous-mass production ­technology led to a sea-change in the institutions of late nineteenth- and early ­twentieth-centuries capitalism, changes that helped foster the subsequent development of the US economy. First, the modern corporation emerged in response to the need to manage railroads in the 1870s and 1880s. The corporate form, with its hierarchical form of management, was soon adopted by other businesses, allowing them to combine mass production with mass distribution. Establishing retail outlets enabled corporations to distribute goods in different geographical locations.3 Second, continuous-mass production technology led to cutthroat competition as businesses cut prices to gain market share. Increased production exceeded what the market could profitably absorb, precipitating the depression of 1894 (see Veblen [1904] 1975). Ruinous competition created losses. Unable to pay for the high fixed costs of machinery, many businesses went into bankruptcy, leading to the merger movement of the 1890s and later in the 1900s. The banks merged the businesses to control output using any number of devices: outright purchase, lease, holding companies, and a representation by a minority in the directorate (see Commission 1900, 310). In many cases, the courts voided the mergers, claiming mergers exceeded the conditions of the charter.4 Among efforts to restrict output, the most successful was the holding company, an institutional device in which one firm held the stock of other firms. While the Sherman Antitrust Act outlawed monopolies, the holding company enabled banks to circumvent the Act by purchasing stock in companies to gain control. In some cases, businesses themselves emerged to dominate the industry. South Improvement Corporation, for example, which later become Standard Oil, used economies of scale to undercut the prices of its competitors, forcing them into bankruptcy (See Tarbell 1966).5 Third, changes in business practices spurred on by the merger movement led to change in the definition of property. Holding companies holding the stock of individual companies, in turn, issued their own stocks, attributing

4  The Origins and Paradoxes of Consumer Capitalism their value to good will, the result of higher prices from restricting output. In the past, businesses were valued based on the cost or replacement cost of their assets. By the late nineteenth century, property came to mean the discounted present value of an anticipated income stream. The change from property conceived as a physical thing to present value, from use value to exchange value, from corporeal to intangible property, laid the basis for financing corporations and extending credit to consumers. Stock prices came to reflect the present value of a firm’s future earnings. Consumer credit enabled corporations to circumvent the limited income of consumers, extending consumers credit based on the value of consumer assets. Sales finance companies provided installment credit, using the goods sold as collateral. The evolution of consumer capitalism reveals efforts to identify consumer assets, liquefy those assets, and encourage consumers to incur debt based on those assets. The fourth strategy involved efforts to increase demand through advertising. Advertising had existed for years. But under corporate influence, advertising agencies appeared, undertaking systematic efforts to increase sales by establishing national brands, providing quality assurance to consumers, and providing producers a measure of certainty regarding sales.

Cumulative Causation and Consumer Culture The rise of consumer capitalism illustrates the idea of cumulative causation. Applied to the evolution of consumer capitalism, cumulative causation refers to changes in technology creating new possibilities. Differences in culture, institutions, and habits reveal to people what’s available. As Anne Mayhew put it, “Active individuals inherit a set of ideas and symbols that are used to understand a world of many options” (2001, 243). Continuous-mass production created an outpouring of new consumer goods, expanding the opportunities available. For business, new opportunities to profit required both controlling output and increasing sales. For consumers, more output and new products offered the opportunity to consume at a higher standard of living. The predisposition toward increasing consumption, however, had already been laid earlier. In the eighteenth century, rising wealth made consumer purchases possible. “Encouraged by new methods of marketing and sustained by an expansion in the purchasing power of households, consumers launched a buying spree of historic dimensions, purchasing unprecedented quantities of household furnishings, clothes, and personal accessories” (Kwass 2003, 87).6 Despite the buying spree, it would be a mistake to interpret the eighteenth century as representing the full emergence of a consumer society: But to claim that the eighteenth century saw the birth of a consumer society or that many aspects of that society were imbued with a new

The Origins and Paradoxes of Consumer Capitalism  5 commercial attitude should not be misinterpreted as a belief that by 1800 England had achieved all the features of modern consumer society. Nor should it be assumed that the birth occurred without a long period of gestation. (McKendrick, Brewer, and Plumb 1985, 13) Many consumer goods continued to be produced in the home, particularly in rural areas. Self-sufficiency among families varied depending on the region of the country and the dependency on the market. In urban areas, households were more integrated in the market economy. “Rural families usually produced their own food, clothing, and tools, while urban families bought them at the market” (Tilly and Scott 1978, 22). In colonial America, families in the south raised cash crops, and in the North and on the frontier families, by necessity, were self-sufficient (Matthaei 1982). In 1750, about 65% of English were involved in agriculture; in France, it was about 75% (Tilly and Scott 1978, 12); in the United States in 1790, it was 90%. Many households had one foot in the market and the other foot in the traditional economy of home production. “In general, husbands took up commodity production, while wives centered on self-sufficient production, given that the former was production of wealth, oriented toward the market, while the latter was production to directly fill the needs of the family” (Matthaei 1982, 31). Household production reduced the need to spend money on goods that a woman could produce. “Her work could include the home production of goods, clothing, candles, soap, household furnishings, and drink” (Matthaei 1982, 31). The decline in home production both in the US and in England largely stemmed from technological changes. Industrialization involved the movement of labor and resources away from primary production (agriculture, fishing, forestry) toward manufacturing and commercial and service activities. The scale of production increased and the factory replaced the household as the center of productive activity. In the terms we have been using, the industrial mode of production replaced the domestic mode of production. (Tilly and Scott 1978, 63). Food represented the single largest expense in the first half of the nineteenth century. Changes in living costs often change behavior. The increased scarcity of firewood made home cooking more expensive, while advances in transportation reduced the costs of basic foods. Changes in the cost of preparing household items led to the decline in household production. In the new urban environment, traditional rural skills, of which domestic baking and brewing were economically the most important, gradually decayed and ultimately disappeared over wide areas of the country. …

6  The Origins and Paradoxes of Consumer Capitalism This was, no doubt, an inevitable consequence of industrialization and the division of labour. Baking and brewing were long, tedious operations, the materials sometimes hard to come by in small quantities and the results often uncertain. (Burnett 1968, 3). Continuous-mass production technology allowed an outpouring of consumer goods: matches, cigarettes, soap, canned goods, photography and so on directed at the mass market. Henry Ford applied the principle of ­continuous-mass production technology to automobiles, greatly reducing the price of the Model T. Initially, the market absorbed the increased output. Enabling automakers to increase production for a ready market. By the mid-1920s, however, Ford and General Motors made plans to increase sales. It became apparent that producing automobiles for the mass market made consumer credit necessary. The evolution of consumer capitalism reveals corporate efforts to increase consumer spending. Corporations engage not only in product innovation, but innovations in advertising and finance to increase consumer demand. In advertising, the purpose was to influence consumer tastes and selectively provide information. In finance, innovation assumed the form of discovering and liquefying consumer assets to circumvent limited income. Credit cards appeared in the early twentieth century, and the universal credit card was not introduced until the 1960s. The purpose, of course, is to increase consumer spending to increase profits. By the late twentieth century, consumer debt became a major contributor to economic insecurity motivating people to work longer and harder. The book takes a cultural approach, synthesizing Thorstein Veblen’s concept of pecuniary emulation with John Maynard Keynes theory of effective demand. Keynes did not include Veblen among the so-called heretics who anticipated the principle of effective demand. Nevertheless, their views are more compatible than generally considered.7 Veblen’s evolutionary, cultural approach complements Keynes’ short-run approach to understand the cause of depression. Veblen provided a cultural theory of consumption, again complementing Keynes. For Veblen, consumers are motivated by status. This, in turn, led Veblen to emphasize the role of pecuniary emulation, copying the money habits of others. Pecuniary emulation leads to competitive spending, increasing the demand for new products, which in turn raises the standard of living. Keynes asserted that effective demand determines the level of employment in the short run. Keynes, however, emphasized the instability of investment as the source of instability of the economy. Keynes and Veblen’s ideas, however, tend to parallel each other. Both emphasized the instability of capitalism; both asserted that preferences are culturally determined, although more so by Veblen. Both agree that the value of corporate assets stems from the present value of the discounted future income stream. Where Keynes

The Origins and Paradoxes of Consumer Capitalism  7 failed to develop a theory of finance, Veblen anticipated Hyman Minsky in emphasizing the difficulty of repaying debts in precipitating crises. Veblen’s view of consumption provides a more comprehensive interpretation of the rise and evolution of consumer capitalism. Further, combining the theories provides an understanding of the paradoxes that confront consumer capitalism. Keynes’ and Veblen’s ideas help explain the unique characteristic of capitalism generally, the growth imperative. Capitalism must grow. Consumer capitalism is the latest version of the growth imperative.

The Story as an Informal Test Explaining economics involves telling stories, a mapping of sorts between theory and the real world. Constructing theories begin with forming a vision, a “preanalytic cognitive act” that “embodies the picture of things as we see them” (Schumpeter 1954, 43). Theories are comprised of models having similar assumptions, generating coherent conclusions. The formal tests of a model are well known: deductions consistent with the assumptions and the ability to generate potentially falsifiable hypotheses. Realistic assumptions are less important. In fact, Milton Friedman posited the irrelevance of relevant assumptions. A hypothesis is important if it “explains” much by little, that is, if it abstracts the common and crucial elements from the mass of complex and detailed circumstances surrounding the phenomena to be explained and permits valid predictions on the basis of them alone. To be important, therefore a hypothesis must be descriptively false in its assumptions. (1953, 14) Friedman’s position serves to shield mainstream economics from critics since the lack of realism is irrelevant. Nevertheless, the lack of realism means that mainstream economics often fails the informal test of a model, failures revealed by the GFC and the Covid-19-induced recession. To reiterate, informal tests assume the form of a story, a mapping between theory and experience. Does the model make sense? Does it cohere with experience? Telling a story involves treating models as metaphors. A metaphor juxtaposes two unrelated things to say that the qualities of one resemble those of another. We use the better known to understand the less well known. Examples abound. In the sixteenth century, philosophers compared the cosmos to a clock and God to the clock maker. More recently, Richard Dawkins refers to nature as the blind watchmaker, underscoring the randomness of natural selection. A student refers to a certain professor he dislikes by part of the human anatomy. The same professor uses the supply and demand for labor concluding that minimum-wage laws cause unemployment. Never mind that labor markets never clear; never mind that labor is not homogenous; never mind that the model depicts a point-in-time analysis, not a process over time.

8  The Origins and Paradoxes of Consumer Capitalism Metaphors shape our stories. As metaphors, economic models are “­pictures” of the economic process. Models isolate those variables and relationships considered important. Models help clarify thoughts by eliminating “extraneous and irrelevant” influences. Marshaling the “facts” to adhere to the model makes the underlying story an “informal test.” A successful story offers a reasonably coherent explanation of events, confirming our beliefs and justifying our actions. Often those “extraneous and irrelevant” influences prove important. Ignoring those influences, however, can blind theorists, resulting in misleading stories. Stories mislead when people mistake the metaphor for reality, committing what Alfred North Whitehead called the fallacy of misplaced concreteness ([1925] 1967, 51). Mistaking the metaphor for reality leads people to deny or filter potentially important information. Metaphors are imperfect representations leading to imperfect stories, often prompting the search for a more appropriate metaphor.8 Ignoring those “extraneous and irrelevant” influences reveal themselves in both the classical and mainstream view of consumer behavior. The mainstream assumes that individuals maximize utility. The consumer is sovereign, implying that consumers determine what, how, and for whom goods are produced. Preferences are taken as given, ruling out the influences of culture, advertisers, family and friends. Financers merely provide purchasing power, allowing individuals to rationally trade off future consumption for present consumption. Advertisers merely provide information to consumers, informing them which commodities will best maximize their satisfaction. This concept of rational economic man, of course, had its origins in classical economics.

Classical View of Consumption The vision with which theorists begin tend to mirror the social and economic relations of their times. In the late eighteenth and early nineteenth centuries, the classical economists—Adam Smith, David Ricardo, and John Stuart Mill, among others—envisioned society as comprised of capitalists, landowners, and workers. Despite positing that “labour was the original purchase price paid for all things,” the classical economists attributed income to the ownership of property, to the ownership of land, labor, and capital. Rents are the remuneration for owning land; wages for labor; and profits are the residual remaining after paying rents and wages. The classical economists focused on economic growth, reflected in the title of Adam Smith’s book, An Inquiry into the Nature and Causes of the Wealth of Nations. Smith envisioned the economy working according to an invisible hand. Each individual pursuing his or her self-interest unintentionally promotes the interest of all. By preferring the support of domestic industry to that of foreign industry, he intends only his own security; and by directing that industry in

The Origins and Paradoxes of Consumer Capitalism  9 such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of this intention. (Smith [1776] 1937, 423) Although “to feed and clothe the community” comprised the purpose of growth, the classical economists discouraged feeding and clothing the people. Feeding and clothing the people meant less saving, which meant less wealth. For the classical economics, saving is the key. “Parsimony, and not industry, is the immediate cause of the increase in wealth” (Smith [1776] 1937, 321). The classical economists offered little hope for the working poor. Malthus’s theory of population, the cornerstone of the classical view of wages, implied that wages tend to subsistence. The moral failings of workers cause their numbers to rise beyond the available food supply. Uneducated and unable to stifle their passions, providing assistance merely creates more poor people. The policy implication: laissez faire. Let the poor fend for themselves. With the emergence of consumer capitalism, changes in society changed the vision with which some economists began. Veblen and Keynes rejected Malthus’ theory of population and the assumption of Say’s law, returning to the problem of social provisioning, the problem of clothing, feeding, and sustaining the people.

Veblen’s and Keynes’ Critiques of Economic Rationality Mainstream economics is defined as the allocation of scarce resources to satisfy unlimited wants. It assumes consumers maximize utility using marginal analysis, weighing the benefits of spending one more dollar on one good versus the benefits of spending one more dollar on another good. A balance between them maximizes net satisfaction (consumers’ surplus) accruing to consumers. Marginal analysis is central to economic rationality, purporting to explain how individuals and firms choose in all times and places. In Veblen’s view, it characterizes a human being as a “lightning calculator of pleasure and pain, who oscillates like a homogenous globule of desire of happiness under the impulse of a stimuli that shift him about the axis, but leave him intact” (Veblen [1919] 1961, 73). By the time Veblen was writing, marginal analysis had already become habitual among the business community. It represents “the principles of action which underlie the current, business-like scheme of economic life, and as such, as practical grounds of conduct, they are not to be called in question without questioning the existing law and order” (Veblen [1919] 1961, 239). There are, however, difficulties. Marginal analysis is static. It assumes a degree of finality, and it presumes that everyone everywhere uses marginal analysis in making choices. In ignoring the institutional setting, it renders the existing institutional setting as irrelevant. Second, marginal analysis

10  The Origins and Paradoxes of Consumer Capitalism does not examine the phenomenon of change. “It offers no theory of a movement of any kind, being occupied with the adjustment of values to a given situation” (Veblen [1919] 1961, 232). It does not examine change in institutions, financial innovation, or industrial production. There is no examination of the effect of continuous-mass production technology on consumer preferences. Consumer preferences are a black box, assumed away in the assumption that consumers are sovereign. Assuming tastes are constant, changes in purchases result from changes in price. The theory offers no explanation of movement, but it merely shows a movement from disequilibrium to equilibrium, from the “abnormal” state of affairs to the “normal.” Veblen continues: To the modern scientist the phenomena of growth and change are the most obtrusive and most consequential facts observable in economic life. For an understanding of modern economic life the technological advance of the past two centuries—e.g., the growth of the industrial arts— is of the first importance; but marginal-utility theory does not bear on this matter, nor does this matter bear on marginal-utility theory. (Veblen [1919] 1961, 232–233) The idea that human beings are passive receptors of pleasure ignores the activities with which people engage. People are active beings. Their activities are generally purposeful directed to a particular end. Further, their actions are often habitual. Of course, people make choices. But choice is more complicated than that envisioned by mainstream economics. As Veblen notes, the idea of economic rationality assumes the level of an institution, a habitual method of choosing. There is no effort to explain how choices change, grow, and mature. There is no effort to explain the origins and subsequent development of choice in response to changes in material conditions. Keynes’ critique of economic rationality is more subdued, more nuanced. Keynes held a cultural view of consumption presented before in the “Economic Possibilities for Our Grandchildren.” His concept of the consumption function presented in The General Theory rests on a psychological law, the idea that as income rises, consumption rises but by a lesser amount. Keynes does not explain this law, taking it as given. He concedes that businessmen use the Benthamite calculus in their decisions, claiming that decisions are much more based on “animal spirits.” Moreover, in his later writings, Keynes discusses the importance of uncertainty in making decisions. As Douglass North (1990, 23) noted, introducing uncertainty into the equation opens the door for culture: “the subjective and incomplete processing of information plays a critical role in decision making. It accounts for ideology, based upon subjective perceptions of reality, playing a major part in human beings’ choice.” Nevertheless, economic rationality provides the basis of the mainstream story of consumer capitalism, including the assumption that more is always preferred to less.

The Origins and Paradoxes of Consumer Capitalism  11

The Mainstream Story of Consumer Capitalism The mainstream story of consumer capitalism is found in Robert Gordon’s book, The Rise and Fall of American Growth. The story addresses increases in US living standards since the Civil War, resting on Solow’s growth model. The model presents the conditions for steady-state growth. So long as per-capita saving exceeds the capital necessary to provide each new entrant into the labor force capital at the same level as before, the capital-­labor ratio will rise. Savings are sufficient to replace worn-out machinery and to provide new entrants in the labor force with additional capital. Solow’s growth model focuses on the supply side, resurrecting the classical notion that growth depends on saving. The model disregards the role of demand and the associated institutions that influence demand.9 It further assumes an aggregate production function characterized by diminishing returns. As the capital-labor ratio increases, per-capita income increases at a decreasing rate. The model incorporates technological change as an exogenous variable. The model implies that countries with a lower capital-labor ratio grow faster than countries with higher capital-labor ratios.10 Over time, the model predicts that growth rates among different countries will converge.11 Gordon applies the model to tell the story of US growth over time, noting that growth was faster from 1870 to 1970 than later. As Gordan explains, some inventions are more important than others, and that the revolutionary century after the Civil War was made possible by a unique clustering, in the late 19th century, of what we will call the “Great Inventions”: electricity, the automobile, the telephone. Following the Civil War, America witnessed an economic revolution “freeing households from an unremitting daily grind of painful manual labor” (Gordon 2016, 1). Gordon, however, largely ignores the effect of technology on institutional changes. Gordon focuses on the products and not the processes involved in creating, distributing, and purchasing those products. Focusing only on the products eliminates the institutional changes associated with the introduction of continuous-mass production technology. Hence, he abstracts from the origin and evolution of consumer capitalism and the paradoxes that ­continuous-mass production poses.

Paradoxes of Consumer Capitalism The technology of continuous-mass production posed a problem that had not previously existed, the problem of depression. Crises had plagued capitalism from its origins. Living on the farm, however, insulated most people from mass unemployment. Moreover, given limited production unemployment was not widespread. All that changed with continuous-mass

12  The Origins and Paradoxes of Consumer Capitalism production. The movement from farm to factory meant that workers i­ncreasingly depended on the factory for their livelihood, giving rise to the prospect of mass unemployment. The technology posed a number of questions. What kinds of goods to produce? Who will purchase the goods? How will those purchases be financed? The answers have shaped the paradoxes that characterize consumer capitalism from its beginning. In the late nineteenth and early twentieth centuries, two dominant solutions emerged regarding what goods to produce: consumer or military goods. Four responses emerged in addressing the problem, that of Veblen, John Hobson, Karl Polanyi, and Keynes. Veblen’s explanation is rooted in the cultural differences between Britain and Germany. In Britain and the United States, the technology created new possibilities for societies predisposed to consumption. Individualism, limited government, and a culture in which the middle class emulate the spending habits of the rich led to an increase in consumer spending in the US and ­Britain. For Germany and Japan, lacking a consumer culture, the effect of continuous-mass production fueled their dynastic ambitions, ultimately manifesting itself in the first and second world wars. Hobson noted that imperialism represented an effort to increase the demand for goods. Karl Polanyi offered another view. The increase in output stemming from the Industrial Revolution helped bring about the market economy, an economy governed “by prices and prices alone.” By the late nineteenth and early twentieth centuries, the need to sell goods and the willingness of haute finance to finance the purchases of those goods, particularly military goods, laid the foundation for World War I. Keynes’ explanation adopted that of John Hobson. Hobson noted that developed nations attempted to increased demand for their output by finding new markets for exports. Finding new markets led to imperialism, culminating in war. The different views complement each other, highlighting the complexity of the impact that continuous-mass production had on the different economies in the late nineteenth, early twentieth centuries. The Great Depression of the 1930s illustrated the paradox of “poverty in the midst of plenty.” To explain the paradox, Keynes formed the theory of effective demand. Keynes emphasized the instability of investment in explaining the depression. Peter Temin, in using Keynes’ theory, attributes the depression to a collapse in consumer spending, especially the problems in the housing market. In the post-war era of the 1950s, pent-up consumer demand helped fuel the economic boom. Banks turned to offering consumers credit. Increasingly, the last half of the twentieth century was characterized by financial innovations to identify consumer assets, liquefy those assets, and extend credit based on those assets. Consumer debt was the lever used to increase corporate and financial profits. Further, consumer debt served as a substitute for rising wages, exacerbating inequality. Following World War II, economists reacted to Keynes’ absolute-­income hypothesis, developing alternative theories of consumer behavior: the

The Origins and Paradoxes of Consumer Capitalism  13 relative-income hypothesis, the permanent-income life-cycle hypothesis, and the hedonic-price hypothesis. With the domination of the ­p ermanent-income hypothesis, economists in the early 1990s and early 2000s were confronted with a paradox: why is the personal-saving rate falling? Their explanation: consumers are myopic. The low-saving rate is related to the increase in the trade deficit. Since 1983, the United States has run a perpetual trade deficit. Americans give foreigners dollars in exchange for goods. Mainstream economics says that as the supply of dollars increases relative to demand, the exchange rate should fall reducing imports, increasing exports, and thereby eliminating the deficit. The deficit continues. Economists refer to the years preceding the GFC as the “great moderation,” characterized by moderate growth, low inflation, and low unemployment. Government had deregulated the financial industry, repealing the Glass-Steagall Act. Alan Greenspan, chair of the Fed from 1987 to 2006, was credited with the economic miracle of the age. Markets work. Government intervention is unnecessary. Ben Bernanke, succeeding Greenspan as chair of the Fed, dismissed the idea that problems in the housing market posed a danger to the economy. The GFC of 2008, however, highlighted the irrelevance of the mainstream view of the economy, expressed in the dynamic stochastic general equilibrium model. In the subsequent years, the Fed adopted the policy of quantitative easing. While quantitative easing socialized the risk to the financial sector by purchasing treasury bonds and mortgaged backed securities, it exacerbated inequality benefiting primarily asset holders. The Covid-19-induced recession further illustrates the irrelevance of mainstream economics. The government shutdown of the economy revealed the importance of the underlying financial relations. An economy is more than the allocation of goods and services and the required inputs. An economy also entails the promises we make to each other formalized contractually. The inability to fulfill those promises required that government provide the money to fulfill those promises to avoid depression, further giving rise to the Modern Monetary Theory. In brief, the Modern Monetary Theory advocates policies to help overcome the limits of the private market economy. Finally, the question that many people have come to recognize, what does our civilization mean for the environment? How do we sustain the economy while protecting the environment? Can these questions be resolved assuming economic rationality? Or is something missing? Do they require a cultural explanation? The environmental crisis presents the most perplexing problem for humankind, for it portends the end of civilization based on continuous-mass production. Continuous-mass production contributes to the environmental crisis in two fundamental ways. First, the mass production of chemicals, including plastics, that never before existed are becoming pervasive in the environment. The ease and speed with which the application of modern

14  The Origins and Paradoxes of Consumer Capitalism technology can clear forests and jungles to raise cattle, monoculture farms, and fisheries; the efficiency with which continuous-mass production catches and processes fish has decimated fish populations; new developments have displaced habitat for myriad of species. All of this has resulted in the sixth great extinction, the first resulting from the activities of a single species. And second, the application of continuous-mass production to extract, refine, distribute, and burn fossil fuels. The Industrial Revolution introduced fossil fuels; the second industrial revolution took it to a whole new level such that we are altering the composition of the atmosphere itself, leading to an increasingly warming planet.

How the Book Proceeds The book focuses on the paradoxes posed by the introduction of continuousmass production, intermingling history, culture, and theory. Chapter 2 presents an evolutionary theory of consumer capitalism based on the ideas of Veblen and, to a lesser extent, Keynes. Veblen presents a cultural view of consumption, focusing on pecuniary emulation and social evolution. Both Veblen and Keynes note the evolution of business enterprise from small proprietors to the corporate form. Chapter 3 examines the origins of continuous-mass production technology and its effect on the institutions of capitalism, the rise of the corporation, the introduction of chain stores and department stores, and the concept of systematic advertising establishing national brands. Chapter 4 addresses the paradox posed by World War I, presenting the views of Thorsten Veblen, John Hobson, and Karl Polanyi. Veblen focused on the cultural differences between England and Germany. Hobson focused on the failure of consumption to keep up with increases in production, leading to imperialism. Polanyi focused on the need to sell goods resulting from the introduction of mass production, ultimately leading to war. Chapter 5 presents Keynes’ views of the Great Depression, focusing on the struggle between the entrepreneurs and the rentier over the surplus generated by capital. The chapter also addresses Peter Temin’s application of Keynes’ theory, emphasizing the collapse in consumption in precipitating the depression. The chapter also includes an appendix presenting a model showing how profits are affected by interest rates, debt, and wages. Chapter 6 addresses the paradox of a decline in the personal-saving rate in the 1990s and 2000s, exploring the different hypotheses of consumer behavior. The chapter relates the different hypotheses to the evolution of the institutional pattern of consumption, connecting corporations to consumers through advertising, credit, and so on, connections that evolve over time. Chapter 7 explores the evolution of consumer credit involving the liquefication of consumer assets, broadening over time. The chapter begins with the cultural change in overcoming the Protestant teachings that saving is a virtue. The chapter focuses on the major financial innovations affecting the evolution of consumer credit: installment credit, the universal credit card, the Marquette decision

The Origins and Paradoxes of Consumer Capitalism  15 that deregulated the interest charged on credit cards, and the effort to expand consumer credit abroad. Chapter 8 examines the perpetual trade deficit beginning in the mid-1970s, examining the role of the United States in the world economy. Chapter 9 examines the GFC, contrasting Hyman Minsky’s financial instability hypothesis with the dynamic stochastic general equilibrium model, the standard model in macroeconomics. Chapter 10 contrasts quantitative easing as a response to the GFC versus policies advocated by the Modern Monetary Theory as a response to the Covid-19-induced recession. The Modern Monetary Theory provides a means of overcoming the ­limits of the market economy. Chapter 11 examines the impact of continuousmass production technology on the environmental crisis, presenting the crisis as the Darwinian dilemma, winning the struggle for existence against other species while making the environment less fit for humans. Chapter 12 offers a summing up, placing consumer capitalism in the context of the evolution of civilization generally, noting the importance of imposing limits on the use of continuous-mass production technology and the seeming insatiability of human wants.

Notes 1 The second industrial revolution applied “the inductive method in the study of an industry, and individual concerns composing it, with a view to gaining facts and generalisations which may serve sooner or later as the basis of the ­replanning of the productive process and plant. The essence of the new industrial revolution is the search for exact knowledge, and the planning of processes: from the minutia, of manual operations (based on motion-study) to the lay-out of the machinery of a gigantic plant-even of a whole industry throughout the country” (Jevons 1931, 1). 2 For Smith, advances in transportation in the form of the water carriage helped create the market. 3 “Integration of mass production with mass distribution offered an opportunity for manufacturers to lower costs and increase productivity through more effective administration of the processes of production and distribution and coordination of the flow of goods thorough them. Yet the first industrialists to integrate these two basic sets of processes did not do so to exploit such economies. They did so because existing marketers were unable to sell and distribute production in the volume they were produced” (Chandler 1977, 287). 4 Exceeding the condition of the charter is referred to as ultra vires, which the courts had forbidden. 5 Oil was largely used to make kerosene for home lighting. 6 And as Jan De Vries mentions, “Consumers came to depend much more on retail shops and venues of sociable consumption than had been the case under the consumption patterns of earlier times. Indeed, the century after 1650 can fairly be said to have witnessed a retailing revolution” (2008). If British culture embraced the rise in consumption, French culture condemned it. A dictionary at the time defined luxury as “an excessive sumptuousness, in clothing, furniture, household, meats and other such things.” People expected the upper classes to consume sumptuously. For the lower classes, however, sumptuous consumption proved shocking. It involved “consuming beyond what one’s status allowed.” Such behavior represented a “seizure of status itself” (Shovlin 2000, 89).

16  The Origins and Paradoxes of Consumer Capitalism 7 Mathew Wilson poses the question, “Why do post-Keynesians rarely cite ­Veblen?” (Matthew 2006, 1030). Randal Wray agrees (Wray 2007). 8 As Philip Mirowski observes, “There is no such thing as a perfect scientific ­metaphor, which has no negative aspects. It is the job of the scientist to reconcile these inconsistencies with the tacit knowledge of the profession as well as with the ‘facts.’ Scientific metaphors can fail, but this is not generally due to some mythical experimentaum crucis, but rather due to an increasingly realization on the part of the scientific participants that the metaphor is cumbersome, awkward, and throws up intractable inconsistencies with its penumbra of meanings” (Mirowski 1987, 89). 9 The model states the conditions for achieving steady-state growth. Per-capita saving equals the investment necessary to provide new entrants into the labor force from the growth in the population, leaving the existing capital-labor ratio constant. 10 Solow, however, did not attribute the increased output entirely to increases in labor and capital. He attributed a portion of the increase to total factor productivity, “This measure is the best proxy available for the underlying effect of innovation and technological change on economic growth” (Gordon 2016, 16). 11 Paul Romer (1986) observed that growth rates among different countries tended to diverge rather than converge, which he explained using his theory of endogenous growth.

References Burnett, John. 1968. Plenty and Want: A Social History of Diet in England from 1815 to the Present Day. Harmondsworth: Penguin Books. Chandler, Alfred D., and Takashi Hikino. 1990. Scale and Scope: The Dynamics of Industrial Capitalism. Cambridge, MA: Belknap Press. Chandler, Alfred Dupont. 1964. Giant Enterprise: Ford, General Motors, and the Automobile Industry; Sources and Readings. New York: Harcourt Brace & World. Chandler, Jr Alfred D. 1977. The Visible Hand: The Managerial Revolution in ­American Business. Cambridge, MA: Belknap Press. De Vries, Jan. 2008. The Industrious Revolution: Consumer Behavior and the ­Household Economy, 1650 to the Present. Cambridge; New York: Cambridge ­University Press. Ford, Henry, and Samuel Crowther. 1922. My Life and Work. Garden City, NY: Doubleday, Page. Friedman, Milton. 1953. “The Methodology of Positive Economics.” In Essays in Positive Economics, 3–43. Chicago, IL: University of Chicago Press. Gordon, Robert J. 2016. The Rise and Fall of American Growth: The U.S. ­Standard of Living since the Civil War. The Princeton Economic History of the Western World. Princeton, NJ: Princeton University Press. Jevons, H. Stanley. 1931. “The Second Industrial Revolution.” The Economic Journal 41 (161): 1–18. https://doi.org/10.2307/2224131. http://www.jstor.org.ezproxy. westminstercollege.edu/stable/2224131. Kwass, Michael. 2003. “Ordering the World of Goods: Consumer Revolution and the Classification of Objects in Eighteenth-Century France.” Representations 82 (1): 87–116. https://doi.org/10.1525/rep.2003.82.1.87. http://www.jstor.org/ stable/10.1525/rep.2003.82.1.87. Matthaei, Julie A. 1982. An Economic History of Women in America: Women’s Work, the Sexual Division of Labor, and the Development of Capitalism. New York: Schocken Books.

The Origins and Paradoxes of Consumer Capitalism  17 Matthew, C. Wilson. 2006. “Budget Constraints and Business Enterprise: A Veblenian Analysis.” Journal of Economic Issues 40 (4): 1029–1044. http://www.jstor. org/stable/4228322. Mayhew, Anne. 2001. “Human Agency, Cumulative Causation, and the State: Remarks Upon Receiving the Veblen-Commons Award.” Journal of Economic Issues 35 (2): 239–250. https://doi.org/10.2307/4227657. http://www.jstor.org/ stable/4227657. McKendrick, Neil, John Brewer, and J. H. Plumb. 1985. The Birth of a Consumer Society: The Commercialization of 18th Century. London: Midland Book. Mirowski, Philip. 1987. “Shall I Compare Thee to a Minkowski-Ricardo-­LeontiefMetzler Matrix of the Mosak-Hicks Type? Or, Rhetoric, Mathematics, and the Nature of Neoclassical Economic Theory.” Economics and Philosophy 3 (1): 67–96. North, Douglass C. 1990. Institutions, Institutional Change and Economic Performance. Cambridge, MA: Cambridge University Press. Romer, Paul M. 1986. “Increasing Returns and Long-Run Growth.” Journal of ­Political Economy 94 (5): 1002–1037. http://www.jstor.org/stable/1833190. Schumpeter, Joseph Alois. 1954. History of Economic Analysis. New York: Oxford University Press. Shovlin, John. 2000. “The Cultural Politics of Luxury in Eighteenth-Century France.” French Historical Studies 23 (4): 577–606. https://doi.org/10.2307/286736. http://www.jstor.org/stable/286736. Smith, Adam. (1776) 1937. An Inquiry into the Nature and Causes of the Wealth of Nations, edited by Edwin Cannan. New York: The Modern Library. Tarbell, Ida M. (1966). The History of the Standard Oil Company, edited by David M. Chalmers. New York: Harper & Row. Tilly, Louise, and Joan Wallach Scott. 1978. Women, Work, and Family. New York: Holt Rinehart and Winston. United States Industrial Commission. 1900. Final Report of the Industrial Commission, edited by James H. Kyle and Albert Clarke, Vol. 19. Washington: Library of American Civilization (Gov’t print. Off). Veblen, Thorstein. (1919) 1961. “Why Is Economics Not an Evolutionary Science.” In The Place of Science in Modern Civilisation and Other Essays, 56–81. New York: Russell and Russell. ———. (1919) 1961. “The Limitations of Marginal Utility.” In The Place of Science in Modern Civilisation and Other Essays, 231–251. New York: Russell and Russell. Original edition, 1919. ———. (1904) 1975. The Theory of Business Enterprise. New York: Augustus M. Kelley. Whitehead, Alfred North. (1925) 1967. Science and the Modern World. New York: The Free Press. Wray, L. Randall. 2007. “Veblen’s “Theory of Business Enterprise” and Keynes’s Monetary Theory of Production.” Journal of Economic Issues 41 (2): 617–624. https://doi.org/10.2307/25511216. http://www.jstor.org/stable/25511216.

2 Toward an Evolutionary Theory of Consumer Capitalism Thorstein Veblen and John Maynard Keynes By the late nineteenth and early twentieth centuries, both Veblen and Keynes recognized the importance of consumer spending. Veblen developed his ideas regarding consumer spending in The Theory of the Leisure Class, noting the pervasiveness of pecuniary emulation. Keynes presented a ­cultural view of consumption resembling Veblen’s in “The Economic Possibilities of our Grandchildren.” In The General Theory, Keynes deemphasized the cultural aspects of consumption although noting its habitual nature. Moreover, Keynes made consumer spending part of the theory of effective demand, a change from the classical focus on the distribution of wages, profits, and rents. Both Veblen and Keynes held an evolutionary point of views found in their views of cumulative causation, noting the ­paradox of the effects of inherited ideas given changes in material ­conditions. For ­Veblen, the changes in material conditions manifested itself in the introduction of ­continuous-mass production, what Veblen called more generally the ­machine process. Keynes focused on the impact of inherited ideas on ­stifling governments from e­ nding the Great Depression, a topic taken up in Chapter 5 along with his theory of effective demand. This chapter compares the evolutionary ideas of Veblen and Keynes. Both agree that the central problem is the problem of social provisioning. Both present an evolutionary view of consumption and investment; both held similar views of depression; both shared similar views of the monetary-­theory production. They differed, however, in their concept of economic waste, the role of government, the power of corporations to influence demand, and their views of the future, a topic considered in the concluding chapter.

Veblen, Keynes, and the Problem of Social Provisioning Both Veblen and Keynes concerned themselves with the problem of ­social provisioning or, as Clarence Ayres put it, “the community’s efforts to feed and clothe and house itself” (Dorfman et al. 1963, 61). Their concerns were prompted, in part, by depression and war. Veblen viewed depression from the point of view of the businessman, interpreting depressions as a ­matter of prices and profits. Keynes examined depressions from the point

DOI: 10.4324/9780429443763-2

Toward an Evolutionary Theory of Consumer Capitalism  19 of view of society at large, expressed in his theory of effective demand. For Veblen, production exceeding what the market could profitably absorb reduced profits. The widespread inability to pay the finance costs precipitated depression. For Keynes, insufficient demand led entrepreneurs to curtail production and employment. Borrowing ideas from John Hobson, Keynes asserted that insufficient demand led nations to find markets for exports, ultimately leading to war. Clarence Ayres faulted Veblen for not basing his views of depression on effective demand. And while Veblen did not emphasize the importance of demand, he nevertheless acknowledged its importance. Ayres also faulted Keynes for not including Veblen among the so-called “army of heretics” who anticipated Keynes’ theory. For as Ayres commented, Keynes’ theory is Veblenian for both Veblen and Keynes concerned themselves with the problem of social provisioning. Both Veblen and Keynes were heretics, questioning the conventional wisdom, choosing to blaze their own paths. Veblen, a first-generation ­Norwegian born on the American frontier, founded, along with John R. Commons, the institutional school of economics. Veblen made little effort to hide his contempt for authority or his dalliances with the ladies, perhaps explaining why he never advanced higher than associate professor. Keynes hid his dalliances with men, married a Russian ballerina, and became the foremost economist of the twentieth century, analyzing the cause of the Great Depression and how to resolve it. Keynes was the son of John Neville Keynes, a well-known economist at the time and a student of Alfred Marshall. Marshall, the most prominent economist in England in the late nineteenth and early twentieth centuries, established economics as a discipline independent of moral philosophy and the law.1 Marshall and his followers presented the economic problem as the allocation of scarce resources to satisfy unlimited wants. Marshall generally advocated laissez faire nevertheless acknowledging problems: inequality of income, increasing returns, and so on. Market economies naturally tend to full employment, a tendency that Keynes subsequently challenged. Keynes described his break with Marshall and the classical school as a “long struggle of escape.”2 Keynes sought to develop a more general theory, a theory that could also explain an economy in depression, transcending the classical explanation of an economy at full employment. If Keynes sought to save capitalism, Veblen sought to transcend it. The touchstone by which Veblen evaluated spending was “whether it serves directly to enhance human life on the whole—whether it furthers the life process taken impersonally” ([1899] 1979, 99). For Keynes, the central problem of the capitalist system is the “paradox of poverty in the midst of plenty” ([1936] 1964, 30). As he reflected years earlier, It is the profound conviction that the Economic Problem, . . . the problem of want and poverty and the economic struggle between classes and

20  Toward an Evolutionary Theory of Consumer Capitalism nations, is nothing but a frightful muddle, a transitory and an unnecessary muddle. For the Western World already has the resources and the technique, if we could create the organization to use them, capable of reducing the Economic Problem, which now absorbs our moral and material energies, to a position of secondary importance. (Keynes 1931, vii) In contrast to Keynes, Veblen dismissed using formal models. He eschewed analyzing the economy in terms of equilibrium, believing that equilibrium approaches obfuscated understanding the economic process. Equilibrium approaches presume a normality that does not exist. They represent a ­taxonomic approach, an approach that leaves economic categories such as land, labor, and capital unchanged. In contrast, Keynes believed equilibrium approaches help in understanding short-run movements. According to Joan Robinson, Keynes condescendingly considered “[t]he long period,” presumably referring to long-run equilibrium of perfect competition, as “a subject for undergraduates” (1980, 80). Despite overlapping periods, Veblen and Keynes came to age in different milieus, confronting different issues. The effects of changes in technology in the late nineteenth century profoundly affected Veblen’s perspective (see Mayhew 1987). Railroads spanned the continent creating a national market giving rise to the first modern corporation; advances in productivity ­transformed agricultural, prompting a migration from country to city; immigration and urbanization expanded opportunities for emulation, helping give rise to a consumer society. Continuous-mass production technology made possible production exceeding what the market could profitably absorb. The resulting depression led to the first merger movement of the late nineteenth century, ushering in the rise of Corporate America. Keynes confronted a different situation: “the characteristics of England’s aging capitalism as seen from the standpoint of an English intellectual” (Schumpeter 1954, 42). Declining investment opportunities, inequality, and World War I left an indelible mark on Keynes. “The war has disclosed the possibility of consumption to all and the vanity of abstinence to many” (Keynes 1920, 21–22). Both theorists anticipated the rise of consumer capitalism, Veblen with his emphasis on pecuniary emulation under conditions of increasing output, Keynes with his emphasis on the possibility of increasing consumption for all. Similarities in the Thought of Veblen and Keynes Despite differences, there are many areas where Veblen and Keynes agreed. First, both viewed capitalism as moving through historic time. Both viewed the institutions of capitalism as transitory, largely resulting from changes in technology. As Joan Robinson noted, “The General Theory broke through the unnatural barrier and brought history and theory together again”

Toward an Evolutionary Theory of Consumer Capitalism  21 (1962, 79). Both held a historical view of the evolution of business enterprise and how businesses are valued. Veblen more than Keynes emphasized the role of culture, the activities, values, and beliefs that people share. For Veblen, culture served as a core concept explaining differences in people’s reaction to change. The growth of culture is a cumulative sequence of habituation, and the ways and means of it are the habitual response of human nature to exigencies that vary incontinently, cumulatively, but with something of a consistent sequence in the cumulative variations that so go forward, – incontinently, because each new move creates a new situation which induces a further new variation in the habitual manner of response; cumulatively, because each new situation is a variation of what has gone before it and embodies as causal factors all that has been affected by what went before; consistently, because the underlying traits of human nature (propensities, aptitudes, and what not) by force of which the response takes place, and on the ground of which the habituation takes effect, remain substantially unchanged. ([1919] 1961, 241–242) Second, both questioned economic rationality as the basis for making choices. Veblen ridiculed the mainstream conception of individuals, with its depiction of individuals as “lightning calculators of pleasure and pain” (Veblen [1919] 1961, 73). Human beings are shaped by their culture. Keynes too challenged the usefulness of the Benthamite calculus. Business decisions depend on “animal spirits—of a spontaneous urge to action rather than inaction, and not the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities” ([1936] 1964, 161). On the basis of the article titled “The General Theory of Employment,” published a year after The General Theory, Keynes addressed the role of uncertainty. In referring to classical economics, Keynes noted that The calculus of probability, tho mention of it was kept in the ­background, was supposed to be capable of reducing uncertainty to the same calculable status as that of certainty itself; just as the Benthamite calculus of pains and pleasures or of advantage and disadvantage, by which the Benthamite philosophy assumed men to be influenced in their general ethical behaviour. Keynes continues: “Actually, however, we have, as a rule, only the vaguest idea of any but the most direct consequences of our acts” (1937, 213). G.L.S. Shackle asserted that in The General Theory, Keynes attempted to form a rational theory of investment. In “The General Theory of Employment,” Keynes realized the folly of all this. Shackle concluded that Keynes theory is, in fact, a theory of disorder. “A theory of unemployment is, necessarily,

22  Toward an Evolutionary Theory of Consumer Capitalism inescapably, a theory of disorder. The disorder in question is the basic disorder of uncertain expectation, the essential disorder of the real, as contrasted with the conventionally pretended, human condition” (1967, 133). Third, both Veblen and Keynes held similar views of the causes of depression. As noted, Veblen attributed depressions to the inability of business to sell commodities at profitable prices. Keynes attributed depressions to insufficient demand. Revenues falling below expenses force business to contract output and employment. Nevertheless, Keynes believed that depressions were a transitory phase in the evolution of capitalism, a struggle between the rentier and entrepreneurs over the surplus generated by capital. Keynes’ solution: make capital sufficiently abundant that the profit rate and interest rate fall to zero, thereby euthanizing the rentier. Veblen held a less sanguine view, anticipating Karl Polanyi’s assertion that the central problem of the future would be the conflict between business interests and democracy. For Veblen, the heart of the problem lay in the conflict between different habits and their associated mindsets, between pecuniary pursuits and service, between making money and making things. Cumulative Causation in the Ideas of Veblen and Keynes Cumulative causation is a running theme in most of Veblen’s books, the proposition that economic process involves multiple, cumulative causes. Ideas, values, and habits reflected in institutions originated in response to past conditions. They define what is important, revealing some options, hiding others. They define the permissible from the impermissible. They serve as the basis for making choices and engaging in activities. Cumulative causation creates a paradox: habits, ideas, and institutions inherited from the past form the lens to evaluate changes in material conditions in the present, generally the result of changes in technology. Cumulative causation is central to an evolutionary approach to understanding economic phenomena, ideas from the past provide the basis for both selecting institutions and making choices in the present. The life of man in society, just like the life of other species, is a struggle for existence, and therefore it is a process of selective adaptation. The evolution of social structure has been a process of natural selection of institutions. (Veblen [1899] 1979, 188) Institutions are habituated modes of behavior, patterns of human relations, and habits of thought that underlie those relations. Social structure changes, develops, adapts itself to an altered situation, only through a change in the habits of thought of the several classes of the community; or in the last analysis, through a change in the

Toward an Evolutionary Theory of Consumer Capitalism  23 habits of thought of the individuals which make up the community. The evolution of society is substantially a process of mental adaptation on the part of the individuals under the stress of circumstances which will no longer tolerate habits of thought formed under and conforming to a different set of circumstances in the past. (Veblen [1899] 1979, 192) This idea of cumulative causation is, in fact, central to The Theory of Business Enterprise. The “machine process,” resting on the standardization of production, created new possibilities for business to make money. The machine process combined with the tradition of natural rights vastly expanded opportunities for business. It also, however, expanded the possibilities for households to engage in competitive spending. Keynes began The General Theory commenting on the difficulty of escaping old ideas. Keynes’ analysis of the social process, manifesting itself in the Great Depression, illustrates the idea of cumulative causation. The depression resulted from the impact of ideas formed in another age, made irrelevant by advances in technology. The ideas of the former age stressed the idea that saving was necessary for economic growth, reinforced by the Protestant view that saving was a virtue. World War I revealed to Keynes that continuous-mass production raised the possibility of raising the standard of living for all. An Evolutionary Theory of Consumption An evolutionary theory of consumption stems from observing people. ­People everywhere seek self-preservation, status, and saving face. Culture influences the manner that we provide for ourselves, our families, and our way of life. The importance of culture arises because people emulate each other. We are “creatures of the herd,” inherently social. Our sociality manifests itself in our desire to acquire the esteem of others. We want acceptance; we want to be “loved.” As Veblen observed, “the usual basis of self-respect is the respect accorded by one’s neighbours” ([1899] 1979, 30). Our desire for acceptance leads us to emulate each other.3 We eat the foods that others eat, play the games that others play, wear the same or similar clothes that others wear. We speak the same language, often share the same beliefs, and engage in the same or similar work. Everywhere, in every culture, people follow each other to acquire status and save face. In Western culture, emulation assumes a pecuniary form. People covet what others possess, particularly if owned by those to whom they relate. “The motive that lies at the root of ownership is emulation. . . . The possession of wealth confers honour; it is an invidious distinction” (Veblen [1899] 1979, 25–26). The pecuniary form that motivates comparisons among individuals often assumes an invidious distinction. People purposely and visibly attempt to outdo others in material worth. As Veblen put it, an invidious distinction

24  Toward an Evolutionary Theory of Consumer Capitalism involves “a comparison of persons with a view to rating or grading them in respect of relative worth or value—in an aesthetic or moral sense” ([1899] 1979, 34). As a culture, we value those with money more than those without. We value the leisure activities that money makes possible as well as the things that money affords. As Veblen noted, “the propensity for ­emulation—for invidious comparison—is of ancient growth and is a pervading trait of human nature” (Veblen [1899] 1979, 109). By absorbing the prevailing standards and conventions, we in turn judge others by the same measure. Changes in culture generally result from changes in technology, making some kinds of behavior acceptable, others shunned. Continuous-mass production technology vastly increased output requiring, from the business point of view, increases in consumption. In the US and Britain, an emphasis on individualism and material success predisposed people to consume new goods, partly because many goods were serviceable and partly because they served as symbols of status. Examples abound. The importation of newly discovered tobacco from the Americas in the early seventeenth century initiated an “an aristocratic craze” (Mann 2011, 52). Sugar entered Europe via the crusades, immediately becoming an object of desire. In the thirteenth century, sugar remained affordable only to the wealthy serving as a symbol of conspicuous consumption. By the seventeenth and eighteenth centuries, sugar was offered at feasts as status symbols (Mintz 1985, 95). In 1686, t­ obacco together with sugar accounted for 76 percent of the imports into Britain. “As for sugar, it was transformed from a luxury of kings into the kingly luxury of commoners—a purchased luxury that could be detached from one status and transferred in use to another” (Mintz 1985, 96). Status goods of one age become part of the pecuniary standard the next. The pecuniary standard marks the standard of consumption necessary to live a respectable life. Firms introduce new goods, hoping to increase demand for their products. People purchase these products partly out of curiosity, partly for status. Salesmanship aspires to increase demand by persuading people that the products will enhance their lives. It represents an effort to sell more goods by raising the standard of living, by raising the level of consumption required for respectability. “But as fast as a person makes new acquisitions, and becomes accustomed to the resulting new standard of wealth, the new standard forthwith ceases to afford appreciably greater satisfaction than the earlier standard did” (Veblen [1899] 1979, 31). Pecuniary emulation together with continuous-mass production laid the foundation for corporate efforts to increase consumer demand. In modern times, business enterprise has made displays of status ­profitable. Businesses spend money to increase sales that foster wasteful ­expenditures, which, in turn, increase profits. Advances in technology make possible the mass production of some status goods. The subsequent price reductions make luxuries previously enjoyed by the few purchasable by the many. The automobile comes to mind, a product that initially represented a luxury of the rich. The democratization of status goods undermines their

Toward an Evolutionary Theory of Consumer Capitalism  25 status, relegating them to those goods requisite for a respectable life. This elevated standard creates new uses, habits, and institutions, raising the requisite standard of living. In a community where class distinctions and class exemptions run chiefly on pecuniary ground, wasteful conventions spread with great facility through the body of the population by force of the emulative imitation of upper-class usage by the lower pecuniary classes; so that an exemption of this kind which is an easy means of distinction among the well-to-do, will presently find its way among the indigent as a necessary mark of reputable living (Veblen [1915] 1968, 142). Even so, many status goods are not readily scalable. Veblen notes the country gentleman who distinguishes himself by having more homes “than he can conveniently make use of,” but “as many and as large as he can afford to keep up” ([1915] 1968, 144). Many of the sports enjoyed by the British elites that Veblen notes including polo, big-game hunting, and mountain climbing also elude mass production. Such leisure activities require money and time, both of which the masses lack. Wesley Mitchell, a student of Veblen, offered another perspective on ­consumer spending. Many households fail to act rationally, that is, to approach consumption in the same or similar manner as business. Mitchell expanded on the difficulties involved in making consumer choices. His article “The Backward Art of Spending Money” represents an effort to understand the complexities of consumer choice. Ignorance of qualities, uncertainty of taste, lack of accounting, carelessness about prices – faults which would ruin a merchant – prevail in our housekeeping. Many of us scarcely know what becomes of our money; though well-schooled citizens of a Money Economy ought to plan for their outgoes no less carefully than for their incomes. (Mitchell 1912, 269)4 Maintaining personal relationships at the pecuniary standard of living fell primarily on women. The primacy of women’s role in maintaining f­ amilial relations means that “the human part of her relationship to husband and children ranks higher than the business part” (1912, 274). In ­contrast, ­business choice is more focused. “In making money, nothing but the p ­ ecuniary values of things however dissimilar need be considered, and pecuniary values can always be balanced, compared, and adjusted in an orderly and systematic fashion” (1912, 276). In many cases, the difficulty of making choices reinforces the tendency of consumers to emulate each other. Emulation reduces uncertainty, assuring people that the choice they make are the best choices. People rely on each other in making decisions.

26  Toward an Evolutionary Theory of Consumer Capitalism Nevertheless, as Armen Alchian pointed out, businesses, too, emulate each other, a low-cost strategy given uncertainty. Uncertainty means that firms are unable to estimate costs and benefits. “In the presence of ­uncertainly—a necessary condition for the existence of profits—there is no meaningful criterion for selecting the decision that will ‘maximize profits’” (Alchian 1950, 212). Each choice is “identified with a distribution of potential outcomes” that may overlap with the distributional outcomes of other choices. Since a decision does not lead to a unique outcome, there is no reason to think that what appears to be the rational choice is best. The collapse of rationality or even relative efficiency poses a problem. For if economic rationality no longer guides decisions, how are decisions made? Alchian responds that “modes of behavior replace optimum equilibrium conditions as guiding rules of action” (Alchian 1950, 218). Alchian offers two different guiding rules of behavior. “First, wherever successful enterprises are observed, the elements common to these observable successes will be associated with success and copied by others in their pursuit of profits or success.” Forms of imitation that from the neoclassical position appears as irrational become “codified imitations of observed success” (Alchian 1950, 218). Imitation is a way of adopting behavior based on information that firms observe. Imitation is a low-cost strategy to capture profits. Hence, “uncertainty provides an excellent reason for imitation of observed success” (Alchian 1950, 219). Another word for imitation, of course, is emulation. Keynes’ View of Consumption Keynes’ view of consumption is more complex and nuanced than generally perceived. In “The Economic Possibilities of our Grandchildren” ([1930] 1963), Keynes presented a cultural, institutional view of consumption. In The General Theory, Keynes dropped the cultural influences on consumption, asserting that consumption depends on a psychological law: “men are disposed, as a rule and on the average, to increase their consumption as their income increases, but not by as much as the increase in their income” (1936, 96). Keynes subsequently described this law as “the utmost importance in the development of my own thought, and it is, I think, absolutely fundamental to the theory of effective demand” (1937, 219–220). At first glance, Keynes’ consumption function resembles the principle of diminishing marginal utility applied to income, the notion that as income rises the satisfaction derived from another dollar of income declines. Consumption, however, rises less slowly than income not because of diminishing marginal utility, but because humans are creatures of habit. For a man’s habitual standard of life usually has the first claim on his income, and he is apt to save the difference which discovers itself between his actual income and the expense of his habitual standard; or, if he does adjust his expenditure to changes in his income, he will over short periods do so imperfectly. Thus a rising income will often be

Toward an Evolutionary Theory of Consumer Capitalism  27 accompanied by increased saving, and a falling income by decreased saving, on a greater scale at first than subsequently (Keynes [1936] 1964, 97). Keynes recognized that the propensity to consume “is influenced by many factors such as the distribution of income, their normal attitude to the future and—though probably in a minor degree—by the rate of interest” (Keynes 1937, 219). Keynes, however, avoided casting his theory in terms of economic rationality. In The General Theory, Keynes mentions eight factors that influence consumption and, therefore, saving: emergencies, planning for retirement, interest, saving for a rising living standard, gaining a sense of independence, for investment purposes, for bequeathment, to satisfy miserliness. Like Veblen, Keynes omitted addressing the possibility of borrowing against the future. In the “Economic Possibilities for Our Grandchildren,” Keynes delved into the cultural factors underlying consumption, distinguishing primary needs from secondary needs. He identified two motives underlying consumption: to satisfy urgent needs and to show superiority. Now it is true that the needs of human beings may seem to be insatiable. But they fall into two classes—those needs which are absolute in the sense that we feel them whatever the situation of our fellow human beings may be, and those which are relative in the sense that we feel them only if their satisfaction lifts us above, makes us feel superior to, or fellows. Needs of the second class, those which satisfy the desire to superiority, may indeed be insatiable; for the higher the general level, the higher still are they. But this is not so true of the absolute needs—a point may soon be reached, much sooner perhaps than we are all of us aware of, when these needs are satisfied in the sense that we prefer to devote our further energies to non-economic purposes. (Keynes (1930) 1963, 365) Veblen agrees; the pecuniary standard bears little relation to the requisite level of consumption required for survival, estimating that half of all expenditures were wasteful. Keynes’ consumption function implies that the poor spend more as a percentage of income than the rich. By redistributing income from rich to poor, governments could achieve the goals of social justice and stimulate the economy simultaneously. In one stroke, Keynes demolished the classical justification for inequality, namely, the assumption that inequality fosters saving by the rich, which classical economics held is necessary for growth. The Evolution of Business Enterprise Veblen’s views of consumption complement the evolution of business enterprise, which he presents in The Theory of Business Enterprise. Corporations are driven by profit. Increasing profit involves different strategies: economic

28  Toward an Evolutionary Theory of Consumer Capitalism sabotage and later efforts to increase sales, culminating in raising the pecuniary standard. Veblen based The Theory of Business Enterprise on the reports of the Industrial Commission of 1902. Veblen’s historical analysis shows how ­ changes in technology expanded profitable opportunities, altering the organization of business, the structure of markets, and the definition of property. Veblen begins with the machine process, which comprises the material framework of the industrial system. The machine process refers to the machines used to augment the power of labor, including those who operate, maintain, and create the machines and their associated behavior (Veblen [1904] 1975, 1). The machine process employed in the late nineteenth century involved ­continuous-mass production technology, entailing two characteristics. First, it required a quantitative precision seen in the standards of weights and measures, making the different parts interchangeable. Standardized production enables mass production, resulting in economies of scale and scope. Second, machine processes are interdependent, each adjusting to the other. “By virtue of this concatenation of processes the modern industrial system at large bears the character of a large comprehensive, balanced mechanical process” (Veblen [1904] 1975, 16). This concatenation means that a disruption in one part affects all parts. The power to disrupt industrial processes provided a new means of earning profits: by withholding output necessary to other businesses. The development of credit changed the investment process. For Veblen, credit refers to both stocks and loans, enabling businesses to purchase other businesses resulting in the appreciation of assets. Veblen identified three types of economic systems, roughly corresponding to different forms of business organization and different ways of generating profits: the natural economy, the money economy, and the credit economy. Under the natural economy, businesses were largely traders, earning profits from buying and selling goods. Under the money economy, characterized by the handicraft system comprised of small proprietors, competition directed pecuniary pursuits toward serviceable ends, illustrated by Smith’s butcher, brewer, and baker. Proprietors used markets to vent surplus goods. Under the credit economy, banks use the capital markets to vent surplus capital. Businesses resort to surplus capital in the form of stocks and credit to purchase other businesses. Recourse to credit becomes the general practice, a means of purchasing assets in anticipation of a rise in values. Under the credit economy, corporations come unto their own. The principles underlying modern business had its origins in the money economy, specifically the handicraft era. The technology of the handicraft era limited pecuniary opportunities. Individuals and their families used the tools they owned to produce products, which were sold for money to purchase goods and services needed. The era provided historical referents for the invisible hand, Locke’s concept of private property, and the notion that the market system is natural. The principal factors in the evolution of business enterprise are changes in technology and the tradition of natural rights. As noted, changes in

Toward an Evolutionary Theory of Consumer Capitalism  29 technology expanded opportunities to profit, opportunities legitimized by the tradition of natural rights. John Locke (1960) conceived natural rights, in part, to critique Robert Filmer’s defense of Feudal rent. Under Feudalism, serfs were obligated to pay rents in kind, in labor services or in goods. Filmer defended Feudal rents based on divine right, obligating serfs to pay rents. Locke disagreed. Echoing Martin Luther, Locke asserted that all men are equal in God’s eyes, endowed with a set of inalienable rights, enabling them to fulfill God’s business. The most important right is private property, the result of “mixing labor with nature.” Locke continues: “The labour that was mine . . . hath fixed my property in that which was held in common (1960, 330). Locke’s concept of natural rights emancipated property from familial ties, religion, and the state. It legitimized the Revolution of 1688, which limited the King’s ability to appropriate the property of individuals without the consent of Parliament, providing the institutional framework for the accumulation of capital and the emergence of capitalism. With the introduction of limited government, sovereignty becomes separate from property; taxes become separate from rents. By extension, the right to property implies that the market is natural, legitimizing making money. Money was necessary to live, the result of providing serviceable products. “Business enterprise came in the course of time to take over the affairs of industry and so to withdraw these affairs from the tutelage of the gilds” (Veblen [1914] 1964, 228). The market tied profits to industry, a point encapsulated in the invisible-hand doctrine. The presumed beneficence of the invisible hand rested on the belief that “[t]he Creator has established the natural order to serve the ends of human welfare” (Veblen [1919] 1961, 115). With the accumulation of capital and advances in technology, natural rights acquired a new meaning. Natural rights justified appropriating the labor of others, enabling property owners “to get something for nothing.” The tradition of natural rights together with the introduction of machines and machine processes created new possibilities for making money. As ­Veblen notes, the spirit of business enterprise lies in the institution of ownership. Business principles predate the machine age but come fully developed during it. Machines standardized production, reduced per-unit costs, and increased the interdependency among different economic sectors. Investment in machines required vast financial resources; managing these resources required new forms of business enterprise. Stocks became the new means of financing businesses and, through stock manipulation, a new means of making money. The corporation became the new and dominant form of business enterprise. “The corporation is a business concern, not an industrial unit.” And later, “It is a means of making money, not making goods.” Providing goods “is incidental to the making of money and is carried only so far as will yield the largest net gain inter terms of money” (Veblen 1923, 85). The machines and machine process provided the technological basis for the modern industrial system: “the modern industrial system is a concatenation of processes which has much of the character of a single, comprehensive,

30  Toward an Evolutionary Theory of Consumer Capitalism balanced mechanical process. A disturbance of the balance at any point means a differential advantage” (Veblen [1904] 1975, 25). By means of their size and power, the modern industrial system offered corporations new means of generating profits: by creating a disturbance, by withdrawing a necessary product. As noted, credit refers to both stock purchases and loans. The capital market is the modern economic feature which makes and identifies the higher ‘credit economy’ as such. In this credit economy resort is habitually had to the market as a vent for accumulated money values and a source of supply of capital. (Veblen [1904] 1975, 151) The capital market vents surplus money, expanding the means to purchase assets. Credit bids up the value of assets, increasing the claims on output. Bidding up asset values rests on the presumptive earning capacity, entailing a change in the concept of property, laying the basis for the modern economy. The value of capital is determined by its “prospective earning capacity.” Keynes’s views regarding the evolution of business enterprise parallels Veblen’s. Keynes presents his views in Chapter 12 of The General Theory. He notes that businesses of the old-fashioned type were valued based on their costs or replacement costs. “Decisions to invest in private business of the old-fashioned type were, however, decisions largely irrevocable, not only for the community as a whole, but also for the individual” ([1936] 1964, 150). With the emergence of corporations, businesses are valued based on their prospective income, discounted by the rate of interest. It also, according to Keynes, increases the instability of the investment process. What becomes liquid for the individual is illiquid for society. It is as though a farmer, having tapped his barometer after breakfast, could decide to remove his capital from the farming business between 10 and 11 in the morning and consider whether he should return to it later in the week. ([1936] 1964, 151) Keynes rejected the invisible hand, noting that what is most profitable is not necessarily beneficial to society. Further, the stock market opened the door to speculative manias, creating new ways of making money. Keynes, however, did not consider that the new way of valuing businesses entailed a change in the concept of property itself. From Tangible to Intangible Property The expanded opportunities for business helped prompt a change in the concept of property from tangible to intangible property. The transition of

Toward an Evolutionary Theory of Consumer Capitalism  31 property in things to the anticipated behavior over things, from tangible to intangible property, occurred gradually. By the late nineteenth century, intangible property had become common among businesses, subsequently formalized by the Supreme Court. Veblen derived intangible property from the exercise of corporate power, from “the right to fix prices by withholding from others what they need but do not own” (Commons [1934] 1961, 3). As summarized by Commons, Andrew Carnegie intended to build a plant that would expand steel production, depressing the prices and the profits of his competitors. Fearing ruin, J.P. Morgan formed a holding company of Carnegie’s competitors to buy out Carnegie’s interests. Carnegie sold his interests for 300 million dollars, assets that cost 75 million dollars (see Commons [1934] 1961, 649–650). Veblen attributed the difference to the power of withholding property, what Veblen later called economic sabotage. As Commons noted, Veblen “distinguished intangible value, or intangible capital, as the purely pecuniary valuations by business men, according to their strategic power of holding up the community and ‘getting something for nothing’” (Commons [1934] 1961, 650). The Supreme Court legitimized the concept of intangible property from the point of view of reasonable value. The court’s decision, in part, rested on the 13th and 14th amendments to the US Constitution. The 13th amendment prohibited slavery and involuntary servitude except as punishment for a crime. The 14th amendment forbids states from denying “any person of life, liberty or property, without due process of law” or “to deny to any person within its jurisdiction the equal protection of the laws.” In the Slaughter House Case (1876), Louisiana granted a monopoly to a slaughter house regulating the prices charged to local butchers for its use. The butchers contended that the regulated prices deprived them of their property. The court decided that property meant use value, not exchange value. Louisiana could regulate prices without infringing on the property rights of the butchers. The railroads resurrected the issue in the Minnesota Rate case (1890). The Railway Commission of Minnesota decided to reduce railway rates. The railroads claimed that the decision represented a taking of property without due process. The court agreed. Forcibly reducing railway rates denied the railroads the right to charge what the market could bear and, consequently, denied the railroads their property. Hence, it was not until the new idea of “intangible property” arose out of the customs and actual terminology of business magnates in the last quarter of the Nineteenth Century that it was possible for Veblen and the Supreme Court to make the new distinctions which clearly separate from each other not only the ownership of materials and the ownership of debts, but also the ownership of expected opportunities to make a profit by withholding supply until the price is persuasively or coercively agreed upon. This ownership of expected opportunities is “intangible” property. (Commons [1934] 1961, 5)

32  Toward an Evolutionary Theory of Consumer Capitalism For Commons, intangible property represents exchange value. Exchange value derives from expected value. Intangible property involves futurity; it involves opportunities to earn profits. It is not corporeal; it is behavioristic since it depends on the behavior of others. As Commons notes, In the course of time this exchange value has come to be known as “intangible property,” that is, the kind of property whose value depends upon right of access to a commodity market, a labor market, a money market, and so on. ([1924] 1957, 19) In the realm of business, there are only two kinds of property: incorporeal and intangible. Intangible property refers to “the exchange-value of anything whether corporeal property or incorporeal property or even intangible property” ([1924] 1957, 19). Intangible property shifted the emphasis to the future, to opportunities to earn profits. The last buyer of goods buys for consumption, but the last negotiator of capital buys for the sake of the ulterior profit; in substance he buys in order to sell again at an advance. The advance which he has in view is to come out of the prospective earnings of the capital for which he negotiates. (Veblen [1904] 1975, 152) Business embraced the shift introducing a number of financial innovations the most important of which is the holding company. The holding company enabled corporations to restrict output “without violating the antitrust laws.” Financed largely by banks, the holding company would purchase stock in other corporations for the purpose of control. The holding company thereby became the financial company. The invention consisted in creating shares of stock of the holding company, with the familiar limited liability, and then exchanging these created shares for at least a majority of the shares of each of the industrial corporations in order to vote the stock and elect the board of directors of each industrial corporation by the management of the financial company. (Commons 1950, 62) For Veblen, efforts to extend the market and, therefore, increase profits assumed two forms. First, the increased output resulting from modern technology required efforts to increase expenditures. New forms of conspicuous consumption, expenditures to promote sales, and the rise of militarism helped absorb the increased output. The second form of extending the market was the concept of intangible property, initially resulting from efforts

Toward an Evolutionary Theory of Consumer Capitalism  33 to restrict output. In this regard, the trust maker became a substitute for a commercial crisis.

Veblen’s View of The Cause of Depression Veblen approaches depression from the viewpoint of the businessman; the businessman cannot “derive a satisfactory gain from letting the industrial process go forward on the lines and in the volume for which the material equipment of industry is designed” (Veblen [1904] 1975, 213). Purchasing capital by issuing debt establishes payment commitments, anticipating Hyman Minsky’s financial instability hypothesis (see Wray 2007). With the development of the credit economy, businesses have recourse to credit, to both loans and issuing stock to purchase other assets. Credit complicates the situation. Recourse to credit creates an obligation. The debt payment constitutes a fixed payment, thereby increasing expenses and, hence, financial fragility. Competition further complicates matters. Businesses need to earn revenue to repay their debts, leading them to increase output. Competition depresses the price, undermining the businessman’s ability to generate sufficient revenue to service the debt. Revenues fall pressuring businesses to cut costs, sell assets, or both. Unable to earn sufficient revenue to repay debts forces businesses into bankruptcy. Hence, for Veblen, crises and depressions are a matter of prices and profits, not overproduction or underconsumption. To increase profits, businesses developed two strategies. First, businesses engaged in economic sabotage, a conscientious withdrawal of efficiency. And second, business made efforts to increase sales through advertising, pointing to the importance of effective demand.

Excluding Veblen from Keynes’ “Army of Heretics” If Keynes “army of heretics”—Thomas Robert Malthus, Bernard Mandeville, John Hobson, and Silvio Gesell—emphasized the role of effective demand, why didn’t Veblen? As noted, Veblen addressed depression from the point-of-view of the businessman as a matter of prices and profits. But he acknowledged the role of effective demand: “There is an excess of goods, or the means of producing them, above what is expedient on pecuniary grounds, – above what there is there is an effective demand for at prices that will repay the costs of production of the goods and leave something appreciable over as a profit. It is a question of price is an earnings” (Veblen [1904] 1975, 216–217). Keynes, perhaps, felt that Veblen’s ideas were obscure, leading Keynes to omit Veblen from the “army of heretics.” But the question remains: why didn’t Veblen couch the matter in terms of effective demand? First, Veblen noted that the initial reaction of business was to reduce output to drive up prices, reflecting business practices in the late nineteenth century. In contrast, society’s interest lay in increasing output. Second, Veblen’s decision to avoid basing his theory of effective

34  Toward an Evolutionary Theory of Consumer Capitalism demand provided him a degree of ethical consistency. Invidious activities such as engaging in conspicuous consumption or conspicuous leisure impairs the provisioning process. Such expenditures leave others wanting. The advantages to some people create disadvantages for others. Even so, Veblen concedes that such expenditures provide employment, employment that could be provided by spending on goods that enhance people’s lives. ­Finally, Veblen held an evolutionary view, eschewing formal models. Keynes, perhaps recognizing this, excluded Veblen from anticipating the theory of effective demand. Veblen and Keynes on Waste Both conspicuous consumption and conspicuous leisure are forms of conspicuous waste, the abuse of power that interferes with the process of social provisioning. For Veblen, waste stems from individual efforts to show superiority, corporate efforts to increase pecuniary returns without increasing industry, and national efforts to exert military dominance. Conspicuous waste involves one-upmanship; it entails a struggle for superiority. “In order to be reputable it must be wasteful” ([1899] 1979, 96). Invariably, the struggle for superiority increases the standard of living. In the pursuit of status, the masses embrace the values, habits, and desires of the leisure class. They want to join the party, consume like things, and engage in like activities. Lack of income, however, relegates them to the backroom instead of the front room. Hence, the masses must content themselves with living at the pecuniary standard.5 For Keynes, waste assumes the form of idle factories, unemployed workers, and unsold goods resulting from insufficient demand. The question arises, do increases in wasteful expenditures provide employment? Veblen avoided inferences that individual aggrandizement contributes to the provisioning process despite acknowledging the role of conspicuous consumption in providing employment and raising living standards. Keynes made employment and hence social provisioning depend on effective demand, the decline of which impairs the provisioning process. But Keynes acknowledged that individual aggrandizement could contribute to social provisioning. Hence, Keynes conceded that individual aggrandizement provides an alternative means of increasing prospective income. In so far as millionaires find their satisfaction in building mighty ­ ansions to contain their bodies when alive and pyramids to shelter m them after death, or, repenting of their sins, erect cathedrals and endow monasteries or foreign missions, the day when abundance of capital will interfere with abundance of output may be postponed. “To dig holes in the ground,” paid for out of savings, will increase, not only employment, but the real national dividend of useful goods and services ([1936] 1964, 220).

Toward an Evolutionary Theory of Consumer Capitalism  35 In contrast, Veblen advocated fostering those activities that promote the life process: “the test to which all expenditure must be brought in an attempt to decide that point is the question whether it serves directly to enhance human life on the whole—whether it furthers the life process taken impersonally” ([1899] 1979, 99). And second, Veblen’s comments regarding conspicuous waste implies that policies should avoid promoting conspicuous consumption. Based on Keynes ideas, policies should stimulate demand, increasing profits that in turn create jobs. Whether scalable or not, however, the economic function of wasteful expenditures is to absorb increases in output. Wasteful expenditures come to serve a pecuniary end. The absorption of output provides revenue, justifying the increase in production. For Keynes, the greatest form of waste lies in unspent saving. An increase in saving, ceteris paribus, means a decision to forgo dinner today. Keynes does not suggest changing the habits of the rich. Instead, he addressed the problem of social provisioning by advocating government deficits and ­socializing the rate of investment, both of which increase the prospective income to businesses, thereby stimulating employment. Effective Demand and Conspicuous Waste Veblen believed that the machine process was undermining the institutional basis of capitalism. Further, he believed that the wasteful enjoyments of the rich impeded the life process for the masses. In contrast, Keynes sought to save capitalism. Moreover, Keynes agreed that there may be justifications for inequality besides saving. Hence, wasteful expenditures have a role in the theory of effective demand. For Keynes, effective demand ­provides the income flows to corporations, enabling them to provide employment. This, however, assumes that both the price level and technology remain unchanged, implying that rising expenditures correlate with rising employment. In contrast, Veblen recognized that prospective income depends on the prices obtained from selling goods. As noted, competition combined with economies of scale increases output, but collapses profits. Depression is not a matter of demand; it is a matter of prices and profits. “The whole matter is very largely a matter of price—of ‘values’ in the commercial sense” (Veblen [1919] 1961 112). For Veblen, increases in demand may absorb output at profitable prices, but such increases will not necessarily provide employment. Advances in technology make possible increasing output without increasing jobs. Conspicuous waste absorbs the difference between output and ­productive consumption, the level of expenditures necessary to create the output. Conspicuous waste provides income for workers engaged in wasteful ­ ­production, but it detracts from the goods and services that contribute to social provisioning. The production of status goods and efforts to sell those goods represent for Veblen a waste, a waste because they deny providing

36  Toward an Evolutionary Theory of Consumer Capitalism goods that enhance the life process. In depressed times, conspicuous waste declines along with output, leaving the difference between output and productive consumption little changed. It may be added that the rate of consumption is also appreciably lower during dull times, particularly in the more wasteful forms of consumption. This lowered aggregate consumption offsets the lowered intensity of production during dull times to such an extent that it is probably safe to say that the net surplus product, measured by weight and tale, is at least not appreciably smaller during depression than during prosperity. (Veblen [1904] 1975, 239n) As noted, wasteful expenditures can help absorb the surplus. But given the efficiency of production, wasteful expenditures cannot sustain profits for any length of time. What is needed is a sabotage of the production process. In contrast to Keynes, Veblen focuses on restricting supply as a means of driving up prices and resurrecting profits. Perhaps because of his hostility to capitalism, Veblen gives short shrift to the idea of increasing demand. Veblen recognized that advertising could in fact increase sales, but Veblen, like Keynes, was blind to the possibility to increasing demand through the extension of credit (Wray 2007; Watkins 2000). The Monetary Theory of Production Both Veblen and Keynes recognized the importance of what Keynes called the monetary theory of production. The concept refers to simple observation that capitalist production requires converting goods and services into money. A business strives to attain revenues exceeding the costs of the original investment. In each case, the business begins with money and ends with money. The resulting profit enables the capitalist to initiate a new circuit, allowing accumulation to proceed on an ever-widening basis. The monetary theory of production refers to making money by selling goods and services to the private sector. From the beginning of capitalism in the sixteenth century, businesses depended on the circulation of ­capital, converting goods and services into money. As Adam Smith noted, capital goes out in one form and returns in another. The introduction of ­continuous-mass production technology, however, imposed greater pressures on business to speed up the circuit by increasing consumer demand.

Conclusion While there are certainly differences, the parallels between the ideas of Veblen and Keynes standout. Both share similar views of consumption recognizing that consumption is very much a matter of habit. Keynes, of course, retreated from his earlier comments regarding the cultural basis of

Toward an Evolutionary Theory of Consumer Capitalism  37 consumption in The General Theory as part of a short-run model of the Great Depression. Both Veblen and Keynes share an evolutionary theory of business ­enterprise, ignored by mainstream economists. Both shared similar views of depression. Veblen recognized the importance of effective demand but chose to couch the effects of depression in terms of the businessman, in terms of prices and profits. Keynes, in contrast, chose to couch the effects of depression largely on employment, reflecting the crisis that Keynes addressed. Together, their theories provide the basis for an evolutionary theory of consumer capitalism. The increased output from continuous-mass production combined with the introduction of new products creates an abundance of goods. Those goods must be purchased to avert depression, requiring an ever-rising pecuniary standard.

Notes 1 Marshall used time to synthesize the cost-of-production theory of value with the subjective theory of value. In the short run, with the supply curve vertical demand determines value. In the secular long run, with the supply curve horizontal cost of production determines value. And in the short period, both supply and demand determine value (Marshall [1920] 1979, 289–291). 2 Keynes defined the classical school as those who believed the private economy tends to full employment. “I have become accustomed, perhaps perpetrating a solecism, to include in “the classical school” the followers of Ricardo, those, that is to say, who adopted and perfected the theory of Ricardian economics, including (for example) J.S. Mill, Marshall, Edgeworth and Prof. Pigou” ([1936] 1964, 3n). 3 “Man as we find him to-day has much regard to his good fame—to his standing in the esteem of his fellowmen. This characteristic he always has had, and no doubt always will have. This regard for reputation may take the noble form of a striving after a good name; but the existing organization of society does not in any way preeminently foster that line of development. Regard for one’s reputation means, in the average of cases, emulation. It is a striving to be, and more immediately to be thought to be, better than one’s neighbour” (Veblen [1919] 1961, 392). 4 See Stanfield and Stanfield (1980). 5 “A large proportion, perhaps the greater part, of what is included under the standard of living for any class, whether rich or poor, falls under the theoretical category of Conspicuous Waste, which comprise the consumption of time and effort as well as of substance” (Veblen [1915] 1968, 132).

References Alchian, Armen. 1950. “Uncertainty, Evolution, and Economic Theory.” Journal of Political Economy 58: 211–221. Commons, John R. 1950. The Economics of Collective Action. New York: Macmillan. ———. (1924) 1957. Legal Foundations of Capitalism. Madison, WI: University of Wisconsin Press. ———. (1934) 1961. Institutional Economics: Its Place in Political Economy. 2 vols. Vol. 1. New Brunswick, NJ: The University of Wisconsin Press.

38  Toward an Evolutionary Theory of Consumer Capitalism Keynes, John Maynard. 1937. “The General Theory of Employment.” The Quarterly Journal of Economics 51 (2): 209–223. http://www.jstor.org/stable/1882087. ———. 1920. The Economic Consequences of the Peace. New York: Harcourt, Brace and Howe. ———. (1930) 1963. “Economic Possibilities for Our Grandchildren.” In Essays in Persuasion, 358–373. New York: W.W. Norton and Company. ———. (1936) 1964. The General Theory of Employment, Interest, and Money. New York: Harbinger. Locke, John. 1960. Two Treatises of Government. New York: New American Library. Mann, Charles C. 2011. 1493: Uncovering the New World Columbus Created. 1st ed. New York: Knopf. Marshall, Alfred. (1920) 1979. Principles of Economics. 8th ed. London: Macmillan Press. Mayhew, Anne. 1987. “The Beginnings of Institutionalism.” Journal of Economic Issues 21 (3): 971–1000. Mintz, Sidney Wilfred. 1985. Sweetness and Power: The Place of Sugar in Modern History. New York: Viking. Mitchell, Wesley C. 1912. “The Backward Art of Spending Money.” The American Economic Review 2 (2): 269–281. http://www.jstor.org/stable/1827579. Robinson, Joan. 1962. Economic Philosophy: An Essay on the Progress of Economic Thought. Garden City, NY: Anchor Books. ———. 1980. What Are the Questions and Other Essays. New York: M.E. Sharpe. Schumpeter, Joseph Alois. 1954. History of Economic Analysis. New York: Oxford University Press. Shackle, G. L. S. 1967. The Years of High Theory: Invention and Tradition in Economic Thought 1926–1939. Cambridge: Cambridge University Press. Stanfield, J. Ron, and Jacqueline B. Stanfield. 1980. “Consumption in Contemporary Capitalism: The Backward Art of Living.” Journal of Economic Issues 14 (2): 437–451. http://www.orgs.bucknell.edu/afee/jei/ Veblen, Thorstein. (1914) 1964. The Instinct of Workmanship, and the State of the Industrial Arts. New York: Augustus M. Kelley. ———. (1919) 1961. The Place of Science in Modern Civilisation and Other Essays. New York: Russell and Russell. ———. 1923. Absentee Ownership and Business Enterprise in Recent Times. New York: Sentry Press. ———. (1904) 1975. The Theory of Business Enterprise. New York: Charles Scribner’s Sons. ———. (1915) 1968. Imperial Germany and the Industrial Revolution. New York: The University of Michigan Press. ———. (1899) 1979. The Theory of the Leisure Class: An Economic Study of Institutions. New York: Penguin Books. Watkins, John P. 2000. “Corporate Power and the Evolution of Consumer Credit.” Journal of Economic Issues 34 (4): 909–932. http://www.orgs.bucknell.edu/afee/jei/ Wray, L. Randall. 2007. “Veblen’s ‘Theory of Business Enterprise’ and Keynes’s Monetary Theory of Production.” Journal of Economic Issues 41 (2): 617–624.

3 Continuous-Mass Production and the Rise of the Modern Corporation

In the late nineteenth century, continuous-mass production technology led to an outpouring of goods. Businesses competed against each other cutting prices to gain market share, helping to precipitate the depression of 1894. Appearing before the Industrial Commission of 1900, the president of the National Association of Manufacturers, Mr. Theodore Search, opined that ­“probably taking all industries together, the world can produce more than it can ­consume.” He concluded that “The best solution to the difficulty is by improving some markets, which can be done by high wages and short hours” (1900, 9). Business offered another solution: restrict output and ­increase sales. Veblen referred to restricting output as “sabotage,” a “conscientious withdrawal of efficiency.”1 Sabotage refers “to peaceable or surreptitious restriction, delay, withdrawal, or obstruction.” The purpose is to obtain an advantage, restricting output to increase prices. Restricting output, however, failed to take advantage of the economies offered by continuous-mass production, which required producing at or near full capacity. Businesses responded by vertically integrating, combining production with distribution. Businesses attempted to increase sales through national advertising campaigns, establishing brands, and providing credit to consumers. Imperialism represented a national strategy to increasing demand, supported by business. “The epochal inventions in machinery increased production so enormously that new markets had to be developed to dispose of the surplus products, and the vast population of Africa and Asia was looked upon as potential customers” (Faulkner 1960, 554). The second industrial revolution prompted any number of institutional innovations in response to continuous-mass production. Businesses adopted the corporate form to manage expanded production and ­distribution ­processes. The holding company represented an institutional innovation circumventing the ultra vires doctrine, which restricted corporate ­activities to their charter, impeding interstate commerce. Holding companies, ­mergers, and trusts rested on a change in the concept of property from use value to exchange value, valuing a corporation not on the replacement value of its assets but on the present value of its prospective

DOI: 10.4324/9780429443763-3

40  Continuous-Mass Production and the Rise of the Modern Corporation yield. The stock market addressed the problem of financing the increased costs of investments associated with the new technology.2 All occurred in a relatively brief period from the 1880s to the 1920s. The establishment of the “great national corporations” followed the panic of 1907 (Chandler 1964, 11). The heart of the change, however, was the change in technology, the widespread adoption of continuous-mass production that marked the second industrial revolution.

The Second Industrial Revolution The second industrial revolution heralded by the introduction of continuousmass production rested on interchangeable parts. Interchangeable parts represented an application of the enlightenment belief that applying science and reason could perfect society. Ironically, in eighteenth-century France, the application of science and reason assumed the form of developing interchangeable parts to produce armaments (Hounshell 1984, 25). The armament industry was the one industry in which there was a relatively constant demand, justifying the use of interchangeable parts. Eli Whitney introduced interchangeable parts in the United States (Hounshell 1984, 31), laying the basis for the second industrial revolution. As Joel Mokyr and Robert Strotz noted, “Modern manufacturing would be unthinkable without interchangeable parts” (1998, 9). Interchangeable parts standardized production, enabling both economies of scale and economies of scope. Economies of scale refers to expanding output to reduce per-unit costs. Economies of scope involved applying the same production techniques to produce different goods. It was the development of new technologies and the opening of new markets, which resulted in economies of scale and of scope and in r­ educed transaction costs, that made the large multiunit industrial enterprise come when it did, where it did, and in the way it did. (Chandler and Hikino 1990, 18) Both economies of scale and scope required large, fixed costs. But the economies came not so much from size, but from speeding up manufacturing, thereby increasing throughput. It was not the size of a manufacturing establishment in terms of number of workers and the amount and value of productive equipment but the velocity of throughput and the resulting increase in volume that permitted economies that lowered costs and increased output per worker and per machine. The savings resulting from the use of the same light, power, and maintenance facilities were tiny compared with those achieved by greatly increasing the daily use of equipment and personnel. (Chandler 1977, 244)

Continuous-Mass Production and the Rise of the Modern Corporation  41 The decreases in per-unit costs from increasing throughput required a ­management structure to oversee production, to ensure the right factor ­proportions, to manage round-the-clock shifts, to ensure sufficient inputs, and to secure markets to sell the output.3 In contrast, the first industrial revolution lacked a scientific foundation. “It created a chemical industry with no chemistry, an iron industry without metallurgy, power machinery without thermodynamics” (Mokyr and Strotz 1998, 1). The increased output stemmed not so much from the first industrial revolution. “It resulted much more from the coming of modern transportation and communication. The railroad, telegraph, steamship, and cable made possible modern mass production and distribution that were hallmarks of the Second Industrial Revolution” (Chandler 1986, 384). Innovations slowed after 1825, only to pick up again toward the last third of the nineteenth century. The last such period, 1896 to 1920, is responsible for the motor-car, the metal filament electric lamp, the gramophone, wireless, and the ­aeroplane; and in the industrial field for such revolutionary ideas as ­independent electric drive of machines, the use of pressed steel parts, the Diesel engine, scientific management and functional organization, and the planning of continuous-mass production. It is the widespread application of these new ideas in industries which is characteristic of the present secular period of falling price-level. (Jevons 1933, 558) The advantages offered by continuous-mass production technology, however, depended on increasing sales, which, in turn, depended on expanding ­markets. The railroad and the telegraph were central in creating a national market. “Besides establishing a new energy source, factory production ­depended on creating a national market. The railroads provided ‘a steady, all-weather flow of goods into and out of their establishments, manufacturers would have had difficulty in maintaining a permanent working force and in keeping their expensive machinery and equipment operating profitably” (Chandler 1977, 245). Continuous-mass production changed how many businesses were managed. “The rise of modern mass production required fundamental changes in the technology and organization of the processes of production. The basic organizational innovations were response to the need to coordinate and control the high-volume throughput” (Chandler 1977, 281). Businesses in late eighteenth-century and early nineteenth-century A merica were small, individual proprietors. Production was mostly ­ ­handicraft, enabling output to keep pace with demand. The phenomenon of widespread depression, characterized by mass unemployment and unsold goods, did not occur. Besides, the predominance of agriculture together with the abundance of land lessened the impact of unemployment. The adoption of continuous-mass production technology, however, necessitated a change in the organization of business. It necessitated the corporation.

42  Continuous-Mass Production and the Rise of the Modern Corporation

The Rise of the Modern Corporation The United States inherited the laws governing corporations from England. At that time a corporation was considered as a “franchise” ­(Norman-French “privilege”): i.e., the very existence of the corporation was conditioned upon a grant from the state. This grant created the corporation and set it up as a legal person independent of any of the associates. (Berle and Means 1932, 120) The government granted charters to corporations to perform public ­functions specified in the charter. Corporations built canals, dams, and other public works (Berle and Means 1932, 11). Following the Civil War, the railroads adopted the corporate form to manage their expanding networks. Placing stations in different locales, providing locomotives with sufficient coal and water, maintaining equipment, and scheduling required an extensive managerial structure that the corporate form provided. Corporations also provided a means of financing the increased costs of investment, stemming from the adoption of new technologies. Few i­ ndividuals commanded sufficient resources to finance railroads, steel mills, or automobile manufactures. To build the railroads, financing was largely provided by foreign investment, mostly from England. Financing the railroads also led to the reconstruction of Wall Street. Because individual railroad companies were so much larger than any other contemporary enterprise, they required brand-new techniques of financing and administration. The acquisition of the huge sums needed to build the roads led to the centralizing and institutionalizing of the American investment market in Wall Street. (Chandler 1964, 9) Railroads also received government subsidies in the form of land grants, tax reductions, the use of eminent domain, and protection against competition. “These land grants included one-fourth of the states of Minnesota and Washington, one-fifth of Wisconsin, Iowa, Kansas, North Dakota, and Montana, one-seventh of Nebraska, one-eighth of California, and onenineth of Louisiana” (Faulkner 1960, 481). Estimates in the 1880s place the holdings of the railroads at one-fourth to one-fifth of all the wealth in the country (See Ely 1887, 73). Businesses adopted the corporate form primarily in industries with large, fixed costs such as railroad and mining. Adoption in manufacturing came slowly. Business integrated mass production with mass distribution not to obtain economies, but to sell goods. “Yet the first industrialists to integrate these two basic sets of processes did not do so to exploit such economies. They did so because existing marketers were unable to sell and distribute products in the volume they were produced” (Chandler 1977, 287). Selling

Continuous-Mass Production and the Rise of the Modern Corporation  43 more goods became imperative to take advantage of the cost advantages offered by mass production. “Mass distribution came primarily though organizational innovation and improvement, using the new forms in transportation and communication. Mass production, on the other hand, normally called for technological as well as organizational innovation” (Chandler 1977, 240). The Industrial Commission of 1900 noted four strategies to control production: outright purchases, leases, holding companies, and a representation by a minority in the directorate (1900, 310). Holding companies held shares in other companies. The holding company itself issued shares based on the capitalized value of prospective income stream, attributing the stream of income to “goodwill” or reputation. Goodwill, in fact, stemmed from restraining trade, enabling the railroads to eliminate or reduce rate cutting. It also eliminated the need to cut rates to favored clients (Commission 1900, 322). Efforts to restrict output through trusts, holding companies, and mergers rested on the capitalized value of corporations, which became the standard practice in the late nineteenth century. “[T]he general business climate of destructive price competition necessitated a change in financial practices – mergers of the scale that had occurred would have been very difficult without some change in the standard business practice” (Hake 1998, 149; Also see Ganley 2004). The courts consistently struck down mergers and trusts as violation of the ultra vires doctrine, which forbade activities beyond the scope of the ­charter. The courts’ actions, however, conflicted with corporate efforts to engage in interstate commerce. In 1888, New Jersey passed a law allowing one company to own stock in another company, thereby legally sanctioning the holding company. In 1893, the law was amended to allow one company to own shares in other companies by a majority of shareholders, leading many corporations to relocate to New Jersey. “As producers of durable consumer goods gained access to a national market, the organization of production changed” (Atkinson and Paschall 2016, 73). Industry after industry became increasingly concentrated.

Continuous-Mass Production Continuous-mass production was widely applied in the late nineteenth and early twentieth centuries. In consumer goods, the technology was applied to the production of tobacco, canned goods, dressed beef, in addition to other products, resulting in a fall in prices. Kellogg’s Corn Flakes, introduced in 1896, fell in price of by one-third, while the package size increased. Campbell’s Soup sold for one-third the price of its non-advertised competitors. The technology was applied to industrial commodities as well: oil refining and steel production, among others. The increased output was sufficiently large that many businesses recognized the need to control distribution. The corporate form further allowed the development of chain stores and departments stores, taking advantage of centralized warehouses.

44  Continuous-Mass Production and the Rise of the Modern Corporation Tobacco Before the Civil War, most men smoked cigars or chewed tobacco. Cigarettes became popular after the Civil War, expanding the market for tobacco, in part, by appealing to women. James Duke changed the tobacco industry, introducing a number of innovations. First, Duke mechanized the manufacture of cigarettes. Hand rollers could produce 2,500 cigarettes per day; machines could produce 120,000 cigarettes per day (Pope 1983, 76). Second, Duke began putting his cigarettes in stiff packages, reducing breakage. Third, in anticipating a reduction in taxes on cigarettes from $1.75 per thousand to $.50, many retailers refused to buy Duke’s cigarettes, anticipating lower prices. Duke ceased production to reduce inventories, cut prices in half, and began advertising. The subsequent increase in sales enabled him to reduce his per-unit costs. “In the case of the American Tobacco Company, cigarette manufacturing costs fell about 40 percent from 1893 to 1899; by 1907, however costs had returned to their 1893 levels” (Pope 1983, 76). Fourth, Duke vertically integrated enabling him to further reduce costs. This organizational innovation was another indication of vertical integration, this time forward into sales and distribution. The cigarette found no ready market; it was a relatively new product of no intrinsic value to the consumer. Producers therefore had to devise a system of sales and distribution to make consumers aware of their products and to see that wholesalers and retailers stocked them. (Chandler 1959, 67) The Beef Trust Following the Civil War, few cities could handle processing beef: Chicago, Saint Louis, and Kansas City. The cost of shipping beef eastward was considerable. Shipping the whole carcass resulted in 45% waste. Refrigerator cars made shipping dressed beef possible, thereby eliminating or reducing the waste. Refrigerator cars were initially wooden box cars with ice. Technological advances made refrigerator cars possible, prompting several firms to enter the market of which the most well-known was Gustav Swift. The railroads initially opposed the use of refrigerator cars because it reduced the tonnage shipped. Besides, a regular car could be used to ship other freight. Large, fixed costs and fierce competition forced the railroads to relent. Due to the overbuilding of railroads and excessively low rates on interstate routes, both of which resulted from ruinous competition among multiple lines, the railroad industry experienced serious financial difficulty causing railroad owners to merge competing railroads and form cartels to set minimum rates. (Hamill 1999, 149)

Continuous-Mass Production and the Rise of the Modern Corporation  45 The railroads also offered rebates, encouraging the meatpackers to ship more beef to ensure that railroad cars ran full, helping concentrate the industry. In 1886, the packers formed a pool for the purpose of regulating the industry, initially comprised of four firms. “The pool fixed prices, profit margins, and even regulated the members’ livestock purchases” (Gordon 1984, 247). The meatpackers argued that they wanted to eliminate periods of gluts. In their view, the perishability of the meat and the difficulty of keeping inventories required controlling the market. By 1890, the pool controlled 89% of the dressed-beef market. Canning Canned goods originated in 1795 to help feed Napoleon’s army. The cost, however, was high and cans tended to explode. The Civil War further stimulated canning, reducing the need for cooks. Following the war, the United States had over a hundred plants canning fruits, vegetables, fish, and oysters. Innovations introduced in the 1874 controlling the temperature prevented cans from exploding, opening the door to mass production. By 1890, canneries exceeded 1,000, comprising one-fifth of all manufacturing (Levinson 2011). Canning became particularly important during World War I. Women were encouraged to bottle surplus produce to reduce the demand for food. Following the war, the canning industry turned to consumers as a new source of demand. “After the war ended, companies that had supplied the military with canned foods improved the quality of their goods for civilian sale, which led to the explosion of the canned foods industry in the 1920s” (Tunc 2012, 213). Automobiles Looking to speed up production, Henry Ford introduced the moving assembly line in 1913, the classic example of continuous-mass production. The idea for the moving assembly line came from the meat packing plant in preparing dressed beer (Ford and Crowther 1922, 39). Initially, it took 12 hours and 28 minutes to produce a Model T. By December of that year, it took 2 hours and 38 minutes. By the following Spring, that had been reduced to 1 hour and 32 minutes, churning out over 1,000 cars a day (Ford and Crowther 1922, 26). Ford’s strategy was to create a product for the mass market and then build a distribution network. The distribution network meant opening branch offices in different geographic parts of the country to increase sales. By 1913, branch offices were located in 31 cities and 13 foreign countries. During the early years, the automobile companies were unconcerned with overproduction since demand exceeded supply. The increased output, however, soon led to supply exceeding demand. As Chandler noted, The industry’s output rose from 1.5 million cars in 1921 to 2.5 million in 1922 and 4.3 million in 1923. But from 1923 until 1929 the market

46  Continuous-Mass Production and the Rise of the Modern Corporation leveled off, taking an average of a little under 4 million cars a year. As had happened or would happen in so many American industries, the initial demand for the new product had reached the level permitted by the existing national income. Moreover, as has also usually been the case, production potentially exceeded demand. By the mid-1920’s the country’s automobile plants had a productive capacity of over 6 million vehicles. (1964, 13) Surveys at the time found that most people had decided what auto to buy before they got to the showroom, indicating the importance of advertising. GM had spent $20 million per year as the largest advertiser in the world. Chain Stores In the 1880s, food distribution was highly inefficient. Most stores sold goods from bins. The lack of brands made it difficult for customers to distinguish quality. Brands reduced uncertainty signaling consistent quality for consumers, enabling food manufacturers to take advantage of economies of scale. In 1889, chain stores did not exist. By 1899, chain stores comprised 4.5% of food sales. Most chains had few stores. Prices varied widely depending on the availability of goods. Wholesalers could not dictate to retailers the price of goods without violating the Sherman Antitrust Act, benefiting chain stores. The Great Atlantic and Pacific Tea Company, also known as A&P, was the first modern grocery store. Previously, different stores offered different products: a dry goods store, a butcher, and so on. The grocery store brought these different stores together. A centralized management and a common warehouse reduced per-unit costs. A&P began after the Civil War selling mostly tea and coffee. By the 1890s, it had established the first chain store. “From 1919 to 1927 sales by chain groceries increased 287 per cent while sales of 5 and 10 cent store chains grew 160 per cent” (Berle and Means 1932, 15–16). A&P along with other chains accepted lower margins, demanding suppliers ship goods to their warehouses. A&P was the Walmart of its era, pressuring brands to cut costs and collecting data to make decisions. A&P eliminated commodities that did not sell well and added commodities that did, in many cases, commodities that consumers could not find elsewhere. A&P diversified, offering a host of different goods appealing to different socioeconomic groups. “Shoppers could choose between A&P lima beans for twelve and a half cents per can, Sultana lima beans for ten cents, and Iona lima beans at three cans for twenty-five cents” (Levinson 2011). In the 1920s, working-class families spent one-third of their income on food, generally exceeding rent. A&P cut prices below that of its competitors, usually ma and pa stores. During World War I, food prices increased, benefiting A&P. Shoppers flocked to the A&P, attracted by low prices. In response, the company opened hundreds more locations. In 1920, the Great

Continuous-Mass Production and the Rise of the Modern Corporation  47 Atlantic & Pacific Tea Company sold $235 million of groceries from 4,588 stores, becoming the largest retailer in the world. A&P applied mass production to the grocery business, consulting with Henry Ford regarding vertical integration to increase profitability. In 1929, there was one grocery story for every 51 families. The number of people engaged in the food industry comprised one of every 18 workers, more than the number of workers engaged in textiles, iron and steel, coal production, and railroads combined. Department Stores The department store originating in the late nineteenth century manifests the transition to a consumer society. “The department-store customer was still a novel type in the late nineteenth century, a result of one of the most profound changes in recent history: the shift from a production-oriented society to one that centered on consumption” (Benson 1986, 75). Given the effort to vertically integrate, the department store threatened wholesalers. “Because they sold directly to the final consumer, the department stores spent more thought and more money on advertising than did the largest wholesalers” (Chandler 1977, 227). The department store “democratized luxury by putting expensive goods on display before any customer who cared to peruse them” (Schudson 1986, 151). Edward A Filene referred to his department store in Boston as “an Adam less Eden” (Benson 1986, 76), suggesting that abundance comes at a price. The emergence of consumer capitalism marks a change in the habits and activities of people, a change in culture itself. Culture reinforces the values at hand. “Culture is the set of socially available names, marketers and reminders that guide human action and establish the meaning of human experience. Attention is a scarce resource that culture organizes and directs. Culture is an attention-focusing institution” (Schudson 1986, xxi). Following the 1880s, Americans turned from growing their own food to purchasing their own food. “A population accustomed to homemade products and unbranded merchandise had to be converted into a national market for standardized, advertised, brand-named goods in general” (Strasser 1989, 7). Despite the decline in prices—the cost of home canning, for example, came to exceed the cost of purchasing canned goods—consumers had to be taught how to use the goods, how to want the goods, and how to buy the goods. “Toothpaste, corn flakes, chewing gum, safety razors, and cameras—things nobody had ever made at home or in small crafts shops—provided the material basis for new habits and the physical expression of a genuine break from earlier times” (Strasser 1989, 6). Individuals found it took less time to purchase the item than to make it themselves. “American consumer culture involved not only introducing products and establishing market demand for them, but also creating new domestic habits and activities, performed at home, away from stores and outside the marketing process” (Strasser 1989, 89).

48  Continuous-Mass Production and the Rise of the Modern Corporation The change in culture also marked a change in advertising. Along with the establishment of brands, advertising assumed a new role, conveying the idea that people could better their lives through the purchase of products. “The advertisement seeks to promote sales, it does not seek to improve the lives of consumers except as a means to the end of sales” (Schudson 1986, 10). As David Potter noted, . . . we revert to the question how the citizen, in our mixed ­productionconsumption society, can be educated to perform his role as a consumer, especially as a consumer of goods for which he feels no impulse of need. Clearly he must be educated, and the only institution which we have for instilling new needs, for training people to act as c­ onsumers, for altering men’s values, and thus for hastening their adjustment to potential abundance is advertising. This is why it seems to me valid to regard advertising as distinctively the institution of abundance. (1954, 175)

Origins of Modern Advertising In the factory system of the early nineteenth century, goods sold with little advertising. Advertising largely assumed the form of classifieds (Williams 2000). The increase in advertising occurred with the increase in print. Advertising increased as the costs of printed newspapers declined, taxes on newspapers eliminated, and incomes increased. The formation of modern advertising has to be traced, essentially, to certain characteristics of the new ‘monopoly’ (corporate) capitalism, first clearly evident in this same period of the end and turn of the nineteenth century. The Great Depression which in general dominated the period from 1875 to the middle 1890s (though broken by occasional recoveries and local strengths) marked the turning point between two modes of industrial organization and two basically different approaches to distribution. After the Depression, and its big falls in prices, there was a more general and growing fear of productive capacity, a marked tendency to reorganize industrial ownership into larger units and combines, and a growing desire, by different methods, to organize and where possible control the market. Among the means of achieving the latter purposes, advertising on a new scale, and applied to an increasing range of products, took an important place. (Williams 2000) The factor, of course, that changed consumption was the mass production of consumer goods. In 1850, 10% of the bread consumed was sold for profit. By 1900, that had increased to 25%. By 1920, 60% of the bread consumed was sold. It was similarly the case for clothes. “Ready-made clothing for men similarly

Continuous-Mass Production and the Rise of the Modern Corporation  49 Table 3.1  Advertising as a Percentage of GDP—1919–1930 Row Labels

Sum of Ads as % of GDP

1919 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930

2.50% 2.80% 2.60% 3.00% 2.80% 2.90% 2.90% 2.80% 2.80% 2.80% 2.80% 2.70%

Source: Galbi (2008).

replaced production in the home or by the local tailor. For women’s clothing, branded and advertised paper dress patterns themselves became an industry by the 1870s” (Pope 1983, 36). From the consumers’ point of view, mass production offered people choice. Brands reduced uncertainty by assuring quality. From the producer’s point of view, brands helped increase turnover. The main problem for the cereal manufacturers and others like them was “to move their goods quickly enough or to advertise them effectively enough to keep their high-volume production facilities operating steadily” (Schudson 1986, 165). Advertising went hand in hand with brands, helping to create a controllable market.4 “Branding was part of a strategy that created demand even if production capacity was insufficient to fill the orders” (Strasser 1989, 53). In a society of scarcity, advertising was unnecessary. In a society of abundance, advertising became a necessity. As Table 3.1 indicates, in 1919 advertising comprised 2.50% of gross domestic product (GDP). By 1922, ­advertising’s share of GDP had increased to 3.0%. Adverting shifted from providing information to increasing demand for products. Marketing programs sought to sell goods regardless of supply, giving way to production dictated by marketing. “W.K. Kellogg’s first national advertising, in the July 1906 of Ladies Home Journal, admitted that as of May 10, with its mills working around the clock six days a week, it had a backlog of orders for nearly half a million packages” (Strasser 1989, 53). At the beginning of the twentieth century, advertising emphasized the product. By 1920, it emphasized the benefits of the product, appealing to the human interest (Marchand 1985, 10). In the 1920s and 1930s, advertisers targeted the affluent, tending to reflect the lifestyles of the rich. The central purpose of an ad was not to reflect reality but to “move merchandise”. Often the strategy of an advertiser would dictate a deliberate distortion of reality—for example, the repeated depiction of women

50  Continuous-Mass Production and the Rise of the Modern Corporation gazing spellbound into their open refrigerators, or lovers rejecting potential mates solely because of bad breath. (Marchand 1985, xvii–xviii) Ladies’ Home Journal of 1929 promoted the democratization of goods. “­According to this parable, the wonders of modern mass production and distribution enabled every person to enjoy the society’s most significant pleasure, convenience, or benefit” (Marchand 1985, 218). Luxury was not so much democratized—it simply became more visible thereby democratizing the desire for luxuries. The myth that average Americans could live like rich Americans rendered efforts to enact policies that promote equality unnecessary. Besides, providing credit could help “democratize” access to luxury goods. Mass media helped inform people their expanded choices. At the same time, it “left people in flux, in uncertainty, full of anxiety about social standing and meaning, vulnerable to the turns of fashion more than playful with them” (Schudson 1986, 155).

Advertising and the Monetary Theory of Production Modern advertising represents a further development of the monetary ­theory of production, helping to convert more output into money. As Karl Polanyi noted, producing more output requires more inputs. Human beings and natural resources previously existing outside the market system become commodified, transforming people and nature into commodities. Marx, too, anticipated the monetary theory of production, noting that the circulation of commodities requires markets to convert commodities into money. Commodities are produced for sale, not for use by the immediate producers. As such, commodity production is central to the accumulation of capital. Accumulation involves converting money into commodities and back into money, a process that Marx referred to as the circuit of capital.5 The circuits assume different forms: retail or merchant capital, finance ­capital, and industrial capital. In each case, the businesses strategize to buy low and sell high. In merchant capital, businesses invest money (M) to purchase commodities (C), which are then sold for an amount exceeding the original purchase (M’), thereby completing the circuit. The circuit comprises M-C-M’.6 The difference between M’ and M is profit, providing an incentive to both shorten and expand the circuit. As noted, the railroad and telegraph helped create a national market. The telegraph provided almost instant communication, providing the ability to control the distribution of products. Modern advertising followed, reducing the transactions costs incurred. As Dudley Dillard reflected, “A monetary theory of production may be viewed as a type of institutional economics because it takes account of the way in which the institution of money capital affects the behavior of business firms and the economy as a whole.” Keynes’ theory of effective

Continuous-Mass Production and the Rise of the Modern Corporation  51 demand restated the monetary theory of production (Dillard 1980). Revenues depend on sales; sales depend on demand. For businesses to produce goods for markets, there must be markets for goods. As Keynes recognized, converting output into money is a problem of inadequate demand. In Warren Gramm’s words, “insufficiency in consumer demand . . . stems, in turn, from excessive inequality in the distribution of income and credit” (1978, 311; see Keynes 1964, 372–373). For Veblen, the monetary theory of production is central to the corporation. “By the sale of the output the businessman ‘realizes’ his gains. To ‘realize’ means to covert saleable goods into money values” (Veblen 1975, 50). The aim of corporations is profit; enhancing profits lies, in part, in salesmanship, that is, in increasing consumer spending. “Its end and aim is not productive work, but profitable business; and its corporate activities are not in the nature of workmanship, but of salesmanship” (Veblen 1923, 83).

Conclusion Advances in communication and transportation led to the creation of a national market, making possible continuous-mass production. ­Continuous-mass production laid the basis for the institutional changes ­associated with the rise of consumer capitalism. The increased output, ­however, stemmed not so much from large, fixed costs, generally ­considered the cause of economies of scale.7 Rather, the increased output stemmed from running machinery continuously, which, in turn, required a ­managerial structure to oversee production, procure a continuous stream of inputs, and ensure the sale of the output. The increased output required the modern corporation, adopted by American business in the late nineteenth, early twentieth centuries. Manufactures of cigarettes, soaps, cereals, flour, razors, canning, automobiles, etc. all adopted continuous-mass production. The ­increased output, in turn, led to the age of abundance, requiring modern ­advertising, the establishment of brands, and changes in how goods are sold, establishing retail outlets, chain stores, and department stores all ­directed at persuading the consumer to purchase the goods. Those purchases, in turn, speed up the circuits of capital, thereby increasing profits. ­ roduction The early twentieth century, however, saw continuous-mass p applied in two different avenues: production of goods for the masses v­ ersus production of goods for dynastic ambitions. The different avenues ­ultimately manifested themselves in the wars of the twentieth century.

Notes 1 As Veblen noted, the etymon of sabotage is the French word sabot meaning wooden shoe. Sabotage means “foot dragging” (see Veblen 1921, 1–4). 2 “Through the corporate form of organization it became possible to combine the small savings of the thousands into huge sums, which could then be given a directing force by the great captains of finance and industry” (Huebner 1910, 483).

52  Continuous-Mass Production and the Rise of the Modern Corporation 3 My thanks to Jan Knoedler for pointing out an article by Anne Mayhew discussing the importance of Chandler’s emphasis on the “economies of speed,” requiring a managerial structure to oversee production. As Mayhew points out, Chandler dropped the term “economies of speed” for the more conventional and less clear economies of scale and scope (see Mayhew and Carroll 1993). 4 The brand name ‘is an institution which counteracts the effects of quality uncertainty’ (George Akerlof quoted in Schudson 1986, 158). 5 The circuit for the worker differs from that of the capitalist. The worker ­aspires to survive. In Veblenian terms, the worker aspires to earn sufficient income to achieve the pecuniary standard, the standard of living requisite to lead a ­respectable life. He sells his labor for money, which he uses to purchase food, shelter, clothing, and other goods. For the worker, the end of the circuit and the beginning differ qualitatively, but quantitatively they are the same. The worker sells the only commodity at his disposal, his labor power, and ends with commodities he needs. Quantitatively, the beginning and the end are the same: the value of worker’s labor power equals the value of the commodities purchased. 6 As noted, the circuits assume three different forms: retail or merchant capital, industrial capital, and finance capital. In Industrial capital, the capitalist takes money (M) to buy inputs (C): labor, capital, and raw materials, which then goes through a production process (P) to produce output (C’). The outputs are then sold for an amount of money (M’) exceeding the original investment. The­ ­difference is profit. In finance capital, the capitalist loans money (M), which the debtor repays later for an amount (M’) exceeding the original loan. The ­difference is interest. 7 Economies of scale are also attributed to specialization and division of labor, increasing the skill and dexterity of workers (see Smith 1937).

References Atkinson, Glen W., and Stephen P. Paschall. 2016. Law and Economics from an ­ Evolutionary Perspective, New Horizons in Institutional and Evolutionary ­Economics. Cheltenham, United Kingdom: Edward Elgar Publishing. Benson, Susan Porter. 1986. Counter Cultures: Saleswomen, Managers, and Customers in American Department Stores, 1890–1940, Vol. 314. Urbana, IL: University of Illinois Press. Berle, A. A., and G. C. Means. 1932. The Modern Corporation and Private Property. Rev. ed. New York: Harcourt. Chandler, Alfred D. 1986. “The Beginnings of the Modern Industrial Corporation.” Proceedings of the American Philosophical Society 130 (4): 382–389. Chandler, Alfred D. 1977. The Visible Hand: The Managerial Revolution in A ­ merican Business. Cambridge, MA: Belknap Press. Chandler, Alfred D., and Takashi Hikino. 1990. Scale and Scope: The Dynamics of Industrial Capitalism. Cambridge, MA: Belknap Press. Chandler, Alfred D., Jr. 1959. “The Beginnings of “Big Business” in American ­Industry.” Business History Review (pre-1986) 33 (000001): 1. ———. 1964. Giant Enterprise: Ford, General Motors, and the Automobile Industry; Sources and Readings. New York: Harcourt Brace & World. Dillard, Dudley. 1980. “A Monetary Theory of Production: Keynes and the Institutionalists.” Journal of Economic Issues 14 (2): 255–273. Ely, Richard Theodore. 1887. “Social Studies.-II. The Growth of Corporations.” History of Economic Thought Articles 75: 71–79.

Continuous-Mass Production and the Rise of the Modern Corporation  53 Faulkner, Harold U. 1960. American Economic History. New York: Harper & Brothers. Ford, Henry, and Samuel Crowther. 1922. My Life and Work. Garden City, NY: Doubleday, Page. Galbi, Douglas. 2008. U.S. Annual Advertising Spending Since 1919, edited by U.S. Annual Advertising Spending Since 1919. http://galbithink.org: New Ideas, Data, and Analysis in Communications Policy. Ganley, William T. 2004. “The Theory of Business Enterprise and Veblen’s N ­ eglected Theory of Corporation Finance.” Journal of Economic Issues 38 (2): 397–403. Gordon, David. 1984. “Swift & Co. v. United States: The Beef Trust and the Stream of Commerce Doctrine.” The American Journal of Legal History 28 (3): 244–279. doi: 10.2307/844700. Gramm, Warren S. 1978. “Credit Saturation, Secular Redistribution, and LongRun Stability.” Journal of Economic Issues 12 (2): 307–327. Hake, Eric R. 1998. “Financial Innovation as Facilitator of Merger Activity.” Journal of Economic Issues 32 (1): 145–170. Hamill, Susan Pace. 1999. “From Special Privilege to General Utility: A Continuation of Willard Hurst’s Study of Corporations.” American University Law Review 49: 81. Hounshell, David A. 1984. From the American System to Mass Production, 1800– 1932: The Development of Manufacturing Technology in the United States, Studies in Industry and Society. Baltimore, MD: Johns Hopkins University Press. Huebner, S. S. 1910. “Scope and Functions of the Stock Market.” The Annals of the American Academy of Political and Social Science 35 (3): 1–23. Jevons, H. Stanley. 1933. “The Causes of Fluctuations of Industrial Activity and the Price-Level.” Journal of the Royal Statistical Society 96 (4): 545–605. doi: 10.2307/2341899. Keynes, John Maynard. 1964. The General Theory of Employment, Interest, and Money. New York: Harbinger. Original edition, 1936. Reprint, 1964. Levinson, Marc. 2011. The Great A&P and the Struggle for Small Business in ­America. 1st ed. New York: Hill and Wang. Marchand, Roland. 1985. Advertising the American Dream: Making Way for ­Modernity 1920–1940. Berkeley, CA: University of California Press. Mayhew, Anne, and Sidney L. Carroll. 1993. “Alfred Chandler’s Speed: Monetary Transformation.” Business and Economic History 22 (1): 105–113. Mokyr, Joel, and Robert H. Strotz. 1998. “The Second Industrial Revolution, ­1870–1914.” Storia dell’economia Mondiale 21945. Pope, Daniel. 1983. The Making of Modern Advertising. New York: Basic Books. Potter, David M. 1954. People of Plenty: Economic Abundance and the American Character. Chicago, IL: University of Chicago Press. Schudson, Michael. 1986. Advertising, The Uneasy Persuasion: Its Dubious Impact on American Society. New York: Basic Books. Smith, Adam. 1937. An Inquiry Into the Nature and Causes of the Wealth of Nations, edited by Edwin Cannan. New York: The Modern Library. Original edition, 1776. Strasser, Susan. 1989. Satisfaction Guaranteed: The Making of the American Mass Market. New York: Pantheon Books. Tunc, Tanfer Emin. 2012. “Less Sugar, More Warships: Food as American Propaganda in the First World War.” War in History 19 (2): 193–216. Veblen, Thorstein. 1921. The Engineers and the Price System. New York: Augustus M. Kelley. Original edition, 1965.

54  Continuous-Mass Production and the Rise of the Modern Corporation ———. 1923. Absentee Ownership and Business Enterprise in Recent Times. New York: Sentry Press. ———. 1975. The Theory of Business Enterprise. New York: Augustus M. Kelley. Original edition, 1904. United States Industrial Commission. 1900. Final Report of the Industrial ­Commission, edited by James H. Kyle and Albert Clarke, Vol. 7. Washington: Library of American Civilization (Gov’t print. Off). Williams, Raymond. 2000. “Advertising: The Magic System.” Advertising & Society Review 1 (1): 320–336.

4 How to Absorb the Output? Consumerism versus Militarism Veblen, Hobson, and Polanyi

At the end of the nineteenth and the beginning of the twentieth centuries, the increased output from continuous-mass production posed a problem: how to absorb the increased output? Thorstein Veblen, John A. Hobson, and Karl Polanyi offered different perspectives. For Veblen, the solution lay in the differences in culture. In England, the system of conspicuous waste ­fostered increases in consumption to absorb increases in output. In ­Germany and Japan, militarism absorbed the increased output, s­ ubsequently ­manifesting itself in war. For Hobson, the solution lay in increasing exports, leading to imperialism and, subsequently, war. For Polanyi, the solution lay in ­abandoning free trade, attempting to protect human beings and businesses from market forces. Polanyi, offering a global explanation, argued that the increased output from the Industrial Revolution necessitated the creation of a market economy, “an economy governed by prices and prices alone.” ­Polanyi warned, however, that the market economy represented a “stark utopia” that, if continued, would eventually destroy society itself. The different explanations turn on the problem posed by modern ­technology, the problem posed by continuous-mass production. Simply put, continuous-mass production posed the problem that continues to today, who will buy the goods?

Veblen and the Theory of Conspicuous Waste For Veblen, acquiring things for status reasons entails an invidious comparison, a valuation of human beings based on material worth. He viewed such comparisons as wasteful because they deny some people access to things they need. Conspicuous waste is a form of one-upmanship, a visible display of superiority. “In strict accuracy nothing should be included under the head of conspicuous waste but such expenditure as is incurred on the ground of an invidious pecuniary comparison” (Veblen [1899] 1979, 99). Conspicuous waste refers to the allocation of time, effort, and resources that detract from the life process, manifesting itself in both conspicuous consumption and conspicuous leisure. Over time, conspicuous waste “becomes a mark of pecuniary excellence,” “a requirement of

DOI: 10.4324/9780429443763-4

56  Consumerism versus Militarism: Veblen, Hobson, and Polanyi pecuniary decency” (Veblen [1914] 1964, 174). Veblen points to dress as an example: “In modern society, where the unit is the household, the woman’s dress sets forth the wealth of the household to which she belongs” (1964, 67). Conspicuous waste forms the “central principle” of all dress, giving rise to novelty because to wear last year’s clothes is considered bad form (Veblen 1964, 72). Conspicuous waste is a part of waste generally. Waste denotes power, manifesting itself in individual engagement in conspicuous consumption and conspicuous leisure; corporate expenditures to sell goods without augmenting industry; and expenditures by government on wasteful activities, notably military.1 All represent means of absorbing production beyond costs; all represent expressions of dominance. Emulation involves acquiring the objects and engaging in activities valued by others. In addition to women’s fashion examples of conspicuous consumption include second homes, the green lawn, devout clothing, and so on. Conspicuous leisure includes time spent learning proper etiquette, learning classical languages, and engaging in sports inaccessible to the masses. Over time, conspicuous waste shapes the standards and conventions that guide consumption. Innovations that prove serviceable may themselves become items of conspicuous consumption. In the process of gradual amelioration which takes place in the articles of his consumption, the motive principle and the proximate aim of innovation is no doubt the higher efficiency of the improved and more elaborate products for personal comfort and well-being. But that does not remain the sole purpose of their consumption. The canon of reputability is at hand and seizes upon such innovations as are, according to its standard, fit to survive. Since the consumption of these more excellent goods is an evidence of wealth, it becomes honorific; and conversely, the failure to consume in due quantity and quality becomes a mark of inferiority and demerit. (Veblen [1899] 1979, 73–74) Over time, conspicuous waste shapes the standards and conventions that guide consumption. Innovations that prove serviceable may themselves become items of conspicuous consumption. For the untrained eye, ornamentation becomes the basis for valuing goods. As Veblen noted, both a machine-made metal spoon and a hand-made silver spoon are equally serviceable. People’s preference for the silver spoon stems from its expensiveness. “The superior gratification derived from the use and contemplation of costly and supposedly beautiful products is, commonly, in great measure a gratification of our sense of costliness masquerading under the name of beauty” ([1899] 1979, 128). Expensiveness becomes synonymous with beauty.

Consumerism versus Militarism: Veblen, Hobson, and Polanyi  57 The System of Conspicuous Waste and the Standard of Living Veblen refers to conspicuous waste as the standard of living, by which he means “the conventions of consumption” ([1915] 1968, 122, 136), a development of the pecuniary standard of living introduced in The ­Theory of the Leisure Class. The standard of living refers to the conventions to which people are expected to consume. The pecuniary standard of living is that required to live a respectable life. In past societies such as ancient Rome, the standard of living occasionally exceeded the available means. There is a constant proclivity to advance this conventional “standard of living” to the limit set by the available means; and yet these conventional necessities will ordinarily not, in the aggregate, take up all the available means; although now and again, as under the Ancien Regime, and perhaps in Imperial Rome, the standard of splendid living may also exceed the current means in hand and lead to impoverishment of the underlying community. (Veblen 1917, 148–49) In the early part of the machine era, however, the productive capacity was not so great as to outrun the consumption of the community: “the ordinary volume of output in the mechanical industries was still relatively slight and manageable” (Veblen [1921] 1965, 35). The situation changed by mid-­nineteenth century in England and in the late nineteenth century in America. “The productive capacity of the mechanical industry was visibly overtaking the capacity of the markets, so that free competition without afterthought was no longer a sound footing on which to manage production” (Veblen [1921] 1965, 36). In The Theory of Business Enterprise, Veblen expressed doubt whether the surplus could be absorbed. Wasteful expenditure on a scale adequate to offset the surplus productivity of modern industry is nearly out of the question. Private initiative cannot carry the waste of goods and services to nearly the point required by the business situation. Private waste is no doubt large, but business principles, leading to saving and shrewd investment, are too ingrained in the habits of modern men to admit an effective retardation of the rate of saving. ([1904] 1975, 255–56) As noted, the rise of the corporate form of organization had two options to maintain or increase profits: limit output and increase wasteful consumption. By one means or another prices must be maintained at a profitable level for reasons of business; therefore the output must be restricted

58  Consumerism versus Militarism: Veblen, Hobson, and Polanyi to a reasonable rate and volume, and wasteful consumption must be ­provided for, on pain of a failing market. (Veblen 1919b, 153) The system of wasteful consumption rests on the technology of mass production. The system channels the income of individuals toward spending. Mass production makes affordable to the masses goods previously accessible only to the wealthy, thereby “democratizing” status goods.2 Examples abound. The reemergence of long-distance trade resulting from the crusades introduced Europeans to tobacco, sugar, and chocolate, what Sidney Mintz referred to as the addictive goods. Initially, sugar was a status good affordable only by the wealthy. By 1850, sugar was consumed by ­commoners alike (see Mintz 1985). The automobile provides another example. Initially afforded only by the rich, Henry Ford applied the assembly line to the ­production of automobiles, making automobiles affordable to the masses. Cell phones represent a more recent example. Mass production reduces the per-unit costs of goods making them affordable to the masses, allowing the status goods at one time to become part of the pecuniary standard the next time. If mass production made some status goods affordable, the system of conspicuous waste represents the emergence of institutions, habits, and conventions that made such goods more accessible. Veblen limited his comments regarding business efforts to increase consumer spending to advertising, the purpose of which is to increase sales. Veblen believed that “salesmanship, is, in a way, the whole end and substance of business enterprise” (Veblen [1921] 1965, 108). Salesmanship increases profits, not industry. While it helps absorb output, salesmanship and advertising also increase costs. Also, it follows that industry is controlled and directed with a view to sales, and a wise expenditure of industrial efficiency, in the business sense, comes to mean such expenditure as contributed to sales; which may often mean that the larger share of costs, as the goods reach their users, is the industrially wasteful cost of advertising and other expedients of salesmanship. (Veblen [1915] 1968, 33). Veblen omitted commenting on consumer credit, suggesting that Veblen was unaware of its emerging role in financing consumer purchases during the durable-goods revolution of the late nineteenth and early twentieth centuries. Nevertheless, both credit and advertising helped make status goods accessible to the masses. Both expand the system of conspicuous waste, making the system the primary means of absorbing ever-rising levels of output, raising the standard of living, and maintaining and increasing profits. Veblen’s view prompts the question: why is increasing the standard of living a problem? Few, perhaps, would reject the serviceability stemming from the automobile, electrification, or modern computers. After all, advances in medical technology, hygiene, and nutrition have extended human

Consumerism versus Militarism: Veblen, Hobson, and Polanyi  59 life ­despite the lack of accessibility for many. In response, Veblen carefully ­ istinguishes the conventions of consumption from individual well-being. d These conventions of consumption may be classed together under the rubric of a standard of living, as is commonly done in the terminology of the economists; although in its technical use the term does not refer to a standard of physical well-being, as its etymological value might lead one to expect. It means rather the standard of consumption, on whatever grounds the consumption has been standardised, and it will commonly include items that bear no relation, or at least no designated relation, to the consumer’s physical well-being. (Veblen [1915] 1968, 136–137) Veblen sharply delineates between the “conventions of consumption” designated as the standard of living and those innovations that, in fact, enhance the life process. Often, however, innovations that can enhance the life process may become sources of power and domination. Providing for the few at the exclusion of the many enhances invidiousness. The existing system has not made, and does not tend to make, the industrious poor poorer as measured absolutely in means of livelihood; but it does tend to make them relatively poorer, in their own eyes, as measured in terms of comparative economic importance, and, curious as it may seem at first sight, that is what seems to count. (Veblen 1919a, 392) In such cases, rising expenditures do little to increase the quality of life: this emulation in expenditure stands ever ready to absorb any margin of income that remains after ordinary physical wants and comforts have been provided for, and, further, that it presently becomes as hard to give up that part of one’s habitual “standard of living” which is due to the struggle for respectability, as it is to give up many physical comforts. In a general way, the need of expenditure in this direction grows as fast as the means of satisfying it, and, in the long run, a large expenditure comes no nearer satisfying the desire than a smaller one. (Veblen 1919a, 394–395) England versus Germany The importance of the system of conspicuous waste reveals itself in Veblen’s comparison of England and Germany in the years before World War I, which Veblen explores in Imperial Germany and the Industrial Revolution. The book “was an examination of the causes of Germany’s emergence as an aggressive and formidable war power.” It concerned itself “with broader questions of the causes and consequences of war, questions seldom

60  Consumerism versus Militarism: Veblen, Hobson, and Polanyi addressed by economists of his day or since” (Biddle and Samuels 2003, 203). The organizing principle is the idea of cumulative causation. Technology developed in England and transferred to Germany evoked distinct cultural responses. England, with its history of individualism, free markets, and limited government, gave free expression to the individual, eventually manifesting itself in the system of conspicuous waste. The dominant note of everyday life was industry and trade, not dynastic politics and war. This national experience gave as its outcome constitutional government and the modern industrial technology, together with the animus and the point of view of the modern materialistic science. (Veblen [1904] 1975, 304–305) In England, the standard of living had been rising since the Industrial Revolution, a standard largely set by the upper classes. In Germany, living standards remained lower than in England. The paucity of data from the late nineteenth and early twentieth centuries nevertheless provides some support for Veblen’s thesis that Germany had a much lower standard of living than that of the England or the United States. Table 4.1 indicates the per-capita GDP in 1990 international dollars for Germany, the UK, and the USA. As noted, as output increased British culture adapted by increasing spending to absorb the increased output. The purpose was to “take up the calculable slack, – the margin between production and productive consumption” (Veblen [1915] 1968, 34). The increased spending, in turn, helps create a feedback loop, fostering an increase in industrial efficiency relative to that found on the continent. Hence, the system of conspicuous waste is associated with the ceremonial practices that ensure that the surplus consumption will, in fact, be purchased. Even so, advances in technology that, in turn, increase economic output does not automatically increase wasteful expenditures, particularly when technology is transferred from one country to another. As Veblen noted, But since the growth and acceptance of any scheme of wasteful e­ xpenditure is after all subsequent to and consequent upon the surplus ­productivity of the industrial system on which it rests, the introduction, Table 4.1  Per-Capita GDP in 1990 International Dollars Year

Germany

UK

USA

1820 1870 1900 1913

$1,112 $1,913 $3,134 $3,833

$1,756 $3,263 $4,593 $5,032

$1,287 $2,457 $4,096 $5,307

Source: Maddison, Angus. Dynamic Forces in Capitalist Development (1991, Table 1-3, 23).

Consumerism versus Militarism: Veblen, Hobson, and Polanyi  61 in whole or in part, of a new and more efficient state of the industrial arts does not carry with it from the outset a fully developed system of standardized consumption; particularly, it need not follow that the standard scheme of consumption will be carried over intact in case a new industrial technology is borrowed. ([1915] 1968, 36) Despite lacking England’s cultural habits, the transference of technology nevertheless provided Germany with an advantage. Germany could avoid the cost of developing the technology. England too had borrowed much of its technology, but over a longer time period and from nations with similar cultures. Being first to develop machine technology later proved to be a deterrent. England had built its railroads using a narrow gauge, which later proved a hindrance as transportation advanced. “It is only that they are paying the penalty for having been thrown into the lead and so having shown the way is the disadvantage of being first” (Veblen [1915] 1968, 132). In Germany, industry served the state. The German state was dominated by dynastic elements. The increased output exerted two effects. First, it enabled the leaders of Germany to extend the power and efficiency of the state. And second, the advances in technology—larger-scale industries, larger scale of trade and industry, and increased costs—forced the state to reorganize. Germany’s purpose was to create a self-sufficient empire, using ­m ilitarism to dispose of its surplus and attain its dynastic ambitions. “The combination of the time-honored ‘fanatical loyalty of feudal barbarism’ with the ­possession of modern technology made the dynastic state a formidable ­warlike force indeed” (Biddle and Samuels 2003, 214). The percentage of government expenditures on military for Germany, the UK, and the USA are indicated in Table 4.2. The dynastic elements in the German state stemmed from Germany’s ­feudal past. For Germany, militarism, not the system of conspicuous waste, absorbed the excess production, providing the basis for the war that followed. What makes this German Imperial establishment redoubtable, beyond comparison, is the very simple but also very grave combination Table 4.2  Military Expenditures as a Percent of the National Budget Year

Germany

UK

USA

1870 1880 1890 1900 1910 1914

92% 75% 51% 44% 43% 64%

33% 34% 36% 38% 44% 40%

44% 27% 19% 23% 39% 42%

Source: Wright, Quincy. A Study of War (1942, Table 58, collumn 12, 670).

62  Consumerism versus Militarism: Veblen, Hobson, and Polanyi of circumstances whereby the German people have acquired the use of the modern industrial arts in the highest state of efficiency, at the same time that they have retained unabated the fanatical loyalty of feudal barbarism. (Veblen 1917, 201)

John A. Hobson and Underconsumption John A. Hobson too recognized the emergence of a consumer society. Hobson’s view of the economic system prominently features the role of the consumer. “The industrial system thus exists primarily as a great cooperative society of consumers. For it is a pecuniary stimuli proceeding from consumers that are seen to maintain the industrial structure at each point and to stimulate its regular activity” (Hobson 1911, 55). Continuous-mass production technology, introduced in the late nineteenth century, had a disruptive effect. Production tending to outpace consumption results in depression, which the industrialized nations attempted to mitigate through imperialism. As one nation after another enters the machine economy and adopts advanced industrial methods, it becomes more difficult for its manufacturers, merchants, and financiers to dispose profitably of their economic resources, and they are tempted more and more to use their Governments in order to secure for their particular use some distant undeveloped country by annexation and protection. (Hobson 1902, 86) Hobson poses the question, why do increases in consumption fall behind production? Why do consumers fail to purchase all the goods produced? Hobson offers two explanations: “first, the conservative character of the arts of consumption, or standards of living, as compared with the modern arts of production; second, the ways in which the current distribution of income confirms this conservatism of consumption” (Hobson [1922] 1924, 32). Different cultural influences result in different spending habits. Individuals who are largely homebodies or whose occupation or location restricts them to the home tend to be more conservative in their spending habits since they are more isolated from “any strong continual stimulus to imitation and competition.” Accordingly, exposure to outside influence enhances consumer expenditures. Consumption patterns in “dress, travel, and recreation” change more rapidly, since they “are subject to publicity and imitation and carry personal prestige” (Hobson [1922] 1924, 33). Hobson continues: Though modern man, in his capacity of consumer, is far more progressive than his ancestors, his power of taking on new economic needs and

Consumerism versus Militarism: Veblen, Hobson, and Polanyi  63 of raising rapidly the quantity, variety and quality of his consumption, is limited by a narrowness of imagination and a servitude to habit which are far less dominant in production. ([1922] 1924, 33) The habitual nature of consumption points to the distinction between producers and consumers. “As a producer he is specialized, as a consumer he is generalized” (Hobson 1911, 51). Producers have a vested interest that consumers generate new interests, develop new tastes, embrace new products. For as a producer his interest lies in selling more goods. The habitual nature of consumption combined with inequality breaks increases in consumption. Moreover, consumers are generally slow to develop new interests, new ­habits, and new tastes. For Hobson, in other words, the different cultural influences may result in an imbalance. As Hobson observes, the interplay between functions of saving and consuming produces a dilemma: “saving and investment for enlargement of production are only economically valid on condition that the enlarged production is accompanied or soon followed by a proportionately enlarged consumption” ([1922] 1924, 38). The second reason for consumption to lag production lies in the inequality in the distribution of income. Income represents the costs of production, assuming the form of payments for land, labor, and capital. Hobson, however, goes further, placing income in three categories depending on their use: income used to maintain the system, income resulting in a productive surplus, and income in an unproductive surplus. Maintaining the industrial system involves payment for subsistence and a fund to replace worn-out machinery. The productive surplus refers to income used to acquire new capital or to pay higher wages. Higher wages increase the quality of labor, enhancing the standard of living. [I]t will evoke and maintain a better physique and morale among the workers. Better food, housing and clothing will improve the “home,” raise the standard of personal dignity and intelligence for the worker, enable the seeds of higher education to take root. And to bear fruit in a better use of money and leisure, and in the development and satisfaction of higher wants. (Hobson 1911, 69–70) The “unproductive surplus” results when “a factor of production receives a payment for its use in excess of what is needed to evoke its full use” (Hobson 1911, 78). Unproductive surpluses reduce economic activity, representing a waste. “It acts simply as a demand for idleness” (Hobson 1911, 80). Further, the unproductive surplus results in underconsumption, manifesting itself as too much saving. In Hobson’s view, saving means reallocating

64  Consumerism versus Militarism: Veblen, Hobson, and Polanyi expenditures from purchasing consumer goods to purchasing producers goods (1911, 59). The real economic function of saving must be clearly kept in mind. . . . It consists in paying producers to make more non-consumable goods for use as capital, instead of paying them to make more consumable goods and consuming them. (Hobson [1922] 1924, 34) This differs from Keynes, who viewed saving as reducing present consumption. As noted, saving has two sources: the conservative, habitual nature of consumption and inequality in the distribution of income. As Hobson comments, “It is this conservatism that is expressed in consumption” (Hobson [1922] 1924, 34). The problem lies in saving resulting in the production of capital used to produce goods that consumers are unable or unwilling to purchase. For Hobson, the problem lies in the distribution of income. if a tendency to distribute income are consuming power according to needs were operative, It is evident that consumption would rise with every rise of producing power, for human needs are illimitable, and there could be no excess of saving. (1902, 88) He concedes that if the country could increase its “standard of consumption to keep pace with every rise of productive powers, there could be no excess of goods or capital clamorous to use Imperialism in order to find markets” (Hobson 1902, 86). Industry, however, has no incentive to raise wages since only a small portion of an increase in wages in any particular industry would go toward purchasing the product of that industry. Besides, competition among workers prevents wages from increasing at the same rate as productivity. “Wages are based upon costs of living, and not upon efficiency of labor” (Hobson 1902, 88–89). Moreover, it is in every industry’s interest to keep wages as low as possible (Hobson 1930, 88). Nevertheless, cutting wages to end depressions is ineffective. Cutting wages may help increase exports for one country but only at the expense of other countries. It serves only to redistribute the depression (Hobson 1922, 14). Depression Excessive saving means investing in capital that results in producing goods exceeding what society can absorb. Hence, for Hobson, depressions result from underconsumption, a lack of demand for finished products (Hobson [1922] 1924, 31). Imperialism represents an effort to avoid depression.

Consumerism versus Militarism: Veblen, Hobson, and Polanyi  65 Hobson distinguishes between colonialism and imperialism. Colonialism involves transplanting the mother country’s institutions, laws, and people to the colony. In response to the inability to assimilate the indigenous people, the mother country resorts to force, a policy adopted by most of the European powers the late nineteenth century (Hobson 1902,  6). Hobson placed the origins of imperialism at 1870, reaching its apex in the mid-1880s. Imperialism involves using the government to advance the interests of the wealthy (Hobson 1902, 99). The purpose of imperialism is to increase unproductive surplus “by seeking foreign markets and foreign investments to take off the goods and capital they cannot sell or use at home” (Hobson 1902, 91). Imperialism, however, is not a long-term solution. Hobson mentions two dangers in extending his analysis to the global economy: first, an uncontrolled industrialism and an increased output and second, peoples of color working at low wages for white owners of capital. Expanding into foreign markets and moving industries overseas substitute the division between capital and labor for a less dangerous division: between the North and South. Moving industries overseas might help, but it is not a long-term solution. “A world-commerce system conducted under such conditions would retain and very probably enhance the inequality of income which, as we have seen, disables effective demand for commodities from keeping pace with the increase of the industrial producing power” (Hobson 1922, 116–117). Hobson points out that the tendency for consumption to lag production led to the industrialized nations of the nineteenth century to turn to increasing exports. One country may increase its saving if other nations increase their consumption.

Polanyi and the Breakdown of Market Economy Polanyi did not explore the institutional changes wrought by the introduction of continuous-mass production. He did not address the rise of the corporation, changes in the concept of property, or anticipate of emergence of a consumer society. He treated imperialism as signifying the breakdown of the market economy. Polanyi focused on the market economy, concentrating on its international dimensions, its origins, and its subsequent demise. The market economy arose in response to the needs of business to sell the goods pouring forth from England’s factories. Arising in response to the Industrial Revolution, the market economy or liberal capitalism rested on four institutions: the self-equilibrating market, the gold standard, the liberal state, and the balance-of-power system. . . . the fount and matrix of the system was the self-regulating market. It was this innovation which gave rise to a specific civilization. The gold standard was merely an attempt to extend the domestic market system to the international field; the balance-of-power system was

66  Consumerism versus Militarism: Veblen, Hobson, and Polanyi a superstructure erected upon and, partly, worked through the gold standard; the liberal state was itself a creation of the self-regulating market. The key to the institutional system of the nineteenth century lay in the laws governing market economy. (Polanyi [1944] 2001, 3) Polanyi treated machine production as an accelerating continuum ­stemming from the Industrial Revolution. The increased output exceeded what ­England could profitably absorb. To sell output and to obtain inputs, England adopted a policy of laissez-faire and erected a system of self-­ equilibrating markets. Selling more output and purchasing more inputs required a market economy, a self-regulating system of markets governed by prices and prices alone. Prices perform the allocative function of determining production and the distributive function of controlling incomes. Once established, the system proceeds without interference. Although markets have existed long before in different societies, the ­emergence of the market economy was historically unique. Past ­societies protected human beings and nature from market forces. In contrast, a ­market economy transforms land, labor, and money into commodities, into something bought and sold. It affects all social institutions because it ­precludes efforts to control land, labor, and money by institutions other ­ arket. Society itself becomes “an adjunct to the market” (Polanyi than the m [1944] 2001, 60). Polanyi continues: Instead of economy being embedded in social relations, social relations are embedded in the economic system. The vital importance of the economic factor to the existence of society precludes any other result. For once the economic system is organized in separate institutions, based on specific motives and conferring a special status, society must be shaped in such a manner as to allow that system to function according to its own laws. This is the meaning of the familiar assertion that a market economy can function only in a market society. ([1944] 2001, 60) Subjecting human relations to market forces means relating human beings, nature, and money quantitatively. This “exchange of equivalents,” to use Marx’s phraseology, involves a process of social abstraction ([1867] 1976). Treating human beings and nature as commodities disregards their qualitative differences. It involves disembedding the economy from its social and ecological contexts. Hence, Polanyi referred to labor and land as fictitious commodities, fictious because they are not produced for sale. Subjecting human beings to market forces requires that the market system provides the only source of support. Income becomes proportional to the value of the commodity contributed. Each person looks to his own interest and not to the interests of others. “An economy of this kind derives from the expectation that human beings behave in such a way as to achieve maximum money gains” (Polanyi [1944] 2001, 71).

Consumerism versus Militarism: Veblen, Hobson, and Polanyi  67 Using Economic Insecurity to Motivate Labor Karl Polanyi’s critique of the market economy reveals the contradictions inherent in transforming labor into a commodity. A commodity is something bought and sold, something alienable. The conceptual basis of the market economy rests on the tradition of natural rights. Natural rights are inalienable. A laborer cannot sell himself. He cannot alienate title to his person. Slavery is forbidden, at least in theory. A laborer sells his promise to work. Transforming labor into a commodity establishes conditions “inducing” the worker to fulfill that promise. There are two conditions creating economic insecurity to induce labor to work for wages. The first condition requires making human beings depend solely on the market to derive their income. This requires disembedding labor, treating human beings as separate from their social contexts, eliminating the prospect of deriving an income from institutions other than the market. This, in turn, requires removing alternative institutions that human beings have historically relied on and continue to rely for support: personal relationships, the government, or self-sufficiency stemming from living off the land or, in Polanyi’s classification, the institutions of reciprocity, redistribution, and householding.3 The second related condition refers to eliciting the “appropriate” behavior, that is, setting the conditions to ensure a “rational” response. A rational response involves avoiding economic insecurity, which found its legitimacy in the ideas of Jeremy Bentham and Thomas Robert Malthus. First, Bentham’s utilitarianism assumed that humans pursue pleasure and avoid pain, rationalizing the threat of hunger to motivate people.4 The rise of the market to a ruling force in the economy can be traced by noting the extent to which land and food were mobilized through [market] exchange, and labor was turned into a commodity free to be purchased in the market. (Polanyi 1968, 156; emphasis in the original) Hunger provided an advantage over other ways of motivating people: “The calculus of pain and pleasure required that no avoidable pain should be inflicted. If hunger would do the job, no other penalty was needed” (Polanyi [1944] 2001, 117). Second, using the threat of hunger to motivate people found further support in the ideas of Robert Townsend and Thomas Robert Malthus. Townsend describes an island of dogs and goats in which only the fittest survive. Malthus subsequently borrowed the idea from Townsend to serve as the basis for Malthus’ theory of population. Both Townsend and Malthus described the struggle to survive as a law of nature, claiming that starvation is natural. For Malthus, avoiding starvation becomes a moral imperative, part of God’s divine plan. Evil exists in the world not to create despair but activity. We are not patiently to submit to it, but to exert ourselves to avoid it. It is not only

68  Consumerism versus Militarism: Veblen, Hobson, and Polanyi the interest but the duty of every individual to use his utmost efforts to remove evil from himself and from as large a circle as he can influence, and the more he exercises himself in this duty, the more wisely he directs his efforts, and the more successful these efforts are, the more he will probably improve and exalt his own mind and the more completely does he appear to fulfil the will of his Creator.5 ([1798] 1982, 158) Polanyi explored the meaning of the market economy for labor, building on the ideas of Max Weber. Weber (1958, 21) defined capitalism as the “rational capitalistic organization of (formally) free labour.”6 In contrast to previous societies, capitalism places the process of social provisioning on a “rational” basis. That is, transforming the labor force into commodities enables organizing labor on a rational basis. “Exact calculation—the basis of everything else—is only possible on a basis of free labor” (Weber 1958, 22). Weber recognized the implications for business interests. Organizing human beings based on slavery, serfdom, despotism and so on renders economic rationality impossible. Under slavery, for example, the slave owner becomes responsible for the slave’s well-being, making a precise calculation of costs impossible. Transforming labor into a commodity, however, casts the capitalist-worker relation in monetary terms, allowing for rational calculation. Since workers are responsible for their own well-being, capitalists can precisely calculate costs and thus profits. While “free” wage labor ­allows applying economic rationality to the purchase of labor-power, Weber did not explore the meaning of “free” labor for wage-laborers. This was ­Polanyi’s contribution.7 As noted, transforming labor into a commodity represents an attempt to disembed society. It attempts to sever human beings and nature from their social and ecological relationships. “Traditionally, land and labor are not separated; labor forms part of life, land remains part of nature, life and nature form an articulate whole” (Polanyi [1944] 2001, 178). From the perspective of the market system, human beings only have value as laborers in the production process; nature only has value as lumber to build, land to develop, or ore to mine; output only has value if it can be transformed into money, which, in the nineteenth century, meant gold. Organizing society as a market assumes that the market system works independently of society and nature. Moreover, establishing a market economy requires “a change in the motive of action on part of the members of society” (Polanyi [1944] 2001, 41). The motive of self-interest replaces the motive of subsistence. The market economy presumes that everyone is a merchant, or in Adam Smith’s words, everyone has a “certain propensity . . . to truck, barter, and exchange one thing for another” ([1776] 1937, 13). The presumption that people are motivated by money justified attempts to eliminate or restrict institutions other than the market. Hence, the creation

Consumerism versus Militarism: Veblen, Hobson, and Polanyi  69 of a market economy necessarily involved “a change in the motive of action on part of the members of society” [Polanyi, 1964, 232, 41]. In establishing the market economy, the motive of self-interest replaces the motive of subsistence. Individuals are motivated by the pursuit of gain and the avoidance of hunger. Polanyi, however, disagrees: “The true criticism of market society is not that it was based on economics—in a sense, every and any society must be based on it—but that its economy was based on self-interest” ([1944] 2001, 249). From the point of view of advocates of the market economy, poverty results either from the irrational organization of society or from morally deficient individuals. Hence, treating labor as a commodity requires eliminating all forms of social protection.8 Of course, eliminating personal support is impossible; eliminating government support, however, requires separating the political sphere from the economic, making society “an adjunct to the market.” Polanyi continues: Instead of economy being embedded in social relations, social relations are embedded in the economic system. The vital importance of the economic factor to the existence of society precludes any other result. For once the economic system is organized in separate institutions, based on specific motives and conferring a special status, society must be shaped in such a manner as to allow that system to function according to its own laws. This is the meaning of the familiar assertion that a market economy can function only in a market society. ([1944] 2001, 60) As expressed in the invisible-hand doctrine, the classical economists ­assumed that the exercise of individual rights would unintentionally lead to the discharge of social responsibilities. They limited, however, social r­ esponsibilities to the production of goods and services, tying together service with profit, identifying progress with growth.9 From the viewpoint of classical economics, increasing output meant increasing profits. Everyone benefits. Profits become central to the process of social provisioning, providing the funds from which labor is paid. The centrality of labor to the provisioning process manifests itself in the classical view that labor, or more generally costs of production, is the source of value, a point that Smith readily acknowledged: “Labor is the original purchase price paid for all things” ([1776] 1937). Polanyi, too, emphasizes the centrality of land and labor to the provisioning process. As noted, however, he objected to characterizing land and labor as commodities; they are fictitious commodities because they are not produced for sale. Hence, the effort to create a purely market economy represented a utopian endeavor to treat land, labor, and money as commodities. The reality of unemployed workers, environmental destruction, and failing businesses created a counter movement to protect labor, land, and business from market forces. In brief, Polanyi’s thesis concludes the impossibility of rationally organizing society on the basis of commodities alone.

70  Consumerism versus Militarism: Veblen, Hobson, and Polanyi Polanyi’s Double Movement The demand for intervention arose spontaneously to protect both human beings and business from market forces. “While laissez-faire economy was the product of deliberate state action, subsequent restrictions on laissez-faire started in a spontaneous way. Laissez-faire was planned; planning was not” (Polanyi [1944] 2001, 147). In Polanyi’s view, “the concept of a self-­ regulating market was utopian, and its progress was stopped by the realistic self-­protection of society” ([1944] 2001, 148). Demands for a shorter workday, for a living wage, for safe working conditions, and so on grew out of an effort to protect human beings, legitimized by a sense of fairness. As Polanyi remarked, The history of the various acts embodying this idea [workman’s compensation], since 1880, showed consistent adherence to the individualist principle that the responsibility of the employer to his employee must be regulated in a manner strictly identical with that governing his responsibility to others, e.g., strangers. ([1944] 2001, 153) As noted, Polanyi attributed both the origins of the market economy and its subsequent breakdown to the Industrial Revolution. The source of the breakdown “lay more than a hundred years back in that social and technological upheaval from which the idea of a self-regulating markets system sprang in Western Europe” ([1944] 2001, 5). The market economy was organized to allow business to profit from machine production. By the late nineteenth century, however, the increased output stemming from the introduction of continuous-mass production spelled the demise of the market economy. The reason is simple enough. To recover the costs of machines using the new technology, businesses needed to sell ever-increasing amounts of goods. Since elaborate machines are expensive, they did not pay unless large amounts of goods are produced. They can be worked without a loss only if the vent of the goods is reasonably assured and if production need not be interrupted for want of the primary goods necessary to feed the machines. For the merchant this means that all factors involved must be on sale, that is, they must be available in the needed quantities to anybody who is prepared to pay for them. Unless this condition is fulfilled, production with the help of specialized machines is too risky to be undertaken both from the point of view of the merchant who stakes his money and of the community as a whole which comes to depend upon continuous production for incomes, employment, and provisions. (Polanyi [1944] 2001, 43)

Consumerism versus Militarism: Veblen, Hobson, and Polanyi  71 Free trade proved inadequate. Business needed protection, found in various forms: imperialism, tariffs, and central banks. Modern central banking, in effect, was essentially a device developed for the purpose of offering protection without which the market would have destroyed its own children, the business enterprises of all kinds. Eventually, however, it was this form of protection which contributed most immediately to the downfall of the international system. (Polanyi [1944] 2001, 201) The domestic economy depended on credit money, the international economy on gold. The working of the gold standard required the lowering of domestic prices whenever the exchange was threatened by depreciation. Since deflation happens through credit restrictions, it follows that the working of commodity money interfered with the working of the credit money altogether and restrict currency to commodity money was entirely out of the question, since such a remedy would have been worse than the disease (Polanyi [1944] 2001, 203). The central bank served as a buffer against the vagaries of the international economy. By centralizing the supply of credit in a country, it was possible to avoid the wholesale dislocation of business and employment involved in deflation and to organize deflation in such a way as to absorb the shock and spread its burden over the whole country. (Polanyi [1944] 2001, 203) Polanyi relied on book Europe, The World’s Banker, 1870–1914 by Herbert Feis, for the role that haute finance played in the breakdown the market economy. Feis’ book “traces the outward flow of European surplus capital from 1870 until the war of 1914–18 caused waste and destruction again to usurp the place of creation and thrift” (Feis [1930] 1964, xix). Feis had hoped that his research might provide the basis for a more synthetic understanding of nineteenth-century European civilization, a synthesis later provided by Polanyi. Despite Polanyi’s argument that the origins of the market economy lay in the Industrial Revolution, it was the introduction of continuous-mass production, combined with the dynastic ambitions of various states, that sealed the fate of Europe. “The motive of haute finance was gain; to attain it, it was necessary to keep in with the governments whose end was power and conquest” (Polanyi [1944] 2001, 12). During the latter part of the nineteenth century and the beginning of the twentieth, haute finance acted independently of governments, as a

72  Consumerism versus Militarism: Veblen, Hobson, and Polanyi sort of supra institution providing the nexus between the political and the ­economic spheres. While haute finance benefited from regional wars, supplying the credit that financed the purchase of weapons, a generalized war was contrary to its interests. Haute finance provided the private financing for much of the investment of the time that resorted to borrowing, both public and private. Its motive, of course, was profit. The dominant economic power in the years leading up to World War I was Britain. The goods that poured forth from her factories were exported the world over. The profits that returned to Britain provided the surplus capital to finance foreign investments. “Western Europe, through its spared accumulations of capital, impregnated all other regions with the growing cells of its civilization. The economic and political arrangements of the world were thereby permanently changed” (Feis [1930] 1964, xxv). British foreign investment fell to almost nothing during the panic of 1873 slowly rebounding. Britain especially helped finance undertakings in countries comprising the British Empire and America. “British capital entered into the movement, providing, in the late eighties especially, unprecedented sums for railroad building, land settlement schemes, construction and mine operation” (Feis [1930] 1964, 19). Estimates place investment in the United States at one-third of Britain’s foreign investment (Feis [1930] 1964, 25). For the most part, British capital was interested in making loans, preferably short term. “British capital favored an economic development that would produce the revenue for debt-service or dividends rather than loans to government or government guarantees” (Feis [1930] 1964, xix). British financiers preferred private investments to government ventures, investing in foreign industries that would not compete against the home country. In 1915, estimates placed the national income of Britain at $11 billion, of which 16% was saved, half of which was invested elsewhere. France took a different approach. The French had few colonies, denying them the opportunity to invest in familiar enterprises. More than the British, the French used investment to advance their political purposes. The French helped finance Russia’s railroads a large percentage of which (37%) were built for military purposes. French creditors assumed borrowers would command sufficient resources to repay their debts “The investment was that of a lender, who relies upon the general solvency of the borrower, rather than upon the success of the enterprise” (Feis [1930] 1964, xv). Germany borrowed to help finance military expenditures. The spark that initiated the collapse was the failure of businesses to convert goods and services into commodity money, that is, into gold or paper backed by gold. As Kari Polanyi Levitt observes, “Both Keynes and Polanyi ascribed a principal role to the international monetary order as the transmission mechanism that placed politically unsustainable pressures on countries forced to adjust to the dictates of financial markets in the interest of rentier bondholders” (2006, 155).

Consumerism versus Militarism: Veblen, Hobson, and Polanyi  73 The foundation of its profit was the gold standard. If governments ran deficits, haute finance demanded cuts. It became the enforcer of the rules, with the backing of the British government if necessary. This, however, introduced an incompatibility between the domestic market and the international market. Satisfying the spending cuts that haute finance demanded help precipitate depressions. Assuming that democracy and socialism are incompatible, Polanyi ­suggested two solutions: socialism or Fascism. The extension of the democratic principle to economics implies the a­ bolition of the private property of the means of production, and hence the disappearance of a separate autonomous economic sphere: the democratic political sphere becomes the whole of society. This, essentially is Socialism. (Polanyi 1935, 392) The fascist solution involves eliminating democracy. “Capitalism as organized in the different branches of industry becomes the whole of society. This is the Fascist solution” (Polanyi 1935, 392). Polanyi did not anticipate the rise of consumer capitalism. He did, ­however, anticipate the basis of consumer capitalism. The Industrial Revolution was merely the beginning of a revolution as extreme and radical as ever inflamed the minds of sectarians, but the new creed was utterly materialistic and believed that all human problems could be resolved given an unlimited amount of material commodities. ([1944] 2001, 42)

Conclusion We have, then, three different views of the impact of the introduction of continuous-mass production: Veblen’s emphasis on cultural differences between England and Germany, manifesting itself in war. Hobson’s emphasis on the response to the increased output, manifesting itself in imperialism and subsequently war. And Polanyi’s emphasis on the impact of the Industrial Revolution, first introducing the market economy. And later, with the introduction of continuous-mass production, the impact led to the demise of the market economy. It would, however, be left to Keynes to explain the impact of continuous-mass production in precipitating depression.

Notes 1 At the business level, waste appears in two forms. First, as noted, waste appears as an effort to increase sales. Advertising, management, personnel, and expenditures associated with increasing sales all represent forms of waste. More recently, the creation and evolution of consumer credit in order to increase

74  Consumerism versus Militarism: Veblen, Hobson, and Polanyi business revenues represents a further development of Veblen’s concept of waste (see Veblen[1921] 1965, 108). 2 In this context, democratizing refers to overcoming restrictions to consumption based on class. Consumption is open to anyone with sufficient means. 3 Human societies are concerned with social provisioning, providing the goods and services necessary to provide for the material needs of people and to maintain the community. They did so using the institutions of householding, reciprocity, and redistribution, in addition to markets. A market, of course, differs from a market economy. A market is a place where buyers and sellers come together. As noted, a market economy is a “self-regulating system of markets; in slightly more technical terms, it is an economy directed by market prices and nothing buy market prices” (Polanyi[1944] 2001, 43). In contrast, reciprocity is the basis of the “gift economy, ” that universal system of obligatory “gift giving” characteristic of personal relationships. Reciprocity is the simple pattern of give and take, illustrated by two friends, two families, or two tribes engaged in mutual “gift” giving. The gift fosters and reinforces social relations, offering a measure of security. “Gift giving” is a recognition that my survival depends on the survival of others (Polanyi [1944] 2001). Reciprocity involves considering the interests of others. People offer rides to friends because their friends are important and because imagining themselves in their friends place they too would want a ride. As Michael Woolcock (2001) observes, “one’s family, friends and associates constitute an important asset, one that can be called upon in a crisis.” Redistribution characterizes arrangements in which claims collected bear no necessary relation to claims paid out. Government represents the obvious example; other examples may include non-profit organizations, insurance, and so on. The general purpose of redistribution is to provide security. Redistributive institutions involve pooling resources that are allocated based on social values. Those values reflect a wide range of purposes: income maintenance, health care, economic development, and so on. 4 Using hunger to motivate people is unknown in hunter-gatherer societies (Radin 1960). 5 As Polanyi observed, “By approaching human community from the animal side, Townsend by-passed the supposedly unavoidable question as to the foundations of government; and in doing so introduced a new concept of law into human affairs, that of the laws of Nature. ‘The biological nature of man appeared as the given foundations of a society that was not of a political order. Thus it came to pass that economists presently relinquished Adam Smith’s humanistic foundations, and incorporated those of Townsend” ([1944] 2001, 119)(See Sievers 1949, 114–15). 6 Weber distinguished the rational pursuit of profit, which has characterized business for thousands of years, from the rational organization of labor characteristic of capitalism. 7 Weber did not realize how workers, dependent on both the market and reciprocity and householding, could further the extraction of surplus labor by reducing wages, thereby shifting the costs of maintaining labor to household production (see Wallerstein 1983). 8 As R.H. Tawney notes, policies that attempt to rationally organize society reveal themselves in the treatment of the poor. “A society which reverences the attainment of riches as the supreme felicity will naturally be disposed to regard the poor as damned in the next world, if only to justify itself for making their life a hell in this” (Tawney 1926, 267). 9 As Smith contends in that often-cited quote, “It is not from the benevolence of the butcher, brewer, or baker that we expect our dinner, but from regard to their self-love” ([1776] 1937, 13).

Consumerism versus Militarism: Veblen, Hobson, and Polanyi  75

References Biddle, Jeff E., and Warren J. Samuels. 2003. “Thorstein Veblen on War, Peace, and National Security.” In The Legacy of Thorstein Veblen, edited by Rick Tilman, 202–232. New York: Edward Elgar. Feis, Herbert. (1930) 1964. Europe, the World’s Banker, 1870–1914: An Account of European Foreign Investment and the Connection of World Finance with Diplomacy before the War. New York: Augustus M. Kelley. Hobson, John A. 1922. Economics of Unemployment. London: George Allen & Unwin. ———. 1930. Rationalization and Unemployment: An Economic Dilemma. London: George Allen and Unwin. Hobson, John Atkinson. 1902. Imperialism: A Study. London: James Nisbet & Co. ———.1911. The Science of Wealth. Vol. 11. London: Henry Holt and Company. ———. (1922) 1924. The Economics of Unemployment. London: George Allen and Unwin. Levitt, Kari Polanyi. 2006. “Keynes and Polanyi: The 1920s and the 1990s.” Review of International Political Economy 13 (1): 152–177. https://doi.org/10.2307/25124065. http://www.jstor.org/stable/25124065. Maddison, Angus. 1991. Dynamic Forces in Capitalist Development: A Long-Run Comparative View. Oxford: Oxford University Press. Malthus, Thomas Robert. (1798) 1982. An Essay on the Principle of Population and a Summary View of the Principle of Population, edited by Antony Flew. New York: Penguin Books. Marx, Karl. (1867) 1976. Capital: A Critique of Political Economy, Vol. 1. New York: Vintage Books. Mintz, Sidney Wilfred. 1985. Sweetness and Power: The Place of Sugar in Modern History. New York, : Viking. Polanyi, Karl. 1935. “The Essence of Facism.” In Christianity and the Social Revolution, edited by John Lewis, Karl Polanyi and Donald K. Kitchin. London: Victor Gollancz. ———. (1944) 2001. The Great Transformation: The Political and Economic Origins of Our Time. Boston, MA: Beacon Press. ———.1968. “The Economy as Instituted Process.” In Primitive, Archaic and Modern Economies, edited by George Dalton, 139–174. Boston, MA: Beacon Press. Radin, Paul. 1960. The World of Primitive Man. New York: Grove Press. Sievers, Allen Morris. 1949. Has Market Capitalism Collapsed: A Critique of Karl Polanyi’s New Economics. New York: Columbia University Press. Smith, Adam. (1776) 1937. An Inquiry into the Nature and Causes of the Wealth of Nations, edited by Edwin Cannan. New York: The Modern Library. Tawney, R. H. 1926. Religion and the Rise of Capitalism. Gloucester, MA: Peter Smith. Veblen, Thorstein. 1917. An Inquiry into the Nature of Peace and the Terms of Its Perpetuation. New York: The Macmillan Company. ———. 1919a. “Some Neglected Points in the Theory of Socialism.” In The Place of Science in Modern Civilisation and Other Essays, 387–408. New York: Russell and Russell. ———. 1919b. The Vested Interests and the State of the Industrial Arts. New York: B.W. Huebsch.

76  Consumerism versus Militarism: Veblen, Hobson, and Polanyi ———.1964. “The Economic Theory of Woman’s Dress.” In Essays in Our Changing Order, 65–77. New York, : Augustus M. Kelley. ———. (1914) 1964. The Instinct of Workmanship, and the State of the Industrial Arts. New York: Augustus M. Kelley. ———. (1921) 1965. The Engineers and the Price System. New York: Augustus M. Kelley. ———. (1915) 1968. Imperial Germany and the Industrial Revolution. New York: The University of Michigan Press. ———. (1904) 1975. The Theory of Business Enterprise. New York: Augustus M. Kelley. ———. (1899) 1979. The Theory of the Leisure Class: An Economic Study of ­Institutions. New York: Penguin Books. Wallerstein, Immanuel. 1983. Historical Capitalism. London: Verso. Weber, Max. 1958. The Protestant Ethic and the Spirit of Capitalism. New York: Charles Scribner’s Sons. Wright, Quincy. 1942. A Study of War. Vol 1–2. Chicago, IL: University of Chicago Press.

5 Keynes and The Great Depression “Poverty in the Midst of Plenty”

The Great Depression accentuated the paradox of “poverty in the midst of plenty.” The depression resulted from the failure of the private sector to generate sufficient demand to absorb the increased output, impoverishing millions. The theory underlying classical economics precluded policies necessary to pull the economy out of depression. Classical economics ­advocated laissez-faire, free trade, and balanced budgets. It argued that government deficits displace private investment, reducing economic growth. In its view, the solution to depression lay in deflation. In The General Theory, Keynes attributed the depression to a collapse in effective demand, resulting from a collapse in investment. Some years later, he attributed the failure to recover from the depression to i­ nsufficient ­consumption. As Keynes noted, the problem lay in an increase in o ­ utput combined with an institutional structure that discouraged consumer spending. But the main explanation of what has happened this year in Great ­ ritain and for several years in the United States is, I am certain, the B ­g igantic powers of production, far exceeding any previous experience, of a modern industrial economy. Coupled with institutional factors which tend to encourage accumulation and retard the growth of consumption when incomes increase, this means an unprecedented output has to be reached before a state of full employment can be approached. (1940, 157) The beginning of the depression is generally attributed to the stock-market crash. Occurring on October 29, 1929, the market fell 20%. Within three years, industrial output measured by the Federal Reserve’s index of manufacturing output fell 48%; gross national product fell 46% in current prices and 27% in real prices. Consumer prices fell by one-fourth; employment declined by 20% pushing the unemployment rate to 25%, leaving 13,000,000 people unemployed out of a labor force of 48,000,000. Durable goods declined by 80%. From the outset of the depression in 1929 to its depth in 1932, one-third of all banks failed, nine million people lost their savings. From

DOI: 10.4324/9780429443763-5

78  Keynes and The Great Depression the stock-market crash to its depth in July 1933, stock values plummeted 83%, wiping out $74 billion in value (see Faulkner 1960, 645). Foreclosures rose along with suicides and crime. In the countryside, farmers burned their fields, slaughtered their pigs, and dumped their milk for want of buyers. In the cities, unemployed workers stood in bread lines for want of food; factories lay idle for lack of orders; and banks closed their doors for lack of money. People lost their jobs, their homes, and, perhaps, most importantly their confidence in the future. Classical economics had taught that markets work. The classical view, encapsulated in Adam Smith’s invisible-hand doctrine, held that each ­individual pursuing his or her self-interest unintentionally promotes the interest of all. Whatever that is profitable benefits society. As Veblen noted, the classical view assumed that God had preordained a harmony between the individual and social interests. The classical view that markets work underlay the policies of the 1920s. Warren Harding, elected President in 1920, ran on the view of “less government in business and more business in government.” And Calvin Coolidge, who succeeded Harding in 1924, proclaimed that “the chief business of the American people is business.” In 1928, Coolidge proclaimed the following: No Congress of the United States ever assembled, on surveying the state of the union, has met with a more pleasing prospect than that which appears at the present time. In the domestic field there is tranquility and contentment . . . and the highest record of years of prosperity. In the foreign field there is peace, the goodwill which comes from mutual understanding . . . (Coolidge quoted in Galbraith 1961, 7) Echoing Coolidge’s optimism, Herbert Hoover, taking office early in 1929, predicted that poverty in America would soon be abolished. The prosperity of the 1920s was heralded by the development of the automobile industry and construction. The economy boomed. Industrial production increased 50% during the 1920s. The Ladies Home Journal published an article claiming that anyone could become rich if they invested in the stock market. Economists, too, were swept up in the euphoria of the day. One month before the stock-market crash of 1929, Irving Fisher proclaimed that America had achieved a “permanent plateau of prosperity.” In response to the depression, the classical economists advised doing nothing. In fact, the United States government exacerbated the situation. It raised taxes and cut spending to balance the budget. It raised interest rates to stem the flow of gold to Britain, which had recently gone off the gold standard. And it enacted the Smoot-Haley Tariff bill, raising tariffs 140% to induce Americans to “buy American.” Andrew Mellon, Herbert Hoover’s secretary of the treasury, echoed the classical prescription to address the depression: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate

Keynes and The Great Depression  79 real estate” (Mellon quoted in Schlesinger 1957, 163). Lower prices would, supposedly, eliminate unsold goods and unemployed labor, lower costs, and resurrect profits. With his vision of a better world shattered, a frustrated and depressed Herbert Hoover went fishing. John Steinbeck wrote the Grapes of Wrath. Using the plight of migrant workers as his backdrop, Steinbeck warned of the impending revolution: I been thinkin’ a hell of a lot, thinkin’ about our people livin’ like pigs, an’ the good rich lan’ layin’ fallow, or maybe one fella with a million acres, while a hundred thousan’ good farmers is starvin’. An I been wonderin’ if all our folks got together an’ yelled, like them fellas yelled . . . Fifty thousand veterans of World War I camped for months on the Washington Mall, demanding Congress accelerate veteran payments. After five months, General MacArthur ran them out. Social unrest spread throughout America, unreported by the press. Many intellectuals believed that the Great Depression represented the fulfillment of Marx’s prophecy that capitalism contains the seeds of its own destruction. After the revolution, workers would establish a communist society, one that Marx envisioned would be based on the “full and free development of every individual” ([1867] 1967, 555). Keynes, however, was unpersuaded. He rejected Marx’s prophecy. He considered Marx’s Capital muddled. And Keynes himself disliked the revolutionary solution that Marx advocated. Moreover, Keynes had no attraction for Soviet-styled communism, which extoled the state at the expense of individual freedom. The depression shook America’s confidence, altered forever the role of government, and spawned new ideas about how the economy works. Economists at the time offered little advice other than wait a few months and the economy will recover. Keynes, however, was not content to wait. Writing in the dark days of the Great Depression, Keynes sought to save capitalism. Saving capitalism, however, required abandoning laissez-faire and rejecting the invisible hand doctrine. “There is no clear evidence from experience that the investment policy which is socially advantageous coincides with that which is most profitable” (Keynes 1936, 157). The depression revealed the inadequacy of classical economics. Governments must act. Before developing a new theory, however, Keynes first had to shed classical economic theory upon which he had been raised. “The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have, into every corner of our minds” (1936, vii). Keynes rejected classical economics because its assumptions are unrealistic. Classical economics pertained to an economy at full employment, not to an economy in depression. Keynes sought to develop a more general theory, one addressing both depression and full employment. First, he attacked the idea that markets could

80  Keynes and The Great Depression restore full employment, arguing that workers respond to money wages, not real wages. Moreover, lower money wages may be insufficient to increase employment if prices fall further, resulting in an increase in the real wage. Second, Keynes rejected Say’s law. He rejected the idea that goods exchange for goods, a view held by J.S. Mill: What constitutes the means of payment for commodities is simply commodities. Each person’s means of paying for the production of other people consists of those which he himself possesses. All sellers are inevitably, and by the meaning of the word, buyers. (Mill quoted in Keynes [1936] 1964, 18) Say’s law fails to apprehend that we are dealing with a monetary economy, “one in which changing views about the future are capable of influencing the quantity of employment and not merely its direction” ([1936] 1964, vii). People may choose to hoard money, reducing demand.1 Third, intended savings does not equal intended investment. Keynes reasoned that those who save and invest are different economic agents, with different objectives. Consumers save, particularly the rentier (the ­functionless investor). Their objectives may be to save for a rainy day, to earn interest, to speculate and so on. In Keynes’ time, the rentier saved the most, the idle rich, those who earn their income from accumulating wealth.2

Keynes’ Vision Placing The General Theory in its historical and institutional context provides an understanding of the vision from which Keynes began. It puts Keynes in the context of an early twentieth-century economist trying to save the capitalist system. His efforts to solve practical problems led Clarence Ayres to comment that “Macroeconomics is Veblenian precisely in the sense that it turns away from the civilities of price equilibrium theory to the realities of the community’s efforts to feed and clothe and house itself.” Ayres continues: This is what Keynes prevailed upon us to do, pointing out that in such an affluent society as ours people go hungry not because of any inexorable laws but only because we choose to do as we do in respects that are quite amenable to alteration. (Dorfman et al. 1963, 61) World War I and the Great Depression manifested the difficulties in transitioning to a consumer economy. The Great Depression established that the private sector could not provide sufficient expenditures to employ the people; World War I and World War II established that government could. “[T]he war has disclosed the possibility of consumption to all and the

Keynes and The Great Depression  81 vanity of abstinence to many” (Keynes 1920, 21–22). As Jean Baudrillard observed, The bourgeoisie knew how to make people work but it also narrowly escaped destruction in 1929 because it did not know how to make them consume. It was content, until then, to socialize people by force and exploit them through labor. But the crisis of 1929 marked the point of asphyxiation: the problem was no longer one of production but one of circulation. Consumption became the strategic element; the people were henceforth mobilized as consumers; their “needs” became as essential as their labor power. (1975, 144) The increased output from the war led Keynes to conclude that the working classes had been deceived, a deception reinforced by the Protestant ethic. The Protestant ethic provided an ideology conducive to the accumulation of capital, expressed in the doctrines of the calling and this worldly asceticism (see Weber 1958). The calling made hard work a duty. People showed their love for their fellow human beings not through sentiment or emotion but through hard work. This worldly asceticism taught the evils of prodigality, making saving a virtue and debt a vice. If the Protestant ethic provided the psychological, cultural rationale for saving, classical economics provided the theoretical. Saving is the key to growth: “parsimony, and not industry, is the immediate cause of the increase in wealth” (Smith [1776] 1937, 321). The increased output associated with continuous-mass production made cultural change a necessity. As Herbert Hoover observed, mass production requires mass consumption. England was slow to increase consumption, a fact that W.W. Rostow (1960, 73) found perplexing: how is one to deal with a long interval between the stages of its maturity in terms of effective application of mid-19th century technology, and the next stage of growth: the age of high mass consumption, when the radical improvements in housing and durable goods and services become the economy’s leading sectors. Keynes’ observation made years earlier offers an explanation. High interest rates helped suppress working-class incomes providing the rentier the high income from which to accumulate their savings. Thus this remarkable system depended for its growth on a double bluff or deception. On the one hand the laboring classes accepted from ignorance or powerlessness, or were compelled, persuaded, or cajoled by custom, convention, authority, and the well-established order of Society into accepting, a situation in which they could call their own very little

82  Keynes and The Great Depression of the cake that they and Nature and the capitalists were co-operating to produce. (1920, 19–20) Understanding the emergence of a new consumer society demanded a new vision. From Adam Smith to David Ricardo to John Stuart Mill, the classical economists had divided society into three classes: landlords, capitalists, and workers. The vision emphasizes the supply side. Workers work, capitalists organize production and invest, and the landlords live off the efforts of others, a parasitical class who “love to reap where they never sowed” (Smith [1776] 1937, 49). Ricardo underscored Smith’s description, adding that “the interest of the landlord is always opposed to that of the consumer and manufacturer” (Ricardo [1911] 1973, 225). Ricardo held that increases in the population, given the scarcity of land, would drive up rents, crowding out profits.3 Eventually, the profits fall to zeroending accumulation and, in turn, ending capitalism. While Mill agreed with Ricardo regarding the tendency for profits to fall, unlike Ricardo, Mill viewed the stationary state with optimism. The stationary state would provide an opportunity to redistribute income to help the poor. Stanley Jevons, too, believed that Britain was on the cusp of the stationary state. But he thought Britain’s growth was based on coal, which was increasingly costly to mine. For Jevons, one of the founders of the marginalist revolution, the stationary state marks the transition in the economic problem from the classical emphasis on growth and distribution to the mainstream emphasis on the allocation of scarce resources. Keynes resurrected the classical problem of distribution and growth. He presented a vision of how the economy functions corresponding to a ­consumer society. Society is composed of three non-discrete classes: consumers, entrepreneurs, and the rentier in addition speculators who, at times, treat markets as casinos. Entrepreneurs’ economic function is to invest, that is, to spend the savings of the community to purchase capital goods and inventories. Entrepreneurs purchase capital goods to produce commodities to earn profits. The rentiers save, receiving dividends and interest from the stocks and bonds they own. Their incomes derive from their accumulated wealth. Everyone consumes, although workers consume more as a percentage of their income than others. Unlike the landowning classes, the new rich were unaccustomed to spending: The new rich of the nineteenth century were not brought up to large expenditures, and preferred the power which investment gave them to the pleasures of immediate consumption. In fact, it was precisely the inequality of the distribution of wealth which made possible those real accumulations of fixed wealth and of capital improvements which distinguished that age from all others. (Keynes 1920, 18–19)

Keynes and The Great Depression  83

Keynes’ Theory of Effective Demand Keynes’ vision is reflected in the theory of effective demand, which Keynes described as the substance of The General Theory. Keynes’ theory of effective demand is short run, with the price level and technology held constant, leaving aggregate supply unchanged. Hence, effective demand determines the level of employment,4 implying a rejection of Say’s law. Supply does not create its own demand. Goods do not exchange for goods, for money changes the nature of the economy. Keynes presents a model in The General Theory depicting the private-­ domestic economy as comprised of consumption and investment (see ­Figure 5.1). Government and the foreign sectors are addressed later in an ancillary manner. Keynes defined the demand function “D” as the expected revenue from a particular level of employment. Keynes defined his supply function “Z” as relating the revenues necessary to induce a particular level of employment (see Keynes [1936] 1964, 24).5 The vertical difference between the horizontal axis and the Z function represents the costs of providing a particular level of employment, costs including interest payments, user costs to other entrepreneurs, wages, and expected profit. Where D exceeds Z, the expected revenue exceeds the revenues necessary to induce that level of employment, leading entrepreneurs to expand production and increase employment. Where D is less than Z, the opposite occurs. Keynes demand function (D) is comprised of consumption (D1) and investment (D2). Consumption is income consumed; saving is income not consumed.6 At the equilibrium level of employment, effective demand equals aggregate supply, or the D function equals the Z function. It is here that entrepreneurs’ expectation of profits is maximized. Even here, however, equilibrium may be less than full employment, leading to economic Z Expected Revenues

D = D1+ D2

Employment

Figure 5.1  Keynes’ Model of Effective Demand

84  Keynes and The Great Depression stagnation. Spending maybe sufficient to purchase the output produced, but that output may be less than potential output at full employment. Since entrepreneurs’ expectations are realized, there is no tendency for employment to change. The key to avoiding depression and achieving full employment, then, is to ensure sufficient effective demand. To do so requires increasing effective demand by increasing consumption, investment, government deficits, or net exports. The point is that the potential output of the community must be purchased to avoid depression, difficult in an economy depending on the private sector to ensure full employment. Keynes’ Consumption Function in The General Theory As noted in an earlier chapter, in The General Theory, Keynes downplayed the cultural influences on consumption, asserting that consumption is based on a psychological law: as income rise consumption rises but by a lesser amount. The law rests on the idea that consumption is habitual, changes in consumption lag changes in income. Keynes considered this law fundamental, both because of its implications for the economy and for policy. For the economy, the increase in saving as income rises, without an increase in expenditures to absorb the saving, has the potential to lead to economic stagnation. Goods and services go unsold, precipitating an unexpected decline in profits. Businesses curtail production, laying off workers. Unemployment rises. Keynes did not believe that a laissez-faire economy would ensure that the savings of the community would be spent, implying an economy characterized by a policy of laissez-faire is prone to stagnate, a point emphasized by Alvin Hansen. As Hansen noted, the tendency for saving to rise as income rises creates a widening gap between demand and output, “and this widening gap may or may not be filled by investment depending upon the prevailing strength of the factors (technology and population growth) which determine the volume of investment outlays” (1953, 34). For economic policy, as noted, the gap must be filled to avoid stagnation. Keynes’ consumption function implies that the poor spend more as a percentage of income than the rich. Hence, stagnation can be avoided by redistributing income from rich to poor. Governments can increase effective demand and therefore employment, achieving a more just economy while stimulating economic activity. In one stroke, Keynes demolished the classical justification for inequality. “Thus our argument leads towards the conclusion that in contemporary conditions the growth of wealth, so far from being dependent on the abstinence of the rich, as is commonly supposed, is more likely to be impeded by it” (1936, 373). Keynes addressed the problem of social provisioning by advocating government deficits and socializing the rate of investment, both of which increase the prospective income to businesses, thereby stimulating employment.

Keynes and The Great Depression  85 The Financial Relations Underlying the Paradox of Thrift Keynes consumption function also served as the basis of the paradox of thrift. There are two aspects to the paradox of thrift. First, the paradox of thrift stems from the logic that a decision to save more means a decision to spend less. If everyone were to double their level of saving, ceteris paribus, the simultaneous decline in consumption would precipitate a decline in effective demand. Assuming that investment and government spending did not increase to offset the decline in consumption, goods would go unsold, inventories would pile up, and profits would fall. Business would react by reducing production and laying off workers. National income would fall. Second, an increase in saving redistributes wealth to he who saves, revealing the effect of increases in saving on the underlying financial relations. Keynes left the financial relations underlying investment undeveloped, ­subsequently more fully developed by Hyman Minsky whose ideas are ­considered in a later chapter. The following scenario clarifies Keynes’ point. Assume that Sandra is a heavy cola user, consuming upwards of 10 cans a day, and 70 cans a week. Concerned for her well-being, her doctor advises her to avoid cola. ­Sandra agrees, switching to water, saving the amount she would have spent on cola. Sandra’s decision has two effects. First, for the grocer, inventories rise ­unexpectedly. To finance the unplanned inventory accumulation, the grocer must either draw down his savings or borrow from the bank. Second, for Sandra, the decision to reduce her spending increases her assets, placing her savings in a savings account increases both the bank’s liabilities and assets, which the bank uses to make loans (purchase debts). Without the borrower using the loan to finance new spending, demand falls. Whether the Grocer draws down his cash reserves or borrows from the bank, the amount financed equals Sandra’s increased savings. Choosing to borrow increases the grocer’s debt an amount equal to the increase in Sandra’s assets, increasing the firm’s debt–asset ratio. Wealth is transferred from grocer to Sandra, from entrepreneurs to the rentier. The interest payment on the debt raises the costs to entrepreneurs, thereby lowering their incomes by the same amount as the increase in incomes to the rentier. The failure of banks to extend credit forces those entrepreneurs unable to meet their contractual obligations to draw down their cash reserves or liquidate assets. If the liquidation becomes general, asset prices fall ­precipitating a deflation. The decline in asset prices causes declines in investment. The decline in asset prices redistributes wealth from those who own non-dollar-­ denominated assets to those holding dollar-denominated assets such as debts or cash. While this scenario implicitly assumes that the banking industry is a passive participant, the assumption is by no means necessary. Focusing on saving or, more generally, the way investments are financed points to an alternative source of depressions: the rentier and the supportinginstitutional arrangements. Joseph Schumpeter succinctly summarizes

86  Keynes and The Great Depression this interpretation of Keynes’ theory: “that who tries to save destroys real ­capital” and that, via saving, “the unequal distribution of incomes is the ultimate cause of unemployment” (Schumpeter 1951, 290). Keynes does not oppose saving. On the contrary, Keynes’ point is that saving unspent drags the economy down. Saving must be spent on investment, government, or exports to avoid stagnation. Of course, those that save the most are the rentier or whom Keynes called “the functionless investor.” Keynes assumed that the rentier save the most since they have the largest incomes, driven to accumulate wealth, valuing the power of compound interest. In a sense, then, it is the saving of the rentier that poses the major threat to the economy. In contrast to classical economics, Keynes’ theory implies that inequality is no longer necessary to maintain full employment. The saving of the wealthy, rather than promoting economic growth, retards growth if the economy is at less than full employment.

Vanishing Investment Opportunities and Depression Keynes resurrected the doctrine of vanishing investment opportunities raised by the classical economists. Keynes, however, rejected the idea that declines in the profit rate result from the scarcity of land or the scarcity of coal. The rate of profit declines because capital becomes less scarce. Keynes’ view of the fall in the marginal efficiency of capital, together with a stationary or rising rate of interest, provides an explanation of the Great Depression. The post-war experiences of Great Britain and the United States are, indeed, actual examples of how an accumulation of wealth, so large that its marginal efficiency has fallen more rapidly than the rate of interest can fall in the face of prevailing institutional and psychological factors, can interfere, in conditions mainly of laissez-faire, with a reasonable level of employment and with the standard of life which the technical conditions of production are capable of furnishing. ([1936] 1964, 219) The depression, Keynes argued, was caused by a failure of effective demand. But the decline in demand was, in turn, caused by several other factors. The stock-market crash altered expectations, such that entrepreneurs reduced investment spending. Interest rate volatility in 1931 and 1934 increased uncertainty, further contributing to the decline in investment (see Ferderer and Zalewski 1994). Second, the distribution of income was highly inequitable. Much of the wealth and income was in the hands of the rentier. As their incomes increased, less was spent and more was saved, causing aggregate demand to fall. Third, in the 1920s, Britain returned to the prewar parity with gold, which required raising interest rates. This, in turn, reduced investment and exports,

Keynes and The Great Depression  87 increasing unemployment, which, as noted above, reduced consumption and further reduced investment. Fourth, during the depression, the various countries of the world erected trade barriers to shift the burden of the depression off on other countries, further reducing aggregate demand.

The Temin Hypothesis Keynes focused on the effect of changes in investment via the multiplier as the primary cause of the depression. Cuts in investment spending reduce the incomes of employees and suppliers. They, in turn, reduce their spending, which reduces the incomes of others, multiplying the effects. As Keynes noted, “The boom of 1928–29 and the slump of 1929–30 in the United States correspond respectively to an excess and deficiency of investment.” To restate, investment fell because the marginal efficiency of capital fell below the rate of interest. Keynes continues: “I attribute the slump of 1930 primarily to the deterrent effects on investment of the long treated dear money which preceded the stock-market collapse and only secondarily to the collapse ­itself but the collapse having occurred it greatly aggravated markets especially in the United States by causing a disinvestment in working capital” (Keynes quoted in Temin 1976, 31). Peter Temin, however, argued that the primary cause of the depression was not a collapse in investment, but a collapse in autonomous consumption. Temin cited two reasons: overproduction in the construction industry and the stock-market crash (1976, 9). The fall in exports further a­ ggravated matters. The data does not support the proposition that the ­depression resulted from multiplier effects from a collapse in investment. “The decline in income in 1930 . . . lies rather in the combined behavior of consumption and exports” (Temin 1976, 65). Temin continues: The large fall in consumption in 1930 therefore has no satisfactory ­explanation. It may have been related to the fall in construction, since construction tends to move in waves and a decline in this activity may have altered expectations adversely. (1976, 82–83) Temin noted that both Alvin Hansen and Thomas Wilson found the cause of the depression in the decline in incomes, which impacted the housing market. “The collapse occurred only because the development of underconsumption was accompanied by a declining demand for houses and a serious exhaustion of investment opportunities” (Wilson quoted in Temin 1976, 32). Wilson continues: There is direct evidence that investment opportunities were exhausted in the construction industry. Residential construction reached a high peak at $5.2 billion in 1925 and it had fallen to $4.3 billion in 1929.

88  Keynes and The Great Depression A further decline took place in 1929 to only $3 billion. The decline may have been due to serval causes. There may have been a steep rise in costs, or a scarcity of credit or a surplus of houses. The first depressing factor—the rise in costs—was responsible for the decline in construction in 1920 but not in 1929. (1942, 156) Wilson rejects the increase in costs as the cause of the decrease in housing. “The second factor—credit stringency—cannot be dismissed so quickly” (1942, 156). Wilson attributes the increase in foreclosures in 1929, in part, to the difficulty in obtaining credit. “The essential fact is that the decline in construction was due to an exhaustion of demand and not to a rise in costs or a scarcity of credit” (italics in the original, Wilson 1942, 157). The result, of course, was a decrease in construction. “Although total construction did not fall as much as residential construction—due to increased investment by business concerns, public utilities and public works—the decline in total construction was substantial” (Wilson 1942, 157). By 1929, excess capacity had developed in a number of different industries: automobiles, tires, and residential construction. Robert Gordon’s findings support Temin’s thesis. It is clear that the rise in output of durable goods in the 1928–1929 was too rapid to be long maintained. Excess capacity was developing in a number of lines, and this meant a decline in demand for capital goods. As a matter of fact new orders for some types of durable goods declined fairly early in 1929. The automobile market was clearly oversold; in addition, the industry’s capacity exceeded even the peak production of 1929. The tire industry had been overbuilt, and the tire production had fallen sharply in the latter part of 1928. The textile industries had been suffering from overcapacity for some time. Residential construction had been declining sharply since the beginning of 1928, and an overbuilt situation obviously existed in that area. (Gordon quoted in Temin 1976, 32–33) Paul Kubik’s (1996) findings also support Temin’s thesis that the depression resulted from a fall in autonomous consumption. Kubik, however, attributed the depression to the failure of the Fed to support consumer credit. Credit had helped finance the spending boom following World War I. Consumer credit, however, was not supported by the Fed; consumer credit was viewed as careless, the result of spendthrift consumers. In fact, a modern economy is dependent on consumer credit to purchase many of things that the economy creates. Martha Olney supports the Fed’s failure to support consumer credit as an important factor contributing to the depression: The 1930 drop in consumption resulted from the unique combination of historically high consumer indebtedness and punitive default consequences. Down payments were large, and contract terms short, so

Keynes and The Great Depression  89 equity was acquired quickly. In an installment payment was just 30 days late, the good being purchased could be and often was repossessed. (1991, 320) As Olney points out, for the most part, consumers did not default on their debts. Instead, they simply reduced their spending to pay down their debts.

Effective Demand and Economic Sabotage In The General Theory, Keynes presents two different analyses of the economy, a static model exploring the determinants of effective demand, and an institutional analysis focusing on motives and power of the various classes. In the static model, employment depends on effective demand, which in turn depends on the propensity to consume and the inducement to invest. The framework is explicitly short run. Both the price level and technology are held constant. Hence, increases in demand increase social provisioning. From an institutional perspective, depressions represent a form of economic sabotage. Entrepreneurs control the means of production; the rentier control the banks and, hence, debt financing. At the time, the rentier controlled the Bank of England, a quasi-public institution charged with monetary policy. In an effort to increase their income, justified by classical economics, the rentier increased interest rates, thereby restricting both capital and employment, sabotaging the provisioning process, manifesting itself in depressions. The Euthanasia of the Rentier Keynes long-term solution to the problem of depression lay in euthanizing the rentier. His antipathy toward the rentier lay, in part, in his observations of late nineteenth, early twentieth-century England. In the 19th century, inequality enabled a new class of wealth holders to amass a large amount of savings, which they used to finance foreign investment. In the inter-war period, Winston Churchill, then Chancellor of the Exchequer, enacted a policy to return England to its prewar parity with gold by increasing interest rates. The policy had two effects. First, the policy increased the value of the pound thereby putting British workers at a competitive disadvantage with respect to foreign workers. The policy devastated the coal industry the revival of which required deflation, adversely affecting wages. And second, the increased interest rates reduced investment. Churchill’s effort was to return London to its former glory as a center of global finance, given its importance as a source of income. As noted, the return to capital depends on its scarcity. For the only reason why an asset offers the prospect of yielding during its life services having an aggregate value greater than its initial supply

90  Keynes and The Great Depression prices because it is scarce; and it is kept scarce because of the competition of the rate of interest on money. (Keynes [1936] 1964, 213) In Keynes’ view, the rentier intended to keep capital scarce by enacting a policy of high interest rates, sabotaging the production of capital. Keynes’ solution: make capital so abundant that the marginal efficiency of capital falls to zero. This, however, required socializing the rate of investment and keeping interest rates low, which meant euthanizing the rentier. Maurice Dobb commented that Keynes theory attempts to “separate the parasitic elements of capitalism from capitalism itself in order to save the lifeblood of the system from exhaustion” (1955, 219). The doctrine appeared something as an embarrassment to Keynes’ disciples. Alvin Hansen referred to it as a “kind of freewheeling detour by Keynes in his less responsible moments” (Hansen 1953, 159). Joan Robinson characterized the prospect of reducing the marginal efficiency of capital to zero by establishing a permanently low rate of interest as “fantastical” (Robinson 1951). Keynes himself in a letter referred to the doctrine as not much more than an “obiter dictum” (Keynes 1979, 213). Moreover, Keynes’ emphasis on the importance of investment over saving and his obscure comments on the financial relationships within capitalism left unclear the role of the rentier in financing investment, a role clarified by Hyman Minsky. Keynes believed that eliminating crises required changing the institutional structure of capitalism itself, specifically the euthanasia of the rentier. “I see, therefore, the rentier aspect of capitalism as a transitional phase which will disappear when it has done its work” (Keynes [1936] 1964, 376). Hitherto, classical economists argued the necessity of the saving of the rich to finance investment. As noted, World War I revealed to Keynes the folly of the classical doctrine. A more equitable distribution of income may, in fact, prove stimulative. Economic justice and full employment are compatible goals. Despite the criticisms, Keynes nevertheless identified a central problem in precipitating economic crises, namely, the debtor–creditor relationship, a problem subsequently explored by Minsky.

Conclusion Keynes’ assumption that as income rises consumption rises by a lesser amount has intuitive appeal. Granted, the assumption applies to the short run. Nevertheless, Keynes did not anticipate rises in consumption in response to new products; he did not address the influence of advertising; and he did not consider the possibility that corporations, to increase profits, would extend credit to consumers, undermining the prospect of vanishing investment opportunities. Of course, we are reminded that Keynes was dealing with the situation of depression, a situation in which the private sector failed to provide sufficient employment.

Keynes and The Great Depression  91 Keynes’ theory marked a revolution in economic thought. It pointed how the government could make up for the deficiencies of the private sector in providing full employment. Government expenditures during World War II represented, in effect, a full-employment policy. The relationship between Keynes and Veblen should become clearer. As noted, the model that Keynes put forward in The General Theory was short run. His comments regarding the long run focused on the conflict between the rentier and entrepreneurs. Veblen’s theory targeted the long run, an effort to understand the evolution of the capitalist system, propelled by changes in technology.

Appendix

The Role of the Rentier in Precipitating Crises

The following model focuses on the relation between entrepreneurs and the rentier, an extension of a model developed by Nicholas Kaldor (1955) in his now classic article “Alternative Theories of Income Distribution.” I make the following assumptions: a two-sector economy composed of businesses and households; a class structure composed of entrepreneurs, rentier, and workers; and no technological change.7For simplicity, government and the foreign sector are omitted. Entrepreneurs finance their investments from their own saving, the savings of the rentier, and the saving of workers. The stock of savings of the rentier finances corporate and worker debt.8 Income is divided among profits, interest income accruing to the rentier from owing debt, and wages. (1) Y = P + R + W where P = profits accruing to entrepreneurs; R = interest income accruing to the rentier; W = wages. Profits are defined as the difference between aggregate demand and expenses. User costs, costs that entrepreneurs pay to other entrepreneurs, are ignored. Expenses equal the interest payment on corporate debt, used to purchase fixed capital, plus wages. (2)

P = AD – (icDc + W)

Aggregate demand is defined as the amount of expenditures that consumers and entrepreneurs plan to spend at a given level of income.9In other words, aggregate demand equals consumption plus investment spending: (3) AD = C + I where AD = aggregate demand; C = consumption expenditures; and I = investment expenditures.

Keynes and The Great Depression  93 Dividing through by income (Y), we get the following: (4) P/Y = AD/Y – (icDc/Y + W/Y) where P/Y is share of income accruing to entrepreneurs, icDc/Y is share of income accruing to the rentier, and W/Y is share of income accruing to workers. Equation (4) permits us to express the typical Keynesian disequilibrium and adjustment process in terms of the profit share. At equilibrium AD/Y = 1, since the amount of income that entrepreneurs produce equals the amount of expenditures. Equilibrium is the point of effective demand, the point at which “entrepreneurs’ expectation of profit is maximized” (Keynes 1936, 31). If AD exceeds current income, profit share exceeds expectations and entrepreneurs expand income; if AD is less than current income, profit share is less than expected and entrepreneurs contract income. Further, an increase in interest rates or an increase in corporate debt increases the interest payment (icDc) for businesses, reducing the profit share, similarly, with an increase in the wages share. Consumption, in turn, equals the consumption of entrepreneurs, the rentier, and workers. Hence, (5) C = cpP + crR + c wW where cp is the marginal propensity to consume of entrepreneurs; cr is the marginal propensity to consume of the rentier; c w is the marginal propensity to consume of workers. Inquiring further into the income accruing to the rentier reveals a potential source of instability. We assume that rentier income is the return from owning corporate and worker debt. Hence, (6) R = icDc + iwD w where ic = the rate of interest on corporate debt, Dc is the stock of corporate debt, iw is the interest paid on worker debt, and D w is the stock of worker debt. Inserting equations (4) and (6) into equation (2) we get the following: (7) P = cpP + cricDc + criwD w + c wW + I – icDc – W which in turn equals, (8) P = (I – sricDc+ criwD w – swW)1/sp

94  Keynes and The Great Depression where sp is the marginal propensity to save of entrepreneurs; sr is the marginal propensity to save of the rentier; sw is the marginal propensity to save of workers. Equation (8) says that profits equal investment spending minus the saving of the rentier from the interest payment on corporate debt plus the consumption of the rentier from the interest payment on worker debt minus the saving out of worker income, all of which is multiplied by the inverse of the marginal propensity to save of entrepreneurs. First, if saving by the rentier exceeds consumption of the rentier out of worker income, profits fall, an event likely to occur assuming the rentier consume a small portion of their income from worker interest payments (criwD w) than they save out of corporate interest payments (sricDc). Second, if workers dissave such that swW is negative, profits rise. This implies an increase in expenditures beyond worker income. Third, assume that workers spend all their earnings and that they have no debt. In this case equation (8) becomes the following: (9)

P = (I – sricDc)1/sp

Equation (9) allows us to examine the relationship between the rentier and entrepreneurs, assuming that workers spend all their income. Equation (8) is interesting for several reasons. First, it indicates that the effectiveness of cutting wages as a means of increasing profits does not affect profits in the aggregate. Some business will be harmed, others benefited. But as Keynes noted, cutting wages lowers costs, but it also decreases demand. One firm can increase its profits by cutting wages since the wage cut has a negligible effect on the demand for the firm’s products; but if all firms cut wages demand falls leaving profits in the aggregate the same (Keynes 1936, 259–261).10 Ultimately, the effectiveness of cutting wages depends on the marginal propensity to save of workers. Second, equation (8) indicates that for entrepreneurs to earn profits, investment spending must exceed the saving of the rentier, otherwise profits equal zero. Third, as noted, an increase in interest rates, increasing interest payment on corporate debt, reduces profits. Fourth, while an increase in the marginal propensity to save on part of entrepreneurs reduces their profits, a result consistent with that of Kaldor, no saving means no profits. Fifth, assuming the absence of the rentier gives us Kaldor’s original equation: P = I/sp, and the result noted by Michal Kalecki, that “capitalists earn what they spend, and workers spend what they earn” (Kalecki quoted in Kaldor 1955, 96). Dividing equation (9) by the capital stock gives us the rate of profit: (10) P/K = (I/K – sricDc/K)1/sp The capital stock is the present value of the prospective quasi-rents discounted by the rate of interest. Capital, in other words, depends on expectations; its value is subjectively determined. Corporate debt represents the financial claims of rentier against the assets owned by entrepreneurs.

Keynes and The Great Depression  95 As noted, corporate debt is contractual. Hence, its value does not vary with expectations. As Minsky noted, in a boom period, both investment and the value of the capital stock increases relative to corporate debt. In other words, Dc/K falls, even though both D and K may be increasing. Many firms use the capital gains resulting from the boom as collateral to finance investment. At some point the boom ends, perhaps because bankers become fearful of the ability of firms to repay their debts. The decision no longer to finance the boom ends the period of capital gains. If the boom turns into a bust the debt– asset ratio begins to rise (Dc/K). The presumed value of assets falls relative to the debt, raising the effective cost to the firm. Presumably, as the asset value of the firm declines, investment spending declines as well. If the income flow (I*1/sp) is less than the debt obligations (icDc1/sp) the firm is forced to find alternative means of financing, all of which involve redistributing wealth to the rentier. From equation (10) we can draw the following conclusions. First, the decision to assume debt makes firms susceptible to financial markets. Increases in interest rates, for example, increase the cash obligations of such firms, while also increasing rentier income. Those firms, however, that have little or no debt are insulated from changes in financial markets, at least as far as their interest expenses are concerned. Obviously, the interests of entrepreneurs are served by lower interest rates. Second, the rate of profit moves inversely with the level of corporate debt, ceteris paribus. Increases in debt, say through mergers, lower the rate of profit assuming the capital stock remains unchanged. In this case, the debt– asset ratio increases even though the presumed value of the capital stock may be rising. Without a corresponding increase in investment, mergers characterized by increases in the debt–asset ratio result in a decline in the profit rate. To a large degree, however, increases in the debt–asset ratio result from the activities of the active rentier, those who actively seek shortterm capital gains. Third, an increase in the marginal propensity to save of the entrepreneurs without a corresponding increase in investment has the effect of lowering the rate of profit. This occurs because an increase in the marginal propensity to save lowers demand and raises costs since entrepreneurs must increase borrowing to finance their unsold inventories. Such increases, then, increase debt as well.

Notes 1 Marx made a similar critique of Say’s law, noting that money separates purchase from sale both in time and place. A person may choose to buy commodities without selling another commodity, or sell a commodity without buying, creating the possibility of crises (See Marx[1867] 1967, 130–134). Marx, however, did not develop a theory of demand. 2 Today, those who save the most are the institutional investors: pension funds, insurance companies, and so on. 3 Henry George ([1879] 1953), taking off on Ricardo’s model, offered a solution: tax all rents. As Joan Robinson notes, Keynes resurrected the problem of growth and accumulation.

96  Keynes and The Great Depression 4 Keynes made effective demand a function of employment, not output. 5 As drawn, the Z function implies that as employment increases, the revenues necessary to induce entrepreneurs to offer a specific level of employment rises. The explanation may lie in increases in resource and labor costs as employment rises. The application of continuous mass-production technology, however, suggests a deflationary bias as employment and output rise. Of course, the Z function is an aggregate of many different industries. 6 Saving is a type of surplus available for investment, export, or government expenditures. This contrasts with the classical economists, who assumed that decisions to save are decisions to purchase capital goods. For the classical economists, the interest rate is the nexus equating saving to investment. They argued that increases in saving reduce interest rates, stimulating investment. Markets ensure that saving equals investment at full employment. 7 While in the context of the model the different classes are treated as discrete entities, there is no reason why a particular individual may not both be a rentier and an entrepreneur. 8 The ability of the rentier to create debt at will is left open. 9 Keynes used employment instead of income, defining aggregate demand as “the proceeds which entrepreneurs expect to receive from the employment of N men” (Keynes 1964, p. 25). 10 Obviously, this is not true for individual entrepreneurs, nor is it true between the wagesgoods producing industries and the capitalgoods producing industries assuming differences in capital intensity. Presumably, the former may sustain a decline in profits, while the latter may sustain an increase in profits, a point first noted by Ricardo.

References Baudrillard, Jean. 1975. The Mirror of Production. Vol. 17. St. Louis, MO: Telos Press. Dobb, Maurice. 1955. On Economic Theory and Socialism: Collected Papers. New York: International Publishers. Dorfman, Joseph, C. E. Ayres, Neil W. Chamberlin, Simon Kuznets, and R. A. ­Gordon. 1963. “The Legacy of Thorstein Veblen.” In Institutional Economics: ­Veblen, Commons, and Mitchell Reconsidered, edited by Joseph Dorfman, 45–62. Berkeley and Los Angeles, CA: University of California Press. Faulkner, Harold U. 1960. American Economic History. New York: Harper & Brothers. Ferderer, J. Peter, and David A. Zalewski. 1994. “Uncertainty as a Propagating Force in the Great Depression.” The Journal of Economic History 54 (4): 825–849. Galbraith, John Kenneth. 1961. The Great Crash 1929. New York: Time Inc. George, Henry. (1879) 1953. Progress and Poverty: An Inquiry into the Cause of Industrial Depressions and of Increase of Want with Increase of Wealth: The Remedy. 15th ed. New York: Robert Schalkenbach Foundation. Hansen, Alvin. 1953. A Guide to Keynes. New York: McGraw-Hill. Kaldor, Nicholas. 1955. “Alternative Theories of Distribution.” The Review of ­Economic Studies 23 (2): 83–100. Keynes, John Maynard. (1936) 1964. The General Theory of Employment, Interest, and Money. New York: Harbinger. ———. (1936) 1964. The General Theory of Employment, Interest, and Money. New York: Harbinger.

Keynes and The Great Depression  97 ———. 1979. The Collected Writings of John Maynard Keynes: The General Theory and After: A Supplement. Vol. 29. London: Macmillan Press. ———. 1920. The Economic Consequences of the Peace. New York: Harcourt, Brace and Howe. ———. 1940. “United States and the Keynes Plan.” New Republic 103: 156–159. http://ezproxy.westminstercollege.edu/login?url=https://search.ebscohost.com/ login.aspx?direct=true&db=rgr&AN=522566742&site=eds-live. Kubik, Paul J. 1996. “Federal Reserve Policy During the Great Depression: The Impact of Interwar Attitudes Regarding Consumption and Consumer Credit.” Journal of Economic Issues 30: 829–842. Marx, Karl. (1867) 1967. Capital: A Critique of Political Economy. 3 vols. Vol. 1. New York: International Publishers. Olney, Martha L. 1991. Buy Now, Pay Later: Advertising, Credit, and Consumer ­D urables in the 1920s. Chapel Hill and London: University of North Carolina Press. Ricardo, David. (1911) 1973. Principles of Political Economy and Taxation. New York: Everyman’s Library. Robinson, Joan. 1951. Collected Economic Papers. Vol. 1. Oxford: Basil Blackwell. Rostow, W. W. 1960. The Stages of Economic Growth, A Non-Communist Manifesto. Cambridge: University Press. Schlesinger, Arthur Meier. 1957. The Age of Roosevelt: The Crisis of the Old Order, 1919–1933. The Coming of the New Deal. The Politics of Upheaval. Vol. 1. London: Heinemann. Schumpeter, J. A. 1951. Essays of J.A. Schumpeter. Edited by Richard V. Clemence. Cambridge, MA: Addison-Wesley Press. Smith, Adam. (1776) 1937. An Inquiry into the Nature and Causes of the Wealth of Nations, edited by Edwin Cannan. New York: The Modern Library. Temin, Peter. 1976. Did Monetary Forces Cause the Great Depression? New York: Norton. Weber, Max. 1958. The Protestant Ethic and the Spirit of Capitalism. New York: Charles Scribner’s Sons. Wilson, Thomas. 1942. Fluctuations in Income and Employment, with Special Reference to Recent American Experience and Post-War Prospects. London: Sir Isaac Pitman and Sons, Ltd.

6 The Myopic Consumer and the Rational Economist The Institutional Pattern of Consumption and Theories of Consumer Choice In the late 1990s, declines in the saving rates alarmed mainstream ­e conomists. The declines did not fit the portrait of a rational, prescient consumer who maximizes utility over a lifetime. Martin Feldstein attributed the declines to myopic consumers. Other economists attributed the decline to social security rendering saving unnecessary, the result of government meddling. An alternative explanation attributes declines in the savings rate to changes in the institutional pattern of consumption, a pattern connecting consumers to commodities. The pattern originated with the introduction of continuous-mass production of the late nineteenth, early twentieth centuries. With the increased output from continuous-mass production, businesses realized the need to “connect” to consumers to boost sales. The new connections came from a myriad of sources: corporations combining production with distribution, retailers, advertisers, financiers, even friends, and family. The pattern evolved, the result of innovations that change connections. New products, new forms of advertising, and new ways of liquefying consumer assets connect in new and everchanging ways, all enticing consumers to buy. Continuous-mass production transformed America from a country of “farmers and merchants” into a society of strangers. Appearances became increasingly important in acquiring the esteem of others. One’s home, attire, manners, and pets became visible manifestations of personal wealth, expanding the opportunities for corporations to influence those appearances. New technologies transformed the pattern of consumption, expanding and intensifying connections to consumers. Canned goods replaced home canning; media entertainment replaced home entertainment; private automobiles replaced street cars. Consumers had to be informed, educated, and persuaded to purchase products. Goods had to be advertised. “National advertising arose to meet the needs of businesses that employed new technologies and sold to new mass consumer markets” (Pope 1983, 293). If consumers lack the income to purchase the goods, financial institutions provided the purchasing power.

DOI: 10.4324/9780429443763-6

The Myopic Consumer and the Rational Economist  99

Veblen on Advertising Veblen addressed advertising and the importance of salesmanship in The Theory of Absentee Ownership. Published in 1923, Veblen noted that the importance of advertising in selling goods had become evident over the past decade. Its purpose is “to get a margin of something for nothing, and the wider the margin the more perfect the salesman’s work” (1923, 291). Veblen found advertising inherently deceptive, comparing it to organized religion. Worked out to its ideal finish, as in the promises and performance of the publicity-agents of the Faith, it should be the high good fortune of the perfect salesman in the secular field also to promise everything and deliver nothing. (1923, 321–322) Advertising appeals to our emulative tendencies, creating images of new possibilities. The imagined effects are almost always positive, promising something better. Veblen pulled the curtain aside, reflecting on the advantages of eliminating the deception. “Still it is worth noting that the eventual elimination of salesmanship and sales-cost would lighten the burden of workday production for the underlying population by some fifty per cent” ([1921] 1965, 113). Advertising and salesmanship achieved an elevated prominence with the introduction of continuous-mass production technology. Advertising enables corporations to expand sales, taking advantage of economies of scale and scope. The resulting decline in per-unit costs helped offset the costs of advertising. “The cause of this advancing sales-cost is quite simple—­ production-cost by modern industrial methods being less, the margin which can be taken up in sales-cost is more” (1923, 312). Veblen viewed the American market of the early 1920s as closed owing to tariffs. Efforts by one business to increase sales through advertising meant declines in revenue for another, compelling businesses to emulate each other. From which it follows that any device or expedient which approves itself as a practicable means of cutting into the market, on the part of any one of the competitive concerns, presently becomes a necessity to all the rest, on pain of extinction. (1923, 303) Veblen further recognized that advertising may reduce saving. [T]he current, very urgent, sales-publicity may be presumed to divert a little something from savings to consumptive expenditures, and so may add that much of a margin of funds to the volume of purchasing-power currently available for expenditure on advertised goods. (1923, 309f)

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Mainstream View of Advertising Veblen’s view of advertising conflicts with the mainstream view that consumers are sovereign. The mainstream view holds that consumers, voting with their dollars, determine what, how, and for whom goods are produced. The assumption of perfect knowledge ensured that consumers choose rationally, rendering advertising unnecessary, underscored by the model of perfect competition. As A.C. Pigou noted, “Under simple competition there is no purpose in this advertisement, because, ex hypothesi, the market will take, at the market price, as much as anyone small seller wants to sell” (1920, 198). In the 1930s, both Joan Robinson ([1933] 1969) and Edward Chamberlin ([1933] 1969), displeased with the lack of realism of the perfectly competitive model, independently developed the theory of monopolistic competition. Monopolistic competition is an oxymoron, a synthesis of competition and monopoly. Firms compete with each other selling similar products while retaining a monopoly over their specific product.1 Firms differentiate their products by advertising, signaling the differences to consumers. Robinson analyzed the impact of advertising on sellers’ costs, ignoring its impact on consumer preferences. Chamberlin found the lack of attention to advertising by economists surprising. He admits that advertising manipulates demand. “Advertising affects demands . . . by altering the wants themselves.” Selling products, old or new, depends on advertising. Certainly, new products and new varieties of old products would have virtually no market at all without selling outlays of this sort. Similarly, the markets for older, better established products could be increased but slowly and within narrow limits if nothing were expended for selling— that is, if the producers merely ask and waited for order to come in. ([1933] 1969, 119) Chamberlin continues: Similarly, selling methods which play upon the buyer’s susceptibilities, which use against him laws of psychology with which he is unfamiliar and therefore against which he cannot defend himself, which frighten or flatter or disarm him—all of these have nothing to do with his knowledge. They are not information; they are manipulative. They create a new scheme of wants by rearranging his motives. As a result, demand for the advertised product is increased, that for other products is correspondingly diminished. ([1933] 1969, 119–120) Different theories of consumer behavior expanding on the assumption of economic rationality did not emerge until after World War II. The pent-up

The Myopic Consumer and the Rational Economist  101 demand following the war, the decision of banks to provide credit to ­consumers, and the reallocation of production from war goods to consumer goods fueled the economic boom of the 1950s. In addition, the advent of television created new ways of advertising goods, all of which laid the basis for new theories of consumer behavior. Mainstream theories of consumer behavior—the relative-income hypothesis, the permanent-income hypothesis,2 and Kelvin Lancaster’s new theory of consumption—select elements of the institutional pattern of consumption of their time. The relative-income hypothesis focuses on how information ­ ermanent-income is conveyed, a display of social interdependence. The p hypothesis focuses on the intertemporal allocation of income, resting on institutional changes allowing individuals to borrow against their wealth. Lancaster’s theory reconciles the independence of consumer preferences with new products, without having to assume consumer prescience. Both the relative-income hypothesis and the permanent-income hypotheses represent responses to Keynes’ absolute-income hypothesis, which rested on the assumption that as income rises consumption rises but not as much as income. A.C. Pigou had already identified a theoretical weakness in Keynes’ absolute-income hypothesis, namely, the role of wealth.3 Moreover, Simon Kuznets’ studies revealed that saving as a percentage of income tended to remain stable over time, an observation seemingly at odds with Keynes’ psychological law. And in 1947, James Duesenberry published the relative-income hypothesis, with its uncomfortable wedding of individual ­utility maximization with social interdependence. Duesenberry’s Relative-Income Hypothesis Duesenberry recognized that “the problem of consumer behavior must begin with a full recognition of the social character of consumption patterns” (1949, 19). Duesenberry acknowledges Veblen’s contribution, but asserts that Veblen failed to develop a “positive analytical theory of consumption—one which would take into account the interdependence of preferences and still be useful in connection with the problems traditionally called economic” (1949, 15). Duesenberry’s purpose was to incorporate the social factors in consumer behavior with the assumption that individuals maximize utility. From the viewpoint of preference theory or marginal utility theory, ­human desires are desires for specific goods; but nothing is said about how these desires arise or how they are changed. That, however, is the essence of the consumption problem when preferences are interdependent. (1949, 19) Duesenberry sought to explain why people save. How do we reconcile “the struggle between desires to increase expenditure and desires to save or ­balance the budget[?]” (1949, 25).4 For Duesenberry, saving is a compromise

102  The Myopic Consumer and the Rational Economist between the desire for more and better goods and a precaution against the uncertainty of the future. Once a compromise is reached the habit formation provides a protective wall against desires for higher quality goods. In given circumstances, the individuals in question come into contact with goods superior to the ones they use with a certain frequency. Each such contact is a demonstration of the superiority of these goods and is a threat to the existence of the current consumption pattern. (1949, 26) At some point, “resistance to them will be inadequate. The result will be an increase in expenditure at the expense of saving” (1949, 27). The “demonstration effect” conveys information from one person to another. It provides potential consumers a vicarious experience. The ­ demonstration effect occurs through institutions that bring individuals into personal contact with one another “demonstrating” the product. As examples, Duesenberry included Tupperware parties, door-to-door salesman, and demonstrations at county fairs. Duesenberry rejected the idea that the demonstration effect is rooted in emulation. Rather, it is a “demonstration” of the use of the item. It provides information; it does not shape preferences. At the time, television was in its infancy and had yet to demonstrate its ­ability to demonstrate products. Duesenberry concluded that advertising is not the primary stimulus to increasing demand. Nor do new products increase demand. “If the ­automobile had not been invented people would have bought pianos and large houses, as they did before when they received higher incomes” (1949, 61). If the demonstration effect merely informs, how do we account for changes in tastes? Duesenberry’s answer leaves intact consumer sovereignty. If neither income nor price nor autonomous changes in tastes account for the growth of sales (or stocks in the case of durables) of new products, how can we account for it? A self-generating shift in preferences seems to be the answer. The Permanent-Income Hypothesis The increase in consumer debt in the decade following World War II provided the backdrop for the permanent-income hypothesis. The hypothesis derived from a study regarding the consumption patterns of dentists and lawyers. Theoretically, Milton Friedman had two goals. First, Friedman sought to debunk Keynes’ absolute-income hypothesis and the policy conclusion that redistributing income from the rich to the poor and middle classes could increase expenditures. Second, Friedman sought to refute Duesenberry’s hypothesis that consumer spending depends on those with whom you identify.

The Myopic Consumer and the Rational Economist  103 Friedman’s solution was the permanent-income hypothesis. Gottfried Haberler and Pigou anticipated the hypothesis, suggesting that consumption as a percentage of income may, in fact, depend on the ratio of wealth to income. Friedman (1957, 7) began his hypothesis with the following ­assumption: “Let us consider first the behavior of a consumer unit under conditions of complete certainty.” The individual knows both past and future income, prices, and interest rates. Under this scenario, the individual will try to “straighten out” his consumption over time. The hypothesis applies the concept of economic rationality to the intertemporal allocation of income. Permanent consumption depends ­ on permanent income and transitory consumption on transitory income. ­Allocating income intertemporally incorporates one dimension of changes in the ­institutional patterns of consumption: the expansion of consumer debt in the decades following World War II. Introducing uncertainty increases the likelihood of saving. Friedman continues: All forms of wealth are not, however, equally satisfactory as a reserve for emergencies. The major general distinction is between human and nonhuman wealth. In a nonslave society, there is no market in human beings comparable to the market for nonhuman capital. It is in general far easier to borrow on the basis of a tangible physical asset, or a claim to one, than on the basis of future earning power. (1957, 16) Friedman wrote before the introduction of universal credit cards, which provides credit based on one’s future earning capacity. Friedman proceeds to explain that declines in the savings rate stem from increases in the ratio of nonhuman wealth to permanent income (future earning capacity). Increases in nonhuman wealth may substitute for saving. As Friedman noted, “The importance attached to a reserve for emergencies depends, of course, on the degree of uncertainty that the consumer unit foresees” (1957, 17). The possibility of liquidating assets enables consumers to incur debt, however, reducing saving. Why save when you can use credit cards for emergencies. This assumes two possibilities. First, individuals are receptive to credit. And second, people have the option to resort to credit. Credit serves as a “private safety net.” Friedman’s permanent-income hypothesis represented an advance over Duesenberry’s relative-income hypothesis. First, by assuming that consumers seek a constant level of consumption over time, Friedman explained the instability of saving. By assuming that individuals consume not out of current income but out of permanent income, Friedman critiqued Keynes’ absolute-income hypothesis and the implication that redistributing income increases consumer expenditures. Third, by viewing consumption in terms of the intertemporal allocation of income, Friedman avoided uncomfortable notions about the interdependence of utility functions.

104  The Myopic Consumer and the Rational Economist How might economists explain the decline in saving rates? Moreover, how might they explain different savings rates in different countries? James Tobin’s ­critique of the permanent-income hypothesis provides an explanation: Even within the lifetime of one generation, households are generally not able to shift consumption at will from a later date to an earlier date. When such intertemporal substitution is possible, it can usually be achieved only at a higher rate of interest than can be earned on ­saving. Even in countries with sophisticated financial institutions and well-­ developed capital markets, opportunities for borrowing against future earnings from labor are limited. (Tobin 1980, 57) A study of different savings rates among countries found . . . that the low levels of consumer debt observed in countries where the excess sensitivity of consumption is high can be interpreted as evidence that liquidity constraints are at the root of the empirical failures of the LC-PIH [Life-cycle permanent-income hypothesis] in time-series tests. (Jappelli and Pagano 1989, 110) An alternate study found that deregulation of credit markets is associated with declines in the savings rate in Britain. Aside from empirical problems, there are important theoretical problems with the permanent-income hypothesis. First, permanent income is not ­observable. It is a theoretical device required to allocate resources over time to maximize utility, a point that Friedman is aware. Second, Friedman believed that the time horizon that an individual could allocate intertemporally was two to three years, roughly the length of time of installment credit on an automobile during the 1950s. The synthesis of the permanent-income hypothesis with the life-cycle hypothesis has extended the horizon to a lifetime, a view of consumer behavior critical to the rational expectations model and Ricardian equivalence. In effect, the hypothesis requires not only prescience but also the assumption that preferences do not change. Third, the assumption that consumers are prescient renders advertising and the associated institutions irrelevant. Generalizing the spending habits of dentists and other professionals to all individuals excludes individuals who have few or no assets. Lancaster’s New Theory of Consumption Lancaster’s theory of consumption considered two issues borrowed from modern culture. First, Lancaster recognized that many consumers have neither the information nor the skills to make good choices. In consumption, as in production, the prime reasons for inefficient use of the existing technology are ignorance and lack of managerial skill.

The Myopic Consumer and the Rational Economist  105 The consumer may not be aware that a certain good possesses certain characteristics or that certain goods may be used in a particular combination to give a specified bundle of characteristics. (Lancaster 1966, 18) To address this problem, Lancaster advocated government intervention to provide information to consumers, such as label laws (1966, 19). Second, novel goods pose problems for the traditional theory of consumer behavior. Either we must add the novel good to a person’s utility function dismissing his previous preferences. Or we assume the prescient consumer anticipated the good and its introduction manifests itself in falling prices. Otherwise, we arrive at the conclusion that the consumer is not sovereign. Traditional consumer theory is at its most unenlightening when confronted by the problem of new goods. Introduction of a new goods requires either that the preferences function defined on n goods is thrown away, and with it all the knowledge of behavior based on it, and replaced by a brand new function defined on n + 1 goods, or the fiction that the consumer has a potential preference function for all goods present and future and that new good can be treated as the fall in that good’s price from infinity to its market level. Neither approach gets us very far. (Lancaster 1966, 20) Lancaster resolved the problem by assuming that preferences for products reduce to preferences for the characteristics of products. Since a product is a collection of characteristics, new products represent new ways of combining the characteristics of old products. “But most new goods can be regarded as simply giving rise to existing characteristics in new proportions, and we have available an operationally meaningful way of approaching the problem” (Lancaster 1966, 20). Goods maybe novel, but their characteristics are not.5 The notion that people seek the esteem of others provides a reason for demanding new goods, including goods sufficiently novel that people lack familiarity with their characteristics. Lancaster’s approach fails to explain the preference for such goods. Further, he fails to address differences in culture. In this case, Lancaster falls on traditional economic theory, assuming preference for the product already exist within the consumer’s utility function. One can only reflect with amusement that television might be something that the Kung bushman had wanted all along.

Galbraith’s View of Consumption In The Affluent Society, John Kenneth Galbraith rejected the mainstream view of consumer behavior. Galbraith’s purpose was “to awaken

106  The Myopic Consumer and the Rational Economist the American public opinion from its complacent worship of mindless economic growth” (Heilbroner 1989, 367). As Galbraith noted, initiative in economic life moves from the consumer, the classical source of all economic decision, to the producing firm. Increasing affluence having released wants from the level of stark physical need, producers adjust consumer taste and behavior to their needs by advertising and salesmanship. (1981, 361) Corporate influence on the market economy results in a social imbalance: too many resources allocated toward the private sector leave too little allocated toward the public sector. Private goods always have a public counterpart. Private autos need public roads; private residences need parks, sanitation, and water; private goods require waste disposal; private investment requires public education. The imbalance stems from corporations’ vested interest in increasing the output of private goods. Private goods are profitable; public goods, generally, are not. Public goods require public financing, generally from taxes, for which there is no advertising, for which the public is reticent to approve, even discouraged, For Galbraith, economic security, inequality, lack of opportunity, underfunded schools, environmental neglect, and so on are manifestations of a social imbalance. The imbalance rose to public consciousness with the launching of the Soviet satellite Sputnik in 1958. The thought that the US might suffer the humiliation of coming in second in the space race prompted officials to invest in education, particularly science and mathematics. The imbalance results from an institutional pattern dominated by corporations that direct resources toward private consumption, all to enhance corporate profits. Corporations profit by producing goods; the more goods produced the greater the potential profits. Hence, corporations have a vested interest in increasing output. To ensure the output will be purchased, corporations advertise to influence consumer desires. Through advertising, consumer desires come to depend on output, a phenomenon Galbraith calls the dependence effect: “As a society becomes increasingly affluent, wants are increasingly created by the process by which they are satisfied” (Galbraith 1958, 128). Galbraith continues: Wants thus come to depend on output. In technical terms it cannot longer be assumed that welfare is greater at an all-round higher level or production than at a lower one. It may be the same. The higher level of production has, mainly, a higher level of want creation necessitating a higher level of want satisfaction. (1958, 128) Consumer debt works in tandem with advertising to stimulate consumer spending. Galbraith notes that from 1952 to 1956, installment debt increased

The Myopic Consumer and the Rational Economist  107 by 133% and income rose by 21%. From this Galbraith drew the following implications: The legacy of wants, which are themselves inspired, are the bills which descend like the winter snow on those who are buying on the installment plan. By millions of hearths throughout the land, it is known that when these harbingers arrive, the repossession man cannot be far ­behind. Can the bill collector be the central figure in the good society? (1958, 143) Galbraith noted that some commodities cannot be purchased on credit, including “the services of schools, hospitals, libraries, museums, police” and so on. This of course is no longer true, reflecting the tendency of the institutionalist pattern to “reach out and touch someone,” anyone at all, so long as they have sufficient credit.

The Role of Advertising From the outset, critics raised the question whether advertising shapes values. For Galbraith, advertising provides the means through which advertisers shape consumer tastes to serve the corporate interest. The initiative in deciding what is to be produced comes not from the sovereign consumer who, through the market, issues the instruction that bend the productive mechanism to his ultimate will. Rather it comes from the great producing organization which reaches forward to control the markets that it is presumed to serve and, beyond, to bend the customer to its needs ([1967] 1978, 7). Mainstream economists disagree. Gary Becker (1993), for example, argues that advertisements are economic goods provided at little or no price. Advertisements are complementary goods, leading to the consumption of goods that advertisers sell. Such consumption depends on altering prices, not shaping preferences. The ad is provided for free; the price of the other good is not. Becker’s argument raises questions regarding the degree of complementarity. Can one enjoy the good without the advertisement? Do I need to drink Budweiser to appreciate frogs croaking “Bud-Wei-Ser?” For Becker, the complementarity is unidirectional: first the ad, and then the good. Further, Becker’s assumption that consumption depends on altering prices implies that preferences for the product were always there. Once again, we return to the sovereign consumer. Advertising has a number of characteristics. First and foremost, advertising aspires to increase purchases using any number of rhetorical devices: informing, educating, demonstrating, entertaining, appealing to our emotions, and so on. Second, advertising is a selective tool, a spotlight focusing

108  The Myopic Consumer and the Rational Economist attention on the products and services that corporations find profitable. Unprofitable products remain in the shadows, including public education, public transportation, cleaning up the environment, alleviating poverty, encouraging a sense of social responsibility, and so on. Third, advertising justifies the decisions of corporate leaders and i­ nvestors. “If investment in advertising keeps the firm’s investors happy, the company can count on a flow of capital for its operations.” So long as businesses feel that advertising is important, the firm can divert resources to those items that it chooses to produce. “Advertisements may affect the goods available to consumers even if they do not persuade consumers which goods to buy” (Schudson 1986, xiv). Fourth, advertising heightens the difference between wanting and having, between expectation and reality. Advertising creates an illusion, an expectation about the kind of experiences the product bestows. The expectation may be factual or fanciful. In either case, the message conveyed is “the pleasures and freedom of consumer choice.” Advertising is an “awareness institution” along with schools and church. But schools and churches generally lack the resources that advertisers command. Advertising makes people aware of those products that allegedly will improve their lives. The message fosters a dissonance, of sorts, between having and wanting. The message fosters a belief that individuals can transform their lives by purchasing goods. As John Berger reflects, advertising “proposes to each of us that we transform ourselves, or our lives, by buying something more” (Berger quoted in Schudson 1986, xix). As society became more fragmented and personal connections declined, the mass media offered a means of reconnecting people with a message, the message to buy. The message conveyed is “the pleasures and freedom of consumer choice” (Schudson 1986, 155). Fifth, from the advertisers view point, advertising merely provides ­information, enabling consumers to make better choices. Advertising, then, identified itself with freedom. Advertising and Selling suggested that the number of items of merchandise for sale provided an authoritative “index of a civilization.” With the plethora of consumer goods, consumers needed the advice and information provided by the advertisers. As one advertising agency put it, “We are going to make living worth while” (Marchand 1985, 347).6 Sixth, advertising reflects corporate desires and the financial power that corporations wield. Given a person’s limited time, individuals are engulfed with messages and products that reflect a particular value system. Satisfying needs depend on income. “Social membership and personal identity have come increasingly to be understood in monetary terms.” As Lee Rainwater reflected (1974), “When people are not protected from this inexorable dynamic of money economies by some local cultural enclave they cannot fail to define themselves most basically in terms of their access to all that money can buy.” To say that advertising makes people buy a specific good is mistaken. But to argue that advertising has no effect on consumer preferences is also mistaken. The value system underlying advertising cannot help but influence

The Myopic Consumer and the Rational Economist  109 the values of consumers, especially given the financial resources that corporations allocate to connect commodities to consumers. One is reminded of a cartoon by Gary Larson. The cartoon depicts a herd of buffalo stretching onward toward the horizon. In the foreground, one buffalo turns to the other and says, “As if we knew where we were going.”

Conclusion Keynes did not address the role of advertising in influencing consumer demand, consistent with his belief that, in the long run, the return to capital would decline. At the time of the publication of The General Theory, Keynes believed that British society was on the cusp of satiating wants. As Hyman Minsky noted, “Keynes held that once the twin evils of abject grinding poverty and war were banished from the earth, not much more in the way of worldly goods than was within sight would be needed to achieve true affluence” (Minsky 1975, 152). Why didn’t this occur? Minsky offers several reasons. First, “the rich turned to consuming capital-intensive bundles of goods rather than philosophy and culture and that their example became generalized, and this conspicuous consumption has led to a continuing capital shortage” (1975, 153). Second, Keynes believed that societies such as the United States and Western Europe could satisfy individuals’ primary needs. Minsky attributed the high return to capital to the growth of relative needs, needs stemming not from self-preservation, but from conspicuous consumption. Third, inequality in the distribution of income maintained a higher return to capital. It is the income distribution associated with capital scarcity that may have set the consumption pattern that has led to a continuing capital shortage. In order to achieve the euthanasia of the rentier, it may be necessary to first achieve the income distribution that Keynes argued would exist after the euthanasia was achieved. (1975, 153) Fourth, consumers’ preferences have been molded, recalling Galbraith’s dependence effect. [T]he direction taken by the growing relative needs is inspired by and largely the product of “education” in the guise of advertising. In our current system, affluence has not brought a demand for the quiet pleasures; but rather has been associated with proliferation of demands for goods that require capital assets. (1975, 153–154) And fifth, Minsky suggests that the dismantling of government programs enacted prior to World War II to provide employment, in addition to

110  The Myopic Consumer and the Rational Economist subsidizing capital in the form of weapons contracts, have maintained the return to capital. Minsky offers the following conclusion: It might well be that the euthanasia of the rentier in the form that Keynes envisaged it requires prior constraints on the growth of relative needs, and the constrained growth of relative needs requires an income distribution based on low or no income from capital ownership, i.e., the prior euthanasia of the rentier. (1975, 154) Mainstream economists, of course, would respond to Minsky arguing that human wants are insatiable. This, of course, conflicts with Marshall Sahlins’ findings (1972) that hunter-gatherers had few wants relative to the available means. As David Hamilton (1987, 1537) reminds us, “wants are not made in heaven.” From the mainstream view, nature has condemned humankind to a life of frustration in the search for happiness. Like Sisyphus, humankind is condemned forever to roll the rock to the mountain top only to have it roll back. The elusiveness of happiness points to the paradox of affluence, “the deterioration in quality of life despite or because of sustained growth in consumption” (Stanfield and Stanfield 1980, 437). William Redmond (2001, 575) rephrased the question. “Suppose that incomes continued to rise indefinitely. Would we spend the whole packet on more consumer goods, or is there some point at which enough is enough?” Redmond answers no, but not because wants are naturally insatiable. In Redmond’s view, wants and preferences are not innate but rather are shaped by institutional forces. For the present purposes, it means that material desire can inflate to match the possessions, and thus the apparent desires, of others. Erstwhile stability of preferences is subverted by social exposure, as the consumer who sees more wants more. (2001, 580) The consumer is not “homo economicus but homo emptor, the acquisitive actor of the consumer culture” (2001, 585).

Notes 1 Chamberlin approvingly quoted Veblen: “. . . it is very doubtful is there are any successful business ventures within the range of modern industries from which the monopoly element is wholly absent” (Veblen quoted in Chamberlin [1933] 1969, 5). 2 Given its similarity to the permanent-income hypothesis, the life-cycle hypothesis is ignored. 3 Known as the real balance or Pigou effect, deflation increases the real value of dollar-denominated wealth, stimulating consumption. While theoretically

The Myopic Consumer and the Rational Economist  111 important, from a practical point of view the Pigou effect is probably negligible. Nevertheless, the Pigou effect served to critique Keynes’s theory, implying that deflation would automatically return the economy to full employment. 4 Duesenberry hypothesized that declines in familial ties would strengthen the desire to save (1949, 67). 5 Veblen agrees that new products may enhance some characteristics, making them more serviceable. But new products also increase the esteem gained by others. “In the process of gradual amelioration which takes place in the articles of his consumption, the motive principle and the proximate aim of innovation is no doubt the higher efficiency of the improved and more elaborate products for personal comfort and well-being. But that does not remain the sole purpose of their consumption. The canon of reputability is at hand and seizes upon such innovations as are, according to its standard, fit to survive. Since the consumption of these more excellent goods is an evidence of wealth, it becomes honorific, and conversely, the failure to consume in due quantity and quality becomes a mark of inferiority and demerit” (Veblen[1899] 1979, 73–74). 6 Schudson asserts that “The prevalence of gift giving suggests that people very often buy things not because they are materialist but because they are social” (1986, 139).

References Becker, Gary S., and Kevin M. Murphy. 1993. “A Simple Theory of Advertising as a Good or Bad.” The Quarterly Journal of Economics 108 (4): 941–964. https://doi. org/10.2307/2118455. http://www.jstor.org/stable/2118455. Chamberlin, Edward Hastings. (1933) 1969. The Theory of Monopolistic ­Competition: A Re-Orientation of the Theory of Value. Cambridge, MA: Harvard University Press. Duesenberry, James S. 1949. Income, Saving and the Theory of Consumer Behavior. Cambridge, MA: Harvard University Press. Friedman, Milton. 1957. The Theory of the Consumption Function. Princeton, NJ: Princeton University Press. Galbraith, John Kenneth. 1958. The Affluent Society. Boston, MA: The New ­A merican Library. ———. 1981. A Life in Our Times: Memoirs. Toronto: Ballantine Books. ———. (1967) 1978. The New Industrial State. Boston, MA: Houghton Mifflin Company. Hamiliton, David. 1987. “Institutional Economics and Consumption.” Journal of Economic Issues 21 (4): 1531–1554. Jappelli, Tulio, and Marco Pagano. 1989. “Consumption and Capital Market Imperfections: An International Comparison.” American Economic Review 79 (5): 1088–1105. Lancaster, Kelvin. 1966. “Change and Innovation in the Technology of Consumption.” American Economic Review 56 (1/2): 14–23. Marchand, Roland. 1985. Advertising the American Dream: Making Way for Modernity 1920–1940. Berkeley, CA: University of California Press. Minsky, Hyman P. 1975. John Maynard Keynes. New York: Columbia University Press. Pigou, A. C. 1920. The Economics of Welfare. London, : Macmillan and co., ltd. Pope, Daniel. 1983. The Making of Modern Advertising. New York: Basic Books.

112  The Myopic Consumer and the Rational Economist Rainwater, Lee. 1974. What Money Buys: Inequality and the Social Menaings of ­Income. New York: Basic Books. Redmond, William H. 2001. “Exploring Limits to Material Desire: The Influence of Preferences Vs. Plans on Consumption Spending.” Journal of Economic Issues (Association for Evolutionary Economics) 35 (3): 575. Robinson, Joan. (1933) 1969. The Economics of Imperfect Competition. 2nd ed. ­London: Macmillan and Co., ltd. Sahlins, Marshall. 1972. Stone Age Economics. New York: Aldine-Atherton. Schudson, Michael. 1986. Advertising, the Uneasy Persuasion: Its Dubious Impact on American Society. New York: Basic Books. Stanfield, J. Ron, and Jacqueline B. Stanfield. 1980. “Consumption in Contemporary Capitalism: The Backward Art of Living.” Journal of Economic Issues (Association for Evolutionary Economics) 14 (2): 437. http://search.ebscohost.com/login. aspx?direct=true&db=buh&AN=4684429&site=ehost-live. Tobin, James. 1980. Asset Accumulation and Economic Activity. Chicago, IL: ­University of Chicago Press. Veblen, Thorstein. 1923. Absentee Ownership and Business Enterprise in Recent Times. New York: Sentry Press. ———. (1921) 1965. The Engineers and the Price System. New York: Augustus M. Kelley. ———. (1899) 1979. The Theory of the Leisure Class: An Economic Study of Institutions. New York: Penguin Books.

7 The Liquefication of Everything Corporate Power and the Evolution of Consumer Credit

The evolution of consumer credit involves using corporate power to extend the market economy, engaging in financial innovation and removing liquidity constraints that limit consumer spending. Financial innovation involves identifying consumer assets, creating markets for those assets, and offering credit based on those assets. To consumers, liquefication provides purchasing power. To creditors, liquefication enables recovering the credit extended plus interest. Removing liquidity constraints involves removing institutions that historically have limited consumer spending, hindering the ability of corporations to transform consumer assets into corporate profits. Power stems from the size of the financial resources that corporations command, the willingness to use those resources to remove institutions that constrain consumer spending, and the willingness to commit resources to create new institutions to foster spending.1 Corporations have a vested interest in ­providing credit to increase expenditures, an interest that stems from the corporations’ interest in increasing output (Galbraith 1958). Credit provides consumers an immediate claim to goods. In exchange, corporations receive a claim to future income of consumers, the present value of which exceeds the credit provided. The claim on future income disciplines the consumer, molding his time, his relationships, and his resources to make payments. Trading off future income for purchasing power today required removing a number of cultural and institutional constraints. Removing the first constraint involved undermining the cultural influences of Protestantism. Protestantism taught that the rewards for thrift, hard work, and discipline are material wealth in this world and eternal salvation in the next. It provided an ideology conducive to the accumulation of capital (Weber 1958). In a materially poor economy that values increasing production, thrift fosters accumulating capital. In an affluent economy churning out an abundance of goods, thrift becomes a hindrance. Overcoming the second constraint meant overcoming the lack of liquidity imposed by a lack of current income. The durable goods revolution of the early twentieth century introduced many new products: radios, washing machines, automobiles, among others. Their expense, particularly that

DOI: 10.4324/9780429443763-7

114  The Liquefication of Everything of the automobile, exceeded the budgets of most consumers. The durable goods revolution occurred concomitantly with innovations in finance. “The ­Consumer Durables Revolution was coincident with a burgeoning credit economy. Most credit extended to households to facilitate purchases of durable goods was installment credit extended by new financial institutions, sales finance companies” (Olney 1991, 134). Installment credit solved the problem by providing liquidity to the consumer, using the purchased good as collateral. The proliferation of installment credit in the early twentieth century was associated with the rise a new institution, sales finance companies, established for the purpose of financing consumer spending. The third constraint lay in providing credit on demand, overcoming the lack of liquidity stemming from a lack of income and a lack of collateral. The universal credit card supplied the solution, an instrument providing instant credit for virtually any purchase based on, among other considerations, the cardholder’s prospective income. Credit cards provide credit based, in part, on the present value of the consumer’s future income stream. Credit cards further required solving the technical problems involved in processing credit and the institutional problems associated with ­establishing national credit-card banks. Further expansions of credit-card use followed the deregulation of consumer credit, reductions in the costs of processing credit, and the automaticity of extending credit, largely owing to advances in ­information technology. In the 1990s, the use of statistics and credit ­scoring further reduced the costs of processing prospective cardhold­ ecuritizing payments streams from credit cards, mortgages, and other ers. S forms of credit further facilitated extending credit to consumers. The fourth and latest constraint has become apparent with dismantling the system of regulations and overcoming the cultural biases against c­ onsumer credit beginning with the deregulatory movement that swept the industrial nations in the late 1970s. While the details differ, the general effect has been to allow consumers in other countries to finance their expenditures with credit. With the American and British markets saturated, credit-card companies and other corporations are continuing their expansion into ­Europe and Asia. Credit enables the consumer to purchase products that would, in many cases, go unpurchased. Credit augments demand, overcomes overproduction, and enhances corporate profits. Deficit expenditures by consumers create surpluses for corporations (Wray 1991). The long-run effects are problematic, depending on credit availability, consumer confidence, entrepreneurial expectations, the willingness of the central bank to support consumer spending, and so on. At some point, consumers may choose to reduce their debts as they did during the Great Financial Crisis of 2008 and 2009. Hence, using credit to boost profits in the short run may pose a problem in the long run: how to maintain an ever-increasing level of spending. From the short-run vantage point of a CEO trying to maximize returns to stockholders, however, the problem is irrelevant. From the corporate point of view, credit has several advantages.2 First, as Warren Gramm (1978) noted, credit enables corporations to increase

The Liquefication of Everything  115 c­ onsumer expenditures without increasing wages (see Gramm 1978). John Hobson (1930), Keynes ([1936] 1964), and others have long pointed to income inequality as limiting effective demand. Since the 1920s, however, consumer credit has lessened the need to redistribute income to increase demand. Second, the emergence of corporations along with the use of stocks to ­finance investment in the late nineteenth century enhanced the importance of consumer credit. The purchase and sale of stocks altered the way businesses are valued, creating new opportunities for amassing wealth. As both Veblen and Keynes observed, older forms of business enterprise were valued based on cost. Corporations are valued based on earning capacity. “The earning-capacity on which the market capitalization runs and about which the traffic in merchantable capital turns is a putative earning-­capacity” ­(Veblen [1904] 1975, 155). By increasing sales, consumer credit boosts the prospective earnings capacity of corporations, thereby increasing their stock value. Credit becomes the lever through which corporations transform the prospective income of consumers into corporate assets. As Edward V. Donnell, former president of Montgomery Ward, observed: “A regular customer [buying on credit] buys two and a half to three times more in a year that the average cash customer” (Donnell quoted in Olney 1991). Third, credit in the form of credit cards provides the holder instant ­liquidity for an almost infinite number of commodities. Once granted, credit cards eliminate the transactions cost of accessing credit. Unless the user refuses to yield to the advertising onslaught appealing to the emulative impulse, providing instant liquidity fosters spending. Credit limits replace checking-account balances in constraining consumer spending, blurring the budget constraint. Fourth, and perhaps most significant is the change in “values.” Consumers become habituated to using credit, a habituation nourished and fostered by corporations themselves. The message conveyed is deceptive. Credit is sold as removing the need to economize. Current income no longer ­constrains consumption; cruising the Caribbean need not require forgoing the Suburban. “Visa is everywhere you want to be.”3 The message conveys the pleasures of instant gratification, suppressing the costs involved. But the costs lie in the future, for many people an abstraction lacking reality. Only the pleasures of the present matter. The reality is that credit imposes an ­obligation, disciplining consumers who find their future income wanting. For such people, the obligation pressures individuals to work longer or more intensely (Schor 1992). As Lendol Calder concludes, “consumers run the risk of being both deceived by consumerism and dragged along by consumer credit. To say there have been worse ways of living is not to say this is a good way to live” (1999, 33). The change in values is significant. Economizing in the present appears more serviceable in an economy dependent on personal savings to finance investment, an economy emphasizing production, and an economy where privatization rules. In an economy characterized by an abundance of consumer goods, the economizing habit among the masses hinders the

116  The Liquefication of Everything accumulation of capital. In such an economy, emphasis shifts to sustaining demand, fostering desires, and providing the liquidity to satisfy those desires. The desire for more things and resorting to credit to satisfy those desires coincides with the corporate purpose. While its purpose assumes different forms—maximize profits, maximize returns to stockholders, increase market share, satisfice—all share in common the pursuit of pecuniary values, finding different ways to accumulate profits.4

Dismantling the Protestant Ethic: The Decline of Thrift Americans’ low savings rate poses a paradox for many economists.5 To them, the lack of saving appears irrational, myopic, a disregard for future wants. Martin Feldstein (1996), however, offered an explanation: “High ­returns” from Social Security render saving unnecessary. Lack of saving becomes a rational choice, the result of government meddling.6 Aside from whether individuals are as rational or prescient as Feldstein suggests, the evolution of consumer credit reveals that personal saving does not serve the corporate interest. In popular culture thrift has become an anachronism, a holdover of the Protestant influences of a time past. The few editorialists, pundits, and economists encouraging Americans to save are drowned out by the chorus encouraging them to buy. 7 But it is one thing to reject the virtue of thrift, quite another to embrace the philosophy of consumerism. In the nineteenth century, attitudes toward thrift and credit differed from that of today. Credit existed primarily in the form of individuals borrowing against their farms to finance the next planting, small proprietors extending credit to locals, and loans provided by pawnshops. During the nineteenth century the things that a self-respecting, thrifty American family would buy on the installment plan were a piano, a sewing machine, some expensive articles of furniture, and perhaps sets of books. People who made such purchases didn’t talk about them. ­Installment buying wasn’t considered quite respectable. (Olney 1991, 130–131)8 Living on the farm, most individuals produced goods that they themselves consumed. The rural nature of the economy impeded access to markets. Many individuals lacked income to buy many goods. Except for pawnshops and a few retailers, consumer credit was nonexistent. Banks refused to ­finance consumer spending, believing the practice irresponsible, risky, and unwise. Such beliefs continued well into the first decades of the twentieth century even after installment credit had become established practice. The use of credit, and particularly the installment type, by consumers was characterized as “an economic sin,” as “enervating to character

The Liquefication of Everything  117 because it leads straight to serfdom,” as setting “utterly false standards of living,” causing judgment to become “hopelessly distorted,” and tending to “break down credit morale.” It was attacked as “marking the breakdown of traditional habits of thrift,” as tending to “weaken the moral fiber of the Nation,” and as dangerous to the economy of the United States. (Phelps 1952, 39) Incurring debt to purchase consumer goods is largely a twentieth-century phenomenon. While changing attitudes toward credit were evident in 1890, the collapse of inhibitions against using consumer credit occurred in the late 1920s. By all accounts, however, a necessary prerequisite to the expansion of credit-financed consumption of not only autos but all other durable goods as well was a fundamental change in society’s attitudes toward the propriety of incurring household debt, a change which can have the effect of increasing demand for credit. (Olney 1991, 130) Several factors led to the change in values in the late nineteenth and early twentieth centuries. First, continuous-mass production transformed the nineteenth century’s emphasis from production to consumption. Advances in agricultural freed up labor, helping to transform farmers into workers. Throughout the last half of the nineteenth century, the decline in farm ­income further prompted the movement to the cities. Urbanization, rising urban incomes, and an abundance of new goods laid the basis of a consumer society. In the short space of just thirty years (1890–1920) American society had established the institutional basis of a consumer society. . . . What was remarkable about this growth was that, almost uniformly, it far ­outpaced the needs of the population. (Leach 1989, 100) In the new consumer society, saving no longer played the same role. In a society of scarcity, or even of moderate abundance, the productive capacity has barely sufficed to supply the goods which people already desire and which they regard as essential to an adequate standard of liv­ roduction. ing. Hence the social imperative has fallen on increases in p But in a society of abundance, the productive capacity can supply new kinds of goods faster than society in the mass learns to crave these goods or to regard them as necessities. If this new capacity is to be used, the imperative must fall upon consumption and the society must

118  The Liquefication of Everything be adjusted to a new set of drives and values in which consumption is paramount. (Potter 1954, 173) Second, with the emergence of the corporation, the role of personal saving in financing investment changed. In the eighteenth and nineteenth centuries, saving was viewed as necessary for investment. Except for a few notable heretics, orthodox economists agreed with Adam Smith’s assertion that increases in saving increase capital. Smith’s assertion became formalized in Say’s law, the proposition that supply creates its own demand and its corollary, whatever is saved is invested. The corollary that increases in saving increases investment has more validity under the older forms of business enterprise. As Keynes explained, the old forms of business enterprise, single proprietorships and partnerships, required a greater commitment than that of corporations. For such businesses, personal saving and bank loans represented the primary source of financing. For newly established corporations, stocks are the primary source of financing. Once established, retained earnings and capital consumption allowances are generally sufficient to finance business investment. In fact, from 1947 to 2000, the average ratio of business saving to investment less residential construction was less than 1.0. Since 2006, the ratio has exceeded 1.10 (see Table 7.1). Third, continuous-mass production made the old ways of doing business obsolete. Continuous-mass production combined with competition proved ruinous. As Veblen observed, business responded by forming combinations Table 7.1  R  atio of Business Saving to Gross Private Domestic Investment Less Private Residential Fixed Investment Years

Ratio of Business Saving to Gross Private Domestic Investment Less Private Residential Fixed Investment

1947–1950 1951–1955 1956–1960 1961–1965 1966–1970 1971–1975 1976–1980 1981–1985 1986–1990 1991–1995 1996–2000 2001–2005 2006–2010 2011–2015 2016–2020

0.98 0.92 0.98 0.99 0.90 0.98 0.96 0.91 0.94 0.97 0.84 1.08 1.13 1.11 1.12

Source: Federal Reserve Economic Data.

The Liquefication of Everything  119 and engaging in economic sabotage, that is, in “such restriction of output as will maintain prices at a reasonably profitable level and so guard against business depression” (Veblen [1965] 1921, 7). As Dudley Dillard commented: Veblen accounts for chronic depression primarily through the technology of mass production, which constantly lowers expected profits on old capital assets, with a tendency to erode profits generally. Technological changes have room to operate within Keynes’s theoretical schema, but it is not brought prominently into the picture. In Veblen’s theory the response of business is to form trusts and other types of combinations to offset destructive competition induced by the new technology. (1987, 1637) New products such as the automobile created new opportunities to engage in conspicuous consumption, conspicuous waste, and conspicuous leisure, establishing a new pecuniary standard. The new standard included embracing debt. By the 1920s, “people were getting to consider it old-fashioned to limit their purchases to the amount of their cash balances; the thing to do was to ‘exercise their credit’” (Allen 1931, 128). What made purchasing those products possible, and in turn the durable goods revolution, was installment credit, which Daniel Bell described as “The greatest single engine in the destruction of the Protestant ethic” (1976, 21).

Installment Credit and the Durable Goods Revolution The durable goods revolution refers to “a structural change in consumer tastes in favor of durable goods” (Olney 1991, 59). In its 1957 study of ­consumer credit, the Fed charactered the change as a decision to hold ­consumer assets. The transformation in the economic behavior of urban consumers over the past 50 years can be described in terms of increasing consumer ownership of physical assets that provide shelter, transportation, household services, and recreation. In the past, the assets were owned, to a great extent, by business establishments and consumers purchased the services. Increasingly, American families have tended to purchase durable assets and thus obtain their services directly. (Board of Governors of the Federal Reserve System 1957b, 9) The transformation of consumer behavior rested on continuous-mass production. Two innovations paved the way for the durable goods revolution: electricity and automobiles. The electrification of American homes made possible a plethora of new products: washing machines, electric irons, radios, among others. Automobiles offered a new means of transportation, appealing to our sense of freedom and providing faster mobility. “The rapid

120  The Liquefication of Everything shift toward purchases of major durable goods was largely but not exclusively due to the purchase of automobiles” (Olney 1991, 40).9 Mass production created a need to sell these products to consumers. Calvin Coolidge perceptively observed that “(m)ass production is only possible when there is mass demand.” Mass production raised the possibility of putting more goods into the hands of consumers, increasing potential profits. Coolidge’s assertion that “(m)ass demand has been created almost entirely through the development of advertising” is only partly true (Coolidge quoted in Olney 1991, 135). Credit too played a role. “The hitch was to find a way of putting these articles into the hands of the people whose income was limited or whose thrift was too uncertain to amass easily the substantial sums of the purchase price” (Niefeld 1938, 65). The first year that Singer introduced installment credit sales tripled. Macys and Sears both abandoned cash-only policies, introducing installment credit in the second decade of the twentieth century. Montgomery Ward introduced installment credit in 1921. By 1930, installment credit financed the sales of 60–75 percent of automobiles, 80–90 percent of furniture, 75 percent of washing machines, 65 percent of vacuum cleaners, 18–25 percent of jewelry, 75 percent of radio sets, and 80 percent of phonographs. (Calder 1999, 201) Sales finance companies arose spontaneously in the first two decades of the twentieth century in response to the need to finance purchases. By the 1920s, sales finance companies provided most of the credit to consumers.10 In the early years, autos were financed by independent finance companies. “In 1929, 40 percent of consumer installment loans (which includes installment contracts bought by sales finance companies as well as personal installment loans) were written by finance companies and just over 5 percent by commercial banks” (Olney 1991, 107). Lack of credit was particularly acute with regard to autos. “The tale of the development of auto sales finance companies is a vivid example of increasing supply of credit leading a revolution in demand for a product” (Olney 1991, 118). General Motors established the General Motors Acceptance Corporation in 1919 to help dealers finance their inventories, establish greater control over dealers, and smooth out production over time. The seasonal demand for autos, increasing in the spring and declining in the fall, posed problems. Most dealers had difficulty financing the changing inventories. Most banks refused to offer adequate inventory financing citing two reasons: one, autos were not considered necessary items for households; and two, the cancellation clause in the dealers’ franchise agreement led to a hands-off policy on the part of bankers. (Olney 1991, 120)

The Liquefication of Everything  121 Alfred Sloan, former CEO of General Motors, sought a solution, We got into this business over forty years ago when the need for financing the distribution of automobiles first arose. Mass production brought with it the need for a broad approach to consumer financing, which the banks did not then take kindly to. They neglected—I might say they declined—to meet the need; and so other means had to be found if the auto industry was to sell cars in large numbers. (Sloan 1963, 302) Henry Ford initially opposed providing installment credit or providing funds to help dealers finance inventories. Unknown to Henry Ford, however, the company’s treasurer Norval Hawkins deposited large sums of money in banks near the various dealers, with the express intent that the banks would use the money to help finance dealerships (Olney 1991, 127). Ford Motor Company initiated a weekly installment plan, which was really a savings account. The customer did not receive the car until the car was paid in full (Olney 1991, 160). Based on the 10-volume study by the National Bureau of Economic Research, Gottfried Harberler concluded that consumer credit is particularly stimulative initially, citing data from the 1920s. Credit served as a means to direct individual savings into the purchase of durable goods. Some of the most pronounced change occurred during the interwar years when, simultaneous with the growth of the installment credit industry, not only saving rates and consumption patterns but also the mix of assets owned by households suddenly shifted. Households bought more durable goods, substituting these goods for perishable goods to some degree but substituting them for saving especially. (Olney 1991, 1) The Fed’s attitude toward consumer credit proved ominous. The Fed did not share the public’s enthusiasm. In the Fed’s view, consumers were overextended, and it saw no reason to support consumer credit. With a few minor exceptions, only paper of a commercial character was eligible for rediscount at the Federal Reserve Banks. It was on the basis of this provision of the Federal Reserve Act that Federal Reserve Board members maintained that paper issued by consumer credit agencies, including Morris Plan banks and finance companies, was ineligible for rediscount. (Kubik 1996, 836) The Fed’s refusal to support consumer spending and the subsequent collapse of the financial system severely disrupted consumers’ ability to borrow. “As

122  The Liquefication of Everything the real costs of intermediations increased, some borrowers found credit to be expensive and difficult to obtain. The effects of this credit squeeze on aggregate demand helped convert the severe but not unprecedented downturn of 1929–30 into a protracted depression” (Bernanke 1983, 257). The Great Depression accentuated the structural changes in the American economy. The rise of corporations, the plethora of consumer goods, and the creation of new institutions to finance consumer spending reflect a shift from an economy based on production to one based on consumption. The depression meant that the market economy could not expand consumer credit without the Fed’s support. More generally, the Great Depression demonstrated the inability of the market economy to foster and sustain demand without government intervention. By 1933, consumer credit began to revive, but it would not attain its 1929 level again until 1940. During World War II, consumer credit dropped severely owing to credit restrictions and the diversion of resources toward the war effort. Before the end of the war banks, having embraced consumer credit, were anticipating the rise of consumer spending and the profits from financing that spending. An article in Banking warned that “The bank which has not made plans for financing distribution of consumer goods after the war is missing one of the most favorable opportunities for fulfilling its purposes and producing profit” (Hammond 1944). Between 1945 and 1956, consumer credit increased 400%, an average increase of 11% per year, a three-fold increase as a percentage of disposable income (indicated in Figure 7.1). Arthur Burns observed the following: “The vast expansion of the nation’s aggregate demand, which was facilitated by an unprecedented expansion of credit, tested the nation’s physical capacity to produce during much of the post-war period” (1957, 6). The expansion alarmed the Eisenhower administration, thinking such expansions could destabilize the economy. The Chairman of the Council of Economic Advisors asked the Federal Reserve to prepare a report on the growth of consumer credit to determine the desirability of establishing credit controls. Many economists supported some form of control, including J. M Clark, R. S. Sayers, and others. Gottfried Haberler recognized the potentially destabilizing effects of consumer credit, but remained cautious about ­ ystem instituting controls (Board of Governors of the Federal Reserve S 1957b, 244–245). In contrast, business emphatically opposed regulation. Phillip Reed, Chairman of General Electric, emphasized the importance of consumer credit to consumers and business alike: Consumer installment credit has made possible the acquisition of consumer goods to a greater extent than in any other country, which is a principal factor in our high standard of living. By expanding the capacity to purchase such products, consumer installment credit has created

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1928

1922

1925

1916

1919

1910

1913

0.00%

Figure 7.1  Consumer Credit as a Percentage of Disposable Income (1910–2000) Source: Data from 1910 to 1964 from Helen Manning Hunter (1966, 126); data from 1965 to 1999 from Economic Report of the President, tables 29 and 75 (Council of Economic Advisors 2000).

a mass market for them, with resulting lower production and distribution costs. (Board of Governors of the Federal Reserve System 1957a, 127) Reed later observed, “Installment credit is part of the marketing pattern of the durable consumer goods industry and its regulation by Government would have an effect similar to Government control over prices and distribution methods, which of course we staunchly oppose.” Other CEOs warned that “[i]f regulation is imposed it would result in a loss of business, cause industry to curtail production, create unemployment, and lead to a recession” (Board of Governors of the Federal Reserve System 1957a, 208). In defending consumer credit, business pointed to the rationality and sovereignty of the consumer. The average American works hard to establish his savings and his credit. Unless the country is facing real danger, he will not relinquish willingly the right to use his savings and his credit as he wishes. It is doubtful that he would consider the sacrifice of this right to be justified only, for example, by the possible but uncertain elimination of some irregularity of employment or by temporary fluctuations in the Nation’s economic growth (Board of Governors of the Federal Reserve 1957d, 119). The issue was subsequently dropped; no effort was made to regulate ­consumer credit. By the late 1950s the growth in consumer credit slowed.

124  The Liquefication of Everything But the most important innovation in the evolution of consumer credit was just developing, namely, the universal credit card.

The Universal Credit Card: Providing Credit on Demand Credit cards originated early in the twentieth century, but their use was ­limited to a few hotels, department stores, and some gasoline chains. The combination of high disposable income, mass production, and an increasingly mobile society created opportunities for providing credit on demand. For the first time in the country’s history, the majority of Americans were earning income in excess of what it took to pay for their basic needs. In addition, the necessities of war had produced a massive U.S. industrial base, which was prepared to produce consumer durables at a tremendous pace. (Mandell 1990, xiv) As the Chairman of Eisenhower's economic advisors observed, the “ultimate purpose” of our economy is “to produce more consumer goods” (Quoted in Reich 1991). After restrictions were lifted following World War II, airlines and trains began issuing cards. Air travel, in particular, provided a powerful stimulus to the growth of credit cards, creating a need to find a more secure means of financing travel. The possibility of theft or loss often makes cash less convenient than credit cards. Oil companies originally issued cards to finance gas purchases, but quickly expanded their use to cover other travel expenses (Hendrickson 1972). Unlike European countries, the US lacked financial institutions to finance business travel. This became increasingly apparent, partly owing to the size of the US economy, partly to the increase in travel associated with the establishment of the interstate system, advances in transportation technology, and the increasing affluence of the US economy in the post-World War II era. Moreover, a payment system based on checks, given the degree of fragmentation among banks, proved inadequate to finance travel. Non-local banks were reluctant to accept non-local checks, which took time to clear. The fragmented banking system resulted in part from America’s distrust of large banks, in part from government policy. “The regulatory system that governs financial enterprises in the United States from the earliest days has been structured to inhibit the growth of the large financial intermediaries that have flourished for some time in England, ­G ermany, and Japan” (Mann 2006, 83). Fragmentation was further fueled by the Federal Reserve’s decision to subsidize check clearing, which eliminated the need to establish large banks to achieve economies of scale to clear checks.

The Liquefication of Everything  125 In other countries, a centralized banking system and smaller economies rendered alternative payment systems unnecessary. In Britain, for example, six large banks dominate the economic. Travelers can always have their checks accepted since one of the banks always has a local presence (Mann 2006, 85). The idea of a universal credit card untied to a particular vendor began with Diner’s Club in 1949. The card served as a credit reference agency, guaranteeing the credit of customers to those restaurants that joined. The founders of Diners Club introduced no radically new ideas. Rather, they combined a number of well-known and widely used techniques for extending credit and changed the way credit service was delivered to the customer. The key to their success was their recognition of the need and untapped demand for a mobile credit device. (Mandell 1990, 11) The universal credit card allowed its holder to purchase goods and services at a variety of establishments across the country. A notable aspect of their plan was the introduction of a third party into the credit equation. Their company would become the middleman between the consumer and the merchant, extending credit to one, providing customers for the other, and charging both for their services (Mandell 1990, xiii). Without goods to sell or promote, the interest of the credit-card issuers was purely financial. “They conceived of credit as a product to be sold, an end in itself rather than simply a means to an end, and the primary vehicle for extending credit was the credit card” (Mandell 1990, xiii). The universal credit card represented the development of a trend. During the 1950s, creditors began relaxing credit terms: repayment schedules were extended, collateral was not needed to purchase many items, and down payments were reduced. The good itself became an inducement to accept debt: Selling consumer credit is, of course, selling debt—a commodity that would generally be an undesirable one as far as the buyer is concerned. The techniques of selling debt today, however, are such that the nature of the commodity for sale is concealed from the buyer. (Troelstrup 1961, 550) Nowhere, however, is “the loan disguised as a sale” more than with regard to credit cards. Banks came late to the credit-card game; Franklin Bank issued the first bankcard in 1951. “According to a report of the Federal Reserve System, of the nearly 200 banks which had credit-card plans in force in 1967, only

126  The Liquefication of Everything 27 had started their plans before 1958” (Hendrickson 1972, 56). In 1958, a number of large banks entered the credit-card business, including Bank of America National Trust and Savings Association, The Chase Manhattan, and others. Until 1965, however, all cards were issued locally. Two developments removed the barriers to offering a universal credit card. First, advances in technology in the form of improved communications and processing led to the establishment of national bank cards in the late 1960s.11 The government began tracking revolving credit in 1968. Second, the Marquette decision in 1978 effectively deregulated the credit-card industry. Prior to the Marquette decision, many states imposed ceilings on the interest rates on unsecured credit. Usury laws combined with relatively high inflation in the late 1970s reduced the profitability of unsecured credit. During this same period, banks were becoming increasingly active in the credit card market. Many banks saw tremendous business potential in this form of consumer credit, but they were prevented from charging market interest rates due to state usury laws. (Rougeau 1996, 11) In the Marquette decision, the Supreme Court held that credit-card companies were subject to usury laws in the state in which they were located, not the state in which the customer was located. Banks quickly relocated their credit-card divisions to those states that had no usury laws, undermining the usury laws in other states.

Preempting State Laws and the Development of Consumer Credit The National Bank Act of 1863 (NBA) provided the basis of the Marquette Decision. The National Bank Act provided considerable powers and protections to national banks. First, the Marquette decision said that states cannot impose their usury laws on banks chartered in other states. Put otherwise, a state with no usury laws could impose its laws on other states, prompting credit-card banks to relocate to states with no usury laws.12 Second, the act dismissed state efforts to protect consumers against high interest rates. The Office of the Comptroller of the Currency (OCC) has repeatedly cited the National Bank Act of 1863 to pre-empt state efforts to protect consumers. The Marquette decision applied to interest rates, not fees. Overcharge fees, late fees, and annual fees violated state usury laws, prompting consumers to bring suit. National banks argued that such laws violated the NBA. In Smiley v Citibank, the Supreme Court agreed, pre-empting state laws limiting the fees that credit-card companies could charge. In expanding the NBA, national banks became “national favorites” (Stroup 1997). In 2000, the state of California passed a law requiring credit-card companies to inform consumers regarding the problems involved in making

The Liquefication of Everything  127 minimum payments. Banks opposed the legislation, arguing that such a law violated the National Banking Act. Further, the banks argued that informing consumers would impose an undue cost, creating inefficiencies. Section 85 of the NBA, however, prevented price-related issues. Since this bill required providing information, the banks based their arguments on section 24 of the NBA, arguing that the act implies that national banks are exempt from state regulations that impose a cost. The OCC agreed, arguing that it reserved the authority regarding the regulation of national banks. The US District court reviewed a number of related cases, concluding that a law that “impairs the efficiency” of national banks is void. Subsequently, the OCC issued rules that effectively eliminates states from protecting their constituents, including predatory practices (Furletti 2004). Aside from the obvious benefits of deregulating interest rates on credit cards, card issuers developed other ways of enhancing profits. In the mid1970s, card issuers switched from assessing interest on a daily basis to assessing interest on the average daily balance. Estimates placed the increase in revenues between 15% and 25%. Card issuers began imposing fees in the late 1970s, prompted by the large number of cards with zero balances. Card issuers also charged businesses a fee when customers purchased an item using a credit card. As Figure 7.2 indicates, following the Marquette decision in 1978 and the recession of 1981, credit-card debt as a percentage of disposable income almost doubled during the 1980s. Not surprisingly, over the same time period credit-card divisions proved to be the most profitable aspect of banking, exceeding other areas of banking during the 1983–1988 period by several times. Profitability, in part, stemmed from higher interest rates charged, which the credit-card industry defended by pointing to the costs of funds and to charge offs. Lawrence Ausubel, however, dismissed this argument, finding that “profits, in fact, dramatically rose at the time that the cost of funds dropped” (1991, 56). Moreover, the credit-card industry displayed the apparently anomalous fact that while there were no barriers to entering the industry, profits remained extremely high. Ausubel attributes this to consumer irrationality: ignorance regarding how interest works, sensitivity to fees but insensitivity to interest charges, susceptibility to advertising, and a refusal to pursue sources of cheaper credit (1991, 71–72). During the 1990s, competition for new customers and efforts to retain old customers led to a decline in interest rates and profitability. Nevertheless, the credit-card industry remains more profitable than other areas of banking. Beginning in the 1990s, both the way banks financed credit cards and their approach to providing credit to consumers changed. Banks began to securitize credit-card debt, using Wall-Street brokers to sell bonds backed by prospective repayment by credit-card holders, providing credit-card banks vast sums of money to loan. At the same time, banks altered their approach to providing credit, shifting from a strategy of risk aversion to risk management whereby banks offset bad loans by expanding the number of

128  The Liquefication of Everything good loans. Advances in technology enabled credit-card banks to automate credit-card applications, use new techniques such as credit scoring to determine credit worthiness, and aggressively seek new customers through mass mailings. Among the 3 billion solicitations mailed in 1997, 1.3% of the recipients responded, down from the 2.5% response rate from 1990 to 1993. As of 1997, there were 405.2 million VISA and Master Cards in circulation. On average, each person has 4.1 cards (The Board of Governors of the Federal Reserve System 1998). From 1990 to 1998, revolving credit as a percentage of disposable income increased from 5% to fewer than 8%. In 1983, 3.6% of all households had credit-card debt equal to their income, and only 1% had credit-card debt double their income. By 1995, 16% of all households had credit-card debt equal to income and 8% more than double their income. “In 1983 3.4 percent of poor households had a debt twice their income, but by 1995, 11.9 percent bore burdens of this magnitude” (Bird and Hagstrom 1999, 132). The increase in consumer debt during the 1990s parallels the declines in the personal savings rate, indicated in Figure 7.3. As a percentage of disposable income, the personal savings rate fell from just under 12% in 1983 to 2.4% in 1999. During that time, total consumer debt increased from 15% of disposable income to 21%. The last dramatic increase in consumer debt from the end of World War II to the early 1960s had a much smaller impact on personal savings. The explanation perhaps lies in an increase in the inequality in the distribution of income, along with the expansion of credit as an alternative to income. As Neil Buchanan observed, “The evidence shows that the response to lower incomes has been to decrease saving and take on more consumer debt, a pattern that was not interrupted by the elimination of the tax deductibility of interest payments on consumer loans” (Buchanan 1999, 65–66). The very recent decline in consumer debt as a percentage of disposable income may be attributable to any number of factors: a healthy increase in disposable income, less aggressive marketing on part of creditors, debt saturation, tapping alternative sources such as stocks to financing spending, and so on. Equity Loans The liquefaction of home equity has been around at least since the 1960s. The increase in home-equity loans is associated with two factors: the rise in real-estate values beginning in the 1980s and the Tax Reform Act of 1986. That act eliminated interest deductibility except for mortgage and home-­ equity loans. The historically low interest rates in the early 2000s further fostered an increase in equity loans. Consumers found it less expensive to borrow against their homes than to use credit cards. The result: consumer credit hardly grew in 2004–2005 while equity loans increased dramatically (see Figure 7.4). Between 2001 and 2002, consumers increased their debt by $725 billion, 90% of that resulted from mortgage borrowing.

The Liquefication of Everything  129 10.00% 9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 1999

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Figure 7.2  Revolving Credit as a Percentage of Disposable Income (1959–2000) Source: Economic Report of the President, tables 29 and 75 (Council of Economic Advisors 2000). 12.0

10.0

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Figure 7.3  Personal Saving as a Percentage of Disposable Income (1059–2000) Source: Economic Report of the President, table 30 (Council of Economic Advisors 2000).

From the corporate point of view, liquefying the value of homes has had a number of obvious effects. First, it enhances the value of houses by making homes a source of speculation. Second, the increase in real-estate values enabled consumers to borrow more. The process fed on itself, to the benefit of the financial sector and consumers alike.

130  The Liquefication of Everything 16% Sum of Revolving Credit/GDP

14%

Sum of Nonrevolving Credit/GDP Sum of HomeEq/GDP

12%

10%

8%

6%

4%

2%

19 59 19 . 61 19 . 63 19 . 65 19 . 67 19 . 69 19 . 71 19 . 73 19 . 75 19 . 77 19 . 79 19 . 81 19 . 83 19 . 85 19 . 87 19 . 89 19 . 91 19 . 93 19 . 95 19 . 97 19 . 99 20 . 01 20 . 03 20 . 05 .

0%

Figure 7.4  Revolving, Non-Revolving, and Home Equity as a % of GDP (1959–2007) Source: Federal Reserve Economic Data.

Securitization Securitization refers to creating securities the value of which stems from cash flows from separate assets. The securitization of credit cards began in 1987. In 2002, credit-card securitization comprised 400 billion dollars. Credit-card securitization differs from other types of asset-backed securities. First, credit cards lack a tangible asset. Second, the terms of the credit cards differ from that of other assets such as cars or mortgages. There is no time limit, no fixed interest rate, no penalty for early payoff. Moreover, the terms of the contract may be changed by the credit issuer at anytime (Furletti 2002). In securitizing debt, the issuer takes the receivables, bundles them up, and sells off the receivables to a trust.13 The trust then issues securities backed by the receivables to investors. The purpose of the trust is to protect investors. The assets, in this case the receivables, are isolated from the credit issuer in case of bankruptcy. Securitization provides creditors a number of advantages. First, it allows the credit issuers to transform previously illiquid assets into liquid assets.

The Liquefication of Everything  131 Prior to the securitization, the credit cards receivables were an illiquid asset held by the issuing bank. The same was true to a lesser degree for mortgages. While a secondary market for mortgages existed in the 1970s, Ginnie Mae and similar government agencies provided a major stimulus to the securitization of mortgages by guaranteeing the securities they sold. This federal guarantee increased the liquidity of home mortgages, enabling creditors to sell risky mortgages. Second, securitizing receivables enables the credit issuer to recoup the money loaned. Securitization enables the creditor to receive a lump-sum payment for the receivables securitized, which can then be loaned again. By expediting the time it takes for banks to recoup the money loaned, securitization enables creditors to make more loans and, hence, more profits. Third, securitizing credit-card receivables enables banks to remove securities from their balance sheets. A necessary condition for selling securitized assets is that the bank forgoes any ownership claims to the asset. This provides banks a major benefit. Since securities are off balance sheet, banks can hold less capital than needed otherwise, thereby increasing the rate of return.

Financial Deregulation and the Global Spread of Consumer Credit The British experience in the 1970s further supports the view that declines in personal saving rates stem from the deregulation of credit markets ­(Bayoumi, 1993). Unlike other peoples, the British are particularly receptive to credit cards. “Britain is one of the few countries in the world, outside of the US, where a considerable number of consumers are willing to revolve card balances, and it has the infrastructure to support card operations” (Lucas 1995). In contrast, Italy has a relatively high saving rate. Regulations, high down payments for the purchase of durables and housing, wide interest rate spreads and limited competition make it considerably more difficult to obtain access to credit and issuance in Italy than in almost all other industrialized countries of comparable level of development. The authors conclude that institutional differences are the most important determinant of savings rates: We argue that capital market imperfections provide a plausible e­xplanation of the evidence. An economy in which households are ­liquidity-constrained exhibits a higher saving rate than an economy with perfect markets, even if the two economies grow at the same rate. (Guiso et al. 1994, 23)

132  The Liquefication of Everything In Japan, the emergence of consumer credit was a response to the decline in industry’s demand for savings and to the efforts of the Ministry of Finance to increase consumption. Following the end of World War II, Japanese financial markets were tightly controlled. For 30 years, from the end of World War II until the late 1970s, law, regulation, and ministerial guidance tightly controlled the Japanese financial sector. Interest rates, lending policies, industry structure, and financial products were governed by a network of policy instruments whose aim was to encourage exports and household saving, and to channel these savings to industrial reconstruction and investment. (Alexander and Oh 1989, iv) The decline in investment spending prompted the Ministry of Finance to encourage banks and other financial institutions to lend to consumers. The Ministry invited a number of American banks “to provide an example and serve as a stimulus to Japan’s conservative banking community.” The Ministry of Finance further removed liquidity constraints by eliminating interest ceilings and other regulations. Further deregulation resulted in part from efforts of the United States to reduce its trade deficit with Japan, again with support of US corporations. “Between 1976 and 1991 consumer credit rocketed from 6.7 percent to 23 percent of disposable income” (Alexander 1993). Somewhat surprising, increases in consumer credit have had little effect on the savings rate. In part, this stems from a cultural habit of repaying debt quickly, the need for large down payments for housing, and a law that forbid banks from offering consumers extended credit not associated with purchasing a specific product. In response, banks require cardholders’ savings accounts to serve as collateral. The removal of liquidity constraints in many countries of the world is part of the deregulatory movement that swept over the OECD countries beginning the 1970s.14 Deregulation opened doors, creating profitable opportunities for financial corporations, particularly Western banks. When the credit card companies set out to colonize what they call the Asia-Pacific region in the late 1970s and early 1980s, they knew they were tapping into a potential mother lode of cards and transaction volume. They knew that if they could realize that potential, they could create the largest credit card market in the world. The region’s middle class was on the rise, and with it, the appetite for product consumption. (Lucas, 1995) The problems were many: lack of infrastructure, lack of credit history, poor communications, cultures habituated to using cash, and governments that constrain the use of credit. Singapore, for example, passed a law preventing anyone with an income less than $20,000 from having a credit card. The

The Liquefication of Everything  133 German government bans outbound telemarketing. And Germans tend to avoid maintaining a balance. Despite China’s invitation to GM and Ford to help finance the purchase of their automobiles in an effort to join the World Trade Organization, many Chinese have an aversion to debt. “Chinese workers on average squirrel away 40% of their salaries” (Roberts, Clifford, and Brady 1999). Still, however, the credit-card companies remain optimistic. Whether removing liquidity constraints will result in an increase in consumer expenditures sufficient to match increases in output remains to be seen.

Conclusion In the nineteenth century, banks helped channel individual savings into capital accumulation. During the durable goods revolution of the 1920s sales finance companies and retail corporations channeled individual savings into the purchase of goods. The emergence of the universal credit card in the late 1960s, the deregulation of credit cards stemming from the Marquette decision, the securitization of credit, and the aggressive marketing of credit cards in the 1990s have virtually removed any remaining barriers to consumer borrowing. Creditors further broadened their efforts to channel prospective income into corporate assets, offering credit to students, low-income earners, and others, further undermining the need to redistribute income as a means of increasing demand. The resulting decline in personal saving has less to do with the prospect of high returns from Social Security as Feldstein suggests than it does with corporate power and rising inequality. The rise in disposable income in the late nineteenth century offered the masses the opportunity to accumulate assets, financial, and otherwise. It offered corporations the opportunity to transform the financial assets of individuals into corporate assets. The removal of liquidity constraints, or “market imperfections” as they are called by mainstream economics, makes consumer expenditures a function of current income and wealth, including prospective income. The development of credit markets and credit instruments circumvents the limits imposed by income, enabling consumers to use their assets to obtain secured credit or to obtain unsecured credit based on their prospective income and “credit worthiness.” From the consumer’s point of view, credit provides the means to obtain goods and services, and some protection against emergencies. From the ­corporate point of view, consumer credit enables corporations to increase profits. Consumer credit provides the lever through which corporations claim the assets of consumers, including personal savings and leisure time. At the same time, credit disciplines an individual to work longer or harder. As Calder points out, referencing Max Weber, consumers have substituted an iron cage for another, albeit gilded cage. The resulting decline in personal savings is unimportant in financing investment. Retained earnings and depreciation allowances provide the main

134  The Liquefication of Everything source of corporate finance. Personal savings are, however, important for other reasons. In an age in which corporations shift the burden of financing retirement to workers, where half of all retirees receive income solely from Social Security, and responsibility for financing a substantial portion of health care lies with the individual, personal savings become increasingly important. In an age where corporations depend on consumer spending to enhance corporate profits; however, it is unlikely that personal savings will rise very much. This line of reasoning also yields insight into the Asian crisis occurring in 1998. Despite the hoopla regarding the variety of causes of the Asian crisis—cronyism, the takeover of Hong Kong, bad loans, and so on—the gist of the problem is the insufficiency of demand relative to capacity. With the high debt levels of most Americans, the prospect that Americans can continue spending at current levels seems doubtful. The dilemma points to the central contradiction of the modern-capitalist economies, namely, the inability to match consumption with ever-rising levels of production. As David Hamilton observed, “To the institutionalist, the great problem of the modern industrial economy is ever-rising consumption to underwrite the ever-rising production potential” (Hamilton 1987, 1552). In the aftermath of the Asian crisis, however, Americans can take credit for keeping the capitalist engine going.

Notes 1 Power is the ability to influence the economic decisions of millions of people by influencing their employment, work conditions, family life, purchases, and so on. For other investigations of the exercise of corporate power, see Bill Dugger (1989), James Brock and Walter Adams (1986; 1987), and John Munkirs and Janet Knoedler (1987). 2 Corporations of course did not create credit. Consumer credit goes back before the origins of capitalism. In fact, Fernand Braudel claims the “principal reason for the development of shops was credit.” The wholesaler granted credit to the retailer, who in turn granted credit to his customers. “[T]he shopkeeper himself granted credit to his customer--and to the rich more readily than to the poor” (1979, 73). 3 Slogan used in Visa credit card advertising. 4 “The enterprise as such must flourish, must grow, must expand. That is what consumers, ­employees, and investors are asked to live for” (Feiler 1938, 7). 5 Christopher Brown (2008) addresses this issue in Inequality, Consumer Credit and the ­Saving Puzzle. 6 Writes Feldstein: “An individual who has had average earnings during his entire working life and who retires at age 65 with a ‘dependent spouse’ now receives benefits equal to 63 percent of his earnings during the full year before retirement. Since the Social Security benefits of such an individual are not taxed, those benefits replace more than 80 percent of peak preretirement net-of-tax income. Common sense and casual observation suggest that individuals who can expect such a high replacement rate will do little saving for their retirement” (1996, 6)). 7 An editorial in the Salt Lake Tribune is illustrative. A two-by-two editorial chastising people for abusing credit and admonishing them to save is overwhelmed by numerous pages of advertising telling people to buy in preparation for the busiest shopping day of the year (Editors 1997, A12).

The Liquefication of Everything  135 8 Singer established installment credit to purchase sewing machines in 1856. Purchasing sewing machines on credit was justified as a form of saving since it saved time in making clothes. 9 In contrast to the 1920s, expenditures on transportation during the nineteenth and early twentieth centuries were relatively minor. “In 1899, 65 percent of durable goods spending (and 5 percent of total consumption expenditure) was for household goods, but just 7 percent (barely . 05 percent of total consumption expenditure) was for transportation goods, and even this was mostly for horse-drawn vehicles. Thirty years later, transportation goods accounted for 36 percent of total spending for durable goods (and 4.4 percent of total consumption expenditure), while household goods accounted for only 51 percent (but now over 6 percent of total consumption expenditures)” (Olney 1991, 33). 10 Sales finance companies differ from other providers of consumer credit in that sales ­finance companies purchase the accounts receivable, installment notes, and so on from retailers. 11 One bank issued the cards, handled the revolving credit, and took care of the centralized accounting (Hendrickson 1972). 12 By 2003, most of the largest credit-card banks holding 70% of credit-card debt were l­ ocated in six states comprising 4% of the population. 13 In the vernacular of the financial industry, the trust is known as a special purpose vehicle (SPV). The SPV is created for the specific purpose of creating and selling securities. It is a legal separate entity from the corporation that created it. 14 The Structural Adjustment and Economic Performance (1987) attributes deregulation to a number of factors: the demise of the financial compartmentalization following the Great Depression, advances in technology, internationalization of the world economy, and so on.

References Adams, Walter, and James W. Brock. 1987. “Corporate Size and the Bailout Factor.” Journal of Economic Issues 21 (1): 61–85. ———. 1986. “Corporate Power and Economic Sabotage.” Journal of Economic ­Issues 20 (4): 919–940. http://www.jstor.org/stable/4225784. Alexander, Arthur J, and Kong D Oh. 1989. The Development and Structure of Consumer Credit in Japan. Santa Monica, CA: Rand Corporation. Allen, Frederick. 1931. Only Yesterday: An Informal History of the 1920’s. New York: Harper & Row. Ausubel, Lawrence M. 1991. “The Failure of Competition in the Credit Card Market.” The American Economic Review 81 (1): 50–81. https://doi.org/10.2307/2006788. http://www.jstor.org/stable/2006788. Bernanke, Ben S. 1983. “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression.” American Economic Review 73 (3): 257–276. Bird, Edward J., and Paul A. Hagstrom. 1999. “Credit Card Debts of the Poor: High and Rising.” Journal of Policy Analysis and Management 18 (1): 125–133. Brown, Christopher. 2008. Inequality, Consumer Credit and the Saving Puzzle. New Directions in Modern Economics. Cheltenham, UK; Northampton, MA: Edward Elgar. Buchanan, Neil H. 1999. “Taxes, Saving, and Macroeconomics.” Journal of ­Economic Issues 33 (1): 59–76. Burns, Arthur Frank. 1957. Prosperity without Inflation. Vol. 1. New York: Fordham University Press. Calder, Lendol. 1999. Financing the American Dream: A Cultural History of ­Consumer Credit. Princeton, NJ: Princeton University. Dugger, William M. 1989. Corporate Hegemony. New York: Greenwood Press.

136  The Liquefication of Everything Feiler, Arthur. 1938. “The Evolution of the Consumer.” The ANNALS of the ­American Academy of Political and Social Science 196 (1): 1–8. Feldstein, Martin. 1996. “Privatizing Social Security: The $10 Trillion Opportunity.” American Economic Review 86 (2): 1–15. Furletti, M. 2002. “An Overview of Credit Card Asset-Backed Securities.” Federal Reserve Bank of Philadelphia, Discussion Paper, December. Furletti, Mark J. 2004. “The Debate Over the National Bank Act and the Preemption of State Efforts to Regulate Credit Cards.” Temple Law Review 77. Federal Reserve Bank of Philladelphia Payment Cards Center Discussion Paper No. ­04-02: 1-38. Available at SSRN: https://ssrn.com/abstract=572581. Galbraith, John Kenneth. 1958. The Affluent Society. Boston, MA: The New ­A merican Library. Gramm, Warren S. 1978. “Credit Saturation, Secular Redistribution, and LongRun Wage Stability.” Journal of Economic Issues 12 (2): 307–327. Guiso, Luigi, Tulio Jappelli, and Daniele Terlizzese. 1994. “Why Is Italy’s Saving Rate So High?” In Saving and the Accumulation of Wealth: Essays on Italian Household and Government Saving Behavior, edited by Albert Ando, Luigi Guiso and Ignazio Visco, 23–70. New York: Cambridge University Press. Hammond, T. D. 1944. “Consumer Credit after the War.” Banking 37 (1): 9. Hendrickson, Robert A. 1972. The Cashless Society. New York: Dodd, Mead & Company. Hobson, John A. 1930. Rationalization and Unemployment: An Economic Dilemma. London: George Allen and Unwin. Keynes, John Maynard. (1936) 1964. The General Theory of Employment, Interest, and Money. New York: Harbinger. Kubik, Paul J. 1996. “Federal Reserve Policy During the Great Depression: The Impact of Interwar Attitudes Regarding Consumption and Consumer Credit.” Journal of Economic Issues 30: 829–842. Lucas, Peter. 1995. “A Dragon by the Tail.” Credit Card Management 8 (4): 34–47. Mandell, Lewis. 1990. The Credit Card Industry: A History. Boston, MA: Twayne. Mann, Ronald J. 2006. Charging Ahead: The Growth and Regulation of Payment Card Markets. Cambridge; New York: Cambridge University Press. Munkirs, John R., and Janet Knoedler. 1987. “The Existence and Exercise of ­Corporate Power: An Opaque Fact.” Journal of Economic Issues 21 (4): 1679–1706. Olney, Martha L. 1991. Buy Now, Pay Later: Advertising, Credit, and Consumer ­Durables in the 1920s. Chapel Hill and London: University of North Carolina Press. Phelps, Clyde William. 1952. The Role of the Sales Finance Companies in the ­American Economy. Baltimore, MA: Commercial Credit Company. Potter, David M. 1954. People of Plenty: Economic Abundance and the American Character. Chicago, IL: University of Chicago Press. Reich, Robert B. 1991. The Work of Nations. New York: Vintage Books. Roberts, Dexter, Mark Clifford, and Diane Brady. 1999. “China: Playing the Credit Card.” Business Week. Rougeau, Vincent. 1996. “Rediscovering Usury: An Argument for Legal Controls on Credit Card Interest Rates.” University of Colorado Law Review 67: 1–57. Schor, Juliet. 1992. The Overworked American: The Unexpected Decline of Leisure. New York: Harper Collins. Sloan, Jr, Alfred P. 1963. My Years with General Motors. New York: Doubleday.

The Liquefication of Everything  137 Stroup, Stephen. 1997. “Comment: Smiley V. Citibank (South Dakota), N. A.: Charging toward Deregulation in the Credit Card Industry.” Delaware Journal of Corporate Law 22: 601–632. System, Board of Governors of the Federal Reserve. 1957a. Consumer Installment Credit: Conference on Regulation. Vol. 2. Washington, DC: United States Government Printing Office. ———. 1957b. Consumer Installment Credit: Growth and Import. 4 vols. Vol. 1. Washington, DC: United States Government Printing Office. ———. 1998. “The Profitability of Credit Card Operations of Depository Institutions.” Federal Reserve Bulletin: Internet: Federal Reserve, . Troelstrup, Arch W. 1961. “The Influence of Moral and Social Responsibility on Selling Consumer Credit.” American Economic Review 51 (2): 549–557. Veblen, Thorstein. (1965) 1921. The Engineers and the Price System. New York: ­Augustus M. Kelley. ———. (1904) 1975. The Theory of Business Enterprise. New York: Augustus M. Kelley. Weber, Max. 1958. The Protestant Ethic and the Spirit of Capitalism. London: ­Charles Scribner's Sons. Wray, L. Randall. 1991. “Saving, Profits, and Speculation in Capitalist Economies.” Journal of Economic Issues 25 (4): 951–975.

8 America’s Perpetual Trade Deficit

With the exception of 1991, the United States (US) has run a current-­account deficit since 1983 (see Figure 5.1).1 The current account is defined as net exports plus income earned abroad by domestic factors of production less the income earned domestically by foreign factors. In the early 1980s, the Fed increased interest rates to curb inflationary pressures. Higher interest rates made US financial assets more attractive, increasing the value of the dollar. This resulted in flooding the US with imports while hurting its export-­ producing industries, creating a trade imbalance that has continued. The seemingly perpetual deficit presents a paradox from the belief that free markets eliminate such imbalances. The story goes something like this. Under flexible exchange rates, imbalances lead to changes in exchange rates, bringing the current account into balance. With imports exceeding exports, US importers offer more dollars than foreigners demand, causing the value of the dollar to fall relative to its trading partners. For Americans, imports become more expensive; exports become less expensive for America’s trading partners. Imports fall, exports rise, eventually reducing or eliminating the deficit. In reality, a different story has emerged, resting on three facts. First, China and other East Asian countries adopted continuous-mass production technology. This combined with low wages, lax environmental laws, and lax safety standards reduced costs, prompting US corporations to move production overseas. Second, the introduction of the shipping container in the 1960s reduced transportation costs. Following World War II, the American worker was relatively isolated from competing against foreign workers. Wages rose and the work week delclined, enabling workers to advance. “The container helped bring an end to that unprecedented advance. Low shippping costs helped make capital even more mobile, increasing the bargaining power of empoloyers against their far less mobile workers” (Levinson 2006, 4). The adoption of shipping containers decreased transportation costs, eliminated the longshoremen, and pitted American workers against foreign workers, keeping prices low. And third, the development of a consumerist culture in the US dating from the introduction of continuous-mass production technology in the late

DOI: 10.4324/9780429443763-8

America’s Perpetual Trade Deficit  139 nineteenth, early twentieth centuries together with a lack of a consumerist culture in China and Japan further fostered the imbalance. Those cultural differences manifest themselves in different levels of consumption as a percentage of GDP. The dependence of China and Japan on exports to the US has led their central banks to intervene in the foreign-exchange markets to devalue their currencies relative to the dollar. Allowing free markets to set exchange rates served neither China’s nor Japan’s national interest. For years, China pegged its currency to the dollar to sustain and increase its exports to the US. The Bank of Japan followed a policy of a dirty float, purchasing billions of dollars to devalue the Yen to maintain or increase Japan’s exports to the US. Reinforcing these actions are two factors. First, the position of the US in the global economy, comprising 18% of global GDP. And second, the US spends roughly 70% of its GDP on consumer goods, much more as a percentage of GDP than most other countries. In 2005, Ben Bernanke (2005) attributed the current-account deficit to the increase in asset prices in the US relative to a lack of appreciation in other, affluent countries. Households substituted their capital gains for saving, increasing spending. “Countries whose current accounts have moved toward deficit have generally experienced substantial housing appreciation and increases in household wealth, while Germany and Japan—whose economies have been growing slowly despite very low interest rates—have not.”

Figure 8.1  US Current Account as a Percentage of GDP Source: Federal Reserve Economic Data.

140  America’s Perpetual Trade Deficit By 2007, the current-account deficit approached 6% of GDP, double what it was in 2000.2 The net international investment position, the net debts owed to the rest of the world, is approximately 25% of GDP. The US gross saving rate was the lowest of any industrialized country. The imbalances point to the central dilemma of capitalist economies. In producing goods for markets, there must be markets for goods. Hitherto, the US has provided that market (Figure 8.1).

British Nationalism and the Theory of Comparative Advantage The case for free trade lies in the ideas of Adam Smith and David Ricardo. Both clothed their free-trade policies in nationalist terms (see Mumy 1986, 294). As Smith famously wrote: By preferring the support of domestic industry to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of this intention. (Smith [1776] 1937, 423) The “end which was no part of this intention” was domestic industry, not foreign. In the very next paragraph, Smith queries, “What is the species of domestic industry which his capital can employ[?]” Smith’s answer, of course, is that the people know best themselves. David Ricardo presented the theoretical foundation for free-trade policy in his model of comparative advantage. “There is no body of economic theory that has achieved greater professional acceptance than David Ricardo’s theory of comparative advantage and the modern emendations of Ricardo’s ‘law’” (Cypher and Dietz 1998, 305). The model assumes two countries trading two commodities, having a single factor of production, namely, labor. By producing and subsequently trading that commodity in which each country has a comparative advantage, each country expends less labor to trade for goods in which it has a comparative disadvantage. Under a system of perfectly free commerce, each country naturally devotes its capital and labour to such employments as are most beneficial to each. This pursuit of individual advantage is admirably connected with the universal good of the whole. By stimulating industry, by rewarding ingenuity, and by using most efficaciously the peculiar powers bestowed by nature, it distributes labour most effectively and most economically: while, by increasing the general mass of productions, it diffused general benefit, and binds together, by one common tie of interest and intercourse, the universal society of nations throughout the

America’s Perpetual Trade Deficit  141 civilised world. It is this principle which determines that wine shall be made in France and Portugal, that corn shall be grown in America and Poland, and that hardware and other goods shall be manufactured in England. (Ricardo [1911] 1973, 81) With the advent of the utility theory of value, mainstream theory redefined the “universal good.” Classical economics defined “the universal good” as goods and services; mainstream theory defined it as social welfare, an amalgamation of the utility maximization of the individuals comprising society. The Heckscher–Ohlin model (H–O model) generalized Ricardo’s argument, making trade depend on different factor endowments. The conclusion, however, is the same: free-trade benefits both countries.3 Redefining the social good, however, introduced some contradictions. The move to free trade obviously involves gainers and losers. Some will lose their jobs; some will gain jobs. Some will pay lower prices, some higher. Advocates of free trade avoid distributional questions invoking the Kaldor– Hicks compensation test in defense. If the gainers can profitably compensate the losers, and if the benefits exceed the costs, social welfare presumably increases. In the absence of compensation, however, the conclusion that free trade increases social welfare is not warranted. A refusal to compensate the losers alters the distribution of income. Stagnant incomes and job losses over some 40 years impugned the presumed benefits of free trade. Robert Reich (2007) attributed the impact on workers to the power of investors and consumers. Investors wanted high returns; consumers wanted low prices. “The main culprit has not been corporate greed or CEO insensitivity but rather the increasing pressure on companies from consumers like you and me who want better deals, and from investors like us who want better returns.”

A Critique of Free Trade Japes Cypher and James Dietz (1998) note the exceptions to free trade: immiserating growth; the failure to achieve full employment; increasing returns, imperfect competition, and so on. The heart of their critique, however, is that the theory of comparative advantage is a static model applied to dynamic, real-world processes. Institutional economists have long criticized free trade, citing real-world examples. Winston Griffith noted that free trade does not benefit the Caribbean-Community countries. Griffith’s argument, in part, rests on Gunnar Myrdal’s view that production in developed nations rests on economies of scale, the result of applying continuous-mass production technology. This enables the developed nations to undercut the prices of the less developed countries (see Myrdal 1957). Robert Prasch points out the complexity of trade relationships. Trade is generally not between only individuals; it is between individuals and different businesses.

142  America’s Perpetual Trade Deficit “This simple fact directly raises the possibility of a ‘coordination failure’ within the larger, international market” (Prasch 1995, 427). Geoff Schneider and Paul Susman (2008) offer an alternative to Ricardo’s theory of comparative advantage based on factor endowments. Schneider and Susman have introduced the theory of comparative institutional advantage, asserting that countries can create their own comparative advantage through institutional adjustment. Institutions affect both the location of production and distribution by supporting high-wage industries attracting educated people. As an example, Schneider and Susman points to Sweden, which has among the highest rates of economic growth. Ha-Joon Chang’s critique of free trade takes a historical approach. The assertion that Britain’s success stems from its laissez-faire policies ignores Britain’s mercantilist past. Chang cites Fredrich List, who attributed Britain’s development prior to the Industrial Revolution to its protectionist policies. As List observed, They perceived that their newly established native manufactures could never hope to succeed in free competition with the old and long-­ established manufactures of foreigners . . . Hence, they sought, by a system of restrictions, privileges, and encouragements, to transplant on to their native soil the wealth, the talents, and the spirit of enterprise of foreigners. (List quoted in Chang 2002, 4) Chang continues, attributing economic development to export-led growth and protectionist policies: [T]he developed countries did not get where they are now through the policies and the institutions that they recommend to developing countries today. Most of them actively used ‘bad’ trade and industrial policies, such as infant industry protection and export subsidies—practices that these days are frowned upon, if not actively banned, by the WTO (World Trade Organization).

(2002, 2)

Britain adopted free trade to sell the goods churning out from Britain’s factories (Polanyi [1944] 2001, 4), a policy that began to break down with the application of continuous-mass production technology. Unlike other nations, however, Britain had the advantage of trading with its empire. Similarly, the US policy of free trade, adopted in the aftermath of World War II, stemmed from nationalist tendencies (Chang 2002, 5). Following World War II, the US retained the only intact industrial economy. The years from 1945 to 1970 represent the golden age of American capitalism, an age in which US corporations lacked competition from foreign corporations. Foreign trade fostered the development of the American economy, enabling the

America’s Perpetual Trade Deficit  143 US to run balance of trade surpluses. In the Marshall plan, the US rebuilt Western Europe as a bulkhead against communism, benefiting both Western Europe and American corporations. Up until the 1960s, the US continued to run trade surpluses, which unraveled from efforts to fight the war on poverty and the war in Vietnam.

Export-Led Growth, Global Imbalances, and the Evolution of International Institutions Relying on exports to stimulate domestic economies dates back to the mercantilist policy of running trade surpluses to accumulate gold. By definition, all countries cannot run current-account surpluses simultaneously. In a two-country world, one country’s surplus is another’s deficit. In the late nineteenth, early twentieth centuries, laissez faire domestically “made domestic prosperity directly dependent on a competitive pursuit of markets and a competitive appetite for the precious metals” (Keynes [1936] 1964, 349). Making domestic prosperity depend on foreign markets continued after World War I. At its inception, therefore, the Great Depression was transmitted internationally by a gold-standard ideology . . . As the American, British and German economies contracted, they depressed other economies through the mechanism of the gold standard. These countries reduce their imports as they contracted, reducing exports from other countries. (Temin 1993, 90) In response, governments abandoned the gold standard to devalue their currencies, making their exports more competitive. The collapse of the German mark in 1930, followed by the pound in 1931 and the dollar in 1934, represented efforts to stimulate domestic demand by increasing net exports. Following the war, the industrialized countries sought to avoid the mistakes of the past. The welfare state replaced the liberal state; government intervention replaced laissez faire. To support government intervention and to eliminate beggar-they-neighbor polices, the allied powers established the Bretton Woods System, a system of fixed but adjustable exchange rates based on the dollar. Making the dollar the reserve currency reflected the dominance and power of the US at the end of World War II. So long as countries were content to hold dollars to settle international disputes, countries were no longer constrained by the supply of gold. Moreover, the International Monetary Fund (IMF) was created to serve as a lender-of-last resort, ready to provide liquidity to enable countries to resolve balance-of-payment problems. The period from 1956 to 1967 represented the “heyday” of the Bretton Woods System. By the late 1960s, however, rising inflation in the US threatened the stability of Bretton Woods. Partly to avoid importing inflation,

144  America’s Perpetual Trade Deficit countries incurring trade surpluses with the US began redeeming their ­dollars for gold. In 1971, President Nixon allowed the dollar to float to stop the outflow of gold, ending the Bretton Woods System. Following the demise of Bretton Woods, nations were free to pursue floating or fixed exchange rates. The dollar remained, however, the currency of choice for settling international transactions. Nations choosing to peg their currency to the dollar had to accumulate sufficient dollars to maintain the peg. Nations running surpluses incurred few if any problems; nations incurring deficits, however, became subject to speculative attacks and currency crises. As Joseph Stiglitz observes, during the era of floating exchange rates for the past 25 years, over 100 currency crises have occurred (Stiglitz 2003). The Washington Consensus and the US Current-Account Deficit As noted, the US current-account deficit partly results from the liberalization of trade and the adoption of laissez-faire policies on part of the IMF. In 1980, Ronald Reagan and Margaret Thatcher came to power espousing the virtues of limited government, low taxes, and free trade. At this time, the “Washington consensus” emerged—a consensus between the IMF, the World Bank, and the US Treasury regarding the “right” policies for developing countries. The “right policies” included balanced budgets, free trade, restrictive monetary policy, and free capital flows. Domestically, central banks should fight inflation; government budgets should balance. Internationally, free markets should reign. The referent for the Washington consensus was the experience of Latin American countries. Brazil, Argentina, and others had resorted to profligate spending and loose monetary policy. The resulting speculative attacks prompted a sudden and calamitous devaluation of their currencies. In response, the IMF agreed to help on condition that the governments reduce spending and pursue restrictive monetary policy. The message conveyed was clear: the only legitimate method for small, developing nations to grow is through exports, reversing the IMF’s previous policies. As Stiglitz observed, the IMF . . . in its original conception, was intended to put international pressure on countries to have more expansionary polices than they would choose of their own accord. Today, the Fund has reversed course, putting pressure on countries, particularly developing ones, to implement more contractionary polices than these countries would choose of their own accord. (Stiglitz 2002, 197) The Asian crisis, however, differed from the Latin American experience. That experience taught that capital flight and currency crises occur in

America’s Perpetual Trade Deficit  145 countries that are fiscally irresponsible. The Asian economies had reined in their government deficits and kept inflation low. Nevertheless, the IMF prescribed the same medicine for the Asian crisis, admonishing the Asian countries to reduce spending and contract the money supply. IMF policies, however, do not apply to larger, powerful nations. Japan has been running government deficits in excess of 6% of its GDP since 1999. In the first decade of the twenty-first century, both Japan and the US aggressively expanded the money supply to avert deflation, as did all the developed nations following the Great Financial Crisis. Rich nations are free to pursue expansionary fiscal and monetary policies to sustain growth; developing countries must content themselves with exports, primarily to rich nations. The policies of the Washington consensus and the institutional structure of the modern world economy provide the US a privileged position. The dependence on the dollar as a reserve currency, the habit of growing economies through exports, and the sheer confidence in the US economy have allowed the US to run large, sustained current-account deficits. For the US, a strong dollar fueled consumerism by flooding the US with inexpensive imports. While benefiting US corporations, moving production overseas left many blue-collar workers without the high-paying jobs they once enjoyed. Export-led growth fueled the economic development of East Asia. Growth through Exports: The Case of China and Japan Both China and Japan along with the other nations of East Asia developed their economies through exports. All placed their domestic objectives above achieving external balance with the US. Japan has gone to great lengths to stimulate its domestic economy, running government deficits in recent years exceeding 7% of GDP. Interest rates have hovered around zero. Yet, Japan has been unable to increase consumer spending. As shown in Table 8.1, consumption as a percentage of GDP for Japanese consumers is approximately Table 8.1  C  onsumption as a Percentage of GDP for China, Japan, and the United States Year

China Cons/ China GDP

Japan Cons/ US Cons/ Japan GDP US GDP

1995–1999 2000–2004 2005–2009 2010–2014 2015–2019

46.04% 43.73% 36.42% 35.58% 38.59%

53.72% 55.33% 56.52% 58.39% 55.70%

Source: Macrotrends (2022).

64.91% 66.93% 67.46% 67.83% 67.92%

146  America’s Perpetual Trade Deficit 56% compared to near 70% for the US. China’s consumption as a percentage of its GDP is approximately 40%. The inability to increase consumer spending is reflected in Japan’s high savings rate. The rate results from several factors including an aging population, socking money away for retirement; the high cost of housing, requiring a large down payment; and limited space, requiring most people to live in flats. In Spring 1990, China made a conscious decision to create a zone of economic development near Shanghai. This zone, however, was not based on cheap labor, but on developing modern manufacturing based on the latest technology. China’s production, trade, and monetary policies were directed toward stimulating exports. The transformation of China into a quasi-­ market economy results from foreign direct investment and domestic–­ foreign investment activities (Rima 2004, 730). The Tiananmen experience marked something of a turning point in China’s economic relations. Loan negotiations with foreign countries and agencies were suspended, and foreign investment declined. China responded restricting imports and expanding export subsidies. Given the US effort to reduce imports, China has tried to increase consumer spending. Table 8.1 indicates that consumer spending is less than 50% of GDP. Its gross saving is among the highest in the word. The lack of spending is generally attributed to liquidity constraints, uncertainty, and efforts to save in order to finance large purchases later. Moreover, China lacks the infrastructure necessary to provide creditors information to make profitable loans, which has already resulted in high default rates (Areddy 2004). Given its massive trade surplus with the US, Europe and the US have pressured China to allow the Yuan to appreciate relative to the dollar. Despite a 20% appreciation of the Juan since 2006, China’s strategy remains: promote growth largely through exports. In exchange, China receives dollars, which it converts into US government securities. China’s problem is not its surplus with US; its problem is providing employment for its people.

Meaning of the US Current-Account Deficit The current US current-account deficit is best understood from the nature of the accumulation process, what Keynes called the monetary theory of production. As noted previously, capital must circulate. The accumulation process largely depends on the private sale of goods and services, including the foreign sector, through which businesses covert goods and services into money. Keynes, Hobson, and others attributed insufficient demand, in part, to inadequate consumption, which they in turn attributed to inadequate income. Since the less affluent spend more as a percentage of their income than

America’s Perpetual Trade Deficit  147 the affluent, both Keynes and Hobson advocated redistributing income to stimulate consumer spending. Over the past several decades, increases in inequality are associated with increases in consumer spending as a percentage of GDP, at least in the US. The explanation, in part, lies in the removal of liquidity constraints, allowing individuals to borrow against their assets. As noted in an earlier chapter, the ability of American consumers to liquefy their assets results from a series of institutional innovations. The breakdown of Protestant prohibitions against debt in the late nineteenth and early twentieth centuries; the introduction of installment credit and the emergence of sales finance companies in the 1920s to finance the durable goods revolution; the elimination of usury laws resulting from the Marquete decision in 1968, which made possible the introduction of the universal credit card; and finally advances in information technology making possible credit scoring, sophisticated credit techniques, and targeting entire groups instead of individuals (Watkins 2000). The increase in consumption

Figure 8.2  US Gross Domestic Purchases as a Percentage of GDP and Consumption as a Percentage of GDP (1959–2009) Gross Domestic Purchases as a Percentage of GDP is Measured on the Left Axis, Consumption as a Percentage of GDP is Measured on the Right Axis Source: Federal Reserve Economic Data.

148  America’s Perpetual Trade Deficit as a percent of GDP conflicts with Keynes’ belief that as a nation’s income increased, saving would increase. This, however, has not occurred. For the US, the explanation lies in a consumerist culture and the associated increase in consumer debt. In recent years, this trend has continued. The increase in property values, a liberalization of credit requirements, and low interest rates contributed to increase in consumer debt as a percentage of GDP. The result has been a steady decline in personal saving as a percentage of disposable income and an increase in consumer spending as a percentage of GDP up to 2008. Figure 8.2 shows the relationship between consumption as a percentage of GDP and Gross Domestic Purchases (domestic absorption) as a percentage of GDP. Gross Domestic Purchases or domestic absorption is defined as consumption plus investment plus government spending. In order to export, however, someone must import. For Japan and China to run current-account surpluses, other nations must run deficits. Currently, the only regions in the world that import more than they export are the US and the transition economies in central Europe. In brief, the meaning of the US current-account deficit lies in providing demand for the surplus output for much of the rest of the world. As Ingrid Rima reminds us, the US offers many nations of the world, but particularly China, a “vent for surplus.” The So-called China Problem President Trump chose Peter Navarro to guide Trump’s trade policy. Navarro claimed that China took advantage of the free-trade model to develop its economy. “China’s hyper-rate of economic growth is export driven: and the ability of the Chinese to conquer one export market after another, often in blitzkrieg fashion, derives from their ability to set the so-called China Price” (Navarro 2007, 2). The China price refers to China’s ability to undercut the prices of its competitors. Navarro points to China’s advantages: lack of unions, lack of environmental laws, lack of safety laws, protectionist laws, and so on. In effect, Navarro points out something that is lacking in the free-trade arguments: the existence of different institutions that tilt the playing field in China’s favor. Navarro’s intent is to tilt the playing field in the US favor. In 2006, the year Navarro’s book The Coming China Wars appeared, the US trade deficit equaled 5% of the US GDP. In that same year, the US absorbed some 25% of the world’s output. The IMF, in its World Economic Outlook of 2006, concluded that the large US current-account deficit was unsustainable, warning that “ultimately exchange rates and trade balances will need to adjust, and adjust substantially” (Helbling, Batini, and Cardarelli 2005). US trade imbalance with various countries as a percentage of US GDP is indicated in Table 8.2. As indicated, the largest imbalance is with China.

America’s Perpetual Trade Deficit  149 Table 8.2  Trade Balance with Various Countries as a Percentage of US GDP Year

Canada China

Japan

Mexico US Trade Balance/GDP

China’s Share of the US Trade Deficit

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

–0.44% –0.45% –0.54% –0.60% –0.52% –0.47% –0.53% –0.15% –0.19% –0.22% –0.20% –0.19% –0.21% –0.09% –0.07%

–0.64% –0.57% –0.62% –0.64% –0.65% –0.58% –0.50% –0.31% –0.40% –0.41% –0.47% –0.44% –0.39% –0.38% –0.37%

–0.34% –0.35% –0.37% –0.38% –0.47% –0.52% –0.44% –0.33% –0.44% –0.42% –0.38% –0.33% –0.32% –0.34% –0.34%

22.0% 23.3% 24.8% 26.2% 28.3% 32.0% 32.8% 45.1% 43.0% 40.7% 43.1% 46.2% 46.9% 49.2% 47.2%

–0.94% –1.08% –1.32% –1.55% –1.69% –1.79% –1.82% –1.57% –1.82% –1.90% –1.95% –1.91% –1.98% –2.04% –1.87%

–4.27% –4.62% –5.33% –5.90% –5.98% –5.59% –5.55% –3.49% –4.25% –4.68% –4.52% –4.13% –4.23% –4.13% –3.96%

Source: Compiled from https://usatrade.census.gov/data/Perspective60/. GDP data from Federal Reserve Economic Data.

Protectionism in a World Dominated by Global-Supply Chains Ricardo’s model depicting England specializing in producing textiles and Portugal specializing in producing wine referenced in a highly abstract form the realities of his day. England could produce textiles at a lower cost by using machines, and Portugal’s advantage in producing wine stemmed from having soils and a climate conducive to raising grapes. China’s comparative advantage arises not because of geographic differences but because of lower costs of labor. China instituted policies that brought down trade barriers, prompting many corporations to move production to China, a decision stemming from efforts to increase profits. In the US, lower consumer prices, stagnant wages, and more discouraged workers resulted. Hence, free trade makes sense when comparative advantage stems from differences in climate or geography. When cost advantages come from economies of scale or lower labor costs, the results are problematic. As Keynes noted, A considerable degree of international specialization is necessary in a rational world in all cases where it is indicated by wide differences in climate [and ] natural resources. . . . But over an increasingly wide range of industrial products . . . I become doubtful whether the economic costs of self-sufficiency are great enough to outweigh the other advantage of gradually bringing the producers and the consumer within the same ambit of the same national economic and financial organisations [to ensure

150  America’s Perpetual Trade Deficit full employment]. Experience accumulates to prove that most modern mass production processes can be performed in most countries and climates with equal efficiency. (Keynes quoted in Davidson 2009, 111) Keynes’ prescience is reflected in the trade in manufactured goods, which today proceeds based on global-supply chains. In a sense, global-supply chains represent fluid institutions established by the lead corporations that guide the exchange of inputs. Outsourcing has shifted corporate control from internally vertically integrated production systems, flowing from the upstream materials to the downstream consumers, to a system of “independent” producers, distributors, assemblers, and transporters. These outsourced functions provide the core corporation with components, products, or services to bring to market. (Ciscel and Smith 2005, 430) The existence of global-supply chains renders the theory of comparative advantage and its progeny, the Heckscher–Ohlin theory of international trade, less relevant if not irrelevant. Comparative advantage still helps explain trade in primary products. It makes sense that Hawaii should grow pineapples, Saudi Arabia produce oil, and Italy make wine. But as South Korea, Japan, and other nations have proven, countries that lack factor endowments can develop. For manufactured goods, the establishment of supply chains enables the corporation that controls the final product to better manage production and costs, thereby better avoiding the possibility of overproduction. Further, supply chains rests of the existence of logistics and the development of a transportation infrastructure. Hence, the current supply chains have, in effect, depended on a market established in the US. No doubt, corporations that benefit from these supply chains will resist efforts to change the status quo. The point is underscored by an editorial by Bill Lane. Bill Lane, a long-time executive at Caterpillar and chairman of the US Latin America Trade Coalition, confessed, “During my 40-year career at Caterpillar, I don’t recall ever being in a management meeting where the sole objective was creating American jobs. No boss ever said, ‘Your annual review will only measure the number of U.S. workers added’” (Lane 2017).

Conclusion The Washington consensus—a consensus among the International Monetary Fund, the World Bank, and the US government—discouraged developing countries from using expansionary fiscal and monetary policies. The further inability to spur sufficient levels of consumer spending left many

America’s Perpetual Trade Deficit  151 countries with one alternative to stimulate their economies: exports made possible by massive deficits. Simultaneously, the removal of liquidity constraints for US consumers, a consumerist culture increased US spending, spending that was further enhanced by the investment boom during the 1990s, and massive government deficits during over the past several years. The policy of free trade originated in England to dispose of its products and foster its growth. In the neoliberal agenda, free trade fosters consumption by American and European households. The beneficiaries of the current arrangement are the lead corporations that outsourced production and established the global-supply chains. With the declines in rates of profits, with the refusal of countries to run deficits as a means of absorbing the output, the Trump administration has chosen to end the role of the US in the global economy by creating a rent-seeking society. In effect, Trump is attempting to redirect demand inward, the rest of the world be damned. This, it seems, runs counter to the corporations that established the current world order. Dismantling the supply chains that cross the globe will be no easy task. The Covid-19 pandemic, however, has disrupted economies, prompted millions to leave the labor force, causing too little demand followed by too much. In the meantime, the countries of the world will continue to support the US trade deficit, so long as the countries of the world depend on the US to absorb their goods. Once counties foster new sources of demand, US consumers will decline in importance. The problem is compounded, however, by China’s relentless growth. As its capital base expands, its capacity to create goods expands as well. To avoid excess capacity, China and the world must find ways to increase demand. The role of the US in the world economy for the past 40 years was to absorb much of the excess output of the rest of the world. The role stemmed from the power and wealth of the US economy, combined with the recognition that consumption drives the US economy. From the neoliberal view, the effort on part of modern capitalism, propelled by the liberal theory, was to make the world safe for modern capital. To expand free markets anywhere and everywhere and to allow the free flow of capital to maximize profits. The cultural and institutional differences among countries provided the basis of the US to run a seemingly perpetual trade deficit.

Notes 1 The surplus in 1991 resulted from payments from the industrialized world for the first US war in Iraq (Davidson 2002). The merchandise balance remained in deficit for that year. 2 The highest previous deficit of 3.8% of GDP occurred in 1872. 3 The H–O model rests on the Bergson-welfare function, which is rife in the i nternational literature. The function analogizes maximizing social wel­ fare to maximizing individual utility, thereby glossing over the problems involved in amalgamating individual utility functions. The function rests on two

152  America’s Perpetual Trade Deficit assumptions. First, the welfare of society depends on the utility functions of the individuals. And second, social welfare depends on the quantity of goods and services. This, in turn, assumes that production and distribution are independent. And yet, the assumption that social welfare depends on an individual’s utility function contradicts the implication that production and distribution are independent. For an individual’s utility depends on the commodities consumed, which, in turn, depends on the size and distribution of national income. As J. de V. Graaff (1967, 92) noted, “Another way of putting the matter is to say that the size-distribution dichotomy is inconsistent with the basic Paretian value judgements that individual preferences are to count and that a cet. par. increase in any one man’s well-being increases social well-being. A satisfactory theory of welfare based on these judgements must, therefore, dispense with the ­time-honored device of drawing a distinction between the size and the distribution of the national income and saying that welfare depends upon them both.”

References Areddy, Kathy Chen and James T. 2004. “Tracking China’s Consumers; Personal Loans Take Off, but Credit-Check System Is Spotty.” Wall Street Journal 2004 (2004): A.16. Bernanke, B. 2005. “The Global Saving Glut and the Us Current Account Deficit.” Sandridge Lecture, Virginia Association of Economics, Richmond, Virginia, Federal Reserve Board March. Chang, Ha-Joon. 2002. Kicking Away the Ladder: Development Strategy in Historical Perspective. London: Anthem. Ciscel, David H., and Barbara Ellen Smith. 2005. “The Impact of Supply Chain Management on Labor Standards: The Transition to Incessant Work.” Journal of Economic Issues 39 (2): 429–437. http://www.jstor.org/stable/4228155. Cypher, James M., and James L. Dietz. 1998. “Static and Dynamic Comparative Advantage: A Multi-Period Analysis with Declining Terms of Trade.” Journal of Economic Issues 32 (2): 305–314. http://www.jstor.org/stable/4227305. Davidson, Paul. 2002. Financial Markets, Money, and the Real World. Cheltenham, UK: Edward Elgar. ———. 2009. The Keynes Solution: The Path to Global Economic Prosperity. 1st ed. New York: Palgrave Macmillan. Graaff, J. de V. 1967. Theoretical Welfare Economics. London: Cambridge University Press. Helbling, Thomas, Nicoletta Batini, and Roberto Cardarelli. 2005. “Globalization and External Imbalances.” IMF World Economic Outlook (April 2005). Washington, DC: International Monetary Fund, 109–156. Keynes, John Maynard (1936) 1964. The General Theory of Employment, Interest, and Money. New York: Harbinger. Lane, Bill. 2017. “Confessions of a Free Trade Lobbyist.” Wall Street Journal, ­February 24, 2017 (2017), A17. Levinson, Marc. 2006. The Box: How the Shipping Container Made the World Smaller and the World Economy Bigger. Princeton, NJ: Princeton University Press. MacroTrends: 2022 The Premier Research Platform for Long Term Investors. Macrotrends. http://www.macrotrends.net/

America’s Perpetual Trade Deficit  153 Mumy, Gene E. 1986. “Silences in Ricardo: Comparative Advantage and the Class Distribution of Free Trade Benefits.” Review of Social Economy 44 (3): 294–305. Myrdal, Gunnar. 1957. Economic Theory and under-Developed Regions. London: G. Duckworth. Navarro, Peter. 2007. The Coming China Wars: Where They Will Be Fought and How They Will Be Won. Upper Saddle River, NJ: Financial Times Press. Polanyi, Karl. (1944) 2001. The Great Transformation: The Political and Economic Origins of Our Time. Boston, MA: Beacon Press. Prasch, Robert E. 1995. “Reassessing Comparative Advantage: The Impact of Capital Flows on the Argument for Laissez-Faire.” Journal of Economic Issues 29 (2): 427–433. http://www.jstor.org/stable/4226957. Reich, Robert B. 2007. Supercapitalism: The Transformation of Business, Democracy, and Everyday Life. 1st ed. New York: Alfred A. Knopf. Ricardo, David. (1911) 1973. Principles of Political Economy and Taxation. New York: Everyman’s Library. Rima, Ingrid H. 2004. “China’s Trade Reform: Verdoorn’s Law Married to Adam Smith’s “Vent for Surplus” Principle.” Journal of Post Keynesian Economics 26 (4): 729–744. http://www.mesharpe.com/results1.asp?ACR=PKE Schneider, Geoffrey, and Paul Susman. 2008. “Trade, People and Places: A Social Economic–Geographic Approach to Comparative Institutional Advantage.” Review of Social Economy 66 (4): 469–499. Smith, Adam. (1776) 1937. An Inquiry into the Nature and Causes of the Wealth of Nations, edited by Edwin Cannan. New York: The Modern Library. Stiglitz, Joseph E. 2002. Globalization and Its Discontents. 1st ed. New York: W.W. Norton. ———. 2003. “Dealing with Debt: How to Reform the Global Financial System.” Harvard International Review 25 (1): 54–60. Temin, Peter. 1993. “Transmission of the Great Depression.” The Journal of Economic Perspectives 7 (2): 87–102. http://links.jstor.org/sici?sici=0895-3309%281 99321%297%3A2%3C87%3ATOTGD%3E2.0.CO%3B2-H. Thomas Helbling, Nicoletta Batini, and Roberto Cardarelli. 2005. “World Economic Outlook Globalization and External Imbalance.” Accessed April 2005. http://www.imf.org/external/pubs/ft/weo/2005/01/index.htm. Watkins, John P. 2000. “Corporate Power and the Evolution of Consumer Credit.” Journal of Economic Issues 34 (4): 909–932.

9 The Great Financial Crisis—A Test of Two Models Minsky’s Financial Instability Hypothesis and the Dynamic Stochastic General Equilibrium Model Financialization, defined as the increased income and power of financial institutions, culminated in the Great Financial Crisis (GFC). The crisis reveals the paradox of increases in consumer debt combined with stagnate wages. Institutional changes relaxing credit requirements, a characteristic of subprime lending, exacerbated the problem, revealing that efforts to increase consumer debt could not continue. The resulting crisis provides a test of two competing theories of the macro economy: Hyman Minsky’s financial instability hypothesis and the Dynamic Stochastic General Equilibrium (DSGE) model, the mainstream model of the macro economy.

Financialization of the Consumer Thomas Palley defines financialization as “a process whereby financial markets, financial institutions, and financial elites gain greater influence over economic policy and economic outcomes” (2007, 2). Financialization manifests itself in the increasing importance of the financial sector relative to the real sector, transferring income to the financial sector, and a rise in inequality combined with wage stagnation. Thus, financialization is marked by “the increasing importance of financial markets, financial motives, financial institutions, and financial elites in the operations of the economy and its governing institutions, both at the national and international levels” (Epstein 2001, 3). As Ugo Rossi (2013, 1069) observed, “Behind the process of financialization of the consumer there is the historical tendency to place consumption at the centre of the functioning of advanced capitalist societies.” The increasing output of modern-capitalist economies means businesses must sell an increasing amount of goods and services. Credit helps stimulate consumption, enabling corporations to increase revenues and therefore profits without increasing wages, enabling corporations, in using continuous-mass production, to achieve a minimum of per-unit cost, further foisted by moving production to low-wage countries.1 In 2008, at the time of the GFC, profits accruing to the financial sector comprised 42% of corporate profits. The financialization of the consumer

DOI: 10.4324/9780429443763-9

The Great Financial Crisis  155 reveals itself in the evolution of consumer credit, culminating in the financial crisis of 2008. Financialization stems from creating new income streams by inducing consumers to acquire debt; the consumer commits to future payments in exchange for purchasing power in the present. Financial innovations allow the transformation of consumer assets into corporate assets. Innovations remove the liquidity constraints that historically limited consumer spending, circumventing the limits imposed by current income. Thus, consumer credit benefits both nonfinancial and financial corporations. Nonfinancial corporations benefit from the resulting increases in consumer demand. Financial corporations benefit by collecting fees in the present and interest in the future. Consumer assets assure creditors that the assets can be liquidated. If liquidation is not possible as in the case of credit cards, the present value of consumers’ future income creates an expectation that income will suffice to repay the debt. Hyman Minsky’s observations regarding the effect of financial innovations on corporations apply to consumers. Minsky contended that capital gains are a necessary condition for successful financial innovation. Financial innovation, however, increases debt thereby increasing financial fragility. A financial market that transforms the market power resulting from successful innovation into capital gains for the innovator and for the financier of innovations is a necessary ingredient for a successfully innovating capitalism. But the very institutions necessary for this realization of the capital value of market power also serve as vehicles for raising the debt level of mature firms . . . (Minsky 1986a, 351–352) Consumer credit accelerated during the period of financialization. The deregulatory movement following the demise of the Bretton Woods Agreement in the 1970s led to rapid innovations in consumer credit and increases in consumer debt. Stagnant incomes combined with increases in consumer debt increased bankruptcies. Between 1980 and 2005, personal bankruptcies increased from 288,000 to 1.5 million per year (White 2007). In response to intense lobbying by financial institutions, Congress passed The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, restricting the ability of people to declare bankruptcy (Scott 2007, 493). Between the periods of 1970–1973 and 2006–2009, total debt doubled, headed primarily by increases in revolving credit and mortgage debt for one to four family residences. Over that same time span, revolving credit increased 10 times, correlating with increases in consumer spending (see Wunder 2012, 182). The evolution of consumer credit from 1970 to 2009 is indicated in Table 9.1. Increases in consumer debt as a percentage of GDP correlate with increases in financial profits and increases in consumer expenditures,

156  The Great Financial Crisis Table 9.1  Evolution of Consumer Credit: 1970–2009 Years

NonRevolving Mortgage Debt Mortgage Debt Total Revolving Credit/ for Multifamily for 1–4 Family Consumer Credit/GDP GDP Residences/GDP Residences/GDP Debt/GDP

1970–1973 1974–1977 1978–1981 1982–1985 1986–1989 1990–1993 1994–1997 1998–2001 2002–2005 2006–2009

11.6% 10.8% 10.2% 9.7% 10.5% 8.6% 8.7% 9.5% 11.0% 11.1%

0.6% 1.0% 1.8% 2.2% 3.2% 4.1% 5.5% 6.3% 6.5% 6.7%

6.7% 6.1% 5.1% 5.0% 5.4% 4.3% 3.7% 4.1% 5.1% 5.7%

29.4% 31.8% 35.0% 36.5% 43.0% 46.2% 47.1% 53.1% 71.0% 76.5%

48.4% 49.7% 52.1% 53.5% 62.0% 63.2% 65.0% 73.1% 93.5% 100.0%

Source: Federal Reserve Economic Data, 2022.

Table 9.2  Growth of Financial Profits, Total Consumer Debt, and Asset-Backed Securities as a Percentage of GDP Years

Financial Asset-Backed Total Consumer Consumption Profits/GDP Securities/GDP Debt/GDP Expenditures/GDP

1970–1973 1974–1977 1978–1981 1982–1985 1986–1989 1990–1993 1994–1997 1998–2001 2002–2005 2006–2009 2010–2013

1.49% 1.38% 1.34% 0.94% 1.29% 1.81% 1.82% 1.61% 2.79% 2.04% 2.66%

0.0% 0.0% 0.0% 0.0% 2.0% 5.0% 9.0% 14.0% 21.0% 29.0% 13.0%

48.4% 49.7% 52.1% 53.5% 62.0% 63.2% 65.0% 73.1% 93.5% 100.0% 86.6%

61.0% 60.6% 62.3% 63.5% 64.4% 64.9% 65.8% 67.3% 67.7% 68.5% 68.4%

Source: Federal Reserve Economic Data, 2022.

indicated in Table 9.2. Financial profits as a percentage of GDP doubled from 1970–1973 to 2002–2005. Financial profits rebounded after 2009 from lows occurring during the Great Recession, despite declines in consumer debt thanks to intervention by the Fed. Subprime loans represent the boldest effort to transfer household assets into corporate profits. Financial institutions relaxed the standards to provide loans to low-income and overextended households. Financial institutions assumed that the loans were both lucrative and riskless. The loans forced borrowers to refinance within a few years, generating additional fees and interest. If the borrowers defaulted, the home could be seized and liquidated. Assuming home prices would appreciate 6% a year, subprime loans provided a means of transforming consumer assets into financial profits.

The Great Financial Crisis  157 The inability of borrowers to pay their mortgages combined with declining home values helped precipitate the financial crisis of 2008, revealing the limits of financial innovation.

The Story as a Test: Minsky’s Financial Instability Hypothesis and the Dynamic Stochastic General Equilibrium Model The GFC provides a test of the different economic theories: Minsky’s financial instability hypothesis and the DSGE model. The tests reveal themselves in different stories. The story itself represents a mapping between theory and reality, marshaling the “facts” in a manner that adheres to the theory. The “test” turns on providing a coherent explanation of events.2 In Minsky’s words: “Relevant theory is the result of the exercise of imagination and logical powers on observations that are due to experience: it yields propositions about the operation of an actual economy” (1996, 358). The test is simple enough: does the theory provide a coherent explanation of the crisis? Does the theory provide a compelling story of events? If not, can the theory be adjusted without undermining the theory itself? The relevance of Minsky’s non-equilibrium approach lies in placing crises in the context of economic processes. This involves understanding that the institutional bases of crises lie in financial relations, specifically the creditor–­debtor relationships. Those relationships, in turn, are influenced by the evolution of economic institutions that specify the types of assets purchased, how they are financed, and how they are liquidated. The desire to hold assets stems from their prospective income flows, affected by attitudes toward risk, attitudes shaped by the economic process and, in the case of the GFC, the crediting agencies that minimized that risk. The uncertainty of the flows implies that Minsky’s hypothesis focuses on the increased fragility of financial relationships moving through historical time. Minsky’s references are patterns taken from the economic process in the post-World War II era. His hypothesis provides a framework with which to understand changes in financial institutions that precipitate economic crises. A historical perspective reveals the complexity of the process, revealing the limits of applying abstract models to specific situations. Equilibrium approaches characteristic of mainstream theory cast crises as departures from equilibrium, departures that are defined not by the real world but by the models themselves. Invariably, equilibrium explanations are defined a priori by the parameters of the model. Equilibrium approaches provide the appearance of certitude, certitude undermined by the march of events. John Henry’s insight is particularly relevant: Essentially, logical time is an abstraction. It need not, and does not, take into consideration real world actions which could disrupt the attainment of the equilibrium conclusion: world considerations are

158  The Great Financial Crisis abstracted out of the argument. Historical time, on the other hand, tries to cope with all the complexities of an ongoing society . . . (1983, 219–220) Tony Lawson affirms Henry’s view: The limited power of formalistic methods to illuminate social reality, the lack of fit of the former to the latter, necessarily results in mainstream economists inventing “a reality” of a form that their modeling methods can address (i.e., a world of isolated atomistic individuals possessed, for example, of perfect foresight, or rational expectations, omniscience, pure greed, and so forth). (2005, 429) In reviewing Stabilizing and Unstable Economy, James Tobin chastised Minsky for his lack of rigor. “Minsky does not provide a rigorous formal model, and without one readers cannot judge whether an undamped endogenous cycle follows from the assumptions or not” (1989, 106). Lack of a formal model, however, was intentional. For Minsky consistently viewed the economy as a process, thereby avoiding the tendency among many economists to mistake the model for reality. Minsky used such models to show that the economic process is inherently unstable.3 The source of instability, however, lays not in the model, but in the institutional structure of capitalism, a decentralized market economy in which economic agents use debt to finance assets yielding uncertain returns. “Uncertainly most directly affects the performance of a capitalist economy by affecting the financial structure, as exemplified by the interrelated portfolios of the various units” (Minsky 1975b, 69).

Minsky and the Asset-Pricing Model The financial instability hypothesis rests on clarifying the asset-pricing model that Keynes left incomplete. A fundamental theme of The General Theory is that the asset-­valuation process is a proximate determinant of investment; Keynes argues that assets, in addition to having characteristics of annuities, may also provide protection by being saleable in the event that an uninsurable unfavorable contingency arises. (Minsky 1975b, 10) Despite presenting a theory of asset prices, Keynes did not address the liability structures underlying investment, a point central to Minsky’s financial instability hypothesis.

The Great Financial Crisis  159 For Keynes, debt stems from an increase in saving. An increase in saving means a decision to acquire an asset financed out of current income. An increase in saving means a decision not to purchase goods and services. This, in turn, results in an increase in inventories, which must be financed. In the absence of retained earnings, entrepreneurs finance inventory increases by issuing debt. The change in assets and liabilities alter financial commitments. The rentier obtains new income streams, matching the payment commitments of entrepreneurs. Keynes’ discussion of debt stems from its use in financing unplanned inventories, not purchasing capital assets. Moreover, the euthanasia of the rentier reflects a concern with the distributional aspects of crises. Profits stem from the difference between revenues and costs, interest income stems from the ownership of debts. While Keynes was aware that speculators could wreak havoc with an economy, especially when the “economy becomes a byproduct of a casino,” Minsky explained how. The decision to invest involves what assets to purchase and how to finance them. In using retained earnings or issuing stocks to finance investment, the entrepreneur avoids financial costs. In using debt financing, the entrepreneur reveals a belief that the value of a newly purchased asset will exceed the liability incurred. Put otherwise, the entrepreneur believes that the income flows generated by the newly acquired assets will exceed the payment commitments. These private financial liabilities set up cash-flow commitments. The cash to meet the liabilities of households and business firms will ordinarily flow from their income-producing operations, as wages, sales proceeds, or gross profits. The possession of money--and of financial assets that are near monies... acts as “insurance” against particular markets behaving in an adverse way; that is, in such a way that cash flows from operations or the ability to raise cash by financial transactions are insufficient to meet needs. (Minsky 1975b, 73) A capital asset yields an income flow from selling goods and services. Income flows, however, are subject to market forces and hence uncertain. Crises stem from an income flow falling below cash commitments. Based on Chapter 17 of The General Theory, Minsky defined the cash flows from investment as equaling q – c + l, where “q” is the stream of quasi rents (the difference between revenues and variable costs), “c” represents the interest payment incurred in debt financing the purchase of fixed capital, and “l” represents the implied liquidity value of the asset. A firm that finances investment from retained earnings insulates itself from fluctuations in short-term interest rates. A firm that must continually borrow short term to finance positions in long-term assets subjects itself to market fluctuations. A spike in short-term

160  The Great Financial Crisis interest rates increases interest payments, increasing the financial fragility of the firm. In crises, the stream of quasi rents (q) is insufficient to cover the interest payment (q < c). Without the ability to refinance to reduce the interest payment, the firm must sell assets to acquire money. Despite yielding no interest, money has special advantages. Its liquidity value stems from its power to terminate debt obligations. Even though the quasi rents and carrying cost of money are zero, money retains a liquidity premium. In times of crises, the liquidity premium from holding money may exceed the return from assets (l money > (q – c + l)capital asset). Applying Minsky’s analysis to the GFC clarifies the actions of policy makers. First, the FED reduced short-term interest rates to near zero, enabling the financial sector to refinance its positions at almost zero cost. Second, the FED provided the financial sector with reserves that now pay interest, providing a costless revenue stream. Third, the Fed purchased the non-­performing assets from the portfolios of financial institutions, helping to shore up balance sheets. And fourth, the treasury supported by the Fed provided money to the eight largest banks to ensure that they had sufficient capital. Minsky’s Financial Instability Hypothesis Minsky’s financial instability hypothesis states that over time financial structures become increasingly fragile, increasing the likelihood of economic instability. The post-World War II era provides the backdrop for the hypothesis, a period in which firms avoided holding risky assets, a legacy of the Great Depression. The end of the war up to the credit crunch of 1966 reveals no financial crises. Bank failures were nonexistent. As Minsky observes, “Prior to the mid-1960s corporations seem to have been internally financing their fixed investment whereas the data indicate that there was an increased dependency on external finance after the middle 1960s” (1982, 50). The open market operations undertaken during the 1930s and especially the increase in government debt to finance World War II left the banking system flush with US government securities. These securities provided banks a steady income flow and a stable asset. Financial institutions could easily raise cash by liquidating government securities. Over time, as the economy expanded, banks began accumulating other, more risky assets increasing their financial fragility. Minsky’s effort to understand the underlying financial relationships led him to focus on those economic agents commanding the power to purchase assets. In his 1975 book titled John Maynard Keynes, Minsky adopted the perspective of “a banker making deals on Wall Street” (Minsky 1975b). The banker serves as a euphemism for a financial entrepreneur. Bankers behave entrepreneurially, deciding what assets to hold, how to finance them, how to create them, and how to liquidate them. As noted previously, financial entrepreneurs also innovated, transforming previously held illiquid property into easily liquidated assets, reflected in the evolution of credit instruments

The Great Financial Crisis  161 generally. A financial asset entails a relationship between a creditor and a debtor. From the creditor’s view, the relation represents an asset, a claim on others. From the debtor’s point of view, the relation represents a liability, a commitment to pay off the claim. Hence, a financial asset entails both an asset and a liability, two sides of the same coin. Financial assets establish a series of future income flows; liabilities establish future cash payments. As noted, the basis of Minsky’s financial instability hypothesis lays in the debtor–creditor relationship, a relationship that changes over time with financial innovation, changes in policy, and changes in the underlying institutions. Minsky sought to explore how these changes affect obligations and the associated cash flows that lay the basis for understanding financial crises. Types of Cash Flows The creditor–debtor relationship manifests itself in financial obligations, the myriad of assets and liabilities, and their associated cash flows. Cash flows stem from the financial commitments the present value of which approximate the market value of assets. Minsky identifies three types of cash flows: income, balance sheet, and portfolio. Income cash flows involve both the expenses of producing goods and services and the revenues generated through their sale; balance sheet cash flows are payments created from past liabilities; portfolio cash flows result from changes in the portfolio: issuing debt, selling assets, or purchasing assets (see Chapter 9, Minsky 1986c). The types of cash flows are summarized in Table 9.3. The decision of consumers to purchase a home represents a portfolio cash flow. The consumer reallocates his portfolio, issuing a liability in the form of

Table 9.3  Taxonomy Classification of Cash Flows Income cash flows Balance sheet cash flows 1 Income from the sale of Cash flows in the form of debt payments goods and services. resulting from prior 2 Payments to labor inputs liabilities. and suppliers involved in producing goods and services. Income cash flows result from the process of production.

Source: Minsky (1986b, 200).

Portfolio cash flows Cash flows resulting from “decisions to sell or acquire assets or put new liabilities in circulation.” Portfolio cash flows stem from reallocating the assets and liabilities held. The decision to sell assets or issue new debt increases the cash available. The decision to pay down debt or purchase assets reduces cash available.

162  The Great Financial Crisis a mortgage to purchase an asset in the form of a home. The creditor too has reallocated his portfolio, purchasing a mortgage, yielding an income flow over time. For the consumer, the mortgage imposes a claim on future income, the time period, and interest rates specified contractually. Payments are denominated either in money or some other spendable IOU (a bank note for example). Minsky identified three types of financing: hedge, speculative, and Ponzi. Hedge financing uses the income flow from selling goods and services to finance the firm’s operation. Income flows are sufficient to pay the operating expenses and costs of financing the endeavor. Speculative finance involves rolling over the existing debt, reducing the cash outflows involved in paying debt. This involves reducing the interest rate on the debt or extending the payout period, all at the discretion of the creditor. Ponzi finance involves issuing new debt to pay an existing debt, usually resulting in an increase in debt overall. Problems arise if income flows from selling goods and services decline such that firms cannot meet their obligations. In this case, firms have several options. First, decrease operating expenses by reducing wages or pressuring suppliers to cut costs. Second, asking creditors to renegotiate the terms of the debt, reducing interest rates, extend the payment period, forgive the debt, or extend more credit. If neither option is available or insufficient to meet debt obligations, firms resort to selling assets to raise cash to meet commitments. If this becomes general, asset prices collapse initiating a debt-deflation depression. Over time, balance sheets of commercial banks have evolved, reflecting changes in the macro economy. During the Great Depression, loans fell precipitously. In an effort to reflate the money supply, the FED allowed commercial banks to use US government securities as collateral for loans. The effect was to establish a new tool for the FED, open market operations. At the end of World War II, government securities were the primary position making assets. Government securities exceeded 51% of the assets of banks, a direct result of the increase in government debt. US government securities provided a riskless asset that banks could easily liquidate. Banks having deficient cash could sell government securities. Other assets are subject to collapse in asset prices, particularly during times of crises. Following World War II, however, government securities declined relative to total assets. During the 1980s, money markets, junk bonds, and other financial innovations provided more profitable opportunities than that from traditional banking. Holding income streams from traditional loans were less profitable than alternative investments, giving rise to the shadow-banking system. Shadow bankers include money market managers, securities lenders, investment managers, pension funds, banks, among others. Banks securitized the receivables of various loans, sold them, and used the proceeds to make new loans or invested the proceeds in other securities.

The Great Financial Crisis  163 According to Gary Gorton, the GFC stemmed not from a bank run by traditional depositors but by a bank run by institutional depositors financing shadow banks (Gorton 2009). Investment banks resorted to the shadow-­ banking system to finance investments in mortgage-backed securities, the value of which derived from the mortgaged payments of thousands of homeowners. Investment banks such as Bear Stearns, Lehman Brothers, and others profited from the difference between the income flows earned on investments and the balance sheet flows paid to the shadow-banking system. Investment banks used mortgaged-backed securities as collateral for new loans. The investment banks depended heavily on the repo market, continuously borrowing short term to finance long-term assets. The term repo refers to a repurchase agreement. Investment banks used the mortgaged backed assets as collateral for new loans, with the value of the collateral exceeding the amount of the loan. At a later date, the investment banks would repurchase the collateral at a discount. The difference between money loaned and repurchase price represents the “interest income” to the shadow banks. The decline in income flows stemming from mortgage payments posed problems for the investment banks. The shadow banks discounted the value of the collateral, meaning that the shadow-banking system demanded more collateral for money loaned. Discounting the collateral meant that liabilities of the investment banks exceeded their assets. The inability to borrow sufficient money to repay debtors forced investment banks to liquidate assets, precipitating the crisis. The demise of Bear Stearns represents a classic bank run, a bank run resulting from the emergence of the shadow-banking system (see Gorton and Metrick 2011). An example helps clarify matters. Institutional investors, preferring not to purchase securities, deposit their money in an investment bank, say Bear Stearns. Bear Stearns refinanced its position in long-term assets by borrowing short term. As one institutional investor withdrew its money another would deposit money. For example, the depositor earns 3% overnight, receiving securities equivalent to the amount deposited as collateral. The securities yield 6%, giving Bear Stearns a 3% profit. In the panic, the depositor demands say $500 million in collateral for a $400 million deposit, in effect, a loan to Bear Stearns. Unable to secure another $100 million, Bear Stearns had to liquidate assets, precipitating a decline in asset price. As this decline become more general, the panic ensued. Banks and other financial institutions played a dangerous game, the implications of which Keynes warned against some 70 years earlier: Speculators may be no harm as bubbles on a steady steam of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of casino, the job is likely to be ill-done. ([1936] 1964, 159)

164  The Great Financial Crisis Bear Stearns assumed that the income flows from mortgages backed securities would be sufficient to meet its obligations. Minsky’s comment made years earlier is particularly relevant: The firm in accepting a liability structure in order to hold assets is betting that the ruling situation at the future dates will be such that the cash payment commitments can be met: it is estimating that the odds in an uncertain future are favorable. (1975, 87) Minsky could not anticipate the efforts that financial institutions took to protect themselves, efforts that aggravated the problem. Banks and other institutions bought and sold credit default swaps, a kind of “insurance,” a contract in which the seller of the swap agrees to pay the value of the security in case debtors default. Others purchased swaps outright, betting they would reap a fortune from the misfortunes of others. As of November of 2008, credit derivatives reported by banks exceeded 32 trillion dollars, more than double the gross domestic product of the US economy at that time. Credit default swaps increase the fragility of the financial system by increasing the potential liability to financial institutions. The American International Group (AIG) earned billions in fees by selling credit default swaps. AIG, however, never set aside reserves in case debtors defaulted; it assumed it would never have to pay. At last count, the cost of bailing out AIG approximated $150 billion. How Financial Crises Can Precipitate Depressions Profits to banks stem from the difference between the income flows (fees and interest earned) and interest paid plus other expenses. When debtors default, income flows fall. When income flows fall below expenses, financial institutions must find new sources of capital. In 2008, financial institutions pursued number of options: find other investors (Warren Buffet investing in Goldman Sachs), issue more stock (General Electric), borrow from other banks (no one, since banks were not lending), merge with more profitable institutions (J.P. Morgan buying out Bear Stearns; Wells Fargo buying out Wachovia), or borrow from the FED. If these options are unavailable, financial institutions sell assets to raise cash to meet obligations. If this becomes general, asset prices collapse in a downward spiral, prompting others to sell, initiating a debt-deflation depression. The collapse in asset prices affects everyone. Many who witnessed their 401ks melt away delayed retirement; people everywhere saved more and consumed less. Declines in consumer spending reduced profits, undermining business confidence. The resulting collapse in investment precipitated layoffs, further suppressing consumer spending, and prompting further

The Great Financial Crisis  165 declines in profits. Intervention by the Treasury and the Fed went far to end the crisis. Over the years, the Fed purchased the non-performing or under-­ performing securities thereby socializing the debts of the private sector.

Criticisms of Applying Minsky’s Hypothesis to the Crisis of 2008 The financial crisis of 2008 has prompted some economists to ask whether Minsky’s hypothesis applies. Paul Davidson, for example, argued that since the financial crisis was not characterized by a movement from Hedge to speculative to Ponzi finance, it did not meet the criteria as a Minsky moment. Davidson’s challenge rests on the interpretation offered by Dimitri Papadimitriou and Randall Wray, namely, their assertion that “[o]ver the course of any expansion, the economy moves from hedge to speculative to Ponzi finance. Minsky argued that this is a necessary precondition for an unstable financial system” (Davidson 2008, 670). Jan Kregel also questions whether the crisis lends itself to Minskyian analysis. The increased financial fragility stems from a decline in the cushions of safety under a backdrop of economic stability. Kregel finds the decline in the cushions of safety during an extended stable environment encouraged investors to assume greater risk. “It’s simply that the universe of borrowing experiences becomes increasingly positive: the expansion itself, rather than any change in evaluation of the part of lenders, validates riskier projects” (2008, 9). Unwilling to forgo potentially profitable returns, competition drove bankers to emulate other bankers. From the banker’s point of view, a history of repayments reassures bankers that the debtor is credit worthy, that he can repay his debts in the future. “Thus, increasingly optimistic expectations of the ability meet cash commitments in a cyclical expansion represent a rational reaction to the valuation of past events, as expressed by in higher probabilities of success” (Kregel 2008, 9–10). Moreover, a history of rising real-estate prices reassured bankers that in the event of default, debtors held an asset that could be liquidated at levels sufficient to compensate creditors. The assumption that real-estate prices would continue to rise 6% a year made risk assessments irrelevant. In other words, the banks believed that extending loans to subprime borrowers was riskless (Lewis 2010). Both Davidson’s and Kregel’s points reveal the complexity of the economic process. As the economy evolves, situations arise that Minsky could not anticipate. Nevertheless, Minsky’s contributions should not be underestimated. As he himself remarks, Minsky sought to complete the asset-­ pricing model that Keynes left incomplete. This involves delineating the types of cash flows; identifying the effects of financial innovation on cash flows and related institutions; and tracing these effects historically. Hence, Minsky provided a framework with which to understand and possibly avert financial crises, something lost on mainstream theory.

166  The Great Financial Crisis

The DSGE Model The initial response to the subprime crisis prompted many mainstream economists to dismiss the problem. The crisis was viewed as manageable, many believing that it would not threaten the broader economy. In a speech before the Federal Reserve Bank of Chicago’s 43rd Annual Conference on Bank Structure and Competition, Ben Bernanke drew the following conclusion: we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system. The vast majority of mortgages, including even subprime mortgages, continue to perform well. Past gains in house prices have left most homeowners with significant amounts of home equity, and growth in jobs and incomes should help keep the financial obligations of most households manageable. (2007) Bernanke’s view, like that of other mainstream economists, rested on the DSGE model. The model implies that central banks should limit themselves to controlling inflation. The model holds that Keynesian policies advocating using fiscal policy to achieve full employment are impotent. The “conventional view” among economists is that “NAIRU or the natural rate of unemployment is unaffected by aggregate demand, and thus that demand does not influence long-run unemployment trends” (Ball 1999, 189).4 Hence, discretionary fiscal policy is unnecessary. As Thomas Palley noted, the assumption that the economy tends to the NAIRU renders fiscal policy irrelevant. The DSGE model has a wide following among economists, often presented as the foundation of mainstream macroeconomics, used by central banks throughout the world prior to and during the financial crisis. It is often viewed as the “correct” model of the macro economy, dominating macroeconomic research for the past 30 years. In some quarters, it is considered a “quintessential achievement,” epitomizing macroeconomics as a science (See Blanchard 2018). The presumed virtues of the DSGE model lie in its mathematical elegance. Ricardo Caballero (2010, 86) refers to the model as “an irresistible snake charmer,” a device that “allows one to generate impulse responses that can be described in terms of seemingly scientific statements.” The phrase “seemingly scientific statements” underscores the problems revealed by the crisis. Referring to heterodox economics as the periphery, Caballero concedes that the periphery has been more successful in describing the macro economy than the core: “up to now the insight-building mode (both past and present) of the periphery of macroeconomics has proven to more useful than the macro-machine-building model of the core to help

The Great Financial Crisis  167 our understanding of significant macroeconomic events” (2010, 88). His approach is that of “gradually bringing the insights of the periphery into the dynamic stochastic general equilibrium structure” (2010, 87). As Caballero concedes, “Rational expectations is a central ingredient of the current core; this assumption becomes increasingly untenable as we continue to add the realism of the periphery into the core” (2010, 91). A revealed-preference approach reveals that mainstream economists prefer mathematical elegance to realism. Such preferences are often associated with the fallacy of misplaced concreteness. The fallacy results in ignoring relevant information, an observation that Caballero attributes to Fredrich Hayek’s critique of scientism. Caballero hopes to avoid the fallacy. Avoidance, however, raises methodological issues. Addressing the failure of the DSGE model implies that economists must consider the “story,” which means, contra Friedman, that assumptions are important. C.A.E. Goodhart notes that mainstream theory assumed “the existence of representative agents, who never default.” Goodhart continues: This makes all agents perfectly creditworthy. Over any horizon there is only one interest rate facing all agents, i.e. no risk premia. All transactions can be undertaken in capital markets; there is no role for banks. Since all IOUs are perfectly creditworthy, there is no need for money. There are no credit constraints (everyone is angelic, there is no fraud, and this is supposed to be properly micro-founded!). Money is generally introduced into the model by auxiliary ad hoc frictions, e.g. cash in advance requirements or limited participation, both of which are totally internally inconsistent with a world without any default. Essentially, therefore, the consensus three-equation model assumes a non-­monetary, non-banking, system, so it is no surprise that most theoretical adherents of it tend to downplay attention to, or concern with, purely monetary variables, e.g. the monetary aggregates. (2009, 826). The DSGE model emphasizes the supply side, incorporating rational expectations, Solow’s growth model, and real business cycle (RBC) theory. Disequilibria result from shocks, which Edward Prescott (1986), author of RBC theory, attributed to changes in technology. Later, shocks were expanded to include changes in fiscal and monetary policies. DSGE models rest on three foundations, expressing highly restrictive assumptions. First, the models reduce the macroeconomy to micro foundations, echoing the neoliberal view that society is a collection of individuals. Economic phenomena result from the optimizing choices of consumers, businesses, and financial intermediaries in response to various shocks. Shocks manifest themselves as shifts in the aggregate supply and aggregate demand functions. Supply shocks that arise from changes in technology increase productivity, exogenously shifting the production function and, in

168  The Great Financial Crisis turn, the aggregate supply function. Demand shocks result from changes in monetary or fiscal policies. Second, the model assumes a competitive economy and all the accompanying ancillary assumptions including a Cobb– Douglass production function characterized by constant returns to scale.5 Hence, the model ignores continuous-mass production and the associated corporate structures necessary to oversee economies of scale and scope. And third, endogenous changes in the price level ensure that the economy returns to equilibrium at an output corresponding to the natural rate of unemployment so long as markets are allowed to work. As noted, the assumption that the economy returns to the natural rate of unemployment enabled economists to ignore policies to achieve full employment. Allowing economic agents to adjust to various shocks, the model implies that the economy would automatically move to equilibrium at the natural rate of unemployment. Palley’s (2020, 598) comments regarding the adaptive-expectations model apply equally to the DSGE model. The theory was adopted by almost the entire economics profession. It says monetary policy cannot affect the long run rate of unemployment and there is no trade-off between inflation and unemployment. That provided policymakers with the justification for abandoning their commitment to full employment and shifting to inflation targeting. There are, however, problems. First, DSGE models depict the economy not in historical time, but a series of point in time events, a result of shocks introduced exogenously. The exogenous source of shocks implies that DSGE models separate the economy from the institutional and technological structure, perpetuating the fiction that market economies can function without governments. Furthermore, as Paul Romer (2016) noted, shocks introduced exogenously are reminiscent of “phlogiston,” that imaginary substance eighteenth century chemists used to explain combustion.6 As noted, shocks create disequilibria. Equilibrium returns by way of rational expectations inducing individuals to rebalance their portfolios, changing relative prices. Second, the rational-expectations hypothesis assumes that individual decisions rest on a shared theory of the macroeconomy, a point noted by Hyman Minsky.7 Using a shared theory, individuals interpret empirical knowledge in similar ways, enabling them to predict the effects of policy changes to protect their portfolios. As John Muth, author of the rational-­ expectations hypothesis, explained: The hypothesis can be rephrased a little more precisely as follows: that expectations of firms (or, more generally, the subjective probability distribution of outcomes) tend to be distributed, for the same information set, about the prediction of the theory (or the “objective” probability distributions of outcomes). (1961, 316)

The Great Financial Crisis  169 Expectations are distributed normally, implying that errors among economic agents cancel each other out. Hence, the predicted results equal actual results. Rational expectations assume away uncertainty and, therefore, improbable but possible outliers (see Taleb 2007), that revealed themselves in the GFC and the Covid-19-induced recession. Third, DSGE models are general equilibrium models, which show how disequilibrium in one market affects other markets. The transmission mechanism rests on Walras law, which assumes the sum of excess demand and excess supply in all markets equal zero. To illustrate, assume two markets: a money market and an output market. Further assume an initial state of equilibrium in which excess demand and excess supply equal zero in both markets (indicated by e1 and e1’ in Figure 9.1). The cause of the GFC poses difficulties. First, aggregate demand (AD) falls, causing the economy to move to disequilibrium indicated by point d at P1, resulting in an excess supply in the goods market and simultaneously an excess demand in the money market. But what caused aggregate demand to fall? Either the money-supply contracts (a monetary shock) or money demand (MD) increased. In either case, the money market is at disequilibrium at P1. In fact, during the GFC money demand increased to payoff non-­p erforming assets, resulting in a disequilibrium at point d’. The model, however, does not incorporate non-performing assets, balance sheets, or the underlying financial relations that might explain increases in money demand. Increases in money demand violate the assumption that the demand for money is stable, an assumption necessary to correlate money-­supply changes with changes in the price level, an implication of the quantity theory of money. Nevertheless, increases in money demand at the existing price level (P1) presents an easy solution: allow the price level to fall until people are content with the amount of money they desire. Deflation would increase real money balances, thereby increasing expenditures through the Pigou effect. Hence, increases in the money supply (Ms), much less something as extreme as quantitative easing (QE), are unnecessary. Central banks, however, opted to avoid

Figure 9.1  The Dynamic Stochastic General Equilibrium Model of the GFC

170  The Great Financial Crisis deflation, resorting to increasing the money supply through the discount window, various facilities, and QE, all of which are consistent with the neoliberal stand that government should intervene to benefit corporations and the affluent. Moreover, the actions of central bankers reveal that they feared deflation would precipitate a depression. In the context of the DSGE model, increases in the money supply (not shown) would eliminate the excess demand for money at P1 and shift back the aggregate demand function, eliminating the excess supply of goods. While this describes the policy adopted by central banks, the model misleads in its simplicity. First, the model assumes the money supply is exogenous, an assumption at odds with reality. The exogeneity of money and the mainstream story of deposit creation present banks as passive participants, again contradicting the active role that banks took in the years before the GFC. Further, an endogenous money supply implies no excess demand for money at the targeted interest rate. Hence, there is no excess supply in the output market, undermining the ability of general equilibrium models to explain financial crises. Conversely, increases in the money supply alone fail to stimulate economic activity. Stimulating economic activity requires that people spend (see Watkins 2014; Fullwiler and Wray 2010). Second, the model assumes commodity money and money neutrality, perpetuating the myth that goods exchange for goods. The lack of realism challenges the relevance of DSGE models in understanding the macroeconomy, particularly financial crises. As Robert Lucas conceded some years before the crisis, The problem is that the new theories, the theories embedded in general equilibrium dynamics of the sort that we know how to use pretty well now—there’s a residue of things they don’t let us think about. They don’t let us think about the U.S. experience in the 1930s or about financial crises and their real consequences in Asia and Latin America (2004, 23). Roberto Marchionatti and Lisa Sella conclude that if you have an interesting story to tell, you can no longer tell it in a DSGE model. To overcome the disappointing outcomes of Lucas’s revolution and to handle the complexity of real world we probably need, once again, to return to Keynes and his methodological and theoretical approach to complexity (2017, 464). Despite obvious flaws in the model, Oliver Blanchard remains faithful, viewing the DSGE model as “eminently improvable and central to the future of macroeconomics” (2018, 44). Paul Krugman counters: “Were there any interesting predictions from DSGE models that were validated by events? If there were, I’m not aware of it” (Krugman 2016). The model illustrates

The Great Financial Crisis  171 Milton Friedman’s (1953) doctrine of the irrelevance of relevant assumptions, sacrificing realism and relevance on the altar of rigor and mathematical elegance.8 In the aftermath of the crisis, central banks abandoned the model, increasing the money supply using various tools, including QE.

Conclusion Minsky believed in the inherent instability of capitalism. Minsky’s belief rested on both history and theory. Instability stemmed from the manner in which investment is financed. Investment represents a decision to purchase a capital asset. Businesses invest with a view to receiving an income flow over time, a flow stemming from the sale of goods and services. Financing the purchase of assets involves using retained earnings, issuing stock, or issuing debt. Debt involves exchange purchasing power in the present in exchange for cash commitments in the future. The decision to invest on part of firms, or consume on part of households, means they believe they will have sufficient income to meet their commitments. More generally, Minsky focused on the financial relations that underlie capitalism. Financial assets represent a series of promises, liabilities from the debtor’s point of view and assets from the creditor’s point of view. Financial assets involve payments from debtors to creditors. Declines in income flows such that debtors cannot meet their obligation force debtors to find other sources to meet their obligations. The inability to find those sources lead debtors to sell assets in an effort to raise cash, leading to a collapse in asset prices. Something similar occurred with the GFC. In contrast, the DSGE model assumes that equilibrium is the normal state of affairs. It ignores the underlying financial relations. Hence, it is no wonder that the DSGE model failed to apprehend the nature of the crisis and, hence, the response. Perhaps not statement reveals the change in the Fed’s attitude more than that of Janet Yellen’s comment that Minsky’s work had become required reading at the Fed.

Notes 1 Providing credit to households in lieu of raising wages represents one of the great success stories of corporate America. 2 Falsification presents an ineffective test since the failure to meet the conditions of the ceteris paribus assumption renders falsification difficult if not impossible (see Hollis and Nell 1975, 33). 3 For example, Minsky used models to show that market economies are inherently unstable (See 1975). 4 Ball (1999) argues that expansionary monetary policy combined with changes in labor-market incentives may reduce unemployment, creating a hysteresis in reverse. 5 Later, some economists added a measure of realism by introducing various “distortions”: wage rigidities, imperfect competition, and so on, but the basic model remains competitive.

172  The Great Financial Crisis 6 Romer concludes that “the methods and conclusions of macroeconomics have deteriorated to the point that much of the work in this area no longer qualifies as scientific research” (2016, 1). 7 “It is now clear that the power of the rational expectations/new classical macroeconomic revolution was derived from the heroic specifications of the model that agents use to guide decisions, rather than upon the proposition that agents use ‘all’ of the available information in making decisions where ‘all information’ takes the form of models (theories) of how the world behaves. The heroic specification was that all agents have a common understanding of the environment within which they operate and that in this commonly understood environment the effect of agents seeking their own good sustains a general equilibrium. The assumption of the rationality of expectations takes the role of Smith’s ‘invisible hand’ in assuring that equilibrium exists and that the commonly understood environment is logically equivalent to the unsatisfactory assumption of perfect foresight in general equilibrium theory” (Minsky 1996, 360–61). 8 “A hypothesis is important if it ‘explains’ much by little, that is, if it abstracts the common and crucial elements from the mass of complex and detailed circumstances surrounding the phenomena to be explained and permits valid predictions on the basis of them alone. To be important, therefor, a hypothesis must be descriptively false in its assumptions” (Friedman 1953, 14).

References Ball, Laurence. 1999. “Aggregate Demand and Long-Run Unemployment.” Brookings Papers on Economic Activity 1999 (2): 189–251. https://doi.org/10.2307/ 2534680. Bernanke, Ben. 2007. “The Subprime Mortgage Market.” Annual Conference on Bank Structure and Competition, Chicago, Illinois, May 17, 2007. Blanchard, Olivier. 2018. “On the Future of Macroeconomic Models.” Oxford Review of Economic Policy 34 (1–2): 43–54. Caballero, Ricardo J. 2010. “Macroeconomics after the Crisis: Time to Deal with the Pretense-of-Knowledge Syndrome.” The Journal of Economic Perspectives 24 (4): 85–102. Davidson, Paul. 2008. “Is the Current Financial Distress Caused by the Subprime Mortgage Crisis a Minsky Moment? Or Is It the Result of Attempting to Securitize Illiquid Noncommercial Mortgage Loans?” Journal of Post Keynesian Economics 30 (4): 669–676. 10.2753/PKE0160-3477300409 Epstein, Gerald. 2001. “Financialization, Rentier Interests, and Central Bank Policy.” Manuscript, Department of Economics, University of Massachusetts, Amherst, MA. Friedman, Milton. 1953. “The Methodology of Positive Economics.” In Essays in Positive Economics, 3–43. Chicago, IL: University of Chicago Press. Fullwiler, Scott, and L. Randall Wray. 2010. Quantitative Easing and Proposals for Reform of Monetary Policy Operations. Accessed July 17, 2020. Goodhart, C. A. E. 2009. “The Continuing Muddles of Monetary Theory: A Steadfast Refusal to Face Facts.” Economica 76: 821–830. Gorton, G., and A. Metrick. 2012. “Securitized Banking and the Run on Repo.” Journal of Financial Economics 104 (3): 425–451.

The Great Financial Crisis  173 Gorton, Gary B., Slapped in the Face by the Invisible Hand: Banking and the Panic of 2007 (May 9, 2009). Available at SSRN:  https://ssrn.com/ abstract=1401882 or http://dx.doi.org/10.2139/ssrn.1401882. Henry, John F. 1983. “On Equilibrium.” Journal of Post Keynesian Economics 6 (2): 214–229. Hollis, Martin, and Edward J. Nell. 1975. Rational Economic Man. London: Cambridge University Press. Keynes, John Maynard. (1936) 1964. The General Theory of Employment, Interest, and Money. New York: Harbinger. Kregel, J. 2008. “Using Minsky’s Cushions of Safety to Analyze the Crisis in the Us Subprime Mortgage Market.” International Journal of Political Economy 37 (1): 3–23. Lawson, Tony. 2005. “The (Confused) State of Equilibrium Analysis in Modern Economics: An Explanation.” Journal of Post Keynesian Economics 27 (3): 423–444. Lewis, Michael. 2010. The Big Short: Inside the Doomsday Machine. 1st ed. New York: W.W. Norton. Minsky, Hyman P. 1975. John Maynard Keynes. New York: Columbia University Press. ———. 1982. “Finance and Profits: The Changing Nature of American Business Cycles.” In Can “It” Happen Again? Essays on Instability and Finance, 14–58. Armonk, NY: M.E. Sharpe. ———. 1986a. “The Evolution of Financial Institutions and the Performance of the Economy.” Journal of Economic Issues 20 (2): 345–354. ———. 1986b. Stabilizing an Unstable Economy. New Haven, CT: Yale University Press. ———. 1996. “Uncertainty and the Institutional Structure of Capitalist Economies: Remarks Upon Receiving the Veblen-Commons Award.” Journal of Economic Issues 30 (2): 357–368. Muth, John F. 1961. “Rational Expectations and the Theory of Price Movements.” Econometrica 29 (3): 315–335. Palley, Thomas. 2020. “Re-Theorizing the Welfare State and the Political Economy of Neoliberalism’s Campaign against It.” Journal of Economic Issues 54 (3): 588–612. ———. 2007. “Financialization: What It Is and Why It Matters.” Working papers// The Levy Economics Institute. Prescott, Edward C. 1986. “Theory Ahead of Business-Cycle Measurement.” Carnegie-­Rochester Conference Series on Public Policy 25: 11–44. Romer, Paul. 2016. “The Trouble with Macroeconomics.” The American Economist 20: 1–20. Rossi, Ugo. 2013. “On Life as a Fictitious Commodity: Cities and the Biopolitics of Late Neoliberalism.” International Journal of Urban and Regional Research 37 (3): 1067–1074. Scott, Robert H., III. 2007. “Bankruptcy Abuse Prevention and Consumer Protection Act of 2005: How the Credit Card Industry’s Perseverance Paid Off.” Journal of Economic Issues 41 (4): 943–960. Taleb, Nassim. 2007. The Black Swan: The Impact of the Highly Improbable. 1st ed. New York: Random House. Tobin, James. 1989. “[Untitled].” Journal of Economic Literature 27 (1): 105–108.

174  The Great Financial Crisis Watkins, John P. 2014. “Quantitative Easing as a Means of Reducing Unemployment: A New Version of Trickle-Down Economics.” Journal of Economic Issues 48 (2): 431–439. White, Michelle J. 2007. “Bankruptcy Reform and Credit Cards.” The Journal of Economic Perspectives 21 (4): 175–200. Wunder, Timothy A. 2012. “Income Distribution and Consumption Driven Growth: How Consumption Behaviors of the Top Two Income Quintiles Help to Explain the Economy.” Journal of Economic Issues 46 (1): 173–192.

10 Overcoming the Limits of the Private-Domestic Economy Quantitative Easing versus Modern Monetary Theory

The response to the Great Financial Crisis (GFC) and a decade later the ­response to the Covid-19-induced recession provide a study in contrast. Quantitate easing (QE) reflects a trickle-down approach to crises. Use the Federal Reserve (Fed) to socialize the risk to the financial sector by purchasing US Treasury Bonds and mortgaged backed securities, thereby increasing the structure of asset prices. In contrast, the response to Covid-19-induced recession reflects the implementation of bottom-up policies advocated by Modern Monetary Theory (MMT). Use fiat money to provide income flows to people and businesses, enabling them to fulfill their obligations, preserve jobs, and stabilize businesses. The depression of 1894, the depression of 1922, and the Great Depression of 1929 among lesser downturns accentuated the failures of the market economy to ensure full employment. The close of the frontier in 1890 and the movement of labor from farm to factory ended the opportunity of many to return to the farm. While the advent of big government following World War II dampened the business cycle, unemployment continued, a befuddlement to those believing that markets clear. Mainstream economics banished the problem altogether, assuming that some level of unemployment is natural, even necessary, to check inflation. An unemployment rate below the presumed natural rate of 5% during the 1990s and much of the 2000s undermined the assumed tradeoff between inflation and unemployment. The GFC and the Covid-19-induced recession placed unemployment front and center, again demonstrating the shortcomings of mainstream theory, again suggesting that output attributable to continuous-mass production technology exceeded what could be profitably purchased.

Quantitative Easing and the Assumed Transmission Mechanism The Fed responded to the GFC to protect the financial relations of the financial sector by providing liquidity to some institutions, enabling them to meet their obligations. The Fed guaranteed J.P. Morgan’s purchase of Bear Stearns to avoid a financial meltdown. Later, the Fed bailed out American

DOI: 10.4324/9780429443763-10

176  Overcoming the Limits of the Private-Domestic Economy International Group, the largest insurance company in the world, for fear its demise would wreak havoc with the world economy. After the fall of Lehman Brothers, the Fed together with the Treasury provided liquidity to the major banks to avoid a collapse in the system of payments. From 2009 to 2014, the Fed instituted the policy of quantitative easing, purchasing Treasury bonds and Mortgaged Backed Assets, thereby socializing the risk to the financial sector. In adopting quantitative easing, the Fed took a page from Milton Friedman, James Tobin, and others. In response to a reporter’s query regarding the Bank of Japan’s options beyond a zero-interest rate policy to avert deflation, Friedman responded that “they can buy long-term government securities, and they can keep buying them and providing high-­powered money until the high-powered money starts getting the economy in an expansion. What Japan needs is a more expansive domestic monetary policy” (2000, 421). Quantitative easing affects the structure of asset prices. In purchasing assets, the Fed increases asset prices leaving banks with excess reserves and other asset sellers with excess liquidity. In rebalancing their portfolios, banks increase lending; other asset sellers rebalance their portfolios bidding up the price of undervalued assets, a process that continues resulting in higher asset prices. Friedman described the effect on the real economy as follows: As the prices of financial assets are bid up, they become expensive relative to nonfinancial assets, so there is an incentive for individuals and enterprises to seek to bring their actual portfolios into accord with desired portfolios by acquiring nonfinancial assets. This, in turn, tends to make existing nonfinancial assets expensive relative to newly constructed nonfinancial assets. At the same time, the general rise in the price level of nonfinancial assets tends to raise wealth relative to income, and to make the direct acquisition of current services cheaper relative to the purchase of sources of services. These effects raise demand curves for current productive services, both for producing new capital goods and for purchasing current services. The monetary stimulus is, in this way, spread form the financial markets to the markets for goods and services. (1969, 231) Nevertheless, Friedman’s explanation regarding how asset purchases increase employment remains obscure. His comment that it becomes cheaper to hire labor than to buy the “sources of services” implies that firms contract for labor services rather than purchase the businesses that supply those services. Employment rises because businesses substitute labor for capital. Asset purchases supposedly affect the real economy by stimulating income flows in three ways. First, the increase in asset prices increase wealth.

Overcoming the Limits of the Private-Domestic Economy  177 At some point, asset holders realize their capital gains, spending a portion on goods and services. Second, increasing asset prices create an expectation of higher asset prices, increasing borrowing and the likelihood of asset bubbles. Third, by reducing interest rates, quantitative easing offers debtors with good credit an opportunity to refinance, thereby reducing their cash outflows and increasing expenditures. All three effects increase the flow of income accruing to businesses, thereby stimulating investment and employment. As Ben Bernanke noted: The idea behind quantitative easing is to provide banks with substantial excess liquidity in the hope that they will choose to use some part of that liquidity to make loans or buy other assets. Such purchases should in principle both raise asset prices and increase the growth of broad measures of money, which may in turn induce households and businesses to buy nonmoney assets or to spend more on goods and services. (2009) Bernanke calls the policy credit easing, implying that the policy works primarily through the asset side of the balance sheet. The policy works by increasing asset prices and reducing interest rates instead of increasing bank reserves. The Fed seeks to influence expectations by signaling to financial markets its intent to continue to purchase assets. Such signaling can also increase household and business confidence by helping to diminish concerns about “tail” risks such as deflation. During stressful periods, asset purchases may also improve the functioning of financial markets, thereby easing credit conditions in some sectors. (Bernanke August 31, 2012) QE creates a disjuncture between asset prices and income flows. As noted, quantitative easing affects asset prices; it works through the price mechanism. Lacking assets, households in lower income brackets benefit only insofar as quantitative easing induces entrepreneurs to invest more or asset holders to consume more, thereby increasing employment. The slow decline in the unemployment rate following the GFC underscores the lack of substitution between labor and other assets. Labor is not purchased at a price corresponding to the present value of discounted future income streams. The income accruing to labor is based on flows of expenditures, flows that are only indirectly influenced by QE. Quantitative easing inverts the historical relationship between asset values and income flows. Under the monetary theory of production, asset prices represent the present value of prospective income or quasi rents, anticipated revenues less variable costs. Prospective income implies that asset prices are subject to animal spirits, which are largely influenced by current income flows. As Hyman Minsky noted, the pervasiveness of income flows falling

178  Overcoming the Limits of the Private-Domestic Economy below that needed to service debt increases the fragility of businesses, particularly financial institutions, which depend on debt to purchase assets (see Minsky 1975). Unable to borrow, financial institutions are forced to liquidate assets, potentially leading to a debt-deflation depression. The Fed’s decision to purchase assets short-circuits the tendency to debt deflation by providing financial institutions with liquidity, enabling them to fulfill their obligations. Monetary policy points to an asymmetry between averting a collapse in asset prices and stimulating economic activity. While providing liquidity enables financial institutions to meet their obligations, providing liquidity does not, in itself, create obligations except to the central bank. Providing liquidity to the financial sector has, however, increased asset prices, benefiting asset holders while aggravating inequality.

What is the Theoretical Relationship between Quantitative Easing and Inequality? Thomas Piketty, in his book Capital in the Twenty-First Century (2014), ­explored the origins and development of inequality in the US and France. Using historical data derived from tax returns, Piketty noted that inequality had been increasing in the US since the 1970s. He attributed its rise to the profit rate exceeding the growth rate. Given the lack of growth, an increase in profits meant worker income must fall, suggesting that the economy, to some degree, resembles a zero-sum game. Piketty’s model shows how quantitative easing increases inequality. Piketty posited the following equation, which he called “the first fundamental law of capitalism.” π = r  K / Y Y π where is the profit share of income, r is the profit rate or the ratio of Y profits to capital, and K/Y is the capital-income ratio (Piketty and Goldhammer 2014, 52). As noted, the Fed implemented QE, in part, to raise the prices of long-term assets. QE increases the K/Y ratio, thereby increasing the profit share, assuming everything else constant. Figure 10.1 indicates the capital-output ratio over time. Capital represents the capitalized value of various stock exchanges; income is measured by GDP. From the bottom of the crisis in 2009 to the present, the capital-GDP ratio has increased by 50%. The equation illustrates in a simplified manner an asymmetry between the effects of monetary policy and fiscal policy. Monetary policy, of course, refers to the central bank’s ability to influence the money supply, interest rates, and asset prices; fiscal policy refers to the government’s power to tax and spend. Fiscal policy is subject to deliberation by elected officials; monetary policy is decided by the Federal Reserve Open Market Committee comprised

Overcoming the Limits of the Private-Domestic Economy  179

Figure 10.1  Ratio of Stock Market Capitalization to GDP (percent of GDP) Source: Board of Governors of the Federal Reserve System. Federal Reserve Economic Data, 2017.

Table 10.1  Monetary Policy and Fiscal Policy Fiscal Policy

Monetary Policy: Quantitative Easing

Power to tax and spend

The Central bank’s power to influence the money supply Affects the profit rate (r) by altering the Affects K/Y by purchasing treasury income flows to corporations bonds and mortgaged backed securities Budget proposed by the President, Proposed by the Federal Reserve Open reviewed by the House of Market Committee Representatives, passed by Congress, and executed by the Treasury Represents the will of elected officials Protect the financial sector

of the 12 governors of the Federal Reserve and the chairperson. The differences between fiscal and monetary policies are summarized in Table 10.1. The different policies affect different aspects of Piketty’s equation. Fiscal policy can affect both the return on capital and the value of capital. Fiscal policy affects return on capital by affecting the flow of income to businesses. That is, fiscal policy affects the profits earned by the firm either by changing effective demand or affecting taxes paid by businesses. In contrast, monetary policy affects the prices of capital assets. In this regard, QE represents a trickle-down approach, increasing the value of assets as a means of stimulating the economy. The approach inverts the usual way businesses make money by selling goods and services.

180  Overcoming the Limits of the Private-Domestic Economy Admittedly, the numerous variables involved make identifying simple causal relationships difficult. The data, however, indicate that inequality is rising. Table 10.2 indicates rising inequality in the distribution of income based on quintiles for households. In 2015, the lowest quintile received 3.1% of the income, while the top 20% received 51.1%. The top 5% of households earned 22.1% of the income. The distribution of wealth, indicated in Table 10.3, is even more unequal. As noted, the only asset that most households own is their home, which sustained a decline in value following the Great Recession. Housing prices have since recovered. For the top 20% of households, homes comprise a smaller portion of total assets than for the other quintiles. For the top quintile, assets assume the form of stocks, bonds, and so on comprising 93% of total wealth. The bottom 20% of households own 0.17% of the wealth, declining from 0.31% in 1992 and 0.22% in 2007. Bernanke (2015) defended the criticism that quantitative easing increased inequality arguing that the effect was probably slight. The claim that Fed policy has worsened inequality usually begins with the (correct) observation that monetary easing works in part by raising asset prices, like stock prices. As the rich own more assets than the poor and middle class, the reasoning goes, the Fed’s policies are increasing the already large disparities of wealth in the United States. Table 10.2  Inequality in the Distribution of Income by Share of Household Income Household Income by Quintile 2019 2016 2014 2010 2007 2004 2001 1998 1995 1992 Lowest quintile Second quintile Middle quintile Fourth quintile Highest quintile Top 5 percent

3.1 3.1 8.3 8.3 14.1 14.2 22.7 22.9 51.9 51.5 23.0 22.6

3.2 8.4 14.4 23.0 51.0 22.2

3.3 8.5 14.6 23.4 50.3 21.3

3.4 8.7 14.8 23.4 49.7 21.2

3.4 3.5 8.7 8.7 14.7 14.6 23.2 23.0 50.1 50.1 21.8 22.4

3.6 9.0 15.0 23.2 49.2 21.4

3.7 3.8 9.1 9.4 15.2 15.8 23.3 24.2 48.7 46.9 21.0 18.6

Source: US Census, https://www.census.gov/data/tables/time-series/demo/income-poverty/historical-­ income-households.html

Table 10.3  Distribution of Wealth by Household Income as a percentage of Total Wealth Household Income 2019 by Quintile

2016

2013

2010

2007

2004

2001

1998

1995

1992

Less than 20 20–39.9 40–59.9 60–79.9 80–89.9 90–100

0.28 1.36 3.54 7.22 16.82 70.78

0.37 1.28 3.68 9.44 17.75 67.49

0.36 1.62 3.81 7.46 16.95 69.81

0.48 2.08 4.86 11.26 19.67 61.64

0.49 2.27 4.79 10.57 20.74 61.14

0.59 2.86 4.72 10.50 19.45 61.88

0.68 4.09 6.31 13.19 22.32 53.41

0.93 5.36 7.08 11.65 19.82 55.17

0.62 4.40 6.27 11.94 18.99 57.78

0.40 1.88 4.10 8.80 16.64 68.18

Source: Board of Governors of the Federal Reserve System (BGofFR). “Survey of Consumer Finances.” 2013. Available at www.federalreserve.gov/econres/scfindex.htm. Accessed July 7, 2017.

Overcoming the Limits of the Private-Domestic Economy  181 Percentages reduce the apparent importance of the changes. For the bottom quintile, wealth fell by almost a third since 2007. Only the top quintile sustained an increase in wealth as a percentage from 2007 to 2013. From the point of view of economic growth, the effect of quantitative appears relatively slight. Asset prices increased along with output and employment. Wage increases, however, rose slightly if at all.

Modern Monetary Theory Both the GFC and the Covid-19-induced recession underscore Keynes’s observation that “The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes” (Keynes 1936, 372). MMT addresses the faults noted by Keynes. The productive power of modern technology stemming from continuous-mass production magnifies the problem of unemployment. Production based on modern technology can produce output exceeding what the market can profitably absorb. The productiveness of modern technology means that the market economy may employ labor at less than full employment. In The Deficit Myth, Stephanie Kelton (2020) distinguishes between the “descriptive side” of MMT and the “prescriptive side” (233–243). The descriptive side describes “how a modern fiat currency works.”1 President Nixon ended the Bretton Woods System in 1971, also ending the system of fixed exchange rates based on the dollar, ending the dollar’s peg to gold. This gave rise to the era of fiat money and floating exchange rates. Using fiat money, a sovereign government issuing a sovereign currency cannot go bankrupt. A sovereign government differs from a household or firm. Households and firms face budget constraints that limit their options. Sovereign governments face no such constraints. No commodity standard, currency pegs, monetary rules, or other institutional constraints limit the government’s ability to finance deficits. Governments are limited only by the available labor, capital, and natural resources that can be employed for productive uses. Financial constraints confronting sovereign governments are mythical, illusory holdovers from the gold standard. In an interview appearing on the news program 60-Minutes, Ben Bernanke (2009) explained how the Fed financed its loans and asset purchases in response to the GFC, “We use the computer to mark up the size of the [banks’] accounts they have with the Fed. So it’s much more akin, although not exactly the same, as printing money.” The government, through its control over sovereign money, can supplement private demand. If there are no limits to the central banks’ ability to create money, why would people hold money? MMT explains that people hold money because they are obligated to pay taxes. Sovereign governments impose on their citizens a tax liability. Satisfying that liability requires payment in sovereign money designated by the government.

182  Overcoming the Limits of the Private-Domestic Economy Lack of financial limits does not mean an unlimited ability to run deficits. The effectiveness of deficits is limited by the amounts of unemployed labor, capital, and resources. Minsky noted that government deficits provide income flows to individuals and corporations. Wynne Godley observed that government deficits enable the private sector to accumulate net-financial assets (see Kelton 2020). By definition, the national income accounts must balance. The accounts of the private sector, the government sector, and the foreign sector sum to zero. Hence, the accumulation of net-financial assets by the private sector depends on the government sector running deficits, assuming the current-­ account balance is zero. Financial assets are contractual obligations. One person’s asset is another’s liability; one sector’s surplus is another’s deficit. The private sector’s net-financial assets are the government sector’s liabilities, again, ignoring the foreign sector. The national income accounts define gross national product (GNP) as follows: GNP ≡ C + I + G + CAB. In other words, GNP equals consumption expenditures plus investment expenditures plus government spending plus the current-account balance, exports less imports plus net external foreign income (income earned by domestic factors abroad less income earned by foreign factors domestically). Subtracting consumption and taxes from both sides yields the following: GNP – C – T ≡ I + (G – T) + CAB. GNP – C – T equals private saving. Private saving (S) equals investment plus the government budget plus the current-account balance. Subtracting I from both sides yields net-financial assets of the private sector (S – I) ≡ (G – T) + CAB. Again, for the private sector to accumulate net-financial assets, either the government must run deficits, the foreign sector runs current-account surpluses, or both. The subtitle of Kelton’s book reveals MMT’s prescriptive side: “the birth of the people’s economy.” MMT advocates using fiscal policy to achieve full employment, rebuild the infrastructure, address climate change, and, in the era of Covid-19, provide economic security to those who become economically insecure. MMT aspires to overcome the shortcomings of the private-­domestic economy, using government to ensure that people are fully employed.

The Institutional Basis of Market Economies Textbooks typically define markets as “places” where buyers and sellers meet. Markets, however, involve more than exchanging goods and services or the land, labor, and capital necessary to make those goods and services. The institutional basis of the market economy lies in the promises that ­private–property owners make to each other, formalized contractually. The vision of the economy underlying MMT recalls the view held by the institutional economists John R. Commons and Hyman Minsky, in addition to Keynes. They viewed the economy as a series of promises, manifesting

Overcoming the Limits of the Private-Domestic Economy  183 itself, among other things, in the ownership of financial assets. As Commons ([1924] 1957, 245) put it, the “essential quality” of capitalism “is transfer of titles and the liberation of debtors from encumbrances through the tender of lawful means of liquidating their promises.” Promises that were previously personal became liquefied. Liquefication of promises means they can be satisfied by money payments. Money provides “a means of release from debt” (Commons [1934] 1961, 459). It entails the power to transfer and settle obligations. In whatever form—check, currency, bank reserves, etc.—money is a spendable IOU. Currency is a liability of the central bank, demand deposits a liability of commercial banks the value of which is guaranteed by the central bank. As a spendable IOU, money is convertible into anything for sale. MMT, however, goes beyond settling obligations. It also involves creating new obligations, employing the resources that the private economy cannot. MMT advocates using fiscal policy to create jobs to achieve full employment,2 rebuild infrastructure, mitigate climate change, vaccinate the population, and so on. As noted, financing such policies requires only a keystroke, something the Fed and every other major central bank has done at least since the GFC.3 Financial assets are the formal manifestation of promises that we make to each other. Financial assets are the obverse, liabilities are the reverse, promises made to others to fulfill obligations payable in money. The almost ubiquitous liquefication of promises comprises a monetary economy. Recalling Keynes, expectations regarding asset prices can affect the level of employment. An expectation that asset prices will fall will, in turn, negatively affect investment spending. The decrease in investment spending will, in turn, reduce employment. The GFC followed 12 years later by the Covid-19-induced recession prompted policy makers to address the underlying financial relations. A debt-deflation depression points to the importance of central banks as lenders of last resort and governments as generators of income flows. Sovereign governments have the power to provide liquidity to individuals and businesses to enable them to meet their obligations. The primary function of the Fed is to serve as lender of last resort.

The Policy Response to Covid-19: The Implementation of Modern Monetary Theory In response to the Covid-19-induced recession, the Fed resurrected QE. But the Fed went further than protecting the financial sector. Together with the Treasury, the government response appears to fall in line with the policies advocated by MMT to protect the promises that we make to each other, the importance of which reveals itself in times of crises. Covid-19, in particular, reminds us of the weakness of markets. Markets are not alert to threats: foreign, domestic, or microbial. Even in “normal” times, markets are unable to provide employment, housing, or healthcare

184  Overcoming the Limits of the Private-Domestic Economy for everyone. Crises make matters worse. In such times, creating the rules and policies to provide people with needed goods and services falls to government. During the pandemic, millions faced eviction; many others confronted the loss of employment; many businesses were shuttered. In the GFC, the government socialized the risk to the financial sector. In the Covid-­19-induced recession, the government expanded its protection, forbidding evictions for lack rent payment, protecting jobs, providing individuals and businesses with cash infusions, helping them to meet their financial obligations. Even so, the Trump administration’s muted response to the pandemic stemmed, in part, from an overreliance on free markets and the associated market mentality. Lack of a coordinated response at the federal level forced Governors, hospitals, and healthcare workers to compete in finding medical supplies and personal-protection equipment, squandering resources and time. Some politicians promoted shunning masks as an expression of individual freedom, a restatement of “nature red in tooth and claw.” In March 2020, the government responded to the pandemic by shutting down the economy. The shutdown impacted the restaurant, entertainment, and the travel industries particularly hard. By April 2020, 20 million people were unemployed, 15% of the labor force, ending the ability of millions to earn income. Unemployment claims increased from 1,737,750 in January reaching a height of just over 22 million claims in April, falling back to just under 8 million claims by November. The shutdown particularly affected women and minorities who are disproportionally employed by the service sector. The labor force participation rate fell from 63.4% to 60.2% in April, only to rebound somewhat by November. Consumption expenditures fell precipitously from almost $15 trillion in January 2020 to just over $12 trillion in April. Similarly, the personal savings rate increased from 7.6% to almost 34%. The increase in the savings rate combined with the government providing taxpayers cash infusions helped households to paydown higher-interest credit-card debt. By comparison, auto loans remained unchanged. The Fed’s response was particularly aggressive. Jerome Powell, in a statement before Congress, noted that in response to the stock market sell-off in March 2020, the Fed used its entire panoply of tools: reducing the Federal Funds rate to near zero, reducing the discount rate and extending the repayment period, reenacting QE, creating the Primary Dealer Credit Facility to extend loans to the primary dealers; expanded swap lines with other central banks, and so on. Between March 11 and August 11, 2020, the balance sheet of the Fed increased by 60%, the Fed’s holdings of US government securities increased 114%; Federal Reserve Notes increased 10%; Reserves increased 59%; and US Treasury General Account with the Fed increased 239%. The Fed had been made responsible for the economy, charged with achieving maximum employment, price stability, and financial stability. Despite the aggressive action, the Fed cannot force consumers and business to spend.

Overcoming the Limits of the Private-Domestic Economy  185 The working rules of the Fed prescribe a trickle-down approach to stimulate economic activity: provide liquidity to financial institutions and businesses. Fiscal policy reveals a more muted, less focused response. Despite this, federal outlays and the deficit increased dramatically. Outlays increased from $405 billion in January to over $1,105 billion in June. For the same months, the deficit increased from $33 billion in January to over $864 billion in June (see Table 9.3). The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) became law on March 27, 2020. The act provided $2 trillion to households and businesses; $1,200 per adult with income less than $99,000 or $2,400 for couples with income less than $198,000; and $500 per child, with a maximum of $3,400 per household. The CARES Act also implemented the Paycheck-Protection Program, loans provided to businesses to enable them to pay employees for eight weeks. The act also required some creditors to provide forbearance to the households “experiencing a financial hardship due, directly or indirectly, to the COVID-19 emergency” (Evans 2020). Jerome Powell commented in a testimony before Congress: The passage of the CARES Act by Congress was critical in enabling the Federal Reserve and the Treasury Department to establish many of these lending programs. We are strongly committed to using these programs, as well as our other tools, to do what we can to provide stability, to ensure that the recovery will be as strong as possible, and to limit lasting damage to the economy. (2020, 2–3) The CARES Act represented the government’s response to the pandemic. In “normal” times, advocates of MMT argue for the government engaging in functional finance, running deficits to provide employment. Currently, deficits are financed by selling US Treasury securities to the private sector. The decrease in bank reserves is offset by the increase in reserves resulting from government expenditures, implying that interest rates need not change (Mitchell, Wray, and Watts 2019, 337).4 Deficits, however, could also be financed by the central bank using its power of the keystroke to deposit money in the Treasury’s accounts, in effect, “creating money.” Creating money requires a sovereign currency issued by a sovereign government. Aside, perhaps, from political constraints, the use of fiat money issued by sovereign governments means there are no constraints limiting central banks from financing government expenditures. No commodity standard, currency pegs, monetary rules, or other institutional constraints limit the government’s ability to finance deficits. Sovereign governments issuing sovereign money cannot go bankrupt (Mosler [1996] 2012).

186  Overcoming the Limits of the Private-Domestic Economy

QE versus Functional Finance The contrast between QE and functional finance can be illustrated using T-accounts. Table 10.4 indicates the effects of QE on the balance sheets of different actors: The Fed, the US Department of Treasury, money managers, and commercial banks. The Fed purchases a $1,000 Treasury bond from, say, a money manager overseeing a pension fund. The money manager sells the bond to the Fed, depositing the proceeds in a commercial bank. The money manager has reallocated assets from treasury bonds to deposits, leaving his liabilities unchanged. Money managers, as profit maximizers, will look to buy corporate bonds, stocks, and other assets, pushing up their prices. The $1,000 deposit represents an asset to the money manager, a liability to the commercial bank, which increases its reserves by $1,000. From the commercial bank’s point of view, the $1,000 increase in reserves represents an increase in its assets, corresponding to an increase in the liabilities of Fed. The increase in bank reserves could lead to an increase in loans. But there are two considerations. First, the Fed now pays interest on reserves, giving banks an incentive to hold a riskless asset that pays interest as opposed to owning a risky, higher-yielding asset. Second, commercial banks cannot induce business and consumers to borrow. Businesses will only borrow if they believe prospects warrant it (see Fullwiler and Wray 2010; Watkins 2014). Now consider the effect of a transaction by the US Treasury engaging in functional finance to employ the unemployed. In the transaction indicated in Table 10.5 step 1, the Treasury issues a $1,000 bond purchased, say, by the Fed. The Fed credits the Treasury a $1,000. The bond represents a liability of the Treasury, an asset to the Fed. The Fed’s assets increase by $1,000, its liabilities increase by the same amount. The balance sheets of both commercial banks and money managers are unaffected since they are not party to the transaction.

Table 10.4  Quantitative Easing

Change in the Balance Sheet of the Fed Change in the Balance Sheet of the US Treasury Change in the Balance Sheet of Money Managers Change in the Balance Sheet of Commercial Banks

Assets

Liabilities

Bonds: +1,000

Bank Reserves: +1,000

0

0

US Treas. Bonds: –1,000 0 Deposits: +1,000 Bank Reserves: +1,000 Deposits: +1,000

Overcoming the Limits of the Private-Domestic Economy  187 Table 10.5  Functional Finance Step 1: An Increase in the Government Deficit Financed by the Fed

Change in the Balance Sheet of the Fed Change in the Balance Sheet of the US Treasury Change in the Balance Sheet of Commercial Banks Change in the Balance Sheet of Money Managers

Assets

Liabilities

Bonds: +1,000

Deposits of the Treasury: +1,000 Bonds: +1,000

Deposits of the Treasury: +1,000 0 0

0 0

Step 2: The Treasury Spends the Deposits Change in the Balance Sheet of the US Treasury Change in the Balance Sheet of the Fed Change in the Balance Sheet of Commercial Banks

Deposits: –1,000 Expenditures: +1,000 0



Deposits of the Treasury: –1,000 Bank Reserves: +1,000 Bank Reserves: +1,000 Private Deposits: +1,000

In step 2, the treasury spends the money providing jobs, keeping its promise as employer of last resort. When the newly employed deposit their checks in commercial banks, both deposits and reserves, liabilities, and assets of commercial banks increase. To drain the increased reserves to the banking system, the Fed could sell the bonds to the commercial banks. In comparing the two approaches, note that QE does not affect the balance sheet of the US Treasury. QE does not affect the debt of the US government and, therefore, does not incur interest payments. This raises a question: what is the function of interest payments on the US debt? The debt represents an obligation of the US government and, by implication, an obligation of US taxpayers to those who hold the debt. Hence, the interest payment represents an income transfer from the government to debt holders. Since QE generates no income transfer, the Fed could either purchase government debt or provide dollars directly to the US Treasury without purchasing US government securities, thereby merging the policies of the Fed and the Treasury (see Kelton 2020, 99–100). Functional finance serves as a means of evaluating the government’s fiscal policies in light of its purpose. The purpose of government deficits is to provide full employment, ensure economic growth, and stabilize prices. Hence, deficits are evaluated in terms of their function. Functional finance is irrelevant to quantitative easing. Its purpose is to stabilize the financial sector by increasing asset prices.

188  Overcoming the Limits of the Private-Domestic Economy

Conclusion Both the GFC and the Covid-19-induced recession are events that prompted governments the world over to take extraordinary measures to stabilize their economies. Those measures were made possible by introducing fiat money. Simple keystrokes enabled central banks to increase bank reserves and purchase of government securities, helping to finance increases in government deficits. There are two dimensions of the market economy, both related, both highlighted by the current pandemic. The first is the institutional basis of the market economy revealed in the promises we make to each other in the form of financial assets, impaired by the inability to earn income. The second is the dependence of people on employment for their livelihood. The inability to earn an income creates insecurity: evictions, food insecurity, poverty, and so on have all increased. The pandemic reveals the need for governments to intervene. The tool to finance interventions is that advocated by MMT, whether the Fed purchasing Treasury Securities or mortgage-backed securities or creating bank reserves to finance increases in government deficits. The European Central Bank has also taken an aggressive role, directly financing government deficits through government-bond purchases. The current pandemic is forcing governments to use the tools advocated by MMT. Governments seem unprepared, however, to embrace MMT in “normal” times. Kelton advocates using fiat money to achieve what she calls “the people’s economy,” using the government’s power of the keystroke to provide economic security to people. We seem to be getting there, one crisis at a time.

Notes 1 Warren Mosler, a bond trader and a founder of MMT, tells the following story. Back in 1992, Italian bonds were selling at a discount to the bonds of Italian corporations. Markets believed that Italy was on the verge of bankruptcy. Mosler recognized that Italy was a sovereign government with a sovereign currency. The Lira was an inconvertible currency on a floating exchange rate. Italy could not go bankrupt without doing so voluntarily. Mosler bought the Italian bonds reaping a fortune (see Mosler [1996] 2012). 2 Commons too had advocated that government employ the unemployed (see Whalen 2020). 3 Invoking a variation of the quantity theory of money, critics argue that increases in the money supply will lead to inflation. MMT responds that inflationary pressures can be dealt with by raising taxes. 4 The federal funds rate, known as the overnight interest rate in other countries, is set by the Fed. If the interest rate increases above the target, the Fed can increase reserves, reducing the rate. If the interest rate falls below the target, the Fed can withdrawal reserves.

References Bernanke, Ben. 2009. 2009: Ben Bernanke’s Greatest Challenge. In 60 Minutes, ­edited by Scott Pelley, New York: CBS News.

Overcoming the Limits of the Private-Domestic Economy  189 ———. 2009. The Federal Reserve’s Balance Sheet: An Update. Washington, D.C.: The Federal Reserve. http://www.federalreserve.gov/newsevents/speech/bernanke20091008a.htm#f2 ———. 2015. “Monetary Policy and Inequality.” Ben Bernanke’s Blog at Brookings (blog). https://www.brookings.edu/blog/ben-bernanke/2015/06/01/monetarypolicy-and-inequality/. ———. August 31, 2012. Monetary Policy since the Onset of the Crisis. Washington, D.C.: The Federal Reserve. https://www.federalreserve.gov/newsevents/speech/ bernanke20120831a.htm Commons, John R. (1924) 1957. Legal Foundations of Capitalism. Madison, WI: University of Wisconsin Press. ———. (1934) 1961. Institutional Economics: Its Place in Political Economy. Vol. 2. New Brunswick, NJ: The University of Wisconsin Press. Evans, Carol. 2020. Ca 20-11: Examination Procedures for the Coronavirus Aid, Relief, and Economic Security Act (Cares Act), edited by Division of Consumer and Community Affairs: Board of Governors of the Federal Reserve System. Friedman, Milton. 1969. The Optimum Quantity of Money and Other Essays. Chicago, IL: Adline Publishing Company. ———. 2000. “Canada and Flexible Exchange Rates.” Ottawa, Ontario, Canada: Bank of Canada. http://www.bankofcanada.ca/wp-content/uploads/2010/08/­ keynote.pdf Fullwiler, Scott, and L. Randall Wray. 2010. Quantitative Easing and Proposals for Reform of Monetary Policy Operations. Accessed July 17, 2020. Kelton, Stephanie. 2020. The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy. 1st edn. New York: Public Affairs. Keynes, John Maynard. (1936) 1964. The General Theory of Employment, Interest, and Money. New York: Harbinger. Minsky, Hyman P. 1975. John Maynard Keynes. New York: Columbia University Press. Mitchell, William, L. Randall Wray, and Martin Watts. 2019. Macroeconomics. London: MacMillan International. Mosler, Warren. (1996) 2012. Soft Currency Economics Ii. Christiansted, USVI: ­Valence Company. Piketty, Thomas, and Arthur Goldhammer. 2014. Capital in the Twenty-First Century. Cambridge, MA: The Belknap Press of Harvard University Press. Powell, Jerome. 2020. Statement by Jerome H. Powell Chair Board of Governors of the Federal Reserve System before the Committee on Financial Services U.S. House of Representatives June 30, 2020. Board of Governors of the Federal ­Reserve System. Watkins, John P. 2014. “Quantitative Easing as a Means of Reducing Unemployment: A New Version of Trickle-Down Economics.” Journal of Economic Issues 48 (2): 431–439.

11 The Darwinian Dilemma Winning the Struggle, Making the World Uninhabitable?

Capitalism must grow, growth driven by the drive to accumulate capital, propelled by continuous-mass production using fossil fuels. The products churning out from factories, first from Britain and the United States and later from the world, resulted in an abundance of goods for those who could afford them. The output pouring forth led to a cultural change, elevating consumption as the purpose of human existence. Continuous-mass production and the drive to accumulate profits has molded our culture, habits, and values. It justifies the enjoyment of some at the expense of others. It feeds profits and satisfies our desire for more, all resting on burning fossil fuels, the extraction of which also rests on continuous-­mass production. We depend on growth to create jobs, provide economic security, and generate revenues for governments. The affluent accumulate profits; the rest of us accumulate the stuff that the affluent sells. More production requires more consumption, requiring more production, threatening the environment. Among the various threats—species extinction, climate change, and the increasing costs of resource e­ xtraction— climate change presents the greatest threat. The threat confronts us as a paradox, as the Darwinian dilemma. Darwin presented natural selection in two different but related forms: the struggle for existence and survival of the fittest. In the struggle for existence, the human species has triumphed. “Two canine animals in a time of dearth may be truly said to struggle with each other which shall get food and live” (Darwin [1859] 1981, 74). We can take comfort in eliminating our predators, subduing many of our pathogens, and securing our food supply. We have outcompeted other species for the available resources. We have removed the checks that historically limited human population. Continuous-mass production has bestowed upon us the age of abundance, at least for those who have wealth and income. For the 44% of the world’s population living on $5.50 a day or less, abundance is beyond their grasp. In terms of the survival of the fittest, the verdict remains unclear. Survival of the fittest refers to a single organism trying to survive changes in its environment. “But a plant on the edge of a desert is said to struggle for life against the drought” (Darwin [1859] 1981, 73). In eliminating other species and impeding the services of others, we have made the environment less DOI: 10.4324/9780429443763-11

The Darwinian Dilemma  191 conducive to our own survival. A four-degree Celsius increase in the mean temperature will leave parts of the planet uninhabitable. Around the equator, day-time temperatures will be too high for humans to live. We confront the Darwinian dilemma, winning the struggle and, in the process, making the earth uninhabitable, at least for humans. To wax metaphorically, Gaia has acquired a fever, attempting to throw off the virus that is us. Nature provides us with raw materials and absorbs our wastes. We depend on nature for the air we breathe, the food we eat, and the water we drink. We cut its forests for lumber; dig its entails for coal, ore, and minerals; foster, modify, and harvest those species we prefer, destroying those we do not. We have entered the Anthropocene, affecting the course of evolution itself. We have become as Gods, deciding which species live, which die. The decision rests on which species prove most profitable and, as Veblen pointed out, which species are most servile.1 Other species avoid our judgment, flourishing in the conditions that we created. Roaches, rats, and coyotes do well in our environs. We want more goods: more automobiles, bigger houses, more things. In a word, we want growth. Growth brings jobs, revenue, and development. But more for us means less for nature and therein lays the tradeoff. How do we satisfy our desire for more without destroying the environment? Is the civilization of consumer capitalism fundamentally incompatible with environmental quality?2 Is the source of this incompatibility, in part, mainstream economics?

Nature as a Commodity Over time, we became complacent, taking the things that nature provides for granted. Until recently, we ignored our impact upon the environment. People continued to trash the highways until the 1960s; individuals thought nothing of dumping used motor oil on the ground; gas-station owners found it less costly to let their storage tanks leak than repair them; and the rivers served as the nation’s sewers.3 Our traditional disregard for nature, legitimized by the invisible hand, reinforces the belief that whatever is profitable benefits society. Adam Smith took nature for granted. “Labour is the original purchase price paid for all things” ([1776] 1937). His labor-commanded theory of value apportioned value according to the ownership of property, according to the value of land, labor, and capital. His “obvious and simple system of natural liberty” represents an elaboration of the concept of natural rights, developed by John Locke. Locke (Locke 2002), writing almost 70 years before Smith, assumed the boundlessness of nature, a reference to the New World, which, for Locke, appeared empty. Before Europeans arrived, population in the New World was relatively abundant. The latest scholarly work estimates that the population of one marginal area, Florida, may have been as high as 900,000 at the beginning of the sixteenth century. Even if we skeptically subtract half from that figure,

192  The Darwinian Dilemma the remainder is impressively large. The southeastern United States, ­relative to what it had been, was vacant circa 1700 when the French came to stay. (Crosby 1986, 212) More output requires more inputs. More inputs require transforming nature into commodities, subjecting nature to market forces. This requires severing nature from its ecological relationships. In itself, nature has no market value. From a market point-of-view, nature only has value as a commodity. To transform nature into a commodity is to dissembled nature. It is to treat the economic system independent of the ecosystem. Trees become lumber; a mountain becomes a mine; a forest becomes a cattle ranch; a jungle becomes a palm-oil plantation. It is the commodification of the natural world. Our traditional disregard for the environment is compounded by our market mentality, the tendency to evaluate things based on price. This poses difficulties for valuing resources for which there are no markets. How do you place a market value on wilderness, the biodiversity of a rain forest, or the services of coral reefs? The efforts of environmental economists have been disappointing. The contingent-valuation approach asks people what they are willing to pay to preserve a wilderness? Or conversely, how much money are people willing to accept to destroy a wilderness? The contingent-­ valuation approach assumes an imaginary market. No actual payment occurs, skewing the results. The travel cost approach determines value by the cost incurred traveling to a national park, preserve, monument, or some other natural phenomenon. Option value asks the value of preserving the option to develop a resource. That is, the value stemming from opting to develop, and therefore destroy, a resource later. Once destroyed, the option vanishes. All assess value based on the preferences of individuals pursuing their self-interests. All the approaches ignore the value of the services provided to the web of life, regulating the environment, or considering future generations. In brief, the different approaches ignore the intrinsic value of a resource, that is, their function in the ecological system. Nowhere, however, is the disregard for nature more pronounced than in the concept of gross domestic product (GDP). Gross Domestic Product GDP is considered the most important indicator of the economy’s performance. Formally, GDP is the total value of all final goods and services produced by the domestic economy in a single year. GDP measures the flow of output over time, not the stock of wealth at a point in time. Its origin lies, in part, in the effort to measure the potential output of the US economy to fight World War II. Assuming happiness is a function of the quantity of goods and services, the greater the throughput the greater the happiness. Since GDP measures the economic value of throughput, the presumption is that the more throughput the better.

The Darwinian Dilemma  193 There are numerous problems with GDP as a measure of economic ­ elfare. For one, it ignores the cost incurred from reducing its stock of rew sources. The GDP of a country may be rising, all the while depleting its resource stock. A developing country experiencing rapid growth often results from harvesting its forest, clearing its jungle, or extracting its stocks of oil. GDP further ignores the distribution of income; the kinds of goods produced;4 per-capita GDP; the value of services provided outside the market, human, or otherwise. GDP is inherently biased against non-economic values: the value of leisure, the value of wilderness areas, the disamenities of urban living, and so on. GDP does not include the economic costs associated with climate change. Rebuilding cities on higher ground, building sea walls for protection, or relocating climate emigrees would be included in GDP. The destruction caused by a changing environment would not.5 As Hermann Daly (1996, 40) noted, “Our national accounts are designed in such a way that they cannot reflect the costs of growth, except by perversely counting the resulting defensive expenditures as further growth.” From the point-of-view of mainstream economics, GDP is a function of capital and labor. Solow’s growth model applies the production function to society at large, assuming the output-labor ratio is a function of the capital-labor ratio. Technology is treated as an exogenous variable, a wild card. Solow’s growth model, however, does not include natural capital and the services that natural capital provides, reinforcing the myth that the economy works independently of nature.6 Those services include cleansing water provided by the wetlands, pollinating crops provided by insects, absorbing cardon dioxide provided by forests, plants, and tidal basins, creating weather, regulating the atmosphere, and so on. Of course, there is no payment for the services provided. The services are simply disregarded. As noted, efforts to measure their value are fraught with difficulties, partly owing to a lack of knowledge, partly because they are part of the ensemble of relations. For the Solow Growth model, diminishing returns result not from the fixity of an input, but increases in the capital-labor ratio, the result of an abundance of capital relative to labor. In contrast, the classical economists attributed diminishing returns to the fixity of the land. Typically, diminishing returns is presented in a functional form. Diminishing returns results from making output a function of capital, labor, and land. Increasing labor, holding land and capital constant, output increases at a decreasing rate. Ricardo offered a more realistic example. Ricardo recognized that land differs in fertility, cultivating the most fertile lands first. Increases in the population require cultivating less fertile lands, resulting in either increasing costs per unit of food or output increasing at a decreasing rate. Ricardo’s theory of growth served as the basis of his pessimism. The scarcity of fertile land limits growth. As the population increases, requiring the cultivation of less fertile land, income to the different factors becomes redistributed, stifling growth. Assuming the profitability of the marginal land, competition among capitalists bids up rents, squeezing profits. As the rate of profit falls, saving and accumulation decline. Wages remain at subsistence,

194  The Darwinian Dilemma the result of Malthus’ theory of population. The increase in rents squeeze profits to the point that accumulation ceases and, with it, capitalism ends. Society enters the stationary state characterized by no growth. Ricardo looked upon the stationary state with dread; John Stuart Mill (1848) looked upon it as the opportunity to achieve a more equitable distribution. Stanley Jevons too believed that England was on the cusp of the stationary state, not because of the scarcity of land, but because of the scarcity of coal. He believed that England’s growth was based on coal, which was becoming more costly to extract. The rising costs would lead to the stationary state marking a change in the economic problem, a transition of the problem from one of growth and distribution to the allocation of scarce resources.7 In fact, the basis of England’s growth in the nineteenth century was not land, but coal. The Industrial Revolution marked the beginning of the transition from an organic economy based on renewable energy, to an industrial economy based on fossil fuels. “Above all, access to a mineral rather than a vegetable energy source expanded the production horizon decisively” (Wrigley 2013, 9). The full effects of the Industrial Revolution did not manifest themselves until the late nineteenth century, with the application of science providing the basis for continuous-mass production.

Resource Extraction Mainstream economics views nature as infinite in quantity. Decreases in oil supplies increase prices, providing incentives to entrepreneurs to find additional oil or find alternatives. This, however, rests on a series of tenuous assumptions: the assumption that markets work, that technology will save us, that substitutes will be found (the assumption of infinite substitutability). The authors of Limits to Growth argue that it is not a matter of depleting resources. It is a matter of the increasing costs of extracting those resources and the rising costs of mitigating pollution. But we conclude from the evidence that the growth in the harvest of renewable resources, depletion of materials, and filling of the sinks, are combining slowly and inexorably to raise the amount of energy and capital required to sustain the quantity and quality of material flows required by the economy. These costs arise from a combination of physical, environmental, and social factors. Eventually they will be high enough that growth in industry can no longer be sustained. (Meadows, Randers, and Meadows 2004, 51) The idea of limited resources underlies what has come to be known as “the tragedy of the commons.” Garret Hardin (1968) tells the following story. A group of sheep herders place their sheep on the commons, a field owned by no one. The sheep thrive on the lush field, benefiting the sheepherders at no cost. As sheepherders place more sheep on the commons, the field degrades,

The Darwinian Dilemma  195 causing the benefit of adding one more sheep to decline. So long as the additional benefit of another sheep exceeds the additional cost, the shepherds continue to add sheep. One day, however, there is nothing left for the sheep to eat. All that remains is a dusty field. For us, the commons comprise the air we breathe, the oceans we fish, and the services that nature provides. The ability of nature to absorb our wastes is passing its limit. The increasing acidification of the oceans, the melting of the polar ice caps, drought and wild fires in some places, torrential rains in others, are manifestations of a warming earth. The warming stems from emitting greenhouse gases and destroying the biota that absorb those gases. Privatizing the commons, as Hardin recommended with the field, is not possible. The air and the oceans are indivisible. The services that nature provides are non-rival. Restraint requires considering the interests of others, of future generations, and of other species. Human activity that impairs the services provided by the commons represents a public bad. In two important ways, a public bad resembles a public good. A public good differs from a private good. A private good is both divisible and rival, illustrated by a hamburger. It can be cut in half; the half I consume denies you consuming the same half. In contrast, a public good is both non-divisible and non-rival, illustrated by national defense. National defense is indivisible. Further, there is no rivalry. Protecting me does not deny protection to you. Climate change shares the characteristics of a public good in two important ways. First, climate change is indivisible—it affects us all. It is also non-rival. Fires burning in California do not prevent similar fires in Greece, Turkey, or Siberia. Second, climate change is non-exclusive. No one owns, so to speak, climate change. One person’s efforts to reduce climate change will have a marginal effect. Mitigating climate change requires a collective effort. In this regard, mitigating climate change resembles an exercise in game theory. One person’s effort to reduce climate change can be thwarted by someone else’s efforts that accelerate climate change. Moreover, affecting climate change has a long-time horizon. The efforts that we take today may not be evident for decades, perhaps centuries. In 2020, half the rain forests remain. Only 4% of the mammals are part of the natural world, the remaining 96% result from domestication: the cows we raise, the rats that infest our cities, the chickens we modify for human consumption. Enter the Anthropocene. The Anthropocene is usually said to have begun with the Industrial Revolution, or perhaps even later, with the explosive growth in population that followed World War Two. By this account it’s with the introduction of modern technologies—turbines, railroads, chainsaws—that humans became a world altering force. But the megafauna extinction suggests otherwise. (Kolbert 2014, 234)

196  The Darwinian Dilemma The megafauna extinction, the demise of the large land mammals at the end of the last ice age, appear to have met their demise with the expansion of humans into the Arctic, Australia, and North America. Homo Sapiens found a hunter’s paradise in Australia and the Americas. All three continents were chock-full of toothsome herbivores utterly inexperienced in defending themselves against human aggressors, providing the newcomers with seemingly inexhaustible quantities of protein, fat, hide, and bone. (Crosby 1986, 16–17)

Winning the Struggle: The Sixth Great Extinction The sixth great extinction represents the triumph of the human species in our struggle for existence, the first resulting from the activities of a single species.8 It is estimated that one-third of all reef-building corals, a third of all fresh-water mollusks, a third of sharks and rays, a quarter of all mammals, a fifth of all reptiles, and a sixth of all birds are headed toward oblivion. (Kolbert 2014, 17–18) One half of the earth’s land mass is devoted to agriculture. The amount of wilderness is declining, a process accelerated by the introduction of continuous-­mass production. The proliferation of invasive species resulting from globalization is unprecedented, beginning with the first invasive species, homo sapiens. The spread of invasive species began in earnest in the sixteenth and seventeenth centuries with the pathogens and animals that Europeans introduced. Pigs were introduced to ensure future meet supplies. Rats and other vermin were introduced unconsciously, spreading rapidly. The indigenous populations had no immunity to the pathogens introduced, resulting in their decimations. By transporting Asian species to North America, and North American species to Australia, and Australian species to Africa, and European species to Antarctica, we are, in effect, reassembling the world into one enormous supercontinent—what biologists sometimes refer to as the New Pangaea. (Kolbert 2014, 206) The growth in human population is a further indicator of the success of the human species, correlating with the increase in atmospheric carbon, negatively correlated with the remaining wilderness (see Table 11.1).

The Darwinian Dilemma  197 Table 11.1  Human Population, Atmospheric Carbon, and Remaining Wilderness Year

Population Atmospheric Carbon Remaining (Billions of People) (Parts per Million) Wilderness

1937 1954 1960 1978 1997 2020

2.3 2.7 3 4.3 5.9 7.8

280 310 315 335 360 415

66% 64% 62% 55% 46% 35%

Source: David Attenborough: A Life on Our Planet (Fothergill, Hughes, and Scholey 2020).

The concept of carbon footprint refers to the amount of gas emissions resulting from the production and consumption of goods and services resulting from human activity (Wiedmann and Minx 2008, 2). Measuring the footprint, however, is problematic, fraught with difficulties. Which gases should be included? Should the footprint include indirect effects? Should it include the effects on the carbon cycle? Comparative data on the amount of CO2 in the atmosphere relative to 3 million years ago, however, is clear. At that time, CO2 was at the same levels as now, 412 parts per million. “At that time, the temperature was 2°–3°C (3.6°–5.4°F) higher than during the pre-industrial era and sea level was 15–25 meters (50–80 feet) higher than today” (Lindsey 2020).

Symbiosis The word symbiosis derives from the Greek meaning “living together.” Lynn Margulis defines symbiosis “as the intimate living together of two or more organisms called symbionts, of different species” (Margulis 1984, 5). The word “intimate” is problematic. As defined by Oxford English Dictionary, intimate means “pertaining to or connected with the inmost nature or fundamental character of a thing, essential, intrinsic.” Modern symbiosis theory originated in the reaction of socialists and anarchists to the emergence of the market economy in the nineteenth century. The term mutualism comes from the mutual aid societies founded in France following the revolution (Boucher 1985, 17). Mutualism means “different kinds of organisms help each other out” (Boucher 1985, 2). Among the first proponents of the symbiotic view was Prince Kropotkin, a Russian aristocrat, anarchist, and socialist. Kropotkin wrote a book titled Mutual Aid, the purpose of which was to counter Darwin’s idea of the survival of the fittest. Kropotkin asserted that though a good deal of warfare goes on between different classes of animals, or different species, or even different tribes of the same species, peace and mutual support are the rule within the tribe or the species;

198  The Darwinian Dilemma and that those species which best know how to combine, and to avoid competition, have the best chances of survival and of a further progressive development. They prosper, while the unsociable species decay. (Kropotkin 1989, 76) For years, biologists studying symbiosis were not taken seriously. Their theories were either dismissed or met with open hostility. The “market mentality” underlying the neo-Darwinian synthesis led biologists to look for conflict. Predator–prey relationships became the focus. With a few notable exceptions, “the literature of evolutionary biology developed independently from profound and important experimental and observational analyses of symbiosis” (Margulis 1991, 6). The empirical discovery of the pervasiveness of symbiosis in the 1960s initiated a revolution in biology, moving biologists studying symbiosis from exclusion to the fringe. Our evolution, and that of all plants and animals, is not due solely to the gradual accumulation of gene changes within species. In fact, we evolved from, and are comprised of, a merger of two or more different kinds of organisms living together. Symbiosis is at the root of our being. (Sapp 1994, xiii) Margulis established that the DNA of mitochondria (mitochondria are the energy source for animal cells) differ from that of the “host” organism. The difference implies that mitochondria, along with chloroplasts in plant cells, originated as separate organisms. Similarly, biologists have suggested that other parts of cells originated as separate organisms. The cell symbiosis theory is supported by increased understanding of biological partnerships. The importance of such partnerships has frequently been overlooked. Evolutionists in the nineteenth century emphasized the competitive theme of Darwin’s work: in a vicious fight of survival, successful organisms leave more offspring, and the strongest competitor is thereby selected. True, the organism ahead in the evolutionary game is the one that leaves the most offspring. Yet there is no single winner of the life game. No individual, in fact no species, can survive in the total absence of all others. Gases and food must be provided, and carcasses and refuse must be carted away, digested and recycled. These processes require many kinds of organisms. (Margulis 1984, 78–79) There are in fact no organisms that are not involved in symbiotic relationships. Organisms of all sizes and from all five kingdoms enter into symbiotic relationships. Bacteria live in the guts of animals, fungi live symbiotically

The Darwinian Dilemma  199 with green algae or cyanobacteria in lichens, and nearly every species of echinoderm (starfish, sea urchin, and the like) has one or two of its own protoctist symbionts. (Margulis 1984, 79) Margulis’s research focused on the cellular level. Others have focused on cooperative tendencies in the behavior of animals. V.C. Wynne-Edwards (1962), for example, hypothesized that the proper selectee was not the individual, but the group. He observed that populations of species tend to remain stable despite the assumption that individuals are assumed to maximize their progeny. Wynne-Edwards hypothesized that individuals within a group monitor themselves, maintaining a population commensurate with food supplies. In practice, some of the attributes of animal behavior are wholly dependent on mutual cooperation for the achievement of beneficial effects, and require that individuals conform to rules in order to promote the common good. The most conspicuous example of this among animals is their (almost) universal precaution in not over exploiting their food resources . . . If nutritional plenty is truly the outcome of innate precaution, then conforming with such rules must be vastly beneficial; and I suggest that it could not exist in a world where individuals were set against each other, all against all, in an unregulated scramble for food and still more progeny. (Wynne-Edwards 1986, ix) To further illustrate the importance of symbiosis, coral reefs have been described as rain forests. The warm waters of the tropics provide few nutrients for life. Researchers have found more than 100 different species in a square meter of coral. Corals provide the shelter that other organisms inhabit. The waste of some species provides the food for others (Kolbert 2014, 130–140). Suzanne Simard, a tree biologist studying the forests in British Columbia, found symbiotic relationships were essential to forest life. She noted that in response to an invasion by budworms, firs increased their defense enzymes, prompting pines to do the same. The Pines defense enzymes—four of them—had dramatically increased, in perfect synchrony with the carbon dump, and this occurred only if Pines were linked below ground to the firs. Even slight injury to the firs elicited an enzyme response in the pine. The firs were communicating their stress to the Pines within twenty-four hours. Simard continues: “What the trees were conveying made sense. Over millions of years, they would evolved for survival, built relationships with their mutualists and competitors, and they were integrated with their partners in one

200  The Darwinian Dilemma system” (Simard 2021, 254). Similarly, Simard found that clear cutting may actually aggravate the problem of climate change, releasing carbon dioxide locked in the roots and mycelium (Simard 2021, 233).

Climate Change and the Entropy Law Symbiosis cannot avoid the entropy law. Symbiosis, however, does provide a more efficient means of dealing with entropy. Entropy is a measure of disorder, the higher the entropy the greater the disorder. Symbiosis implies that the high entropy wastes of one organism are food for another. Our form of production ignores the symbiotic relationships formed over millions of years, increasing the level of entropy on earth. Climate change is a manifestation of rising entropy. The entropy law is the second law of thermodynamics, the first law is that energy can neither be created nor destroyed. The second law states that within a closed system entropy increases. A closed system is defined as one that does not interact with its environment. Except with regard to meteorites and solar energy, the earth is a relatively closed system. The transformation of inputs into outputs raises the level of entropy. Hence, the production and consumption of goods increases the level of entropy, magnified by tapping the energy stored in fossil fuels. The increase in entropy manifests itself in pollution and climate change. In a prescient comment, Nicholas Georgescu-Roegen concluded that “Since the Entropy Law allows no way to cool a continuously heated planet, thermal pollution could prove to be a more crucial obstacle to growth than the finiteness of accessible resources” (1975, 358). Transforming inputs into outputs increases entropy, manifesting itself in pollution, the unwanted by-product of production, and consumption. All production, all consumption involves entropy. Entropy implies qualitative change. As the mean temperature of the earth approaches a tipping point, the biosphere undergoes qualitative, irreversible change. The melting of the polar ice caps, shutting down the gulf stream, the death of coral reefs, mass extinctions, melting the tundra, and the permafrost releasing methane, all accelerating a warming planet. The problem, of course, is twofold: the scale with which we generate waste, accelerated by the introduction of continuous-mass production. Mankind is like a household which consumes a limited supply from a pantry and throws the inevitable waste into a finite trash can—the space around us. Even ordinary rubbish is a menace; in ancient times, when it could be removed only with great difficulties, some glorious cities were buried underneath rubbish. We have better means to remove it, but the continuous production calls for another dumping area, and another, and another . . . In the United States, the annual amount of waste is almost two tons per capita and increasing. (Georgescu-Roegen 1975, 357)

The Darwinian Dilemma  201 And second, much of the waste is unconsumable by nature. Focusing on maximizing output disregards nature’s services, producing goods that take hundreds if not thousands of years to break down, all resting on the assumption that the earth’s ability to absorb our wastes is infinite.

Conclusion We burn fossil fuels to make things to sell to people, using the proceeds to burn more fuels, clear more forests, make more things. Kenneth Boulding (1971) described the underling ideology as the “frontier economy,” the belief that resources are infinite. Climate change, mass extinctions, and resource depletion suggest otherwise, an unintended consequence of Adam Smith’s invisible hand. Each individual pursuing his or her self-interest does not promote the interest of all. The invisible hand needs visible guidance. There is a third more carbon dioxide in the atmosphere than at any time in the past 800,000 years. Half of the carbon dioxide emitted by burning fossil fuels has been emitted in the past 30 years, 85% has been emitted since World War II. Long ago when carbon dioxide matched current levels, forests grew in Antarctica and the seas were 60 feet higher. Natural capital provides the flow of services that make life comfortable for humans. Natural capital in the form of plants, trees, algae, and so on absorb carbon dioxide that human activity emits. Two things have impaired nature’s ability to absorb carbon dioxide. First, our form of production and consumption has tapped the fossil fuels that accumulated over eons in coal, oil, and natural gas. Over the past 200 years we have tapped those fuels that serve as the basis of our continuous-mass production technology, suddenly releasing vast quantities of carbon dioxide. Second, we have destroyed much of the natural capital that serves to absorb that carbon dioxide. The ideology that we can consume forever originated in the “frontier economy” of the past. On earth, the frontier no longer exists. We have entered the age of the Anthropocene, the age where human beings affect life on earth. The Apollo missions to the moon showed us the earth as a small blue sphere hanging in a black void. Boulding characterized the modern world as “spaceship earth” (1971). There is only one earth, and when the earth is no longer usable, there are no substitutes.

Notes 1 Among the domesticated animals, the dog is the most favored for its servile, fawning attitude towards humans (see Veblen [1899] 1979, 141). 2 See Herman E. Daly and Jr Cobb John B., For The Common Good: Redirecting the Economy Toward Community, the Environment, and a Sustainable Future (Boston, MA: Beacon Press), 1989. 3 The burning of the Ohio river shocked the nation, prompting the passage of the Clean Water Act. 4 An increase in domestic violence requires an increase in police, judges and jails, social workers, psychologists, and lawyers, signifying an increase in GDP.

202  The Darwinian Dilemma 5 A similar example is found in the response to the Exxon Valdez oil spill in 1988, Exxon hired students to wipe oil off rocks and paid off fisherman whose fisheries were despoiled, boosting Alaska’s GDP. GDP does not include the environmental destruction or the impairment of services provided by nature, an absence underscored by the typical production function. 6 “Natural capital is a stock that yields a flow of natural services and tangible natural resources. This includes solar energy, land, minerals and fossil fuels, water, living organisms, and the services provided by the interactions of all of these elements in ecological systems” (Daly and Farley 2011, 17). 7 Jevons, of course, was one of the founders of the marginalist revolution and, hence, modern economics. 8 Quoting Anthony Hallam and Paul Wignell define mass extinctions as the demise of a ‘significant proportion of the world’s biota in a geologically insignificant amount of time’ (Kolbert 2014, 16).

References Boucher, D. H. 1985. The Biology of Mutualism: Ecology and Evolution. Oxford: Oxford University Press. Boulding, Kenneth E. 1971. “The Economics of the Coming Spaceship Earth.” In Collected Papers: Volume Two: Economics, edited by Fred R. Glahe, 383–394. Boulder, CO: Colorado Associated University Press. Crosby, Alfred W. 1986. Ecological Imperialism: The Biological Expansion of Europe, 900–1900. Cambridge, England: Cambridge University Press. Daly, Herman E. 1996. Beyond Growth: The Economics of Sustainable Development. Boston: Beacon Press. Daly, Herman E., and Joshua Farley. 2011. Ecological Economics: Principles and Applications. Washington, D.C.: Island Press. Darwin, Charles. (1859) 1981. The Origin of Species. Danbury, CT: Grolier Enterprise Corp. Fothergill, Alastair, Jonathan Hughes, and Keith Scholey. 2020. David Attenborough: A Life on Our Planet. United Kingdom. Georgescu-Roegen, Nicholas. 1975. “Energy and Economic Myths.” Southern Economic Journal 41 (3): 347–381. Hardin, Garrett. 1968. “The Tragedy of the Commons.” Science 162: 1243–1248. Kolbert, Elizabeth. 2014. The Sixth Extinction: An Unnatural History. New York: Henry Holt and Company. Kropotkin, Petr Alekseevich. 1989. Mutual Aid: A Factor of Evolution. Montreal: Black Rose Books. Lindsey, Rebecca. 2020. Climate Change: Atmospheric Carbon Dioxide. https:// w w w.climate.gov/news-features/understanding-climate/climate-changeatmospheric-carbon-dioxide Locke, John. 2002. The Second Treatise of Civil Government Dover Thrift Editions. Mineola, NY: Dover Publications. Margulis, Lynn. 1984. Early Life. Boston: Jones and Bartlett Publishers. ———. 1991. “Symbiogenesis and Symbionticism.” In Symbiosis as a Source of Evolutionary Innovation, edited by Lynn Margulis and René Fester, 1–14. Cambridge, MA: MIT Press.

The Darwinian Dilemma  203 Meadows, Donella H., Jørgen Randers, and Dennis L. Meadows. 2004. The Limits to Growth : The 30-Year Update. White River Junction, VT: Chelsea Green Publishing Company. Mill, John Stuart. 1848. Principles of Political Economy with Some of Their Applications to Social Philosophy, edited by W. J. Ashley. London: Logmans, Green and Co. Sapp, Jan. 1994. Evolution by Association: A History of Symbiosis. New York: Oxford University Press. Simard, Suzanne. 2021. Finding the Mother Tree: Discovering the Wisdom of the Forest. First edition. New York: Alfred A. Knopf. Smith, Adam. (1776) 1937. An Inquiry into the Nature and Causes of the Wealth of Nations, edited by Edwin Cannan. New York: The Modern Library. Veblen, Thorstein. (1899) 1979. The Theory of the Leisure Class: An Economic Study of Institutions. New York: Penguin Books. Wiedmann, Thomas, and Jan Minx. 2008. “A Definition of ‘Carbon Footprint’.” Ecological Economics Research Trends 1: 1–11. Wrigley, E. A. 2013. “Energy and the English Industrial Revolution.” Philosophical Transactions: Mathematical, Physical and Engineering Sciences 371 (1986): 1–10. http://www.jstor.org.ezproxy.westminstercollege.edu/stable/23364180. Wynne-Edwards, V. C. 1986. Evolution through Group Selection. Oxford: Blackwell. ———. 1962. Animal Dispersion in Relation to Social Behavior. Edinburgh: Oliver and Boyd.

12 The Civilization of Consumer Capitalism

Placing consumer capitalism in the context of the evolution of civilization reveals that, unlike other civilizations, consumer capitalism represents “production for the masses.” As Joseph Schumpeter noted, “the capitalist engine is first and last an engine of mass production” ([1942] 1976, 56). Production for the masses depends on several factors: first, applying continuous-­ mass production technology to produce consumer goods. “It is the cheap cloth, the cheap cotton and rayon fabric, boots, motorcars and so on that are the typical achievements of capitalist production” ([1942] 1976, 67). It is continuous-­mass production that made possible the increase in living standards that Robert Gordon (2016) finds began in 1870. It is continuous-­mass production that increased the pecuniary standard, ushering in the modern corporation, combining production with distribution, with modern advertising and consumer credit in its wake. It is continuous-mass production that necessitated government intervention to avert depressions and overcome the limits of the market economy. And it is continuous-mass production that created the growth making possible both intervention and the ability to wage war on a global scale. Second, as Keynes noted, production for the masses depends on consumer spending. In turn, consumer spending depends on what Adam Smith ([1776] 1937, 56) called effectual demand, on the masses having both the will and the power. Without the will, without the desire, there is no effectual demand. And without the power—without income, wealth, or credit—there is also no effectual demand. Creating the will depends on advertising: educating, persuading, and enticing consumers to want the goods, partly for self-preservation, partly to engage in competitive spending.1 Competitive spending refers to competition among the masses to attain the pecuniary standard, to acquire the esteem of others, and to best neighbors. “The technology of wasteful consumption is large and elaborate and its achievements are among the monuments of human initiative and endeavor” (Veblen, [1915] 1968, 35– 36).2 Wasteful consumption becomes problematic. What appears wasteful at one time appears necessary at another. Desires motivated by achieving status or saving face subsequently become habitual. What becomes

DOI: 10.4324/9780429443763-12

The Civilization of Consumer Capitalism  205 habitual generally becomes necessary, raising the pecuniary standard and, in effect, the standard of living. Having the power to purchase goods entails having purchasing power. The evolution of consumer capitalism reveals efforts to identify an ever-­ broadening array of consumer assets, liquefying those assets, and providing credit based on those assets. The result has been the financialization of the consumer, increasing the income accruing to financial institutions and increasing their power, resulting from increases in consumer debt. As Veblen noted, the culture of competitive spending is rooted in individualism, liberalism, and free markets. In the late nineteenth century, American culture was receptive to applying continuous-mass production to consumer goods. Mass production requires mass consumption, underscoring the idea that culture itself forms a whole, intimately related to the dominant technology. Technology shapes the activities of people in relation to the work and education required. “As a workman, labourer, producer, breadwinner, the individual is a creature of the technological scheme; which in turn is a creation of the group life of the community” (Veblen [1914] 1964, 144).3 Increasing consumption required educating consumers and influencing their preferences regarding what to consume, how to consume, and for whom to consume. By the late nineteenth century, relatively free markets allowed the application of continuous-mass production both to consumer goods and, to a lesser extent, armaments. The autocrats of the twentieth and twenty-first centuries adopted the technology from Britain and the United States, using continuous-mass production to feed their dynastic ambitions. The Western liberal states applied continuous-mass production to create armaments to expand markets, consumables, and profits. As Veblen noted, “The modern warlike policies are entered upon for the sake of peace, with a view to the orderly pursuit of business” ([1904] 1975, 392). The trend toward militarism calls into question the presumed superiority of “civilized peoples.” War predates modern times, seemingly originating with the emergence of civilization itself if not before. Continuous-mass production, however, has expanded the lethality of war. The number of people having died at the hands of so-called civilized peoples is exceeded only by our willingness to do so. The technology that gives us power to create en masse also gives us the power to destroy en masse.

The Origin of Civilization and the Economic Surplus Civilization is often thought to begin with writing. Writing, in turn, presupposes a priestly class, class divisions, organized religion, and formal rules. All rests on the creation of an economic surplus, goods and services beyond subsistence, and a willingness to use that surplus to support the activities and desires of a ruling class. As Marshall Sahlins (1972) pointed out, hunter-gatherer societies had time to create a surplus but used that

206  The Civilization of Consumer Capitalism time to engage in leisure activities and socialize. Sahlins’ characterization of hunter-­gatherer societies as the first affluent society stems not from abundant means, but limited wants. “Want not, lack not.” Sahlins’ view of hunter-­gatherer societies conflicts with the assumption that wants are infinite, one of the enabling myths of mainstream economics and a product of the capitalist culture. Hunter-gatherers, in fact, represent the antithesis of homo economicus. His wants are scarce and his means (in relation) plentiful. Consequently he is “comparatively free of material pressures,” has “no sense of possession,” shows “an undeveloped sense of property,” is “completely indifferent to any material pressures,” manifests a “lack of interest” in developing his “technological equipment.” (Sahlins 1972, 12) As John Gowdy explained, hunter-gatherers “had structured their lives so that they needed little, wanted little, and, for the most part, had all the means of fulfilling their needs at their immediate disposal” (1998, xv). Underscoring Gowdy’s point, Sahlins noted that “Mobility and property are in contradiction” (1972, 12). As Owen Lattimore noted, “the pure nomad is the poor nomad” (Lattimore quoted in Sahlins 1972, 12). Sahlins’ and Gowdy’s views support Veblen’s.4 Veblen speculated that preliterate societies were mainly void of weapons and generally peaceful. They lived “in relatively small groups or communities; without any of the more useful domestic animals, though probably with some domestic plants; and busied with getting their living by daily work” (Veblen [1914] 1964, 120). They likely avoided conflict with others. Their primary concern was “providing of subsistence for the group and the rearing of offspring” (Veblen [1914] 1964, 122). Veblen continues: a community which has to make its own living by the help of a rudimentary technological equipment can not afford to be habitually occupied with annoying its neighbors, particularly so long as its neighbors have not accumulated a store of portable wealth which will make raiding worth while. ([1914] 1964, 123) As Veblen noted: A culture virtually without weapons, whose gods are mothers and whose religious observances are a ritual of fecundity, can scarcely be a culture of dread and of derring-do. With the fighting barbarians, on the other hand, male deities commonly take the first rank, and their ritual symbolises the mastery of the god and the servitude of the worshiper. ([1914] 1964, 126)

The Civilization of Consumer Capitalism  207 The transition from savagery to barbarism, from preliterate societies to class-divided societies, is obscure. The technology of agriculture and husbandry forming the Neolithic Revolution made possible an economic surplus, giving rise to class-divided societies. 5 From Veblen’s point of view, class-divided societies involve a leisure class characterized by a predatory instinct, which Veblen also referred to as exploit. Veblen defines exploit as “the conversion to his own ends of energies previously directed to some other end by another agent” ([1899] 1979, 12–13). Exploit enabled allocating the surplus toward developing ceremonial rituals, myths, and artifacts, legitimizing the power of the elites. Yet, in a general way such a supersession of free workmanship by a pecuniary control of industry appears to have been necessarily involved in any considerable growth of culture. Indeed, at least in the economic respect, it appears to have been the most universal and most radical mutation which human culture has undergone in its advance from savagery to civilization; and the cause of it should be of a similarly universal and intrinsic character.6 (Veblen [1914] 1964, 147) Developing religion and philosophy, building structures, creating art, producing artifacts, and engaging in activities enjoyed by the elites required an economic surplus.7 As Veblen noted, “subsistence must be obtained on sufficiently easy terms to admit of the exemption of the community from steady application to a routine of labour” (Veblen [1899] 1979, 8). All require an economic surplus, the result of a predatory instinct. The emergence of a predatory instinct changed the form of emulation. “The activity of the men more and more takes on the character of exploit; and an invidious comparison of one hunter or warrior with another grows continually easier and more habitual” (Veblen [1899] 1979, 16). The economic surplus as a precondition for civilization is itself a manifestation of cultural development. As noted, luxury goods at one time appear necessary at another, a point acknowledged by Adam Smith. “By necessaries I understand, not only the commodities which are indispensably necessary for the support of life, but whatever the custom of the country renders it indecent for creditable people, even of the lowest order, to be without” ([1776] 1937, 821).8 Running water was a luxury in 1850, a necessity by 1950, part of the pecuniary standard. The same is true for automobiles, cell phones, and televisions.9 Throughout human history, the visible manifestations of the surplus reflect the underlying social values—what the ruling class felt important. Visible manifestations of the surplus embodied in the art and architecture from past civilizations generally convey religious and military themes. They are ceremonial artifacts reinforcing the power and authority of the elites. For the most part, the artisans that created these artifacts themselves believed,

208  The Civilization of Consumer Capitalism expressing their beliefs, stories, and myths in carvings, sculpture, and paint. As Henry Adams reflected, “Religious art is the measure of human depth and sincerity” ([1905] 1981, 4). Religion enabled human beings to cope with their mortality by asserting the immortality of the soul. The Pyramids of Ancient Egypt transported the Pharaoh and his retinue in the next life. The Parthenon in Ancient Athens served as a temple to the goddess Athena, symbolizing the wealth and power of Athens. The Pantheon in Ancient Rome was built as a pagan temple, subsequently becoming a Catholic church. The Sophia Hagia, again, erected by Constantinople to honor a Christian God, subsequently became a Muslim mosque. The great cathedrals of Chartres and Mount Ste Claire, considered the epitome of Gothic architecture, again convey religious themes. All represent ceremonial artifacts, justifying and reinforcing the class divisions of their times. Similarly for the military, the chariots of Ancient Egypt, the Trireme of Ancient Greece, the roads of ancient Rome enabling its armies to move from coast to coast, the castles of Medieval Europe, the knight’s suit of armor, the Great Wall of China, the list goes on. For Veblen, both religion and militarism represent expressions of the predatory instinct. Religion—along with customs, mores, and the law— provides a means of social control internally10; militarism provides a means of subduing others externally. As noted, all required extracting an economic surplus from the masses. Overtime, society developed increasingly efficient means of extracting the surplus. In ancient times up to relatively recent times, subjugated people became slaves, an inefficient means of extracting surplus labor.11 Moreover, slaves slept in barracks, supervised by an overseer, impeding reproduction (Weber 1988). Slaves were procured by conquest. Similarly, feudal institutions tended to inhibit the extraction of the surplus. The institution of primogeniture kept the manor intact, discouraging production (see Smith [1776] 1937, 361–362). Wage labor, using economic insecurity to motivate labor, is far more effective, enhanced by the introduction of continuous-mass production. With continuous-mass production, the paradoxical nature of capitalism reveals itself. The masses become important not merely as a source of the surplus but also as a source of demand. The accumulation of capital, resting on continuous-mass production, also rests on mass consumption, an extension of the monetary theory of production. The development of continuous-­mass production and mass consumption altered the culture, ushering in consumer capitalism. The culture shed the Protestant virtue of saving, so important to classical economics and market capitalism. Accumulation, relying on continuous-mass production, requires that the masses spend. Under capitalism, the use of the surplus to finance religion and the military broadens. The skyscrapers gracing the cities of the modern world symbolize the power of capital, the use of the surplus to make more surplus, the infinite pursuit of profit. With the introduction of continuous-mass production,

The Civilization of Consumer Capitalism  209 the increase in output led for the first time in human history the possibility that the masses might significantly increase their standard of living. Property, in the form of labor power or assets, serves as the sine qua non for accessing the goods pouring out from the world’s factories. The description of capitalism as that “whole system of appetites and values, with its deification of the life of snatching to hoard and hoarding to snatch” seemingly applies to consumer capitalism as well (Tawney 1926, 286). The rich accumulate profits in addition to stuff, the masses accumulate the stuff that the rich sell.

Keynes and Veblen on the Future None of us can see beyond the horizon of our time. All we can do is extrapolate current trends into the future. The future itself is always surprising. The storm clouds that form from wars, pandemics, climate change, technology, and other events have consequences that, in the present, remain unclear. They become clear, or at least clearer, after the storm has passed, after the dust has settled and the contours of the land have changed. Keynes’ aphorism “In the long run we are all dead” has become a hackneyed phrase. The sentence he wrote that followed, however, is trenchant. “Economists set themselves too easy, too useless a task, if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again” (Keynes quoted in Harrod 1951, 341). We should act before the storms rage. Keynes was an optimist. He believed that mass production would satiate people’s desires, causing a decline in profit rates. His view was further supported by the belief that Britain’s population would soon decline (see Keynes [1937] 1978). In time, he believed profit rates would fall to zero, ending the struggle between entrepreneurs and the rentier over the surplus, thereby euthanizing the rentier and ending depressions. “All this means in the long run that mankind is solving its economic problem” (italics in the original [1930] 1963, 364). Keynes believed that in ending scarcity, in solving the economic problem, people’s values would change, no longer obsessing over accumulating capital. We shall be able to rid ourselves of many of the pseudo-moral principles which have hag-ridden us for two hundred years, by which we have exalted some of the most distasteful of human qualities into the position of the highest virtues. Echoing Polanyi and, in turn, Aristotle, “The love of money as a p ­ ossession— as distinguished from the love of money as a means to the enjoyments and realities of life—will be recognized for what it is, a somewhat disgusting morbidity” ([1930] 1963, 369). Keynes, it seems, underestimated the power of pecuniary emulation to thwart declines in the rate of profit. He underestimated the power of corporations. Competitive spending and pecuniary emulation, fostered by corporations in pursuit of profits, suggest the impossibility of satiating human desires.

210  The Civilization of Consumer Capitalism Veblen was less sanguine about the future and more critical of capitalism. Writing in the years before World War I, Veblen saw the efforts of the business community to overcome the tendency toward producing more than the economy could absorb. He recognized the tendency toward imperialism, commenting in The Theory of Business Enterprise that “Business interests urge an aggressive national policy and business men direct it. Such a policy is warlike as well as patriotic” ([1904] 1975, 391). In Engineers and the Price System ([1921] 1965), Veblen dismissed the prospect of revolution, noting the power of the vested interests, those who “get something for nothing.” Returning to a theme he introduced in The Theory of Business Enterprise, Veblen noted the increased interdependency of various parts of the economic system, making it increasingly subject to disruption. He noted, too, the system managed by engineers, whose interests more closely align with that of the community. In Veblen’s view, “Twentieth-century technology has outgrown the eighteenth-century system of vested rights. The experience of the past few years teaches that the usual management of industry by business methods has become highly inefficient and wasteful” ([1921] 1965, 100). Veblen, of course, was referring to the market economy with minimum intervention by government. At present, government intervention appears to have solved the problem of depression, largely along Keynesian lines. As the progeny of Keynes’ and Minsky’s ideas, modern monetary theory holds the promise of overcoming the limits of the market economy.

Conclusion Three broad paradoxes remain. First, continuous-mass production continues to provide goods for the masses who own property, not for those lacking property. As Veblen noted, “The wasteful expenditure of goods and services enjoyed by the pecuniary canons of conspicuous consumption gives an economically untoward direction to industry, at the same time that it greatly increases the hardships and curtails the amenities of life” ([1914] 1964, 175). The challenge lies in providing goods and services to those lacking property. The required goods and services are those that promote the life process. Promoting the life process involves removing obstacles to individual freedom by providing people education, health care, clean water, food security, and so on (see Sen 1999). Second, we remain shackled by nationalist myths giving rise to dynastic ambitions. Such ambitions manifest themselves in war or preparing for war, further wasting resources, further denying the masses goods that contribute to the life process. And third, humankind now confronts the Darwinian dilemma, the paradox posed by besting other species while warming the planet, possibly making the planet uninhabitable, at least for humans. Resolving the paradoxes requires, in part, a change in culture, a change in the belief that wants are infinite. The insatiability of wants stems not from human nature, but from the capitalist culture. Pecuniary exigencies imposed by climate change, wars, and inequality may yet

The Civilization of Consumer Capitalism  211 precipitate a change in values. One can only hope that humankind can find the wisdom to change before the storms rage, once again.

Notes 1 Mainstream economists respond that individuals maximize utility. Utility maximization, however, assumes that utility functions are independent, required for the doctrine of consumer sovereignty. The assumption, however, renders emulation, status, saving face, culture, and history irrelevant. 2 Veblen continues: “The diligence so fostered by emulative self-interest is directed to the acquisition of property, in great part to the acquisition of more than is possessed by those others with whom the invidious comparison in ownership is made” ([1914] 1964, 172–173). 3 For Veblen, “Technological knowledge is of the nature of a common stock, held and carried forward collectively by the community” (Veblen[1914] 1964, 103). 4 Sahlins’ and Gowdy’s views conflict with Edward O. Wilson’s: “For millions of years human beings simply went at nature with everything they had, scrounging food and fighting off predators across a known world of a few square miles. Life was short, fate terrifying, and reproduction an urgent priority” (1984). 5 “The first revolution that transformed human economy gave man control over his own food supply. Man began to plant, cultivate, and improve by selection edible grasses, roots, and trees. And he succeeded in taming and firmly attaching to his person certain species of animal in return for the fodder he was able to offer, the protection he could afford, and forethought he could exercise” (Childe 1951, 59). With the neolithic revolution, children become economically useful. They could be used in agriculture to pull weeds, harvest the bounty, etc. With nomadic peoples, children hindered mobility (Childe 1951, 61). 6 Presumably, pecuniary control refers to appropriating the surplus away from producing serviceable goods. 7 For Plato to write The Republic, among his other works, slaves had to generate sufficient food to feed themselves and more, freeing Plato, Socrates, and Aristotle to engage in philosophic pursuits. Given that they viewed slavery as natural, they never recognized the importance of the surplus or the labor required to create it. 8 For a comparison of the similarities between Smith’s and Veblen’s view of human nature see Jon Wisman (2019). 9 Conversely, technological advances may render a necessity at one time may a luxury at another time. In nineteenth-century America, horses were necessary as a means of transportation; today, a horse is an expensive luxury. 10 For the use of religion, custom, mores, and the legal system as means of social control during the era of classical economics, see Samuels (1964). 11 “For not only was slave capital insecure and subject to unpredictable risks, there was also the fact that the slaves used in large enterprise naturally had no interest in any technical advance or in any increase in the quantity or quality of production. The moral qualities which render slaves amenable to exploitation are precisely those which make them most inefficient as workers in a large enterprise” (Weber 1988, 55).

References Adams, Henry. (1905) 1981. Mont-Saint-Michel and Chartres. Princeton, NJ: Princeton University Press.

212  The Civilization of Consumer Capitalism Childe, V. Gordon. 1951. Man Makes Himself. London: New American Library. Gordon, Robert J. 2016. The Rise and Fall of American Growth: The U.S. Standard of Living since the Civil War. The Princeton Economic History of the Western World. Princeton: Princeton University Press. Gowdy, John M. 1998. Limited Wants, Unlimited Means: A Reader on Hunter-­ Gatherer Economics and the Environment. Washington, DC: Island Press. Harrod, R. F. 1951. The Life of John Maynard Keynes. New York: W.W. Norton & Co. Keynes, John Maynard. (1937) 1978. “Some Economic Consequences of a Declining Population.” Population and Development Review 4 (3): 517–523. http://www.jstor. org/stable/1972863. ———. (1930) 1963. “Economic Possibilities for Our Grandchildren.” In Essays in Persuasion, 358–373. New York: W.W. Norton and Company. Sahlins, Marshall. 1972. Stone Age Economics. New York: Aldine-Atherton. Samuels, Warren. 1964. “The Classical Theory of Economic Policy: Non-Legal Social Control.” Southern Economic Journal 31: 1–19. Schumpeter, Joseph Alois. (1942) 1976. Capitalism, Socialism, and Democracy. New York: Harper & Row. Sen, Amartya. 1999. Development as Freedom. 1st ed. New York: Knopf. Smith, Adam. (1776) 1937. An Inquiry into the Nature and Causes of the Wealth of Nations, edited by Edwin Cannan. New York: The Modern Library. Tawney, R. H. 1926. Religion and the Rise of Capitalism. Gloucester, MA: Peter Smith. Veblen, Thorstein. (1914) 1964. The Instinct of Workmanship, and the State of the Industrial Arts. New York: Augustus M. Kelley. ———. (1921) 1965. The Engineers and the Price System. New York: Augustus M. Kelley. ———. (1904) 1975. The Theory of Business Enterprise. New York: Augustus M. Kelley. ———. (1899) 1979. The Theory of the Leisure Class: An Economic Study of Institutions. New York: Penguin Books. Weber, Max. 1988. The Agrarian Sociology of Ancient Civilizations. London: Verso. Wilson, Edward O. 1984. Biophilia. Cambridge, MA: Harvard University Press. Wisman, Jon D. 2019. “Adam Smith and Thorstein Veblen on the Pursuit of Status through Consumption Versus Work.” Cambridge Journal of Economics 43 (1): 17–36.

Index

Note: Bold page numbers refer to tables; italic page numbers refer to figures and page numbers followed by “n” denote endnotes. absolute-income hypothesis 12, 101–103 accumulation of capital 1, 29, 50, 81, 113, 116, 208 AD see aggregate demand (AD) Adams, Henry 208, 211 Adams, Walter and James Brock 134, 135 advertising 4, 6, 14, 33, 36, 39, 44, 46, 47, 51, 58, 73n1, 90, 98, 106, 115, 120, 127, 134n7, 204; mainstream view of 100–105; modern, origins of 48–50, 49; and monetary theory of production 50–51; rational 1; role of 107–109; systematic 1, 14; Veblen on 99 Advertising and Selling 108 aggregate demand (AD) 87, 92–93, 96n9, 122, 166, 169, 170 AIG see American International Group (AIG) Alchian, A. 26 American International Group (AIG) 164, 175–176 Argentina 144 asset-backed securities 130, 156 asset-pricing model 158–160 assumed transmission mechanism, quantitative easing and 175–178 Ausubel, L. 127 automobiles 2, 3, 6, 45–46, 51, 58, 88, 98, 113, 119–121, 133, 191, 207 Ayres, C. 18, 19, 80 balance sheet cash flows 161, 161 Ball, L. 171n4

Bank of America National Trust and Savings Association 126 The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 155 barbarism 61, 62, 207 Baudrillard, J. 81 Bear Stearns 163–164, 175 Becker, G. 107 The Beef Trust 44–45 Bell, D. 119 Bentham, J. 67 Berger, J. 108 Bernanke, B. 13, 122, 139, 166, 177, 180, 181 Blanchard, O. 166, 170 Boulding, K. xvii, 201 brand name 52n4 Brazil 144 Bretton Woods Agreement 155 Bretton Woods System 143, 144, 181 Britain see England Brown, C. 134n5 Buchanan, N. 128 Buffet, W. 164 Burns, A. 122 business enterprise, evolution of 27–30 Caballero, R. 166–167 Calder, L. 115, 133 Campbell’s Soup 43 canning 45, 47, 51, 98 capital 11, 20, 22, 28, 36, 71, 88, 94–95, 96n6, 96n10, 108, 113, 119, 131, 138, 140, 146, 151, 167, 176, 177–179, 182, 193, 194; accumulation of 1, 29, 50,

214 Index 81, 113, 116, 133, 208; British 72; circuit of 50; consumer (see consumer capitalism); finance 50, 52n6; Hobson on 63–65; industrial 50, 52n6; Keynes on 34, 82, 86, 87, 89–90, 109, 159, 163; market 28, 30, 104, 131, 167; Minsky on 109–110, 155, 159, 171; natural 201, 202n6; retail or merchant 50, 52n6, 115; Veblen on 30, 32–33 capitalism 79, 142, 190; definition of 68; market 208 carbon footprint 197 cash flows: taxonomy of 161; types of 161–164 cell symbiosis theory 198 central bank 71, 114, 139, 166, 169–170, 171, 178, 183, 184, 185, 188 chain stores 14, 43, 46–47, 51 Chamberlin, E. 100, 110n1 Chandler, A. D. 2, 3, 15n3, 40–47, 52n3 Chang, H.-J. 142 Chase Manhattan 126 China 151; current-account surplus 148; export growth 145–146, 145; exports to the US 138, 139, 145; financial deregulation 133; problem 148; protectionism 149 Churchill, W. 89 circuit for the worker 52n5 circuit of capital 50 civilization: of consumer capitalism 204–211; origin of 205–209 Civil War 11, 42, 44, 45 Clark, J. M. 122 Clean Water Act 201n3 climate change 182, 190, 193, 195, 209, 210; and entropy law 200–201; mitigation 183, 195 Cobb–Douglass production function 168 colonialism 65 commodification 2, 192 Commons, J. R. 1, 19, 31–32, 182, 183, 188n2 comparative advantage, theory of 140–142, 149, 150 competitive spending 6, 23, 204, 205, 209 conspicuous leisure 34, 55, 56, 119 conspicuous waste 34–36, 37n5, 119; England versus Germany 59–62, 60, 61; system of 57–59; theory of 55–62 consumer capitalism 47; basis of 73; civilization of 204–211; evolutionary theory of 18–37; mainstream story of 11; origins of 1–16; paradoxes of 1–16

consumer credit 4, 6, 58, 88, 204; creation of 73n1; cultural biases against, overcoming 114; deregulation of 114; development, preempting state laws and 126–131; evolution of 14–15, 73n1, 113–135, 155, 156; global spread of 131–133; growth of 122, 123; importance of 122–123 consumer culture 4–7, 12, 47 consumer debt 6, 12, 102, 104, 106, 128, 148, 154, 155, 156, 205 consumerism 55–74, 115, 116 consumption: classical view of 8–9; function 10, 26, 27, 84–86; Galbraith’s view of 105–107; institutional pattern of 14, 98, 101, 103, 106; underconsumption 33, 62–65, 87 continuous-mass production 1–4, 6, 10–15, 18, 20, 23, 24, 28, 36, 37, 39–52, 55, 62, 65, 70, 71, 73, 81, 98, 99, 117–119, 138, 141, 142, 154, 168, 175, 181, 190, 194, 196, 200, 201, 204, 205, 208, 210; automobiles 45–46; The Beef Trust 44–45; canning 45; chain stores 46–47; department stores 47–48; tobacco 44 Coolidge, C. 78, 120 Coronavirus Aid, Relief, and Economic Security Act (CARES Act) 185 Covid-19, policy response to 183–186 Covid-19-induced recession 2, 7, 13, 175, 181, 184, 188 credit, advantages of 114–116 credit card 6, 114, 124–133; debt 127, 128, 184; universal 124–126 creditor–debtor relationship 161 credit worthiness 128, 133 cronyism 134 culture 47; consumer 4–7 cumulative causation 4–7, 18, 60; in the ideas of Veblen and Keynes 22–23 currency 139, 183 current-account deficit 138–140; meaning of 146–150; Washington Consensus and 144–145 Cypher, J. 141 Daly, H. 193 Darwinian dilemma 15, 190–202, 210; nature, as commodity 191–194; resource extraction 194–196; sixth great extinction 196–197, 197; symbiosis 197–200 Davidson, P. 165

Index  215 Dawkins, R. 7 debt-deflation depression 162, 164, 178, 183 democracy 22, 73 democratization of goods 50, 58 department stores 47–48 depression 1, 3, 6, 11–14, 18–20, 22–23, 35, 36, 39, 41, 42, 47, 62, 64–65, 73, 77–91, 119, 122, 175, 204, 209, 210; causes of 6, 22, 33; chronic 119; debtdeflation 162, 164, 178, 183; financial crises and 164–165; Great Depression 12, 14, 18, 19, 23, 37, 48, 77–91, 122, 135n14, 143, 160, 162, 175; Temin hypothesis 87–89; vanishing 86–87 De Vries, J. 15n6 Dietz, J. 140, 141 Dillard, D. 50–51, 119 diminishing marginal utility 26–27 Diner’s Club 125 division of labor 2, 6 Dobb, M. 90 Donnell, E. V. 115 DSGE see dynamic stochastic general equilibrium (DSGE) model Duesenberry, J. 103, 111n4; relativeincome hypothesis 101–102 Duke, J. 44 durable goods revolution 113, 119–124, 133 dynamic stochastic general equilibrium (DSGE) model 13, 15, 157–158, 166–171, 167, 169 economic insecurity: for labor motivation, using 6, 67–69 economic rationality 13, 21, 26, 27, 68, 100, 103; Veblen’s and Keynes’ critiques of 9–10 economic surplus 205–209 economies of scale 2, 3, 28, 35, 40, 46, 51, 52n3, 52n7, 99, 124, 141, 149, 168 economies of scope 2, 40, 52n3, 99, 168 economies of speed 52n3 effective demand 35–37, 65, 77, 85, 89–90, 93, 179; failure of 86; income inequality and 115; role of 33; theory of 6, 12, 18, 19, 26, 34, 35, 50–51, 83–84, 83, 96n4 Eisenhower, D. 122, 124 employment 96n9, 176; full 19, 37n2, 77, 79, 80, 83–84, 86, 90, 91, 96n6, 111, 141, 150, 166, 168, 175, 181, 182, 187; see also unemployment

emulation 12, 18, 23, 25, 26, 37n3, 56, 59, 99, 102, 115, 165, 207, 211n1, 211n2; pecuniary 6, 14, 18, 20, 24, 209 England 14, 19, 20, 42, 73, 81, 149, 190, 194; aging capitalism 20; Bank of 89; conspicuous waste 55, 59–62, 60; consumer capitalism 12, 205; consumer society 5; credit cards 114, 124, 125; decline in home production 5; depression 86–87; evolutionary theory of consumption 24; financial deregulation 131; foreign investment 72; free trade 142, 151; growth of 194; laissez-faire policies 142; market economy, breakdown of 65, 66; military expenditures 61; modern corporation, rise of 42; nationalism 140–141; protectionism 149; stationary state 82 entropy law, climate change and 200–201 equilibrium approaches 20, 157 equity loans 128–130, 129, 130 Europe: 109, 114, 124, 143, 146, 148; export 146; sugar in 24, world’s banker 70–72 European Central Bank 188 Europeans 191, 196, 208; households 151 evolutionary theory of consumer capitalism 14, 18–37 exploit 42, 81, 207 export growth 145–146, 145 Exxon Valdez oil spill 202n5 Fascism 73 federal funds rate 184, 188n4 Federal Reserve 77, 88, 121–122, 123, 124, 125, 128, 130, 138, 139, 147, 149, 156, 160, 162, 164, 166, 175–177, 179, 180, 181, 183, 184, 186, 188n4; Open Market Committee 178 Federal Reserve Bank of Chicago: 43rd Annual Conference on Bank Structure and Competition 166 Feis, H.: Europe, The World’s Banker, 1870–1914 71, 72 Feldstein, M. 98, 116, 133, 134n6 Filene, E. A. 47 Filmer, R. 29 finance capital 50, 52n6 financial deregulation 131–133 financial instability hypothesis 15, 33, 154, 157–158, 160–161 financialization 1, 2; of the consumer 154–157, 156, 205; definition of 154

216 Index first industrial revolution 41 fiscal policy 166, 178–179, 179, 182, 183, 185 Ford 6, 121, 133 Ford, H. 2–3, 6, 45, 47, 58, 121 France: foreign investment 72; second industrial revolution 40 Franklin Bank 125 free trade 55, 71, 77, 140, 144, 149; critique of 141–143 Friedman, M. 102–103, 104, 167, 176; irrelevance of relevant assumptions doctrine 7, 171 frontier economy 201 Fullwiler, S. 170, 186 functional finance vs. quantitative easing 186–187, 186, 187 functionless investor 80, 86 Galbraith, J. K. 109; The Affluent Society 105; view of consumption 105–107 General Electric 122, 164 General Motors (GM) 6, 46, 120, 133 George, H. 95n3 Georgescu-Roegen, N. 200 Germany: 14, 72; conspicuous waste 59–62, 60; consumer capitalism 12; credit cards 124; financial deregulation 132–133; militarism 55; military expenditures 61, 72 Gesell, S. 33 GFC see Great Financial Crisis (GFC) gift economy 74n3 Ginnie Mae 131 Glass-Steagall Act 13 GM see General Motors (GM) GNP see gross national product (GNP) Godley, W. 182 Goldman Sachs 164 Goodhart, C. A. E. 167 Gordon, R. 88, 204; The Rise and Fall of American Growth 11 Gorton, G. 163 Gowdy, J. 206, 211n3 Graaff, J. de V. 151n3 Gramm, W. 51, 114–115 Great Atlantic and Pacific Tea Company (A&P) 46–47 Great Depression 12, 14, 18, 19, 23, 37, 48, 77–91, 122, 135n14, 143, 160, 162, 175 Great Financial Crisis (GFC) 2, 7, 13, 15, 114, 145, 154–172, 175; criticisms of applying Minsky’s hypothesis to 165

Great Recession 156, 180 Greenspan, A. 13 Griffith, W. 141 gross domestic product (GDP) 49, 49, 60, 60, 130, 139, 139, 140, 145–148, 145, 147, 148, 149, 151n3, 155, 156, 156, 164, 178, 179, 182, 192–194, 201n4, 202n5 Gross Domestic Purchase (GDP) 147, 148 gross national product (GNP) 182 Haberler, G. 103, 122 Hallam, A. 202n8 Hamilton, D. 110, 134 Hansen, A. 84, 87, 90 Harberler, G. 121 Hardin, G. 194–195 Harding, W. 78 haute finance 12, 71–73 Hawaii 150 Hawkins, N. 121 Hayek, F.: critique of scientism 167 Heckscher–Ohlin model (H–O model) 141, 150, 151n3 hedge financing 162 hedonic-price hypothesis 13 Henry, J. 157–158 Hobson, J. A. 12, 14, 19, 33, 55, 73, 115, 146, 147; on depression 64–65; on underconsumption 62–65 Hong Kong 134 Hoover, H. 78, 79, 81 IMF see International Monetary Fund (IMF) imitation 25, 26, 62 imperialism 12, 14, 39, 55, 62, 64, 65, 71, 73, 210 income cash flows 161, 161 income inequality 19, 51, 63–65, 109, 128; and effective demand 115 industrial capital 50, 52n6 Industrial Commission of 1900 28, 39, 43 inequality 12, 13, 20, 27, 35, 51, 84, 86, 106, 133, 147, 210; income 19, 63–65, 109, 115, 128; and quantitative easing, relationship between 178–181, 179, 179, 180; wage 154; wealth 82, 89, 180 installment credit 4, 14, 104, 116, 119–124, 123, 135n8, 147 institutional pattern of consumption 14, 98, 101, 103, 106 intangible property 4, 30–33

Index  217 interest income 92, 159, 163 International Monetary Fund (IMF) 143–145, 150; World Economic Outlook 148, 151n2 invidious 23–24, 34, 55, 59, 207, 211n2 invisible hand 9, 28, 29, 30, 78, 79, 172n7, 191, 201 irrelevance of relevant assumptions 7, 171 Italy 150, 188n1; financial deregulation 131 Japan 150; Bank of Japan 139, 176; consumer capitalism 12; credit cards 124; current-account surplus 148; export growth 145–146, 145, 148; exports to the US 139, 149; financial deregulation 132; militarism 55; Ministry of Finance 132 Jevons, S. 82, 194, 202n7 Jevons, S.H.: second industrial revolution 15n1, 41 J.P. Morgan 31, 164, 175 Kaldor, N. 94; “Alternative Theories of Income Distribution” 92 Kaldor–Hicks compensation test 141 Kalecki, M. 94 Kellogg’s 43; advertising 49 Kelton, S. 182; 187, 188; The Deficit Myth 181 Keynes, J. M. 1, 6–7, 12, 14, 18–37, 64, 72, 73, 115, 118, 119, 143, 146–148, 183, 204; absolute-income hypothesis 12, 101; “army of heretics” 33–34; asset-pricing model 158; on classical school 37n2; on conspicuous waste 35–36; consumption function in The General Theory 84–86; critiques of economic rationality 9–10; on cumulative causation 22–23; on depression 86–87; “Economic Possibilities for Our Grandchildren” 27; on economic sabotage 89–90; on effective demand 35–36, 89–90; on euthanasia of rentier 89–90; on the future 209–210; The General Theory 10, 18, 20–21, 23, 26, 27, 30, 37, 77, 80, 83–86, 89, 91, 109, 158, 159; “The General Theory of Employment” 21; on Great Depression 77–91; on Modern Monetary Theory 181; on monetary theory of production 36, 50–51, 146; on protectionism 149–150; Pigou effect as a critique of Keynes’

theory 111n3; psychological law 101; social provisioning, problem of 9, 18–33; on tangible and intangible property 30–33; theory of effective demand 50–51, 83–84, 83, 96n4; on vanishing investment opportunities 86–87; and Veblen, similarities in thought of 20–22; view of consumption 26–27; on waste 34–35 Keynes, J. N. 19 Knoedler, J. 52n3 Kregel, J. 165 Kropotkin, Prince: Mutual Aid 197–198 Krugman, P. 170 Kubik, P. 88, 121 Kuznets, S. 101 Ladies’ Home Journal 49, 50, 78 laissez-faire economy 70 Lancaster, K.: new theory of consumption 101, 104–105 Lane, B. 150 Larson, G. 109 Latin America 144–145, 150 Lawson, T. 158 Lehman Brothers 163, 176 Levitt, K. P. 72 liquefication 14, 113–135, 183 liquidity 104, 113–116, 131–133, 143, 146, 147, 151, 155, 159, 160, 175–178, 183, 185 List, F. 142 Locke, J. 28, 29, 191 Lucas, R. 131, 132, 170 Luther, M. 29 MacArthur, D. 79 machine process 18, 23, 28, 29, 35 Malthus, T. R. 33, 67–68; theory of population 9, 194 Mandeville, B. 33 Marchionatti, R. 170 Margulis, L. 197–199 market economies, institutional basis of 182–183, 188 market economy 2, 5, 12, 13, 55, 74n3, 106, 113, 122, 146, 158, 181, 197, 204, 210; breakdown of 65–73; overcoming the limits of 2, 15 market imperfections 131, 133 Marshall, A. 19, 37n1 Marx, K. 50, 95n1; Capital 79; phraseology 66 mass extinctions 202n8 Master Cards 128

218 Index Mayhew, A. 4, 52n3 Meadows, D. H.: Limits to Growth 194 Mellon, A. 78–79 metaphors 7, 8, 16n8 militarism 1, 32, 55–74, 205, 208 Mill, J. S. 8, 37n2, 80, 82, 194 Minsky, H. 7, 85, 90, 95, 109–110, 155, 165, 168, 171, 171, 171n3, 172n7, 177–178, 182, 210; asset-pricing model 158–160; on cash flows 161–164; financial instability hypothesis 15, 33, 154, 157–158, 160–161; John Maynard Keynes 160 Mintz, S. 24, 58 Mirowski, P. 16n8 Mitchell, W.: “The Backward Art of Spending Money” 25 MMT see Modern Monetary Theory (MMT) modern corporation, rise of 3, 20, 42–43 Modern Monetary Theory (MMT) 2, 13, 15, 175, 181–182, 210; implementation of 183–186 monetary policy 89, 144, 168, 171n4, 176, 178–179, 179 monetary theory of production 36, 146, 177, 208; advertising and 50–51 Morgan, J. P. 31 mortgage-backed securities 163, 188 Mosler, W. 185, 188n1 Muth, J. 168 mutualism 197 Myrdal, G. 141 NAIRU (natural rate of unemployment) 166 National Bank Act of 1863 (NBA) 126–127 nature, as commodity 191–194 NBA see National Bank Act of 1863 (NBA) neo-Darwinian synthesis 198 Neolithic Revolution 207 Nixon, R. 144, 181 North, D. 10 OECD 132 Office of the Comptroller of the Currency (OCC) 126, 127 Olney, M. 88–89, 114, 115, 116, 119, 120, 121, 135n9 Palley, T. 154, 166, 168 Papadimitriou, D. 165

paradoxes of consumer capitalism 1–16 paradox of thrift 85–86 Paycheck-Protection Program 185 pecuniary emulation 6, 14, 18, 20, 24, 209 permanent-income life-cycle hypothesis 13, 101–104 Pigou, A. C. 37n2, 100, 101, 103, 110–111n3 Pigou effect (real balance effect) 110n3, 169 Piketty, T.: Capital in the Twenty-First Century 178 Plato: The Republic 211n7 Polanyi, K. 12, 14, 22, 50, 55, 74n3, 74n5, 142, 209; on breakdown of market economy 65–73; double movement 70–73; on economic insecurity 67–69 Ponzi finance 162, 165 portfolio cash flows 161–162, 161 Portugal, protectionism 149 poverty 1, 12, 19, 69, 77, 78, 108, 109, 143, 188 Powell, J. 184, 185 Power, defined 134n1 Prasch, R. 141–142 price equilibrium theory 80 private-domestic economy, overcoming limits of 175–188 private property 28, 29, 73 protectionism 149–150 Protestant ethic 81; dismantling 116–119 Protestantism 113 quantitative easing (QE) 13, 15, 169, 175–180; and assumed transmission mechanism 175–178; vs. functional finance 186–187, 186, 187; and inequality, relationship between 178–181, 179, 179 Rainwater, L. 108 rationality 123; economic 9, 13, 21, 26, 27, 68, 100, 103, 172n7 RBC see real business cycle (RBC) theory Reagan, R. 144 real business cycle (RBC) theory 167 reciprocity 67, 74n3, 74n7 Redmond, W. 110 Reed, P. 122–123 Reich, R. 141 relative-income hypothesis 13, 101–103

Index  219 rentier 14, 22, 72, 80–82, 85, 86, 91, 209; euthanasia of 89–90, 109, 110, 159; in precipitating crises, role of 92–95, 96n7, 96n8 resource extraction 190, 194–196 retail or merchant capital 50, 52n6 Ricardo, D. 8, 37n2, 82, 95n3, 96n10, 140–142, 149, 166, 193, 194 risk management 127–128 Robinson, J. 20–21, 90, 95n3, 100 Romer, P. 168, 172n6; theory of endogenous growth 16n11 Rossi, U. 154 Rostow, W. W. 81 Russia: foreign investment 72; Sputnik 106 sabotage 28, 31, 33, 36, 39, 51n1, 89, 119 Sahlins, M. 110, 211n3; view of huntergatherer societies 205–206 salesmanship 24, 51, 58, 99, 106 Salt Lake Tribune 134n7 Samuels, W. 211n10 Saudi Arabia 150 savagery 207 saving 96n6, 101–102; Protestant virtue of 208; rates or rates 13, 14, 98, 104, 121, 131, 140, 184; rate of saving 57 Sayers, R. S. 122 Say’s law 9, 80, 83, 95n1, 118 Schneider, G. 142 Schudson, M. 111n6 Schumpeter, J. 7, 85–86, 204 Sears 120 second industrial revolution 2, 14, 15n1, 39–41 securitization 130–131, 133, 162 self-sufficiency 5, 61, 67, 149 Sella, L. 170 Shackle, G.L.S. 21–22 shadow-banking system 162, 163 Sherman Antitrust Act 3, 46 Simard, S. 199–200 Singapore: financial deregulation 132 Singer 120, 135n8 Sisyphus 110 sixth great extinction 196–197, 197 60-Minutes 181 slavery 31, 67, 68, 211n7 Sloan, A. 121 Smith, A. 15n2, 28, 36, 52n7, 68, 69, 74n5, 74n9, 81, 82, 118, 140, 211n8; Inquiry into the Nature and Causes of the Wealth of Nations, An 8–9;

invisible hand doctrine 78, 79, 172n7; labor-commanded theory of value 191; The Wealth of Nations 2 Smoot-Haley Tariff bill 78 socialism 73 social provisioning 9, 34, 68, 69, 74n3, 89; problem of 18–33, 35, 84 Solow, R. 16n10; growth model 11, 167, 193 South Improvement Corporation (Standard Oil) 3 South Korea 150 sovereign government 181, 183, 185, 188n1 sovereignty 29, 102, 123, 211n1 special purpose vehicle (SPV) 135n13 speculative finance 162 SPV see special purpose vehicle (SPV) standard of living 6, 23, 24, 25, 34, 37n5, 52n5, 57–59, 60, 63, 86, 117, 122, 205 Stanfield, J. B. 37n4, 110 Stanfield, J. R. 37n4, 110 Steinbeck, J.: Grapes of Wrath 79 Stiglitz, J. 144 story, as informal test 7–8, 157 Structural Adjustment and Economic Performance 135n14 sugar 24, 58 Susman, P. 142 Sweden: economic growth, rate of 142 Swift, G. 44 symbiosis 197–200 tangible asset 103, 130 tangible property 30–33 tariffs 71, 78, 99 Tawney, R. H. 74n8, 209 Tax Reform Act of 1986 128 Temin, P.: 12, 14, 143; hypothesis 87–89 Thatcher, M. 144 thrift: 1, 71, 88, 113, 120; decline of 116–119, 118; paradox of 85–86 tobacco 24, 43, 44, 58 Tobin, J. 104, 176; critique of Minsky’s Stabilizing and Unstable Economy 158 Townsend, R. 67, 74n5 trade deficit 13, 15, 132, 148, 151; perpetual 138–152 transportation expenditure 135n9 Trump, D. 148, 151; administration 151, 184 underconsumption 33, 62–65, 87 unemployment 7, 11, 12, 13, 21, 41, 77, 84, 86, 87, 123, 175, 177, 181, 184;

220 Index natural rate of 166, 168; see also employment United States (US) 5, 72, 77, 78, 109, 124, 190, 200; conspicuous waste 60, 60; consumer capitalism 11, 12, 205; continuous-mass production 12, 98, 205; credit cards 114, 124; current-account deficit 144–148, 147; decline in home production 5; depression 86, 87; evolutionary theory of consumption 24; export 139, 145; financial deregulation 131, 132; free trade, policy of 142–143; GDP 192; installment credit 117; Marshall plan 143; military expenditures 61; modern corporation, rise of 42; perpetual trade deficit 13, 15, 138–152, 139; second industrial revolution 40, 45; trade balance 149; Treasury 144, 165, 176, 183–188, 187; Treasury Bonds 175; war in Iraq 151n1 universal credit card 6, 14, 103, 114, 124–126, 133 US see United States (US) US Constitution: 13th amendment 31; 14th amendment 31 utilitarianism 67 utility maximization 101, 141, 211n1 vanishing investment opportunities 86–87, 90 Veblen, T. 1, 3, 6, 9, 12, 16n7, 18–37, 55, 73, 78, 91, 101, 110n1; 111n5, 115, 118–119, 191, 201n1, 205, 211n8; on advertising 99, 100; on conspicuous waste 35–36; on consumer capitalism 7, 206–208; critiques of economic rationality 9–10; on cumulative causation 22–23; on effective demand 35–36; evolutionary theory of consumption 14, 23–36, 211n2; on the future 209–210; Imperial Germany and the Industrial Revolution 59–60; and Keynes, similarities in thought of 6, 20–22, 80, 115; on monetary theory of production 36, 51; on the origin of civilization and the economic surplus

205–208; on sabotage 39, 51n1, 118–119; social provisioning, problem of 18–33; on tangible and intangible property 30–33; on technological knowledge 211n3; The Theory of Absentee Ownership 99; The Theory of Business Enterprise 23, 27–28, 57, 210; and theory of conspicuous waste 55–62; The Theory of the Leisure Class 18, 57; view of cause of depression 33, 119; on waste 34–35, 74n1, 204 VISA 115, 128, 134n3 Wachovia 164 wage inequality 154 Walras law 169 Washington Consensus 144–145, 150 waste 34–35, 74n1; conspicuous 34–36, 37n5, 55–62, 71, 73n1, 119; nature’s ability to absorb waste 191, 195, 199, 200, 202 wealth 4, 9, 23, 24, 42, 56, 81, 84, 89, 101, 103, 115, 133, 139, 151, 176, 206, 208; accumulation of 80, 82, 86; distribution of 82, 85, 95, 180, 180, 181, 190; inequality 82, 89, 180; material 113; nonhuman 104; personal 98; production of 5 Weber, M. 68, 74n6, 74n7, 81, 113, 133, 208, 211n11 Wells Fargo 164 Whitehead, A. N. 8 Whitney, E. 40 Wignell, P. 202n8 Wilson, E. O. 211n4 Wilson, T. 87–88 Wisman, J. 211n8 Woolcock, M. 74n3 World Bank 144, 150 World Trade Organization 133, 142 World War I 12, 14, 20, 23, 45, 46, 59, 72, 79, 80, 88, 90, 143, 210 World War II 12, 80, 91, 100, 102, 103, 109, 122, 124, 128, 132, 138, 142, 143, 157, 160, 162, 175, 192, 201 Wray, R. 16n7, 33, 36, 114, 165, 170, 186 Wynne-Edwards, V. C. 199