The Investor's Dilemma

The whole point of Distributism is to restore distributive justice to the economy. It does this by ensuring that most men and women have access to property, the means of production. Without this, they cannot properly bargain for wages, and the wage contract becomes leonine, that is, based on inequality. The employer can hold out much longer or (in today's economy) outsource the work to subsistence laborers in other countries. The worker is therefore forced to accept whatever terms are offered, and distributive justice is violated. However, this causes a great imbalance in the economy, a disproportion between supply and demand.

It would seem that in a leonine labor market the capitalist will gain all that the worker loses. And certainly in the short term this must be true. The investor thinks himself happy to increase his profit by lowering his labor expense. And for any given investor, this is true. But if it is the general condition of the economy, a severe problem arises. For as Chesterton pointed out, you cannot lower the amount that your employee makes without also lowering the amount that your customer can spend; they are the same person. If one manufacturer out-sources his labor to a subsistence country, he will gain a great advantage over his competitors. But if everyone does it, not only will he lose his advantage, he will lose his customers. Economics is much like accounting: it is purely a question of balance. This problem is at the root of the investor’s dilemma.

When the worker gets less than his productivity demands, capital concentrates at the top. But while wealth is concentrating, the market is narrowing, for the market depends on a broad base of consumers; a narrow base simply cannot spend fast enough and purchasing power is lost to the economy. The result is an increasing concentration of capital and a less-stable market. Capital thus has a more difficult time finding decent returns, because more capital is chasing fewer investments in a narrow market, and returns fall. This leads to several consequences. The first is that consumption must be subsidized by consumer credit if the markets are not to fail entirely. However, consumer credit leads to further concentrations of wealth, thus exacerbating the problem. Further, such credit mortgages the future: you can increase consumption by a borrowed dollar today only by decreasing it by that same dollar, plus interest, tomorrow. Which leads to a further need for consumer borrowing, a greater concentration of wealth, etc. A vicious cycle is set up that must fall of its own weight.

The second effect of wealth concentration follows the first: risk premiums become flattened or disappear entirely. The search for returns in a narrowing market exploits every possible market niche in ever-more sophisticated and incomprehensible ways. More and more loans are made to weaker and weaker borrowers at lower and lower rates. Wider and wider segments of the economy are caught up in increasingly risky loans, and are caught up without being aware of it. But while risk premiums may disappear, risk itself does not. It may hide, but it will surface, given enough time. And when it does, investments that seemed sound turn sour. And when large numbers of loans turn sour at the same time, banks, hedge funds, pensions, mutual funds, and ordinary investors discover risks in their portfolios that they did not know they had; they did not know they had these risks because the risks were not properly priced. At the same time, failed loans cause a drop in the underlying asset values; asset values change, but debt remains. Risk is replaced with uncertainty. There is a crucial difference between the two: risk can be priced, uncertainty cannot. Risk is looking at a package of 1,000 loans and being able to say, with some degree of confidence, "5% of these loans are likely to fail." Uncertainty means looking at the same package and saying, "I have no idea how many are likely to fail."

The investor’s dilemma is simply that he got what he wanted and found he didn’t want it at all. He wanted more than that to which he was entitled in order to increase his financial security, and found that he destroyed the security of the whole economy. But getting more is no good if it merely means someone else gets less. The balance is destroyed and an unbalanced economy is headed for a fall. Only by a proper sharing, a sharing in accord with distributive justice, can economies maintain their balance.

Today, this scenario is being played out, as it has often been played out in the past. The government is likely to attempt a bail-out of the market. This will end up rewarding the people who made the bad loans and the bad investments and punish everybody else. It will restore, for a moment, the confidence of the markets, but at the cost of inflation, that is, at the cost of taking a little from everybody and giving it to a few. Further, it will likely end up multiplying uncertainty, not reducing it, as well as encouraging the very behaviors that got us here in the first place.

6 comments:

Anonymous,  Sunday, September 9, 2007 at 1:38:00 AM CDT  

I wouldn't say that the whole point of Distributism is to restore distributive justice to the economy, since it can do other useful things too - that is, things that serve some other purposes that may have their own derivative rationales.

It is incorrect to assert that "you cannot lower the amount that your employee makes without also lowering the amount that your customer can spend; they are the same person". Minor discrepancies come from things like "the rich" or "exports" or "the government" being customers, and from people drawing down savings as consumption after they retire from active paid employment, but the largest one is that in general you cannot treat mindless groups like "employers", "customers" and "employees" as individuals. There are exceptions, as when the Great Pullman Strike was aggravated by cutting employee pay only to find that their rents to the employer-as-landlord stopped coming in. However, in general, cutting employee pay spreads the loss of customer base across the whole of the economy. You get a Tragedy of the Commons and so on, but it is all quite rational. This is an externality driven by Vagrancy Costs, and it encourages sub-optimal minimising of labour use (unless something else like bureaucratic empire building provides a compensating bias). Of course, Distributism reinstates this nexus - an individual producer is far more identically the same person as his producer, and so on; this is a non-justice benefit of Distributism, if you were looking for an example.

P.M.Lawrence (temporarily anonymous while between ISPs).

papabear Tuesday, September 11, 2007 at 9:11:00 PM CDT  

Mr. Médaille, I have not had an opportunity to get your book, so I do not know if you address this question in it, but what do you think of the explanations of the "business cycle" put forth by the various schools, including the Austrian school? What explanation would you favor?

John Médaille Tuesday, September 11, 2007 at 10:31:00 PM CDT  

Papabear,

I believe the Austrian "explanation" is a set of closed assumptions that are not "falsifiable"; that is, they can neither be proved nor disproved. The theorist is therefore at liberty to devise clever explanations that fit the ideology rather than the economy, and no one can say him nay. The whole explanation rests on the unknowable "time preference for money." Thus, it is adaptable, rhetorically, to any situation. You can say any particular cycle fits can be explained in the Austrian way because the explanation can be adjusted (after the fact) to fit any cycle. Who needs such explanations?

That doesn't mean the entire explanation is wrong. It means that it is worse than wrong: it is very nearly right. If the banks or the govmint start printing up money, they will inflate both the currency and expectations, expectations that must soon come back to earth. Often with a hard crash.

The real cause, in my opinion, is injustice. When rewards of production are not equitably distributed, you get an imbalance of supply and demand. It's really that simple. Printed money is part of an imbalance (so my explanation can include the Austrian one) because generally the loaned funds go to a limited group.

I believe that in general, when the means of production are widely dispersed throughout society, business cycles are much flatter, because there are so many more decision makers. Disequilibriums tend to be local and short-lived, as it is easier to move capital among a large variety of small enterprises than between large enterprises.

The Investor's Dilemma is a phenomenon that repeats itself with appalling frequency (see Hyman Minsky). There should be no reason for the economy to be in such cycles, and the fact that they do occur is a symptom of a problem with whatever theory or practice is guiding the economy.

Paul Tuesday, September 18, 2007 at 7:01:00 AM CDT  

The problem with this argument is that wages are NOT determined by 'bargaining power' this is an erroneous notion. Rather they are determined by the supply and demand for that labour. The demand for labour is in turn determined by amount of revenue that an employer can reap by hiring the employer. This revenue is in turn determined by the consumers spending on the products made by the employee.

The fact that employers may wish to pay minimal wages and workers may still be willing to work for the lowest of wages is true but irrelevant to the subject of wage determination.

Competition among employers forces the wage rate to be reflective of the productivity of the work. Bear in mind that this is not always easy to measure precisely ahead of time. However, the principle still stays the same: the very fact that employers can make a profit from hiring an employee gives incentive for other employers to hire away the underpaid workers


Let us address the issue of firing of workers.

It is true that when an investor is able to fire a worker or pay him a lower wage that the worker has decreased purchasing power. But this does not in any way show harm to the whole of society.

The key question is: "where does the wealth go?" The answer is that the released workers now find work in another firm producing goods.

Thus when technology or better equipment lets a firm produce the same amount with less labour society benefits because the labour is employed elsewhere providing other goods or services.

Increased supply means lower prices and hence increase the purchasing power of everyone else in the economy.

The situation of outsourcing is the same: other workers have access to cheaper goods - both the imported goods and the goods the are now able to come into existence because the availability of the domestic labour.

John Médaille Tuesday, September 18, 2007 at 2:15:00 PM CDT  

Dear Paul,

Certainly you could not have meant what you said in your first sentence. I know of no free market theory which does not make prices depend on free bargaining. The only alternative theory I know of is that prices are set by the state, or by some combination of state power and market bargaining (the "common estimation" theory of Aquinas).

What the theories do say is that free bargaining will result in prices that reflect the productivity of the factors of production. However, they have difficulty in coming up with a third term that connects power (bargaining) and productivity. The connecting term is supposed to be "competition." More on that in a moment.

When you say that "supply and demand" fix the price for labor, is that not equivalent to saying that it is power? For if a person has a productive skill which is in short supply, he will have enormous bargaining power; but if he has an equally productive skill that is over supplied, he will have little bargaining power. So what's the difference in my statement and yours?

The problem with using competition as the connecting term is not so much that it is wrong; the problem is much worse: it is very nearly right. My experience tells me that the greatest problems come not from outright errors (they are too easy to spot), but from things which are almost correct but are incomplete. And a worse problem arises from the fact that defenders of a theory often ignore the starting conditions under which the theory is true, but without which the theory becomes false.

And that is what happens here. Both the Austrian and neoclassical theories depend on certain initial conditions; their defenders ignore these conditions. Under these theories, competition will correlate productivity and power only when two starting conditions are fulfilled: one, under conditions of full employment, and; two, when production is spread over a vast number of firms (which is distributism). The farther an economy is from these conditions, the less power and productivity will be correlated. And please note, this is a critique that arises from within the theory; I could give half a dozen reasons why the theory itself doesn't work for reasons that are external to the neoclassical assumptions, but I think the strongest critiques are always the internal critiques. If you want to see the other critiques, click on the icon in the left-hand column and buy the book (always marketing!)

John

Paul Tuesday, September 18, 2007 at 10:56:00 PM CDT  

The problem is that you have a erroneous concept of "power". Could you please elaborate on this?

"Certainly you could not have meant what you said in your first sentence. I know of no free market theory which does not make prices depend on free bargaining. The only alternative theory I know of is that prices are set by the state, or by some combination of state power and market bargaining (the "common estimation" theory of Aquinas)."

So called "free bargaining" means that both the seller and the buyer exchange at a price that they BOTH agree. There is no third party forcing either to contract. Note that free bargaining does not mean that the seller gets as much money as he wants or that the buyer will pay as little as he wants. Of course, I'm sure many employers would like to pay an annual wage of 50c and that most employees would want an hourly wage of $1 million.

Rather than me give you an economics lesson I suggest that you listen to these lectures:
http://mises.org/multimedia/mp3/Salerno-Klein2007/3-Klein.mp3
http://mises.org/multimedia/mp3/Salerno-Klein2007/5-Klein.mp3

"Under these theories, competition will correlate productivity and power only when two starting conditions are fulfilled: one, under conditions of full employment, and; two, when production is spread over a vast number of firms (which is distributism)."

None of these assumptions are made at all by Austrians. In fact Austrians spend much time arguing against these assumptions.

Distributism will result in drastically decrease real wages. This is because capital formation and productivity enhancements will be so hampered in such a system. There will simply be less material wealth for everyone.

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