Economics

Adam Smith, Karl Marx, and Charles Darwin: A New Economic Paradigm

The Piketty debate exposed the dysfunction in economics

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By George Cooper

We are now far enough through the cycle of Piketty analysis to know how it will end. There will be no clear victor. Those who were instinctively supportive of Piketty’s thesis before reading his book will be able to ignore any alleged flaws in his data, and challenges to either his mathematical theory of capital accumulation or his narrative theory of capital destruction. This group will conclude what they already knew – inequality is too high and rising and should be addressed with higher taxation. On the other side, those who were immediately skeptical of his thesis will dwell on the discrepancies in his data and the challenges to his mathematics and history. This group will conclude that his thesis can safely be dismissed.

Of the small minority who have the time and patience to delve into multiple layers of argument and counter argument there will be a vanishingly small proportion who are persuaded to materially alter their position, based on what they have learned. A much larger number of people, on both sides, will find reason to consider their prior point of view as vindicated by the Piketty debate. This group will emerge from the affair with more deeply entrenched positions than before. As a result the economic debate will become more polarised and even more dysfunctional. In short, the confusion generated by Piketty’s book will push an already deeply dysfunctional economics further into crisis.

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Perversely the deepening crisis in economics is a triumph for Thomas Kuhn and his theory of scientific revolutions.

Anyone familiar with the science fiction of Isaac Asimov will know what is meant by a Seldon Crisis. According to Asimov’s stories, Hari Seldon was the supreme exponent of ‘psychohistory’ a fictitious mathematical branch social science (which bears more than a passing resemblance to mainstream economics) which allowed Hari Seldon to forecast social crises and revolutions with precision, hundreds of years into the future. In a sense Thomas Kuhn is the Hari Seldon of scientific theory. In Kuhn’s famous book, The Structure of Scientific Revolutions , he maps out in detail, how scientific crises begin, how they mature and how they are eventually resolved. Kuhn even spells out how the old guard will lash out against any new ideas in a final futile attempt to defend their own discredited theories.

It is fascinating to look at the debate over Thomas Piketty’s work through the lens of Thomas Kuhn’s analysis. Just as Kuhn predicted, new data is unable to resolve disputes once a field has entered a state of pre-revolutionary crisis. On one side Piketty has provided enough evidence to persuade the pre-converted and on the other side Chris Giles, of the Financial Times, has now provided enough doubt to persuade the un-converted. According to Kuhn, this crisis phase will persist indefinitely, regardless of the emergence of new data, until a new way to think about economic theory emerges – this will be the paradigm shift which resolves the crisis. The various competing schools of thought will see in any new data what they want to see. They will use their individual interpretations to convince themselves that they and their theories are correct and their opponents are wrong. Confirmatory data will be embraced uncritically while any inconvenient challenging data will be doubted, ignored, discarded or belittled.

In the debate over Piketty’s data this process of selective interpretation has been common on both sides. Those on the left-wing embraced Piketty’s data uncritically but immediately rejected the analysis of the Financial Times. Those on the right-wing largely ignored Piketty’s data until the Financial Times provided them with an excuse to belittle it. As Kuhn forecast, Piketty’s data has served only to harden rather than change opinions.

Similarly, when it came to either Piketty’s mathematical model of capital accumulation or his narrative model of capital destruction, the response was largely driven by prior opinions. For anyone whose priors were confirmed, Piketty’s models were accepted without challenge. On the other hand, those whose priors were challenged went looking for reasons to doubt Piketty’s arguments. I fell into this latter camp. I instinctively disagreed with at least two aspects of Piketty’s argument. Firstly my experience as a professional investor meant that ‘I knew’ he was wrong to assert that the return on capital was both structurally high, at around 5%, and largely independent of the rate of economic growth –  his famous r > g relationship. This feeling sent me on a quest to challenge his r > g inequality which lead to the following arguments: The Magical Mathematics of Mr Piketty Part I and Part II and Credit in the 21st century.

In addition, coming from a coal mining community in the North East of England ‘I knew’ that it was the union movement, not World War I, that achieved greater equality in the late 19th and early 20th centuries. This prompted me to examine his ideas about capital destruction in World War I. And this examination in turn furnished me with another reason to doubt Piketty’s historical analysis: The Horrible History of Mr Piketty.

Naturally constructing these arguments has left me, as Kuhn predicted, more firmly convinced that I was correct to be sceptical of Piketty’s thesis. On the other hand a few people have read my rebuttals of Piketty and a written their own counter rebuttals. Doubtless this exercise has left them also more certain of their own opposite views!

For those of us who enjoy debating macroeconomic issues this is all good entertainment. However, as a process for deciding how best to manage our economies, this sterile, divisive, debate is a dreadful way to proceed. Economics is ultimately responsible for setting the policies which determine the livelihoods of millions of people – we therefore owe it to ourselves and our children to find a better way to conduct the debate.

Fortunately Thomas Kuhn did more than just describe what scientific crises looks like, he also told us what needs to be done to resolve a scientific crisis. Kuhn explained we need to find a way to reconcile the apparently irreconcilable world views of the various competing schools of thought.

On the face of it appears an almost impossible task to find a theory which is able to agree with both the instinctively pro-Piketty crowd with his instinctive opponents. But with a little imagination there may be a way through this impasse.

Let’s step back from the details of Piketty’s data and his models, for a moment, and consider just the essence of Piketty’s thesis: capitalism has an inbuilt tendency to cause wealth polarization which must be counteracted with progressive taxation.

Now let’s consider the antithesis to Piketty’s argument: inequality must be preserved as it is the driving force of competition, innovation, economic progress and ultimately wealth generation.

According to Kuhn the path to progress is in finding a way to reconcile these competing world views. In other words, we need the paradigm shift which makes it clear why inequality and redistribution are both necessary features of a healthy economic system.

The problem is not as difficult as it looks:

Step 1: Accept that Adam Smith was correct

As a first step let’s side with those on the right-wing and agree that Adam Smith’s thesis is correct: it is the pursuit of self-interest that is the key motivating force for economic activity, innovation and progress. I doubt that many readers will have difficulty with this step.

Step 2: Accept that Charles Darwin was correct

Now let’s add just a small corollary to Smith’s idea. Let’s imagine that what really motivates us is not the pursuit of absolute wealth but rather the pursuit of relative wealth. Put differently we are not neoclassical optimizers but rather Darwinian competitors – we are motivated by our relative position in the social pyramid. (For those interested I provide some reasons to support this notion in Money, Blood and Revolution)

Step 3: Recognise the darker side of Darwinian competition

Our Darwinian competitive spirit has both a bright side and a dark side. On the bright side the spirit of competition spurs us on to achieve more than our peers. This is what continues to motivate us to generate ever more economic progress even when we have long since satiated our immediate needs. However, on the dark side, it also means that our social position is paramount. It is our wealth and status relative to our peers that dominate our behaviour. Those on the bottom of the social pyramid are motivated to compete to move up to a higher position. But for those at the top of the social pyramid, with few above them, the overriding priority becomes an urge to preserve the status quo, to ensure that those beneath them do not move up to displace them.

Darwinian competition motivates those at the bottom to strive for improvement while it motivates those at the top to strive for preservation of the status quo. For this reason an unfettered, Darwinian, competitive economy tends to evolve into a near stagnant feudal system.

Step 4: Accept that Karl Marx was also correct

Now let’s accept that the Karl Marx and therefore the essence of Piketty’s argument is also correct: capitalism does indeed have an inbuilt tendency toward wealth polarization.

Despite my previous posts criticising aspects of Piketty’s thesis I believe these wealth polarizing forces are real. I just happen to think Piketty has homed in on the wrong mechanisms.

Piketty has chosen to focus on the return on capital and its relationship to the rate of economic growth. By contrast I believe he could have built a more robust theoretical argument for wealth polarisation based on the cost of credit rather than the return on capital.

Those at the bottom of the social pyramid are, almost by definition, less credit-worthy than those at the top of the social pyramid. For this reason those at the bottom must pay higher interest rates to borrow money, reflecting their greater default risk. The ultra-rich can borrow almost directly from the central bank at rates often close to or below zero percent, in real terms. By contrast, the ultra-poor are forced into the hands of payday lenders charging hundreds or even thousands of percent in interest.

This differential cost of credit runs throughout the social pyramid. As most lending occurs vertically through the pyramid, with the poor borrowing from the rich, through the banking sector, these differential interest rates ensure a steady trickle-up effect, whereby wealth flows from poor to rich.

Differential interest rates also cause a secondary wealth polarising mechanism. As the profitability of any business venture is a function of the gap between the cost of capital and return on capital, it follows that any given venture will be more profitable, and less risky, to those who can borrow money at the lowest possible rates. For this reason there are more potentially viable business ventures available to the rich than to the poor – as the saying goes: ‘the first million is always the hardest’.

Step 5: Properly integrate the state sector into our economic models

Having acknowledged the validity of Marx’s critique of capitalism and the darker side of our Darwinian nature the next step, toward a sensible unified economic paradigm, is to recognise that we have already established the necessary institutional arrangements to deal with both our Darwinian instincts and capitalism’s wealth polarization.

Marx failed to recognise that, at least in Britain, America and France, the social revolutions he called for in had already happened. The English Glorious Revolution followed by the American and French Revolutions began the democratising reforms necessary to check the power of those at the top of the social pyramid and, eventually, to counterbalance to the trickle up effect of capitalism.

Democracy eventually brought improvements in workers’ rights, minimum wages, state funded education, social security and of course redistributive taxation. All of which helped gradually establish the conditions necessary to allow those lower down the social order to compete more effectively with those above them.

In short, the partnership of democracy and capitalism established a circulatory flow of wealth through the economy – capitalism pushed wealth up the social pyramid and democracy pushed it back down. Together this partnership of capitalism and democracy placed the whole of society onto an invigorating competitive treadmill, enabling those at the bottom of the pyramid to compete and also obliging those at the top to compete.

It is forgivable that Marx failed to recognise that his revolution was already in progress as he wrote his ‘Capital’. Indeed it could be argued that his writings helped complete those revolutions. On the other hand I have rather less sympathy for the stance taken in Piketty’s ‘Capital’ where, like Marx before him, he chooses to analyse capitalism as an isolated entity, largely ignoring the role of the state sector with its progressive taxation and transfer payments. For example, his r > g relationship fails to take into account that, when thinking of wealth accumulation, we should consider returns net of taxation.

In Marx’s ‘Manifesto of the Communist Party’ he calls for a number of reforms. Two of the most important – “A heavy progressive or graduated income tax” and “Free education for all children in public schools” – have already been implemented. We should not now resurrect a new version of Marx’s critique of capitalism without acknowledging that these countervailing redistributive arrangements are already in place. A more reasonable approach would be to recognise their presence and to debate their size and construction.

[Intriguingly for those who are now arguing for monetary reform the Communist Manifesto also calls for: “Centralisation of credit in the hands of the State, by means of a national bank with State capital and an exclusive monopoly.” The parallels with the recently published ideas of the Positive Money organisation are interesting.]

Thinking about our economic system with a circulatory flow model is far from a complete model of an economy. It may better be thought of as the kernel of a new approach to economic thinking – the first step in rethinking economics. Nevertheless, with only a little thought it becomes possible to see how such a circulatory growth model could reconcile the key ideas of Smith, Marx, Keynes, Hayek, Minsky, Schumpeter, Fisher, Veblen and Darwin with the ideas of the institutional, historical and behavioural schools of economics.

I discuss these ideas in greater detail in Money, Blood and Revolution where I also explain how the circulatory growth model can be used to understand why the excessive use of monetary stimulus – both through low rates and quantitative easing – leads directly to: structurally low economic growth, higher social inequality, deflationary pressures, high government deficits and an inevitable pressure for higher taxation.

It is impossible to know if this circulatory growth idea represents a ‘correct’ model of the economy, but at least until a better idea comes along, it could provide a useful conceptual device to encourage a more constructive debate over both macroeconomic theory and policy.

There is an unfortunate corollary to Kuhn’s analysis. Kuhn also explained the difficulty of changing people’s opinions once formed. Kuhn notes that the leaders of a discipline almost never accept the new ideas necessary to resolve the crisis in their field. Instead they simply insist that the way forward is for everyone to agree with them. Therefore the old guard either refuse to engage with the new ideas or attacks both them and their proponents. So far the reaction to the circulatory growth idea proposed in Money, Blood and Revolution has been precisely as Kuhn would have anticipated. Paul Krugman, for example, has managed to finesse the fine line of both rejecting the idea and refusing to acknowledge it! See: Paradigming is hard.

My reply to Krugman is simple: if you have got better ideas on how to fix the dismal failure of economic theory then let’s hear them. If you do not have the ideas then at least have the courtesy to respect those of us who are making an honest attempt to find a way out of the current confusion. With thousands of students of economics around the world now engaged in an open revolt against the teachings of mainstream economics the position that ‘all is well in economic theory’ is no longer tenable.

2015 september 4


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  • Pingback: Piketty Versus Kuhn. The Debate Over a New Econ...()

  • Brian Gladish

    Maybe the best idea would be to stop trying to manage the economy, and let it evolve (as in evonomics) on its own: http://fee.org/freeman/the-man-behind-the-hong-kong-miracle/

  • Swami Cat

    This is an excellent article reflecting original thought and a desire to redefine paradigms. Allow me to “add on” to your ideas…

    Markets and politics are complex adaptive problem solving systems of different but overlapping domains. Another such problem solving system is science. Together, a society can solve and accumulate an infinite range of solutions. The key is to grok the paradigm and to use the proper problem solving system in the particular domain (not always easy, and probably best determined via extensive experimentation).

    Each problem solving system has its strengths and weaknesses. Alone each is a mess, as likely to create problems as solutions (a solution for some can often be used as a problem for others). Together the potential is to improve the prosperity,mknowledge and constructive cooperation of the human species to unimaginable levels.

    Some minor pushback… Beware static views of income. In general, the young almost always start at the bottom of the stairs. Everyone I know did. We get a job, and work up from there getting minor loans which grow as our earning potential grows. The problem is with folks who are unable to move up the stairs. In some cases the problem is best solved via better politics and institutions (freeing inner city kids from bureaucratic union-run puppy-mill schools with no grasp of the power of constructive institutional competition and creative destruction might be a great place to start). In other cases, we almost are certainly encountering innate skill differences between people — some are simply terrible at climbing the stairs due to learning issues, behavioral issues, etc. These will probably need non market safety nets funded from market prosperity.

    • Brux

      — The key is to grok the paradigm and to use the proper problem solving system in the particular domain

      I am sorry, your comment hits me as a nice, respectful, participatory comment, which I have no right to judge, so I mean no offense … but what on Earth does that mean and how are people supposed to do it. It is so high level and abstract that to me at least it is meaningless.

      I see what you are getting at, and it is not that I disagree. For example, your focus on young people, our system grows young people like a crop of cattle. Cattle do not move up the stairs. Virtually every story about someone “moving up the stairs” is a fairy-tale fiction that if examined closely enough has a majority or elements that will never ever occur and can never ever occur for 99% or more of the people on the planet.

      Look at the people who get resources, focus and attention … they can have severe physical and emotional problems, but if they are not beat down like we do to process most people they can rise to their potential, and that is almost always amazing.

      It is amazing not so much because of people’s abilities, but because when people randomly go about pursuing their interests they learn different things and put things together in unique and individual ways. It has nothing to do with the ego or greatness of the man, more about the random path that ( God? ) reveals. As is usual in this world, man keeps what God ( not sure what other term to use here ) has created from other men to keep them down.

      Anyway, I mean to say I see things more as not changing because they people do not have the power to exert their will and rights … they do not even know how to define what that is … cattle is an apt description. We have a dehumanizing planet and all for the gain to be able to disempower people.

      This is a conceptual thing, so perhaps that is where you can I can agree, but it is a Marxist power and consciousness thing mostly. Class warfare is forced on people … it is the fighting back that is impossible, there are no natural channels for.

  • I am of the view that the flaw lies in the way both capitalism and democracy are currently practiced. The flaw arises from the government and businesses being able to borrow and use other peoples money. In terms of the government, it is the ability to use the future generation’s money and in terms of businesses, the ability to use the small saver’s money. The ability to borrow of governments, industry & trade, as well as citizens that drives excessive consumption/ environment issues (denuding the Earth at a fast pace and leaving the future generation to be taxed and pay back government borrowing). The future generation cannot vote out the government that actually taxed it (we steal their democratic right). The same borrowing is a key driver of inequality. For paucity of space I provide a link to a paper I wrote http://therules.org/the-illusion-of-legitimacy-the-predatory-borrower-an

  • My 2c: (1) Your criticism of Piketty has a problematic starting point as can be seen in the way you represent Marx. Marx first and main insight was that “capital is a social relation”. More specific the relation between paid labor and the owners of the production facilities. And these owners hire labor to realize profit (surplus-value) in the first place, which in turn should become profitable capital. Unchecked and problematic growth, (very) inequal distribution of wealth, accumulation in “publicly” owned multinationals all flow from this primary concept. And only by somehow altering this relationship a real solution is possible. This does not necessarily involve dissolving all inequality, the total disappearance of all notion of capital, or a (bloody) revolution.

    (3) I prefer reference to evolution in stead of Darwin as this encompasses more recent advances in the social and psychological fields. Also the misunderstanding around “fittest” and as a consequence the accusation of “social Darwinism” is better avoidable.

    (2) The invocation of Kuhn won’t help much. The status as “science” as compared to the object of Kuhn’s theory is problematic. Mainstream economics is still more ideology than science. And of course it is the dominant, hegemonic ideology. It will take a lot of strategical thinking to overcome it.
    (PS1: It would be nice if contributions are dated)
    (PS2: I wonder if the author will answer.)
    (PS3: You can mail me at victor(dot)onrust-at-xs4all(dot)nl)

  • Duncan Cairncross

    I am not sure what you have added to the debate
    NOBODY is calling for “equality” – that is just a straw man

    Piketty simply formalizes the
    Those who have – Get
    That everybody knew beforehand

    So now we are looking at
    (1) What is the optimum level of inequality
    (2) How doe we get there and maintain that level

    We should now be looking at arguing about the optimum level of inequality
    NOT zero and almost certainly less than the current level

    • Carbonman1950

      Mr. Cairncross – Your question “What is the optimum level of inequality.” Contains in it the assertion that there is an optimum level of inequality. And assertion that is not by any means settled.

      • Duncan Cairncross

        I don’t understand your comment
        There has to be an optimum level –
        even if it is one of the extremes – total equality or one man owns everything

        There must be a level that gives society the best performance

        There is an optimum level for EVERYTHING

        • David Whitlock

          A single value optimum level may not occur if relative weighting functions are non-linear, if there are multiple objectives to be optimized, if they change over time, or if there is noise in the system, or if there are unknown factors involved (all of which are true for economic systems).

          What constitutes “best performance” is subjective. Of course the single person who owns everything is certain that this is the distribution that gives the “best performance”, even as 6,999,999,999 others are certain that it does not.

          Because of the “veil of ignorance”, we can’t know the effects of a particular distribution a priori. We can’t know that a particular level of inequality will produce an outcome that is “optimum”. People may, through self-delusion, convince themselves a certain distribution will produce optimal results (as in trickle-down economics), but this is more of a self-fulfilling prophesy. Of course the “haves” say that “trickle-down economics” is the “best of all possible policies”. This is a faith-based religious concept, not a result from any analysis.

          https://en.wikipedia.org/wiki/Best_of_all_possible_worlds

          • Duncan Cairncross

            Hi David
            Sorry not to have replied earlier
            Maybe I should have changed that to from “optimum level” to a more general “optimum level to aim for in the current situation”
            Understanding that the “optimal level” is probably a moving feast

            This is like optimising engine performance – and really only applies when you get close

            At the moment we have a number of societies with different levels of inequality
            The graph of “goodness” v inequality shows a noticeable slope – we don’t have a limit case where the reduced inequality starts to move the line the other way

            In our current situation I would rephrase it as
            There is a “better” level of inequality – and it’s thataway!

  • Hannes Radke

    So common sense it almost hurts.

  • jothwu

    I thoroughly enjoyed reading your book, “Money, Blood and Revolution”. Regarding the optimal level of inequality as discussed here, is anyone suggesting this optimal level will have been achieved once saving rates have been equalized among various income levels, and specifically between median income earners and high income earners?

  • Kuhn did not suggest that competing paradigms were to be “reconciled”. The theory of the aether was not “reconciled” with Einsteinian relativity. It just disappeared. Rather, Kuhn suggests that the competition is only decided by the process of competition. Eventually, one side or the other wins.

    • Bruce Preville

      Kuhn also asserts that the new and old paradigms remain unreconciled, with the new paradigm continuing after the adherents to the old paradigm die off.

  • Chuck Willer

    George, Your essay is excellent. Thank you.

    One recommendation regarding the philosophy of science (i.e. Kuhn), if you haven’t already – you might find Larry Laudan of interest. His work may help in untangling the Gordian knot of economic theory’s possible evolution.
    Brief review of Laudan here:
    https://en.wikipedia.org/wiki/Larry_Laudan

    “Even those who disagree with Laudan recognize that his utilizing detailed evidence from the history of science is an important contribution to how philosophy of science is practiced.”
    and
    “In Beyond Positivism and Relativism, Laudan wrote that “the aim of science is to secure theories with a high problem-solving effectiveness” and that scientific progress is possible when empirical
    data is diminished. “Indeed, on this model, it is possible that a change from an empirically well-supported theory to a less well-supported one could be progressive, provided that the latter resolved significant conceptual difficulties confronting the former.”[4] Finally, the better theory solves more conceptual problems while minimizing empirical anomalies.”

    • Laudan is a conservative thinker, and tends to objectify things like “problems”. He fails to ask: who’s problems? Who defined them as such? Who are the beneficiaries from their solution? Neither economics, nor science more generally, are asocial structures which operate independently of the larger human community. Formulations like “the better theory solves more conceptual problems while minimizing empirical anomalies” only obscure the fact that scientists and economists are workers in a social system, with all that such a fact entails. They are not working to abstract truth-conditions. They are working to produce intellectual goods which will be used by certain people to achieve certain ends, and abstract truth-conditions are just shorthand for an evaluation that the intellectual products have served their purpose. Obscuring this fact impedes efforts at changing both society, and the kinds of intellectual production which Evonomics so extensively critiques.

      • Chuck Willer

        Just noticed your reply David. I hardly believe the label ‘conservation’ applies to the debates in the Philosophy of Science circa 1960-1990 – Laudan’s era. If the label does apply it seems to me hardly helpful. I’m very aware of the Sociology of Knowledge and there is no question a strong sociology of power is operating in the social sciences – if not all sciences. I find arguments that attack mainstream economics by reference to the obvious interest and power dynamics useful but that doesn’t get the job done in my book. One needs to explain problems and offer better alternatives. Steve Keen is an example in economics.

        • Hi Chuck. Since I wrote that I’ve had to revise my understanding of Laudan, so: agree! I think however the power dynamics are inescapable. My understanding of science as social practice is that it’s intellectually and practically tied into the question of control of material reality. The common operating thesis of many scientists, where theories are tested against theoretical predictions enables the production of knowledge that can be used to control. Since much of this is physical production (part of the economy), and physical destruction (warfare), science is socially entangled in both. It also presupposes that true knowledge is the ability to control, and therefore that the a piece of music or a piece of poetry do speak truth. And thus science becomes the allies of certain interests and sectors in our society, and does nothing for others. And your latter proposal doesn’t get us out of that. One explains problems, yes: but who defines the problems to be explained? One offers better alternatives, yes: but who defines better. Inevitably, the answer is: elites. Financial elites, political elites, or professional elites. Now, being a member of the last group, I can hardly damn the existence of elites. In fact, I think they’re inevitable, and even useful. But that doesn’t blind me to think that this problem solving paradigm doesn’t continue a social order defined by elites, and—more important—by the particular ways in which they (or rather we) see the world.

  • Also, if Marx is correct (I think so, largely) then capitalism does not have inbuilt tendencies. To think in this way is precisely what Marx warned against in his concept of reificaction, in which is to see people as subject to impersonal economic “forces”, and to take mental abstractions (those same forces) and treat them as real.

    Other than these quibbles: thanks for your paper. Very useful.

  • Jan de Jonge

    This article is written long ago, so I don’t know whether my comment is reached by the writer.
    You write: “Thinking about our economic system with a circulatory flow model is far from a complete model of an economy”. And you describe this as the kernel of a new approach to economic theory. A first step in rethinking economics. You apparently don’t know that the idea of the economic system as a circular flow was the starting point of economics as a science. The Physiocrats wrote about it and Adam Smith learned about it when he was in France. His book The Wealth of Nations was an elaboration of this idea. It remained the core of economic theory until Robbins took scarcity as the key concept. But it remained the core of Keynes’ macro economy.
    Maybe Heilbroner’s great book “The Worldly Philosophers”is still available in a library.

  • Let’s start with this:

    “Let’s step back from the details of Piketty’s data and his models, for a moment, and consider just the essence of Piketty’s thesis: capitalism has an inbuilt tendency to cause wealth polarization which must be counteracted with progressive taxation.

    Now let’s consider the antithesis to Piketty’s argument: inequality must be preserved as it is the driving force of competition, innovation, economic progress and ultimately wealth generation.

    According to Kuhn the path to progress is in finding a way to reconcile these competing world views. In other words, we need the paradigm shift which makes it clear why inequality and redistribution are both necessary features of a healthy economic system.”

    ———
    Mr. Cooper asserts that the inequality is driven by the cost of credit. This is true as one factor, but the cost of credit is largely a function of collateral through the accumulation of real assets. So, those with assets can leverage returns and accumulate more asset wealth than those without assets (see Buffett, Gates, etc.). State redistribution does almost nothing to alleviate this problem; we would have to redistribute asset wealth, not income. But wealth taxes merely regress us to the past where the process recommences. In other words, it’s the process, not just the endowment that drives polarizing wealth.

    Finance theory will show that wealth accumulation is a result of successful risk-taking – so how do we promote successful risk-taking regardless of income levels? By looking at how factors of production – capital, labor, and information – influence the distribution of outcomes. (Labor unions may have served well in the 1940s industrial economy – they will not in the Age of Information.) By looking at how we tax risk-taking at different class levels and how we empower risk-takers through insurance pooling against loss. Social insurance and entitlements play a role here, but must be subordinate to market solutions. Tax and redistribute fails in this respect.

    Mr. Cooper is correct to cite Kuhn – we need to start thinking outside the box. A circulatory growth model is a good start as dynamic macroeconomies are wholistic, not mechanistic. Piketty reminds me of Marx – right diagnosis, wrong prognosis.
    http://www.casinocap.wordpress.com

  • Great some steps are made towards reality that includes both sides of the distribution, outside of unreachable absolute idealistic states views.

  • Derek R

    Everything old is new again. The idea of the economy as a circulatory system with money flowing around was originally promoted by Adam Smith’s hero, Francois Quesnay, the leader of the Physiocrats. So forward to the 18th century! The last 250 years of economics have been a distraction! Now we can finally put economics back to what it was originally meant to be!

  • GaryReber

    I do agree with author George Cooper that the denial to access to low or interest-free capital credit by the essentially 99 percent of the population is a root cause of economic inequality. As Cooper stated:

    “Those at the bottom of the social pyramid are, almost by definition, less credit-worthy than those at the top of the social pyramid. For this reason those at the bottom must pay higher interest rates to borrow money, reflecting their greater default risk. The ultra-rich can borrow almost directly from the central bank at rates often close to or below zero percent, in real terms. By contrast, the ultra-poor are forced into the hands of payday lenders charging hundreds or even thousands of percent in interest.

    “This differential cost of credit runs throughout the social pyramid. As most lending occurs vertically through the pyramid, with the poor borrowing from the rich, through the banking sector, these differential interest rates ensure a steady trickle-up effect, whereby wealth flows from poor to rich.

    “Differential interest rates also cause a secondary wealth polarising mechanism. As the profitability of any business venture is a function of the gap between the cost of capital and return on capital, it follows that any given venture will be more profitable, and less risky, to those who can borrow money at the lowest possible rates. For this reason there are more potentially viable business ventures available to the rich than to the poor – as the saying goes: ‘the first million is always the hardest’.”

    Those at the bottom of the social pyramid are, almost by definition, less credit-worthy than those at the top of the social pyramid. For this reason those at the bottom must pay higher interest rates to borrow money, reflecting their greater default risk. The ultra-rich can borrow almost directly from the central bank at rates often close to or below zero percent, in real terms. By contrast, the ultra-poor are forced into the hands of payday lenders charging hundreds or even thousands of percent in interest.

    This differential cost of credit runs throughout the social pyramid. As most lending occurs vertically through the pyramid, with the poor borrowing from the rich, through the banking sector, these differential interest rates ensure a steady trickle-up effect, whereby wealth flows from poor to rich.

    Differential interest rates also cause a secondary wealth polarising mechanism. As the profitability of any business venture is a function of the gap between the cost of capital and return on capital, it follows that any given venture will be more profitable, and less risky, to those who can borrow money at the lowest possible rates. For this reason there are more potentially viable business ventures available to the rich than to the poor – as the saying goes: ‘the first million is always the hardest’.

    Those at the bottom of the social pyramid are, almost by definition, less credit-worthy than those at the top of the social pyramid. For this reason those at the bottom must pay higher interest rates to borrow money, reflecting their greater default risk. The ultra-rich can borrow almost directly from the central bank at rates often close to or below zero percent, in real terms. By contrast, the ultra-poor are forced into the hands of payday lenders charging hundreds or even thousands of percent in interest.

    This differential cost of credit runs throughout the social pyramid. As most lending occurs vertically through the pyramid, with the poor borrowing from the rich, through the banking sector, these differential interest rates ensure a steady trickle-up effect, whereby wealth flows from poor to rich.

    Differential interest rates also cause a secondary wealth polarising mechanism. As the profitability of any business venture is a function of the gap between the cost of capital and return on capital, it follows that any given venture will be more profitable, and less risky, to those who can borrow money at the lowest possible rates. For this reason there are more potentially viable business ventures available to the rich than to the poor – as the saying goes: ‘the first million is always the hardest’.

    Te number one rule in business and commerce is “confidence,” another way of saying contracts — promises — are sacred. Another word for trust — confidence — in economics and finance is “creditworthiness.”

    This is why the new paradigm must provide equal access to capital credit investment. This is why a key component in the proposed Capital Homestead Act (aka Economic Democracy Act) is the replacement of traditional forms of collateral with capital credit insurance and reinsurance, as Louis Kelso proposed in both of the books he co-authored with Mortimer Adler, The Capitalist Manifesto (1958) and The New Capitalists (1961). The latter book especially focused on the need for capital credit insurance. Given that the primary use of past savings is collateral, not direct reinvestment, the subtitle to The New Capitalists given meaning to its subtitle: “A Proposal to Free Economic Growth from the Slavery of Savings.”

    Below is a scenario that will accomplish broadened ownership of productive capital simultaneously with the growth of the economy.

    The common belief is that you can’t get money for investment––to buy capital (productive assets)––except by saving it yourself or borrowing it or just taking it away from somebody who has managed to save, is true. But this belief has a critical error, it assumes that the only way to save is to cut consumption and accumulate cash. And this therefore is what Louis Kelso and Mortimer Adler called “the slavery of past savings.”

    Beyond conventional thinking there is another way: Let the capital pay for itself out of its “own” future earnings. Anybody can “create money” by promising to pay for something he or she receives now or in the future and having the promise accepted. It’s called “credit.” When it’s used to purchase food, clothing and shelter (consumer goods) now and pay later, it’s called “consumer credit,” and it’s pretty much the worst form of credit possible. When it’s used to purchase productive capital that pays for itself out of future earnings, it’s called “capital credit,” and can be the very best form of credit––and of creating money and help finance future growth, which this economy sorely needs.

    This is called “future savings.” Instead of reducing consumption in the past or now to finance new capital, increase future production from new capital that you’ve promised to pay for, out of future profits. You don’t save to save now, produce later. You can produce now, and save later. In other words, get “capital credit” now. Credit is nothing more than a promise to repay a loan out of future profits. You can use the promise itself as money to buy capital, then use what the capital produces to repay the loan. It’s a lot easier and faster than saving now and then producing later, and is much broader and larger in scale. It is the same basic architectural model of financing used by every 100 percent leveraged Employee Stock Ownership Plan (ESOP).

    Here is how, it could work. You would get a notice in the mail from the federal government that the Congress passed the Capital Homestead Act of 201_. A government survey of the capital growth needs of the economy has been determined that in the coming year, new and existing small and large “for-profit” companies want to sell $2.31 trillion (with a capital ‘T’) worth of newly-issued, full dividend payout, full voting shares to meet their growth and modernization needs in response to the demands of their U.S. and global customers. The Act gives all financially sound companies a way to invest in new capital and create new jobs to meet new customer demand for new and better products and services and even begin to construct and modernize new infrastructure through citizen-owned (as individuals) for-profit corporations. The obvious keywords, is new and citizen owned.

    The notice informs you that, as a new right of citizenship under the Act, like the political ballot, you have the right, if you choose, to receive a free government-issued Capital Credit Card that for the coming year will entitle you to receive free of charge capital credit to purchase, say $7,000 worth of the newly-issued shares of “qualified” companies (business corporations) with interest-free “new money.” The Capital Credit Card isn’t money, but it allows you to get productive credit, another form of money, to buy capital (productive assets) that can pay for itself.

    You will not be at risk if the loan cannot be paid off, because the loan will be insured by one of several “qualified” private capital credit insurance companies and/or reinsured by a for-profit Capital Credit Reinsurance Company established by many capital credit insurers, and not government insurance. Your loan is to be entirely backed by the anticipated profits in the form of dividends on each of the “qualified” shares that you, with your advisors, decide you wish to buy, with added backup from the capital insurance pool if the shares fail to earn sufficient dividends to repay the Capital Credit loan. After the Capital Credit loan on each of the shares is repaid, you will receive outright all future dividends directly as “supplemental income” over and above income received from your work (job) and all other sources.

    The notice would also inform you (and your family members) that you should go down to your local commercial bank that is a member of the Federal Reserve System to set up in your own name a “Capital Homestead Account” (CHA). Like an Individual Retirement Account or “Super-IRA,” a CHA would be a “tax-shelter” for you to build up a growing accumulation of income-producing investments to meet your future consumption needs. Your CHA is designed to distribute dividend incomes during your working career as well as when you retire or become disabled.

    Your Capital Credit Card would authorize your CHA “tax shelter” to be the legal vehicle for receiving each year’s loan to purchase “qualified” shares that you want to buy from the market––and would allow you to defer taxes on the income used to purchase the shares until you take the assets out of the CHA or die––at which point the assets become income to your heirs, not to the estate. The heirs, not the estate, pays taxes, unless the heirs put the assets into their own CHAs, in which case taxes are again deferred.

    Each annual loan for buying additional shares would take the form of a promissory note backed with a “bill of exchange” that you “draw” or “issue.” Your bill (which, like any bill, has to be paid) is backed in turn by the full stream of future profits paid out to your CHA. These anticipated (but obviously uncertain) future profits would in turn be backed by the “future savings.” These future savings take the form of the future capital products and future consumer products and services that the company issuing the new shares expects to produce with the money the companies receive from the sale of shares to your CHA.

    The local commercial bank “discounts” your bill of exchange (gives you less than the face value of the bill), issuing a promissory note in return. The discount covers the cost of the bank’s own services and the risk premiums to be paid out of future dividends expected on the shares purchased by your CHA. Each bank’s promissory note is thus a form of asset-backed (non-fractional) “money” over and above money issued by the government in the form of coins and official currency. Bills of exchange discounted by member banks of the Fed can be rediscounted in the financial markets or directly at the (re)discount window of the regional Federal Reserve Bank to be backed by the Fed’s promissory notes: newly-issued currency or Fed demand deposit accounts under Section 13, paragraph 2 of the Federal Reserve Act. In other words, “money” is anything that can be used in settlement of a debt, and new capital credit can be created in ways that it can be repaid entirely with “future savings,” making it possible for today’s propertyless to own future productive capital. Maybe your entire family could open their Capital Homestead Accounts at the same time.

    And that is how we will finance the future and help pay down the national debt.

    Help Pass Capital Homesteading Now!

    Support Monetary Justice at http://capitalhomestead.org/page/monetary-justice.

    Support the Capital Homestead Act (aka Economic Democracy Act) at http://www.cesj.org/learn/capital-homesteading/, http://www.cesj.org/learn/capital-homesteading/capital-homestead-act-a-plan-for-getting-ownership-income-and-power-to-every-citizen/, http://www.cesj.org/learn/capital-homesteading/capital-homestead-act-summary/ and http://www.cesj.org/learn/capital-homesteading/ch-vehicles/.

    For free downloads of “The Capitalist Manifesto” and “The New Capitalists” see http://www.kelsoinstitute.org/pdf/cm-entire.pdf and http://www.kelsoinstitute.org/pdf/nc-entire.pdf.

  • Interesting article as far as it goes, and I agree with all of Swami’s additions, and even when those are included, there seem to me to be three major paradigms that are missing, if one is to create interpretive schema that have utility in this very complex set of systems we find ourselves in.

    1 The view of evolution given focuses only on competition, and ignores cooperation. That view is fundamentally incomplete.
    Evolution is an exploration of systemic possibility spaces through differential survival.
    Competition is one of the systemic possibilities.
    Cooperation is the other major systemic possibility.
    And systemic strategic spaces are infinite, with infinite variations of themes.
    In games theory terms, when the major survival factors are within group, then competitive modalities dominate; and when the major threats to individual survival are from outside the population of individuals, then higher levels of cooperation can be strongly selected. And games theory is clear, that raw cooperation is always vulnerable to cheating strategies, and requires attendant strategies to prevent invasion by cheating strategies. Arguably the entire finance industry can be characterised as cheating strategies in this sense, and it is more complex than that, as I am sure Swami will point out. And each sentence in this part could become a book, as could some of the words alone.
    So saying evolution or economic systems are about competition ignores more than half of reality.
    Yes competition is real, and so is cooperation, and everything in between.
    And when one looks at the evolution of complexity, in every case major advances are characterised by the emergence of new levels of cooperation.
    When one takes this view, our long terms security lies not on competitive, but in cooperative paradigms.
    And I enjoy competing as much as anyone else, and I do so within a higher level cooperative context.

    2/ the possibility of indefinite life extension.
    In 1974, as I completed my undergraduate studies in biochemistry, I could see that from a “cell’s eye” perspective, every cell alive today in all organisms alive today would consider itself to have been alive for some 4 billion years. Because from the perspective of each cell alive, whenever it divided, the other other half of the division was the “other cell”.
    So from this cells eye view, every cell alive today in a human being has gone through many cycles of division in a body, becoming either an egg or a sperm, joining with either an egg or a sperm, and being part of another body.
    So therefore, every cell must carry as the default set, the biochemical tools for indefinite life, and all the mechanisms for organ differentiation and cellular senescence (biological aging) must be overlain on top of that. So achieving indefinite life extension is “simply” a matter of understanding that process.
    In 1974 I saw that 4 stages of understanding were required.
    1 Map the entire human genome (2002)
    2 Accurately model protein 3 dimensional folding structure (2008)
    3 Develop useful simulations of quantum chemical effects within those enzyme structures (2012)
    4 Build a digital model of a living cell – in progress.
    We are very close.
    Many groups have now seen the logic that was clear to me 43 years ago.
    If that final step isn’t already understood by some small number of individuals, it soon will be.
    When every individual has personal self interest stretching out thousands of years into the future, then the sort of long term view I have held for the last 43 years will become more common.

    3/ the impact of exponential technologies, particularly in the area of fully automated manufacturing. At present we can fully automate many processes, mostly related to information processing, and the economic value of many of those has dropped to zero.
    As that technology spreads into manufacturing and energy production, an exponentially increasing set of goods and services will become like the air we breath – vitally important to each of us, yet of no economic value.
    That reality poses a fundamental challenge for any market based system of values.
    How can we use markets to manage things sensibly when many things have zero value.
    Putting zeros in equations doesn’t usually produce sensible outcomes, particularly where divisions are involved, but also with multiplications.

    We are in a period of transition.
    We are moving from a historical reality dominated by scarcity, to a coming reality of technological abundance.
    How we manage that transition is fundamental to our survival.

    We do not see vast numbers of high tech civilisations sending messages from nearby stars or galaxies.

    I suggest that would seem to indicate that the coming transition is not simple.

    Yes we live in very complex systems.
    And we are capable of making choices as to the nature of the highest levels of such systems.

    And at the highest level, games theory is clear – only the cooperative have a high probability of survival.

    And nothing is certain.
    Everything is probability functions.
    We could all make our best efforts and still have it all go “belly up”, that is a real possibility.
    And if we don’t make our best efforts, belly up is a very high probability. The number of possible failure modalities is also increasing exponentially.

    • Eric Snow

      Yes and yes and yes….and then no. Technical abundance leads not, necessarily, to an absence of scarcity. And then yes, again. “Nothing is certain.”

      • Hi Eric,
        Within the set of things required for human existence and reasonable degrees of freedom of action (air, water, food, shelter, sanitation, energy, education, communication, healthcare, transport, tool-sets), then we can achieve universal abundance.
        Of course in the infinite set of the possible, the vast majority will remain scarce. And the sorts of lifestyle possibilities that most currently conceive as high end don’t actually require a lot of mass or energy if you get really smart about how you provide them and close all material loops to achieve close to 100% recycling.

        When technical abundance achieves Drexler’s molecular level manufacturing, then we are very close to universal abundance for all practical purposes.

        The Sun is a vast source of energy, and likely to remain so for a considerable time (far longer than mammals have existed to date) – so not of immediate concern.

  • pbillp65

    Very nice, except you make one rather small but immensely important mistake. You do not consider that the people at the top of the economic pyramid have the ability to “purchase” the government and thereby greatly reduce the governments ability to tax and redistribute the monies that naturally flow to the top. The history of the last 70 years in the United States is a clear picture of how to insure that the poor stay poor and those at the top never have to worry about someone challenging their position via government intervention.

    • wjohnfaust

      Yes. The author does seem to require a properly functioning democracy to offset the failures of capitalism — something that isn’t found in the US.

      • pbillp65

        The problem is not simply American. Big Money elites corrode and erode democratic systems everywhere, including G.Britain and Europe. The only way to stop that would be to do away with Capitalism, or do away with how the business decisions are made. Take the power away from the dozen of so Board Members and give it to the workers of the company/organization/corporation. In other words, democratize the enterprise. Until we do that, we will always be forced to suffer the instability that is inherent in the Capitalist System, and the takeover of the government for the benefit of them Board Members. That is the flaw in the theory and the system. The one mainstream economists seem to be blind too.

  • Brux

    This is a really great website and these ideas need to permeate the world,
    or at least our nation as fast as possible. That said …

    — The Piketty debate exposed the dysfunction in economics

    I think the Piketty debate would be more about criticizing capitalism, not
    so much economics except as it is used to bolster and support capitalism.
    That is that those who have money are at a huge advanteage in terms of
    their lives and making more money. The idea of working and saving, or
    even investing at a low level – a fledgling capitalist still puts you in a scale
    where unless you hit the jackpot in some way, legal, gambling or illegal
    you – and by you I mean most of the billions of people on this planet will
    be nothing because everything is already owned by the big time oligarchic
    capitalists.

  • carolannie

    I would be a lot happier with academics if they could simply refrain from the pettifogging attacks on each other and simply discussed their ideas. It is one reason I tend to avoid blogs by academics.