Wednesday, December 26, 2012

Reading Keynes part 3

In my previous post in this series I described some thoughts that came from reading book III of Keynes's General Theory. Before moving on to discussing subsequent books, I'd like to make some notes regarding the simple model I discussed in that post.

The first note regards how a lack of consumer spending (in the absence of saving and investment) could drive an economy to disaster. A step in the argument was that employees who feared for their jobs will cut their consumer spending. This is plausible, but there are really two types of such spending. The one that can be most readily cut is the spending on luxuries, but spending on essentials, such as food, clothing, rent and repairs cannot be cut below a certain level. This enforced minimal level of consumption can stop a descent into complete economic collapse, but the word 'disaster' is still applicable as this bottomed-out economy will doubtless have high unemployment and a class of the employed that are living on the breadline.

My second note on the last post concerns the statement at the end on how effectively the 1% can syphon away the wealth of the 99%. This jars with the fact that the 1% own the companies that pay the wage bill of the 99%, and that they are therefore reliant on the consumers (the 99%) recycling the money back to them by spending and/or saving. I think the answer here is two-fold. A minority of companies do successfully syphon money to themselves (e.g. Apple) but it's at the expense of their competitors (e.g. Microsoft) not their customers. But I was really meaning sums of money summed up across the whole economy, and I believe that aggregate syphoning from consumers isn't significant, and that it can actually occur towards the poorer 99%. However, it is clear that the 1% start off with disproportionate ownership of wealth, including the capital to generate and control it, and they use that control to make sure they continue to own their unfair share.

Book IV of The General Theory is entitled The inducement to invest and its first of eight chapters is called The marginal efficiency of capital. In very loose terms, the marginal efficiency of capital is to capital what interest is to money (despite the popular misconception, capital is not synonymous with money). If we give money to another party, we can expect them to pay us a sum of money over time  - the interest - for allowing them to hold and use the money. Likewise, if we invest in purchasing some capital equipment, say machines for making mobile phones in a factory, then we will expect our ownership of those machines to bring us a net income over time from the sale of produced goods. Keynes makes a rigorous definition of the marginal efficiency of capital so he can go on to compare such income with interest rates. The main conceptual difference between the two is that for the latter the owner of the money is not directly concerned with how the asset (i.e. the money) is used to generate a return.

Much of the subsequent chapters are concerned with discussing the interplay between the marginal efficiency of capital and interest rates. If interest rates are low then there is a greater incentive to invest in purchasing capital assets and expect a return from them, and vice versa for high interest rates. But, of course, it is not so simple. There are psychological factors at work. How do people perceive the future? If there is optimism that consumer spending will remain strong, then investment in capital will be more attractive. But if not, people may have a preference for liquidity and be less inclined to lock up money in more difficult to release capital equipment, even if interest rates are not very high.

Keynes discusses what sets money apart from other repositories of wealth and makes the point that interest is not actually unique to money. One example that occurred to me was carrots. A crop of carrots is perishable, unlike money, but a given number of carrots can be planted and grown - that is "invested" - so that year-on-year, assuming you didn't sell them, you would add to the total number of carrots in your possession (even though these wouldn't be the same carrots). You could quite legitimately call the extra number of carrots each year your interest. If you instead, as most farmers do, sold those carrots to receive a return in terms of money then that return would feed into your calculation of your marginal efficiency of capital (along with the initial stock of carrots, land, machinery etc).

The carrot example illustrates a couple of points, most obviously that money is preferential to carrots for holding wealth because it doesn't necessarily incur land, labour and storage costs. But it also demonstrates what Keynes calls "own-interest", i.e. you can define the interest rate of carrots in terms of carrots. This helps explain what he means in this key quote from Chapter 17 Section III:
No further increase in the rate of investment is possible when the greatest amongst the own-rates of own-interest of all available assets is equal to the greatest amongst the marginal efficiencies of all assets, measured in terms of the asset whose own-rate of own-interest is greatest.

He argues that the thing with the greatest own-rate of own-interest is money. So, in plainer English, he is saying that people will put their wealth into a form that they see as most likely to increase their wealth. The convoluted digression into interest defined in terms of other assets (such as carrots) strikes me as possibly a distracting abstraction, but it shows the rigour that Keynes wished to apply to his arguments.

To return to the key point, the halting of investment caused by a high money rate of interest can (and usually does) stop an economy proceeding to full employment. To put it more starkly: even if companies are wanting to find a way to increase profits, and even if willing and able unemployed workers are wanting employment, the economy might not be able to respond because of a blockage caused by a shortage of the very thing that is supposed to facilitate the economy: money. Keynes highlights this absurdity in his delightfully idiosyncratic style:
Unemployment develops...because people want the moon;- men cannot be employed when the object of desire (i.e. money) is something which cannot be produced and the demand for which cannot readily be choked off. There is no remedy but to persuade the public that green cheese is practically the same thing and to have a green cheese factory (i.e. a central bank) under public control.
He goes on to highlight the folly of attempting to anchor the value of money against a rare substance extracted from the Earth:
It is interesting to notice that the characteristic which has been traditionally supposed to render gold especially suitable for use as the standard of value, namely, its inelasticity of supply, turns out to be precisely the characteristic which is at the bottom of the trouble.
In other words, if you tie money to something that appears to have tangible value, then you actually make the situation worse because you lose all control over the supply of money to the economy and are then completely helpless in dealing with a money shortage.

But, putting gold standards, interest rates and capital aside, the problem is very simple: we have become too preoccupied with money itself, to the extent it distracts us from the essentials of the production it is supposed to facilitate, namely, securing food, shelter, employment and health.

No comments:

Post a Comment