Online Primer

By Noah Nissani

Copyright 1996 -- Authorized free distribution of non-modified copies for non-commercial purposes.

Chapter II

POLITICAL ECONOMY -- Part I

Adam Smith
Adam Smith
(Encarta Encyclopedia)

Contents:

Introduction
Historical Antecedents
Free-Market Economy
Supply-Demand Law
Marginal Cost
Relative Efficiency
Surplus Value
Saving and Investment
Notes 
   

Chapter I     Chapter III     Chapter IV    Chapter V

 

Introduction

The period spanning from 1687 to 1789 saw the birth of three modern sciences: Physics, economics and chemistry. Modern physics began with Sir Isaac Newton's (1642-1727) book, "Philosophiae Naturalis Principia Mathematica" (Mathematical Principles of Natural Philosophy), published in 1687. Modern economics emerged with Adam Smith's (1723-90) book, An Enquiry into the Nature and Causes of the Wealth of Nations, published in 1776. Alchemy was transformed into chemistry with Antoine Laurent Lavoisier's (1743-94) Treatise of Chemistry, published in 1789. In all three cases, the transition was not an evolutionary, but rather a gigantic leap that involved basic concepts, ways of thinking and scientific method, changing primitive science into modern science.

Newton introduced the basic concepts of force, mass, gravitation and inertia, which constitute the fundamentals of classical physics up to our days. He established the laws that govern the movement of bodies on earth's surface as well as in stellar space. He also invented, simultaneously with but independently of Gottfried Wilhelm von Leibniz (1646-1716), the infinitesimal calculus needed for his physical investigation. Any later physical theory, e.g., the Theory of Relativity or the Theory of Quantum Mechanics, had to show, within the boundaries of ordinary experience, results similar to Newton's. As a personal note, Elhanan Leibowitz and myself became convinced of the acceptability of our tensorial expression for the relativistic gravitational energy, only after we succeeded in obtaining values concordant with Newton's for the total gravitational energy in the surrounding of a star, and for the velocity of a free-falling body(1)

Aristotle's theory that four primary elements -- air, water, earth, and fire -- are the building blocks of matter, prevailed unchallenged for more than two millennia (Aristotle, (Physics , Book II, Part 1). It was the "theoretical" basis of the medieval alchemy, and of the alchemists' obsessive search for the philosopher's stone capable of transmuting ordinary metals into gold, the elixir of immortality and the panacea for all illness. Although Robert Boyle (1627-91) dismissed this speculative theory in his book The Skeptical Chymist (1661), it was not definitely invalidated until Joseph Priestley (2) (1733-1804) and Henry Cavendish (173 1-1810) demonstrated that air and water are compounds in themselves. With his discovery of oxygen (1774), Priestley showed that air is a mixture of gases and therefore cannot be a primary element. Soon afterwards, Cavendish showed that water also cannot be considered a primary element, since it is a compound of oxygen and hydrogen. Finally, in 1789, only fifteen years after Priestley's discovery of the oxygen, Lavoisier established the bases and scientific methods of modern chemistry.

In this general atmosphere of rational criticism and replacement of speculative theories by scientifically based ones, Adam Smith's book appeared founding modern economics.

 Historical Antecedents

I will risk asserting that the first historical testimony of the inherent dangers of a centralized economy is found in the Bible. The previous chapter deals with the Biblical description of the liberal regime that ruled the Israelite tribes during the period of the Judges (app. 12th & 11th centuries BC.), which the Bible defines as the reign of God (1 Samuel 8:7). As counterpart the Bible also provides a detailed description of a totalitarian regime with a centralized economy, which seemingly acting for the welfare of the people, ultimately enslaves them.

As the Bible tells us, Joseph foresaw seven years of abundance followed by seven years of famine. Following Joseph's advice, the excess crops produced during the seven years of abundance, were gathered by government, thus saving the Egyptian people from starvation during the subsequent seven years of shortage. The famine also affected Canaan, causing Joseph's father and brothers to move to Egypt, where they were heartily received, and settled in the land of Goshen (Genesis chapters 41, to 47). This government intervention in Egyptian economy has a sad epilogue revealed in verses 13 to 25 of Chapter 47: The Egyptians became slaves of Pharaoh, who "moved them into the cities, from one end of the borders of Egypt to the other end" (Genesis 47, 21) (3). Thus the Bible tell us: "You have hereby been warned".

It is worthwhile noticing that these versicles have very little to do with the Jewish people's history, hence they are somewhat outside of the main narrative line of the Bible. Furthermore, they destroy Joseph's image as a wise ruler, which seems to be opposed to the general tendency of the story. Therefore, one cannot escape the feeling that they are present as a warning of the danger implied in even the best intentioned government intervention in economy, which is in accordance with the (classical) liberal tendency of the Bible.

Philosophical debates on the issue of common versus private ownership are found in the Greek classics. In Plato's book "The Republic", Socrates argues in favor of totally common ownership, including sharing of women and children: "Yes; and where there is no common but only private feeling a State is disorganized --when you have one half of the world triumphing and the other plunged in grief at the same events happening to the city or the citizens?".. "Such differences commonly originate in a disagreement about the use of the terms 'mine' and 'not mine,' 'his' and 'not his.'" (Plato, The Republic, Book V:215). "..the possession of women and the procreation of children, which will all follow the general principle that friends have all things in common, as the proverb says." (O.c., Book 4:58). Socrates is, therefore, a precursor of Karl Marx and other totalitarian ideologists that imagine a different society, and believe they are capable of changing God's creation by decree. Liberal thinking, in contrast, sees legislators function as searching for the laws of society, as physicists do it for nature's laws. "Fatal is the illusion which legislators fall into when they pretend their talent and desire can change the nature of things or supplant nature by sanctioning and decreeing creations" (Bernardino Rivadavia, first president of Argentina, 1826 -- Cited in "The Bases", Chap. 17, of Juan Bautista Alberdi. The latter was the most outstanding Argentinian liberal ideologist.) Note that these prophetic words were said over twenty years before the appearance of Karl Marx's The Communist Manifesto (1848).

This liberal attitude regarding legislator's function has been misunderstood, leading to the false idea that liberals are conservative-minded individuals who oppose all change. On the contrary, liberals have always had a clear idea of the desired characteristics of man and society, and liberal ideas have deeply transformed the world. The main difference between Liberalism and Totalitarianism, resides in the partition of functions between government and people. "A people having sovereign power should do for itself all it can do well, and what it cannot do well, it must do through its ministers" (The Spirit of the Laws, 1, 2, 2, (1748), Charles Louis de Secondat Baron the Montesquieu (1689-1755).) In accordance with this liberal principle, transformation of society should be carried out by the people, and not by government decrees. Indeed, the liberal revolution, which generated far reaching changes in society, was more an outcome of the authorities' abstention than of their intervention.

Aristotle, in contrast, was a precursor of Adam Smith in economics, and of Montesquieu in politics. In Aristotle's book Politics, II, V, we read: "Property should be in a certain sense common (4), but, as a general rule, private; for, when everyone has a distinct interest, men will not complain of one another, and they will make more progress, because everyone will be attending to his own business."

In modern ages, before Adam Smith, economics closely resembled medieval alchemy. Like alchemists, who were looking for the philosopher's stone that could turn ordinary metals into gold, economists focuses on searching for the unique source of the wealth and prosperity of nations. Mercantilism, which prevailed during the 17th and part of the 18th centuries, equated bullion reserves with the wealth of the nations. It advocated, therefore, government restriction of imports and promotion of exports. Traces of this perspective are reflected in the increased customs taxes and export subsidies during the last half of the 19th and the beginning of the 20th centuries.

In the bloody first half of the 20th century, these restrictions on free international trade granted privileged access to raw material and markets, to those European nations that owned large colonies such as England and France. It was no doubt, a short-term economic advantage for these European nations, to the detriment of others less favored with colonial possessions, such as Germany and Italy. This inequality was probably one of the causes of the two world wars. How unfortunate that tens of millions men needed to die in order to convince the world to renounce colonialism and to return to international free-market.

In the 18th century, the French economist Francois Quesnay (1694-1774) founded a new school of economists, the physiocrats. He maintained that agriculture is the unique source of wealth, since it creates new material, whereas industry and commerce only transform and distribute them. It seems that the physiocrats grew out of an atavistic reminiscence of the primeval human experience, when passing from the recollection of fruits to their cultivation. This cultural revolution has certainly had a lasting influence, which is currently evidenced in differential status of agriculture vis-a-vis other economic fields. It is perhaps one of the causes that agriculture is the most subsidized economic activities in Western world.

It was against this prescientific background that Smith's scientific work appeared, and established the fundamentals of modern economics. The attempt to examine the unique cause of a nation's wealth, which characterized Smith's predecessors, was replaced by rational analysis of free-economy's complexity. The latter is characterized as possessing internal regulating mechanisms that make it the most appropriate means of providing for the people's welfare. It also suits human nature, and even human selfishness contributes to general welfare and prosperity. After more than two centuries, Smith's work, like Newton's and Lavoisier's in physics and chemistry, continues serving as the basis for current political economy.

Adam Smith's assertion that human selfishness also contributes to general welfare through the mechanism of free-market competitiveness, has been misunderstood by some detractors of Liberalism. It was been argued that Liberalism promotes anti-social behavior and lack of concern for the poor. Nothing could be farther from liberal ideology than this fallacy. The fact is that human nature is not simple. Every individual possesses a complex set of contradictory qualities such as selfishness and altruism, in varying proportions. Capitalists are neither more egocentric nor more generous than workers, and liberals are no less concerned than socialists with the disadvantaged strata of society. Most of classical liberals were from a religious background. This motivated them to consider all human possessions, including one's own body, as a temporary deposit by God, which must be administered according to God's will. According to this liberal approach, capital is a source of power that should be used by capitalists, just as political power should be used by politicians, for the benefit of society. No politician is completely devoid of personal ambition, and most capitalists act with some degree of idealism.

Nearly one century after the publication of Adam Smith's book, Karl Marx (1818-83) published "The Capital" (1867), in which "scientific socialism" is offered as an alternative to free-economy theory. Marx's main claim was that surplus value, i.e., the excess of price over cost, is actually what capitalists steal from workers. Private ownership of the means of production is the cause as well as the result of this robbery, constituting a vicious cycle that perpetuates exploitation and misery of the working class. Therefore, in order to create a more just society, social ownership must replace private enterprise. Nevertheless, Marx acknowledges that surplus value will also be required in a socialized economy, in order to allow for development of new factories. What Marx fails to explain is why government employees would handle surplus value more efficiently than capitalists. Today, after the universal collapse of the Marxist regimes, the hundreds of millions of violent deaths and subjugation of people in the process of imposing them, and the aftermath of misery, crime, prostitution and ecological disaster left behind them, Marx's fallacies have become self-evident.

Today the liberal economy confronts a less "scientific" and more instinctive, or perhaps demagogic, adversary. We will call it the "dog's curve thinking", i.e., an instinctive way of thinking similar to the path followed by a dog when running after prey. Let's assume a dog that pursuing a rabbit, runs at any time toward the place where the rabbit is. Given the path of the rabbit, the place where the dog was at the beginning of the pursuit, and the respective velocities of each animal, it is a known exercise for students of calculus to find the path followed by the dog. The instinctive behavior of dogs differs from the more rational behavior of a military pilot who, when intercepting an enemy aircraft, flies toward a point ahead of the enemy's current position.

There are numerous examples of dog's curve thinking on economical issues: One of them is in the very basis of the Marxist "scientific" socialism. Contrasting the wealth of capitalists with the misery of workers in the 19th century, it was clear, according to dog's logic, that transferring ownership of factories from capitalists to workers will improve the fate of the latter. Universal experience has shown the catastrophic outcome of this "scientific-dog's thinking".

As a contemporary example of "dog's logic" there is the assumption that it is possible to favor the poor by subsidizing products by means of money taken from the rich. The fallacy in this case is double. On the one hand subsiding disturbs the competitive process, and hence retards the improvement of tools and means of production, which is the only real way to increase the purchasing power of salaries. On the other hand, there is no chance that it would reduce the living standard of the rich. In practice, the money is taken from the part of capital gains that would otherwise be diverted to the creation of new jobs and improvement of means of production. Therefore, this populist policy retards the raising of the living standard of the masses, and increases unemployment.

Other examples of "dog's logic" are: imposing taxes on imports and subsidizing exports in order to preserve local jobs; increasing salaries at the expense of capital gain; etc.. In practice, all of these measures contradict their intended purpose. The fallacy inherent in some of these examples of "dog's logic" will be clarified in the following sections.

 Free-Market Economy

Economics is currently divided into "macro- and micro-economics". Macro-economics deals with the laws governing the economy of states as a whole, while micro-economics deals with the economic behavior of individuals, firms or specific branches. This primer deals only with macro-economics, known as "political economy" until the 1930's.

The laws of macro-economics are statistical in nature, i.e., they only establish relations between average values, and say nothing about individual cases. They are similar to the laws of statistical physics, e.g., the laws of ideal gases, which establish the relation between temperature and molecular average velocity, but reveal nothing about the velocity of any given molecule.

Statistical physics deals with the laws of "ideal gases", rather than those of "real gases", since the behavior of the latter is too complicated to deal with, and the results obtained after the simplification involved in their idealization are approximated enough for practical purposes. The same principle can be applied to the laws of macro-economics. Even though these laws are assumed to be exact for "ideal societies", they provide useful insight into real societies.

This chapter is based in the ideas espoused by economists of the 18th and 19th centuries, whose prominent representatives where Adam Smith, Jean Baptist Say (1767-1832), author of "A Treatise on Political Economy" (1803), David Ricardo (1772-1823) Principles of Political Economy and Taxation (1817), and John Stuart Mill (1806-73), Principles of Political Economy (1848). In the next chapter later contributions, such as those of John Maynard Keynes (1883-1946), General Theory of Employment, Interest and Money (1936), and Milton Friedman (1912), will be considered.

The following sections deal with laws that establish relations between the average values of salaries, prices and profits. In order to determine these relations, let's assume an idealized society characterized by a totally free competitiveness in a quasi-static isolated market of great dimensions. The competitiveness must be free of external and internal disturbances such as government and monopolist constraints. Isolated market means that there is no interaction with any external market, although many free-interacting free-markets may combine to form one isolated unity. The number of people and enterprises in each sector must be large enough to allow for reliable statistical results. It must also exist, with all its sectors, for a long enough period to reach a quasi-static state, i.e., a state in which the changes are slow enough to allow for passage from a static state to another static state, similar to the series of static pictures that make up a film. These conditions are similar to the ones required for a gas to be considered an ideal gas. However, no society meets all of these requirements, as there is no ideal gas. Nevertheless, the conclusions reached when considering such idealized gas or society are useful for understanding real ones.

 Supply-Demand Law

Everyone has heard about the law of supply and demand, which determines prices in a free-market. When demand exceeds supply, prices rise. When supply exceeds demand, prices drop. When the demand for a given product exceeds its supply, the rise in price stimulates its production and thereby increases the supply. At the same time the high price discourages potential buyers, the demand decreases and the price drops. Ultimately, a balance is achieved between supply and demand, stabilizing the price of the merchandise.

The above supply versus demand mechanism is right, but there is more to the story. In order to understand the behavior of free-market, three additional concepts must be introduced: marginal cost, relative efficiency, and surplus value.

 Marginal Cost

From here on, unless specified otherwise, the word "production" refers to the entire process, including transport and marketing, from raw material to the delivery of the finished product to the user. "Factory" refers to all intermediate agents between raw material as it is provided by nature and the final consumer. For simplicity's sake, taxes and subsidies (negative taxes) will generally be omitted when considering prices (P), salaries and gains.

The following classic example explains marginal cost:

Let us assume that corn is produced at its lowest cost per pound in a given geographic area, and that as one moves away from that area, corn crop per acre decreases and its cost of production rises. A high market price of corn provides an incentive for farmers to grow it in the regions where its production cost is lower than its current price. The resulting increase in supply will reduce corn's price, leaving farmers in a marginal area without profits. This mutual regulation mechanism between corn market price and the radius of its cultivation area, tends to maintain the latter within the marginal region where cost statistically equals price (P). The production cost that equals the market price will be named "marginal cost" (M). Therefore, P=M is an identity (5) independently of the actual existence or not of such a farmer that grows corn at its marginal cost.

In practice, production cost is more influenced by variable means and systems of production, than by fixed geographic factors. Free-market competitiveness leads to a continuous seeking of more efficient tools and techniques, which in turn reduce prices. Consequently, enterprises that fail to maintain production cost below the continuously lowering marginal cost are pushed out of the market.

 Relative Efficiency

Relative efficiency (RE) is the difference between marginal cost, and cost of producing a product (C) in a given factory, i.e., RE=M-C=P-C. Hence, RE varies from one factory to another and is the source of capital profits. Enterprises that produce at the highest relative efficiency, i.e., at the lowest production cost, tend to increase their profits by price reduction and consequent sales increases.

Therefore, the presence of factories with varied relative efficiency in a competitive market causes a continuous decline in prices, and forces the least efficient enterprises to either improve their efficiency or disappear from the market. Thus, relative efficiency leads to a continuous searching for new methods and products, with the consequent reduction of costs and prices, improvement of salary/prices ratio, and a raise in workers' standard of living.

As an example of this process, let's examine changes in bread production from the beginning of the industrial revolution to the present. Bread production begins with repeated plowing and raking of the soil until it is ready for sowing. For thousands of years, from time man moved from gathering to cultivating food, up to the 19th century, plowing was done with one-colter plow, drawn by an ox, a horse, or a donkey, sometimes together with farmer's wife. Afterwards, the wheat seed was sown and scattered by hand. Superficial plowing, irregular seed distribution, low seed quality, and lack of efficient resources to counteract pests and weeds yielded very poor crops at best, if they were not completely destroyed by drought or locust.

The hardest task, however, was gathering the crops by reaping the wheat spikes with a sickle or scythe, binding the spikes in sheaves, and carrying the sheaves to the threshing floor. Then the wheat grains were separated from the straw and the chaff by beating with a flail or by trampling on it. Afterwards, the straw and chaff were removed from the grain by the wind, through continuous flinging in the air with pitchforks, Finally, the grain was sacked and carried to the windmill to be milled into flour, and the flour was kneaded by hand and baked.

This meager pound of bread, which required an investment of so many man-hours, was had to be shared with the workhorse, with the smith who made and repaired the work tools, as well as with many other material or spiritual service providers, the government, and the landowner (6). It is not surprising, therefore, that the remaining bread could not provide sufficient sustenance for the farmer's family. Many children died when the birth of a new baby weaned and forced them to share the scarce bread with their older and stronger siblings. Hence, despite the high birth rate, an average of nearly two children per family survived to adulthood.

Furthermore, the large amount of manpower required for food production prevented the development of other areas of economic activity, and created an agricultural mono-economy. As a result, temporary adverse climatic conditions and agricultural plagues caused famines, which had catastrophic consequences. These factors, together with the primitive state of medicine, whose accelerated development began simultaneously to the expansion of liberal ideas in the 19th century, explain why the world population remained quasi-static for thousands of years.

The industrial revolution replaced the one-share plow, hand-forged by the town's smith and drawn by a horse, with the multiple-share plow, manufactured by a metallurgic factory and pulled by a tractor. Today, deeper and more effective plowing is carried out by one man, who comfortably sits protected from sun and rain, and does the work that once required the effort of nearly thirty men. Concomitantly, the improved quality of seed, and effective means of counteracting plagues and weeds, have led to a multiple increase in the yield of crops per acre. Finally, gathering, the once complex and difficult operation described above, is presently carried out by the harvester, a machine with long blades that simultaneously reaps the wheat spikes, separates the grains from the straw and chaff, and puts them in sacks. Today, only one or two men are needed to gathering tens of acres of wheat -- one at the steering wheel, and the other controlling the correct functioning of the whole process.

The decrease in the amount of manpower required for food production increased the salary/food-price ratio, increasing the worker's buying power, and enabling them to purchase new products. This new buying power, which equals the salaries of the workers displaced from agriculture combined with the associate landowner profits, provides for the salaries and profits in the industries that supply the new merchandise. This is an example of the internal equilibrating forces operating in free-market -- the new tools that cause unemployment, they also free acquisition power, which in turn creates new jobs for the displaced workers (7).

Surplus Value

Surplus value (SV), an expression coined by Marx, expresses the difference between market price and cost of production. Given the quantitative equivalence of marginal cost and market price, surplus value and relative efficiency are also quantitatively equivalent, i.e., SV=P-C=M-C=RE. Whereas "relative efficiency" refers to improvement of methods and tools, which ultimately results in reduced prices and increased standard of living, "surplus value" refers to the source of the envy-causing capitalist gains.

The surplus value that remains after income tax is deducted, generates new capital, which attempts to find lucrative investments. Part of it is invested in construction of new factories in industrial branches with good prospects of profits, i.e., branches in which there are enterprises marketing with high surplus values. This results in increased supply and consequent reduction of price, marginal cost, and surplus value. Another part of the new capital generated by the surplus value is reinvested in enhancing the relative efficiency and consequent gains of the enterprise, through development of new merchandise and methods of production, which ultimately results in lower prices and new commodities. Therefore, part of the surplus value makes more commodities accessible to more people, and will be referred to henceforth as the "positive part" or "part A". Of these new commodities, two categories deserve special mention on light of their transcendental social relevance: medicines, and new tools for agriculture and other food industries.

There are two other less positive but unavoidable components of surplus value. The first, which will be named "B", is wasted in faulty investments. Although capitalists aim toward complete success in their investments, some inevitable fail and result in capital loss. The amount of this loss is an inverse function of the capacity and personal involvement of the decision-makers. Finally, another component of surplus value, which will be referred to as "C", is enjoyed by capitalists and their families and allows them a standard of living above to that of the majority of the population. Thus, the prospects for a high standard of living in capitalist societies stimulates the youth to risk the instability and danger associated with entrepreneurship. This component of surplus value, which capitalists and their families enjoy, may be seen as the wage for their work in enterprise management and investment planning.

Furthermore, the continuous increase in the salary/prices ratio enables workers to put aside an increasing proportion of their salary for future use. This workers' saving is directly or indirectly invested in industry and commerce through shares or bank deposits. As a result, an increasing portion of surplus value returns to the workers in the form of dividends or interests.

The sum of parts "B" and "C" will be referred as the negative part of surplus value. The relation between the positive and negative parts of the surplus value, i.e., A/B+C, is one of the discriminant factors for evaluating any economic system. As Karl Marx pointed out, surplus value is not limited to capitalist economy, but is also necessary as a source of new jobs and merchandise in a socialist regime.

The differences between surplus-value in capitalist and socialist regimes can be described as follows:

1) In socialists regimes, the element of competitiveness is eliminated, and salaries and prices are determined by bureaucratic decision. Hence, surplus value is no longer the result of relative efficiency, i.e., of the constant improvement of means and methods of production that entails reduction of prices and rising of the living standard of the people. Hence, the standard of living of the population in a socialist society remains lower that it would have been in a capitalist regime.

2) The decision-makers in socialist regimes are bureaucratic employees with less personal involvement and incentive than their capitalist counterpart, which increases the possibility of wrong decisions, i.e., the negative part "B" of surplus value.

3) Part "C", i.e., the part of surplus value that benefits capitalists and their families, is now replaced by salaries and bribery of a hypertrophic bureaucracy.

4) As a dubious compensation, factories constructed by means of surplus value are now bookkeeping as pertaining to the people.

In sum, in a free-market economy, relative efficiency and surplus value are two sides of the same coin. Though conceptually different, they are mathematically equivalent and measured by the difference between price and cost of production. Each one generates the other, and both together raise the living standard of the masses, by lowering costs and prices, and by developing medicines, tools, and commodities. Although factories established out of surplus value resources, are officially owned by capitalists, they are a social asset that benefits the entire population. In practice, capitalists are the administrators of surplus value in charge of investing it in the most efficient way. From an economic point of view, only part "C" of surplus value, which is used for the personal benefit of business owners and their families, is the capitalists' share of the collective wealth.

 Saving and Investment

In every society manpower is divided into two categories -- workers that produce merchandise for current consumption, and those that lay the groundwork for future production. For example, one group produces food, clothing, etc., while others build new factories, or seek new tools and commodities. The aggregate labor of the latter constitutes the "social saving or investment", which is present in even the most primitive societies, e.g., preparing of soil for future cultivation, or planting of trees that will bear fruit in the future. From an economic point of view, saving and investment are equivalent concepts, which imply that those who produce merchandise for current consumption must share it with those who are preparing future production. They represent, therefore, a collective renouncement to some consumption in the present, for the sake of more or better consumption in the future.

In modern society the concepts of saving and investment are complicated somehow by financial and bookkeeping considerations, and although they are no longer identical, their equality reflect a sound economy. In financial terms, saving is defined as the difference between disposable income, i.e., salaries and profits after income tax deduction, and consumption expenditure. It is therefore equal to part A+B of surplus value plus the aggregate sum put aside by workers for contingent or planned future use, whereas investment is defined as current expenditure for the purpose of future consumption production. Saving is the main but not the sole financial source of investment. Taxes are also partially invested in infrastructure or in government enterprises, and, in a non-isolated market, foreign investment must be considered. The line separating consumption and investment expenditures is also not always clearly defined, as there are gray areas such as housing construction and education. In the present context it will simply be assumed that taxes are the payment for government services, and they will be considered part of consumption. Neither foreign investment nor national investment in foreign markets will be considered, as we are dealing with the economy of isolated markets.

Saving and investment may differ because the decisions in each of those areas are taken by different people. Whereas savers are entrepreneurs as well as workers, investors only are entrepreneurs. It is therefore possible that enterprisers may not be eager to use all disposable savings, or savers may prefer alternative ways of preserving their money, without putting it at disposal of entrepreneurs. Both cases result in savings that are unproductively invested in cash, precious stones and metals, or speculative acquisitions of stocks and real state. Investment in the stock exchange is economically positive, since it facilitates financing of investment by means of issuing new stocks. Also residential construction enterprises are in need of buyers like any other productive activity. However, the mere transfer of shares and real state from one hand to the other does not fit to the definition of investment as current expenditure for the sake of future consumption production.

Furthermore, speculative saving in shares and real state causes an artificial rise in prices over real values, and creates a dangerously unstable economic situation which has been referred to as a "financial bubble". It creates a false illusion of wealth, which may reduce savings and increase consumption. As a result, the equilibrium between consumption and investment supplies and their respective demands is broken. The excess of demand over supply for consumption products results in inflation, whereas the excess of supply over demand for investment products may result in dismissal of investment workers. If this process is slow, workers move from investment to consumption industries, and the market simply passes from one state of equilibrium to another, with a different distribution of consumption and investment expenditures. However if the process is rapid there may be a notorious lag between workers discharge from one sector and their absorption in the other, because the latter may require creation of new jobs and new investments, and a general recession may ensue. Inflation of stocks and real estate values has preceded major economic crises, such as the recession in the 1930's, and the recent real estate crisis in Japan that undermined the stability of Japanese banks.

The main causes for saving-investment disequilibrium are adverse political conditions that discourage enterprisers from confronting the risks inherent in promotion of new enterprises. These adverse political conditions are generally: political instability, high income taxes, excessive government intervention, bureaucracy, and labor legislature. It was only after the rise of the "laissez faire laissez passer" liberal doctrine, that wealth became capital, i.e., enterprise replaced cash, real state and precious metals as the preferred way of accumulating wealth. For centuries, savings in the form of goods that can be easily realized or transported was an understandable precaution against political instability and totalitarian regimes.

Government intervention as a forced partner in administration of gains but not in losses is a strong deterrent against investment. Furthermore, the wealthier the taxpayers, less their standard of living is affected by taxes. Hence, the demagogic justification of income tax as taking from the rich and giving to the poor, is incorrect. In practice tax revenue is derived from investment, which delays job creation and increase in the living standard of the masses. Economy is like a system of linked tubes with the thin ones above and the thick below. No matter where the water comes out, the thin tubes are always emptied.

In terms of bookkeeping, factories established by saving investment in free-marked economies are formally owned by capitalists, and in an increasing share by workers who invest their savings in stocks. Whereas, in a socialist regimes the assets are registered in the name of government. In practice, however, the only difference is the party responsible for administration of social savings. From a social perspective, all that matter is how efficiently savings achieve the goal of improving the salary/prices ratio, creating new jobs, and making more commodities accessible to more people.

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NOTES:

(1) Nissani N., and Leibowitz E., "Experimental Facts and Gravitational Energy in General Relativity". International Journal of Theoretical Physics, Vol.31, No. 12, Pg. 2065, (1992)

Abstract:

It is shown that there are coordinate systems in curved space-time wherein energy-momentum is globally conserved. These coordinates share the experimental features of the inertial frames of flat space. The falling of matter in a spherical symmetry gravitational field is studied on the light of the energy-momentum conservation valid in these coordinates. A recently proposed tensorial expression for the gravitational energy-momentum is used. Return

(2) Joseph Priestley (1733-1804) was also one of the founders of modern Liberalism in the areas of religion and education, where he opposed all government intervention. Among other political philosophic works, he is the author of "An Essay on the First Principles of Government and of the Nature of Political, Civil, and Religious Liberty" (1771). Return

(3) The New King James version of the Bible translates the Hebrew word "avadim" as "servants", while other translations use the term "virtual slaves". It seems that "slaves" is a more accurate translation of the Hebrew expression and fits the context better. E.g., verse 23 says: "Indeed I have bought you and your land this day for Pharaoh". Return

(4) Aristotle refers to the state, the army and such as "common property". Hence, this expression should not be understood as supporting what is currently referred to as mixed economy. Return

(5) The existence of pairs of quantities that are conceptually different but quantitatively equal is a characteristic of economics. Return

(6) Beyond a doubt the landowner is the more questionable participant from the farmer's bread. While other forms of ownership are warranted by the natural right of possessing the product of one's effort, landownership is rooted in a primal act of violence and usurpation. Furthermore, other ownership of any other means of production, such as factories, requires constant initiative, investment, management, and other issues which do not concern the landowner.

Liberals have always been concerned with this dubious aspect of private ownership. The Bible, which is the eldest source of liberalism, prevents latifundio by establishing that land cannot be sold forever, and that every fifty years, in the jubilee, all land should be returned to its original owner. In modern times, some liberals have supported agrarian reform, i.e., that land must be possessed by whoever cultivates it. The problem with agrarian reform lies in the fact that it is based in the notion of economic unity, i.e., the amount of land that can be cultivated by an ordinary farmer family. Extension of economic unity is a function of the means of production, which have been rapidly changing since the beginning of the industrial revolution. What was once a satisfactory land unit, soon could not sustain a farmer's family. Hence, the partition of land into economic unities resulted in unexploited fertile extensions, and transformed agriculture into an economic branch that was not self-sustaining and required subsidies. Return

(7) The accuracy of this reasoning, and any other rationale that includes economic equilibrium, is contingent on the assumption that we only are concerned with quasi-static states. When sudden and massive unemployment ensues, it is necessary to consider the decline of acquisition power of the unemployed workers, and the reacting time of each step of the economic process.

Furthermore, the transition of displaced workers from agriculture to industry requires available capital needed to establish new industries, as well as political and social environment that encourages capitalists to risk investing their money in new enterprises. It seems that the absence of one or both conditions would explain why the industrial revolution did not occur in the Third World. Return

Contents    Chapter I    Chapter III    Chapter IV    Chapter V    

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