There are two primary reasons for the existence of this economics newsletter. The first is to bring to the readers the growing relevance of what some like to call the New Paradigm in Economics. By the end of the Second World War, the American economy had become burdened with a bias to both inflationary and recessionary episodes. It appeared that episodes of both were becoming more frequent and more severe in terms of both depth and duration. These biases have seemed to weaken as the economy evolved to the present time. ‘What has happened to the business cycle” and “where has the power of firms to control prices gone”, and again, “are we entering a deflationary period”?
The attempt to make economic sense of these changes constitutes the body of economic analysis increasingly termed, The New Paradigm. The century leading up to the Second World War saw pretty much, a continuous decline in competition in product and resource markets, including labor markets. As has been shown in the book, THE NEW PARADIGM, ECONOMIC UNDERSTANDING FOR THE 21ST CENTURY, (Donald R. Byrne, 2003), a landscape change began to slowly evolve in the U.S. microeconomy that was to lessen the economy’s biases toward frequent and severe episodes of inflation and recession. The U.S economy was gradually being transformed from one better characterized as cartelistic free market capitalism to one more consistent with competitive free market capitalism. Monopoly power over prices including wages had increasingly spread throughout the economy as we approached World War Two. Following WWII, that same power was on the wane and gradually began disappearing from an increasing number of markets.
Globalization, deregulation, privatization and commoditization of goods and services and productive resource markets have changed economic behavior. An increasing number of firms in an increasing number of markets have had to seek relief from declining profits by cutting costs and not by raising prices as was the old remedy. In labor markets, rising union compensation for labor has resulted in growing structural unemployment.
As this occurs along with the diminishing frequency and diminishing severity of recessions, structural unemployment has replaced cyclical unemployment as a major concern. Many economists and most policy makers have failed to understand these changes. Recent monetary and fiscal policies have proved failures and gave us the 2001 recession that should have never occurred. See the major article, “WHAT RECESSION” in this first issue for a discussion of this policy failure.
Many good things are coming from this economic evolution to more competitive markets. The income distribution is becoming more equal as market power disappears gradually. The efficiency of resources such as labor increases more rapidly than before as a consequence of restructuring. These changes have gradually been occurring and continue to pervade the economy will help explain the various issues that will make up this newsletter.
The second reason for this newsletter is to avoid as far as possible, ideologically driven arguments. For this reason, only officially published data will be used such as the National Income and Product Accounts from the Bureau of Economic Analysis, the Flow of Funds Accounts from the Board of Governors of the Federal Reserve System, the Census Bureau data, etc. Hyper links to that data will be an integral part of this newsletter. This data will be readily accessible to the reader – only a mouse click away.
Feedback via e mail is encouraged and appreciated by us and will be incorporated into the newsletter as space permits.
Free Market Capitalism:
Salvation or Damnation?
The role of the Invisible Hand
Much confusion exists over the meaning of free market capitalism. As a Professor of Economics, I learned first hand of this confusion. As I watch the electronic and read the printed media, it is clear that confusion abounds over its meaning. Even among the Libertarians, the confusion continues. The intention of this follow up to our introduction is to attempt to clear up the confusion.
Much of the problem revolves around the “good” things that come from free market capitalism. The literature of microeconomics of the classical-neoclassical tradition points out the limiting case or the end game, as the modern expression goes. The good things that come from free market capitalism are found in the achievement of the theoretical welfare conditions of equity and efficiency. These conditions can be achieved from market forces only if the markets approach what is termed perfect competition. In the terms of Adam Smith, the Invisible Hand of competition is fully operative. That is to say, no single firm or productive resource employed by firms in the transformation process called production has any market power. They are pure price takers and have no price making power. The demand facing them is perfectly elastic. To restate what we the editors of this newsletter, as well as a growing number of other economists, have been arguing for the past several years: we are embarked on a new era in this country; one where a sea change has occurred – a New Paradigm in Economics that has been evolving since the Second World War. This is a result of increasingly widespread and significant growth in competition. We argue that the growing importance of the invisible hand of competition is bringing the United States economy toward the achievement of efficiency and equity in the microeconomy and is also eliminating the biases toward recessions and episodes of inflation that the lack of competition was causing.
In effect, that is what Keynes and his macroeconomic revolution was all about. Lord Keynes, himself, was a neo-classical economist of the Marshallian mode. Not too long before he published his momentous GENERAL THEORY, 1936 (background on Keynes http://www.econlib.org/library/Enc/bios/Keynes.html ;the text is available in an electronic formathttp://gutenberg.net.au/ebooks03/0300071h/printall.html) , he was advising the British Government to return to a gold standard with pre-WWI prices or parity as it was called; a policy of deflation was required to achieve the pre-War parity for gold (the war had brought about significant inflation). He despaired of this recommendation as he saw the depression continue, deepen and spread. By the time Keynes wrote his GENERAL THEORY, he was calling gold a barbarous relic (“In truth, the gold standard is already a barbarous relic.”). Why such a drastic change? As Marshall pointed in his Principles, Book V (http://www.econlib.org/library/Marshall/marP28.html#Bk.V,Ch.I) circa 1890, the lack of competition, or presence of monopoly power led the economy away from the achievement of Say’s Law and its bias toward the Natural Rate of Employment to a bias toward recessions and episodes of inflation.
“The primâ facie interest of the owner of a monopoly is clearly to adjust the supply to the demand, not in such a way that the price at which he can sell his commodity shall just cover its expenses of production, but in such a way as to afford him the greatest possible total net revenue.”
As Keynes argued, any level of economic activity was possible and as a by-product, recessionary and inflationary gaps could and usually did occur. Excesses or deficiencies in Aggregate Demand were the rule and not the exception. Government intervention was needed to eliminate recessionary and inflationary gaps Laissez faire, laissez passer policies of Say’s Law had to be replaced with an active interventionist policy by the central government. Monetary and especially fiscal policies were required, or disasters like the Great Depression that followed the First World War would certainly reoccur.
As in the case of many revolutions, the Keynesian Revolution proved no exception; the passage of time changed the underlying conditions – where once the Keynesian prescription for active government involvement in the economy was warranted, in the past few decades the government intervention has become less desirable…and some argue, less necessary. From zenith of price power of cartelistic and oligopolistic markets prevalent at the onset of WW II, we have experienced six decades of growing competition. The once oligopolistic market structures in autos, lumber, telecommunications, etc. have become very competitive.
A number of factors have resulted in an increasingly competitive economy. The resurgence of international trade due to GATT (General Agreement on Tariffs and Trade http://www.wto.org/English/thewto_e/whatis_e/tif_e/fact4_e.htm) and over a decade of more or less fixed exchange rates is one of them. Many years of deregulation of markets, especially in transportation and communications have added to the competitive nature of the U.S. economy. Another of the competition invigorating factor has been the privatization of many formerly collectivized industries fro m sanitization to municipal lighting. Another factor in the Post WW II period competitive upsurge in the American was the rapid technological change brought on by the hot, cold and space wars which eliminated many of the foundations for monopoly power. This set of wide ranging changes have given the economy an increasingly wide spread and significant increase in competition. The Invisible Hand of Competition (http://en.wikipedia.org/wiki/Invisible_Hand) has returned and in some cases, entered for the first time. This has caused a general decline in market power that was the basis of the Keynesian Revolution. While some exceptions and reversals have occurred, professional sports and the recartelized U.S. oil industry, the trend is very clear and pronounced.
So be careful when someone uses the term, “it’s the market” and hopes to conjure up feelings that to get the good side of the market, we have to tolerate the bad things like $3.00 for a gallon of gas. Monopoly power as shared by the far fewer firms in the American oil industry is not “the market”.
It is a perversion of the market. It means that the Policeman, the Invisible Hand of competition, has been expelled. It undermines the good things that come only from competitive free market capitalism. Remember what those god things are that only COMPETITIVE free market capitalism brings us.
The consumer surplus is at a maximum subject to the constraint that the productive resources (labor, debt and equity capital, entrepreneurship, etc receive their opportunity cost and no surplus or con economic rent.
The per capital standard of living is at a maximum given the current state of technology, the current stock of all resources, etc.
ELIMINATION OF THE TWIN BIASES TOWARD FREQUENT AND SEVERE BOUTS OF RECESSION AND INFLATION
In fact a mild deflationary pressure as the productivity dividend is partially passed forward in the form of lower costs and prices.
LESS INEQUALITY IN THE INCOME DISTRIBUTION
Equity allows inequality to occur but only based on the opportunity costs of the resources and not through the market power of the firms employing the productive resources.
These are the good things that come to a market that is truly a competitive free market capitalistic economic system.