Capitalism’s Ugly Secret

lead_largeA recent article regarding how Mexican drug cartels benefit from free markets spurred a revelation for me. Remember that I am not an economist, so this may be common knowledge to those in the economic and finance communities. In any case, I think (hope) I have a much better handle on why inequality is so much more prevalent and why there is very little that can be done to change it in our current economic system.

The way I see it, it all boils down to the basic principles of supply and demand. There is an ideal position in which prices are maximized, an equilibrium point where the most of a product or service will sell relative to how much is being charged for it. Now consider this concept over the scale of the entire economy:

What conditions would need to exist for greater economic equality? One might be either full or near full employment, but it’s debatable that such a condition is actually necessary. However, there would be generally higher wage levels across the board. In other words, the economic differences between the wealthy and everyone else would have to be much lower than they are now.

But what conditions would need to exist for that to happen? The main factor would likely be collective bargaining. Unions, acting in the interest of Labor, could make sure that the financial success of corporations is shared with their workers. The net result would be greater prosperity across a wider population.

If you’re working class, this is ideal. You get maximum value for your labor and, in theory, you get to live a relatively comfortable existence. Or maybe not, but we’ll get to that in a minute.

However, if you’re rich, economic equality is a disaster. Here’s why:

Costs for everything are through the roof. Capex, opex, it doesn’t matter. If you own or are running a business, the cost of labor is killing you, either directly in wages and benefits or indirectly in the labor costs associated with capital expenditure. No matter where you look, labor is eating your profit margins alive. Because of that, economies of scale are difficult to build. It’s just too expensive to scale up supply.

Sure, you have a prosperous middle class, but its purchasing power is far from being maximized and it definitely isn’t being turned into profit. Even with a prosperous middle class, a combination of lower economies of scale and higher wages means that prices are relatively high. In other words, there is more money chasing fewer products and services, so businesses charge more for their wares to collect more of those dollars as profit. But this slows spending and forces people to be more judicious with their purchases. If you’re in the business of maximizing profit or economic growth, economic equality is also stagnation. In this scenario, the economy has very little dynamism.

On top of that, based on a generally healthy, large middle class, the “supply/demand equilibrium” as it relates to the full economy is likely to fall well short of full unemployment. So, if you are running a government under these circumstances and you’re faced with a high level of unemployment, what are your options? Businesses can’t pull you out of the hole because labor costs, in both capex and opex, make ramping up supply pretty much impossible. High marginal tax rates are also a deterrent to business investment. But hundreds of thousands to millions of unemployed people are a budget strain as well as a potential political instability problem. Maybe you have a history of mass, violent protests related to civil rights or an unpopular war or what have you. The last thing you want is hungry, angry people with time on their hands gathering together. You remember what happened in Russia and France.

So you have an economy with stagnant growth, high inflation, and relatively high unemployment. All as a result of economic equality.

Sounds implausible, right? But that is exactly what happened in the 1970s in the U. S. These conditions led to the rise of economist Milton Friedman as well as the concept of “supply-side” economics.

“Supply-siders” figured that the only way to pull the system out of its funk was to greatly increase the supply of goods and services to spur economic growth. But, in order to do that, the government would need to make what turned into a Faustian pact with Big Business and the rich … it would sacrifice tax receipts (and future balanced budgets) to allow wealthy people and businesses to keep more of their money in order to increase investment and capital expenditure. The theory was that, as overall supply increased, price drops would lower inflation and increase demand which, in turn, would lower unemployment as businesses hired to fulfill the increased demand.

If only it were that simple.

I’m not sure if it was an intentional dupe or if everyone was really clueless, but someone figured out that supply-side economics didn’t necessarily solve the problem. Sure, it did what it initially set out to do, but it didn’t solve the problem of high labor costs. “Stagflation” was always just around the corner.

So, instead of supply-side economics, the government, Big Business, and the rich figured out that what was needed was really supply-side economics, an all-out assault on Labor. Forays into undermining the power of collective bargaining in the U.S. had already taken place earlier in the 20th century with “right to work” legislation. However, when Labor’s power proved too intractable, then governments and their rich backers shifted gears in the 1980’s and went with the nuclear option, full globalization. With a massive starving population in the developing world dying (literally) to reap the benefits of Capitalism, it was simply a matter of hammering out favorable trade agreements. By transferring a fraction of their labor costs to the developing world, millions of people there would come out of poverty, a few of whom would even join the ranks of the global oligarchs. It was a win-win; Capitalism got to proclaim its virtue as a force for worldwide good by “lifting millions out of poverty” while gutting Labor in the developed world.

Flash forward to today: a combination of loose monetary policy through fiat currency, globalization, and technological advancement has decreased poverty worldwide at the cost of increasing poverty in the developed world. Inflation has been mostly controlled by keeping money at the top of the economic chain and having it “trickle down” in the forms of venture capital and private investment. The working class in developed countries has been largely pacified with the greater availability of less expensive, higher quality goods and services. However, their wages have generally been stagnant for years and they face much higher labor competition and job insecurity. Everyone has better stuff, but many people in the developed world live under the constant threat of losing it all at a moment’s notice, either through mass layoffs or the whim of a surly boss.

This has worked out like gangbusters for the rich. Economic inequality is so high a book on the topic became a world-wide bestseller. Most economists agree we are reaching 19th century levels of economic disparity. While the poor are somewhat less poor, the rich in relation to everyone else have almost never been richer. All simply from increasing economic inequality.

Some may look at the situation and think: so what? Don’t the poor have better lives? Isn’t the rising tide lifting all boats? Well, the millions of people immersed in forced slavery and both sexual and non-sexual exploitation may not agree. The billions living on less than $2 a day may have something to say about it as well. The majority of the world’s population, which is living on about $10 a day or less apiece, may also have some mixed feelings about it.

But the real problem is debt. We purchased a higher standard of living by running up the tab. At some point, debt levels will become so high that mass default is easier than repayment. Then we get to again experience another interesting aspect of the 20th century: depression.

There’s no such thing as a free ride. Sooner or later, the bill for our progress will come due. When it happens, not even the wealthy will have enough to cover the check.

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