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thanks to Phil McShane

“To help the poor, study economics”: income inequality, justice, and economic theory

Part 4: the rise of Spud Island

If you have read this far, thank you, Gentle Reader! If not, Part 1 outlined income inequality as a huge danger to the human species; Part 2 focused upon the inadequacy of current economic theories to address this reality, or even to predict booms and busts; Part 3 introduced the “new political economy” of Bernard Lonergan as a truly scientific approach.

Specifically, he paid attention to a fundamental aspect of every human economy, whether hunter-gatherers or our own: there are always two economies, not one, in play. The one we all participate in is the basic economy of selling and buying goods and services. The second distinct economy is the producing of those goods and services; Lonergan calls this one the “surplus economy”. Since mainstream economists rarely pay attention to this fact — so obvious as to go unnoticed? — they usually cannot account for the total reality of any economy. One exception is Joseph Schumpeter, though he did not develop his insight.[1]

There are therefore always two economies, two types of firms, two interrelated processes that move at differing rates or velocities. Indeed, accelerations and decelerations are indicative of booms or busts.[2] Each economy functions on the basis of equal exchanges: selling and buying, or income and expenditure. Expenditures also occur at each stage in the parallel productive processes, but income only comes at the final stage when the finished product or service is purchased. Expenditures include not only raw materials and implements but also utilities, maintenance, wages, and taxes. Producers’ expenditures are spread over time at each stage, and there is always a series of lags with revenue.

Moreover, there is a third basic function that also touches profoundly upon these processes, namely, redistribution. Savings, loans and lines of credit, dividends, rents, interest, royalties, resale or secondhand markets, stocks, bonds, in short, all exchanges that take place outside the productive process fall in the redistributive process.

This process normally serves the other two, providing loans and capital to producers, and managing income for the rest of us. The rise of massive income inequality is due to the usurpation of that role by financiers, those once called “the masters of the universe” — until they made a mess in 2008.[3] Since we cannot get along (“do business”) without some financial services, we are at the mercy of finance capitalism — a perverse form of capitalism that literally produces money out of money.

So we — you, me, all of us — are behind two eight-balls: the lack of a real science of economics, and an out-of-control finance sector.

For the rest of this Part 4, I want to introduce you to Bernard Lonergan’s lifework. The example I use is I think fairly simple, but it won’t look quite like what you might expect.

Lonergan insists that one must always attend to the concrete, because that is where life happens for real. I borrow an example by the late Philip McShane to help us grasp the nettle. (He gave me permission and advised me with what comes next.)

McShane imagines an island dependent on growing potatoes, which I call “Spud Island.” A woman comes up with a bright idea about a spade and a horse to help plant and harvest the potatoes. As she outlines her “crazy” idea, the banker of the Spud Island Saving and Loan listens and congratulates her, saying “I have to give you credit for that.”[4]

As she and her firm work out a design for a plow, leather- and metal-working expand — and credit needs. Earnings are up, but for a while increased production of potatoes and other crops lags behind. The surplus economy is heating up; the basic economy hasn’t surged ahead yet. It catches up some time later as the surplus growth calms down (enough plow-making equipment is now available) and the plow production increases as farmers buy plows. Then that levels off as well.

Related industries that provide and repair and replace equipment get a boost. Plow retailers spring up and some do well. Horse-breeders profit. Farmers increase output of all their crops, which allows them some leisure in which to improve the quality of all their crops. The Spud Island Bank & Trust is busy.

Hopefully each phase or surge has taken place in such a way that all islanders are better off in the long run. But in the short term there will be ups and downs of income, and things can go badly. “The first period’s new income flowing into consumer purchases that simply raise the prices of the old level of production, e.g., potatoes”[5], or other short-circuiting of the island economy, can happen, and here is where intelligent, democratic regulatory and financial processes are needed to achieve concomitance in both economies, surplus and basic.

Two things are worth noting about Phil’s imaginary island. First, innovation will create an increase in the standard of living of all the Spud Islanders, if it can proceed from surplus economy expansion to basic economy expansion to leveling off. Income inequality is not eliminated, but the poorer citizens benefit significantly as well, and not just because a rising tide lifts all blah blah blah.

Second, the role of credit here is richer than in the typical economic textbook. Credit is a promise (from the Latin credere, to believe), just as money itself is at heart a promise. It denotes the real implication of finance, a central redistributive function, in creating economic activity. Using this example, it should be clear that the success of the plow-woman and her collaborators means coming up “with credit needs that are related to the best aggregated turnover in reference to the island’s requirements.” This means learning how to fine-tune production turnover with the minimum necessary credit.

As Phil points out, the fact of turnover — “so much every so often” — is rarely addressed in economic textbooks. But the matter is intensely practical: how many plows to manufacture, and how often?[6] (Find a schematic representation of a Spud Island economy below.)

Spud Island helps exemplify one small aspect of Lonergan’s scientific economics. The banker’s credit is in fact a willingness to share the risk, because he trusts the plow-woman enough to take a chance on her willingness and ability to repay, and not just the potential value of her invention. The funds he extends seem to come from the savings of the Spud Islanders, but only apparently. In fact, modern banking has not depended on loaning actual cash reserves for centuries. The actual risk the banker takes is to credit the woman’s account by simply increasing the number of units of currency in it. He adds a corresponding debit on his balance sheet. The risk is that he may be forced to call the loan prematurely.

If the bank were a modern private commercial bank, the loan would be funded by literally creating the money. While central banks issue banknotes and coins, — tangible instruments of trust — commercial banks are licensed to create money by extending credit. It does not depend on cash reserves, which are hardly ever spent down. Instead, each bank has a debtor relationship to its respective central bank. Therefore, there is always “enough” money, and claims to the contrary that justify impoverishing the poor and the middle class are either simply ignorant of the facts, or pure propaganda.[7]

Money is and has always been a social construct, an expression of mutual trust.[8] Markets and exchanges depend on such trust just as much, hedged around by checks and balances, as money itself. In other words, modern economies require a myriad of covenants — declarations of relationships of trusts — in order to function at all. These are part of the morality of capitalism that Lonergan alludes to. The present economic crisis and its recent predecessors have eroded that trust.[9]

Finance-dependent capitalism has created a phony “third economy” based on manipulations of capital markets that still exist to serve the needs of the surplus and basic economies.

We turn now to the “baseball diamond”, the schematic of the rhythms of capital flows of a static economy without foreign experts or imports. Start at lower left and work your way around, moving counter-clockwise.

Part The Last will round off where we started: the humungous inequalities of our world, where just 28 people own as much wealth as 3,300,000,000 other people.

Go to Part The Last.

Below is a simple graphic representing exchanges in a static economy. This is a snapshot at time t:

From lower left, counterclockwise:

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D’ = consumer demand

F’ = basic firms

d’ = consumer demand

f’ = income to consumer

m1 = maintenance expenditures of basic firms

D” = basic firms’ demand

d” = surplus demand

m2 = maintenance expenditures of surplus firms

f” = income to surplus firms

F” = surplus firms

m2 /f”= income to consumer (e.g., wages from surplus firms into base economy)

R = redistributive activities

This shows schematically the crossover flows of monies in a productive process, in a theoretical closed static system like Spud Island (one with no foreign trade). Redistribution is especially but not exclusively the finance role, for the productive “so much every so often” takes place in a wider context.[10]

[1] Joseph Schumpeter, The Theory of Economic Development, (New Brunswick, NJ: Transaction Publishers, 2012), 16: ““It is good to classify goods in “orders,” according to their distance from the final act of consumption. Consumption goods are of the first order, goods from combinations of which consumption goods originate are of the second order, and so on, in continually higher or more remote groups.”

[2] Lonergan, Macroeconomic Dynamics, Edited by Frederick Lawrence, Patrick Byrne, and Charles Hefling. (Toronto: University of Toronto Press, 1998). Volume 15 of 24, 14. Hereafter MD.

[3] See Michael Lewis, Liar’s Poker: Rising through the Wreckage on Wall Street (New York: W. W. Norton, 1989) for the beginning of the end of finance’s servant role. See The Big Short: Inside the Doomsday Machine (New York: W. W. Norton, 2009) for the backdrop to the worst financial crisis since 1929 (the movie is good too). And Flash Boys: A Wall Street Revolt (New York: W. W. Norton, 2015) shows how little has really changed since the crash of 2008.

[4] Note the several meanings of his sentence.

[5] Philip McShane, Piketty’s Plight and the Global Future (Vancouver: Axial Publishing, 2014), p. 50ff.

[6] Ibid. As he points out, this then directly impinges on the quantity theory of money, which is at the heart of the rivalry between monetarists like Milton Friedman, and John Maynard Keynes and his followers. Lonergan’s analysis takes a different route from both schools, focusing on where the money goes and in particular how fast the funds circulate (circulation analysis) rather than to begin with how much. “Follow the money” is not just good criminology.

[7] In other words, money is not a commodity: commodities are natural resources, which are abundant or scarce. Money, however, is a human creation.

[8] See Lonergan’s discussion of the “dummy.” For a New Political Economy Edited by Philip McShane. (Toronto, Canada: University of Toronto Press, 1998). Volume 21 of 24: 38–40. Hereafter FNPE.

[9] The creation of the Bitcoin, a currency not issued by a bank but rather created via computerized interactions, is a reaction against the erosion of trust. It is supposed to be an alternative to the present system, which is deemed to be failing. Bitcoins are “mined” and traded as currency, but without the need for trust. Some have argued that it is in fact a massive Ponzi scheme. See Ann Pettifor, Just Money (Commonwealth Publishing, 2014), 8–13.

[10] With many thanks to Philip McShane, who helped me create this schema, using his own work in editing FNPE. See his website, philipmcshane.org. Lonergan’s own diagram is FNPE, 258. See also “A history of the diagram,” MD, 177–202.

Written by

Bishop in charge, Convocation of Episcopal Churches in Europe, 2001–2019. French-American. Musician, composer, author, happily married. www.pierrewhalon.info

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