Wednesday, June 15, 2011

Economic Recovery, Part VII: The Formation of Capital (2)

Yesterday we noted that the facts of financial and economic history did not bear out the contention that the rich were always the ones to control the means of production — initially. When there is a breakthrough, the ones who know how to take advantage of the financial system are the ones who become rich, often displacing the old rich. This was the case when the new industrial and commercial magnates of the Industrial Revolution displaced the landed aristocracy, and when the computer revolution brought in a lot of new "dot com" million- and billionaires, displacing those whose fortunes depended on industry and commerce.

Of course, in the background are the managers of money, those whom Pope Pius XI referred to as a "despotic economic dictatorship," who "often are not owners but only the trustees and managing directors of invested funds which they administer according to their own arbitrary will and pleasure." (Quadragesimo Anno, § 105.) Thus, in one of the most startling paradoxes of history, the belief in the necessity of past savings to finance the new industrial and commercial capital ensured that ownership of the new wealth would be concentrated — but that control would be vested in the money managers. As Hilaire Belloc presciently — but incorrectly — analyzed the situation,

"Consider in what way the industrial system developed upon capitalist lines. Why were a few rich men put with such ease into possession of the new methods? Why was it normal and natural in their eyes and in that of contemporary society that those who produced the new wealth with the new machinery should be proletarian and dispossessed? Simply because the England upon which the new discoveries had come was already an England in which perhaps half of the whole population was proletarian, and a medium for exploitation ready to hand. When any one of the new industries was launched it had to be capitalized; that is, accumulated wealth from some source or other had to be found which would support labor in the process of production until that process should be complete. Someone must find the corn and the meat and the housing and the clothing by which should be supported, between the extraction of the raw material and the moment when the consumption of the finished article could begin, the human agents which dealt with that raw material and turned it into the finished product. Had property been well distributed, protected by cooperative guilds, fenced round and supported by custom and by the autonomy of great artisan corporations, those accumulations of wealth, necessary for the launching of each new method of production and for each new perfection of it, would have been discovered in the mass of small owners. Their corporations, their little parcels of wealth combined would have furnished the capitalization required for the new processes, and men already owners would, as one invention succeeded another, have increased the total wealth of the community without disturbing the balance of distribution. There is no conceivable link in reason or in experience which binds the capitalization of a new process with the idea of a few employing owners and a mass of employed nonowners working at a wage. Such great discoveries coming in a society like that of the thirteenth century would have blest and enriched mankind. Coming upon the diseased moral conditions of the eighteenth century in this country, they proved a curse." (Hilaire Belloc, The Servile State. Section 4, "How the Distributive State Failed." Indianapolis, Indiana: Liberty Fund Classics, 1977, pp. 100-101.)

The mixture of brilliant economic analysis and financial naïveté demonstrated in this passage is instructive. Trapped by the assumption of the necessity of accumulating savings before new capital can be financed, Belloc assumed that, had the first workers displaced by the new machinery pooled their savings, they would have been the owners, not the new industrial and commercial aristocracy that took the place of the landed aristocracy.

Belloc was partly right: whoever finances new capital owns that capital by right of private property — although they must be careful not to let control slip from their hands if they want to call their souls their own. Belloc was also completely wrong in supposing that the investments of the new industrial and commercial elite had been financed by the old landed elite. Had that been the case, it is obvious that power would never have shifted away from the landed aristocracy and to the industrial and commercial aristocracy. The former would have been the owners of both the land and the new capital.

This also puts period to the myth that America's tremendous industrial and commercial expansion of the latter half of the 19th century was financed from England. On the contrary, while there was some investment from England, by and large the financial capital of England was needed in England, suffering periodic currency crises as a result of the inelastic currency imposed by the Bank Charter Act of 1844.

This leaves the question: how is new capital formation financed? We find the answer in the third book in the series published by the Brookings Institution, The Formation of Capital (1935).

The most important point in The Formation of Capital is that economic progress and growth need not be limited to existing accumulations of savings. In fact, Moulton showed that the economy grows faster when it is not dependent on past savings, and businesses can employ future savings to finance their economic growth. As Moulton explained,

"Even though the flow of funds from individual savings for investment purposes may, for the moment, be inadequate, it is still possible to procure liquid funds with which to buy essential materials and employ the necessary labor.

"Funds with which to finance new capital formation may be procured from the expansion of commercial bank loans and investments. In fact, new flotations of securities are not uncommonly financed — for considerable periods of time, pending their absorption by ultimate investors — by means of an expansion of commercial bank credit." (Harold G. Moulton, The Formation of Capital. Washington, DC: The Brookings Institution, 1935, 104.)

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