By Michael Hudson
Most wealth through the ages has come from privatizing the public domain. Europe’s landed aristocracy descended from the Viking invaders who seized the Commons and levied groundrent. What is not taken physically from the public domain is taken by legal rights: HMO privileges, banking privileges, the rezoning of land, monopoly rights, patent rights everything that falls under the character of economic rent accruing to special privilege, most recently notorious in the post-Soviet kleptocracies, and earlier in the regions of the world colonized by Europe. (The word “privilege” derives from the Latin, meaning “private law,” legis.) These bodies of privilege are what make national economies different from each other.
Classical economists, the original “liberals”, were reformers with a political agenda. The “scientific” mathematizers seek to strip away their agenda, above all by exiling the analysis of rent extraction and special privilege to the academic sub-basement of institutionalism, claiming that a sphere of study that is not mathematized cannot claim the mantel of scientific method. The problem with this reactionary stance is that attempts to base economics on the “real” economy focusing on technology and universals are so materialistic as to be non-historical and lacking in the political element of property and finance. By the 1970s, for example, economic observers were talking about the convergence of the Soviet Union and America on the ground that each used virtually the same technology, along with Japan and Western Europe. For that matter, as early as the Bronze Age (3200-1200 BC) the economies of Mesopotamia (Sumer and Babylonia), Egypt, the Indus Valley and other regions all shared a similar technology, but each had entirely different economic and social systems. A “real” economic analysis focusing on their common denominators would miss the distinct ways in which each accumulated wealth in the hands of (or under the management of) a ruling elite different modes of property and finance, and hence with what the classical economists came to classify as “unearned income.”
Mathematizing economics and its claims to become a science overlooks these institutional differences, including the land rent and other revenue that John Stuart Mill said landlords made “in their sleep.” What this approach leaves out of account is the social policy wrapping for technology. If we lived back in 1945 and were told of all the marvelous technological breakthroughs of the past half-century, we would imagine that societies would now be living a life of leisure. Why has this not occurred? The reason is largely to be found in the predatory behavior that has enriched the finance, insurance and real estate (FIRE) sectors.
The problem is not mathematics as such, but the junk economics and junk statistics used by the mathematicians who have captured the discipline of economics. For contrast, one need only turn to the 19th century’s rich toolbox of economic concepts developed to analyze today’s most pressing problems. What could be more relevant, for example, than the question of whether the exorbitant salaries and bonuses that bankers pay themselves are unfair, and how much they should fairly charge for their services? To answer this question the 13th-century Schoolmen developed the theory of Just Price. For the next six centuries down through the late 19th century, economists refined the distinction between technologically necessary costs of production and “free lunch” exploitation, using the labor theory of value to define intrinsic costs (reducible to labor, including that embodied in the capital goods and other materials used up in production) and the complementary concept of economic rent (unearned income above these costs, that is, market price less cost value).
To what extent does our burdensome and intrusive debt overhead grow faster than the economy¹s ability to pay, and what is the best policy to deal with excessive debts? Already in 1776, Rev. Richard Price dealt with the “magic of compound interest”, its tendency to grow exponentially (“geometrically”) while the economy grew at only simple (“arithmetic”) rates. This idea survives only in the form that Malthus borrowed in his 1798 population theory.
The overburden of public debt prompted Adam Smith to comment that year that no government ever had repaid its debts, and to propose means to keep it in check by freeing the American colonies that were a major source of conflict with France, for instance, and most of all, by paying for wars out of current taxation so that populations would feel their immediate cost rather than running into debt to international bankers such as the Dutch. Interest on Britain’s public debt absorbed three-quarters of its fiscal budget after the Napoleonic Wars. Writers such as Malachy Postlethwayt analyzed how this debt service added to the cost of living and doing business. His logic along these lines is part of the lost science of classical political economy.
The early 19th-century French reformer St. Simon proposed that banks shift from making straight interest-bearing loans to “equity” loans, taking payment in dividends rather than stipulated interest charges so that debt service would be kept within the means to pay. (Islamic law already had banned interest.) This became the inspiration for the industrial banking policies developed in continental Europe later in the century. St. Simon influenced Marx, whose manuscript notes for what became Vol. III of Capital and Theories of Surplus Value collected what he read from Martin Luther to Richard Price on how debts multiplied by purely mathematical laws independently of the “real” economy¹s ability to produce a surplus. The classical concept of productive credit was to provide borrowers with the means to pay. Unproductive debts had to be paid out of revenue obtained elsewhere.
This distinction threatened the financial sector’s option of making unproductive loans. More congenial were the Austrian School and marginal utility theorists who depicted debt as a voluntary trade-off of present consumer utility (“pleasure,” not need) for future income that presumably would rise, thanks to the prosperity brought in the train of technological progress. Interest paid by consumers was treated as a psychological choice, while industrial profit was treated as a return for the widening time it presumably took to produce capital-intensive goods and services. The ideas of “time preference” and the “roundabout” cycle of production were substituted for the simpler idea of charging a price for credit without any out-of-pocket cost or real risk undertaken by bankers. The world in which economic theorists operated was becoming increasingly speculative and hypothetical.
Financial analysis turned away from viewing interest as a form of economic rent income achieved without a cost of production. After the Napoleonic wars ended in 1815, Britain’s leading bank spokesman, David Ricardo, applied the concept of economic rent to the land in the process of arguing against the agricultural tariffs (the protectionist Corn Laws) in his 1817 Principles of Political Economy and Taxation. His treatment deftly sidestepped what had been the “original” discussion of rentier income squeezed out by the financial sector.