ECORY

What is a capitalistic society?

By Heiko de Boer

http://www.vonmisesinstitute-europe.org/

Keynes believed a capitalistic structure does not work. He believed that savers and investors are two separate groups, not finding each other easily. The classical economists also distinguished between the separate classes workers, rentiers and land owners. Laborers earn wage, owners of capital earn interest and owners of land earn rent.  Pikkety thinks along the same lines these days.

Our capitalistic society however looks different.  If a worker buys a house, he is also a land owner.  Working people save for their pension. Their pension fund invests this money in companies and bonds. Workers and investors (rentiers) are then the same people. The money invested by a pension fund belongs to the saver. The people managing this money are working for the people who are saving. Everyone is or can be a capitalist. Whether or not you are depends among others on your time preference.

Each person prefers a current good compared to that same good in the uncertain future. In money terms, you prefer 1 Euro now  instead of 1 Euro in the future. There is a discount of future goods compared to current goods. This discount is the interest rate. Interest is always positive. Interest is not a dirty word. It is no crime charging an interest rate. Interest is a natural thing. It belongs to normal people. It is a category of human action.

The discount depends on people’s time preference.  Each individual has a different time preference. This can be influenced by age or cultural aspects. At higher interest rates, people will be inclined to offer more money or current goods against future goods. And, vice versa. At the interest rate where demand and supply meet, the market is in equilibrium. Mises spoke about this rate as the natural interest rate.

The interest rate applies to all goods, not just money. The ‘present-future’ market consists of the loan market, but also the production structure. The production structure is very important. This is our capital, the basis of our welfare. Without capital we cannot produce anything. In order to produce things you need tools, buildings, infrastructure, human capital and Time.

Time is an important element in our day to day life. People do things in order to improve their situation. It generally takes time to improve our situation and to increase our welfare.  It takes time to produce things. For some products it takes more time than others.  There are as such various stages in our production structure.  Examples of early stages are the mining of raw materials. Of these materials we produce machines and tools.  In the later stages consumption goods are produced and sold.

The capital in our production structure needs maintenance. If we do not maintain our buildings, our IT and human capital, it will wear down. We will then not be able to keep on producing the same number of the same products. In order to maintain our capital, we always have to invest part of our money in our existing capital structure. If we invest the amount which is just needed to maintain our capital, we can keep our consumption pattern the same.

This is our capitalistic society. If we want to consume more in the future we consume less now, and invest more in our capital structure. This way we can produce more stuff in the future. Or we can retire at a younger age. If the amount of money stays the same, prices will go down. That’s great.  We can then buy more stuff with the money that exists. If we think we own enough stuff, we do not need to produce more in the future. If we want stability, we just continue with the same pattern of consuming and investing.

Banks and pension funds play a vital role in this process. Both are intermediaries between saving and lending or investing. In case of a pension fund savers and lenders are the same people. The investments will be tuned towards the requirements and time preferences of savers.  Banks and pension funds will invest in the time market, of which the production structure is a most important element.  This way the investments are aligned with the preferences of the consumers, via productive investments. In pension fund language, the assets and liabilities are matched.

Every participant in the capitalistic society is free to choose. All transactions take place on a voluntarily basis. Would this work? I think so.

The following graph summarises the ‘capitalistic society’ nicely. This graph is from Prof. Roger Garrison’s book Time and Money: The Macroeconomics of Capital Structure.

 Figure 1: Framework for Capital-based Macroeconomics

Note: Upper-left diagram shows the structure of production (Hayekian triangle), upper-right diagram an augmented production possibility frontier (showing the trade-off between consumption and investment – future consumption), the lower-right diagram is the loanable funds market portraying the credit market.

Source: R. Garrison, Time and Money: The Macroeconomics of Capital Structure, 2001, p.50

The graph to the left is our production structure with the various stages of production.  This is our capital structure. Investors invest in the production structure, to maintain our capital. The slope is positive. If an investor invests in a low stage such as mining, the investor makes money by being able to sell a product at a higher price. This price difference, between money invested and proceeds of products sold, is the interest. This price difference is NOT the profit of the producer. Interest and profit are 2 different things. The slope is always positive, because interest is always positive. Please note that the proceeds are the number of goods times the price of these goods.

The graph top right depicts how much consumers spend on consumptions goods and how much they invest. Consumers buy a certain number of goods, at a certain price. The amount they spend equals the number of goods times the price of these goods. The consumption goods are produced in our production structure and paid by the consumers.  The money people earn but do not consume can be used to invest or saved. If people invest, this money will not be available for a certain period. It takes time to produce things and it takes time to harvest the proceeds of any investment. If people save money, they want to have this money available at all times.  They will not receive any interest. In this capitalistic society, you only earn interest by giving up this money for a certain period of TIME.

The graph bottom right is the supply and demand of loanable funds. The supply of funds consist of people’s savings.  The higher the interest rate, the more people will be induced to save or to invest. The demand for funds is from investors. The demand is from investors wishing to borrow money, in order to invest in the production structure. The lower the interest rate, the more investors believe they see opportunities for investing this money in a profitable manner.

The graph is a schematic way of illustrating the capitalistic society. Hopefully it helps in our thinking of how a capitalistic society can work.