What Does an Economy Do?
If what we said in the last installment is correct, then the first task of any humane science is to determine what its purpose is. The indispensable requirement for any economic system is that it must provide the material basis for life for a sufficient number of its citizens so that society can continue for another season. In addition, it must provide a sufficient surplus so that society can be re-populated and continue for another generation. If either of these conditions is not met, then society simply disappears and further discussion is unnecessary.
But in addition to the few things that an economy must do, there is a longer list of things it ought to do. For example, an economy ought to provide the material basis of life for as many members of society as possible, and ideally for all members. It ought to provide for a certain level of material comfort and security; it ought to reward work, ingenuity, thrift, and inventiveness; it ought to supply sufficient excess to fund common goods such as the national defense, religious works, education, etc.; it ought to provide the ground for liberty; it ought to provide the ground for social harmony, that is, each citizen ought to be able to believe that his efforts and fairly rewarded, and that no one lives off the efforts of another.
Having a list of things an economy should do implies another list of things it should not do. For example, it should not depend on slavery; it should not deprive work (including the “stored-up” work known as “capital”) of its just rewards; it should not reward sloth, that is, create wealth without work, wealth not based on some productive endeavor; it must not weaken social bounds or encourage class warfare, and so forth. Taken together, these lists of what an economy must do, what it ought to do, and what it ought not to do, provide us with a set of criteria upon which we may make firm judgments about the success or failure of any particular economy, most particularly our own. But I suggest that in addition to these criteria, there is a fundamental measure that sums them all up, something that an economy must do if it is to meet all of these other criteria. This criterion is that it must balance supply and demand; this is the most fundamental measure in any economy. This balance of supply and demand is known as equilibrium, and it can be supplied by either economic or non-economic means.
Equity and Equilibrium
When people come together in families or firms to produce things, they add wealth to the economy; in fact, this is the only economic way to add wealth. If they get an equitable share of the output, or the wealth they create, they will be enough purchasing power in the economy to buy all the things they produce. This is the much-maligned “Say’s law of markets,” which states that “supply creates its own demand.” When there is an excess of goods supplied to the economy, we have recession, or worse. Say’s Law is much criticized because if you examine it closely, it says that recessions are impossible; there will always be enough purchasing power to clear the markets. Clearly, we purchase things in terms of other things. If, for example, you are a fisherman and you want some shoes, you catch some fish and trade them with the cobbler (in a barter economy). The total number of things created equals the total number of things that can be used for purchasing the other things. The two quantities are in fact the same quantity, so that there can never be a shortage of purchasing power in the economy. Granted, there may be temporary imbalances in any particular market. The fisherman may catch more fish than people really want to eat, the cobbler may make too few shoes. But such a situation will normally not persist. A fisherman who cannot sell all of his fish will cut back on the time spent fishing and devote himself to other things. Perhaps leisure, or perhaps he will take up cobbling, thereby adding to the supply of shoes. But in any case, a recession in these circumstances cannot be of long duration or great importance. And yet, recessions do happen, quite obviously. Long ones. Deep ones. Serious ones. And they happened more so in Say’s day, the heyday of the laissez-faire economy, then in ours. So what is wrong with Say’s “Law”?
To understand the problem, we have to look at the sources of demand in a money economy. And these sources are two: wages, and interest or profit. Wages are, of course, the rewards of labor and profit the reward of capital. In another sense, however, these are the same rewards since capital is merely “stored-up” labor, or things produced in one period to be used to continue production in the next period. For example, if a farmer wishes to have a crop next year, he must save some seed-corn from this year’s crop. Now, the corn he consumes and the corn he saves are the same corn from the same crop. But by saving some corn for seed, it becomes “capital.” Hence, the return on this capital is really a return on his prior-period labor, just as his wages are a return to current-period labor. Clearly the returns to capital and labor, interest and wages, spring from the same source (labor). Capital, then, ought to have roughly the same rewards as labor, plus some premium for saving. Or, to put it in economic jargon, the returns to capital and labor should be “normalized” to each other. This normalization of incomes from capital and labor is the condition of equity in an economy. That is, the same kind and quality of labor, whether in its original or “stored-up” form of capital, should produce roughly the same return.
Interest (or profit) and labor constitute the economic sources of demand, and if they are normalized to each other, economic recessions are unlikely. There will be enough purchasing power distributed equitably to clear the markets. In capitalist economies, the vast majority of men are not capitalists; that is, they do not have sufficient capital to make their own livings, either alone or in cooperation with their neighbors, but must work for wages in order to live. And since the vast majority of men and women work for wages, then the vast majority of goods will have to be distributed through wages. In conditions of equity, this will not be a problem; so long as there is equity, there is likely to be equilibrium, and periods of disequilibrium are likely to be brief. But it may happen, and quite often does, that interest and wages are not normalized to each other. In almost all cases (although there are exceptions), this means that capital gets an inordinate share of the rewards of production. This, in turn, means that the vast majority of men and women will not have sufficient purchasing power to clear the markets, and the result will be a disequilibrium condition, that is, a recession. When this happens, governments and societies often look to non-economic ways of restoring equilibrium.
The major non-economic means of restoring equilibrium are charity, welfare and government spending, and consumer credit (usury). Each of these methods transfers purchasing power from one group (which, presumably, has an excess) to another which has a deficit. The first method, charity, will always be necessary to some degree. This is because even in the most equitable and well-run economies, there will always be people who are incapable of making a decent living, perhaps because of mental impairment, moral deficiency, or physical handicap. One hopes that there is enough generosity and benevolence in society to voluntarily cover the needs of these people. However, when low wages become widespread, and when self-interest becomes the dominant motivation in society, it is likely that charity will be insufficient, and other means must be used.
The second non-economic means is welfare and government spending in general. By these means, the government seeks to re-establish equilibrium conditions either by supplementing the income of some portion of the population, or simply by increasing its spending to create more jobs and thus add more purchasing power to the economy. This strategy is at the heart of Keynesian economics. The “market” economy is allowed to continue to produce inequitable (and therefore disequilibrium) conditions, but the government will tax and redistribute the excess incomes in an amount sufficient to restore equilibrium. For a while, this method worked fairly well. However, it created some problems. In the first place, it created entitlements. Unlike charity, which depends on the benevolence of the donors and may evoke gratitude on the part of the recipients, welfare depends on the police powers of government and is more likely to evoke resentment on the part of both the recipients and the “donors.” Further, these re-distributions require increasingly intrusive bureaucracies to collect and disburse the funds. The recipients, no less than the donors, find that every aspect of their life is subject to government review and control, and this is never a comfortable feeling for either.
Despite the fact that Keynesian transfers now consume a huge portion of the federal and state budgets, these transfers have been, for some years now, insufficient to balance supply and demand, and for some time now the economy has depended chiefly on the third method, usury or consumer credit. This is the plastic economy, an economy based on credit cards. And to the extent than an economy depends on consumer credit, it is, quite literary, a house of cards, and will be as unstable as those structures usually are. In fact, usury is the most destructive way of increasing demand. Usury actually delays the problem, postpones the crisis to a future period. This is because a borrowed dollar used to increase demand today must be paid back tomorrow and hence decrease demand in a future period by that same dollar—plus interest. This requires more borrowing, which of course only makes the problem worse. Eventually, the system falls of its own weight, as credit is extended to an increasingly weakened consumer, and a credit crises results.
The Just Wage and Equilibrium
If the markets are to be cleared, that is, if all of the products and services we make are to be sold, there must be sufficient purchasing power in the mass of men. Work must get its just rewards, a just share of the wealth it creates. In other words, economic order requires a just wage (and, I might add, a just interest rate, since interest is the “wage” of capital, or prior-period labor.) Although the just wage has its roots in the economic philosophy of Aristotle and the Scholastics, it was first enunciated in the modern era by Pope Leo XIII in the encyclical Rerum Novarum. Leo defined this as the wage that would be “enough to support a worker who is thrifty and upright.” Furthermore, the wage must be sufficient to allow a thrifty worker to save and acquire a little wealth of his own. Leo was expounding on a moral requirement, but as it turns out, his dictum was eminently practical. Without justice, there is no way to balance the economy by free-market means; equilibrium will then depend on non-economic means, which means, almost inevitably, an increase in government power and an expansion in usury.
The question now arises, “Just how much is a just wage?” The answer is that the just wage is not really a number at all, or at least not a number we can calculate with any precision. Given the immense variety in the kinds of quality of labor, the varying level of effort, the vast differences in training, etc., it is not feasible to calculate a just wage for each and every circumstance. Further, since different societies and cultures have different levels of productivity, they will provide different standards of comfort and security.
What the just wage really supplies is a standard of judgment We can say that the just wage is fulfilled under the following four conditions:
- One, that working families, as a rule, appear to live at the level of dignity appropriate for that society;
- two, that they can do so without putting wives and children to work;
- three, that they have some security against periods of enforced unemployment, such as sickness, layoffs, and old age; and,
- four, that these conditions are accomplished without undue reliance on welfare payments and usury.
While it may be difficult to give precision to any of these factors, it is certainly possible to make reasonable judgments and set reasonable standards. Moreover, from the standpoint of an economy as a whole, it is fairly easy to determine, with scientific precision, whether wage levels are just. One needs merely to note how much the economy is dependent on non-economic distributions to achieve equilibrium. Charity, welfare, and usury measure the precise distance between the prevailing wage rate and the just wage. Economies that are overly dependent on these non-economic factors cannot be just economies. And therefore, they cannot be free economies. They create an endless series of dependencies that always tend to make men less free, to make them objects of charity, clients of state bureaucracies, or to place them at the mercy of usurers. In such circumstances, men lose even the memory of freedom; they cease to be citizens of the nation and become mere clients of the state or servants of the usurers.
Books by John Médaille and on distributism are available in The Imaginative Conservative Bookstore. This is part III of Dr. Médaille’s series on the Economics of Distributism. Click here for parts I, II, IV, V. This originally ran on Front Porch Republic and is published here with the permission of the author.
1. There is actually a third source of income, ground-rent, or the amount of money paid to rent a piece of property, minus any amounts paid to rent the improvements to that property (such as a building). Ground-rent introduces certain complications which are beyond the scope of this article, and will, therefore, be ignored for the present.
2. Here we must distinguish between lending for investment and usury. Investment means giving money to firms and entrepreneurs in order to expand production and increase the wealth of society. In this case, interest is merely the investor’s participation in the profits; it is the “wage” of the capital supplied, and the one who supplies it is entitled in justice to that “wage.” Usury, on the other hand, is lending money at interest to increase consumption. Nothing is added to the wealth of society, however much may be added to the wealth of the lender. Since nothing is produced, there is no valid claim to profit; interest payments in this case merely constitute a transfer of wealth from the borrower to the lender, but no net increase in the social stock of wealth. In fact, wealth is actually “used up” in this process without making a contribution to production, hence the name “usury.”
3. P. Leo XIII, Rerum Novarum (Boston: St. Paul Books and Media, 1891), Para. 63
4. Ibid., Para. 65