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Paul Krugman and interventionist monetary policy

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Here is another short and unfairly brief attempt to convey a sense of what the Austrian Business cycle theory is about. It is in no sense intended to be a complete or anywhere near the best or a scholarly explanation of ABCT.

Austrian Business cycle is all about capital theory, and the importance of the interest rate to the allocation of capital.

In ABCT there is a strong recognition of the role of interest rates in the economy. Its not just number, interest rates play a “coordinating” function in the economy. When the interest rate is unhampered and allowed to perform this coordinating function, what the interest rate does is coordinate production over time. ABCT is all about intertemporal allocation of capital across various stages of production.

When we save more, and interest rates consequentially decline, that is the very time it makes sense for businesses to engage in projects that are going to bear fruit in the future.

When we save more, we are forsaking consumption now for consumption in the future.

It is this desire for future consumption that investor/entrepreneurs are preparing for in investing in future production, in capital intensive products. The investors/entrepreneurs can make these capital investments because we have saved and thus interest rates are low, making borrowing more attractive than at higher interest rates.

The longer term the production is, what is often referred to as multiple stage production or complex production stages, the more interest rate sensitive the production. Interest matters more when you make a 20 year loan to develop property or to build a factory than it does over a shorter time frame.

The interest rate coordinates consumer’s desires to consume in the present versus the future, and business production of good for the present and the future.

By saving part of one’s income, one is forgoing a claim on the current resources out there in the economy and freeing these resources up to support more complex, longer stage production. This deferral of present consumption releases resources into the economy, which provide the material wherewithal to see all the new business projects undertaken by entrepreneur/investors through completion.

The interest rate in effect coordinates the supply of real saved resources in the economy.

ABCT basically says when you tamper with the structure of interest rates as the market sets them, you are tampering with the coordinating function of capital production in the economy, introducing dis-coordination.

So now, if for example a Central Bank wants to force interest rates down through open market operations, we see that the public has not necessarily indicated a desire to consume in the future, yet investor/entrepreneurs are being told (and incentivized) in effect by the lower interest rate to begin more capital intensive, longer term stage investment for the production of future goods.

But people are not saving, they want to consume now. Yet businesses are being encouraged to engage in production of the future, in long term investment. People are demanding more goods for consumption now, but entrepreneurs are being mislead into engaging in long term product development, in producing for the future.

Thus we see the time mismatch, or what Austrians call the intertemporal misallocation of capital resources.

In the initial short run we see the boom, as present consumption stays high while we see artificially lowered interest rates stimulating what is ultimately unsustainable entrepreneurial production. We are buying TVs and building stuff like houses and cars. The houses and cars require lots of inputs, lots of other factories have to be built and stuff made to put into the houses and cars. So unemployment goes down during the boom as society culls its resources to engage in capital production in response to low interest rates.

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Just because a Central Bank forces interest by pumping money into the banking system does mean consumers are deferring present consumption. The pumping of money to drive down interest rates does not release any more resources into the economy for investor/entrepreneurs to use to complete their long term investment projects.

With artificially lowered interest rates you have an unchanged resource pool to fund all the new long term capital production projects. There are not enough resources to fund all of these projects, and you have a bust as resources dry up and projects have to be abandoned. The investment was not financed with savings, but with printed money. Printed money is not a capital resource. Printing money does not produce anything of value, it just misleads people to think this is the case.

Printing money to lower interest rates just encourages more wasted resources as investor/entrepreneurs are incentivized to undertake long term projects that they will not be able to complete. They will have to abandon these projects, and thus squander (waste) valuable human and physical resources (capital resources).

Keeping interest rates down is not the cure for a recession/depression, it is the cause. Artificially low interest rates are what gets entrepreneurs onto these unsustainable future investment trajectories.

If you keep interest rates artificially lowered you just keep encouraging people to plan, design, build and make things that ultimately can’t be finished or won’t be profitable or for which there won’t be sufficient consumer demand in the future.

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Austrian Business Cycle Quickie:

1. The FED lowers the rate of interest below the natural rate.

2. This creates a boom.

3. Misalignment sets a course of events into line that is seen as "prosperity" (increase in average standard of living), but it is really an illusion.

4. The boom is really an accumulation of malinvestments.

5. The bust is a necessary and beneficial liquidation of malinvestments, which are really misallocated resources (wasted resources).

* The Austrian Business Cycle theory is a theory of the boom-bust cycle, not just a discussion of recession. The ABCT does not say that all recessions are explainable by the ABCT; albeit, most modern business cycles are ABCs. Earthquakes and natural disasters and foreign invasions are other things that for example could impact economic production and cause economic busts.

** As is sort of implicit, the real issue is the expansion of credit. While the modern business cycle is dominated by the Governmental injection of money into the economy that drives interest rates lower, ABCT is really a tale of the artificial expansion of capital.

"Tulipmania" is a famous episode that can be explained by ABCT and the boom/bust of credit expansion. Doug French studied at UNLV under Murray Rothbard and has written and studied Tulipmania extensively. From

The Truth About Tulipmania:

The story of Tulipmania is not only about tulips and their price movements, and certainly studying the "fundamentals of the tulip market" does not explain the occurrence of this speculative bubble. The price of tulips only served as a manifestation of the end result of a government policy that expanded the quantity of money and thus fostered an environment for speculation and malinvestment. This scenario has been played out over and over throughout history.

Like other periods of heightened speculation, Dutch interest rates "declined sharply" in the seventeenth century according to Homer and Sylla (1996, p. 141) and tulip bulb futures could be traded with no margin required (Garber 2000, p. 44). The tulip trading clubs were "soundly organized" and "proved very effective in smoothing transactions" (Gelderblom and Jonker n.d.). Dash (1999, p. 110) writes that the masses speculated in the tulip trade as an outgrowth of "an increasingly feverish boom in the Dutch economy as a whole, which began in 1631 and 1632 and gathered pace toward the end of the decade and meant that in many cases there was more money around than ever before." As more novice florists became interested in tulip speculation, professional growers introduced "an unusually large number of new varieties in 1634, which had the effect of depressing prices," but provided an avenue for commoners to participate in the mania (Dash 1999, p. 111).

But what made this episode unique was that the government policy did not expand the supply of money through fractional reserve banking which is the modern tool. Actually, it was quite the opposite. As kings throughout Europe debased their currencies, through clipping, sweating or by decree, the Dutch provided a sound money policy, which called for money to be backed one hundred per cent by specie. This policy, combined with the occasional seizure of bullion and coin from Spanish ships on the high seas, served to attract coin and bullion from throughout the world.

Here is Mr. French's review of Tulipmania: Money, Honor, and Knowledge in the Dutch Golden Age by Anne Goldgar.

Doug French has also published a book on Early Speculative Bubbles & Increases in the Money Supply. The Chapters:

# Chapter 1: The Greater Fool Theory

# Chapter 2: Tulipmania

# Chapter 3: Free Coinage, the Bank of Amsterdam, and Tulipmania

# Chapter 4: John Law, Genius or Swindler

# Chapter 5: John Law's Monetary Theories

# Chapter 6: The Mississippi Bubble

# Chapter 7: The South Sea Bubble

# Chapter 8: Increases in the Supply of Money, Speculative Bubbles, and the Austrian Malinvestment Theory

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Think about building something complex like an airplane. You have to build all the factories to build the various parts, you have to build all the necessary equipment before you can even think about building the airplane. And you have to plane and do all kind of science to learn how to fly and then you have to educate your workforce, you need highly skilled engineers and mechanics and etc. You have to build an enormous plant that takes years to build and requires huge hangars and lots of land.

The inputs themselves involve multiple stages of production. This means for example producing x, selling it to another producer who puts in into z, who then sells to another producer who adds it to W, and so on until it is finally incorporated into the final consumer good.

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Leonard Reeds’ classic article 1958 article “I Pencil” beautifully illustrates this point. The article is written in the first person from the point of view of an Eberhard Faber pencil. The pencil narrator details the complexity of its own creation, listing its components (cedar, lacquer, graphite, ferrule, factice, pumice, wax, glue) and the numerous people involved, down to the sweeper in the factory and the lighthouse keeper guiding the shipment into port. It illustrates the complex capital structure necessary to make a simple pencil.

I, Pencil. My Family Tree as told to Leonard E. Read

I, Pencil, simple though I appear to be, merit your wonder and awe, a claim I shall attempt to prove. In fact, if you can understand me—no, that’s too much to ask of anyone—if you can become aware of the miraculousness which I symbolize, you can help save the freedom mankind is so unhappily losing. I have a profound lesson to teach. And I can teach this lesson better than can an automobile or an airplane or a mechanical dishwasher because—well, because I am seemingly so simple.

Simple? Yet, not a single person on the face of this earth knows how to make me. This sounds fantastic, doesn’t it? Especially when it is realized that there are about one and one-half billion of my kind produced in the U.S.A. each year.

Pick me up and look me over. What do you see? Not much meets the eye—there’s some wood, lacquer, the printed labeling, graphite lead, a bit of metal, and an eraser.

...

Does anyone wish to challenge my earlier assertion that no single person on the face of this earth knows how to make me?

Actually, millions of human beings have had a hand in my creation, no one of whom even knows more than a very few of the others. Now, you may say that I go too far in relating the picker of a coffee berry in far off Brazil and food growers elsewhere to my creation; that this is an extreme position. I shall stand by my claim. There isn’t a single person in all these millions, including the president of the pencil company, who contributes more than a tiny, infinitesimal bit of know-how. From the standpoint of know-how the only difference between the miner of graphite in Ceylon and the logger in Oregon is in the type of know-how. Neither the miner nor the logger can be dispensed with, any more than can the chemist at the factory or the worker in the oil field—paraffin being a by-product of petroleum.

...

If I, Pencil, were the only item that could offer testimony on what men and women can accomplish when free to try, then those with little faith would have a fair case. However, there is testimony galore; it’s all about us and on every hand. Mail delivery is exceedingly simple when compared, for instance, to the making of an automobile or a calculating machine or a grain combine or a milling machine or to tens of thousands of other things. Delivery? Why, in this area where men have been left free to try, they deliver the human voice around the world in less than one second; they deliver an event visually and in motion to any person’s home when it is happening; they deliver 150 passengers from Seattle to Baltimore in less than four hours; they deliver gas from Texas to one’s range or furnace in New York at unbelievably low rates and without subsidy; they deliver each four pounds of oil from the Persian Gulf to our Eastern Seaboard—halfway around the world—for less money than the government charges for delivering a one-ounce letter across the street!

The lesson I have to teach is this: Leave all creative energies uninhibited. Merely organize society to act in harmony with this lesson. Let society’s legal apparatus remove all obstacles the best it can. Permit these creative know-hows freely to flow. Have faith that free men and women will respond to the Invisible Hand. This faith will be confirmed. I, Pencil, seemingly simple though I am, offer the miracle of my creation as testimony that this is a practical faith, as practical as the sun, the rain, a cedar tree, the good earth.

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As Sheldon Richman has commented:

But there’s another lesson in “I, Pencil” that has been largely overlooked, perhaps by Read himself. “I, Pencil” is also an excellent primer in the Austrian approach to capital theory. It’s worth looking at Read’s essay in that light.

Early on, Read’s pencil describes his family tree, beginning with the cedars grown in northern California and Oregon that provide the wooden slats. But he doesn’t really start with the trees. He notes that turning trees into pencils requires “saws and trucks and rope and the countless other gear used in harvesting and carting the cedar logs to the railroad siding,” and those things have to be produced before a pencil can be produced. “Think of all the persons and the numberless skills that went into their fabrication: the mining of ore, the making of steel and its refinement into saws, axes, motors; the growing of hemp and bringing it through all the stages to heavy and strong rope; the logging camps with their beds and mess halls, the cookery and the raising of all the foods. Why, untold thousands of persons had a hand in every cup of coffee the loggers drink!”

What emerges here is what Austrian economists call a structure of production. This structure is characterized by two closely related elements: multiple stages (distinguished by their “distance” from the consumer) and time. The pencil that eventually emerges at the end of the process must first proceed, in various states of incompleteness, through a series of stations at which components are transformed in ways consistent with making pencils. The stations themselves have to be prepared through earlier stages of production. Thus before trees can be cut down and turned into wooden slats, saws, trucks, rope, railroad cars, and other things must be produced first. Before steel can be used to make saws, trucks, and railroad cars, iron ore must be mined and processed. And so on. The same kind of description can be provided for each component of the pencil: the paint, the graphite, the compound that comprises the eraser, the brass ferrule that holds the eraser.

I Pencil Revisited

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In Human Action, Ludwig von Mises uses the example of a master builder who is building a house but he is under a misleading impression as to how many bricks he has to explain ABCT. The master builder thinks he has 20% more bricks than he actually has (Mises posits he can’t buy more bricks). So the master builder begins building a house, but he is building the wrong kind of house, as he would build a different house if he knew how many bricks he actually had. In the master builder’s microeocnomy, the pool of real savings is not large enough to support his house. The master builder is undertaking a project he will not be able to finish.

What would be the best way to get the builder out of this predicament? To alert him as to the real supply of his bricks, to tell him he is building a house he will not be able to finish. And you want to do this as soon as possible, not right before he runs out of bricks, because he has to demolish the partially built house and start anew.

We see the master builder has squander society’s resources by undertaking a project that cannot be completed.

The boom period, when he is building the house and employing lots of peoples, that is when is doing the damage, wasting the resources. The bust period is when he is fixing his past mistake, correcting his prior waste of resources and labor time. This is the healthy correction of his prior error.

Applying this example to the real economy, we can see why its best to find out now what is unsustainable, to stop it and start viable, sustainable projects. Not to prop up the unsustainable, non-viable projects that squander capital and labor on what could be seen as quixotic production paths, on unsustainable production trajectories.

When people say the solution is to pump more money into the system, they are saying lets drive the interest rate down to keep entrepreneurial investment going. Its sorta like saying lets get the master builder drunk so he doesn’t notice the dwindling supply of bricks and just keeps building the doomed house, he keeps up the inherently unsustainable production.

But this does not hold up the bust, the bust is inevitable. Pumping money and other intervention only leads to the waste of more resources as we prop up unsustainable activities. When Alan Greenspan did exactly this in 2001 by lowering rates to stimulate the economy, he refused to let occur the the healthy process that is the reallocation of capital to sustainable projects during a bust. Greenspan sought to stimulate the economy to fight the bust, he perpetuated this misallocation and squandering of resources in unsustainable liens of production.

And for the first time on record, we had a recession where housing starts did not decline. And thus we see the heart of the myths that housing never declines, prices always go up, home prices don’t go down during a recession, a home is the best investment you can make, that you can buy and flip houses and make lots of money with no risk, etc. – the Fed’s intervention in the economy. Greenspan kept the master builder drunk, and we kept building houses and commercial/residential real estate developments that we did not have the savings to consume. Bust.

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Bob Murphy (Ph.D. in Econ from NYU where he studies under Israel Kirzner and Mario Rizzo) expounds on thsi idea in Mises's Example of the Master Builder

The single best analogy for the Austrian business-cycle theory comes from Mises himself, and I will take some creative liberties with his original exposition for our purposes. Imagine a master builder. He has at his disposal the labor of many workers, as well as a collection of bricks, shingles, panes of glass, and so on. Mises then asks us to suppose that the subordinate in charge of counting the available supply of bricks inflates the number by 10 percent. Thus the master builder draws up the blueprint for the house, erroneously thinking he has more bricks to work with than he really does. Because of this error, he embarks on a building plan that is unsustainable; there are not enough bricks to finish the house as it is designed on the blueprint.

Now obviously, the sooner the builder learns of the mistake, the better. If he finds out immediately after the excavators have dug the hole for the foundation, the waste will consist merely of the extra labor and gasoline needed to use the earth movers to put back some of the dirt and make the hole smaller.

But suppose the builder doesn't find out until after he has already laid the foundation and erected the frame of the whole house. Now of course the waste is much worse. Given the materials at his disposal—and we assume that he can't go onto the market and buy more—the builder must now make some very tough choices. He probably will decide to leave the foundation as is, even though it is bigger than he would have designed it, had he known the true number of bricks from the beginning. He will have to redo the blueprints, naturally, and scale down the size of the house, though keeping the same size foundation. Some of the lumber already used might be salvageable, though some will have to be torn down and discarded. And of course, the finished house will be inferior in quality to the house the builder would have designed originally, had he known the true amount of his various supplies.

Now consider the scenario where the subordinates realize their mistake, but the master builder has not yet discovered it. They decide to deceive him as long as possible, by using tarps to cover up gaping holes in the stockpile of remaining bricks. "After all," they convince themselves, "look at how happy everyone on the site is, coming to work in the morning and building this fine house! Imagine how furious the master would be, if he learned that we don't have as many bricks as the blueprint calls for! Why, whole teams of the construction crew might be thrown out of work if that happened! He's got three guys alone working on the paneling for the third-floor balcony, but there might not even be a third floor in the revised plan. So let's just keep the good times going as long as possible, lest we end up with a bunch of guys standing around with nothing to do."

In Mises's story, it is clear that the builder's error is not overinvestment, but malinvestment, of resources. It isn't a question of how many bricks should be used on the house as a whole. Rather, the mistake is that the builder allocated too many bricks to the first floor. With each subsequent brick that his men put in place, following the original (and flawed) blueprint, the options for salvaging the project become narrower and narrower. In the worst-case scenario, the builder would only learn of the inflated brick count the moment he had laid the last brick—at this point, no subterfuge by his subordinates could deny the fact that they were physically out of bricks. And at that horrible point, the builder would have to survey the remaining materials littering the yard, hoping to be able to at least seal the unfinished house to keep the rain out. Whatever the outcome, the builder would have sorely preferred learning of the brick shortage much earlier.

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Here is one of my favorite pieces by Bob Murphy in which he responds to criticism of ABCT from Paul Krugman and Tyler Cowen. Murphy explains the importance of capital consumption to ABCT, or what happens when we don't really save but simply keep consuming and thus do not release resources into the economy to support newly undertaken allocations of productive capital resources.

Above I've pointed out some of the basic flaws in Krugman's and Cowen's arguments. (Other Austrians have responded to Krugman in the past. See the replies of Garrison and Cochran.) More generally, they are ignoring the all-important notion of capital consumption. This is why one needs to understand capital theory, as pioneered by Carl Menger and Eugen von Böhm-Bawerk, in order to make sense of what the heck just happened in the US economy. Any talking head on CNBC who doesn't understand capital consumption is going to give horrible policy recommendations.

When thinking about this article, I went back and forth. I have decided that I should spell out a "model" of intermediate complexity, because if I simplify it too much, it might not really click with the reader, but if I go overboard with it, no one in his right mind would finish the article.

A Sushi Model of Capital Consumption

The island starts in an initial equilibrium that is indefinitely sustainable. Every day, 25 people row boats out into the water and use nets to catch fish. Another 25 of the islanders go into the paddies to gather rice. Yet another 25 people take rice and fish (collected during the previous day, of course) and make tantalizing sushi rolls. Finally, the remaining 25 of the islanders devote their days to upkeep of the boats and nets. In this way, every day there are a total of (let us say) 500 sushi rolls produced, allowing each islander to eat 5 sushi rolls per day, day in and day out. Not a bad life, really, especially when you consider the ocean view and the absence of Jim Cramer.

But alas, one day Paul Krugman washes onto the beach. After being revived, he surveys the humble economy and starts advising the islanders on how to raise their standard of living to American levels. He shows them the outboard motor (still full of gas) from his shipwreck, and they are intrigued. Being untrained in economics, they find his arguments irresistible and agree to follow his recommendations.

Therefore, the original, sustainable deployment of island workers is altered. Under Krugman's plan for prosperity, 30 islanders take the boats (one with a motor) and nets out to catch fish. Another 30 gather rice from the paddies. A third 30 use the fish and rice to make sushi rolls. In a new twist, 5 of the islanders scour the island for materials necessary to maintain the motor; after all, every day it burns gasoline, and its oil gets dirtier. But of course, all of this only leaves 5 islanders remaining to maintain the boats and nets, which they continue to do every day. (If the reader is curious, Krugman doesn't work in sushi production. He spends his days in a hammock, penning essays that blame the islanders' poverty on the stinginess of the coconut trees.)

For a few months, the islanders are convinced that the pale-faced Nobel laureate is a genius. Every day, 606 sushi rolls are produced, meaning that everyone (including Krugman) gets to eat 6 rolls per day, instead of the 5 rolls per day to which they had been accustomed. The islanders believe this increase is due to use of the motor, but really it's mostly due to the rearrangement of tasks. Before, only 25 people were devoted to fishing, rice collection, and sushi preparation. But now, 30 people are devoted to each of these areas. So even without the motor, total daily output of sushi would have increased by 20%, assuming the islanders were equally good at the various jobs, and that there were plenty of fish and rice provided by nature. (In fact, the contribution of the motor was really only the extra 6 rolls necessary to feed Krugman.)

But alas, eventually the reduction in boat and net maintenance begins to affect output. With only 5 islanders devoted to this task, instead of the original 25, something has to give. The nets become more and more frayed over time, and the boats develop small leaks. This means that the 30 fishermen don't return each day with as many fish, because their equipment isn't as good as it used to be. The 30 islanders making sushi are then in a fix, because they now have an imbalance between rice and fish. They start cheating, by putting in smaller pieces of fish into each roll. The islanders continue to get 6 rolls per day, but now each roll has less fish in it. The islanders are furious — except for those who are repulsed by the idea of ingesting raw fish.

Being a trained economist, Krugman knows what to do. He suggests that 2 of the rice workers and 2 of the sushi rollers switch over to help the fishermen. Now with 34 workers, the islanders are able to catch almost as many fish per day as they were in the previous months, even though they are now using tattered nets and dilapidated boats. Krugman — being very sharp with numbers — moved just enough workers so that the fish caught by the 34 islanders matches up perfectly with the rice picked by the remaining 28 islanders who go to the paddies every day. With this amount of fish and rice, the 28 workers in the rolling occupation are able to produce 556 sushi rolls per day. This allows everyone to consume about 5 and a half rolls per day, with a bonus roll left over for Krugman.

The islanders are a bit concerned. When they first followed Krugman's advice, their consumption jumped from 5 rolls to 6 per day. Then when things seemed to be all screwed up, Krugman managed to fix the worst of the discoordination, but still, consumption fell to 5.5 rolls per day. Krugman reminded them that 5.5 was better than 5. He finally got the crowd to disperse by talking about "Cobb-Douglas production functions" and drawing IS-LM curves in the sand.

Because this is a family-friendly website, we will stop our story here. Needless to say, at some point the 5 islanders devoted to net and boat production will decide that they have to cut their losses. Rather than trying to maintain the original fleet of boats and original collection of nets with only 5 workers instead of 25, they will instead focus their efforts on the best 20% of the boats and nets, and keep them in great shape. At that point, it will be physically impossible for the islanders to prop up their daily sushi output. In order just to return to their original, sustainable level of 5 sushi rolls per person per day, the islanders will need to suffer a period of privation where many of them are devoted to net and boat production. (We can only hope that Professor Krugman has been rescued by the Swedes by this time.)

The 5 people looking for ways to synthesize gasoline and motor oil will have to abandon that task, because it was never appropriate for the islanders' primitive capital structure. The islanders will of course discard the motor brought to the island by Krugman once it runs out of gas.

Finally, we predict that during the period of transition, some islanders will have nothing to do. After all, there will already be the maximum needed for catching fish with the usable boats and nets, and there will already be the corresponding number of islanders devoted to rice collection and sushi rolling, given the small daily catch of fish. There would be no point in adding extra islanders to boat and net production, because then they would end up building more than could be sustained in the long run. Hence, the elders rotate 10 people every day, who are allowed to goof off. They could of course go try to catch fish with their bare hands, or go gather rice that would just be eaten in piles by itself, but everyone decides that this is a waste of time. Given the realities, it is decided that during the transition, 10 people get the day off, even though everyone is hungry. That is just how bad Krugman's advice was.

Conclusion

As our simple story illustrates, in modern economies workers use capital goods to augment their labor as they transform nature's gifts into consumption goods. Because of the time structure of production, it is possible to temporarily boost everyone's consumption, but only at the expense of maintaining the capital goods (the boats and nets), which are thus "consumed." At some point, engineering reality sets in, and no "stimulus" policies can prevent a sharp drop in consumption.

Although the story of the sushi economy was simplistic, I hope that it illustrated essential features of a boom-bust cycle. When the islanders first implement Krugman's advice, they all feel richer. After all, they really are eating 6 rolls per day instead of 5; there is no arguing with results. And they would have no reason to suspect an unsustainable restructuring, either: after all, they are using a new outboard motor. This is analogous to the arguments about the "New Economy" during the dot-com boom, or the confidence placed in the new financial instruments used during the housing boom. During every boom, people can always come up with reasons that "this time it's different."

In the sushi economy, this initial prosperity was illusory. Although there were indeed benefits from the new technology, the bulk of the extra consumption was being financed through capital consumption, i.e., by allowing the boats and nets to deteriorate. This is analogous to Americans' consuming a massive amount of imported consumption goods during the housing boom, because they erroneously thought their rising house values would more than compensate. In other words, had Americans realized that their real-estate holdings would plummet in a few years, they would not have consumed nearly as much. They were consuming capital without realizing it, just as the islanders didn't realize that their extra sushi consumption was largely financed through neglect of their boats and nets.

Edited by Baltimoron

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Robert Higgs has written extensively on the Great Depression.

Robert Higgs is Senior Fellow in Political Economy for The Independent Institute and Editor of the Institute’s quarterly journal The Independent Review. He received his Ph.D. in economics from Johns Hopkins University, and he has taught at the University of Washington, Lafayette College, Seattle University, and the University of Economics, Prague. He has been a visiting scholar at Oxford University and Stanford University, and a fellow for the Hoover Institution and the National Science Foundation.

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Here is a December 2008 interview with Russ Roberts (Ph.D. in econ from University of Chicago, teaches at GMU), about:

Robert Higgs, of the Independent Institute, talks with EconTalk host Russ Roberts about the Great Depression, the New Deal, and the effect of World War II on the American economy. Using survey results, financial data, and the pattern of investment in the 1930s, Higgs argues that New Deal policies created a climate of uncertainty that prolonged the Great Depression. Using consumption data, he argues that prosperity did not return during wartime, but rather after the war when government intervention in the economy subsided.

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Wartime Prosperity? A Reassessment of the U.S. Economy in the 1940s is a shortish article by Higgs addressing the Great Depression:

ABSTRACT: Relying on standard measures of macroeconomic performance, historians and economists believe that “war prosperity” prevailed in the United States during World War II. This belief is ill-founded, because it does not recognize that the United States had a command economy during the war. From 1942 to 1946 some macroeconomic performance measures are statistically inaccurate; others are conceptually inappropriate. A better grounded interpretation is that during the war the economy was a huge arsenal in which the well-being of consumers deteriorated. After the war genuine prosperity returned for the first time since 1929.

“War prosperity is like the prosperity that an earthquake or a plague brings.”

—Ludwig von Mises

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A longer piece is this pdf "Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Returned After the War,".

Higgs has also written a book (a collection of longer essays) called "Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Returned After the War,".

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here is Higgs' 33 minute speech

(youtube video), which looks at the connection between monetary inflation and war funding. He examines budgets, inflation and such in the US in WWI and WWII.

Its a lot easier to fund a war by printing money than it is to tax people the full amount (assuming its not such a small war it can be fought out of present inventory).

Here is a pdf file Dr. Higgs discusses in Death Fuel lecture that details budgetary information from WWI and WWII.

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Baltimoron,

Not sure what you're trying to do here. If you are interested in any Actual Discussion, it might work better if you would speak for yourself, instead of just giving folks a reading list about one dogmatic school of thought about economics. On the other hand, if your purpose is to provide a series of advertisements about the Austrians, based on a long series of long cut-and-pastes quotes combined with a syllabus for indoctrination, well, that's fine. It just depends on what you're trying to do.

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Baltimoron,

Not sure what you're trying to do here. If you are interested in any Actual Discussion, it might work better if you would speak for yourself, instead of just giving folks a reading list about one dogmatic school of thought about economics. On the other hand, if your purpose is to provide a series of advertisements about the Austrians, based on a long series of long cut-and-pastes quotes combined with a syllabus for indoctrination, well, that's fine. It just depends on what you're trying to do.

I have two posts responding to Lucky Jim on Derrida, and a response to Clapdiddy.

==========

Isn't this what we do in school? Teach kids by giving them stuff to read so they can learn. I'm not sure why you dismiss my references to scholarly articles and other sources, or my excerpts and highlights of pertinent passages. Are you against education?

Do you not read? Don't you discuss new ideas with others? Is this not the point of a message board, to share ideas and opinion?

What is a syllabus on indoctrination? Is this a cult reference? How many "public" cults are there that try to get people to listen to their ideas and arguments in public?

Or more accurately, what is not a syllabus for indoctrination? If I post something from Tom Tango, or from Baseball Prospectus, is that a "syllabus for indoctrination"? Why is it not an idea for discussion, or an explanation of a concept?

I'm appealing to intellect by offering ideas and arguments advanced by scholars with advanced degrees in economics. There has been a lot of banter about what Austrian believe and who they are, and I feel a lot of that is misleading. So I'm presenting their words and ideas.

I've made two posts on my own hand (see all the typos/misspellings, disgraphia is the suck) explaining the theory for which F.A. Hayek was awarded the Nobel prize in economics. There is a lot of ignorance on economics, and a lack of exposure to it. Is your objection about economics, or just certain schools of economics?

I think the Austrians are right on a lot of issues. I got an undergrad in econ and have always had an interest in economics. And I like their ideas, becuase they make sense.

======

I'm sharing what I believe to be a destroyer of wealth and a cause of widespread pain and suffering to my fellow humans. Unemployment and its related social ails, poverty, war, etc. Bad stuff.

This is the rants forum. I am ranting about the perceived nonsense that is happening today. People are being hurt.

Remember Bruce Springsteen's "Born in the USA"? A song that had such appeal because it both spoke to the promise of our supposed great nation of idealistic potential, and contrasted it with the harsh reality, the failure of recent government, of a silly war that had ruined lives, families, and communities. Prosperity and a chance were denied to so many.

Similar themes. We could do so much to help humanity, but yet we do not. That makes me sad. So I post in the Rants forum and explain my point of view and the economic ideas I think are correct.

====

I'm sorry the study of economics is not a simple matter. As is obvious, many brilliant humans have devoted their lives to the study of economics.

There are different schools in economics. Austrians are on board with most schools on a lot of stuff. But they also differ from the other schools. Just as the other schools differ from each other in their own way. Otherwise they wouldn't be different schools.

I'd be happy to have a respectful discussion with you. I've made that clear to you. What is on your mind?

==========

If you want you can ignore this thread, as can everyone else too. It won't bother me. But I like econ, and I think people deserve to the right to hear all sides to a debate. There are a lot of intelligent people here.

What's the harm in my publishing/discussing it? Won't that just expose it for all its silliness? The ship will sink itself, you can just sit back and watch.

Edited by Baltimoron

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"All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident."

Arthur Schopenhauer, German philosopher (1788 - 1860)

Maybe the Austrians are all wrong.

But history makes clear acceptance of truth is evolutionary. People used to think the Earth was flat after all.

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"All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident."

Arthur Schopenhauer, German philosopher (1788 - 1860)

Maybe the Austrians are all wrong.

But history makes clear acceptance of truth is evolutionary. People used to think the Earth was flat after all.

Baltimoron - I have found your posts to be very interesting. Keep them coming!

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"All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident."

Arthur Schopenhauer, German philosopher (1788 - 1860)

Maybe the Austrians are all wrong.

But history makes clear acceptance of truth is evolutionary. People used to think the Earth was flat after all.

No, they are not "all wrong". They are partially right and partially wrong. Just like Marxists were. The idea that it's one or the other is when it gets to be dogma.

Claiming that the reason people disagree is because they don't buy "the truth" and are "ridiculing" it is about the most vacuous comment that can be made about any of this stuff. The Austrians see a slice of the truth, just like other schools of thought do. The diff is that some of the Austrians are arrogant enough to think that what they see is all that matters and that everybody else is wrong. That's just like some of the Marxists. Same exact thing, just a different set of partial-truths being mistaken for a comprehensive understanding. It's not a comprehensive understanding, it's one very-partial theoretical view of whatever the truth is, masquerading as the One True Answer. If real life teaches anything, it's anybody who claims to have the One True Answer about these matters should be immensely distrusted.

Not all proponents of the Austrian perspective claim it's the One True Answer. But it is something of theme that shows up among it's main advocates and recent adherents. Here's how you can tell when that's happening when: when folks want to make it national and/or international policy to adopt some completely unproven abstract theory that is based on a set of iffy assumptions. To proponents, it all makes sense in their head. As long as you stay inside that Thought World, it all adds up. It only gets messy when you start dealing with the Real World of real people and real human behavior. That's the exact same problem the Marxists had.

Edited by rshackelford

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Marx was wrong. A quickie. Mises in 1951:

The Marxian dogma of the inevitability of socialism was based on the thesis that capitalism necessarily results in progressive impoverishment of the immense majority of people. All the advantages of technological progress benefit exclusively the small minority of exploiters. The masses are condemned to increasing "misery, oppression, slavery, degradation, exploitation." No action on the part of governments or labor unions can succeed in stopping this evolution. Only socialism, which is bound to come "with the inexorability of a law of nature," will bring salvation by "the expropriation of the few usurpers by the mass of people."

Facts have belied this prognosis no less than all other Marxian forecasts. In the capitalist countries, the common man's standard of living is today incomparably higher than it was in the days of Marx. It is simply not true that the fruits of technological improvement are enjoyed exclusively by the capitalists while the laborer, as the Communist Manifesto says, "instead of rising with the progress of industry, sinks deeper and deeper." Not a minority of "rugged individualists," but the masses, are the main consumers of the products turned out by large-scale production. Only morons can still cling to the fable that capitalism "is incompetent to assure an existence to its slave within his slavery."

=========

Murray Rothbard, 1976, Praxeology: The Methodology of Austrian Economics

Praxeology is the distinctive methodology of the Austrian school. The term was first applied to the Austrian method by Ludwig von Mises, who was not only the major architect and elaborator of this methodology but also the economist who most fully and successfully applied it to the construction of economic theory. [1] While the praxeological method is, to say the least, out of fashion in contemporary economics as well as in social science generally and in the philosophy of science it was the basic method of the earlier Austrian school and also of a considerable segment of the older classical school, in particular of J.B. Say and Nassau W. Senior. [2]

Praxeology rests on the fundamental axiom that individual human beings act, that is, on the primordial fact that individuals engage in conscious actions toward chosen goals. This concept of action contrasts to purely reflexive, or knee-jerk, behavior, which is not directed toward goals. The praxeological method spins out by verbal deduction the logical implications of that primordial fact. In short, praxeological economics is the structure of logical implications of the fact that individuals act. This structure is built on the fundamental axiom of action, and has a few subsidiary axioms, such as that individuals vary and that human beings regard leisure as a valuable good. Any skeptic about deducing from such a simple base an entire system of economics, I refer to Mises's Human Action. Furthermore, since praxeology begins with a true axiom, A, all the propositions that can be deduced from this axiom must also be true. For if A implies B, and A is true, then B must also be true.

Let us consider some of the immediate implications of the action axiom. Action implies that the individual's behavior is purposive, in short, that it is directed toward goals. Furthermore, the fact of his action implies that he has consciously chosen certain means to reach his goals. Since he wishes to attain these goals, they must be valuable to him; accordingly he must have values that govern his choices. That he employs means implies that he believes he has the technological knowledge that certain means will achieve his desired ends. Let us note that praxeology does not assume that a person's choice of values or goals is wise or proper or that he has chosen the technologically correct method of reaching them. All that praxeology asserts is that the individual actor adopts goals and believes, whether erroneously or correctly, that he can arrive at them by the employment of certain means.

All action in the real world, furthermore, must take place through time; all action takes place in some present and is directed toward the future (immediate or remote) attainment of an end. If all of a person's desires could be instantaneously realized, there would be no reason for him to act at all. [3] Furthermore, that a man acts implies that he believes action will make a difference; in other words, that he will prefer the state of affairs resulting from action to that from no action. Action therefore implies that man does not have omniscient knowledge of the future; for if he had such knowledge, no action of his would make any difference. Hence, action implies that we live in a world of an uncertain, or not fully certain, future. Accordingly, we may amend our analysis of action to say that a man chooses to employ means according to a technological plan in the present because he expects to arrive at his goals at some future time.

The fact that people act necessarily implies that the means employed are scarce in relation to the desired ends; for, if all means were not scarce but superabundant, the ends would already have been attained, and there would be no need for action. Stated another way, resources that are superabundant no longer function as means, because they are no longer objects of action. Thus, air is indispensable to life and hence to the attainment of goals; however, air being superabundant is not an object of action and therefore cannot be considered a means, but rather what Mises called a "general condition of human welfare." Where air is not superabundant, it may become an object of action, for example, where cool air is desired and warm air is transformed through air conditioning. Even with the absurdly unlikely advent of Eden (or what a few years ago was considered in some quarters to be an imminent "postscarcity" world), in which all desires could be fulfilled instantaneously, there would still be at least one scarce means: the individual's time, each unit of which if allocated to one purpose is necessarily not allocated to some other goal. [4]

Such are some of the immediate implications of the axiom of action. We arrived at them by deducing the logical implications of the existing fact of human action, and hence deduced true conclusions from a true axiom. Apart from the fact that these conclusions cannot be "tested" by historical or statistical means, there is no need to test them since their truth has already been established. Historical fact enters into these conclusions only by determining which branch of the theory is applicable in any particular case. Thus, for Crusoe and Friday on their desert island, the praxeological theory of money is only of academic, rather than of currently applicable, interest. A fuller analysis of the relationship between theory and history in the praxeological framework will be considered below.

...

===================

Bob Murphy, 2003, Mises's Non-Trivial Insight

Perhaps the most distinctive feature of the economics of Ludwig von Mises is his insistence on the a priori approach. For Mises, economic "laws" must be logically deduced from antecedent axioms, so that—assuming the initial assumptions are true—the conclusions reached are just as valid as any result in Euclidean geometry.

This stands in sharp contrast to the method of the positivists, a camp that includes most of today's practicing economists. In their opinion, economics can only be "scientific" if it adopts the procedures used by the natural scientists. Roughly, the positivists feel that economists should form hypotheses with testable implications, and then collect data to measure the accuracy of their predictions. Those tendencies that enjoy the most success in this sense are then deemed to be better "laws" than conjectures that do not fit the data so well.

Against the mainstream's impressive mathematical tools and vast budgets spent on data collection, the Misesians meekly insist that economics must start from the premise that humans act. This action axiom lies at the core of "praxeology," Mises' term for the science of human action. The Misesians argue that all of the true economic laws can be derived from this simple axiom (sometimes with additional assumptions about the world, such as the fact that labor is onerous).

I must confess that I used to be embarrassed by this apparent dogmatism on the part of the Misesians. Of course human beings act—but so what? Do the Misesians really think that they have a monopoly on this insight? Do they really believe that mainstream economists would deny that human beings act?

However, the more I study Austrian economics and related fields, the more I understand just how ingenious Mises's move was. When we really study the action axiom, we see that it summarizes an incredibly complicated, and tremendously important, fact about the world. In order to succeed in the present environment, it is simply indispensable for each of us to attribute intentions and reason to other beings. To put it simply, if you want to get anywhere in life, you have to assume that other humans act.

To say that a man acts, the Misesian does not simply mean that the man's body behaves in a certain way. If a man falls off a bridge, his downward motion is not action in the Austrian sense. Moreover, if a man is in danger, his increased heartbeat is not (for most people) action either. Human action is the purposeful striving after desired ends. It is the intentional effort of a rational being to achieve a greater degree of satisfaction, from the being's subjective point of view.

I admit, at first these reflections seem too trivial to deserve mention. But it is only because we take the insights for granted, that we do not realize how crucial they are. The approach of the natural scientist would work quite well for a man on a deserted island. When building a fire, he would not need to think, "The sparks want to stay inside the rocks, so I must bang them together to convince them to jump on the sticks instead."

But once we introduce another person onto the scene, the situation changes dramatically. Now it is essential for our original man to attribute preferences and reasoning to the new "thing," in order to have any hope of understanding "its" behavior. Without delving into philosophical arguments, we can make the case quite pragmatically: If the original man tries to deal with the new "thing" (i.e. the second person on the island) using the same mental apparatus that he used when dealing with rocks and trees, then he will not be nearly as successful (from his own point of view) as he will be if he instead adopts the action axiom.

Austrians have argued that the method of the natural sciences "wouldn't work" in social affairs for two reasons. First, there are no underlying constants in human behavior, unlike the natural constants (such as the charge on an electron) that can be observed in, say, physics. Second, there is no way to conduct a truly controlled experiment in the social sciences. For example, two economists can't test rival theories of taxation on "the same" population, because the very occurrence of the first experiment (say, an increase in taxes) will change the initial starting point for the next experiment. The most obvious difficulty for this approach is that the subjects of the experiment—the people in the economy—are aware of the experiments and react accordingly. There is no way to hold their ideas "fixed" from one test to the next.

....

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Corporatism is a system of legal privilege that protects the structure of a corporation against capitalists.

For example in the USA shareholders have little power over the major industries other than as someone a dividend must be paid to. The executives in the corporate hierarchy control the corporation, the capital-owners control nothing. Big corporate executive salaries and golden parachutes and incentives to cook the books and maximize wealth in the short term that funnel wealth from the rightful capital owners.

This is not free-market Capitalism (see the legal, G does that).

One could say Corporatism is just another name for Mercantilism, with Mercantilism being defined as the use of force by the State to produce particular winners and losers in the market (In Mercantilism, exporting businesses are favored by the State, in Corporatism, the class of individuals who control corporations). The leftist view of the question in terms of profit tends to lead one to see Mercantilism/Corporatism as just a species of Capitalism.

I see Corporatism as a subset of Mercantilism. Both involve the State's threat/use of force as an essential feature to its existence.

=====

What is a Capitalist?

We conclude that any man can be a capitalist if only he wants to be. He can derive his funds solely from the fruits of previous capitalist investment or from past “hoarded” cash balances or solely from his income as a laborer or a landowner. He can, of course, derive his funds from several of these sources. The only thing that stops a man from being a capitalist is his own high time-preference scale, in other words, his stronger desire to consume goods in the present. Marxists and others who postulate a rigid stratification—a virtual caste structure in society—are in grave error. The same person can be at once a laborer, a landowner, and a capitalist, in the same period of time.

Murray Roth bard's Man, Economy, State - Chapter 6, 5. Time Preference, Capitalists, and Individual Money Stock

=====

The (Free) Market for Corporate Control

The Securities Exchange Commission (SEC) was created as a response by forcible government to the perceived excesses of the free market that led (if you believe government reports) to the 1929 stock market crash that precipitated the Great Depression.

In actuality, loose credit policies, possible only when an entity divorced from the pressures of supply and demand creates a money substitute not based in any economic reality, were what led to the rampant speculation that led in turn to the 1929 correction in the stock market. The depression that followed, itself a result of government market interventions such as high minimum wages and trade protectionism, convinced the central government to create more rules and bureaucracies to rein in the speculation that itself was a child of government intervention.

What we have now is a cornucopia of SEC regulations having the force of law intended as surrogates for investor due diligence. These are accompanied by state regulations that in large part are advertised as shareholder prophylactics that in practice are nothing more than expensive favors given to local corporations by sympathetic state legislatures.

...

Poison Pills and Anti-takeover measures are bad, or why Drexel Burnham Lambert was the hero:

Along with these great aggregations of wealth comes the possibility of conflicts of interest. Rationally disinterested investors, like you and me who hold our little 401k retirement accounts that are invested in dozens of large corporations, are the true owners of the corporations. While we are the owners, the great wealth amassed on our behalf is controlled by a few — perhaps seven to eighteen — corporate directors and officers. These directors and officers control great wealth, and are entrusted to employ it to our benefit. As these individuals control the wealth, they face incentives to grant themselves lavish perquisites, and to instantiate defenses against loss of control in order to entrench themselves in their cushy positions. Ross Johnson and the officers of RJR Nabisco, who lost control in a takeover battle memorialized in a book and movie, provide an example: their 20 corporate jets and other emoluments helped make RJR Nabisco a stagnant, mediocre performer ripe for takeover by anyone who could raise the funds and make better profits after taking control.

This market for corporate control, exemplified by mergers, acquisitions, hostile and friendly takeovers, and all manner of complicated transactions — reverse triangular mergers, statutory short-form mergers, cash buyouts, etc. — designed to skirt otherwise-mandatory shareholder votes and statutory obstructions, often is the only incentive for managers to pursue diligently corporate efficiency and profitability. Reputation and credibility are often enough to induce managers to perform well. When this is not the case, the threat of losing one's job certainly lights a fire under even the most complacent corporate officer.

And yet, in the guise of coming to the rescue of hapless shareholders (who, incidentally, rely on the expertise of analysts who buy securities for large institutional investors such as retirement funds, mutual funds, and insurers), in gallops the valiant SEC and state legislatures to save the day.

The term "poison pill" denotes a variety of takeover defenses, most authorized by statute, that make corporate takeovers difficult for one who wants to acquire a corporation whose directors and managers decide to resist. Here's how a poison pill works: Boards of directors create "rights" held by owners of common stock in a corporation. These rights are similar to stock options or warrants, granting the holder the opportunity to, for example, buy a number of shares (in accord with the number of shares already owned) at a discount price. Upon a triggering circumstance, such as a certain percentage of stock owned by an outsider (usually 20%), the rights are instantiated, and the rights apply only to the shareholders not attempting to take over the corporation.

Michigan and Indiana are examples of (the many) states that have anti-takeover statutes in effect. Under such statutes, if a single stockholder crosses a specified threshold of ownership (again, usually 20% of the outstanding shares), that stockholder loses his voting rights unless a majority of the other shareholders vote to restore those rights.

The result: There are fewer corporate takeovers than there were in the 1970s and 1980s, before such statutes were passed, and before the poison pill was invented by the inventive corporate defense attorney Martin Lipton. The takeovers that succeed today are "friendly" ones, of which the target corporation's board of directors approves, as opposed to the "hostile" takeovers that characterized the wild and woolly 1980s. In friendly takeovers, please note, the acquirer usually buys out the directors and officers with offers of lucrative "consultant" contracts that keep the ousted officers and directors gainfully employed.

State legislatures approve such laws because the laws are lobbied for by representatives of the corporate directors and officers in the legislatures' jurisdictions. "We mustn't let some outsider come in and fire all our constituents" is the usual lobbyists' battle cry. The result for shareholders, however, is loss of wealth — essentially, the possible gains in value of all our little retirement accounts are transferred to the sellout directors and officers.

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I think Baltimoron and RShackleford might actually find some common ground here with the anti-corporatism stuff.

I guess the question is whether Rothbard, Mises, et al really provide a workable alternative to the corporatist system.

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Corporatism is a system of legal privilege that protects the structure of a corporation against capitalists.

For example in the USA shareholders have little power over the major industries other than as someone a dividend must be paid to. The executives in the corporate hierarchy control the corporation, the capital-owners control nothing. Big corporate executive salaries and golden parachutes and incentives to cook the books and maximize wealth in the short term that funnel wealth from the rightful capital owners.

This is not free-market Capitalism (see the legal, G does that).

One could say Corporatism is just another name for Mercantilism, with Mercantilism being defined as the use of force by the State to produce particular winners and losers in the market (In Mercantilism, exporting businesses are favored by the State, in Corporatism, the class of individuals who control corporations). The leftist view of the question in terms of profit tends to lead one to see Mercantilism/Corporatism as just a species of Capitalism.

I see Corporatism as a subset of Mercantilism. Both involve the State's threat/use of force as an essential feature to its existence.

=====

What is a Capitalist?

Murray Roth bard's Man, Economy, State - Chapter 6, 5. Time Preference, Capitalists, and Individual Money Stock

=====

The (Free) Market for Corporate Control

...

Poison Pills and Anti-takeover measures are bad, or why Drexel Burnham Lambert was the hero:

Baltimoron, you are so right. Carl Icahn made billions by forcing his way onto boards and cutting sweetheart deals for himself. All with very little input from the sharholders.

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