This is the seventh and final installment of a series that began last week. Read the first, second, third, fourth, fifth and sixth parts.

The Main Source of Economic Imbalance and Polarization, and the Policies to Cope With It

Credit—and hence debt—obviously has been needed since a specialization of labor developed with the seasonal rhythms and gaps between planting and harvesting in the Neolithic agricultural cycle. It is implicit wherever there is a time gap between initial investment and the final product being delivered and paid for. Interest is first documented in the third millennium BC as a way for Sumerian public institutions to estimate their fair share of their gains on commercial advances to traveling merchants.

Most agrarian debts were also owed to royal collectors, mainly for land rental fees, water and shipping, and consumer loans. When this “barley debt” overhead grew too large, early Near Eastern rulers restored order with Clean Slates annulling these unpaid charges. Rulers were under no illusion that their economies automatically would settle in economic and financial balance. Instability was inevitable from natural disasters and wartime disruption, and simply from interest accruals increasing the debt balances quickly beyond what debtors in low-surplus economies could pay.

Administrators were not so idealistic or utopian as to attempt to design a system that somehow would not get out of balance. The archaic approach was to deal with the inevitable insolvency when it became necessary to annul consumer debts. The fact that most debts were owed to palace and temple collectors meant that the authorities were basically cancelling debts owed to themselves. (Commercial silver debts for productive loans among merchants were left in place.) These clean slates restored order in times of natural disaster or emergencies, and also when new rulers took their first full year on the throne. The aim was to inaugurate their reign with the economy in balance, by clearing away the accumulation of unpaid obligations that had built up as a result of an inability to pay.

Realization that there is no inherent tendency toward equilibrium (much less an equitable balance) is missing from today’s theorizing. Equilibrium mathematics based on diminishing returns and marginal utility (while ignoring compound interest and its growing debt burden) is irrelevant at best, and at worst a deliberately engineered distraction. When we see unrealistic economics built on false assumptions maintained in the face of repeated failure, we must look for special interests as the beneficiaries.

So just as industrial engineering has given way to financial engineering, rentier lobbying has given way to ideological engineering to shape perceptions of what is happening—because the diagnosis determines the policy cure. As economies veer out of balance and polarize, rentiers aim to deter economies from doing anything to prevent this widening imbalance. They pretend that “automatic stabilizers” will restore normalcy. But no such stabilizers are strong enough to rectify financial imbalance and predatory behavior. Antiquity was able to avoid polarization for many thousands of years precisely because it was free of such preconceptions. These are only a century old, promoted by the anti-classical reaction against

Progressive Era Reforms

In behavioral terms, today’s targeted dulling of perceptions that something is drastically wrong with the economy’s health is similar to what parasites do in biological nature: They numb the host’s ability to perceive that a free rider has taken over. The economic equivalent is Milton Friedman’s popularization of the science fiction writer Robert Heinlein’s motto, “There is no such thing as a free lunch.” What better way is there to deter the study of just how much of the economy is indeed a free lunch (economic rent), who gets it, and who is being exploited?

Parasites love deregulation—as the financial sector loves “free markets.” There is no room for the study of economic rent in the marginal utility approach to pricing or the Austrian economics sponsored to replace classical value theory. Denying that there is any such thing as unearned income or wealth, the new ideology seeks to erase the contrast between fair and equitable pricing and taxation as compared to exploitative rent extraction or, for that matter, the outright fraud that has become almost part and parcel of today’s financial sector.

Biological parasites trick the host into believing that they are part of its own body, even to be nurtured as if they were its offspring. But what actually is being reproduced is the parasite’s own life cycle. The economic equivalent of this favoritism for the free luncher occurs when interest is made tax deductible so that the financial sector can obtain more revenue to nourish its growth at the expense of the nonfinancial host economy. It occurs also when the Treasury favors debt over equity financing, and taxes financial gains from asset-price inflation and speculation (“carried interest”) at only a fraction of the rate levied on earnings from tangible capital formation, wages, and salaries.

In biological nature a smart parasite will keep the host alive and even help it find new sources of food, and perhaps keep it disease-free in a symbiotic relationship. The aim, of course, is to obtain most of the nourishment for itself and its offspring, over and above the basic subsistence level needed to keep the host alive.

But parasites shorten their time frame as they approach the end stage of the relationship with their host. Realizing that the game is nearly up, the free luncher does the equivalent of taking the money and running. It may encourage its host to act recklessly and be eaten by its own natural predator. A parasitized insect, for example, may lower its defenses and be eaten by a bird, which will become the new host for the parasite’s eggs to hatch within it. The parasite’s progeny will start a new life, higher in the food chain where the numbed and value-free host has ended up being “globalized.”

Alternatively, the parasite lays its eggs in the host directly, to hatch and devour its body as their food supply. This is essentially what occurs when the inexorable mathematics of compound interest absorbs the “real” economy’s profits, disposable personal income, and tax revenue. Since economies were stricken in September 2008, the financial sector has adopted a hit-and-run business plan, using its control of the host economy’s brain (government agencies, above all the Treasury and Federal Reserve) to give it bailouts, and threatening to paralyze the host economy by stopping its circulation of payments if it does not get its way.

Today’s financial free riders are abandoning ship to enter into a new symbiosis with new host economies. By the time the Federal Reserve gave the banks $800 billion in QE2 in 2012, most was spent in the BRIC countries and other healthy targets via exchange rate and interest rate arbitrage. The financial game plan is to numb the defense mechanisms of China and other less financialized countries the way neoliberals did to Russia in the 1990s.

What will happen to the host economies left as emptied out shells? Will the Untied States and Europe simply be left nearly for dead, having been turned into zombies by being financialized?

Today’s industrial host economies stand at a crossroads over this problem. To survive, they need to reverse the disabling of their regulatory defense mechanisms. The first step must be to revive classical political economy’s distinction between cost-value and price. The labor theory of value was an analytical tool to isolate economic rent as the element of price that has no necessary cost of production—“unearned income” because it has no counterpart necessary cost of production. To bring prices in line with cost-value called for a revolution against feudal privileges in Europe and the regions it colonized. On the eve of World War I, the reform program seemed to be succeeding. But it was rolled back when the “real” host economy had its analytic perception and regulatory warning organs disabled.

Suppose the host economy wakes up and senses what is going on. How is it to translate this perception into action in the political, law-making, and fiscal sphere?

In Europe, Parliamentary reform was expected to be the political catalyst, assuming that voters would act in their enlightened self-interest. Britain cleaned up its “rotten boroughs” in the 19th century, and the constitutional crisis of 1910 was resolved by an agreement that the House of Lords could never again block a House of Commons revenue bill. The way was freed for reformers to tax unearned land rent.

However, rentier-backed demagogues have relegated the classical emphasis on the fiscal and monetary dimension of political economy to merely a secondary position. Elections are fought over ethnic rivalries (in the Baltics and the American South), conservative horror at the thought of legalizing women’s rights and sexual equality (in right-wing religious areas and white collar urban precincts), or “democracy” (in U.S. protectorates abroad, where the term has become synonymous with pro-U.S. regimes rather than reflecting any particular political system). This calls into question the optimistic Enlightenment political premises of full knowledge of what is happening and enlightened self-interest as a guide for action.

If most voters are to act in their self-interest, this requires a revival of the logic that underlay the Progressive Era’s reform program. It must start by re-establishing the grounding of 19th century discussion in value, price and rent theory, the tax policy that follows from it, and monetary theory as it applies to financing public budget deficits.

Chicago School censors exclude such discussion from the journals and the curriculum where they hold sway—not always at gunpoint as in Chile, but more simply by controlling young professors’ access to tenure-track positions under “publish or perish” in journals fallen prey to rentier intellectual numbing and blind spots.

The result may seem ironic, because it has left the critique of pro-rentier markets “free” from public regulation and investment, and from progressive taxation, and predatory finance has been left mainly to Marxists. The explanation is that, as Patten pointed out, classical economics culminated in Marx (and in Henry George’s advocacy of taxing land rent). Marx and the socialists simply pushed the classical analysis to its logical conclusion in using the labor theory of value to isolate economic rent as unearned and hence unnecessary income—and applying this concept to banking and finance (which Ricardo never did!) as well as to land ownership and monopolies.

The classical focus on freeing markets from technologically and socially unnecessary overhead charges frightened high finance and its rentier clients, inspiring them to back an anti- classical reaction. Economic theory and ideology remain traumatized by this conflict between these rentier interests and those of industrial capital and labor. This trauma has become political, and is now challenging the core of how Western civilization has defined its postfeudal identity since the Enlightenment.

The underlying conflict between creditors and debtors has happened ever since antiquity succumbed to the post-Roman Dark Age. A negative equity economy is one that is losing blood—in economic terms, the circulation of income is drained to pay debt service. And the financial sector that receives this revenue behaves much as rats jumping ship or parasites steering their host to be devoured, or simply devouring them directly from the inside.

This is the state in which today’s debt-ridden economies are suffering, from Iceland and Latvia to Greece and Ireland. The deadly demographic effects are emigration, falling family formation and birthrates, shortening lifespans, and rising suicide rates.

This is not a natural death process. Yet the financial sector blames it on demographic aging. It blames budget deficits not on cutting taxes on real estate, finance and other wealth, but on the elderly for trying to enforce payment of the Social Security and pensions they were promised and for which they pre-saved in their wage agreements. Yet the productivity gains since World War II—or indeed, since 1980—have been large enough to support these payments and, for that matter, the leisure economy that was promised.

The problem is financial disease. It gained its initial foothold by crippling the guiding hand of government’s forward planning and regulatory mechanisms, and replacing progressive taxation and rent collection with favoritism over industry and labor. So the fight is not really a demographic one between the elderly and the “working population.” It is between employed labor and retirees together vis-à-vis an extractive financial elite allied with real estate and monopolies.

The fight is being waged over who will control government, its tax, and its regulatory system. In the political sphere, it is between economic democracy and financial oligarchy. This is the struggle that classical economics set out to arrange and quantify in order to design an appropriate cure aimed at creating amore equitable society and doing away with “false” and unnecessary rentier costs of production. Today’s neoliberalism is just the opposite: it seeks to load economies down with debt extracting interest beyond their ability to pay, and then demands privatization of public infrastructure to create monopolies to serve as further rent extraction.

This is what the European Troika has demanded of Greece. Its product is austerity, and it threatens to impose a new economic Dark Age.

Originally published by Levy Economics Institute