Market Based Society
11/03/97; 03/17/98; 03/19/98; 10/25/98; 10/27/98
Protection of Innovation*
Means of Exchange*
U.S. Monetary System*
Wealth and Money*
Reduction of Imbalance*
"Effective Market" Myth*
Credit Based Economy*
Shortage of Collateral*
General Public as Lender*
Intangible Assets as Collateral*
Growth of the Wealth*
Super Exponential Growth*
Perception of Money Value*
"Sink" in Demand Based Economy*
Fragility of Market*
Market and Bureaucracy*
Equal Rights and Diversity*
Predators and the Market*
Market and the Age Groups*
Old People and Perpetual Learning*
Young People and Boundaries of Protection*
Conflict of Generations*
Mechanics of Recession*
Management of Oscillations*
Dangers of Bad Theories*
Capitalism and Socialism*
Market of Ideas*
We present here some basic concepts needed to understand the society with market economy.
While the concept of the power seems to be very natural for any social group, the concept of wealth exists only in relatively developed social groups. It is absent in the prison society, or army society, or former socialist societies. When USSR was starting to move to the market economy, only a few were looking for the opportunities to build a business, but a lot were looking to fill the newly available positions of social power.
Hence it is reasonable to start with (loose) definition of wealth. The wealth is an ability to access goods and services relevant to current system of preferences. From this we can define the wealth of the individual, and the wealth of the society (social group). We see, this is a very psychological concept - it depends on system of preferences. Fortunately this system does not deviate mach from one member of society to the other: only a few do not feel being wealthy while other perceive them as such.
The system of preferences is changing - contemporary people placed back in time into the similar social group would not feel themselves as wealthy as before, because things they are accustomed to could be to expensive, possibly out of reach.
The system of preferences is not simple. Our "basic needs" are only a small part of what we want, and they can be a subject of (partial) compromise - people are ready to live in small quarters in Manhattan, to have access to other "things" they want. A person involved in the business wants special equipment - according to the current state of the art. Many people want to see movies as soon as they come on screen.
In the society with developed specialization (only in this society the concept of wealth has sense) there are two factors which affect wealth. One is the process of creation of "things" we want, and the other is the distribution process, which delivers these "things" to us when and where we want them. Both processes are difficult to maintain, because they face the limitation of nature, limitation of our knowledge, and uncertainty of our future system of preferences. This part of the social activity we call economy.
Market economy creates wealth, non market economy satisfies needs, needs which have to be defined outside economy. No wonder that non-market economies do not succeed in the wealth creation - they were not designed for that.
For better or worse we are creative creatures. Our preferences are changing because we learn, expand, or simply change our areas of activity. All this is affected by the changes in society, which in turn are affected by changes in economy. We have a "feed back" - economic changes brought about by our system of preferences change this system.
To satisfy our desires the economy has to take something from the Nature. How much we can take and how difficult it is affects how much the economy can deliver and how much it costs (in terms of efforts of members of society).
However much more important are other factors - how inventive we are and how soon the new ideas can be implemented.
The obvious part - creative solutions reduce the cost and needs for natural resources. Less obvious is, that by the very nature of the wealth, the economy has to creatively respond to the creative change of our system of preferences.
This other factor - that the economy has to be fast enough to catch up with our ever-changing desires, is becoming more and more important. The situation is similar to the weapon development - in the moment when we perfect the production of the current weapon system, the adversary have implemented the new more effective weapon system and we are behind, therefore we have to move with new systems early and abandon perfectly good old ones. Competition places economy players in the situation similar to the sovereigns (states) competition and leads to similar results - rapid introduction of innovations, that economy follows the change of our system of preferences.
The satisfactions of our basic needs (food, shelter, reproduction and safety) are only small part of our desires in the market economy. Market works as a tool of the society, which searches for resources end explores them. On the way it creates new tools – new economic and social structures, and satisfies our basic needs. Societies, which concentrate on the satisfaction of the basic needs of their members, usually do not satisfy the need for the active exploration, and finally can not satisfy basic needs also.
We can say that the need for the exploration is a basic need. Some societies are introverts – they make the exploration of the "spirit", "psyche", usually they are religious society, other are extraverts – they explore the ability to change and control the nature. Market is a tool of these extravert societies.
Protection of Innovation
Economic innovation – successful introduction to the market new goods and services, is one of the major sources of the wealth of society. Economic innovation often is based on technological innovation, however technological innovation is not enough – the product is much more than technology.
This is so important that market based society is ready to sacrifice the basic principle of the competition as a foundation of the market and grant monopoly to innovators, at least for a while, that innovators can benefit "excessively" from their work. The tools of these exceptional rights are patents, trademarks and brand names. These tools are abused – they are used often to restrict competition without production of new products, or "milk" potential producers, for example by registering patents without any plans to produce anything, but still they work well.
There is a need for some new form of the patent. Many inventors are not good businessmen or do not have time or desire to implement their invention. The publication of the invention can benefit an inventor, who had dedicated his life to academia, but practically no one else. However it is clearly in the interests of the society to keep them inventing.
There is a solution to this problem. The society needs a new form of the encouraging of the innovation – a special form of the patent, which licensing is automatic. The law should regulate the way the patent holder is paid, if this patent is used. The last step – this patent can be owned by one special non-profit organization, which takes care of collecting the payment, and shares proceeds with the inventor in the form prescribed by the law.
The goods are created in one place, move through a chain of "handlers" and consumed in the other place. If this complicated and time and effort consuming process was set in motion, it means that there is some kind of "value" associated with these goods. Obviously, the value created in this manner is higher, than all time and effort needed to create it (including all previously spent time and efforts, for example to create machinery, transportation etc.). What is "higher" and how much we measure with our system of preferences.
This value is higher than what we spent to get it, because we took something from the nature, but most important, because we created something on the way, we introduce new "organization", which we treasure. Also we learnt how to consume the new product. Our system of preferences is the only basis to judge what is valuable, and we prefer things organized in a special way.
All participants of the process want to benefit from it they want "a cut" of this value. How this "cut" is taken is a secondary issue here - some consume the product, some get paid and consume the other product, etc.
From the point of the view of society as a whole there is no difference between any member in this chain - they all divide value which society had delivered. However there is an important difference if there are a lot of similar chains – when we have a mass production. Proper distribution stimulates the proper use of resources and encourages the exploration in the proper direction.
The "proper distribution" should reflect the scarcity of the resources – natural resources, skills, etc. In this case the society automatically optimizes the use of resources.
The value of the same type of goods or services is changing in time because the society and circumstances are changing.
For the economic modeling measuring of the value is important. The price is different from the value. The price is a market tool for the distribution of the value. However, we can use money to measure value. However when the economy is in turmoil money is not precise enough tool to measure value, because the relationship between monetary system and economic system becomes unstable.
Money is the tool of distributing value between market participants. Current concept of money includes other roles also, however this is a basic one.
Means of Exchange
The functioning of the Market requires easily transferable liquid assets of decent reliability. If the gold is used as such asset, its market value is higher than its utilitarian value. If the debt obligations of particular entity are used as such assets their market value is higher than their face values, and the entity can pay less interest on its debt. In addition there is some amount of debt obligations have to circulate to facilitate the economic transactions, and this amount does not need any real collateral – this is a value produced by this entity.
In many countries the state produces means of exchange of superior quality – currency. Currency acceptance as means of the repayment of the debt is enforced by the law. Expanding market needs in these special goods allow state to produce it perpetually and benefit from it directly (state has additional expenses also – it has to replace old currency notes, and it has to protect it against counterfeit).
If the state abuses its power of the currency issue and issues more than the market needs the exchange ratio of the currency and goods drops – this is "inflation".
U.S. Monetary System
In U.S. the government can not issue currency directly, it only produces the currency in exchange for the equivalent value of government (interest paying) debt obligations – Treasuries (Notes and Bonds).
The entire U.S. Monetary System is based on responsible lending. Only the country with well-developed financial system can build a monetary system where the money is "created" by lending.
The lending institutions (mostly banks) issue in circulation the amount of money equal to the value equivalent to the collateral. The experienced lenders determine the equivalency.
The government is the biggest borrower, its repayment ability is supported by its ability to collect taxes. This is a government’s "collateral", supported by the stability of political institutions – the reputation.
The reputation stays as a "collateral" in personal lending, as credit cards, also.
U.S. government produces the biggest amount of the debt obligations, which have the highest rating. This assets are highly liquid because the government eagerly buys them back, and because banks need them to exchange on currency for their customers. These government obligations are used also to satisfy many financial needs. Hence Treasuries are the value by themselves. This allows the government to pay the lower interest rate, than it would pay based on their probability of default. Also it allows assuming that there is a minimal level of Treasuries in circulation which the economy needs, and for which the government does not need "collateral" – the tax collecting abilities.
If the government abuses its power and issues more Treasuries than the market needs, it produces two complementary reactions – the interest rate of Treasuries rises and the prices rise. We have inflation, however somewhat softened by the nature of this monetary system. If the government decides to restrict the issue of Treasuries below the level of the market need, we might have deflation – falling prices.
It is not always easy to find this balance between the demand for the currency and its supply. The wide acceptance of the payments means, which bypass the use of currency, as credit or debit cards, leads to lower demand for the currency. Hence if the government does not adjust for that it introduces inflation.
Wealth and Money
Our system of preferences is changing. If we use the same amount of money to buy amount of goods and services today and in the past, we might buy different values. Today we measure the value according to today’s system of preferences, in the past - according to the system of preferences we had in the past. There is a good chance that the values are not equivalent, because the relation between our preferences and what economy can deliver had changed substantially.
The changing relationship between numeric value of money and perceived level of wealth this amount of money delivers captured by the concept of "inflation".
The exploring and changing society stretches the available resources trying to reach new goals, as a result resources become more difficult to get, hence they are more "expansive" than they were before. Slow changing societies should not have substantial inflation, but when the change is rapid, and especially when it leads to (temporary) imbalance, the inflation is inevitable. Hence the Federal Reserve tactic of slowing down the speed of economic change by raising interest rates. In addition we get more balanced growth.
There are other causes of inflation.
One is a changing system of preferences, which leads to the change of perception of the value of the same goods and services. Usually with the progress we expect better quality hence we have inflation.
The other is in the nature of the U.S. monetary system where the money is "created" by lending. In this system there is a balance between the money in circulation (it is not actually in circulation – it is a right to use it in most cases) and collateral. Bad loans upset this balance – more money for the same collateral. This is the other component of inflation.
Excessive issue of Treasuries as a cause of inflation we mentioned above.
Ineffective distribution system freezes resources, goods and services in places where they can not be used, and therefore reduces the wealth of the society. In relatively poor societies it produces shortages, and hoarding of resources and goods, which reduces the wealth even further.
Trade is an effective distribution vehicle, and we have to agree that trade is one of the engines that produce the wealth. Without delivery there is no wealth.
Reduction of Imbalance
Traders reduce imbalance in the economy, so to speak reduce "entropy". This is the work they are paid for. If there shortage of goods in one place and there are means of delivery, goods are taken from the place with relative excess and brought to the place of shortage. If there is demand-supply imbalance in time (produced in one time needed in other), then special trade contracts bind together producers, consumers, and insurers.
Sophisticated financial markets have the same trade in its nature: arbitrage between different stock exchanges, contracts binding together buying and selling in different moments.
"Effective Market" Myth
There is a popular theory of the "effective financial market" which says that when the information is disseminated so rapidly and all market participants have the same goal there is no inefficiency in the market. If this is true there is no trade on the financial market, which goal is elimination of inefficiency. The flaw of the theory is in the assumption of the same goal of market participants - they have different goals. One is long term investor, the other has to close all trades at the end of the day, third has to produce enough cash flow to cover unexpected outflow, etc. Financial market, as other markets has a multitude of goals, which produce supply-demand imbalances. Financial traders bring the market to the balance and they are paid for this work.
Trade reduces uncertainty (reduces entropy), and allows stable economic patterns emerge. In turn this stable economic patterns allow more predictable creation of goods and services, which reduces the cost and allows further specialization, and hence higher productivity.
Credit Based Economy
The developed market is based on the developed credit system.
There is a need to differentiate two types of money (or other recourses) landing.
One occurs when the person or the family needs money to survive, because for some reason they entered a period in their life, when they do not have enough resources to satisfy their basic needs. This kind of landing has nothing to do with market activity. In the moral society it should be viewed as a kind of charity. The ancient law in the Bible forbids charging interest on this loan, and requires forgiving it if the borrower can not repay it. There is an obvious wisdom in it.
The other occurs when the entrepreneur needs resources to participate actively in the market. In this case he does not need them to survive, he needs them to increase his wealth and the wealth of the society as a whole.
The ability to move resources easily from the place of limited opportunity to the place of bigger opportunity is essential for the agility of the market. The credit does it. Without the system of credit the owner of resources has to take a full risk in the enterprise, for example has to be a partner in an overseas trading operation. This limits sharply the ability of the society to experiment with new opportunities. The credit system is two layered, when the owner of resources takes much smaller risk for the smaller reward. This frees up the movement of resources. The market readily takes the task of moving them from one place to the other.
What about widely used personal credits and mortgages on the family homes? To which category do they belong? Most likely that in the modern society many people can’t help but be the active market participants. Even the job hunting is perceived by employees and employers as a selling skills (and connections) to the higher bidder. Personal credit is mostly used to enhance the "market position" of the person. However there are cases when people use their credit to pay for necessities. If they can’t repay – they declare the personal bankruptcy. This is close to what common sense suggests how it should be.
Shortage of Collateral
Collateral can be something that has a constant demand and limited supply. Real estate seems as a natural candidate for it. And it is used widely as collateral. Banks hungry for the collateral generate the great majority of real estate mortgages. Hence the underlying collateral for money created by banks in part is real estate.
When economy is growing fast there is a shortage of the collateral, hence assets, which can be used as collateral, according to the traditional lending norms, grow in value – they posses additional property needed for the society. Hence their price grows accordingly.
When the economy slows down, the needs for the loan drop, the additional value of the assets used as collateral drops, their price goes down.
When oscillation in the price of assets used as collateral is small – this is a normal market oscillation and interest charged for the loan includes the price charged to cover the risk related to this oscillation. However when the price drops substantially the chain of events unfolds. If the prop in prices produces bad loans and losses in the loan’s principal, the value underlying the money issued is reduced and the inflation unfolds. The inflation reduces the value of the fixed interest payments – and this leads to lenders’ (including banks’) losses. Banks’ losses lead to bans defaults and consequently to destabilization of all financial system, and destabilization of the market in general.
Personal lending (credit cards) is under the same pressure of the shortage of collateral. This pressure leads to relaxed rules of the creditworthiness and hence leads to higher rates of defaults and to higher losses in the banking industry and higher inflation. These losses are hidden while the lender expands its operations - new profits cover losses from old mistakes. However this market segment is limited and very sensitive to the demographics. Rather sooner than later it will reach its saturation, and the same chain reactions, which are caused by overpriced real estate, will occur in the credit card business.
The entire system looks as too inflexible.
General Public as Lender
The developed system of bond issue, and demand for them from the general public (often through intermediaries as mutual funds) creates expanded set of assets used as collateral. What can be used, as bonds’ "collateral" is less restrictive than what can be used as ordinary loan’s collateral. This eases up the pressure on traditional assets.
Banks are gradually loosing business loan business to the equity and bond market, because their rules of prudent lending are not flexible enough to accept new types of collateral. It is too dangerous for the economy to relax the rules of prudent lending - the banking system is a basis for the economic activity, and it should not take high risks. The solution can be in the introduction of new types of loans, where the excess of the risk is passed to general public.
Bank lends money to businesses often based on their estimates of the business ability to generate profit, which can be used to repay loan. These estimates can be done with big stable businesses, but it is hard to make them with small and young businesses. However the latter are mostly in need of the loans. They use any assets they can find as collateral, and this easily spills over to the residential real estate. Hence prices on residential real estate go up, and the rent goes up.
The current monetary system freed the economy from the limitations of the precious metal based standard, only to produce enormous prices for the shelter. One of the possible solutions is a consistent and perpetual expansion of the types of assets, which securely can be used as collateral.
Intangible Assets as Collateral
Landing based on the estimates of the future business' profit is already the use of intangible assets as collateral. This tendency should expand.
Businesses should prepare themselves for the use of their intangible assets as collateral. Their divisions should be relatively independent that they can be sold out to pay for the loan. It should have a bankruptcy plan ready, from which it is easy to estimate how much the lender can recover in the case of bankruptcy. Business’ assets and divisions should be easily detachable with appropriate outsourcing (which make the business’ functioning more expensive, but still realistic). This makes the business a better take over target, but it makes its price higher also.
To proceed in this direction, the society has to reduce the price of business transfer (taxes), and has to proceed with unification of business units, that transition of the business does not need much of adjustment.
Growth of the Wealth
If we look at the bond portfolio (with reinvestment), we see that its monetary value grows exponentially.
From this observation we can conclude, that active market participants (investors, businessmen, etc.) in the stable society with market economy see their wealth grow exponentially.
This means, that as a rule the ratio of levels of wealth of two active market participants stays the same, and the difference - grows (the gap grows).
Passive participants, who live on their salaries and do not invest, do not have the growing wealth at all.
All this seems to be a natural consequence of the market economy. Social events and government intervention changes this trend. Trade unions’ victories produced a jump in salaries (and new social groups, which are good consumers), employee options program made from ordinary salaried employees active investors, etc.
Super Exponential Growth
The bigger the amount of money which can be put to work, the higher risk can be taken, because the higher loses can be sustained without braking the enterprise. Also many business innovations can be introduced only with big initial expenses. In other words, the bigger the capital the bigger the market opportunities, hence the bigger profitability. For example consolidation of operations allows introduction of new methods and with lower cost, or it is possible to jump-start a new product, which has sense only in the case of mass acceptance.
Perception of Money Value
Active market participants have money they can risk. Money needed to satisfy the needs is not money, which can be used as a capital. Active market participants have to be ready to loose a big part of their capital and still survive.
It is important to know how strongly active market participants react on gain or loss of some capital.
We know that our reaction on sound, light, touch depends on the level of "base" stimuli. We respond the same if the new sound is two times louder than quiet "base" sound (in the bedroom), or two times louder than a loud "base" sound (in the factory floor). In other words our perception corresponds not to absolute value of parameters but to the ratio of the parameter to its current "base" level.
Similar situation exists with money. We react on the ratio of our gain or loss to the initial amount of money. This corresponds well with the exponential growth of investment - the ratio of the gain to the current amount stays the same.
We can assume that reaction of the market participants on the relatively small gain or loss is close to proportional to the ratio of this gain or loss to the invested amount. It grows weaker as the invested amount grows – investors anticipate bigger return when the amount is bigger.
There are tasks which society has to perform in a coherent managed way, tasks the market can not perform, as protection from the external threats, maintaining of the system which assures the internal stability, etc. These are tasks, which any stable complex system has to perform. A good analogy is a living organism. What can be the better source of resources than the market? Taxation is a tool of redistribution of the wealth generated by the market, to perform all these tasks.
There are a few basic observations about the system of taxation.
Market based society easily tolerates progressive taxation, when bigger income is taxed at higher rate. This seems natural from above observation about perception of money value. This progressive taxation is achieved with few tools. Income tax usually is progressive. On top of it there is the sales taxes and taxation of the corporation’s profit before distribution to shareholders, which work as a progressive tax also – who spends more (because can afford to spend) and earns more in interest and dividends (because can afford to invest), pays more.
The system of taxation is changing perpetually, because the market brings new changes to the economy and society in general, and taxation has to adjust. The creator of tax rules experiment with the new rules and adjust them according to the reaction of population. The society has to monitor closely the reaction of the population on the existing and new tax rules – this is a major tool of the adjustment of the system to ever changing reality.
The effective tool of the market management is a system of "tax breaks" – reduction of taxes which happen if the business is engaged in activity which society wants to encourage, and additional taxes which business pays for the activity society wants to discourage. They are more effective than many other ways of the governmental intervention in the business activity.
Badly structured tax lead to mass tax violation, because they viewed as excessive, or confusing, or requirements are difficult to verify, etc. This is the worst side of taxation – it produces the violation of the law, with feeling of fear and guild, reduced social activity, lowered moral level of society. This is why the system of taxation, especially its part which is relevant to the majority of taxpayers should be clear and simple, and all measures have to be taken that population feels it is fair.
There are forms of taxation, which make market less effective, those should be avoided or at least limited. For example all kinds of taxes on wholesale operations. Those are taxes imposed by sovereigns on goods moving across their borders (especially popular in Middle Ages when there were so many borders), and taxes on the stock operations, when the stock is sold and proceeds are invested into the other stock. Last kind of taxes is among capital gain taxes and taxes on interest and dividends, which do not discriminate on the basis of the use of the proceeds. Similar with proceeds of the sale of real estate.
There are some general recommendations in this area:
"Sink" in Demand Based Economy
The value is created in chains as the product or service moves from its creation to consumption. Somewhere there is a bottleneck in this system. In the command economy (planned economy created by the socialists societies) the bottleneck is supply. In the market-based economy usually the bottleneck is demand. This produces an interesting phenomenon in the market-based economy.
Sometimes to improve the functioning of the market the society introduces a "sink" – an artificial demand, an artificial consumption. This consumption has no visible positive social effects – neither new technical or social structures are created, nor basic needs of anyone are satisfied. Two major examples are weapon manufacturing and spending on religious activities. We do not declare that they are not needed from some wide non-economic point of view. We observe only that usually spending is way beyond the need. In the Middle Ages the exaggerated consumption of upper classes create a basis for the trade and prosperity of cities. In our time the military spending creates jobs. The donation into temples in ancient times created a perpetual demand, which led to developed economy. In the modern society we have an excessive consumption of the general public.
These "helpful excesses of consumption" create special structures, which are useful in many areas. Hence the society supports it.
Sale taxes do not change the working of the "helpful excesses of consumption" – the government spends all it collects.
There is an optimal ratio between the active use of resources in the market (investments, which misleadingly is called savings), and the "helpful excesses of consumption". This ratio depends on many factors, and society finds it experimentally – by oscillating around it.
The excessive consumption is embedded into social structure - many social niches require some level of the excessive consumption. This can be a serious problem for some people whose income level become reduced, if they do not know how to get into other social niche, which allows lower level of consumption.
The "pet projects" of politicians, as means of distribution of tax money, can be an effective way of managing the excessive consumption. Politicians try to channel money to the diverse economic structures, from which their voters benefit, this works as a kind of decentralized management, where the best solution is achieved with negotiation between politicians as representatives of different interested social groups. This market-like system can be more effective than centralized management of the "Sink" with military spending.
Environment Control emerges as a new recipient of the "Sink". While many environment control measures lead to better society (whatever it means) other hardly can be justified from the reasonable point of view, for example, because they try to control something they can't, because of the overwhelming forces of nature or society. From the social point of view, the additional restrictions imposed by these kind of environmental rules are the waist of recourses, which can be justified, however, as other forms of the "Sink".
Healthy living and healthcare issues bring us to the "Sink" elements of economy also. As the farmer takes care of his tractor or horse the market based society takes care of its participants – all kinds of them: workers, engineers, customers living on the pension, etc. All of them are needed to make the market function. On the way it creates new sectors of economy, which support this activity, this makes the market more developed, stronger. Some issues are solved with global initiatives, as care of water and air resources, other with local, as creation of new drugs or new services, which shorten the periods when people stay sick. There are sectors of population the market demands to keep healthy – who participate in the market actively, temporarily unemployed and active consumers. We can see that these groups have access to healthy living and health care. The group the market does not care much is people who do not have work, on the welfare, etc. As we see it is a difficult task to extend the healthcare to them. This can be done only with governmental regulation and special efforts. From market point of view this is a "Sink" kind of activity, from which the market benefits also. If welfare recipients have an access to the health care and retired workers have the access to very good health care while the low-wage workers do not have it – this is a sign of imbalance.
"Sink" by its very nature is not effective way of spending money. Hence when it is incorporated in the market based society it has a tendency of sucking as much money as it can. Prices on weapon grow as far as they can, the prices on the health care services grow with unreasonable speed, and the price tag of the "pet projects" grows uncontrollably. The clear problem with the "Sink" is unwillingness of society to recognize it as a feature of the economy, and as a useful feature.
There is only one way to control the "Sink" in the market-based society – strict explicit limits need to be set on the expenditure related to "Sink". The distribution of the allocated for the "Sink" resources can be done with all available now tools, and other tools which will emerge. However it should not be any way of going beyond preset limits. The projects funded by the "Sink" money should be let to go "bankrupt" if they run out of money. If the society see the need to extend "Sink" spending, as in the case of the economic depression, then this has to be done explicitly. There is no need for the strict accountability in the "Sink" sector of the economy, but there is a need for the strict spending limits.
The very possibility of complex economic relationships relies on the stability of the society. The possibility of the effective work of the market as a tool of the society’s exploration requires fast pacing society where creativity is appreciated – a free society. Those are prerequisites of the successful market based society. Civility is a necessity for the market.
However market produces the circumstances which can easily lead to social unrest and degradation of moral values. The society has to deal with it perpetually with non-market based methods.
The bottom part of the society, if it has hard time satisfying its elementary needs, can easily become antisocial. Market economy naturally generates this part. However market economy can exist only in stable society. This is a natural contradiction, which society has to deal with all the time. In other words, the government has to pull people from the bottom of the society, and it has to feed and shelter ones it can not pull - this is a perpetual work. This is not a charity, this is a requirement of the existence of the stable market based society.
Sometimes the immediate profit of the close economic relationships with non-democratic societies can lead to assumption that it is acceptable to ignore the suppression of the freedom in these societies. However in the case of the export of capital the people who contact these societies involuntarily in cooperative form, because of the business needs, have to subject themselves and adjust themselves to the restriction of freedom. This has an immediate negative impact on the society and the market – part of the society became less free and less creative. Again the very basic necessity of the market-based economy requires the perpetual political pressure on our economic partners to make them freer societies. This is not a good will, this is an economic necessity. Note that trade contacts by their nature competitive and not cooperative are not dangerous from this point of view.
Civil societies or even civil social groups benefit from the civility of relationships of their members in the market economy. Hence civility is prized and encouraged in market based societies.
Higher than average civility of the social group can directly lead to the bigger level of the wealth this group can accumulate. Examples are "clubs" of industrialists, where the word can be as strong assurance as a written document, or "exchanges" – Stock Exchange or Diamond Exchange, where the very business relies on the high level of responsibility of their members.
It is possible that cultivation of legal market relationships in the social groups, which fell off the mainstream of civil relationships (all kinds of ghetto), can be the best way to return them to civility.
Fragility of Market
Market being a tool of change does not have any prediction or forecast ability – it acts as if future circumstances are the same as current ones. This is only natural – because there is no way to predict future of the highly complex system as society or even only economy. Particular market participants can not counteract based on their forecasts – they are kept by the flow of the events. For example a big lender can not increase the interest rate unilaterally based on its projections of the state of the market, because it will loose all clients. The manufacturer can not reduce production in anticipation of the turn of economic cycle, because it becomes less profitable than its competitors, with dire consequences.
Active market participants fight hard to push all competitors out of the market, however if they succeed the very mechanism which delivers their wealth get broken. Trapped in the race to keep their market position, manufacturers produce more goods than the demand warrants and as a result have to drop prices and lower their profit if not loose money.
Hence the society has to manage its Market. It has to keep it from self-destruction for example with the antitrust regulation, which protects competition. It has to protect the stability of the insurance and banking industries, by restricting their activities and compensating these restrictions with special rights (tax exempt status of many insurance products, the right to "create money" of banks, etc.). It has to anticipate the vibrations of the Market (with unfortunate consequences of depressions) and manipulate the market. One way is to slow down the market growth, to make period of downturn of the Market less deep. The other way is to substitute vibrations of big period and high amplitude with vibrations of the short period with the small amplitude.
There is little theory on the ways how this can be done, hence society has to experiment, and it has to maintain special governing organizations, which sole purpose is this kind of work. Federal Reserve Bank is one of these organizations.
The Congress performs many functions of Market management. This is unfortunate, because this work requires special knowledge and skills. It could be done more effectively with special governing bodies acting under the Congress supervision, may be with the Congress voting yes or no on each important decision of these bodies. However the creation of these bodies is a long process and requires first of all an understanding of their need.
The society has to manage its Market in the other direction also. The Market as a power tool can be very helpful in skillful hands and very destructive in the hands if irresponsible people, for example it can easily destroy the very foundation of people life, their habitat. This is a responsibility of the society to regulate the business activity in the way it keeps market effective and not destructive.
In the developed market the schedules of repayments of the credit rely on each other. This produces dangers of the chain effects in the case of defaults of even one payment, especially payments, which are perceived as reliable, as coupon payments of Treasury bonds. Financial system manages this type of risk, and this is a difficult task.
There is a clear danger in the strong market regulating measures imposed for the long term. The market is an adaptive system, if the regulating measures become a kind of substantial boundary for the market activity, the market creates tools and ways to go around this boundary. The result usually is absolutely unexpected, and can be socially undesirable even destructive. Hence regulation should be "soft", and all measures should be short term.
Fast moving society enters time after time the situation, where there is needed a fast economic reorganization. This means that employers have to lay off their workers, and workers have to learn new skills, while they are not working, and they have to find new niche for themselves. Salaries and consumption patterns among majority of people, who rely on their salaries, are structured that the worker and the family can not survive a long time without salary. In the modern society the biggest spending item is spending on the shelter – unavoidable spending. However the society does need this level of flexibility, because employers can not foresee the future, where the economy gets into tight spot. The good solution is unemployment insurance. The payments of it, in the case of unemployment should be somewhat above the level needed to satisfy immediate needs, because the worker has to have the resources to adjust to new situation. The society should not blame the person who lost the job, but should appreciate person’s efforts acquiring new skills. This is about how it is treated in the modern society.
The low level of unemployment is usually viewed as a sign of the shortage of the workforce and, as in the case of any shortage, the higher prices of this resource (higher salaries). The additional problem related to the low level of unemployment – the low level of the market flexibility, there is difficult to start the business or to change it radically, because there is difficult to find needed specialists. This in turn leads to slow down in the investment and business borrowing, and to the flight of capital – investment in places where the market is more agile.
The high level of unemployment means that people stay unemployed the period of time beyond one, which is supported by unemployment insurance, they get frustrated, and this has destabilizing social effect.
Hence there is an optimal level of unemployment. This level reflects the dynamic pool of people, which mostly consists of people who leave one job, stay unemployed for awhile to find the other niche, and jump back into the next job. This is a pool of active people, in each moment different people belong to it. This pool has different sources: from the active workforce, from the new generation coming to the workforce, from the immigration, from the unsuccessful entrepreneurs, from people who relied on the family for their living, from people who relied on investment income for their living. It has a few "sinks" – some go back into active workforce, some retire, some start an enterprise, some can live from their income. The dynamics of this pool depend on the dynamics of all factors, not only the state of the economy.
The optimal level of unemployment and the structure of unemployment insurance are interrelated.
Market and Bureaucracy
The other organization tool widely used by society is Bureaucracy.
If the bureaucratic organization survives the pressures of ever changing world, it means it is well design, it has qualities, which help it survive. It was pointed already many times, that the same qualities make bureaucratic organization ineffective – it uses increasingly more and more resources to strengthen itself and less and less to perform the tasks it was design for. Bureaucracies functioning without substantial accountability grow increasingly ineffective. Examples are many governmental Bureaucracies, school Bureaucracies. However Bureaucracy, which activity is tested all the time, can be very effective, as military, which are tested in the military conflicts, or businesses, which are tested by competition. Business Bureaucracy insulated from competition because of monopoly grows ineffective the same way as any governmental Bureaucracy.
There is a basic difference in the foundation of the Bureaucracy and the Market. Bureaucracy is a social structure based on the people’s drive to the power – this is a special way of division of the power, social power. The drive is primitive, sits deep inside psyche, hence this kind of structures can successfully function in the primitive societies and in the time of social turmoil.
Market is based on people’s desire of wealth, the desire which can appear, be cultivated and be passed to the next generations only in relatively developed society. Market requires mobility of resources and, hence, at least some degree of social freedom.
If the Bureaucracy is a basic social structure (as it was in the former USSR), then market elements can exist in the society in the extremely limited forms.
However in the market-based society Bureaucracies can be used effectively.
Any real society has a mixture of the bureaucratic and market structures. Bureaucratic structures being more primitive have a tendency of taking over the society, when the society gets in the difficult situation. Hence Market needs a perpetual conscious protective efforts. It is interesting to analyze how Bureaucracy took over Roman society, causing the shift from the republic to empire, from the democracy to totalitarian rule. The shift was inevitable – the Roman expansion produced huge Bureaucracy, which managed provinces, and at some point the Market could not carry this load of Bureaucracy and was overtaken by it. The other example – British Empire, went different way. The market forces drove the building of empire. When the new social forces started to break the Empire, it did not respond with creating more powerful Bureaucracies, but it found the way of keeping market advantages with new social structures. As a result the British democratic structure did not suffer.
There is always a contest between different social structures – a competition for the resources. It can get really ugly when these structures are associated with different national groups, when people see more the difference between them than the commonality. The low trade barriers produce shared resources, the high trade barriers produce the pressure from the party, which does not have the access to some resources to get it with political means. The lowering of the trade barriers produces the internal problems – the new situation where people associating themselves with one social structure have to compete with other people who associate themselves with the other structure.
Market based societies should consistently push for the lowering trade barriers, they should push against external forces as well as against internal forces. The argument, that lowering of the trade barriers hurts its own people should be dismissed for two reasons. First, if the society can not adjust to the new more open market situation, there is even less hope it will be able to stand against inevitable political pressure, if the market stays closed. Second, from the global and long-term point of view, the more open market means wider access to the natural resources and faster growth of the wealth of the society. The trade restrictions as a political tool should be used very judicially, possibly only from security (national or global) considerations.
As much the trade should stay open, the investment in the non-democratic Bureaucracy-based societies should be limited. It is easy to understand why it can be tempting. Bureaucracy is inefficient, sometimes extremely inefficient. If there is a mixture of the Bureaucracy elements and Market elements in the society (this is only the case, if someone considers the investment in this society), then market elements can easily find the holes in the bureaucratic system and get cheap access to valuable resources. Usually it goes together with bribery and other forms of illegal activity with the associated risk, however the profit potentials often are very tempting. The problem is, that one can not simply invest in the stock market of Bureaucracy-based society, because non-market forces drive that stock market. One has to create a special structure (a business, for example), which fits into the social structure, hence which is bureaucratic and corrupt. This automatically supports the bureaucratic structure of the society and has bad corrupting consequences back at home.
We can not expect the market participants – businessmen, to have the global view and make their decisions based on "common good". The market-based society has a separation of tasks – economic system works with economic issues and the political system works with political issues, creating the framework for the economic system. There is a task of political system to promote relentlessly free trade, and limit the investment in non-democratic societies. If it does not press to lower trade barriers – it does not do its job. If the other country pushes to lower the trade barriers and it resist – something is wrong with it. If some non-democratic country pushes for new investments and it does not resist – it does not do its job. If it does not impose the limitations on the investments in non-democratic countries – something is wrong with it.
Equal Rights and Diversity
The normal functioning of the market requires an even field, where different players perform similar tasks many times and the great equilibrium can be achieved through trial and error, and competition. Hence the social concept of Equal Rights is closely tied to the concept of the market itself.
The concept of Equal Rights applied to the society, each member of which has skills, recourses and background, which differ substantially from the other, produces huge inequality. This inequality can be ether a source of frustration or satisfaction, depending on the system of values of the society.
The primitive society rigidly ranks its members according to limited set of criteria. This produces a lot of people with low rank, frustration and desire to change the society.
The developed society has many sectors equally respected that person can find the niche according to person’s circumstances.
The attempts to make society more equal go in two different directions. One demands more respect for different groups of society (in moral terms). This works well. The other demands more legislation, which protects different groups, gives them additional privileges – shifts the job of finding the niche from the individual to the society. And this does not work well at all, because the artificial structure can not compete with the market. All these artificial structures are abused as soon as they are introduced.
Market based society benefits when equal rights are protected and efforts are made to break existing boundaries. However the members of the society have to know better to use these rights wisely according to their unique circumstances. The society has to make perpetual efforts to explain that to its members.
The diversity of the society leads to the specialization and higher productivity. This makes the principle of Equal Rights even stronger.
Specialization in turn makes person’s life less diverse, boring. This is a serious social problem – the drive for the expansion of the knowledge, area of our control is a basic drive of the human being, the drive which allows us to survive in the rapidly changing environment. This produces a strong demand for entertainment. Entertainment brings missed emotional and intellectual training. It became an important sector of economy – the market takes the stimuli out of the one side of people’s life and brings it to the other side.
Predators and the Market
The "theoretical" market requires specialization, and different specialties attract different types of characters, and if these types of characters are successful in their social and economic place, they dominate this place, even if we might not like it. The situation can be even tougher if some types of character have only a few social and economic places to be - they fight for these places.
Salesmen are a good example.
The art of selling is based on exaggerated form of respect - to sell we should not care of the client interests, we should assume he takes care of it himself. We deliver all kinds of persuasion, we watch what caught the client attention, and feed him similar ideas and images. We negotiate - and this is an art of war. All this is in the nature of selling. The art of buying is similar art of war.
This produces a convenient ground for the predators. The situation is exasperated because in the civil society there is not so many places for this type of character outside the criminal word. As a result predators want to be salesmen, the rest of population getting hurt a few times with salesmen, adopt a militant stand in relations with all salesmen, and non predator can hardly succeed in the salesman position - we have a stable social structure salesmen-predators.
The other example are employers of the "early capitalism", who squeeze everything they can from their workers, which have nowhere to turn. Employer with the long term view and social responsibility could not survive in this predatorily environment, because different capitalists have to understand each other to have some mutual business.
This shows that as good the theoretical market can be, the real "implementation" can be not so pretty or outright ugly. The civil society introduces laws and regulations, which soften the negative effects of these stable social structures – consumer protection laws, minimal wage, etc.
Criminals are asocial, because their behavior is socially destructive and hence immoral. They can form sometimes small social groups with the structure similar to the animal pack (alpha – leader, beta – helps alpha, maintains the binding of the group, slaves – try to please alpha, independents – recognize alpha authority, but try to walk by themselves and omega – a jester and scapegoat). They do not go beyond that, they do not develop analytical skills because they do not communicate ideas, and they relay heavily in their decisions on emotions, and sometimes on feelings. They destroy the big social value to take a small part of it. This is their "modus operandi".
Not all asocial types are criminals, but asocial types with undeveloped mental skills have a good chance to become criminals. In U.S. each wave of immigration brings people who broke their old social ties, and who have a hard time adjusting to the new society. Some of them become criminals.
Strong criminal organizations are rather exception, than the rule. They can exist only if they fulfill some social need, for example, provide security for the social group, which does not have proper protection. Hence the very presence of the criminal organization is a sign of the flaw in the social structure, the flaw which has to be fixed first, before society starts the war against that organization.
American society traditionally provides an outlet for the criminal types. First it was Frontier, where the life was dangerous, but independent. And there was an opportunity to take something from the Indians. Later it was a prohibition, where huge profits could be made by breaking the law. Now it is drags, with the same consequences.
As much as some would like to believe, criminal organizations never become a part of the normal social structure. Criminal world is always a threat to the moral of the society, hence it is a thread to the market.
Market and the Age Groups
Old People and Perpetual Learning
Older people do not learn and act as fast as young and have less courage to make bold decisions. The only advantage they have is experience. In the fast pacing society, where the market forces the change, the ability to learn fast can outweigh the experience. Hence at some age older people can not compete with younger people and have to retire. This happens not only in the work place, this happens in families also – because the decisions, which people face in ordinary life, require the understanding of the changed society. Hence created the whole class of "consumers" separated from the active life of society. This can create tensions in the society and destabilize it, which is damaging for the market.
The solution can be similar to one employed by the military – they live in the world of perpetually changing weapon systems and methods of conducting of military actions. They use regular retraining of personnel. The same can help in the work place – regular courses, every year, each year new material for all employees without exception. This reduces the need for many years of college, prolongs productive life, keeps analytical abilities of employees at the high level, and allows the passage of the experience of older employees to younger ones.
This tactics is used already in some companies one way or the other. It can be expanded to the national level.
Young People and Boundaries of Protection
Any society protects children from the dangers of the world, because they do not have enough experience to make proper decisions. The society, which does not do that, does not survive.
The market-based society has the other goal also - it protects its stability from young people. Market based society is very reactive – it does not take much to implement the decision which can affect the society as a whole, and it requires maturity to distinguish which decision is safe and which is not. As a result the society creates a special artificial environment (kind of cocoon), where it keeps its young people.
There is not much difference in the process of introduction of the young person to the real world in the age 13 or in the age 21 – about the same level of shock. There is not much gain in spending time in the school in the period from 13 to 21.
Interestingly enough how little of what is taught in school is used in real world. Here is a list of useful things:
The school does not hone the kids’ creativity. Kids are already too creative for the stability of the society by their nature. The very first goal of the school is preparing members of the society – make kids social. Only the second goal is teaching them some basic knowledge. Not less important goal in the modern society, where often both parents are working, is to keep them occupied, while parents are at work.
Kids are different, the school system tries to treat them as equal, and this produce the problem for kids who are substantially different from the average in the particular community, where the school is located. There is no hope that "good" teachers can help. School system, by its very design, discourages teachers from being outstanding educators. This is because the first goal of the system is to teach conformity. The solution can be only in the changing the system in the direction, which it had tried and is used already. As much as resources allow, the school system should allow the creation of groups, where kids similar to each other can belong. These groups do not need to be permanent as classes – the kid can belong to a few groups simultaneously, as in the real world. In other words, we can solve the problem, as it is solved in the market-based society, through niches and respect for each niche. This makes teaching easier also. The teacher can not help but to orient teaching on the weakest group in the class, as a result we have very low level of knowledge and very frustrated group of smart kids. We deprive the very group from which we expect the innovations in the future - innovations, which drive the society to prosperity.
The insistence of the society in keeping young people in the protective cocoon for so long already works against the society interests. The fast pacing economy produced by technological innovations needs fast thinking and creative individuals. Entrepreneurial individuals have enough guts to drop early from the cocoon and start their own businesses. The attitude of the society stays on their way – they are not treated as adults and do not have access to needed resources. Now even employees are better off in many industries if they start work early and learn at work, not at school or college.
Many other who stay in a cocoon increasingly grow frustrated and antisocial – they use drags, get their own kids, when they do not have means to support them, form violent gangs, etc.
There is no need to guide young people to get into the college. The college education gives better life, and young people will go for it with the help of their parents, only give them an opportunity. In this case market works the best.
The market-based society has a real need for what the school has to offer. It needs socially adopted and active members. It needs members with developed general mental abilities, who can search for the relevant knowledge and learn fast. Special knowledge is not so important, because the society is changing fast.
The current school system does not deliver what the society needs. There are a few reasons why.
Current education theory makes an emphasis on the honing the individuality and diversity, the goal it should not and can not pursue. This "feel good" attitude instead of "work hard" attitude is a waist of money and time.
The lack of respect in the school system is a big social problem. Educators are symbols of the stable social structure, and children come in school to learn this social structure and find the way to use it in their advantage. This can be done only if there is a general culture of respect toward teacher, which is not.
The general despise of the science is a dangerous trend. Young people have to get from the school a rich set of interconnected concepts and ability to manipulate them. This makes them competitive and inventive. There are only a few areas in our society where this wealth of ideas can be found. Mathematics and Science are among them. Again, not the knowledge itself is important, but the richly developed mentality. This can not be achieved if the school does not make an emphasis on it.
Over the ages many education schemes were tried. For example, in the former USSR it was a period when very advanced mandatory course of mathematics was introduced in schools (at all levels). It was so advanced that teachers had hard time catching up with it. The paradox was that it was a dangerous move for the society. This course taught children to think independently – very dangerous for the society based on suppression and forced conformity.
Some educational schemes are adequate for the society, the other not. The system adopted in USA had obviously failed, there is a time to admit it and move to other one. The market, which is a basis of prosperity, demands new education scheme.
Conflict of Generations
The advantage of the old age is experience, the advantage of the youth is the quick learning and adaptation to new circumstances. In the slow changing society experience gives the advantage over speed and old people stay in command, and the young listen to them. The strong family structure and low speed of growth of wealth cements this order – older people are in control of family assets, and anyone who tries to break out of the family control places himself in disadvantageous economic situation, sometimes in impossible economic situation.
The market based society on the way of accumulating of the wealth of society and opening new opportunities for its member inadvertently ruins this structure. Young people can survive without support of the family and even can thrive in spite of lack of it. The society is changing fast and the moment in the person’s life when the speed of young beat person’s experience comes earlier and earlier. The pay structures where the salary grows with the length of employment and seniority means more than skills are increasingly a feature of the past. The society enters the period when the old people if they are to survive and stay employed as long as it is possible need some subsidy. This can be some kind of a allowed regular taxable withdrawals from tax free accounts as a supplement to the salary, that older people can take part time jobs or less paying gobs and compete with youth. It is doubtful that any amount of the legislation forbidding age discrimination can protect against market forces.
Restrictions on economic activities produce a lucrative opportunity for ones that can and dare to bypass them. People involved in this kind of activity seek each other as economic partners and the special market – Black Market, emerges. Black Market can be substantial. It exists in countries with high level of taxation, as Norway or Sweden. It exists in U.S. – market on illegal drags, and illegal market sectors where taxation is avoided as gasoline Black Market.
Black Market has all characteristics of the legal market – it exploits some resources (undocumented or stolen) uses work force, has distribution system etc.
In American colonies Black Market quickly had emerged when the English government had introduced high taxes. When the government tried to enforce the regulation – the revolt had erupted with tremendous consequences. This example shows that Black Market is a sign of the serious social imbalance (society does not want these restrictions), and it shows that it is difficult to suppress it.
Black Market deprives the government of its ability to redistribute the value created by the Market. However this is a smallest problem. The bigger problem is – it undermines the moral structure of the society and in makes people who participate in the Black Market an easy pray for criminals.
The most unfortunate examples of the Black Market participants are many small vendors in the metropolitan areas, who run the cash business, underreport their tax liabilities, and often have to pay for the "protection" to criminal groups. This is already a stable social structure from which it is hard to escape – they can not ask the police for the protection because they are beyond the law themselves. Still there is a hope that with the proper tax structure it is possible to minimize the size of the Black Market, because legal market is so much more developed and more effective, that Black Market can not compete with it on the level field.
Welfare system is an economic necessity in the market-based society. Without some form of the welfare system the dangers of the revolt of the bottom part of the society make society unstable, and hence the developed market infeasible. Even in ancient Rome existed kind of the welfare with distribution of the food and entertainment to the poor Romans. It was not driven by the religious values, but by the cold calculation.
In some respect the ancient Roman welfare system was better than current one. Romans did not need to go through humiliating process of proof that they have right to get assistance, and they did not need to provide a proof that they live at particular address. However humiliation is the least of the problems of current welfare system.
Current welfare system creates a trap – the first step outside it leads to the social position worse than on welfare. People on welfare have health insurance. If they get a job (minimal wage or close to it), they can not afford to pay for one, and usually the employer does not provide it ether. This trap creates underclass with no way out and with the special way of life and special mentality. The employers do not want to hire people from the welfare, because they are familiar with that mentality, which is far from needed work ethics.
It is very important to create welfare system, which encourages people to move out of it to better life. We can not force people out of it – people in mass will beat any system, we have to make it attractive to move out, and to make attractive the very first step in this direction.
The other problem is much more dangerous. The way welfare is structured forces welfare recipients to break the law. The person or family can receive welfare payments only if the assets and income are below certain level. This rule is strictly enforced. However housing is so expensive that welfare payments are not enough to cover needs. Hence people are forced to work "on cash" – illegally, and hide their income from the welfare agency – break the law again. This creates a special work force, which needs illegal work, and employers who do not register their workers and do not pay taxes – break the law also.
It is very important to structure the welfare the way it does not create black market, as current does. The problem goes much beyond lost taxes. The situation reminds me a situation in the former Soviet Union. There the system of law was structured in the way, that practically everyone breaks one law or the other – it is impossible to obey all. This produces a feeling of guilt and fear in people. There the government used it to control population. Here it leads to the corruption of the welfare agency (everyone is afraid, no one reports) and to the control of criminals over the created black market. All together, it leads to the degradation of moral values. This is extremely destructive in any society especially market based one.
Expansion is a requirement for the existence of the market. If there is a possibility to involve more people in the market activity, then the market-based society will involve them to keep market expending. If there is a possibility to involve more natural resources into market activity, then market-based society will acquire them (through trade or war). If there is a possibility to expend through technological development, then market-based society will force this development.
Expansion is a driving force of many "mysterious" developments of the market-based society. There are no obvious benefits for the members of the society from very active involvement in the market, the lower involvement can keep them happy, or from aggressive acquisition of resources - what the society has already is usually more than enough. Definitely the technological development did not make people happier - it replaced one type problems with the other. This is the price we pay for the use of this marvelous tool - free market.
If we do not understand this phenomenon, we can fall victims of the market pressure demanding some kind of expansion, but if we understand it, then we prepare the venues of future market expansion. We will look for directions of promising expansion, and we will prepare the society for it.
The worst thing, which can be done to the market is forceful limitation of the its expansion. In many cases it was done with the best intentions. For example protectionism - limitation of the trade to save jobs or industries, usually leads to the rapid shrinking of the market, which can not function properly without needed speed of expansion. When market shrinks, with it go jobs and industries which suppose to be protected. The expansion of American economy has a unique engine - immigration. Limit immigration and you have reduction of the speed of the market expansion, which can lead to market instability and sharp decline.
Growing population should naturally lead to some expansion of the market - with the speed of population growth. However this speed of expansion is not enough for the normal functioning of the market. Market has to produce growing wealth for each member of the society. Otherwise who wants it? Hence if we want to monitor the health of the market, we have to monitor per capita characteristics of the market - they have to grow with the speed bigger than some level.
Mechanics of Recession
What if Market does not expand fast enough?
In this case investors do not anticipate the rate of return needed to justify their risk, and they move money from the risky investment to capital preservation investment. Businesses do not anticipate the demand for new product and they do not introduce it. Also they do not anticipate the expanding demand for their current product and they do not expand the production - this leads to shrinking demand from the businesses. All together leads to the shrinking of the Market - its volume decreases.
Rapidly shrinking Market forces structural changes in businesses - reorganization of the businesses and their interconnections.
Eventually this two processes - decreasing of the volume of production and reorganization lead to the state of economy where perspective of sustainable growth with at least minimal needed speed is clear. This perspective is judged for some period. How big this period is defined mostly by our ability to forecast future development of economy. We do not have really good forecasting ability, because there are so many unpredictable future changes in economy. Hence we predict for some rather limited period and hope, that when the time comes, that according to our prediction the Market has to hit the limitation of its expansion, the new opportunities will emerge, which will ease the limitations. When we reach such optimistic point of view, the recovery from the recession starts.
We can summarize this observation in the form of a "macro-model".
There is a basic characteristic of the Market - minimal speed of its expansion. As we had mention above, we have to measure it in per capita basis, and possible, that the result of this measurement has to be not one number but a set of numbers.
Also there are Market limitations which affect the speed of Market expansion. It is very important to specify them carefully and monitor their influence on the Market. As soon the Market reaches the state where these limitations do not allow it to expand with at least minimal speed, the Market cannot function properly.
In this moment Market reaches the transitional state - state of reorganization. In transitional state many Market phenomena, which were perceived as normal, are not perceived as normal any more and disappear from the arsenal of active Market participants. Market volume shrinks, GNP drops.
Market volume is not primary parameter for the Market as automatic mechanism, the speed of expansion - is. There is a degree of shrinking of the Market needed to "clear the space" for it to expand with the needed speed for sufficiently prolonged period of time. At this point Market has the room for its normal functioning and it automatically starts function normally.
Hence the best cure against recession is management of change - preparation the place for the Market expansion far in advance before Market hits the limitations of expansion.
Currently, perpetual lifting of limitations is achieved with technological development. Wise society stimulates it. There are many ways how this can be done; many of them are used already:
All these measures do not have and cannot have economic characteristics of their effectiveness - they are "meta-economic" by their nature. Their effect can be seen only by how easily the economy can go through recessions, or if it can avoid them at all.
Nothing concerns market participants more than the possibility of the market recession, depression or crash.
The reactions of the government on such events are often inadequate. The example is the protection measures taken by the US government after the market crash in 30's, which blocked the possible market expansion and caused long depression.
The oscillation of Market between periods of expansion and contraction is a natural Market phenomenon. This oscillation should not be prevented but managed.
We start with kind of philosophical analysis of this phenomenon. Whatever is the object of our study - in this case Market, it is separated for the purpose of the study from the world, we ignore for the purpose of the study all interrelations of this object with other objects. We can do it because there are characteristics of the object, which are stable, which make it possible to perceive this object as something independent.
"Stable characteristics" is something that oscillates with the small "amplitude" around some "mean" state - nothing in the real word is beyond the change. This "mean" state is what we perceive as an object.
If we apply this reasoning to Market, then we have to expect the oscillation of market characteristics. Absence of such oscillation we have to perceive as a sign of low precision of measurement of these characteristics. Hence the periods of Market expansion and contraction are as natural as it can be. We have to study the degree of this oscillation, the area where this oscillation is not damaging to the society, mechanisms of the managing of it, and details of it, which allow its modeling and forecast.
The difficulties of the description and modeling of these oscillations come from the place of the Market in the modern market-based society. Market acts in the area, where there is little study - it acts on the edge of the knowledge of society.
By its nature Market is statically unstable system - it can exist only dynamically, it always maintains imbalances. However there is some limit to the level of these imbalances.
When the possibility to produce a lot of goods was discovered, the natural Market imbalance - supply exceeds demand, was exaggerated and Market contracted to restore the acceptable level of this imbalance. Now businesses know to watch this level and plan production according to the potential demand.
Recently the possibilities of the global economy were discovered and natural Market imbalance - the level of investment exceeds the level of its justification, was exaggerated and Market contracted to restore acceptable level of this imbalance.
In general it is in the nature of Market to expand into unknown area and learn the limits of this area by doing, because there is no other way to learn it - there is no theory, there is no experience. In the way expansion goes beyond acceptable limits and the Market cannot function properly - each time different set of limits of Market functionality is hit. Then Market contracts in this particular area, where excessive expansion had happened. This sets the stage for the next cycle of expansion in the same area, but much more cautious - market participants have already more knowledge here. Consecutive cycles of expansion and contraction are the process of learning of limits of this new area.
Because Market tightly connects its elements, the expansion in one particular area, where the experimentation is going on, causes expansion in many other areas, the contraction causes contraction in many other areas also. The real problems start, when this expansion-contraction endangers the core of Market - financial system, monetary system, and the supply of goods and services needed for satisfaction of basic needs of population. This is where the oscillation goes beyond the area, where it can be allowed.
Oscillation of Market causes oscillation of any value measured with money. If we measure something with natural characteristics - the results of such measurement do not change from the market crash overseas. However the usefulness of something, usefulness as a product or as a business, the ability to exchange it for something else or to get profitable production from the business strongly depends on the state of Market as whole. Hence, when Market expands the particular value as a rule grows, and when it contracts - it diminishes.
This is very inconvenient property for modeling, but it comes with the convenience of measuring value and wealth with money.
Management of Oscillations
It is possible to manage the oscillation of Market. This was shown by the consistent policy of Federal Reserve Bank. The Bank consistently rises some interest rates, which it controls when speed of market expansion reaches high levels and lowers them, when market contracts. While this activity was motivated by the desire to keep level of inflation low (or more precisely to keep prices stable), the result was an activity in contra-phase with the movement of Market. This was exactly the negative feedback in the system, which made the system more robust.
Management of Market oscillations can be done only with force external to Market - a kind of government intervention. This activity in contra-phase with the movement of Market not need to be expensive - it can accumulate "resources" in one leg of the cycle (rising interest rates) and spend them on the other leg (lowering them).
For example, in this particular case of Market Management, it is in the nature of Market to rise interest rates when Market contracts, more loans and bonds default, risk of lending grows and lenders need higher payments to compensate for it. Market system does not allow lenders to have a long time horizon and charge high interest rates in good times to accumulate the cushion for coming bad times. Only external government intervention, which changes market conditions uniformly for all lenders, can force this prudent strategy.
Dangers of Bad Theories
As innocent as it can look, the social and economic theories can be very dangerous. Any theory is limited, and while it is in hands of scientists, who expect it to be limited, and do not make decisions based on one theory alone, but on all their scientific experience, they are (relatively) safe.
However some theories link their conclusions with moral and emotional judgment, making them a political weapon, a way to gather and lead the crowd, to grab some power.
Good examples of this horrible combination are Karl Marx’ ideas expressed in "Capital". He uses right tools – an analysis of the society and economy as a whole (as an organism), he sees the distribution of the produced value between participants. However he brings from nowhere a moral judgment that distribution has to be according to time spent, hence workers has to get about everything. This arbitrary judgment in the time of social tension produced an explosive political theory.
Again he uses a right tool – an analysis of the market economy as a system of interconnected processes, mainly a process of the movement of goods and a process of the movement of the capital. He arrives to the right conclusion that vibrations – the cycles of the overproduction and depressions (when tools of production are replaced cheaply) are in the nature of the capitalistic society. After he (implicitly) brings an idea that the goal of society is satisfaction of basic needs with the minimum of efforts and the market economy is ineffective and has to be replaced by what we call now "planned" economy. We all know now how wrong it is, that in this case the bureaucracy has to take over the tasks performed by the market, and that bureaucracy is much more expensive and much less effective way to do this as soon the size of economic system exceeds some level. We know that even big corporations have to introduce the "market elements" in their management system to be effective, because of their bid size. However some still crave for this simple "scientific" solution.
More recent examples are some environmental movements, which mix some scientific results with moral judgements to produce an explosive political weapon and political movements, which in turn can be used to achieve some non environmental results – political visibility and power. The real environmental issues only suffer from these movements – they require careful analysis and special solutions coordinated with the current state of the economy and the society in whole.
Capitalism and Socialism
Neither socialism nor wild capitalism can be an economic basis for the stable society.
Socialism keeps the society in poverty and produces dictatorships, which simply kill population to maintain their power. We had plenty of examples of social experiments with pure forms of socialism (USSR the biggest), to convince ourselves that it does not work.
Wild capitalism really never existed in a pure form, it was emerging in the societies with some existing economic structures. However we can extrapolate what can happen if the society experiments with the pure form of it. It is obvious that such social structure is unstable – it generates frustrated underclass, which destroys the society in the first moment of the social weakness without regards for consequences.
Developed market based society has survivability and social stability as first goals, it is not restricted by any logical scheme, whatever attractive it sounds.
Market of Ideas
Market based society is in a process of perpetual exploration. On the way it inevitably hits situations never happened before. Market crashes are interesting example. Each next crash is very different from any previous. This requires a mature society, which members can operate with sophisticated economic and political concepts.
In the fast moving society academia can not supply ideas in time – the process of moving ideas from academia to the general public is slow. Neither politicians nor media take seriously their role in the learning process of society, even worse – they oversimplify the set of concepts, which they operate. Even more, in the heat of political debate they undermine the very respect for the political and economic institutions.
This has at least two dangers. First, it can lead to a situation when the social maturity is needed to make a difficult decision (there is no way the simple set of images can lead the way to the right decision), and it is not here. Second, it undermines moral values – the very foundation of the society.
The market-based society needs a system of generation of economic and political ideas, and active discussion of them. Otherwise people have the chronic disenchantment with politics. When subjects are not discussed seriously and people in mass can not expand their understanding of events as they occur – the emotionally charged images are used, which do not help in decision making. This goes against the basic needs of market-based society, which needs strong moral values and active involvement of population in political decision making.