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A "New Deal" for Europe
The Great Depression in the United States was the worst and longest economic collapse in the history of the modern industrial world, lasting from the end of 1929 until the early 1940s. At the worst point in the depression, more than 15 million Americans - one-quarter of the nation's workforce - were unemployed.
The solution was found and applied by the newly elected President Franklin Delano Roosevelt, who created the programs known as the New Deal to overcome the effects of the Great Depression. These programs pumped large amounts of money into the economy through public works programs and relief measures. Public works projects provided jobs building schools, dams, and roads.
Although economic conditions improved by the late 1930s, unemployment in 1939 was still about 15 percent. However, with the outbreak of World War II in Europe in September 1939, the U.S. government began expanding the national defense system, spending large amounts of money to produce ships, aircraft, weapons, and other war materials. This stimulated industrial growth, and unemployment declined rapidly. After the United States entered the war in December 1941, all sectors of the economy were mobilized to support the war effort. Industry greatly expanded, unemployment was reduced to 0% and indeed, unemployment was replaced by a shortage of workers.
In this short story we find both the problem and its solution. The problem was massive unemployment. The solution was to pump large amounts of money into the economy, first in the form of public works programs, then in the form of military-oriented production.
Can we use this same solution today?
The first and most essential point is that money or credit is pumped into the economy, and yes, we can use this same solution today. But we cannot do so with government programs.
The programs of President Roosevelt were funded through deficit spending by the government. This is not an option today. Governments are trying desperately to reduce their accumulated deficits, not to increase them.
The principle remains valid: that we inject money into the economy and direct its flow. But we will need to find another source of money. To do this we must explore briefly the workings of the standard western banking and monetary system, and its use in controlling the level of economic activity.
Economic Expansion and the Banking System
We are in recession with high unemployment. How exactly do we expand the economy? The answer lies in the quantity of money, or credit, which circulates through the economy.
There are millions of people working, all contributing different skills to millions of different products or services. And there are millions of consumers for those products and services. We need to trade and exchange our goods and services, and this is done with the use of money or credit. Without it we can only barter, and trade becomes very slow indeed. Without credit, saving and investment are impossible. The whole economic system depends on credit. Without it, the economy will come to a halt.
Credit is vital to the economy, and credit is used to regulate economic activity. We expand the economy and increase economic activity by making more credit available in the national system. We reduce economic activity by reducing the flow of credit.
The commercial banks create credit by making loans to their clients. But the amount of loans they are permitted to create is limited. The total amount of loans that a commercial bank can create is proportionately related to its reserves. The commercial banks are required by the Central Bank to retain a certain proportion of reserves in relation to their loans.
To expand the economy the Central Bank lowers the key interest rate and lowers the reserve requirement. The commercial banks will then offer more loans to business for investment, and to consumers for major purchases.
To reduce economic activity the opposite action is taken. Interest rates are raised, and the credit flow is reduced.
The supply of money, or flow of credit, is the nation's engine of economic expansion. Which institution should control this flow? The Government, or an independent Central Bank? Britain's in-coming socialist government in 1998 gave total control to Britain's Central Bank, the Bank of England. The main issue is politics versus economics. Bankers want monetary stability, or low inflation. Politicians want full employment. An important area of debate in the European Union at this time concerns the question: "who controls the economy". The German viewpoint favours control by a wholly independent Central Bank in order to guard against inflation. French politicians take a more socially oriented approach, and are seeking a measure of political control.
The essential facts of the system remain however. The continuing circulation of credit drives the economic machine, credit which business requires for investment, and to trade with its consumers. This flow of credit is created and re-created by the commercial banks as they provide loans to their clients. The amount of credit that they can create is related to their reserves and to the Reserve Requirement. The Reserve Requirement is set by the Central Bank, with or without government participation.
The Absence of Banking Discipline
As we have already observed, the Central Bank sets limits on the total quantity of loans which the commercial banks are permitted to create. But no further regulation is applied. The destination of new credit and its uses is a matter entirely for the discretion of individual commercial banks.
Do they use this discretion wisely? A long and continuing history of scandals and bank failures would suggest that they do not.
In 1993, banks in Norway, Sweden and Finland were in trouble. The banks got into trouble in all-too-familiar ways. Financial deregulation gave them greater freedom to lend, which they exploited unwisely. Scandinavian property went through a nasty boom-bust cycle. And recession led to mountains of bad debts.
In 1996 it was the huge French bank Crédit Lyonnais which got into trouble. Three years later the French government is still "conducting rescue operations" which in effect means pouring money into a near-bottomless pit.
Of the ex-socialist bloc countries, the Czech Republic is often considered as one of the more economically and financially stable. In January 1998 however the country's four biggest banks were in a state of near-collapse. Loans were made irresponsibly to business friends, and funds were invested in speculative property ventures. The major financial news of 1998 was the "meltdown" in the Asian markets. Here again, the banks were in substantial trouble largely through speculation in stock markets and property. Further banking scandals surfaced in France and Switzerland.
Warnings of insufficient banking supervision went unheeded, and the potential for a major world banking crisis was realized in 2008 when the mortgage crisis developed into a full-scale, fear-motivated run on the banking system.
Bankers traditionally imply that they are simply lending depositors' funds to local business. In fact the commercial banks are creating new credit within the overall framework of the national monetary system. They are handling a National Resource of extensive proportions. And yet this System-generated Credit is created and channeled by the banking sector with little reference to the overall needs of the economy. Worse still, bank loans are frequently made with insufficient financial responsibility.
It may well be argued that the time has come when we should consider establishing some sort of directional and qualitative controls over the use to which banks put the credit which the monetary system empowers them to create.
On the negative side, we might spare ourselves the chagrin and the cost of future speculative crashes if appropriate controls and guidelines are established to ensure that banking resources are not employed for purely speculative purposes in property and stock markets.
On the positive side, we might begin to make use of System-generated Credit for the benefit of the economy as a whole.
Maximizing a National Resource
When we recognize that system-generated credit is a national resource, we may be moved to consider how it could be used to the greatest benefit. Several possibilities may be reviewed.
First and foremost we should begin at the highest level by establishing a National Investment Bank to handle major infrastructure projects, environmental protection measures, and industrial development in backwater areas or areas experiencing major unemployment. These projects are presently funded, either not at all, or by government as non-returnable grants out of taxes. Grants lack the financial discipline of loans which must produce a repayment. And the use of taxpayers' funds for what should be investment only succeeds in further enlarging and obscuring government accounts. A National Investment Bank, making open decisions based on nationally debated priorities, could take a proportion of the credit quantity and use it to make repayable loans for infrastructure and development on a more businesslike basis.
We also need to establish strategic investment guidelines at regional and local level based on a ground-up assessment of local needs, potentialities and skills. Beginning at local level, every city, town and community should be encouraged to develop channels for debate. Participants must include business people, industrialists, chambers of commerce, educators, consumer groups and community development institutions. Additional assistance may be sought from specialist advisors: professional planners, market researchers, industrial designers, and cost accountants. The result is a composite review of local needs and potentialities. Using this as a guide, industry, educators, bankers and local government can dynamically coordinate resources to ensure the fullest possible employment of financial resources and productive potential.
This is not a revolutionary, nor even a new proposal. It is already being implemented on a wide scale. Most regions and cities today expect to take at least some measure of economic initiative to attract new jobs to their area. What we are proposing here is to recognize the importance of this activity and to place it on a more formal footing, and most importantly, to integrate the banks' credit creation into the process.
Once again we need to remind ourselves of the fundamental justification for requiring that the banking sector's loan activities should be subject to the demands of strategic planning. The flow of credit created by the banking system is a national resource, not a resource of any specific bank or investment institution or individual saver. It is a resource having a substantial potential for economic development. It is also a scarce and finite resource. It is therefore entirely appropriate that this resource should be directed purposefully and publicly into projects which will improve employment, productivity and prosperity.
Thus we establish a political-financial partnership with clearly defined demarcation lines. Politics is concerned with directing the flow of our System-generated Credit towards areas and infrastructure projects which will maximize the nation's or the region's productive and employment potential. It is the individual banker's responsibility to ensure that the flow of credit is directed into loans that are secure.
When investment for economic expansion is channeled entirely through System-generated Credit, we have a method of expanding and regulating economic activity which is totally independent of government and government accounts. In this way there is no temptation to use deficit spending as an impetus to economic recovery.
We would unleash the power of President Roosevelt's New Deal, without incurring additional government debt.
Economic Expansion: Removing the Limitations
Any government can harness the flow of credit in order to generate expansion throughout the whole economy. From this point of view, full employment is possible. But there is another problem. The extent of economic expansion is limited by the threat of inflation. Economists generally accept that we cannot reduce unemployment below 6%.
So what is inflation? And more importantly, is there a way of controlling inflation without maintaining permanent unemployment?
Inflation is an increase in price without a corresponding increase in value. If the price goes up for a better product that costs more to make, that is not inflation. But if a producer asks more tomorrow for the same product he sold for less yesterday, that is inflation.
The same applies to wages. If you want more money for more work that is not inflation, it is simple justice. But if you want more money for doing exactly the same work, that is inflation.
How does the level of economic activity affect inflation?
To answer this we should not study economic science, but human nature.
When the economy is in recession, producers and retailers cannot easily sell their goods. They therefore try to keep their prices as low as possible. As the economy expands, and consumer demand expands, prices can be moved up without hurting sales.
Wage demands react in a similar way. Workers and employees will not demand more money, or threaten strike action, when there is high unemployment. But when the economy approaches near-full employment and workers are hard to find, now is the time to demand a wage-increase.
So we find a continuing conflict between full employment and inflation. Inflation is controlled by means of unemployment. Is there any other way?
Stabilizing Inflation: Remunerations
Inflation is generated when producers demand more money for the same product or service. Inflation is generated when employees demand more money for the same amount of work. Why are they able to make these demands?
The answer is that our pay and prices are fixed by a form of disputation between producer and consumer, between employer and employee. Economists call it "free collective bargaining". But it is inherently unstable. Is there an alternative? Yes. And it is already in use.
Many major companies and government agencies use a system of Job Evaluation to measure the work of each employee. Each job is analyzed. Its essential characteristics are measured on a series of common scales. These characteristics would include, for example, training, responsibility, working conditions and physical or mental effort. The result is fair pay. The remuneration for every job is fair, both in relation to the work done, and in relation to the pay and the work of others. This type of evaluation system is not unusual; it is practiced fairly widely in American and western European countries. The different systems in current use are well tested and work successfully. The only problem is that there are several such systems, and no single standard.
The European Union could quite easily establish a common standard, based on evidence supplied by companies with existing experience, together with management and worker representatives. The resulting European Standard for Job and Pay Evaluation should be simple to understand and widely publicized. In this way, the Standard would gain wide acceptance. Initially it would be applied on a voluntary basis, with legal enforcement introduced following a period of familiarization. Pay at all levels and in all companies and government departments throughout the European Union would be mathematically defined according to a socially accepted formula, and thus stabilized.
It is important to understand that this is not an "Incomes Policy". Prices and Incomes Policies attempt to freeze prices and/or incomes. They are neither fair nor acceptable. Such policies simply freeze existing pay and price inequities, perpetuating perceived injustices, and preventing any flexibility.
We may also anticipate criticism from the rules of classical economics, according to which a Job Evaluation Standard would be impractical. Classical economics teaches that scarcity of a particular skill allows those having such skills to demand a higher price for their labor. The higher price encourages others to learn that same skill thus restoring the balance between supply and demand. Similarly, a surplus of a particular skill allows employers to reduce the price of such labor, thus discouraging further entrants into that skill-market.
Today however, we have gained more expertise in the art of predicting future requirements for labor and skills. And this in turn affects education and training programs.
The major advantage of a Standardized Job and Pay Evaluation System is that it would stabilize remunerations at all levels. Can prices also be stabilized?
Stabilizing Inflation: Profits and Prices
The total costs of a factory's output consist of three elements. First, the cost of bought-in raw materials and components; second, the direct labor added in the factory; and third, the costs of capital write-off, overheads and finance.
These are the costs of making a product, or supplying a service. From these costs a Unit Production Cost can be calculated for each product or service supplied. If this Unit Production Cost then becomes the Selling Price there would be a direct and fair relationship between cost and price, and therefore between pay and purchasing power.
But the Unit Production Cost is not normally equated with the Selling Price. The difference between the two is commonly referred to as the net profit
Part of the net profit is distributed as dividends to investors, and in many companies, as bonuses to employees. Net profits are also used for re-investment, either in research and equipment or to provide increased working capital.
There is one more claimant to a share in the profits, and that is the customer. It is the customer who pays the price and generates the profit; with this view a further claim on profits would come from the consumer in the form of lower prices.
The stabilization of prices would require the establishment of public policy for profit distribution. This policy might first establish an overall profit ceiling. Profits could then be applied using an agreed formula of percentage shares. Such a formula should be established by social consensus. It should recognize the claims and contributions of consumers, investors, co-workers, and the future security of the business itself.
If pay at all levels and prices were stabilized, based on mathematical definition and social consensus, there would no longer be any danger of inflation. The economy could then be expanded steadily to a condition of permanent full employment.
A condition of permanent full employment would have many beneficial effects.
Social conditions would be improved and public spending on welfare would be reduced.
It is generally agreed among economic observers that many European companies need to reduce their employment in order to improve productivity, reduce costs, and remain competitive. This process is not painful for employees in conditions of full employment.
Full employment is the answer to most economic problems. Permanent full employment can be achieved through two simple steps.
The first step requires that we recognize the flow of credit created by the banking system as a national resource. It should be subject to proper safety controls, and to a measure of priority apportionment. In this way we would protect our economy from banking disasters, and we would unleash the power of President Roosevelt's "New Deal" to expand the economy without incurring additional government debt.
In the second step, we define and stabilize pay and prices. A European Standard for Job and Pay Evaluation should be established, then applied universally and at all levels. A social consensus on the level and distribution of profits would effectively stabilize prices. With mathematically defined and socially accepted definitions, pay at all levels, and prices, would be stabilized. The economies throughout the European Union could then be expanded to permanent full employment without risk of inflation.