Monday, March 23, 2009

Why Socialism?

In college we had a good time with C, S, I, M, X and Y. That's Consumption, Investments, and eXports which add to Income (Y), with iMports and Savings reducing it. 

Y = C + X + I - S - M

This was to say that if you wanted to stimulate economic growth (i.e. income) you needed to ensure there was less savings. It sounds like an ode to indulgence but is in fact the opposite. Why? Consider: Which income-groups saved more as a percentage of what they earn? The poorer or the rich? (Duh)

It was the wealthy who saved more NOT because they were more prudent and careful with their spending (how we wish), but because they had more to spend over and above the basics. The lower classes, on the other hand, needed to consume more of their three- (and barely four-) figure incomes.

In a word, it's the folks running Genting, as opposed to the folks cleaning the Gents', who get to make huge (and regular) bank deposits. Needless to say, if money money is in the banks, then less money is being spent(!).

And what, in truth, does a modern economy fear the most? Answer: A sudden contraction of consumption and investment. Translated, this means a sudden rise in savings i.e. an action falling firmly within the domain of the rich.

If the rich become richer and if inequality grows, the moment-by-moment inclination (or, in econs terms, the marginal propensity) to SAVE rises and that to CONSUME/SPEND drops. As the bubble expands, the likelihood of it popping goes up. 

When it pops, the story is familiar: Less consumption (more savings) means less profits, leading to lower wages, lower investments, creating even lower spending, ad infinitum depressiorum (smile). 

That's the diagnosis - what's the prescription? Devilishly straight-forward: Transferring more money from the rich to the poor, reducing the income-gap and replacing 'luxurious spending' (which can be easily turned off) with 'subsistence spending' (which, like water and power, needs to stay on most of the time).

This would ensure that - here we go again - the marginal propensity to consume, goes up and the marginal propensity to save falls.

Important: The free market by itself would NEVER 'recognise' the problem let alone work to correct it. In many ways, the market is like evolution - it has no purpose, no inherent meaning, no design, no morals and doesn't "prefer" a recession over double-digit growth. Market equilibrium can be obtained with both 0% and 90% unemployment!

The economy's only hope, in this case, would be its bigger spender and (at least in the past) its most powerful player, the government and its fiscal and monetary policies.

So there we have it. If governments don't intervene to keep the rich in check and the poor less poor, the economy will make us wish they did. Without socialism, capitalism dies.


Todd Moore said...

Any book recommendations on this topic for a skeptic?

alwyn said...

Hi Todd, the best i can think of:

- Naomi Klein's "Shock Doctrine" (most recent)
- almost anything by Joseph Stiglitz
- John kenneth Galbraith's Affluent Society, American capitalism, New Industrial State (a little dated but great reads)

hope this helps