While having already addressed the argument which asserts a mechanical alleviation of the economic duress in the eurozone’s periphery by virtue of spontaneous or instigated rising inflation in the core, Germany in particular, I continue to feel an inclination to restate my position on the matter, after having been stimulated or inspired to proceed thus by a discussion I held with a friend earlier this day, which reminded me of the assemblage of questionable assumptions still prevalent in certain political or intellectual circles, concerning ideas on the most optimal response to the eurocrisis.
What I shall venture to deconstruct and to unmask its underlying tissue of fallacies, as I see them, is none other than the essentially europhobic and dubiously self-contained proposition that against the backdrop of the single currency there can be no genuine and sustainable recovery in the periphery unless the core tolerates relatively higher inflation rates for an extended period of time. Inflation is, in this context, regarded as the single most important factor for development and, moreover, as the midpoint of any and all measures that can and may be adopted with the two-fold objective of planting the final nails to the coffin of the crisis and setting the foundations for a future that will realize a more robust, inclusive and just economic model.
My critique of this understanding of the political economy of the euro area, which is often peddled as the most benign and expedient alternative to the inane orthodoxy of austerity, while occasionally being embellished with nebulous patriotic palaver, shall be separated in three sections concerning economic thought, with the tacit recognition that the broader political-institutional picture must also be accounted for, if one is to reach a holistic understanding of the interplay of forces in operation. The economic issues to be examined herein are as follows (each section has its own permanent link which can be copied, bookmarked or shared separately):
- Zero sum games as antithetical to the endogeneity of increasing economies of scale,
- The subjectivity of the inflationary process as a primary factor for credit allocation,
- Macroeconomic magnitudes as phantasmagorized ontological entities.
1. Zero sum games as antithetical to the endogeneity of increasing economies of scale
The conventional wisdom in macro-economics, in any and all of the schools of mainstream economic thought found therein, is concentrically fastened upon the chimerical general equilibrium of Léon Walras, adherence to which necessarily forces a remorseless analyst to draw the erroneous inference that economics is essentially all about a static approach to the optimal allocation of scarce resources. Consequently and against this backdrop, one beholds the emergence of a restrictive interpretation of the economic world as an inescapable antagonism between options on the management of a fixed world, where inevitably the competition for resources resembles what game theorists refer to as “a zero sum game”, i.e. a process in which one must necessarily win at the expense of the other and, conversely, where it is impossible for both to realize a simultaneous or mutual increase in utility or returns.
Thus, we are faced with the dubious assertion that the euro area’s periphery may only realize gains as against the core; a postulate that casts to the wind the insight that equilibrium and its fixed conceptions are irrelevant in an economy with perpetually new capital and labor divisions, combinations and interrelations; and that the trade which is necessary for these particularizations and specializations to be meaningful and possible, is beneficial for both sides, at least in an ex ante sense, by increasing the availability of resources that would have otherwise not been brought into being.
The error in the standard understanding exists in the fact that it blithely ignores the direct impact of labor and capital division in increasing returns that would have not been realized in the absence of these new and evolving inter-subjective structures while also neglecting the endogeneity and related variability of these impulses; for as Allyn A. Young correctly suggested in his Increasing Returns and Economic Progress and whose validity was further acknowledged by Nicholas Kaldor in his The Irrelevance of Equilibrium Economics it is pointless to labor under the illusion that a robust objectivity, the general equilibrium, is what determines economic progress, in the presence of the processes that engender capital combinations and their internal capital/labor ratios. As Young puts it:
It is generally agreed that Adam Smith, when he suggested that the division of labour leads to inventions because workmen engaged in specialised routine operations come to see better ways of accomplishing the same results, missed the main point. The important thing, of course, is that with the division of labour a group of complex processes is transformed into a succession of simpler processes, some of which, at least, lend themselves to the use of machinery. In the use of machinery and the adoption of indirect processes there is a further division of labour, the economies of which are again limited by the extent of the market. It would be wasteful to make a hammer to drive a single nail; it would be better to use whatever awkward implement lies conveniently at hand. It would be wasteful to furnish a factory with an elaborate equipment of specially constructed jigs, gauges, lathes, drills, presses, and conveyors to build a hundred automobiles; it would be better to rely mostly upon tools and machines of standard types, so as to make a relatively larger use of directly applied and a relatively smaller use of indirectly applied labour. Mr Ford’s methods would be absurdly uneconomical if his output were very small, and would be unprofitable even if his output were what many other manufacturers of automobiles would call large.
[…] Modified, then, in the light of this broader conception of the market, Adam Smith’s dictum amounts to the theorem that the division of labour depends in large part upon the division of labour. This is more than mere tautology. It means, if I read its significance rightly, that the counterforces which are continually defeating the forces which make for economic equilibrium are more pervasive and more deeply rooted in the constitution of the modern economic system than we commonly realise. Not only new or adventitious elements, coming in from the outside, but elements which are permanent characteristics of the ways in which goods are produced make continuously for change. Every important advance in the organisation of production, regardless of whether it is based upon anything which, in a narrow or technical sense, would be called a new “invention,” or involves a fresh application of the fruits of scientific progress to industry, alters the conditions of industrial activity and initiates responses elsewhere in the industrial structure which in turn have a further unsettling effect. Thus change becomes progressive and propagates itself in a cumulative way.
The gist of the argument thus far is that what really matters is the size of the industry or of the market and the forces that are at play in allowing for labor and capital division. In this respect, the very idea of inflation qua factor for recovery is specious, since there is nothing intrinsic to it that could, in and of its own, determine the existence, manner, function and end of capital-labor constructs and contribute to the real expansion of industries and/or markets in which these will be made operational and, above all, there is nothing inherent in either inflation as such or the legal-cultural, political-economic and institutional morphology of the Economic and Monetary Union that provides evidence to the existence of a causal relation between the rise of aggregate nominal prices in one part of the monetary union with recovery/growth in another. To understand why that is so, we may proceed to the next section on the subjectivity of the inflationary process.
2. The subjectivity of the inflationary process as a primary factor for credit allocation
Inflation, just like everything that exists in the human world, the inter-subjective world or, to use a term of Edmurd Husserl, the lifeworld, is the product of a complex, interweaving web of factors traced to the actions, decisions, expectations and perceptions of individuals, in an incessant process of created-and-creating differentiation. While this philosophical tenet of thought may beg for further elaboration, I shall abstain from treading in such fields and, instead, venture to pit further stress upon two notions familiar to economists, expectations and incentives, as couched in the terms of the inflationary process. Contrary to conventional economic wisdom, or rather to the belief that has been bestowed upon us as a re-branded version of the quantity theory of money originally developed by Nicolaus Copernicus and the medieval scholastics, the phenomenon of inflation does not attain the form of a universal, proportionate, equilibrated and uniform expansion in some unrealistic abstraction called “the price level”, but rather appears as a series of ripple effects, of gradual, cascading, cumulative increases in the amount or velocity of transactions in some industries or even classes of goods as against others in the passage of time, something than even John Maynard Keynes, whom many claim to be followers of, had recognized in his The “Ex-Ante” Theory of the Rate of Interest.
New media of exchange, which in a fiat monetary system usually make their first appearance in the expansion of the money supply by the central bank that injects liquidity through the credit channels all the way to the real economy, do not have a single destination and, even if they did, their reaching that end does not take place either instantaneously or simultaneously. Put differently, the credit canals from the central bank to the real economy, which pass through financial intermediaries—banks—do not necessarily furnish credit to the real economy in a one-off expansion; for in between the central and the presumed destination of the new money—the real economy—a number of incentives and expectations of widely dispersed economic actors exists, exerting a powerful influence on the prior direction of this liquidity into the markets for sovereign bonds, commodities, capital goods and money before any issuance of loans to the real economy is considered.
To avoid a lengthy and tedious exposition of the theoretical underpinnings of this proposition and to rather appreciate it in more concrete terms, one may only be reminded of the failure of the European Central Bank’s Long Term Refinancing Operations to not only restore the then-and-still crippled credit channels, but most importantly to smoothly transmit the approximately €1 trillion to the real economy. In addition, the very fact that the ECB proceeded with the introduction of the Outright Monetary Transactions programme while it currently is contemplating ways of raising additional credit to SMEs, which comprise the vast corpus of the European economy, are evidence of the fact that certain powerful and pervasive expectations and incentives are in force which decisively contain the injection of new money to the financial system. For as long as these psychological, subjective factors remain in operation, any inflationary impetus can only feed into a bottomless pit or else a liquidity trap, with all its concomitant side-effects and the sub-optimal outcomes it may lead to.
Generally speaking, it is the lifeworld’s factors that determine credit allocation and in the specific framework of the Euro Area’s political economy one could identify and enumerate the following three parameters, which in no sense constitute an exhaustive list:
- capital adequacy: new regulation that requires banks to increase their capital adequacy ratios provides the incentive—or rather constitutes an edict—for investment in sovereign bonds of a fair quality, which necessarily entails a misdirection of credit away from the real economy and into state coffers,
- zombification: the crippling of the credit channels is both caused by and causes mistrust between banks, impelling financial institutions to opt for remaining dependent on ECB liquidity, so as to be on the safer side, effectively confining credit to the rigid boundaries of the financial system; which by the way is a clear indication of a dangerous trend towards the zombification of the European banking system,
- regime uncertainty: the manner in which economic integration in the midst of the eurocrisis is realized leaves much to be desired in the areas of predictability and foreseeability of institutions, thus fostering a regime uncertainty that forces those who gain first access to ECB liquidity, in the time context, to place money in unproductive areas that are presumed to be more robust to the vicissitudes of the market with its increased risks manifested across the real economy and the financial system.
The incentives and expectations may vary substantially, but what remains is the realization that their impact on the actual allocation of credit in the inflationary process through the passage of time cannot be dismissed, nor can their function be sacrificed to the altars of a spurious method of inquiry on the subject matter. Lastly, as Ludwig Lachmann put it in the introduction to his Capital and its Structure:
The fact remains that the two greatest achievements of our science within the last hundred years, subjective value and the introduction of expectations, became possible only when it was realized that the causes of certain phenomena do not lie in the ‘facts of the situation’ but in the appraisal of such a situation by active minds.
While this may appear as a superfluity arising from the recognition or presupposition of is self-evident character, at least to anyone conscious of the profound distinction between the social and the natural sciences, it should be stressed that inflation is not and can never be tantamount to a law determining the behavior and movement of liquids in communicating vessels that a researcher diligently searching for a new discovery would identify by holding controlled experiments. Adherence to the monolithic prejudice in the talismanic impact of inflation in the eurozone’s core being the prolegomenon and the prerequisite to the periphery’s recovery, appears to be an oversimplification of reality, to the point where it distorts the very picture it seeks to paint. This should not strike us as a surprise, for there exists an even more profound and egregious misunderstanding underlying this conception of that monetary aggregate, and it is none other than the conviction in the quasi-natural, ontological existence of macroeconomic magnitudes, as independent from the forces and the historical-institutional context that engender and sustain them, to the variable extent, manner and duration that they do. This theme shall be outlined in the following section.
3. Macroeconomic magnitudes as phantasmagorized ontological entities
Another fundamental misunderstanding of conventional macroeconomics, apart from those mentioned above, is its pretense to intellectuality and the scientism found in the ascription of mechanical interrelations and causalities to macroeconomic magnitudes, which is structured on the questionable predisposition of them being ontological entities in their own capacity, rather than mere accounting figures and, therefore, products of the imaginary. Indeed the plonky macroeconomist of our era, who may also enjoy widespread recognition and a good press, customarily treats such macro indicators as “inflation”, “investment”, “spending” as decontextualized parameters, hypostesized forces singularly and jointly determining the “optimal” distribution of scarce resources in the context of the profound though unrecognizable exteriority of those elegant curves of supply and demand.
The argument now under scrutiny, assumes the ontological presence of inflation and fallaciously proceeds to concatenate a series of other such aggregates qua beings (in the ontological sense), ultimately reaching the conclusion that inflation in the euro area’s core is on its own accord the ultimate determinant to the development of the periphery, and that, conversely, the absence of such inflationary pressures in the core will doom the periphery, in splendid determinist fashion, to years of grinding and irreversible austerity.
The kind of critique a subjectivist and relativist such as the present author may level against this sort of oneiric understanding of the complexity of the world, is to unequivocally reject any quasi-natural, spectralized ontological property bestowed upon these macroeconomic aggregates on the epistemological grounds that such figments, even once provided with the patina of scientific formalism and the veneer of geometry, constrain the potential capacity of our organon, courtesy of their illusory underlying assumptions, rather than contribute to—or facilitate—its unencumbered operation beyond the hermeneutics of stylized facts. In simpler terms, this means to deny the very idea of them having any mechanical interrelations, without however refusing their existence as accounting figures and average measures of an interplay of factors that occur at a much more organic and evolving milieu.
Understandably, a knowledge of the real world and of economics as process, not mechanics or counterfeit physics, can only result in the issuance of the modest pronouncement that inflation as such is irrelevant or of minor significance to whatever dynamics between the eurozone’s core and periphery. An increase in the “price level” in Germany does not necessarily result in an equivalent rise in aggregate demand for, say, Portuguese exports nor does it necessarily, by the operation of the mysterious determinism underpinning the macroeconomist’s scurrilous misconceptions, impel consumers and producers in Germany to automatically allocate their excess media of transaction to the importing of those specific goods and services that the periphery can provide them with.
Inflation in the core may eventually contribute to rising demand for imports from the periphery, but this can only be known a posteriori, and only as a secondary element, provided that the primary factors discussed in the preceding two sections are favorable to such a shift. There is nothing germane to inflation that “will” or “shall” decisively work its way towards a benign symmetrization of the macroeconomic figures across the eurozone, in what can be visualized as a spectacular ironing out of all imbalances and erratic fluctuations between core and peripheral countries. To assume thus, is to assign to inflation a status of omnipotence layered upon the presumption of ontological presence and, even worse, to disregard the range of possibilities that arise in the lifeworld, courtesy of the decisions, incentives, expectations of individuals and of the specific capital and labor divisions as well as social institutions that all together play their part in the economic process.
In conclusion and as a corrective to the erroneous and arid controversies of macroeconomic policy in Europe, the scrupulous critic should turn attention away from incorporealities of national accounting towards the insight that capacity building is a product of the inter-subjective world, manifested in new capital and labor structures, combinations and interrelations, rather than it emerging in nihilo and cum nihilo by a change in the aggregate figures of another state of affairs not sharing insoluble ties with the one under consideration.
Development springs from new combinations of resources, expanded division of labor and capital, in what Eugen von Böhm-Bawerk referred to as “roundabout methods of production”, which give rise to new opportunities for further investment by freeing resources for use in more economically productive areas, in a cumulative and self-invigorating manner. In times of economic tranquility this is realized, efficiently or perhaps inefficiently, through the operation of the imaginary institution of the market economy; but in the midst of a severe and persistent depression, where plentiful idle resources exist across all sectors of the economy and where the social imaginaries related to the market are brought into question, the initiation of concerted action ought to be deemed necessary, legitimate and desirable, to solve coordination problems and to engender agglomerative or other forces that can set in motion processes for the formation of a new constellation of capital structures that will absorb unemployed labor and other resources on a solid basis of renewed confidence in these imaginary constructs.
What remains to be noted is that the default response to inflationist calls must be the illustration of the inherent complexity of the lifeworld, as contrasted to the simplistic, mechanistic and thus unrealistic nostrums of those who delude themselves in thinking that a single parameter, an exalted incorporeality, tacitly and perhaps unwittingly elevated to the level of an ontological entity, constitutes the epicenter of any solution to the systemic crisis of the Euro, if not its only panacea. Simplification is a necessary part of learning, but in the absence of a firm understanding of the complexity from which it emanates, can only impregnate ideas whose application would definitely result in adverse effects, sometimes misanthropic and calamitous policies, courtesy of their incompatibility with the given-and-varying state of affairs in the spatio-temporal and political-institutional dimensions.
At any rate, the obstinate concentration on inflation, the “fetishization” (if I may use a very Marxian term) of this macroeconomic magnitude, the exaggeration of its significance as permeating and penetrating all that there is in the macro sphere of the Euro Area’s political economy, may only be understood as an opportunity forgone, as a lamentable waste of talent, as a loss of intellectual strength and valuable time in the elaboration of fallacious theorems that can only lead to a robust terminus, a dead end; and if the periphery is to recover from austerity, at least those people who really care about their livelihood and their prospects for liberty and eudaimonia, should consider allocating at least part of their vital energy to the ideas that exist outside the little box they concocted or accepted as a heteronomous, self-alienating given.
Picture credit: Wikipedia | Prometheus chained by Vulcan. Painting by Dirck van Baburen.