Tea Party Economist

Recently by Gary North: Leadership: Missing in Action

“Centralization induces apoplexy at the center and anemia at the extremities.” ~ Lamenais

The present political system is clearly insane. It suffers from schizophrenia. Around the world, almost no one trusts the politicians, yet almost everyone votes for incumbent politicians who promise to reform the government.

Voters now suspect (correctly) that all Western governments are headed for bankruptcy because of the pension programs and government-funded medicine, yet these two programs are politically untouchable. Voters demand them.

For four decades, soft-core critics of the pension/Medicare systems have come to voters with this announcement: “The two systems can be reformed, but we must act now. If we delay, they will bankrupt the government.” Yet the systems are never reformed.

Then, a decade later, the next group of optimistic reformers comes forward with this same promise: “The systems can be reformed if we just act now.” Nobody believes them. Nobody should. If the programs really can be reformed “if we act now,” then the previous warnings were mere scaremongering. There really was no hurry. So, Congress asks rhetorically: “Why should we believe that we need to hurry now?” Result: the systems never get reformed. Congress kicks the can.

THE GREAT DEFAULT

The federal government really is headed for default. The numbers don’t lie. This fact produces pessimism in some circles. People who look at the numbers conclude, accurately, that the federal government will not muddle through this crisis. All over the world, national governments will not muddle through. They will no longer be able to kick the can.

I have good news and bad news. The bad news first. If you are dependent on the government for your old age security, you have only one hope: an early death. The good news: when Washington’s checks bounce, the bureaucrats will have to go into another line of work. Millions of them. All over the world.

I am now going to present a scenario that is not widely shared. The process that undergirds it is not widely recognized. Yet this process is relentless.

If I am correct about it, judgment day is coming. Not the final judgment. A liberating judgment.

There are self-proclaimed optimists who say Medicare will muddle through. Similarly, there are self-proclaimed optimists who say the present Keynesian system will muddle through. These people are in fact pessimists. They argue that moral evil and economic irrationality can be made to work. That is a pessimistic message. Fortunately, they are wrong.

People will muddle through. The Keynesian system won’t. Neither will the finances of the people who have bet the farm on the Keynesian system’s ability to muddle through.

THE LAW OF EMPIRES

Empires disintegrate. This is a social law. There are no exceptions.

The first well-known social theorist to articulate this law was the prophet Daniel. He announced it to King Nebuchadnezzar. You can read his analysis in Daniel 2. Verses 44 and 45 are the key to understanding the law of empires.

The Roman Empire is the model. But there is a serious problem here. There are at least 210 theories of why it fell. There are so many that even my 1976 Ron Paul office colleague Bruce Bartlett gets credit for one of them — on Wikipedia, no less. He has made the big time!

In any case, Rome did not collapse. It wasted away over several centuries, wasting the treasure of its citizens along with it.

I suppose there were highly educated people who came to the voters in the late Roman republic and said something like this: “Unless decisive action is taken now, Rome will go bankrupt.” If so, they were right. But it took a lot longer than they thought.

These days, it does not take nearly so long.

An empire grows at first almost unconsciously. No one goes to the powers that be and says, “Hey! Why don’t we create an empire?” It is more like the person who says this: “I’m not greedy. All I want is to control the land contiguous to mine.”

In military affairs, there are economies of scale. An army of warriors makes conquest cost-effective. There are also taxation advantages. An army of tax collectors makes tax collection cost-effective. “Hand over your money” is more effective. Pretty soon, you’ve got an empire.

But there is a law of bureaucracy that applies to empire. At some point, it costs more to administer the bureaucracy than the bureaucracy can generate through coercion. Then the empire begins to crack. It cannot enforce its claims.

So, the growth of empire has economics at its center: economies of scale. The fall of empire also has economics at its center: economies of scale.

I think this process is an application of the law of increasing returns. In the initial phase of the process, adding more of one factor increases total output. But, as more of it is added, another law takes over: the law of decreasing returns.

Example: water and land. Add some water to a desert, and you can grow more food. Add more water, and you can grow a lot more food. There is an accelerating rate of returns. The joint output is of greater value than the cost of adding water. But if you keep adding water, you will get a swamp. The law of decelerating returns takes over. Add more water, and the land is underwater. You might as well have a desert.

This law applies to power. Add power, and you generate more income. But if you keep adding power, expenses of the bureaucracy will begin to eat up revenues. Resistance will also increase: internal and external. The system either implodes or withers away.

With only one exception in history — the Soviet Union in 1991 — empires have not gone out of business without bloodshed.

In the case of the Soviet Union, the senior politicians privatized the whole system in December 1991. They handed over the assets to what immediately became the ultimate system of crony capitalism. They divvied up the Communist Party’s money and deposited it in individual Swiss bank accounts. The suicide of the USSR was “Vladimir Lenin meets David Copperfield.” Now you see it; now you don’t. In the history of Marxism, no event better illustrates Marx’s principle of the cash nexus. It seduced Lenin’s vanguard of the proletariat.

Notice the pattern of empire. It begins slowly, building over centuries: the Roman Empire, the Russian Empire, the French Empire. Then the empire either erodes or else it is captured by revolutionaries, as was the case in France (1789-94) and Russia (1917). But this only delays the reversal. It does not overcome it.

THE MODERN NATION-STATE

Economies of scale shaped the development of the modern nation-state. In 1450, the governments of Western Europe were small. They controlled little territory. They were remnants of the medieval world, which had been far more decentralized.

By 1550, this had begun to change. The beginnings of the modern nation-state were visible.

Tax revenues flowed into the centralizing kingships. Trade was growing. Revenues were increasing. Weaponry was advancing. All of this had been going on for half a millennium. But, like an exponential curve, the line began to move upward visibly around 1500.

Maritime empires grew: Spain, Portugal, England. They challenged each other on the seas. Then came the Netherlands and France. The fusion of naval power and trade monopolies lured nations into competition for trade zones. The idea of free trade was centuries away, except in the academic enclave of the school of Salamanca.

The law of increasing returns was evident in this process. It paid rulers to tax more and extend the jurisdiction of the nation-state at the expense of local governments internally and foreign governments externally. The benefits accrued mostly to the political hierarchy and its system of connected families.

Economies of scale drove the process. The division of labor favored centralization. Local units of civil government could not compete.

Let me give an example from the field of historiography. The historian of colonial America can write about lots of topics: immigration, technology, family structure, town planting, economic development, intellectual trends, and so forth. He writes about the issues of life that affected people’s daily lives. He cannot write about national politics until after May of 1754: the “battle” of Jumonville Glen.

The Battle of Jumonville Glen is unknown to all historians except specialists in colonial America. This is a pity, because that battle was the most important military event in the history of the modern world. It literally launched the modern world. It led to (1) the French & Indian War (Seven Years’ War), (2) the Stamp Act crisis, (3) the American Revolution, (4) the French Revolution, (5) Napoleon, (6) nationalism, (7) modern revolutionism, (8) Communism, (9) Fascism, and (10) the American Empire. It was started by Virginia militia Major George Washington, age 22.

Before the ratification of the U.S. Constitution, it is both possible and wise to write about America without tying the narrative to politics. After 1788, every textbook writer is drawn like a moth to the flame: Presidential elections. He cannot narrate the text without hinging everything on the outcome in the four-year system of national covenant renewal-ratification.

We are fast approaching a day of judgment. It has to do with economies of scale. It has to do with the law of decreasing returns.

The best account of this process is a book by Israeli military historian Martin van Creveld: The Rise and Decline of the State (Cambridge University Press, 1999). He traces the history of the Western nation-state from the late Renaissance until the late twentieth century. He argues that there will be a break-up of nation states and a return of decentralization. I have discussed this here.

CAPITALIST PRODUCTION

Another manifestation of the economies of scale is the development of the factory system. In 1750, most production was home-based. Most people lived on farms. Most farms were close to self-sufficient.

Cities were few and far between. They were located on the coasts or along great waterways. They were based on trade. Perhaps 10% of the West’s population lived in cities.

This began to change around 1800 in Great Britain. It may have been in 1780. It may have been in 1820. But the economy began to change. No one has a plausible explanation for why it happened, but it changed the history of man’s lifestyle as nothing else ever has. The economy began to grow at 2% per annum, compounded.

This process soon spread to the United States. The world began to be overwhelmed by a wave of gadgets.

This process was driven by price competition. A few business owners got rich by serving the needs of the masses. The masses got richer. They got more productive.

The feature most hated by the older producers was capitalism’s relentless service of the poorer buying public. The division of labor is limited by the extent of the market, Adam Smith had correctly observed, and in order to use the newer, more specialized techniques of production, capitalists had to broaden their markets. The most efficient means of gaining access to new markets was price competition.

All of the British troops who marched off to India and the Far East in a quest for new markets in the day of England’s “glory” never matched the market-broadening effects of a 25% discount at home. The producer who could not match this discount steadily was forced out of the market, that is, was forced to give up control of scarce economic resources that could better be used to satisfy the demands of the public in the hands of more efficient producers.

How could poor, uneducated buyers compete against the entrenched wealth of the English landed aristocracy? How could their meager purchases compete against the wealthy man’s competition for the services of producers? How could some dust-covered miner hope to bid scarce economic resources away from the men of wealth? Simply because there were so many of them!

As capitalist techniques of production steadily increased the output of the laboring classes, the poor became slightly but steadily less poor. A few pennies here, a few yards of cloth there, multiplied a million times over: no aristocracy on earth was rich enough to withstand this relentless economic pressure of slightly less poor men, when so many of those men were being created by the labor markets of England.

As individuals they were poor, especially before 1840, but they were not so poor as they had been in 1780, and here was the new fact of life for producers using the older methods of production.

Men who could not afford fine wool suits could now afford a cheap cotton one, and very rapidly it became obvious to English entrepreneurs that it would pay more dividends to start producing hundreds of thousands of cotton garments than a few thousand high-priced wool or silk ones.

What served as the economic liberation of a whole class of people, anti-free market aristocrats saw as a form of bondage, the grinding servitude of the factory, with its time schedules, long hours, routinized production, and child labor. What they resolutely refused to see was what would have been the fate of these masses under the old system of production: famine and death. It was Ireland, not England and Scotland, that suffered the famine of 1848-50, and it was Ireland which had not seen the “plague” of factory production.

John Ruskin, the conservative literary critic of the mid-nineteenth century, summarized the case against capitalism. Ironically, his words were put on mass-produced cards and inserted into mass-produced picture frames for display on the walls of the highly popular Baskin-Robbins ice cream parlors (31 flavors): “There is hardly anything in the world that some man cannot make a little worse and sell a little cheaper, and the people who consider price only are this man’s lawful prey.” I saw this in a store in 1973. I have not seen one lately. I never go into a Baskin-Robbins store. The chain is nearly invisible today.

Conservative social critics saw not only the hard conditions of the factory system — hard in comparison with the life of social criticism, but not in comparison with low productivity subsistence (or less than subsistence) farming — but they also saw the initial effects of mass-produced goods. They were cheap in price and cheap in quality — again, in comparison to the quality standards of the educated social critic.

Those who did appreciate the new clothes, better housing, and preferable working conditions seldom wrote tracts; they simply went to work and spent their money. Undoubtedly, there was a standardization of production. However, as the productivity of laborers increased, and as their wages increased, this standardization was left behind for those coming up — Irish immigrants, for example — and variety began to be an economic possibility.

This indicates the nature of capitalism’s powers of social transformation. At first, price competition expands the market. New groups gain access to goods not previously available to them, either because prices were too high before, or because the products did not even exist.

As participants in the production process, workers add to other people’s wealth. Producers are buyers; step by step, as output per unit of input increases, as a result of the specialization of production, the wealth of all the participants increases. The initial expansion of buying alternatives itself expands as productivity increases. Some producers may specialize in producing for this newly improved buying public; others may branch out and aim at the still excluded buyers — the next level down.

Henry Ford’s Model T — “available in any color, as long as you want black” — made the automobile available to the masses. But as everyone’s wealth increased as a result of capitalist methods of production-distribution (the two are basically the same process), large numbers of men wanted some other color.

Ford failed to recognize this phenomenon of modern capitalism, and his resistance to change — in this case an upgrading of quality and choice — led to the triumph of General Motors in the 1920s. GM offered more brands and more choices within these brands.

GM’s dominance did not last. The company went bankrupt in 2009. It took a government bailout to save it — and the defrauding of bond holders.

The factory is scaling down in the United States, even as it is getting gigantic in China. Smaller, computerized specialized steel factories have replaced the old steel factories. The old factories are empty. They cannot compete.

We live on the cusp of a new era of manufacturing: 3D production. We will have factories on our desks.

Mass production reduces costs. Production initially is centralized. The era of the factory replaces the era of homespun. The economies of scale take over. This is phase one: the law of increasing returns to centralization.

This does not last. The law of decelerating returns takes over at the factory. The era of the factory is replaced. The economies of scale favor local production. I write this on a $500 computer using a $50 word processing program.

When you think “economies of scale,” think “Post Office.”

CONCLUSION

I could apply this analysis to the history of urbanization: from villages to towns to huge cities to the suburbs. Urban historian Jack Lessinger has chronicled this in a series of books.

The economies of scale no longer favor centralization. They favor decentralization: in manufacturing, in education, in urban development, in finance, in politics, and even in military affairs. Non-state resistance movements hold the advantage today. So does the terrorist cell. If the urban West is ever threatened by weaponry, it is more likely to be from a home-brew biological weapon than from a nuclear device.

Small may not be beautiful, but it surely is efficient. You don’t see a virus. You can see a mushroom cloud.

For those of us who dread the centralization of anything, our boats have begun to come in.

No ship will come in. Its model is the Titanic.

Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

Copyright © 2012 Gary North