Example of Correspondence Analysis

1.  Background Information for this Study

This hypothetical study involves 18 respondents doing in-depth interviews.  It is written from the perspective of Allergan, i.e., I am assuming that Allergan is the client that I am advising.  We ask these 18 respondents to evaluate Allergan as well as nine of Allergan’s competitors on eight firm attributes.  We are asking them simply “does the firm possess this attribute or not.”  In other words, we are creating a tally.  Each time the respondent says yes, we make a tick to symbolize that the respondent agrees to the idea that the specific firm does in fact have the attribute in question.  At the end, we count the number of ticks or yes responses; these counts form the data matrix or cross-tabulation table or contingency table results.  The attributes are:  Product Quality, Strategic Orientation, Overall Service Level, Delivery Speed, Price Level, Sales Force Image, Price Flexibility, and the firm’s Image.  I picked the following companies to represent the pharmaceutical industry:  Biodel, Merck, Bayer, Allergan, Novo Nordisk, Shire, Roche, Pfizer, Glaxo, and Novartis.


2.  Discussion of the Contingency Table

The numbers in the chart, which appears at the bottom of this section, represent the number of times we get ‘yes’ responses.  In the first row and first column, we see a 4 in the cell created by Product Quality and Biodel.  This means that 4 of our 18 respondents said in their interviews that Biodel has product quality.  If we move one cell to the right, we see a 3 in the Product Quality and Merck cell.  This means, of our 18 respondents, 3 said that Merck has product quality and consequently 15 said that Merck does not have quality in its products.  

Contingency Table

              Biodel     Merck     Bayer  Allergan      Novo     Shire

Quality            4         3         1        13         9         6

Strategi          15        16        15        11        11        14

Service           15        14         6         4         4        15

Speed             16        13         8        13         9        17

Price             14        14        10        11        11        14

Sforce             7        18        13         4         9        16

Flexibil           6         6        14        10        11         8

Image             15        18         9         2         3        15

Total             92       102        76        68        67       105

               Roche    Pfizer     Glaxo  Novartis     Total

Quality            3        18         2        10        69

Strategi          16        12        14        14       138

Service           14        13         7        13       105

Speed             15        16         6        12       125

Price             12        13        10        14       123

Sforce            14         5         4        16       106

Flexibil           7         4        14         4        84

Image             16         7         8         8       101

Total             97        88        65        91       851

3.  Correspondence Analysis and Perceptual Mapping

Now, this gigantic collection of counts in the contingency table is hard to interpret.  It hides a bunch of important strategic findings.  To make these findings obvious, I use correspondence analysis.  The general idea is to draw an attribute-company combination close together if they are strongly associated with each other.  Similarly, if an attribute-company combination is not strongly associated with each other, they are drawn apart.  Moreover, the creation of dimensions or ‘components’ lets us know the key drivers in this industry when it comes to perceptions in the minds of the respondents.

A simple way of explaining the thought process behind correspondence analysis is as follows.  Suppose that a new car brand is being presented to the public for the first time.  This car brand offers a value proposition to the customers that can be described as fun, sporty, sexy, energetic, and cool.  Suppose that two customer groups are being evaluated to see their degree of correspondence with this brand’s value proposition.  The first group consists of 18 to 25 year old males.  This group is looking for a fun, sporty, sexy, energetic, and cool looking car.  Consequently, the value proposition that this car brand offers and the value proposition that the 18 to 25 year old males want are highly similar.  This implies that the number of sales of this car brand to this customer group will be above average.  The correspondence analysis will pick this up as actual sales to this group exceed expected sales (technically the expected cell value used to compute the chi-square statistic).  The analysis will assign to this result a positive value and draw 18 to 25 year old males and this car brand close together on the perceptual map.  Suppose further, that a second group consists of 55 to 65 year old males.  This group is looking for a car that can be defined as refined, elegant, safe, dignified, and expensive.  The value proposition offered by the car brand and the value proposition desired by this 55 to 65 year old group of males are dissimilar.  Correspondence analysis will pick this up as actual sales to this group will be below the expected value.  Intuitively, this makes sense.  Since the car brand does not satisfy the needs of this customer group, then few sales will take place.  The analysis will draw the 55 to 65 year old group and this car brand far apart on the perceptual map.

The graphical output or perceptual map is provided in this blog at the bottom of this section.  The attributes are plotted with red squares; the companies are plotted with blue squares.  To understand the competitive landscape, we look for the extreme attribute cases to try to figure out what the components (the axes in the graph) mean.  Component 1, the y-axis, (i.e., why we can move up and down in this picture) is driven by Product Quality (at the top of the picture) and Firm Image (at the bottom).  Component 2, the x-axis, (i.e., why we can move right and left in this picture) is driven by Price Flexibility (on the left) and Service (on the right).  So now, we have the four key drivers that explain most of what is going on in this market space.  We also know that component 1 (i.e., product quality and firm image) is more important than component 2.  This is because component 1 explains 53.1% of the variation while component 2 explains only 33.2%.  Moreover, when I look at the “explanation by component” information, Allergan is very heavy (88.2%) on component 1 and much lower on component 2 (9.3%).  Further, when looking at the similarity values (i.e., signed chi-square values), the two largest values for Allergan are +10.165 on Quality and –4.566 for Image (the minus implies dissimilarity).  All of this suggests that component 1, i.e., product quality and firm image are the most important things for the marketing manager at Allergan to address.  The secondary issue to address is component 2, i.e., service and price flexibility.

From a strategic point of view, we see that Allergan is viewed as being very strong on product quality and very weak on firm image.  With regard to component 2, Allergan does fine on price flexibility but not so well on service.  This suggests an advertising strategy based on product quality mainly with a secondary focus on price flexibility, assuming the plan is to play to the existing strengths.  We also observe that Allergan is perceived as being very similar to Pfizer since both firms are very strong on product quality.  We might expect competition here because these two firms are very similar. 

Moreover, suppose that you are no longer Allergan but rather a new entrant into this industry.  One thing you might want to consider is where to position your new brand.  One possible solution would be to analyze this perceptual map to see if any ‘gaps’ exist.  Are there any areas where existing firms have not yet been positioned?  For example, the top-left hand corner of the graph is currently unoccupied.  No firm is currently offering the combination of strong product quality and strong price flexibility.  Consequently, this could be one area to further study using a feasibility analysis (since one needs to verify the profitability of such a combination).  If this combination were to be profitable, the new entrant would have achieved a successful differentiation strategy.

Blog 9: The Global Communist Ideology of the Venus Project

A few weeks ago, I came across a rather heavily commented on Facebook post regarding the Venus Project in my Facebook news-feed.  I have heard on the Zeitgeist/Venus movement for some time now, but I had never really looked into it seriously.  What motivated me to launch a more thorough investigation was a comment posted about how ‘airtight’ the arguments are in favor of the Venus Project.  This commenter mentioned how he had never seen anyone present any solid arguments against the Venus Project.  Case closed apparently.  Such self-assured comments are suspicious because I have never seen any social science debate that is ‘airtight.’  Social science debates normally are quite passionate and quite divisive and are not normally settled in any way.  Consequently, I launched this investigation into the Venus Project.  I wanted to see whether this ‘airtight’ claim could stand up to a thorough criticism.  My conclusion is that it cannot be considered ‘airtight’ because the arguments are all unconvincing.  There are also many issues I have with the logic of their arguments, and with the historical accuracy of what they say.  I also wanted to see if I could figure out the ideology driving this project.  My conclusion is that it is a form of global communism mixed in with anarchist rhetoric, or some sort of global anarcho-communism system.  

The Venus Project flatly denies my claims that they have anything to do with communism.  Here are some quotes from their website where they explicitly reject my linking of their project to communism, to Karl Marx, etc. 

This first quote is the first half of their answer to Question 55 “How does The Venus Project Compare with Communism?”

Communism being similar to a resource-based economy or The Venus Project is an erroneous concept. Communism has money, banks, armies, police, prisons, charismatic personalities, social stratification, and is managed by appointed leaders. The Venus Project's aim is to surpass the need for the use of money. Police, prisons and the military would no longer be necessary when goods, services, healthcare, and education are available to all people.

This second is part of their answer to Question 54 “Is this what Karl Marx advocated?”

Although Marx was a brilliant man for his time, he did not foresee the methods and advantages of a high-tech resource-based economy. Communism used money and labor, had social stratification, and elected officials to maintain the communists' traditions. Most importantly, Communism did not eliminate SCARCITY nor did they have a blueprint or the methods for the production of abundance.

The global nature of this plan is stated explicitly in their answer to Question 2 entitled “What is a Resource-Based Economy?”

To transcend these limitations, The Venus Project proposes we work toward a worldwide, resource-based economy, in which the planetary resources are held as the common heritage of all the earth's inhabitants. The current practice of rationing resources through monetary methods is irrelevant, counter-productive, and falls far short of meeting humanity's needs.

Simply stated, a resource-based economy utilizes existing resources - rather than money - to provide an equitable method of distribution in the most humane and efficient manner. It is a system in which all goods and services are available to everyone without the use of money, credits, barter, or any other form of debt or servitude.

Terminological Issues:

One of the major problems is that the terms ‘communism’ and ‘socialism’ and even the terms ‘communist’ and ‘socialist’ have historically had inconsistent meanings.  Initially, these terms were all synonymous.  However, over time, shades of difference in meaning of all of these four terms emerged.  Part of the reason for this has to do with changes in tactical issues pertaining to how to implement communism or socialism.  One view held that communism would come about inevitably and would be achieved in a manner independent of the wills of individuals.  Another view held that communism had to be achieved by revolutionary means.  A further view held that communism had to be achieved through parliamentary means because it was important that the public supported the cause.  Moreover, further refinements in terminology differentiated between an early stage and a late stage with socialism being the early stage and with communism being the later stage.  Further hairsplitting could be raised over whether a proposal should be classified as ‘interventionist’ or ‘petty bourgeois’ or whether it is legitimately communist or socialist.  Furthermore, the history of communism and socialism is full of examples of one communist party accusing other parties of not being ‘true’ communists or being sellouts to capitalism. 

To address these issues, I will try to add modifiers to my use of the terms socialism and communism.  So for example, if I am alluding to revolutionary communism, I might add in a modifier such as the Bolshevik or Leninist or Sorel approach.  My plan is to keep these terms as clearly differentiated as possible.  This will not only cut down on confusion but it will also help classify what the Venus Project is and what it is definitely not.  

Analysis of Question 55:

The Venus Project states that it is not communism because, unlike communism, the Venus Project does not have police, prisons, and military.  All that has been proven is that the Venus Project is not planning for revolutionary communism.  It opposes the Leninist Bolshevik brand of communism.  The Venus Project openly rejects the George Sorel approach of ongoing bloody riots and violence.  I conclude that the Venus Project is not revolutionary communism.

But this is insufficient proof for the Venus Project to go on to claim that their non-violence makes them non-communists.  Take for example Ludwig von Mises’s 1947 work entitled Planned Chaos (which appears as an appendix to his larger treatise Socialism:  An Economic and Sociological Analysis.)  Back then, the socialist authors that Mises was debating against said exactly the same thing the Venus Project says today.  Mises writes on page 521 (Emphasis is mine.):

Socialism, they asserted, will bring true and full liberty and democracy.  It will remove all kinds of compulsion and coercion.  The state will “wither away.”  In the socialist commonwealth of the future there will be neither judges and policemen nor prisons and gallows.

Of course, this 1947 quote does not conclusively prove that the Venus Project is socialist.  Moreover, Mises does not specify which socialist authors he is alluding to in this quote so I cannot give any modifying phrase here.  In fact, one could easily quote modern day anarcho-capitalists who vehemently attack the state as a tool of coercion and compulsion.  This is not surprising given their openly anarchistic views as espoused especially by Murray Rothbard.  Furthermore, one could also quote a classical liberal, such as Mises himself to support this claim.  Mises said in Liberty and Property that, “Government is essentially the negation of liberty.”  (Classical liberals call for the ‘minimal state’ that would be restricted to a narrow range of activities usually only the protection of life, liberty, and property.)

However, neither a classical liberal nor an anarcho-capitalist would ever advocate for the abandonment of money.  The advocating for the elimination of money by the Venus Project is, however, a staple of communist literature.  Here are three historical examples of communist experiments that all tried to eliminate money.

Murray Rothbard’s book, Economic Thought before Adam Smith, discussed, what he called the totalitarian communism of Munster.  Munster in northwest Germany in the 1530s provides a nice historical lesson of an early attempt at money-less communism.  From page 153 (Emphasis is mine.):

After two months of severe and unrelenting pressure, a combination of propaganda about the Christianity of abolishing private money, and threats and terror against those who failed to surrender, the private ownership of money was effectively abolished in Munster. The government seized all the money and used it to buy or hire goods from the outside world.

         

Rothbard’s essay entitled The Myth of Monolithic Communism points out the failure of the Soviet’s experiment with abolishing money.  They quickly learned from experience that the plan to abolish money is impracticable even in a fairly economically backward nation, i.e., 1917 Russia.  One has to wonder how this plan could ever be applied to an advanced capitalistic nation.  (Emphasis is mine.)

When the Bolsheviks assumed power in late 1917, they tried to leap into full "communism" by abolishing money and prices, an experiment so disastrous (it was later dubbed "War Communism") that Lenin, always the supreme realist, beat a hasty retreat to a mere semisocialist system in the New Economic Policy (NEP).

Finally, in his book entitled Classical Economics, Murray Rothbard provides, on page 333, historical information on the Pol Pot attempt to abolish money in order to abolish the division of labor (i.e., specialization in production).  To abolish the division of labor is also a rather typical Marxian theme mainly because capitalist production is based on the division of labor.  (Emphasis is mine.)

Perhaps the closest approximation was the short-lived communist regime of Pol Pot in Cambodia which, in attempting to abolish the division of labour, managed to enforce the outlawry of money - so that for their tiny rations the populace was totally dependent upon the niggardly largesse of the communist cadre.

Obviously, this does not prove that the Venus Project will turn into the totalitarian dictatorships that appeared in Munster, in Bolshevik Russia, or in Pol Pot’s Cambodia.  The Venus Project certainly could turn into a global totalitarian dictatorship especially because of their global common holding of property idea.  The point is that historical examples do not prove future events.  They do, however, suggest that communist regimes have a tendency to favor plans that will abolish money.  A capitalist regime can never suggest a plan that would abolish money because money facilitates indirect exchange.  Indirect exchange (i.e., trading goods and services for payment in money) exists because of the division of labor.  The division of labor is specialization in production and so requires exchange between the different specialized producers.  These exchanges are facilitated by the use of a medium of exchange, i.e., by money.

The Venus Project is correct when it asserts that communism tends to lead to social stratification.  In Planned Chaos, page 506, Stalin’s regime suffered from the creation of a small ruling elite that lived very well while the masses of people lived in horrific poverty.

Stalin finds it necessary to explain to the vast majority of his subjects why their standard of living is extremely low, much lower than that of the masses in the capitalist countries and even lower than that of the Russian proletarians in the days of Czarist rule.  He wants to justify the fact that salaries and wages are unequal, that a small group of Soviet officials enjoys all the luxuries modern technique can provide, that a second group, more numerous than the first one, but less numerous than the middle class in imperial Russia, lives in “bourgeois” style, while the masses, ragged and barefooted, subsist in congested slums and are poorly fed.

The Venus Project’s assertion that communist leaders are appointed is questionable.  Lenin did not get appointed; he seized power from the Constituent Assembly at gunpoint (see Planned Chaos, p. 502).  Stalin moreover eliminated his competitor, Trotsky, by forcing him to have to flee the country (see Planned Chaos, p. 514).  Historically speaking, these communists are not appointed; they like to appoint themselves.

Analysis of Question 54:

Question 54 begins by asserting that Marx was a brilliant man.  Given the historical context, this is probably a fair statement to make.  In the Preface to the Second German Edition of Socialism:  An Economic and Sociological Analysis, Mises (pages 5-6) points out that socialism was basically a dead philosophy by the middle of the nineteenth century and that Marx successfully resurrected it.

Thus, about the middle of the nineteenth century, it seemed that the ideal of Socialism had been disposed of.  Science had demonstrated its worthlessness by means of strict logic and its supporters were unable to produce a single effective counter-argument.  It was at this moment that Marx appeared. 

Then, this Venus Project quote mentions that Marx’s major failure was that he did not anticipate a high-tech economy.  However, this claim is contradicted by Rothbard’s discussion on pages 327 to 328 in his book Classical Economics.  Although not technically from Marx, this quote is from Marx’s collaborator, Engels.  Notice that Engels, like the Venus Project, links a discussion of the use of new technology with a discussion of the abolishment of scarcity and the creation of superabundance to satisfy the needs of everyone.  (Emphasis is mine).

Furthermore, in 'The Principles of Communism', an essay written in late 1847 that became the first draft for the Communist Manifesto, Engels laid bare one of the crucial, usually implicit, assumptions of the communist society – that superabundance will have eliminated the problem of scarcity:

Private property can be abolished only when the economy is capable of producing the volume of goods needed to satisfy everyone's requirements...The new rate of industrial growth will produce enough goods to satisfy all the demands of society... Society will achieve an output sufficient for the needs of all members,

This superabundant production somehow will have been achieved by a wondrous technological progress that would eliminate the need for any division of labour.

The Venus Project laments the fact that communist failed to eliminate scarcity.  Ironically, on page 54 (everything is 54 I guess in this section!), George Reisman, in is treatise entitled Capitalism, explains that it is impossible to eliminate scarcity.  As he says, “The desire for goods will always remain far greater than the ability to produce them.”  In his book, Young Lessons for the Young Economist, Robert P. Murphy that scarcity means that at any particular point in time we have limited resources but unlimited desires and so tradeoffs have to be made.  Reisman does differentiate between pre-capitalistic (i.e., food, clothing, and other necessities) and capitalistic definition of scarcity (e.g. I do not want to take the bus, now I want a car).   At first, I thought that maybe the Venus Project was using a pre-capitalistic definition of scarcity as opposed to the capitalistic definition and that a terminological issue existed.  It is certainly possible to eliminate the pre-capitalistic version of scarcity.  However, the Venus Project seems to go beyond the pre-capitalistic definition and wants to provide a superabundance of all goods.  This then makes the wishes of the Venus Project unattainable.  You cannot eliminate the capitalistic version of scarcity because the invention of any new technology creates even more desires on the part of individuals and so desires will always be greater than the ability to produce them.

To conclude my analysis of Question 54, the Venus Project said that communism did not have a plan for the creation of superabundance.  This is not historically accurate.  The revolutionary communists certainly had plans.  The Soviet Union was notorious for having Five-Year Plans.  It seems contradictory to me to claim that communism, which has always been about central planning, does not have any plans for abundance.

Analysis of Question 2:    

Question 2 begins by admitting openly that the Venus Project is global communism.  To abolish private ownership of the means of production is the essence of all socialist and communist plans (and interventionist plans as well.)  Going back to Rothbard’s historical Munster example, from page 153 of Economic Thought before Adam Smith, we clearly see that communist experiments eliminate private property, want to redistribute everything equitably, and also plan to eliminate manual labor.  (Emphasis is mine).

This compulsory communism and reign of terror was carried out in the name of community and Christian 'love'. All this communization was considered the first giant steps toward total egalitarian communism, where, as Rothmann put it, 'all things were to be in common, there was to be no private property and nobody was to do any more work, but simply trust in God'. The workless part, of course, somehow never arrived.

Conclusions:

The Venus Project is global anarcho-communism.  They certainly are not calling for revolutionary communism because of their views against violence and against government coercion that comes in the form of police and prisons.  They are also not for the parliamentary version of socialism because they do not want any government at all (I took this fact from some of their other frequently asked questions—they explicitly state that they want to abolish all government).  I suppose that this makes them orthodox Marxians—that is, they think that global communism is inevitable.  Or in the Venus Project’s case, this new technological revolution is inevitable and so their global communist scheme is therefore inevitable.  But they certainly are kidding themselves if they think they are not communists.  They want to eliminate prices and money—that is pure communism.  They want to hold all property in common—that is pure communism on a global scale.  They want to distribute all goods equitably—that is communism.  They want to somehow violate all known laws of economics and abolish scarcity—that is communism.  They want to create superabundance through all this new radical technological innovation—that is communism.  They want to eliminate manual labor—that is communism.  Everything that they want is some variation of communism of ideology.  Therefore, I conclude that the Venus Project is global communism and is most consistent with the orthodox Marxian version of the inevitable communism.

Blog 8: My First Contribution to Refuting the Venus Project's Economics

Simply stated, a resource-based economy utilizes existing resources - rather than money - to provide an equitable method of distribution in the most humane and efficient manner. It is a system in which all goods and services are available to everyone without the use of money, credits, barter, or any other form of debt or servitude. 

It is not money that people require, but rather free access to most of their needs without worrying about financial security or having to appeal to a government bureaucracy. In a resource-based economy of abundance, money will become irrelevant.

If all the money in the world were destroyed, as long as we have sufficient arable land, the factories, the necessary resources, and technical personnel, we could build anything and even supply an abundance.

Instead people will be introduced to limitless opportunities to explore, create, participate, and learn.

Distribution of goods and services without the use of money or tokens would be accomplished by establishing distribution centers.

The Venus Project's major concerns are producing products with limited labor and eventually eliminating labor and at the same time giving people all the amenities of a prosperous, high energy society.

–From the Venus Project’s Website

To fully disprove why these quotes are completely contrary to sound economics would require me to write a full essay on economics.  I do not intend to do so.  But I will give enough evidence to demonstrate why the Venus Project’s views on economics are utterly nonsense.

The first major point that I want to make is that these quotes are not new.  The Venus Project is not a new vision of society; it is the Soviet Union’s vision of society.  As a student of economic history, I find nothing original in the Venus Project’s proposals; I have read them all before in my books on economic history.  I recognized these quotes right away as being simply regurgitated 1920 arguments coming out of the mouths of socialist dreamers. 

For example, here is a textbook example from Ludwig von Mises’s Liberalism:  The Classical Tradition (1927, p. xxxi) based on a 1925 quote from Leon Trotsky (Literature and Revolution).  All socialist propaganda promises a world of human bliss and abundance.

Socialist authors promise not only wealth for all, but also happiness in love for everybody, the full physical and spiritual development of each individual, the unfolding of great artistic and scientific talents in all men, etc.  Only recently Trotsky stated in one of his writings that in the socialist society “the average human type will rise to the heights of Aristotle, a Goethe, or a Marx.  And above this ridge new peaks will rise.”  The socialist paradise will be the kingdom of perfection, populated by completely happy supermen.  All socialist literature is full of such nonsense.  But it is just this nonsense that wins it the most supporters.

  

All hardcore socialist propaganda calls for the abolition of money and prices.  Take a look at Chapter 12, starting on page 127 of Richard M. Ebeling's book Selected Writings of Ludwig von Mises, Volume 2.   The essay was originally published on November 17, 1920.  This quote from the Soviet Union is exactly what the Venus Project wants, namely, no money and goods to be given out at distribution centers.

According to a report from Copenhagen, the Soviet government has abolished money.  In the future, payments are no longer to be made in rubles but in requisition vouchers that the state distribution facilities must honor.

History teaches us that attempts to abolish money and prices are utter failures.  Even the Bolsheviks realized fairly quickly that the Venus Project approach of abolishing money and establishing distribution centers cannot work. Keep in mind, the Bolsheviks were hardcore communists; they stood for revolutionary communism.  I take this quote from Murray N. Rothbard’s essay entitled, The Myth of Monolithic Communism.

When the Bolsheviks assumed power in late 1917, they tried to leap into full "communism" by abolishing money and prices, an experiment so disastrous (it was later dubbed "War Communism") that Lenin, always the supreme realist, beat a hasty retreat to a mere semisocialist system in the New Economic Policy (NEP).

The Venus Project seems to think that by abolishing money it can eliminate hardships, problems, and suffering.  It thinks that it can create abundance and bliss.  It assumes that mankind can be liberated and freedom will come, but only if we first abolish money.  These views are contrary to historical evidence.  In fact, history teaches us that one of the first things that dictators do is abolish money and prices.  The quote above from Lenin and the Bolsheviks certainly proves that point.  To hammer away at the historical link between dictatorship and the abolishment of money, I will now cite Murray Rothbard’s essay entitled:  Messianic Communism in the Protestant Reformation. Notice also that these communists promised, just as our present day Venus Project promises, that they would create a world without manual labor and work (emphasis mine).

After two months of severe and unrelenting pressure, a combination of propaganda about the Christianity of abolishing private money, and threats and terror against those who failed to surrender, the private ownership of money was effectively abolished in Münster. The government seized all the money and used it to buy or hire goods from the outside world. Wages were doled out in kind by the only remaining employer: the theocratic Anabaptist state.

This compulsory communism and reign of terror was carried out in the name of community and Christian "love." All this communization was considered the first giant steps toward total egalitarian communism, where, as Rothmann put it, "all things were to be in common, there was to be no private property and nobody was to do any more work, but simply trust in God." The workless part, of course, somehow never arrived.

In summary, the Venus Project is just a restatement of failed Soviet and communist experiments.  There is not one original idea in the entire project.  If Lenin were still alive, he would be proud to know that his autocratic and dictatorial plan is still being sold to the naive public.  The best part of this propaganda is that it is sold as liberty and freedom when it is, in fact, a textbook recipe for dictatorship, poverty, and privation.  Please keep in mind, that I have ignored many of the reasons as to why the Venus Project’s plans cannot work.  The purpose of this short essay was to stress two points:  1.  The Venus Project is not new, and 2. The Venus Project is Soviet Communism repackaged.  Simply, this plan cannot work because it is in direct violation of the fundamental principles that make a society work, namely, the division of labor facilitated by indirect exchange.  These are the concepts that make a civilization work.

The Venus Project is what happens when people forget (or aren't taught) to follow Santayana's advice:  "Those who do not remember the past are condemned to relive it."  

Blog 7: Freedom has made a comeback

There were on the campuses once again friends of freedom and they had the courage to speak their minds.  Collectivism was challenged by individualism. […] There are overcautious skeptics who admonish us not to attach too much importance to these academic affairs.  I think these critics are wrong.  The fact that, out of the midst of the college youth, a new movement in favor of the great old ideals of individualism and freedom originated, is certainly of paramount importance.  The spell of the dreadful conformity that threatened to convert our country into a spiritual desert is broken.

--Ludwig von Mises, Statement at Young Americans for Freedom Rally, Madison Square Garden, March 7, 1962.  From Economic Freedom and Interventionism, p. 200.

In this pep-rally speech in 1962, Mises lays out the two competing ideologies, namely, collectivism with conformity versus individualism with freedom.  Reading over his entire statement reveals the optimistic hope that Mises had for the future.  He went so far as to speak of the birth of a new “young generation of liberators.”  If Mises were alive today, he would be so proud to see our current young generation of liberators spreading the ideas of liberty on school campuses, on Facebook, on Twitter, on YouTube, and even on the website of the Institute built to honor his teachings and his legacy.  Mises would also be pleased to see that his message is being listened to not only by Americans but also by people from all over the world.  Today, liberty is making a comeback not only in America but also globally.  People are waking up to the problems inherent in fractional reserve banking.  They see the strings behind the system.  They are beginning to realize that the government is not always right; Big Brother does not know best.  People are starting to see the insanity of perpetual wars, crushing government debts, and interminable business bailouts.  People are starting to ask questions; they are starting to watch alternative news sources.  Conformity has certainly taken a beating.

But why should anyone support freedom and liberty?  Are there any logical reasons to justify the substitution of liberty for conformity?  Or is this just simply a debate over political opinions, i.e., a debate where some people like liberty while others prefer conformity? 

Dictionary.com defines conformity as: “Agreement between an individual's behavior and a group's standards or expectations.”  It then defines a conformist as:  “A conformist is one who follows the majority's desires or standards.”  These definitions imply sameness—a society of conformists would act alike, talk alike, and think alike.  The problem, then, is that, humans are not all alike.  There is no innate equality.  “The fact that human beings are born unequal in regard to physical and mental capacities is not denied by any reasonable man, certainly also not by pediatrists” (The Elite Under Capitalism, p. 21). 

Conformity, then, goes against nature.  Conformity tries to transform inherently unequal people into equal people.  This is counterproductive for society; everybody loses under this scenario.  To increase the amount of goods produced, society turns to the division of labor or specialization.  By specializing, each person can produce more than he or she could by trying to be self-sufficient.  Specialization is simply playing to each person’s natural strengths.  It is leveraging the fact that people are born unequal.  If Bob is physically weak then he will not specialize in an area that depends on physical strength.  If Mary is weak at math then she will not specialize in an area that depends upon mathematics.  If Bob is strong at math then he will specialize in that area.  If Mary is physically strong then she will specialize in a position that requires lots of muscles.  In summary, specialization will dictate that Mary will work in a position requiring physical strength, and Bob will specialize in a position that requires math.  Mary and Bob will be able to produce more goods and services by specializing therefore making both of them better off.  By letting Mary be what Mary is naturally and by letting Bob be what Bob is naturally, everyone is ultimately better off, assuming of course that Bob and Mary are allowed to exchange goods and services voluntarily.

In conclusion, conformity is against nature.  It forces people to be something that they are not.  It undermines the division of labor (actually, conformity is the opposite of the division of labor), and so impoverishes a nation.  It forces people to do things that they are not naturally very good at doing.  Liberty, on the other hand lets people be what they were born to be.  Bob can now spend his days doing what he loves, namely, solving math equations.  Mary can now spend here days doing what she enjoys, namely, using her physical strength to rescue people from burning homes.  By letting everyone specialize in the area that they are best at, more goods can be produced, and the standard of living of society will then go up.  Liberty in this sense means: "do not use coercion to force people to be something they do not want to be."                

Blog 6: Decentralization of Power and Consumer Sovereignty

 

In the market economy every specialist—and there are no other people than specialists—depends on all other specialists.  The mutuality is the characteristic feature of interpersonal relations under capitalism.  The socialists ignore the fact of mutuality and speak of economic power.  For example, as they see it, “the capacity to determine product” is one of the powers of the entrepreneur.  One can hardly misconstrue more radically the essential features of the market economy.  It is not business, but the consumers who ultimately determine what should be produced.  (25-26)

--Ludwig von Mises, The Elite under Capitalism in Economic Freedom and Interventionism:  An Anthology of Articles and Essays, Liberty Fund, Indianapolis.

One of the most important contributions to economic thought was Dr. Ludwig von Mises’s insistence that consumers—the masses of people not a handful of capitalists—ultimately run the market economy.  The masses of people—the ‘labor class’ are also the consumers.  From The Economic Foundations of Freedom, p.6, he wrote: “The same people who are employed by the big corporations are the main consumers of the goods turned out.” 

Actually, this opening quote is fairly tame because it understates the full extend of the power placed by the free market economy in the hands of the masses.  It does so by restricting the discussion to production of consumer goods.  A full treatment of this issue would delve into how the consumers, control the distribution of income, how the time preferences of consumers control the supply of loanable funds thus influencing the rate of interest, how the consumers form the prices of all goods both producer (i.e., material factors of production, human or labor) and consumer, how the consumers decide what gets produced in what quality and in what quantity, and how the consumers ultimately regulate profit and loss.  The study of government interventionism in economic affairs can always be reduced down to the one common denominator of substituting government control for consumer control.

A central bank means that a handful of central bank governors have replaced the consumers in setting the interest rate.  By unilaterally imposing an interest rate, the central bankers can distort the time preferences of the consumers.  (“Time preferences” refers to how ‘future oriented’ versus how ‘present oriented’ people are, so it asks do they want to have more goods today or more goods in the future.)  Redistribution of income through transfer payments means that legislators not consumers get to decide what the income distribution will be.  Government bailouts of businesses are the overriding of the consumers’ decision to impose losses on companies and the overriding of the consumers’ decision to shift the control of factors of production away from inefficient producers and toward more efficient ones.  Trade barriers are a way to override the consumers’ purchasing decisions by replacing them with the decisions of trade negotiators.  Labor union contracts substitute the union’s wage demands for those of the consumers.  State funded health care and education substitute the plans of social engineers for those of the consumers.  In sum, government interventionism always means the substitution of the government’s unilateral plan for the personal plans of the masses of consumers. 

Consumer sovereignty means decentralized control.  It means that individuals can form their own plans in life and endeavor to make them a reality.  It means that individuals get to decide what is produced, when it is produced, who produces it (i.e., who controls the factors of production), how much of income should be invested or saved and how much of it should be consumed, and a whole host of other decisions.  This is a perfect recipe for stopping tyranny in government because power has been distributed into millions of hands.  Moreover, notice that everybody wins in this scenario—both the producers and the consumers.  By obeying the orders of the consumers, the producers become rich.  Therefore, a harmony of interests has been achieved; everybody wants to keep the system going because everybody is winning under it.  Everybody wants to keep working together.  Everybody wants to cooperate.  The owners of the firm want to keep satisfying the consumers so that they can keep earning profits.  The consumers want to keep lending funds to this firm so that it can expand and grow and satisfy even more of the consumers’ needs. 

Now, contrast consumer sovereignty with government interventionism, which is basically just producer sovereignty.  Producer sovereignty means that the producers of goods get to dictate terms to the consumers.  The best illustration is trade protectionism where the producers, through trade barriers, get to dictate to the consumers what they will be allowed to buy.  All government interventionist measures lead to social disharmony because they inherently create winners and losers.  In the examples above one group wins at the expense of another.  The losing group is always the masses, the consumers.  You cannot run a society where some groups are winning at the expense of other groups.  This just breeds hatred, hostility, frustration, resentment, and maybe even revolution. 

Mises goes even further and argues in Planned Chaos (the Epilogue to his treatise on Socialism called Socialism:  An Economic and Sociological Analysis) that government regulations of business sow the seeds of socialism of the German pattern through a gradual step-by-step process of regulation, failure, more regulation, more failure and so on.  This process is reminiscent of the Theory of Bureaucratic Displacement, mentioned in my earlier blog pertaining to the continual ‘dumbing down’ problem in public education.  This ‘socialism of the German pattern’ goes by the name Zwangswirtschaft (compulsory economy) and was used by the Nazis.  Conceptually, this process is like a cancer that slowly spread to infect all stages of production.  Once the government has the power to regulate and restrict activities at all stages of production, it can easily control the entire economy, meaning, it can override all the wishes of the masses of consumers. 

In conclusion, the choice is ultimately between consumer sovereignty and producer or government sovereignty.  Consumer sovereignty places the power to make decisions in the hands of individuals.  Because power is now so widely dispersed, tyranny in government becomes a relic of history.  The government will return to its limited role as servant of the people, meaning that the government will be restricted to doing only those things delegated to it by the people.  Producer sovereignty or government sovereignty means that the masses will be placed in a subordinate role.  They will no longer be making decisions; instead, they will be taking orders from their superiors.  In this world, the consumers, the masses, have no way of controlling the behavior of the government.  No ‘checks and balances’ exist under such a scenario.  This in turn, creates the distinct possibility of the arbitrary use of power and hence the creation of tyranny.  The choice then, is between individual liberty and slavery.                                                            

Blog 5: What is Capitalism?

Everything that is considered unsatisfactory in present-day conditions is charged to capitalism.  The atheists make capitalism responsible for the survival of Christianity.  But the papal encyclicals blame capitalism for the spread of irreligion and the sins of our contemporaries, and the Protestant churches and sects are no less vigorous in their indictment of capitalist greed.  Friends of peace consider our wars as an offshoot of capitalist imperialism.  But the adamant nationalist warmongers of Germany and Italy indicted capitalism for its “bourgeois” pacifism, contrary to human nature and to the inescapable laws of history.  Sermonizers accuse capitalism of disrupting the family and fostering licentiousness [immoral sexual activity].  But the “progressives” blame capitalism for the preservation of allegedly outdated rules of sexual restraint.  Almost all men agree that poverty is an outcome of capitalism.  On the other hand many deplore the fact that capitalism, in catering lavishly to the wishes of people intent upon getting more amenities and a better living, promotes a crass materialism.  These contradictory accusations of capitalism cancel one another.

--Ludwig von Mises, From the Epilogue of Socialism:  An Economic and Sociological Analysis, p. 481 (Liberty Fund page numbering).  Originally published in 1947 as Planned Chaos.

Capitalism is probably one of the worst terms to use in any political or economic discussion because it has too many divergent and contradictory meanings.  Dr. Mises’s quote certainly captures this problem.  Capitalism is simultaneously pro-religion and anti-religion, pro-poverty and anti-poverty, pro-war and anti-war, and pro-sex and anti-sex.  Of course, this is completely illogical—these arguments are at the logical level of me saying that I am dead and I am alive right now as I write this blog.  What are we to make of this?  I suppose that “capitalism” has become one of those terms that the author of a paper gets to define as he or she sees fit.  Maybe I can get around this problem by citing a “textbook definition.”  In Liberalism:  The Classical Tradition, p. xxv, Mises defines capitalism as:  “A society in which liberal principles are put into effect is usually called a capitalist society, and the condition of that society, capitalism.”  Unfortunately, he used the term ‘liberal’ and that is such a misunderstood term as well.  He took 160 pages plus and introduction to define what the term ‘liberal’ means in a classical sense.  The term ‘liberal’ in modern usage is very different from its classical usage and so another source of confusion exists.  Today’s usage implies that liberal means progressive or moderate socialism; in a classical sense liberal means literally “philosophy of freedom.”  Moreover, if memory serves me correctly, the term “capitalism” was a Marxian invention intended to serve a political purpose by implying that capitalism is meant for the interests of the  ‘class of capitalists’ only.

For this blog, my definition will be as follows:  capitalism is a social philosophy that explains why social cooperation can exist without the need for government coercion or compulsion.  Consequently, it is inherently anti-violence, anti-war, and anti-concentration of political power.  Logically, this implies that it is a philosophy based on individual choice.  Individuals specialize in different areas of production because nobody is alike; we are all different and being different is a good thing.  No attempts are made in a capitalist system to try to make everyone equal.  Specialization in production, or the division of labor, ensures that more output will be produced in total than could be produced if everyone tried to go it alone and be self-sufficient.  The division of labor ensures that the standard of living tends to rise over time.  Capitalism is the refutation of class warfare and other antagonistic social philosophies because everyone—factory owners, laborers, and consumers—benefits materially when voluntary exchange occurs.  To earn profit, the factory owner must produce the goods that the consumers or the masses want and so the interests of the masses and the producers are aligned.  In order to defend his or her profitable position, the factory owner must continually innovate, must continually upgrade his or her machines, and must continually find better ways to produce because if he or she fails to do so then someone else will.  The factory owner is forced to invest in capital goods—and it is this process of capital accumulation that leads to higher real wages and so is in the interests of the workers.

I think that today many people despise capitalism because they think that capitalism means a rigged system meant to benefit the special interests of Wall Street bankers and the power elites.  The idea that capitalism will lead to business monopolies that will then abuse and control the people is actually and old socialist argument that usually goes under the rubric of the ‘inevitability of socialism’ or ‘dialectical materialism.’

The argument seems to be that specialization and the division of labor, as anti-self-sufficiency ideas, lead to the creation of larger and larger firms producing a specific good.  These larger firms have ‘concentrated’ an industry and represent a threat to the masses because now the firm can do all sorts of nasty things to the consumers and the consumers have no way of protecting themselves.  The firm might price gouge, might sell the product to only preferred customers, might charge different prices to different groups of customers, might deny access of a product totally to a certain market and so on.  By this chain of reasoning, capitalist production is going to lead to its own demise—concentration will transition from a system of social cooperation into a system of exploitation.

Let us suppose that for some reason General Motors becomes the monopoly car company in the world.  I am not sure how that could possibly happen, but just play along and let me not have to write something stupid such as “company X” sells product to “customer Y.”  In this scenario, the only producer of cars and trucks is General Motors—absolutely no alternative supplier of cars and trucks exists anywhere on Earth.  And just to take this to the extreme, I will also assume no inter-planet trade with little green aliens from outer space.  One objection is that “transportation services” can be provided by train, airplane, buses, walking etc. and General Motors does not hold a monopoly on these alternative modes of transportation.  Customers, ticked off by all the evil price gouging and price discrimination of General Motors will switch to alternative modes of transportation.  General Motors will suffer losses and be forced to liquidate, that is, to sell machines, equipment, etc., to the producers of trains, airplanes, and buses.  General Motors will be punished for its anti-consumer policies by suffering losses and might even go out of business, assuming government bailouts are prohibited in our little model.  Consequently, the threat of losses forces General Motors to adopt pro-consumer policies.

But what if General Motors were to somehow monopolize all forms of transportation—buses, cars, trucks, trains, even walking (by buying up all the sidewalks), boats, and so on.  Now, we have more concentration in this model than before and I have taken out all substitute products.  I am also assuming that transportation is an essential service—people will still want to get around and will not renounce transportation and stay in bed 24/7.  Is the General Motors global monopoly of all transportation sources now able to abuse the masses of consumers and force them to pay ridiculously high prices?  My suspicion is that the people can still break this monopoly and force General Motors to adopt a pro-consumer policy.  General Motors can only I assume produce all the world’s transportation services by using both capital goods and labor.  I am not going to assume some sort of Terminator world where cyborgs are running around.  In other words, General Motors will have to buy both capital goods (machines, tools, equipment), and labor services in order to run this global monopoly.  At the end of each time period (weekly, monthly, whatever) General Motors will have to pay out income to workers (wages) and dividends to shareholders.  Now, our workers and shareholders are also consumers—they also buy lots of different goods and services, including of course transportation services.  In the short run, our workers/dividend receivers are being mistreated by the price gouging and price discrimination policies of General Motors.  Normally, at this point, we would be hearing cries for anti-trust laws and government interventions to stop General Motors’ evil behavior.  But, it is important to remember that certain forces are working behind the scenes against our global monopolist.  I see two major enemies working against General Motors:  1.  all the consumers now have an interest to work against General Motors’s anti-consumer policies, and 2.  depreciation of capital assets.  I think that ultimately, these two sources, WITHOUT any government intervention, will break our global monopolist.  Let me explain.

Depreciation of capital assets simply means that machines, tools, equipment and so on, used by the General Motors factories slowly wears out, breaks down, seizes up and needs to be replaced.  Machines do not last forever; they are not immune to damage and destruction.  How will our General Motors monopoly pay for these replacement machines, tools, and equipment?  Now remember, General Motors is paying out most of its income as either dividends to shareholders or as labor income wages to its workers.  This means that General Motors will have to go hat-in-hand to its workers and shareholders—the same people being discriminated against—and ask to borrow funds.  To use more of the economic terms here, the workers and dividend receivers have been given ‘income.’  They can take this ‘income’ and either consume it (buy pens, milk, cars etc.) or SAVE it.  The workers and shareholders become the SUPPLIERS of SAVED FUNDS.  This is logical—Bob has a job; he gets a paycheck (income); and every week he puts $200 away for his retirement—he is SAVING funds every week.  (The rest of his paycheck is spent on food, clothing etc. or simply ‘consumption.’)  Our General Motors global monopoly is STILL DEPENDENT UPON SAVERS.  General Motors still has to borrow these saved funds so that General Motors can go out and pay for all these capital investment projects—i.e., to buy new replacement machines, equipment and so on.  Our angry consumers/dividend receivers/workers can pool all of their saved funds and not give them to General Motors but instead give them to new capitalists who promise to build new sidewalks, cars, buses, etc. at a non-price gouging price.  In other words, General Motors, even as a global monopoly is still dependent upon savers to provide funds that it needs to buy new capital goods.

Now, how might General Motors get around this problem?  I suppose that it could try to find a new source of saved funds.  Remember, General Motors has insulted the world’s suppliers of saved funds—the workers who are saving funds for retirement will not lend these funds over to General Motors.  There is, however, a source of artificial savings—a central bank.  So, General Motors might run to a central bank to create these artificial savings through credit expansion.  This is exactly what central banks do, by creating new money through credit expansion, they artificially supply new ‘savings’ to the loanable funds market.  But, once again, as long as people are free to use whatever they want as money, (gold, silver, beaver pelts, whatever they want), these central bank run-arounds will not work.  No one will accept these central bank notes (think inflation problem here) and so General Motors cannot use them to go out and buy new machines or labor.  If General Motors wants to stay in business, it will have to buy new machines and equipment.  To do so, it needs funds that are supplied by savers.  But the savers are also the consumers (and workers, and receivers of dividends).  Therefore, our global monopoly firm must comply with the needs of the consumers.  Without a central bank providing artificial savings, General Motors, even as a global monopoly, must comply with the needs of the masses—the needs of the consumers.                         

Blog 4: Preliminary Observations on Capital-Based or Austrian Macroeconomics

I am currently in the process of learning about capital-based or Austrian Macroeconomics, so these comments are reflective of what I have learned so far, what questions remain unresolved in my mind, and what I anticipate to read in further study.  I like to learn by getting a basic idea of a topic and then trying to guess where this is all going before reading everything.  I also try to sniff out possible problems that I see with what I have read again before reading ahead for all the ‘answers.’  Consequently, this blog is a collection of these guesses of mine based on a very preliminary understanding of the theory and also is reflective of what I am currently playing around with in my mind.  As such, I really haven’t edited this blog; you are reading thoughts that just poured out of my mind! 

The Austrian theory was a popular and growing view in the early 1930s that attempted to explain the cause of economic depressions.  From this causal theory, it offered up the solution to depressions, namely, laissez-faire economics.  Simply put, the Austrian view is completely opposite of what you will find in a stand undergraduate textbook.  This is because the typical textbook is written from a Keynesian perspective when it comes to depressions and recessions—meaning fiscal and monetary stimulus.  In other words, the typical textbook response is to get the government spending on projects, typically through deficit spending programs, and to get the central bank to lower interest rates through quantitative easing.  The Austrian view recommends the complete opposite—no government fiscal expansion, budget cuts (yes budget cuts and a policy of shrinking government), no central bank interest rate manipulations, no propping up of prices, and no business bailouts.  

Right off the bat, one can see the political ramifications stemming from this debate—the Keynesians wanting big government and a central bank versus the Austrians that want no government and no central bank.  So I suppose part of the reason why some people—myself included—favor one model over the other has to do with political perspectives.  For me, the Austrian view is attractive because it certainly appears to me to be more consistent with individual liberty than the Keynesian model.  However, there is much more to this debate than simply political preference.  This is, after all, a debate over economic models.

The Austrian model seems to address four different areas and how they are all interconnected.  These four areas are as follows:  The Loanable Funds Market, Production Possibility Frontiers, Stages of Production (or the Hayekian Triangle), and stage-specific labor markets.  I will now give a quick overview of what these four different areas address.

The Loanable Funds Market seems to be at the core of the Austrian model because it zeros in on the interest rate manipulation question.  My suspicion is that this Loanable Funds Market model is the competing model to the Keynesian Liquidity Preference model. 

In standard textbook treatments, the nominal interest rate is found based on the intersection of the real demand for money curve and the real supply of money curve.  This then morphs into the LM or Liquidity Money curve by changing real income (and holding everything else constant) and seeing that the real money demand curve shifts to the right and interest rates rise.  Consequently, the LM curve is an upward sloping curve, with real income on the horizontal axis and nominal interest on the vertical axis.  The equation for this is M/P = Y*L(i) where M stands for nominal money, P stands for the price level, M/P is the real money supply, Y stands for real income, and L(i) is the interest rate liquidity component.  Y*L(i), stands for the real money demand.  Specifically, it is Y times this "L function of i" term [think of basic algebra where you often deal with y = f(x); here the f(x) functional term becomes L(i).]  

The Loanable Funds Market model, on the other hand, has the interest rate on the vertical axis, and both Saving and Investment on the horizontal axis.  It looks identical to a supply curve and demand curve from any Economics 101 course!  The supply curve, meaning the supply of loanable funds is all based on savings from the public.  This makes sense; I save some of my money and so I can lend it out—I can ‘supply’ it to the loanable funds market.  The demand for loanable funds is based on business investment decisions—obviously, a lower interest rate will encourage businesses to invest more in capital projects (meaning, new machines, factories, raw materials, retail inventories, etc.)  In the loanable funds framework, the intersection of the supply and demand curves determines savings, investment, and the interest rate.

The second part of the Austrian analysis draws out a production possibility frontier.  The idea seems to be that the economy has a given amount of resources, (I think they mean factors of production such as land, machines, equipment, ‘capital goods,’ labor and so on) and that a trade-off exists between the production of consumption goods and the production of investment goods (i.e., future consumption goods).  The idea seems to be something like this:  I have 50 hours of labor and 20 machine hours available in my economy.  If I allocate all hours to producing (current) consumption goods, then I will be able to invest nothing in new machines, new tools etc.  This will compromise the future productive capacity of the economy because as the current machines and equipment wear out, there will be no new machines to replace the old ones.  Hence, the economy is a gigantic ‘trade off’ system between current consumption and investment—where investment sets the stage for the creation of new machines (that become available in the future) and hence future production of consumption goods.  This approach, of course, is very different from the textbook Keynesian Cross approach, which looks at consumption and investment as additive expenditure functions.  In the Keynesian world, we go Y = C + I or real income (Y) equals consumption expenditure (C) plus investment expenditure (I).  [This is a very similified version of the GDP equation; a more detailed version would look like this:  Y = C + I + G + X - E*IM; G stands for Government spending, X stands for exports, E stands for the real exchange rate, IM stands for imports.  The term E*IM exists because they are trying to solve the apples and oranges problem in this equation, that is, some of this is measured in terms of domestic goods (apples) and some of this is measured in terms of foreign goods (oranges).]  In the Austrian world, we have a tradeoff, more consumption today means less investment today.  More investment today means less consumption today--but it also means more consumption in the future (because investment today implies that the economy will have more machines, factories, tools, mines etc. in the future and so will be able to produce more consumer goods in the future). 

The third part of the model, which looks at stages of production, is also known as the Hayekian Triangle because it is a product of Professor Hayek’s thinking and because it looks like a right triangle.  This part of the story is completely new to me.  The gist of it is that production of final consumer goods goes through a number of stages of production.  It kind of reminds me of the ‘value chain’ material that is usually attributed to Michael Porter.  Central bank credit manipulations are modeled by changes in the shape of this Hayekian Triangle.

The last part of this model is stage-specific labor markets.  What they mean by stage-specific is a specific stage in the production process.  In other words, an early stage of production, such as mining, will have one labor market.  A later stage of production, such as selling cars at the retail level, will have a separate labor market.  The model allows for the equilibrium wage in these separate labor markets to be different.  Pictorially, each labor market has its own labor supply curve and labor demand curve and hence its own unique equilibrium wage rate.

At this point, I will admit that I do not completely understand all the rest of how this model works (all the internal dynamics) with regard to central banking credit expansion.  But I do understand the very general gist of it.  I will explain the gist of it and then have a discussion of some of my questions, concerns, etc.

The general gist of the model is that central bank credit expansion—quantitative easing—causes the loanable funds market to go into disequilibrium.  This disequilibrium sets in motion a number of changes in the production possibility frontier graph (basically the economy in the ‘boom’ stage is pushed into a theoretically impossible situation between consumption and investment).  Also, the Hayekian triangle graph gets all distorted in shape, and the stage-specific labor markets have a number of changes (it sounds like the wage rates get distorted and overbid).  In other words, the problem originates in this loanable funds market and then causes adverse changes in the three other areas in the model.

The loanable funds model goes into disequilibrium when the central bank creates additional credit, the so called ‘print money up out of thin air’ problem.  This causes the supply of loanable funds curve to shift to the right.  The interest rate then is found at the intersection of this new supply curve of loanable funds and the original demand curve for loanable funds.  The problem stems from the fact that the public is still functioning along the ORIGINAL supply of funds curve.  The public, seeing the lower interest rate, moves down and to the left along the original supply curve—private sector savings actually fall.  But, investment (borrowing by firms) booms as firms take advantage of the lower interest rates (they move down their demand curve to the right.)  The gap between the supply of savings and the demand for savings (demand for savings is the demand by firms to borrow funds for investment projects) is satisfied by this newly created money.  This seems to be the root of the Austrian theory of economic depression.

For me, part of the thinking process is to figure out why firms will go along with this.  Don’t firms learn from experience that such artificial credit expansions lead to a boom followed by a bust?  I have a few temporary hypotheses to account for this.  First, I suspect that some entrepreneurs do not know about economic history and so see the lower interest rates that are produced by the bank credit expansion, and borrow because the money is cheap.  They do not anticipate that their borrowing is setting up a boom-bust cycle.  Projects that once looked unprofitable now appear to be very profitable and so they jump for it.  This stems from the net present value calculation being done to determine whether a project should be done or not.  Lower interest rates will certainly make the net present value number appear better.  Maybe also there is some sort of optimism bias in entrepreneurial decision-making.  These entrepreneurs may certainly know about the boom-bust set up but convince themselves that the losers will be ‘somebody’ else.  They assume that the problems of the bust will affect other firms, not their own firm.  If every entrepreneur were to think this way, then everyone would favor taking out new loans at the cheaper interest rate engineered by the credit expansion.  I also think that maybe the use of metrics to judge management leads managers to take out these loans.  If a mutual fund manager invests when stock prices are rising, then his quarterly figures look better and he might get a bigger raise.  So maybe the short term compensation considerations of a manager will drive him or her to borrow this money in order to invest.  The reason I have for this last hypothesis goes something like this.  Part of the Austrian model is based on the idea that credit expansion leads to misinformation being sent into the market—the below free market interest rate [the actual observed interest rate is below the rate that would exist in a free market--where the term free market implies that no central bank exists].  The observed interest rate is faulty and leads to bad decision-making on the part of businesses.  I noticed, from my own experience, how the use of student evaluations of teachers leads directly to bad decision-making on the part of teachers.  Specifically, the use of student evaluations of teachers directly punishes teachers for being demanding and rewards them for being fun and entertaining.  So by forcing teachers to maximize their student evaluation numbers, teachers actually make decisions that tend to be contrary to the actual objectives of education.   Demanding courses, lots of reading, lots of studying, lots of homework etc. all tend to disappear in order to satisfy the 'customer' student.  Consequently, I am thinking that maybe the interest rate manipulation problem in the loanable funds market is exactly the same as the problem of manipulation of student evaluation scores in higher education.   Both are based on managing behavior (i.e., the behavior of the teacher or the behavior of the business firm) by some sort of metric (student evaluation number or the interest rate) and both seem to place short-term considerations ahead of longer-term objectives.  (Goodbye long term objective of critical thinking or goodbye to a sustainable economy.)

One thing that bothers me about this loanable-funds framework is that of what exactly is this interest rate being determined?  Is it a short-term rate or a long-term rate?  My impression is that this is a short-term rate.  Why then are long term investment decisions being made on a short-term rate?  Or does the entire structure of interest rates change in addition to the short-term rate?

I think that is enough for now!  I’ll post any more comments in a later blog.