Wednesday, March 23, 2022

General Equilibrium Theory is Nonsense

General Equilibrium Theory is nonsense. We live in an uncertain world and can't predict the future. Households and firms hoard assets (cash, securities, inventories) in order to provision themselves should they be needed in the future. If equilibrium theory was correct, and markets were perfectly efficient where supply magically balances with demand, there would be no inventories. All this "buffer stock" savings requires financing. Purchasing inventories, securities, or holding cash are uses of funds, and require an original source. While banks typically finance inventories and securities, and hold cash deposits, the ultimate source of funds is the government. This shouldn't be controversial, considering that private banks hold their own deposits at the relevant central bank. And these deposits are liabilities of the central bank, which are typically guaranteed by the full faith and credit of the government.


What equilibrium theory also gets wrong is the idea of markets "clearing" for goods and services. This concept is relevant in financial markets, assuming equal access to information and rational actors. However, it doesn't apply in the same way for the exchange of goods and services in the real economy, because of the impact of power structures on the means of production. Consider the following: an Italian immigrant comes to America and sets up a pizza shop in a town where no one had ever previously heard of pizza. Setting up a pizza shop requires a permit from the local government, and money to use up front to pay for rent, purchase equipment and supplies, and perhaps hire a worker. It's not likely the Italian would have access to financing from a bank, because this is a novel concept and banks aren't usually in the business of making risky loans. So, already there is a bias in that the Italian already had money, and the local government gave its stamp of approval on his new business venture. It wouldn't be possible otherwise - the Italian would end up in jail if he broke the town's laws by setting up his business without a permit. So already, the Italian has been granted the privilege of having money and being allowed to run his business. This gives him power over the means of production. And because no one in the town has had pizza before, there is no demand that his supply of pizza can balance with - the power granted to him by the local authorities allows him to create his own demand!

The Freedom to Buy Only What Corporations Want to Sell You

Another example is wholesale food suppliers. Oxfam put together this graphic several years ago to show how just ten companies control most of what we buy for groceries:


How can we look at something like this and say we live in a country with competitive, "free" markets? The level of concentration on such a critical portion of the means of production in our economy, where production is controlled by a handful of powerful bureaucrats, more closely resembles failed states like Venezuela and the USSR, where control over the means of production was monopolized by the government. And yet, we still call this "capitalism." No wonder we've been dealing with toilet paper shortages (among other items).

The high industry concentration leaves few alternatives, enabling these companies to have incredible pricing power over consumers. This power dynamic obliterates the equilibrium theory narrative, as sellers in these transactions are price makers, and buyers are price takers. Sellers can raise prices without a change in demand. Which is exactly what they're doing, by the way, contributing to the recent surge in consumer prices. So no, the market is not "clearing" at its "natural equilibrium" price. The distribution of power in a society has profound effects on economic outcomes.

Everyone Has to Pay Taxes

Speaking of grocery stores, why can't we use any currency other than dollars to transact at them? In a free country, shouldn't I be allowed to show up to the grocery with my bananas and exchange them for oranges? Or pay for oranges with unmarked gold coins? Or Bitcoin?

Obviously, the answers to the above questions are all the same: no. The reason is simple: the grocery store owner has to pay taxes on income generated from its operations. The landlord who owns the property and collects rent from the grocery operator has to pay income and property taxes. The utilities and insurance companies that service the grocery operator have to pay income taxes. The wholesale food suppliers have to pay income taxes. The workers who collect wages to run the store have to pay income taxes. Everyone has to pay taxes!

And what currency are those taxes paid in? In the US, by law taxes must be paid in dollars. So, the government coerces the citizenry to all pay taxes in a currency for which it is a monopoly supplier. As laid out brilliantly by Warren Mosler and Stephanie Kelton, the ability to levy a tax in dollars is the key to creating demand for them. Once again, it's not a market dictated by buyers and sellers. It's an example of a powerful entity - the US government - creating demand for its product that did not previously exist. No one was born with a desire to accumulate dollars; there is no "natural" demand for them, just like there is no natural demand for pizza. The demand comes from people's desires to stay out of jail.

Every year, the government is guaranteed to require us to pay taxes. Even Americans who don't technically pay federal income taxes do generally transact in the domestic economy, and taxes are embedded in the cost of every product or good they purchase. Sales taxes are prevalent in 45 out of 50 states in the US. And while renters may not pay property taxes, the rental outlay paid to the landlord sure does, which manifests in the rental rate.

Cue: The Job Guarantee!

Many Americans, particularly those on the political right, despise paying taxes. I'm sympathetic to this line of thinking, but MMT shows us the anger is misplaced. The real injustice is that the government guarantees the People have to pay taxes in its currency, without guaranteeing the People opportunities to obtain said currency. In fact, it's even worse: the government proactively restricts opportunities for people to obtain its currency, through its administration of monetary policy and the Fed's "dual mandate" for maximizing employment and stable prices as set by the Congress. This is not just cruel; it's an abomination. People suffer and go hungry as a result of these policies. Congress' refusal to extend the Child Tax Credit has inhumanely forced children into poverty. And what do we get out of this? Elevated levels of poor health, chronic disease, anxiety, depression, and lower academic achievement, among other things. Enacting a federal Job Guarantee would go a long way towards eliminating child poverty. It is my genuine belief that a Job Guarantee (or "Employer of Last Resort" if you prefer) is not only one of the most important legislative proposals of our generation, it can also serve as a bridge between the political left and right in our country. Neither side wants to be perceived as being "anti-work." And, a federal Job Guarantee would perhaps make paying taxes less miserable in the eyes of conservatives, as they can always get a job to cover their tax debts. 

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