Friday, July 24, 2015

The economics of democratic communism: financial crises and zombies

In "Zombies and cannibals: The horrors of China’s financial system, charted, Gwynn Guilford argues that China's financial system is becoming unbalanced because of (among other things) Chinese banks are preserving unprofitable companies rather than letting them fail. They do so because as long as the company doesn't default, even though they're borrowing money to pay back earlier loans (Minsky's definition of a bubble), bankers don't have to take the write-off of a bad loan against the bank's equity; the loan is still technically an asset. A company that is surviving only because of financial life support is labeled a "zombie."

Zombies are a real problem. One of the theoretical advantages of capitalism is that it lets failing companies fail: Schumpeter's "creative destruction." Note that capitalism too has a problem with banking and creative destruction; as capitalism's many financial crises have shown, capitalism too accumulates zombies until there's a general financial crisis. Worse yet, propping up zombies also tends to inflate the asset prices of viable companies, which causes later problems when asset prices fall to realistic levels: if we let too many zombies accumulate, real people get dragged down when the zombies finally die.

(Not all financial crises are strictly caused by accumulation of zombies, but the run-up to a financial crisis by any cause does cause zombies to accumulate.)

The system of democratic communism avoids financial crises by fundamentally changing the capitalist financial system. After considerable study, I've come to the conclusion that the capitalist financial system is one of the most important contradictions in capitalism: it tries to create a market in something that does not have immediate material feedback, and markets work only when there is immediate material feedback to regulate prices.

Democratic communism just smashes financial markets. Finance becomes instead just public policy. We track both nominal and real financial information because we want to know what's going on, but no one's life, wealth, or status depends on nominal asset prices. If nominal asset prices fall to match a new understanding of real value, well, nominal prices fall, no big deal. The only entity "hurt" is the government, but the government does not need money; the government can always print more.

We first care about whether we have enough to eat, stay warm, etc.. If we don't, the people will surely notice, and vote for more investment and employment in the production of food, housing, etc. If we do have enough to eat, then if we make bad investments in fun stuff, we write it off and try to do better tomorrow. The only people harmed by a write off are the workers producing stuff that no one wants, but they will at worst be inconvenienced; they will not be impoverished. The government will either employ them directly in something more socially useful, or pay them to learn to produce stuff that people do want. At worst, that we've lost X dollars in fake asset value (the nominal value of companies that were producing stuff we didn't want) will just cause a little inflation. And since no one lives on financial assets, that inflation has eroded their financial assets won't kill them.

But even if zombie companies won't cause financial crises, zombies are still a problem, at least aesthetically. It seems wasteful and ugly to artificially prop up companies producing stuff people don't actually want.

First, democratic communism makes a sharp distinction between profitability and social utility. There is sufficient institutional incentive under democratic communism to produce public goods, goods with high social utility but low (or negative) profitability. This distinction occurs because profit can come only from production of goods that are both exclusive and rival. Trying to force non-exclusive and/or non-rival goods into an exclusive/rival model is more trouble than it's worth (e.g. intellectual property laws). The problem is that unlike profitability, social utility cannot be objectively measured. Because democratic communism values social utility more than profitability, and does not consider profitability a proxy for social utility, investment decisions are moved from the private to the public, political realm.

Thus, a company that is not profitable has to convince the majority of a constituency, either that of a locale, region, or nation, that their unprofitable business offers social utility. And not just in a vague way, but convinces that constituency to allocate existing autonomous spending away from other projects, increase taxes to offset increased autonomous spending, or tolerate extra inflation. Note that under democratic communism, only the national government can raise income taxes; local and regional governments can spend only their per capita portion of autonomous national government spending and any capital taxes of profitable companies; people employed through the government as Employer of Last Resort are funded directly from the national government.

I'm going to have to create a model of this economy, and see what happens from various kinds of shocks and dynamics. Coming soon, with all good luck.

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