By Dr Frank Shostak
According to the 2018 Nobel Prize winner in economics, Paul Romer, the technical knowledge that spills over into the creation of new products is the key to sustained economic growth. If this is the case why do we still experience wild fluctuations in economic activity known as boom-bust cycles? After all our technical knowledge has increased enormously in relation to past periods.
Most economic commentators are likely to agree that in relation to the period prior to the 1930’s Great Depression, the present world is many times more sophisticated in terms of advanced technological knowledge in particular with respect to computer technology. It is then tempting to suggest that with the present advanced technology we are in a position to generate enough real wealth to prevent economic slumps.
We suggest that one could have argued along the similar lines in the period prior to the Great Depression i.e. prior to the 1930 when comparing it to the end of the nineteenth century. During the first 30 years of the twentieth century, important technological break-throughs occurred, such as the development of the electricity, the radio, the automobile industry and the airline industry. Consequently, individuals’ wellbeing had risen significantly in the western world. Yet despite all the sophistication, the world still experienced the Great Depression. We hold that boom-bust cycles are the result of central bank policies and have nothing to do with technological knowledge. Furthermore, regardless of how many ideas individuals have what always limits the implementation of new ideas is the availability of real savings.
Real savings the key for economic growth
While new ideas can result in a better use of scarce resources, they can however, do very little for real economic growth without the expanding pool of real savings.
In “Man Economy and State” 2nd edition page 542, Rothbard says that technology, while important, must always work through the investment of capital in order to generate economic growth. Furthermore, Rothbard quotes Mises who says,
“What is lacking in (underdeveloped counties) is not knowledge of Western technological methods (“know how”); that is learned easily enough. The service of imparting knowledge, in person or in book form, can be paid for readily. What is lacking is the supply of saved capital needed to put the advanced methods into effect”.
So regardless of how knowledgeable we are and regardless of various technological ideas, without an expanding pool of real savings the increase in economic growth is not going to emerge.
It is through the expansion in the pool of real savings or the subsistence fund that an increase in the stock of capital goods is possible. The increase in the capital goods, once correctly allocated, permits the increase in the economic growth. On this, Richard von Strigl wrote:
Let us assume that in some country production must be completely rebuilt. The only factors of production available to the population besides labourers are those factors of production provided by nature. Now, if production is to be carried out by a roundabout method, let us assume of one year’s duration, then it is self-evident that production can only begin if, in addition to these originary factors of production, a subsistence fund is available to the population which will secure their nourishment and any other needs for a period of one year……..The greater this fund, the longer is the roundabout factor of production that can be undertaken, and the greater the output will be. It is clear that under these conditions the “correct” length of the roundabout method of production is determined by the size of the subsistence fund or the period of time for which this fund suffices.
The essence of the subsistence fund can be widened to include many individuals that trade with each other. This means that the subsistence fund now comprises of a greater variety of goods ready for human consumption. According to Bohm-Bawerk:
The entire wealth of the economical community serves as a subsistence fund, or advances fund, and, from this, society draws its subsistence during the period of production customary in the community.
Note again that the improvement in the infrastructure is what sets in motion economic growth. The improvement in the infrastructure in turn can take place because of the increase in the subsistence fund. Hence, anything that weakens the subsistence fund undermines the prospects for economic growth. Again, we suggest that individuals that are engaged in the various stages of production require access to consumer goods i.e. the subsistence fund in order to support their lives and wellbeing.
Loose monetary policy is the key behind the boom-bust cycles
One observes that during an economic downturn, businesses fail despite sophisticated technology being employed. Careful analysis reveals that the root of the problem is not the lack of advanced technology but the misallocation of resources by the businesses.
The employment of resources contrary to the approval of consumers leads to losses by businesses. One of the major factors contributing to the misallocation of resources is the falsification of price signals brought about by the monetary policies of the central bank.
The persistent falsification of these signals leads over time to a production structure that might be very sophisticated nevertheless in defiance to the wishes of consumers.
Consequently, regardless of the degree of sophistication, once the process of adjustment towards the structure that is in line with consumers top priorities begins, various unwanted sophisticated structures start to crumble.
As a rule, a tighter monetary stance of the central bank sets this process of adjustment. The liquidation of structures that do not correspond to consumers’ wishes is what a recession is all about. If the central bank were to pursue an ever-aggressive loose monetary stance at some point in time the pool of real savings will start declining.
Consequently, the economy will follow suit. If the central bank were to intensify its loose monetary policy further this will only weaken the pool of real savings further and make things much worse.
Money out of “thin air” sets boom-bust cycles
Now, we suggest that a major reason for boom-bust cycles is the loose monetary stance of the central bank. The loose stance results in the expansion of money out of “thin air”, which sets in motion an exchange of nothing for something – the catalyst for the boom-bust cycle menace.
On a pure gold standard, an increase in the supply of gold does not set the exchange of nothing for something, but to the exchange of something for something. (One form of real wealth is exchanged for another form of real wealth).
In the absence of the exchange of nothing for something, there is a very low likelihood of a persistent misallocation of resources, which culminates in boom-bust cycles.
Note that the expansion of money out of “thin air” through the setting of the exchange of nothing for something falsifies the price signals and leads to the misallocation of resources. Note that also in a free unhampered market we will have a misallocation of resources as a result of business errors. We suggest that the incurring losses would prevent the misallocations to become long lasting.
In addition, the misallocation of resources or the errors committed by businesses are not going to be widely spread, as is the case with the misallocation caused by the loose monetary policies of the central bank. The errors committed by businesses are of a local nature related to how well businesses are managed. When the central bank and government policies set the misallocation of resources in motion these distortions tend to be long lasting since neither the government nor the central bank operate in the profit and loss framework.
Conclusion
We suggest that despite new technologies a major impediment to economic growth is the relentless central bank tampering with financial markets. These policies are responsible for the boom-bust cycles and the erosion of the pool of real savings and thus to a weakening of the process of real wealth formation.
