SYNOPSIS. 1
Eliminating Interest 2
Discontinuing Income Tax. 2
Instituting Asset Tax. 2
Free Capitalism.. 3
GLOBAL RESOURCE CHALLENGES. 4
Double squeeze for developed countries. 4
Unfavorable Composition of growth. 5
Zero sum global economy. 5
MAKING OF THE CURRENT CRISIS. 6
Overcrowding and Over Capacity. 6
Resource Intensive Mix of Products. 6
Global Warming and Dwindling Oil Supply. 7
Low Wage Competition. 8
The underlying cause. 8
UNSUSTAINABLE FINANCIAL SYSTEM… 9
Squandering natural resources. 9
Ignoring Environmental costs and benefits. 10
Myopia. 10
Capital Destroying Bubbles. 11
REFORMING THE FINANCIAL SYSTEM… 12
PROPOSED SOLUTION.. 13
Eliminating interest 13
Discontinuing Income Tax. 16
Instituting asset tax. 16
Salient Benefits of Free Capitalism.. 19
ANSWER TO GLOBAL ECONOMIC CHALLENGES. 21
Meeting the great labor employment challenge. 21
Meeting the great resource constraints challenge. 23
SHAPING THE FUTURE. 24
Protecting capital and capitalism.. 24
Protecting free markets. 25
Global peace. 25
Global leadership. 26
Rising human population and increasing per capita consumption of finite resources has brought mankind face to face with the limits of the planet. The resource limits of the planet are impeding global economic growth and causing the current economic crisis.
The mix of products and services produced under the current economic system is very resource intensive, particularly in fossil fuel. Since global resources are shrinking, the product mix and the mix of production facilities of the world should include higher proportion of resource adding and resource preserving products and facilities.Resource adding and resource preserving products and facilities e.g. wind, tide and solar power require huge amounts of capital.Fortunately the world has limitless Capital. A modern economic system should therefore generously allocate capital to economic activities that:
However, the current financial system only allows allocation of capital to businesses that can pay interest; most resource adding or sustainable industries don’t make profits high enough to be able to pay interest. The interest based system by preventing allocation of capital to most sustainable industries is preventing the natural economic response to environmental and resource constraints, thus limiting economic opportunities and causing economic slowdowns.
In spite of the global resource constraints, the huge and cheap labor pool in developing countries is still driving growth there. Since resource limits don’t allow the global economy to grow freely, growth in developing countries exerts offsetting downward pressure on growth in developed countries. Growth in developing countries is coming at the cost of growth in developed countries, which is one of the reasons for the intractability of this crisis.
This book titled “Free Capitalism,” presents a new model of a market driven economic system that will generously allocate capital to sustainable industries and similar assets. The proposed system will make the mix of products and industries in an economy, increasingly sustainable. It will minimize the effects of resource constraints causing the global economic crisis and start a new trajectory of sustainable economic growth that will last for generations.
The salient features of “Free Capitalism,” include:
Free Capitalism will help achieve sustainability firstly by eliminating interest and secondly by using the Asset tax structure to incorporate resource and environmental considerations in everyday economic decisions. Sustainability is the key to future economic growth.
The proposed system basically replaces Interest and Income tax with Asset tax, an annual tax on all assets including cash. Eliminating a major economic cost (interest) will significantly bring down costs and consequently improve competitiveness and productivity, particularly that of developed countries. Free Capitalism will bring in prosperity and economic growth by increasing sustainability and decreasing costs.
Eliminating Interest
Interest has to be eliminated, because it is the major reason for most unsustainable choices being made in capitalistic economies. Interest incentivizes rapid extraction and consumption of mineral resources because minerals in the ground don’t earn interest. Interest requires consumption of mineral and other resources by businesses, because the increased financial returns or benefits from the use of fossil fuels and minerals enable them to cross the hurdle of interest. On the other hand, interest will not allow investments to pick up in sustainable industries because they cannot always pay interest.
If interest is not eliminated most investments would continue to be made in unsustainable industries till the world manifestly starts running out of resources. Global fossil fuel reserves would be dangerously depleted for global peace. In the meantime the global economy will suffocate from increasing resource constraints and lack of business opportunities. Therefore, to change the current mix of products and production facilities to a sustainable one, interest, which drives most unsustainable business and economic choices, needs to be eliminated.
Interest is an allocation cost not a production cost; if an allocation or administrative cost can be eliminated, it should be eliminated, because the competitiveness resulting from globalization requires that developed countries bring down costs very significantly – – thus, interest which is a huge and unnecessary cost should be eliminated.
Discontinuing Income Tax
Income Tax has to be discontinued because it is not needed in the proposed Free Capitalism system. Currently, income tax performs the function of generating revenue for the government. Asset tax would do that with higher efficiency and fairness. Wealth is a far better measure of an entity’s ability and fair share of tax than its income in a particular year.
Instituting Asset Tax
Asset tax will perform the function of both interest and income tax.
The proposed Asset tax system will incorporate incentives for investing in sustainable economic assets, and disincentives for unsustainable ones. This is accomplished by the Asset tax rate structure, e.g. low Asset tax for sustainable assets and industries, and high Asset tax for polluting ones. Sustainable industries currently yield low returns primarily due to the fact that current measure of financial return fails to account for the economic benefits of sustainability. Once interest is replaced by asset tax, sustainability benefits will translate into financial return because financial returns will be net of asset tax. Financial return will again become a measure worthy for driving the capitalistic system.
Asset tax will be easier to assess and administer than income tax. As in any tax system, there will be exemptions, thresholds, moratoriums etc. to keep the system fair and productive.
Free Capitalism
The current economicsystem was developed during the time when the environment and other planetary resource constraints were not real issues. Now they are; therefore, the current economic system needs to be reformed to incorporate in it the ability to handle scarcities and constraints of planetary dimensions.
The proposed Free Capitalism economic system will adapt capitalism to modern times.
Free Capitalism will bring about the environmental revolution. The economic impact of environmental revolution will be comparable to that of the industrial revolution!
In Free Capitalism, risk to capital of all kind, including business and credit, will be fully compensated through credit premiums. Risks will be better understood, assessed, priced and compensated under Free Capitalism.
Over population, resource depletion, over dependence on fossil fuels, and environmental degradation are all critical factors that materially affect current economic conditions. Rising population and increasing per capita consumption of finite resources has brought the global economy face to face with the limits of the planet.
Massive industrialization of developing countries is severely stretching the limits of the local and global resources. Developing countries are building factories, homes, and infrastructure that require use of ever increasing volume of finite global resources. Since everybody has started producing and using resource intensive products like cars, air conditioners, and other appliances, the local and global resource limits, particularly that of fuel and of the environment, are restricting and impeding growth.
When economic growth picks momentum the resource limits show up in resource prices and environmental conditions and restrict growth. The 2008 Beijing Olympics provided an example of the limits of the local resources with respect to the environment. An example of global resource limits is the price of oil which has increased more than ten fold in a decade. Oil price went from a low of $9.48 a barrel in December of 1998 to a high of $137.11 in July of 2008 and has hovered around $75 a barrel in most of 2010. The resource intensiveness of the global mix of products, particularly with respect to fossil fuel, is interacting with the global resource and environmental constraints to create the current economic crisis.
Double squeeze for developed countries
The global resource limits are affecting developed and developing countries in very different and opposite ways. The economies most affected by the global resource limits are those of the advanced countries. In a globalized world, low wages enable developing countries to compete globally and generate growth. Given globalized commodities markets, developing countries can produce end products far cheaper than those produced in developed countries. Developing countries can commercially absorb higher oil prices and continue to sell cheap consumer products globally. For commercial and production purposes, developing countries’ ability to absorb high oil or energy prices will continue as long as their wages are very low. Their growth is likely to continue in spite of rising oil and other resource prices.
The additional wages and income generated by producing cheap products gives developing countries the ability to buy additional resources (fuel) for consumption. Additionally, since their per capita use of fossil fuel is far less than that of developed countries, developing countries are also likely to derive higher value from increasing per capita consumption of fossil fuel. Given supply limits, developing countries increasing demand for oil and other resources are likely to keep the upward pressure on resource prices.
It may seem that developed countries have more buying power, but as far as oil and similar global resources are concerned the production and consumption economics favors developing countries and gives them better buying power. Global resource limits are working, through resource, labor, end product and other prices, to reduce developed countries’ resource use and increase that in developing countries. This market pressure to reduce resource use in developed countries may be called a “market driven correction” but its real life manifestation is the economic crisis!
The global resource limits and the explosive growth in the global labor pool are creating a “double squeeze” for developed economies.The global resource limits are not allowing the global economy to grow; but the growing labor pool in developing countries is competitively driving growth there, which results in taking business away from developed countries. Due to limited global resources, growth in developing economies is coming at the cost of growth in developed economies. Global resource constraints have currently put developed countries at a significant disadvantage vis-à-vis developing countries.
Global Warming and Dwindling Oil Supply
Whether there is consensus on the science and reality of Global Warming or not, its impact on the economy is obvious. Investors are shying away from investments in fossil fuel driven industries. The uncertainty about carbon tax or other climate change regulation is increasing risks and cost estimates. Significant economic impact of global warming is already here and very real.
By 2009 remaining proven global reserves of oil stood at 1.3 trillion barrels [1]; at the current rate of consumption we may have just 58 years [2] of oil left. Supply uncertainties translate into higher business risks. Inelasticity in demand for oil creates severe price shocks in case of supply shortfalls. Sky high oil prices in the recent past have demonstrated the precariousness of the demand-supply balance and its economic impact. The negative impact of oil supply and price uncertainties can be felt on investments and businesses today.
Oil supply constraints and global warming are reinforcing each other in developed countries to reduce investments, not only in fossil fuel industries, but also in a large number of other industries such as automobile, heavy industry, service industries, and even infra structure. Fossil fuel is so much part of the fabric of economic life that uncertainty about it makes everything else less certain and more risky. Developed countries have to find ways to wean their economies away from fossil fuel and into sustainable energy, which will free their economies to grow and expand without the environmental and supply limits imposed by fossil fuel. The answer may lie in changing the mix of products.
Unfavorable Composition of Demand Growth
Even though there is considerable growth in developing countries that growth is not translating into demand for high value products from developed countries, because the growth in real demand in developing countries is in agricultural products, domestic consumer products, and fuel. Most of the growth in demand in developing countries is not helping demand growth in developed countries. Demand growth in every country follows their own pattern or hierarchy of needs, e.g. that proposed by Maslow [3]. Growth in demand for high value products should not be expected when basic needs are difficult to meet for most people in developing countries.
Demand for advanced high value products will only grow significantly if there is high growth in real income. For instance, real incomes in China have to increase considerably, may be double, for the Chinese consumer to generate significant demand for US products. Currently, however, the demand growth in developing countries is for global resources, which negatively effect developed countries because of the global resource constraints.
If there were no global and local resource limits, developing countries’ economic growth would enable real incomes (real wages, profits, environmental quality) to grow freely which in turn would also raise demand for high value and high end industrial and service products. If people in developing countries could consume natural resources at the same per capita level as that in the US, developed countries would have plenty to sell to developing countries and vice versa. There would be economic growth everywhere. But that is not the case and lack of adequate growth in global real incomes is and will keep demand low for US and other developed countries products. In short, global resource constraints won’t allow demand growth in developing countries to translate into demand for developed countries.
Zero sum global economy
Since resource limits will not allow the global economy to grow freely; growth in developing countries will exert offsetting downward pressure on growth in developed countries. Under the current financial system economic growth has become a sort of zero sum game among developing and developed countries. Migration of industries without replacement is just one example. Growth in developed countries can only continue if the global economy can grow freely. The global economy can only grow freely if resource limits are removed or made porous. This book is about making resource limits porous.
In the 1930s Mahatma Gandhi said; “if the 300 million people of India choose to industrialize the world cannot handle the consequence.” Now that the two billion people of India and China have chosen to industrialize, the worldmust handle the consequences. Global resource constraints and the cutthroat competitive pressure for jobs and resources are the consequences that the developed world has to handle immediately.
Globalization and the big wave of industrialization in developing countries have not only altered resource conditions but also the competitive positions of most advanced countries. These competitive changes are having disastrous effects on most developed economies, and leading to the current crisis. Let us ignore for the time being the regulatory lapses, the financial excesses committed by lenders and borrowers, and other similar causes that may have made this crisis worse or allowed it to happen in the way that it did, and focus on the underlying economic factors that continue to drive this crisis even today. An analysis of these continuing economic factors will help us see clearly the declining competitiveness of most developed countries, and thereby help us in formulating a strategy for dealing with this crisis. The current economic crisis is also a competitiveness crisis. The analysis follows.
Low Wage Competition
Extremely low wages in developing countries, like China and India, provide a cost advantage in labor intensive industries that is currently not matched by other advantages of developed countries. As a result, a large number of labor intensive businesses in developed countries migrated or moved production to developing countries to take advantage of low labor costs. Most manufactured goods sold in the global consumer markets are now being profitably produced in developing countries with low wages.
In a globalized world if there is a job that can be efficiently done in India it will be done there and not in the U.S. because of low wages in India. Since the bulk of global production is increasingly being done in low wage countries, employment and investment opportunities are moving there as well. When production moves overseas, a significant part of the economy goes with it, the most significant of which is employment.
Furthermore, resource constraints will not allow real wages in developing countries to grow freely. As long as global resource constraints are not allowing real incomes in developing countries to grow freely, low real wages in developing countries will keep attracting jobs and businesses. It seems that low wage competition is here to stay, unless developed countries find ways to alleviate the effects of resource constraints. Changing the resource intensive product mix to a sustainable one will certainly allow wages to really increase in developing countries and consequently improve competitiveness of developed countries. Every country will have plenty to do domestically; developing countries will no longer need exports to survive or to drive economic growth.
As long as the current mix of products continues developed countries will keep losing jobs and business to developing countries.
Overcrowding and Over Capacity
Two billion people joined the global workforce after the collapse of communism and the onset of globalization. Massive industrialization and abundant workforce has tremendously increased the production capacities of the global economy. Competition for existing markets has therefore severely intensified. Businesses in the US have been badly hit by competition from developing countries. The competition for jobs and markets is intense, globally. The world seems to have more labor and production capacity than it can profitably use for the current mix of products.
Mix of products is a very good indicator of the potential size of an economy and its ability to employ people and capital. If the mix only includes food, clothing and other essentials the size of the economy will be much smaller than that of the economy in which luxury goods are also produced. When durable goods are introduced the potential size of the economy goes up further; and so on. The current mix of products can drive a global economy which will be far smaller than the economy that can be potentially built by employing most of the globally available labor and capital. In short, the global mix of products, including investment and service products, is not broad or diverse enough for employing the globally available labor and capital.
As elaborated in the following section, which starts the concluding segment of this analysis, the remediable and strategically actionable cause of the current economic crisis is hidden deep inside the global mix of products. Global resource constraints and massive resource intensive industrialization in developing countries have created the inevitable need for change in the product mix to a sustainable one. There really is: no other way.
Resource Intensive Mix of Products
The current mix of products and services produced is very resource intensive, particularly in fossil fuel. Since global resources are shrinking, the production mix of the world should include higher proportion of resource adding, resource preserving products and services. An example of resource adding product would be a wind turbine: when a wind turbine or a solar power plant is established the planet’s effective resource pie increases, but when oil powered power plant is established the planet’s resource is consumed. Likewise, when an efficient and effective mass transit system is established the resource pie increases whereas when cars are built (and used) the resources are consumed. When effective recycling systems are established the resources increase whereas they are wasted when land fills are used. When oceans are cultivated for food and for carbon sinking [4] the resource pie increases, but when oceans are just fished the resource is consumed. Every product used is a net resource addition or consumption, either in absolute or relative terms.
When hunter-gatherers faced resource constraints they tried agriculture, which at that time was a resource addition. The process has continued ever since and is an integral part of human progress. Resource additions can also be unsustainable. New mine is a resource addition of unsustainable kind. The current mix of products is not only resource intensive but the resource it uses is mostly of the unsustainable kind. The current mix of products is doubly or extremely unsustainable or unsustainable squared.
To resume global economic growth, particularly in developed countries, the current global mix of products has to change to a sustainable mix of products; one that is not resource intensive and includes many resource-adding products. Since the new global mix will be sustainable and would consequently not be affected as much by the resource constraints, the global economy will be able to grow freely. There will be plenty for every body and every country to produce and to sell. The global labor and product markets will no more be suffering from over crowding and over capacity. The labor pools in developing countries will then not represent cutthroat competition but provide the thriving markets that developed countries need.
The underlying cause
Global resource constraints, overcrowding of global workforce, low wage competition, global warming and oil supply uncertainties are forces that are working against the global economy, particularly in developed countries. However, the underlying factor that is making these forces work against the global economy is the resource intensiveness of the current mix of products. If the mix of products was resource adding instead of resource consuming these forces would not work against global economies but in their favor. Resource adding mix of products would add consumption and investment, which in turn would translate into higher employment opportunities for labor and available capital. The villain in the ongoing drama of global economic crisis is therefore the current mix of products.
Many societies and economies stay at a certain level of development or affluence not because they choose to stay at that level, but because many other choices and decisions they make, in turn, determine their affluence and other levels of prosperity. The same happens on the personal level, if we choose to regularly consume certain substances and refuse to take the stress of hard work, these decisions, in turn, determine one’s level of prosperity and affluence. As stated in the previous section, our choice of product mix is among the kind of choices which in turn determine the potential size of the economy and its potential prosperity.
Humans have so far chosen to take the easy path of fossil fuel consumption which can only deliver a certain finite amount of prosperity to the global population. Our continued reliance on fossil fuel limits the potential size of the global economy to a level far below its potential, given the supply of labor and capital.
To keep the global economy growing for everybody, it has to be lead towards a sustainable model that does not further stress the known limits of the planet and introduces a large number of new and sustainable products. The outdated and resource intensive global product mix, therefore, needs to change to a sustainable and resource efficient product mix. The change itself will create huge investment demand and generate global economic growth for generations. Once the global product mix becomes sustainable the swelling global labor pool will create demand and business for the US and for other developed countries.
While the product mix may be the villain, the financial system is the force behind the villain because the current financial system won’t allow sustainability into economies and product mixes. The current financial system has a major role in determining the global product mix. The current financial system therefore is the major source of un-sustainability of most contemporary economies. The following are some of the ways it incorporates un-sustainability in economies and their product mix.
Squandering natural resources
Minerals in the mine do not earn interest, thus companies that extract minerals want to extract and sell them quickly. The possibility of earning interest speeds conversion of minerals resources into cash. The sooner the minerals are converted into cash the earlier they can start earning interest. Faster exploitation of mineral resources translates into faster consumption through a series of intermediate steps that are also driven by interest. At every step along the way, interest drives the flow of goods towards the fastest conversion into cash, which eventually happens to be through consumption. The system is thus incentivizing rapid consumption of resources whether needed or not.
The financial system is extremely powerful and effective in making humans consume resources rapidly. It not only incentivizes rapid consumption of mineral resources, it also prevents any shift away from mineral resources, particularly in the energy sector. The rate of return driven financial system strongly favors increasing use of fossil fuels because fossil fuel delivers almost four times the energy per unit of capital than that delivered by wind or sunshine. The increased financial returns or benefits from the use of fossil fuels and minerals enable businesses and other assets to cross the hurdle of interest.
Since rate of return on capital is the sole qualifying criterion for business and investment in an interest based system, it is obvious that the current financial system will favor fossil fuels over wind or sunshine for energy production as long as fossil fuel continues to be commonly available. Interest based system is causing depletion of earth’s resources with maximum speed; it needs to be replaced by a system that incorporates measures of sustainability as part of the qualifying criteria for investments while allowing financial rate of return to play its final role in the investment process.
Ignoring Environmental costs and benefits
Environment friendly businesses and industries, particularly clean energy, are not taking root because their rates of return are low. Their rates of return are low because they use weak and thinly spread sources of energy like wind and sunshine as compared to fossil fuel, which is very concentrated. Their rates of return are low also because a significant part of the benefits of clean industries accrue to the environment, to the planet, and to humankind. In other words, a significant part of the benefits of clean industries while beneficial to humankind, do not get translated into financial benefits. Conversely, the loss and harm caused to humankind by use of fossil fuel is not translated into financial costs.
[1] The Energy Information Administration, an agency of the US government Department of Energy.
[2] Consumption data: The Energy Information Administration an agency of the US government.
[3] Maslow’s hierarchy of needs is a theory in psychology proposed by Abraham Maslow in 1943. The hierarchy, from the most basic upwards is: physiological, safety, love/belonging, esteem, and self-actualization.
[4] Carbon sinking is an effort to absorb or remove carbon from the atmosphere and sink it in the ocean.
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