The Internet, Creative Destruction and The Falling Rate of Profit Crisis

The Internet, Creative Destruction and The Falling Rate of Profit Crisis

             1.1 Labor-Dominant vs. Knowledge-Dominant Products:
                   The Web & a Falling Rate of Profit Crisis
              Chart 1, Web Deflation Model 2000-2009

             4.1 Alan Greenspan, 'Creative Destruction' & the Steady State Economy:
                   'The New Economy'

             4.2 Smoothing the Long Waves and the Internet: Alan Greenspan's Model
                   of 'Creative Destruction'?

             4.3 Moore's Law, the Internet and the Decline of Private Business

             4.4 Too Rapid Efficiency Increases: Failed Monetary Policy and Collapsed
                   Creative Destruction

             4.5 Monetary Velocity during the Great Depression: Creative Destruction vs.
                  Falling Rate of Profit?

            5.1. World War Economics, Postwar Recovery & the Internet

            5.2 The Internet, Rapid Efficiency Increases and Greenspan

            5.3 Stagnation, Deflation and First Falling Rate of Profit Crisis
                  or A New Input-Output Model

Current newspaper headlines show the longest running expansion in history, but explanations for how this economy is working are few. Even the architect of the 'new economy', Federal Reserve chief Alan Greenspan, seems unsure of the logic for the current growth. In brief, I believe that pressure upon retail prices by the Internet retailers, is going to force the manufacturers to use the Web to increase efficiency so fast, that by about 2003; deflation will begin to hit the economy and unemployment will begin to rise [see Chart 1, Web Deflation Model 2000-2010]. Whenever the rate of productivity begins to rise faster than the rate of growth in the economy as a whole, unemployment will eventually begin to rise as well.

1.1 Labor-Dominant vs. Knowledge-Dominant Products: The Web & Falling Rate of Profit Crisis

In trying to understand how the Web might trend the economy towards a falling rate of profit crisis, it is useful to compare how different the development, production and distribution of labor-dominant products are from knowledge-dominant products. The dichotomy between labor-dominant and knowledge-dominant products is obviously not distinct; but for theoretical purposes these differences will be magnified, as German sociologist Max Weber might have applied the term 'ideal type'.

The key labor cost in a knowledge product like software is in the initial writing of the code. Once the knowledge product has been created and debugged, the normal costs associated with mass-producing additional units is very low. This reality combined with an effective monopoly on the desktop is the Microsoft Model. Once Bill Gates's staff has written a new piece of software, the costs of reproduction drop very low. Still the distribution of knowledge products through conventional retail 'brick and mortar' stores requires the physical reproduction, packaging, transportation and retail display of that product, usually on CD-Roms.

Many or all of these costs are decreased or eliminated in Web-based retailing. A great deal of thinking, planning and physical work are often involved in developing a prototype for physical commodities such as an automobile or a shirt. The marginal costs of reproducing more such labor-based commodities may and should drop with the increasing size of the production run, but these costs seldom if ever approach zero.

The ultimate lowering of costs occur when a knowledge product has been written for free and placed upon a public server for free, mass access- with the underlying program code. Two products stand out today in that model. Linux is an outstanding server and desktop operating system. It was written in the early 1990s by Linus Torvalds and put onto the Web for free access. Other writers created a Web-server operating system known as Apache. The combination of Linux and Apache provide competition for Microsoft's Windows and Windows NT Server. Perhaps the ultimate example of this model is the Web 'browser', a graphical interface for the Internet created by Tim Berners-Lee and given away. It is the 'browser' which makes the Web so easy to use. This model of software development and distribution threatens the business model for almost all existing private sector software companies.

2. Adam Smith, Karl Marx, Nicholai Kontradieff: Rising Rates of Profit vs. Falling Rates of Profit

Leftists have been waiting since Marx's death in 1883 for the final economic collapse and the 'Great Tribulation' leading to the creation of the new work-free utopia. Yet as the decades piled on since 1883, the capitalist system has been able to overcome problem after problem, seemingly confounding Marx greatest economic idea, the falling rate of profit crisis tendency or theory. Leftists and others have a legitimate beef with Marxism on this issue, for if the falling rate of profit is correct; why has not the economy already collapsed?

In truth, capitalism has never really escaped from the falling rate problem. A series of labor-based innovations have simply pushed the problem forward each time the economic has crisis seemed about to fatally crash the system. What has occurred, is that periodic falls in the rate of profit have been met with periodic increases in the rate of profit, at least from about 1790 to about 1930. That is to say, periodic 'falling rate cycles' have been followed by periodic 'rising rate cycles'. This cyclical or 'long wave' model of growth in the West was first described by Nicholai Kondratieff around 1920. [see Long Wave Chart for model].These 'rising rate cycles' have been times when new labor-based innovations have pulled large numbers of people into the paid labor force. The 'falling rate cycles' have been times when rising efficiency has squeezed out large numbers of workers.

The 1929 crisis was not resolved in a 'rising rate' fashion however. The 50 % rise in industrial efficiency between 1923 and 1928 had created too much overproduction by 1929 [see Chart 3, Hoover Report on economic conditions 1899-1927]. Worse, no new labor-based innovations were ready for private sector investment. Only a massive global war was able to destroy enough productive capacity and enough workers, to rebalance production and consumption- and then only temporarily through the early 1960s.

3. The Great Depression & World War ll: From Labor to Debt with the Input-Output Model

3.1 The Depression: Keynes, Secular Stagnation & Counter-Cyclical Federal Spending

During the early 1930s, British economist John Maynard Keynes described the economic process as 'secular stagnation' or simply 'stagnation'. Private investment was no longer as able to keep most people employed, as it had during most of the 1800s. Keynes's solution to the problem of severely weak private investment, was to have the central government direct public investment through the creation of short term public employment, paid for by issuing federal debt. This model gradually evolved into the first American input-output model.The model worked in America only after World War ll started and the debt to GDP percentage began rising from 30 percent in 1940 to about 150 percent in 1945.

A system of federal planning gradually evolved during the first years of war, rationing most civilian consumption and turning the rest into war production. This 'input-output model' resembled a giant spreadsheet like Lotus or Excel, with the rows representing 'inputs' and the columns representing 'outputs'. The federal government directed the war and asserted some control over the private sector. However, the private sector provided most of the manufacturing capacity- albeit often under cost-plus contracts, which essentially guaranteed good profits. High tax rates prevented this system from accumulating too much wealth in the owning class. Two crucial elements allowed the economy to revive under the input-output model':

1. attack by Japanese at Pearl Harbor
2. existence of a new economic theory of large federal debts [see Chart 2 again on Long Waves]

The external attack gave Roosevelt the political power to overcome the strong isolationist sentiments at home. He then used the economic power of John Maynard Keynes's theory to create a planning mechanism, capable of applying America's huge industrial capacity to war production.

Although theoretically Franklin Roosevelt probably could have developed a similar economic system and recovery without going to war; politically it probably would have been impossible for Roosevelt to have increased the national debt so rapidly without an external military attack. The country was simply too divided by class for the wealthy to have permitted the national debt to rise so far or the central government to have become so involved in directing the private economy.

The demands of war between 1941 and 1945 led to deferred consumption for most Americans. Much of the federal debt for fighting the war was purchased by American workers or soldiers, as there was little else upon which to spend the good wartime wages. The end of war removed the political logic for continuing federal direction of the economy as far as the owning class was concerned and in any case, Harry S. Truman was no Franklin Roosevelt in terms of political competence. The input-output model was soon killed by the rich, but so great had been the effects of Keynesian debt, that the American economy roared on from 1947 until the middle 1960s.

At demobilization at the end of war, this privately held debt soon began to be recycled back into personal consumption. The effects of the Marshall Plan for reviving Europe, the GI bill and additional personal debt increases combined with the World War ll debt to provide a 20 year boom, similar in nature and length to conventional long wave up swings. By then, many had forgotten the tremendous efforts, sacrifices and 300 thousand dead required to revive America from the Depression. And in a way that Keynes could never have imagined, the mountain of American debt created to fight the war, became an ongoing stimulus for economic growth until the middle 1960s.

Although even Keynes could not have planned such a success, it was the very length of the post-war expansion, which allowed conservative economists to revise the history of the Depression years. By the early 1960s, Milton Friedman had largely won the economic 'spin' battle as to the causes of the Depression and the slowing global economy of the late 1960s was not simply seen as the logical continuation of 'stagnation', as Keynes had defined the 1930s. Different ad hoc terms popped up. The simultaneous occurrence of stagnation and inflation was described as 'stagflation'. MIT Economist Lester Thurow had a book out entitled, The Zero Sum Society. The idea that the 1960s might slowly be returning back into Depression seemingly was not seriously considered; so great had been the influence of conservative economic thinking from places like the Chicago School. Still what Federal Reserve chairman, Alan Greenspan, may have learned theoretically from the post-war expansion was probably more from long waves and Schumpeter than from Friedman.

3.4 Reagan, 1981-1987; Greenspan, 1987-1992: Fiscal and Monetary Policy after the 1970s

After a decade of economic problems during the 1970s, Ronald Reagan injected another huge surge of debt-funded military spending into the economy during the early 1980s. This debt-surge was grossly maldistributed and the market collapsed in October 1987. Greenspan, immediately poured enough cash into the monetary system to prevent an economic meltdown, but the economy stayed flat into 1989. Greenspan then began feeding interest rate decreases into the economy and over about two years, lowered the interest rate level at which banks borrow their money by almost 7 %, an unprecedented decrease for such a short length of time. The banks did not begin lowering their rates as soon as Greenspan began lowering the banks's rates in 1989, thus the stimulative effect on the 'real' economy of the rate cuts, almost $ 700 billion over two years, was delayed until late 1992. By this time George Bush had lost the presidential election. Bush's sometimes stated belief that Greenspan cost him the election is probably not correct. Chairman Greenspan did his part starting around summer of 1989 by lowering rates at the Fed level, but the banks simply treated this as 'found money' for several quarters, and absorbed the rapidly dropping Fed rates into their profit margin. If anyone cost Bush the election, it was the banks.

4.1 Alan Greenspan, 'Creative Destruction' & the Steady State Economy: 'The New Economy'

In the early 1900s physics rested upon the idea that the universe was literally in place physically, in a 'steady state'. This was before Albert Einstein, Edwin Hubble and the idea of an expanding universe. Alan Greenspan has created an approximate, economic equivalent of the steady-state universe, Greenspan uses Joseph A. Schumpeter's old term 'creative destruction' to imply that through the judicious use of monetary policy, the rough edges of private investment can be smoothed out over time. Another way of looking at it is that monetary policy can defeat the ever-present falling rate of profit problem.

It could be said that Alan Greenspan seems to have found a monetary path to deal with the 1930s type of crisis, albeit 70 years after the fact. At a minimum, he has found a way to slow down the effects of massive global deflation upon the domestic American economy- a feat which seemingly was not accomplished in the 1930s until federal war expenditures began to kick in after 1939. This is no small success. However, such current successes only go from month to month, sometimes only from week to week.

4.2 Smoothing the Long Waves and the Internet: Alan Greenspan's Model of 'Creative Destruction'?

Schumpeter's interpretation of Kondratieff's self-regenerating waves of capitalist growth were based upon new innovations spurring lagging private investment; eventually reemploying the large amount of people squeezed out of the workforce by the annual increases in efficiency congenital to capitalist development. Schumpeter attempted to 'normalize' this chaotic process of investment. Keynes followed somewhat in this line of thinking, only he substituted federal debt to stimulate the economy, in the absence of enough private investment. In Greenspan's model, monetary policy is substituted for federal debt to smooth out these lagging gaps in investment. In this respect, 'creative destruction' can be seen as the mainstream response to Marx's falling rate of profit model.

The crucial error, is that the Kondratieff-Schumpeter long wave theory, upon which Greenspan's model seems to reside, describes successive profit-deriving, labor-based innovations being created by private investment. Greenspan's model does not seem to see the difference between the first three labor-based long waves based in private investment and the long wave associated with federal debt and the debt-based growth from 1945 to 1965. Moreover, seemingly his model does not seem to see the difference in innovations which put people to work and those which rapidly create large amounts of efficiency. Thus his model cannot predict the level of unemployment likely to result from large scale migration to the Web.

The Internet is a largely government-created innovation, which seems to be a way of extending Moore's Law from the technology sector to the general economy. Moore's Law says that efficiency in the technology sector doubles every 18 months, about 70 % annually. Almost every existing business which goes onto the Internet seems to be faced with almost violent competition and declining profits.
.
The proof of this view is easy. Simply look at the number of businesses which have the possibility of raising their prices as a result of going onto the Web. What seems most likely, is that businesses will attempt to maintain profits during the early 2000s by using the Internet to keep roughly existing sales, but using fewer workers in the process. The problem for any single company, is that although sector-wide sales might hold constant or even increase somewhat during the early 2000s, market share may flunctuate radically depending upon the level and quality of Web utilization. Thus Merrill Lynch has recently had to adopt the Internet model created by Charles Schwab.

The problem is compounded in that 'creative destruction' as Greenspan practices it, has a hard time dealing with overly rapid efficiency increases. Greenspan's model depends upon the 'true' GDP growth rate being the combination of two items, the percent rise in employment and the percent rise in efficiency. (See Barrons 1999 articles). A range of annual GDP growth of between one and three percent seems to work for Greenspan's model. Greenspan seems to try to calculate monetary velocity in such a way as to keep price 'stability' within this GDP growth range of one to three percent. I question whether or not his model can deal with efficiency increases above four percent. Efficiency increases of five to eight per cent are probably well beyond the practical capacity of conventional monetary policy to cope. It was about five years of such efficiency increases during the period from 1922 until 1927 which may have destabilized the American economy of that era. Herbert Hoover wrote a congressional report around 1928 which described this period of rapid efficiency increase.

This brings up the obvious question, as to how long the stock market valuation can grow at rates of ten to twenty percent annually, while the underlying economy simply plugs along at three percent. Worse, how can monetary policy cope with potentially destabilizing productivity increases of perhaps 5 to 10 % annually, along side these rapidly escalating stock market evaluations.

4.5 Monetary Policy during the Great Depression: Creative Destruction vs. the Falling Rate

One way of viewing the Depression is that the process of 'creative destruction' became more 'destructive' than 'creative'; that is, job destruction through efficiency became far too rapid for the innovative, creative side of capitalism to overcome. In such a situation, the very term 'creative destruction' became self-contradictory, oxymoronic. Possibly, even probably Alan Greenspan would accept such an explanation- at least in general terms.

What if a new innovation was capable of creating GDP efficiency beyond four percent and the GDP failed to rise in tandem with the increase in efficiency? If the GDP were to grow less rapidly than the increase in production efficiency, then the clear implication is that employment could decrease at least by the arithmetic difference between GDP growth and efficiency. Decreased employment implies decreased buying power and decreased aggregate demand. If such a situation were to persist for several months or a few years, the decreased aggregate demand would cause a rise in unsold inventory- what leftists refer to as 'over-production. Increased over-production would shortly lead to decreased employment. This is one way of looking at the American economy from about 1922 until about 1934. [see disaccumulation and America as a Developing Nation, by Martin Sklar, 1968, 1980s] The Web is such an efficiency machine.

Monetary policy can keep creative destruction alive as a process for defeating Marx's falling rate of profit model- but only in practical range of about one to three percent efficiency. Theoretically the range should or at least could be higher, but the practical aspect of trying to calculate monetary velocity 12 months ahead in such circumstances makes it unlikely. In my opinion, this equation between employment, efficiency and GDP increases becomes unbalanced when efficiency rises beyond four percent.

Another way of seeing this is through the early 2000 stock market valuation. Seemingly the market valuation has risen beyond the ability of the existing real economy to validate over time through enough growth in the real GDP to pay reasonable profits. Existing very high price to earnings ratios of many perhaps most Internet stocks, simply cannot be maintained. Either the prices must fall, gradually or otherwise; or the real economy must grow at previously unseen rates in advanced industrial economies, perhaps 5 to 8 % for several years. The idea that the real economy can grow fast enough to maintain these very high capitalizations, is no more than a hope. It is this misplaced hope which is leading Alan Greenspan to raise short term interest rates. The new attempt by Lawrence Summers at Treasury to purchase much of the 30 year federal debt is confounding this effort by Greenspan. This is creating a rare event known as inversion, whereby the 'long bond' has a lower rate of return than the 30 or 60 day bond.

5. Conclusions: The Internet & the Triumph of the Falling Rate over the Rising Rate

A book on the Japanese occupation was reviewed in the New York Times last month. One of the more interesting points was that Douglas MacArthur did not significantly alter the existing Japanese economic structure. In many ways, the global economy was not significantly altered either by the end of the war, or the postwar occupations of Europe and Asia. Britain was greatly damaged both by the financial loses, as well as by the huge casualties total, but the United States simply picked up part of the colonial responsibilities of Europe and continued to oppose Great Russian/Soviet expansionism. A vast sea of war debt had floated the American economy out of Depression and the 1945 aggregate debt-to-gdp ratio remained constant from 1945 until the mid-1960s. While war may not have been the only possible way of lifting the Depression in 1939, there was little doubt by most contemporaneous officials and academics by 1943 that it had succeeded. A 1943 book, Postwar Economics by the Twentieth Century Fund, had numerous rising economists praising the Keynesian debt-war model. Scarcely a harsh word was uttered. Their primary fear was that the end of war might return the economy to stagnation, something that not even the more conservative writers was prepared to accept.

The reason these matters are important is that the post-1945 economy has about ended. We are about to return to the 1930s problem, without the capacity to reemploy the Keynesian solution. First, the federal debt-to-gdp ratio is likely to begin dropping around 2005, all other things being equal. It is an open question as to whether or not the existing American monetary system can function without a rising debt-to-gdp ratio or at least a constant very high such ratio. This problem was hinted at by Louis Uchitelle.recently in The New York Times. The bond market is in trouble because of the proposal to buy up much of the existing Treasury debt. Normally long term federal bonds must pay about 1 to 1 ½ percent more than short term bonds, the idea being that the longer bond carries additional risk. Today, the long bond is now lower than the short term bond, a situation known as 'inversion'. Federal debt is used as the base by which other bonds are valued.

Second, shortly the Internet is going to begin to create service sector efficiency which may approximate efficiency increases in American manufacturing and agriculture during the 1920s [see again 1920s production chart from the Hoover Report]. Efficiency accelerated then largely because of electricity, and factory and farm automation. In theoretical terms, we are beyond Smith, Marx and Keynes. Political economy is floating in hyper space.

5.3 Stagnation, Deflation and First Falling Rate of Profit Crisis or A New Input-Output Model

The most important thing at this point for Greenspan is to keep the market alive until the majority of the infrastructure necessary for a full input-output model is in place. Software components of the new input-output model are being developed by private companies now, although their purpose is to sell the software for profits. [I will cover this software and Y2K issues later.] The time frame in America is about three to five years, which oddly enough is about the same time frame that I see for Americans to realize that the Internet is not going to generate endless profits. Thus Greenspan is running a race with catastrophe. Somewhere between 2003 and 2005, the stock market is going to wake up and realize that 'its not in Kansas any more' and that most Web business are not going to be very profitable.

At whatever point that realization occurs, the market could take a sharp tumble. Then business will even more rapidly begin to use the Internet to increase efficiency, as will all levels of public government, compelled by dropping tax revenue from a deflating economy. Increasing efficiency is just another term for cutting the work force. Another downward spiral of private investment for cutting labor and decreasing national income will have begun. Stagnation as Keynes described it will have returned, although for probably for a shorter length of time and without the possibility of another Keynesian debt-surge to resolve the crisis. I believe that unlike the 1930s, stagnation will not hold the American economy together long enough for something to revive it.

This time economic stagnation will feed into the first falling rate of profit crisis. At that point, America will have to develop enough cultural cohesion to permit a new input-output model to evolve over the existing Internet infrastructure or face a severe internal collapse. The question of survival will depend upon whether the left is prepared to drop the practice of diversity and the right is prepared to accept the idea of large scale federal involvement in the economy. By definition, the internal politics necessary for the input-output model to work requires a high degree of cultural cohesion- almost the exact opposite of prevailing left theory. A nation-wide input-output model cannot be constructed by private companies alone, nor can it function under the political regime of diversity.

Economic definitions are seldom agreed upon by different economic tendencies. These terms are likely to be disagreeable to some, but are at least a point of departure.These definitions as regards authors include only the theory as explained in this text.

Civil society: transformation of society from norms and mores based upon feudal, national and entho- cultural criteria towards more market-based criteria. Sociologist Max Weber described this a moving towards a more bureaucratic model, based upon written rules of law. Other sociologists described different 'continuums' of this transition towards modern identity as rural-urban or gemeinschaft-gessellschaft [see New Soviet Man]

Counter-cyclical spending [ Keynes ] : deficit spending by federal government during recession

Creative Destruction [ Schumpeter, Greenspan ]: process by which efficiency squeezes out some jobs, but new innovations and investment creates new jobs.

Falling rate of profit [ Marx ]: idea that too much investment in machinery might lead to too much overproduction/underconsumption and to general collapse of capitalism [see rising rate of profit]

Federal Reserve: government agency founded at beginning of 1900s, primary current job is to keep money supply current with aggregate production levels

Greenspan, Alan : Federal Reserve Chairman from 1987 until present, using revised model of 'creative destruction', Greenspan prevented possible Depression in October 1987, then supplied enough liquidity during early 1990s to fund the rising Web-based global economy

Inflation: situation with prices generally rising faster than production levels

Innovation: [Kondratieff, Schumpeter ] new technological idea or device capable of employing labor within capitalist, profit-making structure

Input-output model: [ Keynes, Leontieff ] way of combining the aggregate production of a country
with a distribution system, normally through the federal level; associated with America during World War ll

Keynes, John Maynard : 1920s through 1940s British economist who developed idea of counter- cyclical spending to stabilize business cycles

Kondratieff, Nicholai : Russian economist who helped develop 'long wave' model of capitalist
development, the idea was that 3 forty-year cycles had occurred between 1790 and 1913 and that some sort of self-stabilizing mechanism existed withinb capitalism; concept later became seen as contradicting Marx's idea of falling rate of profit, leading to Kondratieff's imprisonment and death

Labor theory of value [ Smith, Marx] : economic idea that the amount of hourly human, physical time
expended in the creation of a commodity largely determines its price; Adam Smith and David Ricardo created the concept; Marx refined and greatly expanded it; but since Marx, it has been fetishized into an almost religious quality by some leftist writers

Labor-Dominant Production : modern economic system in which commodities are produced with
large proportion of available workers involved and with most information in the process is spread out among the workers and management, and information control is relatively fragmented

Leontieff, Wassily : economist who helped develop the 'input-output' model with which the
United States fought World War ll

Liquidity trap [ Keynes ]: unusual economic situation where central back has lowered interest rates
close to or actually below zero (through artificially induced inflation ), but private investment in job-producing area is too slow to maintain good employment; much of modern economy was in such a liquidity trap during the 1930s, quite possibly present day Japan has been in a liquidity trap since the early 1990s

Long wave theory: [ Kondratieff ] idea that capitalism has gone through a series of up and down eras of profitability starting around 1790

Knowledge-Dominant Production : a new postcapitalist economic system in which commodities are
produced with a smaller proportion of available workers involved and with most information in the process centralized within a computerized network; the method of control over this information base will largely determine both the survival of this hypothesized system, as well as its political and social nature

Marx, Karl : radical economist who revised Adam Smiths and David Ricardo's labor theory of
value;basically Marx believed that the aggregate effect of the labor theory would be to promote too much efficiency in the manufacturing process and lead to economic crisis

Monetary policy: the acts of the Federal Reserve and the Open Market Committee which increases or decreases the amount of physical currency in the banking system and the short term interest rate

Moral hazzard : central bank policy of altering monetary policy, usually to monetize debts of major
financial entities facing looming unpayable debts; normally the term denotes pejorative behavior or unfair positive treatment by the Fed; the 1998 ?? 'coordinated effort' led by the Fed to bailout Long Term Capital scrapes very close to moral hazzard, the unwillingness of the Fed to lower interest rates to try to preserve the few surviving family farms probably is the opposite of moral hazzard

the 'New Economy': muddled concept of the American economy since the early 1990s; for present purposes, it represents the transition stage between the end of existing capitalism and a new, yet to be formed 'postcapitalism'

New Soviet Man (sic): belief by early Soviet theorists that it was possible to use massive government intervention to create new identity among peasantry of former Czarist empire, comparable to the changes apparent among European and American working class during the early 1900s, seen as 'civil society'. This concept was twisted by T. Lynsenko under Stalin to apply to genetic theory as well. At its base, New Soviet Man theory implies capitalism and socialism are equivalent, multiple roads to modern identity. Present day cultual diversity theory has part of its roots here, except that diversity has basically dropped the idea that there is something valuable about the modern identity. Theory required massive governmental police bureaucracy to continually monitor the population and possibly helped set the stage for Stalin's terror and purges of the 1930s. It was as successful in former Soviet Union as in United States, which is why the Soviet Union is no more.

Open Market Operations : the process by which the Federal Reserve attempts to regulate the money
supply through the banks by buying and selling bonds, if the Fed purchases bonds, this puts money into the banks, if the Fed sells bonds, this decreases the money supply; normally the Fed uses Treasury bonds in these transactions, but the current drive to erase the federal debt may alter this practice

Organic composition of capital [ Marx ] : the proportion of labor (or 'variable capital') and machinery
(or 'fixed capital') in the capitalist system; Marx believed that a rising organic composition would be associated with a collapse in the economy; this complicated term could be reduced to the idea of overly rapid efficiency increases leading into overproduction

Over production [ Marx ] : idea that GDP is producing more than can be consumed; roughly equivalent
to term 'under consumption'; opposite of 'supply-side' economics

Productivity: producing the same amount of GDP with fewer labor hours, also known as efficiency

Profits: difference between the expenses in aggregate production by a country's owning class and the amount that the owning class is able to charge for the aggregate production

Ricardo, David : English economist of the early 1800s who further developed Adam Smith's labor theory of value

Rising rate of profit : a new term created to explain how the Kondratieff long waves have tended to
mitigate the effects of increasing efficiency and Marx's falling rate of profit

Secular stagnation [ Keynes ] : term used to describe the difference between the 1800s model of
investing from the 1930s model; this type of investment tended to try to maintain short term profits within the monopoly sector; through investment in productivity increases within in a flat or slowly falling GDP; private investment continued throughout the 1930s, but not generally in job-producing areas; secular is another term for economic, thus 'secular' or 'economic' stagnation

Schumpeter, Joseph A. : Austrian economist who refined Kondratieff's long wave model, created term 'creative destruction' and trained many economists while at Harvard University

Under consumption [ Marx ] : idea that aggregate wage base in insufficient to consume all that economy is producing; roughly equivalent to term 'over production'

Velocity ( monetary velocity ) [ Keynes ] : the average number of times the physical money base
circulates or 'turns over' annually; a simple calculation is to divide the GDP by the physical currency base

Wealth effect [ Greenspan ] : a rapid rise in aggregate stock market value over the value of the real
GDP, which could lead to consumer demand for items not already produced and into inflation

Postscript:
Greenspan on Web Productivity and GDP Increases: The Road to the New Economy and Postcapitalism
Reuben L. Norman Jr., PhD
March 7, 2000

In testimony before Congress on February 23, 2000; Federal Reserve Chairman Alan Greenspan was asked about the immediate situation of farms. With short term interest rates rising, oil prices at high levels and farm commodity prices down, farm belt Congressmen are worried. Greenspan replied with an answer which went into the history of farm productivity, but ended with his usual reply, that farms will have to export their way out of the problem. Aside from the fact that farms have been following that policy off and on since the 1920s, even as the actual numbers of farms has steadily dropped; Greenspan's reply showed what could be a crucial fact in understanding his view on the Web economy. It may also have revealed a potentially fatal weakness in how Greenspan hopes to deal with the large productivity increases about to hit the American economy from the merger of business-to-consumer and business-to-business Web systems.

The road to stability in the New Economy cannot lie with the major trading blocs each trying to export their industrial surpluses. That was tried during the late 1920s. Today's New Economy is probably no more than a temporary stage in what will either become a successful or unsuccessful transition to a postcapitalist economy; a Web-based, real-time, input-output model similar to the American economy of World War ll.

First, it has to be stated just how wide and deep Greenspan's knowledge is on the broad sweep of economic and cultural history. Whatever one's views about Greenspan's policies, he is a true Renaissance man. It has been his extraordinary knowledge which has brought us thus far into the 'New Economy'. Having said that, it is fair to attempt to critique Greenspan's views, not in a negative accusatory fashion, but in the spirit in which he seems to operate, that of developing civil society into a global model.

Greenspan may or may not be primarily concerned with inflation at the moment. There is little evidence of inflation internationally or domestically. China and Japan have both been in deflation for several quarters, although recent evidence has appeared which indicates an amelioration in both countries. The euro has fallen from 1.17 to 0.97 per American dollar since its opening last year. In dollar terms, euro-denominated trade items have deflated by roughly 20%, although domestic European prices probably have not deflated much. Even in America, with the energy prices factored out, inflation is almost non-existent.

Greenspan has suggested that the rapid rise in aggregate stock market value over the real GDP could lead into consumer demand for items not already produced and hence into inflation. The idea of a 'wealth effect' as a possible cause of future inflation and consequently as a reason for increasing interest rates has plausibility; but Greenspan may have deeper concerns. I believe that Greenspan is worried about how the productivity increases of the early and middle 1920s may have fed into the 1929 crash, and then into the Depression. He may be trying to delay impending productivity increases from the head long rush onto the Internet in order to try to avoid a parallel problem within the next five years. (See Chart 1)

The Internet and Rapid Productivity Increases in a Stagnant GDP: Formula for a Depression

While fears of inflation are frequently brought out to justify interest increases, Greenspan's 'creative destruction' model of monetary management is far more nuanced and complex. The Internet promises to yield
huge productivity savings as it moves into the heart of industrial production. The problem is that overly rapid productivity increases may damage monetary policy, perhaps even lead into a Depression. He may believe that

if full conversion of the economy onto the Internet can be delayed some, so can the speed of the productivity increase and the potentially destabilizing effects of a large productivity increase may be prevented. This would be in keeping with his use of a model, where Fed policies are tied into keeping new innovations moving into the working economy fast enough to absorb workers displaced by efficiency increases.

The problem with this logic is that while too rapid productivity increases may overwhelm monetary policy, the primary problem is that once investment becomes oriented towards productivity increases in a constant size GDP -as opposed to an increasing GDP, the speed of this shift is less important than the fact of the shift itself. If the 1800s were a period of profits from increasing growth in labor-absorbing innovations, punctuated by periodic drops in the rate of return; the 1930s were a period of stagnant or falling GDP, with unstable profits maintained through investment in labor-saving innovations in the existing capital infrastructure. The solution to such a 1930s type of problem lies in developing a way to deal with a 30% to 50% aggregate productivity increase; not simply to dilute the rate of increase over more years, rather than face that rapid rise in only four or five years.

Greenspan seems to derive some of his thinking from the 'long wave' model of capitalist growth. This idea was first developed and popularized in the 1920s by Russian economist Nicholai Kondratieff. The model claimed that capitalism had gone through 3 'long waves' of approximately 40-year lengths since 1790. Kondratieff believed that capitalism had an internal, self-stabilizing mechanism. Long waves evolved into a direct argument against Marx's falling rate of profit model. After the crash of 1929, Stalin imprisoned Kondratieff in the Gulag where he died. Later, Austrian economist Joseph A. Schumpeter developed the term 'creative destruction' in describing certain aspects of the long wave. Greenspan frequently uses the term 'creative destruction' when describing his own model of the economy, but perhaps with different meanings than Schumpeter; thus Greenspan seemingly relies upon long wave concepts in his work.

Over Productivity and Production Increases in 1920s and 1990s: Disaccumulation

The productivity increases in America over the last five years have been extraordinary, perhaps unprecedented. Greenspan is not shy about telling people that he too is perplexed and somewhat unsure of the existing situation. The only era which seems comparable is that of the early and middle 1920s. What caused the 1920s increases, as well as how they should have been dealt with, remain major questions.

The key to understanding the 1920s is that at some point between 1923 and 1926, employment began to drop, even as manufacturing output continued its rapid rise; productivity began to increase faster than production itself. That is to say, the percentage increase in productivity began to rise faster than the percentage increase in the GDP. In 1968, economist Martin Sklar defined this employment-output gap as 'disaccumulation'. Since the non-inflationary rise in GDP is normally seen as being a function of the annual increase in productivity, plus the percentage increase in the working labor force; a temporary rise in productivity which is itself faster that the rise in GDP causes a problem in the mathematics of the GDP formula. Such an inversion over several years could lead to a decline in the employment level. By 1927, the continued rise in industrial production and decline in factory workers kept profits strong and fed into the stock market boom of 1928.

How this productivity rose so rapidly for so long during the 1920s is understood by a handful of economic historians, but has not become part of the mainstream view of economics. What seems to be missed even by the economic historians, is the relationship between this 50% productivity increase in the early and middle 1920s, the rapid rise in stocks in 1928 and 1929 and the collapse in October 1929. Hundreds of thousands of individual electrical motors were installed on assembly lines at the point of production and replaced the long belt-driven systems common since the beginnings of capitalism. A five year period betweenabout 1922 and 1927 marked a productivity increase of almost 50%. Small mechanical tractors began replacing mule and horse-driven farming, bringing similar efficiency increases to the farms.

The factory system has not seen annual productivity increases in the 10% range since the 1920s, but the trend towards high productivity increases on the farm has continued until the present. Farm productivity increases have exceeded the percentage increase in domestic demand for food and fiber almost every year since the middle 1920s. This explains why the number of commercial farms and farmers has dropped almost every single year since the 1920s as well. Where productivity increases continually outstrip the domestic demand in a sector, either that sector must send the extra production to external markets, or that sector must shrink its employment levels. In the case of farms, both things have occurred, even as the indebtedness and capital intensity of the surviving farms has risen.

Continued federal efforts at controlling these productivity increases since Roosevelt's first years have basically failed, so far as farm families are concerned. Before World War l, well over half of the population was required to produce the needed food and fiber, while less than 4 % remain on the farm today. What is so threatening about the Internet is that it has the potential to bring back the middle 1920s era of 10% annual productivity increases to the general economy and a medium term increase of perhaps 50% over five years. It should be recalled that the dictum in computers has been Moore's Law, which translates into roughly 70% annual productivity increases.

My belief is that the Web has become the transmission belt for bringing Moore's Law to the wider economy, although full 70% annual productivity increases are unlikely. To damage the American economy, productivity need increase only a few percentage points above the GDP, in the range of perhaps 5% to 8%. Increases above 10%, without corresponding export increases may almost immediately lead the American economy back into the 1930s. America's lead onto the Internet is perhaps 60 months ahead of Europe and Asia, but probably not much more, so exports are not likely to be a way out. During the early 1930s, few countries were able to peacefully increase their export markets sufficiently to resolve domestic unemployment. By the late 1930s, alternative means were increasingly used to obtain export markets.

The Stagnation Investment Model in America: Farming 1919-1929 & Service Sector 2000-2010

What probably predicts a period of secular stagnation is a rising ratio of annual efficiency increases to GDP increase, yielding ultimately such a ratio greater than 1:1. That is to say, an innovation applied to the capitalist system begins to allow efficiency to increase much faster than the overall GDP growth rate. Normally non-inflationary GDP growth is defined as the percentage addition of employment to the increase in productivity. Thus a 2% increase in productivity added with a 1 % increase in employment should yield non-inflationary growth of about 3 %.

When several quarters occur, in which productivity is higher are higher than the increase in overall GDP; something is amiss. Inflation becomes anticipated by the Federal Reserve, whatever the immediate balance between inflation and deflation. Thus in much of 2000, Alan Greenspan was pushing up interest rates- not to slow actual inflation, but to prevent anticipated inflation, whileglobally deflation seemed much more prevalent than inflation. And in the technology field, annual productivity increases of 75 % have become common. The Internet is the means by which the secular stagnation investment model may be transported into the general economy, especially the service sector.

Although it seems counter-intuitive to assert than efficiency may increase much faster than the over all GDP, manufacturing and agriculture America between about 1921 and about 1927 saw such a period with close to 10 % annual productivity increases. In fact, America agriculture has remained mired in Depression levels of overly-rapid efficiency increases. About 75 years of continuing rapid efficiency leading into rising farm debt

and huge overproduction of foodstuffs, has resulted in declining numbers of farms depending ever more on exports for basic survival, and requiring increasing federal subsidies simply to survive. Again, the Internet is the means by which the stagnation investment model may be transported into the general economy, especially the service sector.

Greenspan's Dilemma: Is a Conversion from the New Economy to Postcapitalism Possible?

What may be the worst problem for Greenspan, is that while he may see the need for slowing down implementation of the Internet, he cannot let it be known why. For if large numbers of investors came to see the1920s relationships in productivity being replicated in the early 2000s, this might not only slow down the Internet, it might begin to abort it and crash the market over night.

The reason that I broach this view is not to upstage Greenspan, but because it probably does not matter whether the Internet productivity occurs more slowly. If anything, the more rapid the process starts, the better chance civilization has that enough of the infrastructure will be in place before investors realize that profits are unlikely to result. In ways similar to the early 1990s fights over Russia's conversion to capitalism, the nascent argument over the conversion to postcapitalism is over whether it should be made in one fast leap or in slower stages. The argument in favor of one great leap used the analogy of trying to jump a wide canyon in 'stages', leaving the usefulness of 'stages' irrelevant. Seemingly the great leap has fallen short for Russia. Now it may be America's turn to try a new 'great leap forward'.

My belief is that the transition to postcapitalism must be done at close to full tilt. Whenever the market finally realizes that profitability on the Internet has become irrelevant, the political structure will have to pick up the pieces, just as it did in the 1930s. Only this time, the possibility of a Keynesian, debt-driven solution may not exist, nor will countries be able to deal with excess production through exports. The next American input-output model will not likely have a foreign military attack as a basis for political legitimacy, nor can it be developed on a platform of cultural diversity.