1.1 Modern Economic Institutions: A Short Historical Perspective; Two Models of Development
revised/edited 11/2010, 1/2012, 7,10/2016, 4/2017, 4/2019
1.0 Introduction and Summary. Misconceptions in Economic Thinking, Climate Crisis – Quality of Life
1.1.1 Developments since the Middle Ages
1.1.2 Shifts in economic thinking and their consequences
1.1.3 Dichotomy of side-by-side existing economic models
1.1.4 Misconceptions regarding capitalism
• Economic developments have significantly accelerated since the late Middle Ages.
• As sciences and technologies developed, European companies conquered and exploited most non-Europeans; kings and premodern capitalist institutions financed the enterprises.
• While cities’ middleclass flourished, poverty and malnutrition of the masses worsened.
• After 1800, nutrition improved, but most craftsmen became destitute workers.
• In the anonymous dictatorial enterprises and many government agencies, corruption has been a major problem.
• The role of banks and investors became extremely important; by individuals and institutions owned money was largely replaced by credit from financial institutions.
• Economies grew but were very unstable; indebtedness has added to the instability; frequent recessions and debts have been detrimental for the lower middleclass and poor.
1.1.1 Developments since the Middle Ages
Since the late Middle Ages, the development of entrepreneurial manufacturing very gradually accelerated. Guilds (first associations of religious groups and later including merchants and manufacturers) gained power and competed with the aristocracy. The dominant role of religious and aristocratic hierarchies decreased. Very gradually, scientific work began to address technological problems and promote improvements. The printing press and religious leaders’ loss of power after the Reformation led to a further acceleration of progress. Wind- and waterpower were more and more utilized, and there was a readiness for the development of the steam engine and later internal combustion and electric engines.
As wealth increased, medieval economies, in which interest earnings were forbidden, were gradually replaced by premodern capitalism and the development of modern financial institutions. Economies grew, however, populations grew as well, and the general health of the poor kept deteriorating as exemplified by very stunted growth and delayed development, At the time of the French Revolution, Europeans were much shorter than in the early Middle Ages, and puberty was delayed into the late teens. In the nineteenth century, nutrition and physical development of people gradually improved, but the quality of life of workers seemed more dismal than previously. In the early and mid-twentieth century, poverty declined, and health, nutrition and general quality of life appears to have improved in most parts of the world, particularly the highly industrialized countries. Western Europeans appear to continue in their progress towards a very healthy, tall people; they surpassed the population of the USA around the 1950s1.
Much of the rural poor in the Third World made little progress except with regard to infant/child and maternal mortality. The growth of most children of the Third World is stunted. Economic development in much of the world has been uneven and erratic. In recent decades, there has still been an unacceptable level of unemployment and in many areas, the income gap between wealthy and poor has been widening2.
A major widespread problem in complex societies has been corruption. When dealings within enterprises and government agencies are anonymous and inaccessible to journalists and other outsiders, there are always incentives to act unethically. Corruption greatly interferes with efficiency and progress; it often leads poor people to feel trapped in poverty and it discourages efforts towards improvements.
Economic growth and progress in capitalism are inherently unstable: if competition works well, profit margins shrink, slowing industries’ research and development. When a few corporations become much more efficient than their competitors, they will earn more profits and advance even further. Many less successful enterprises fail, and unemployment leads to a contraction of the economy. Small new industries will try to find new niches, and may compete for some time with very little profits to invest, until, in a new cycle, most efficient companies crush most small competitors. Financial institutions’ actions further destabilized economic growth.
See also: Appendix A – Poverty and Hunger in Economic Theories 
1.1.2 Shifts in economic thinking and their consequences [revised 8/2015, 7/2016]
With the spread of modern capitalism, major shifts in economic thinking took place:
• Profits became widely considered the mark of success and progress. If a product or service sells, economists assumed that it is desired by people and good for society, even if it is known that the product is deleterious for consumers, other people, and/or future generations.
• Ownership rights, considered crucial in a modern economy, were gradually expanded. There is hardly any public land that is communally used other than parks and roadways.; in many countries resources found in privatized land are considered owned by land owners, rather than society at large; even springs and rivers are in many places private property. Copy and patent rights have been broadly expanded even though much of what is patented is based on research that is old and/or mostly carried out in public institutions. Chemical industries even patented plant products that have been used for centuries if not millennia.
• Financial institutions propagated expectations that goods and services be available at any time: we should get them on credit and pay for them as we utilize them. In the past people usually used their savings to replace worn-out durable goods and to add new ones. To start a family business, family savings were often pooled. While money still serves to measure the economic value of goods, it is no longer expected to belong to people, businesses, and governments: money has become a “commodity” we “rent” from financial institutions.
• The big majority of U.S. businesses rely on investors. Corporations then have a fiduciary duty to pursue profits for the investors and profits for the owners (shareholders) become a primary goal. They have no longer the right to primarily work towards the founders’ goals, act ethically, consider ecology, etc.
• In large corporations, the founders are no longer owners and persons in charge unless a committed core group keeps 51% of the shares. Profits are a priority of their boards ahead of ”idealistic” ideas and ‘mission’ of the founders, and company founders may even be dismissed. Often, even long-term planning is not a priority, as potential buyers of stock mainly look at present profits (‘returns’) and shareholders may not intend to keep their stock for long.
• People generally associate high prices with value. With credit, people readily pay high prices for what they consider valuable, and conversely, if something is marketed with a high price tag, they usually believe that it is valuable. In addition, unconscious associations with instincts make many inferior products attractive (e.g. shoes’ brand name labels imply belonging to an esteemed social group, impractical cars may suggest masculinity, individualism and high rank. Poor people generally want the products middleclass people usually choose.
• Rather than new money being infused into the economy by paying for government-sponsored projects, banks expanded the money supply by irresponsible, erratic lending; and when federal banks increased the money supply to save the collapsing economy, the money was infused into the banking system as reserves and to encourage more lending. If consumers would stop buying on credit, the economy would collapse. However, being indebted has severe psychological consequences, particularly if borrowers have to pay high interests: indebted people ‘discount’ or largely ignore their future since they do not know whether they will be able to pay back loans and keep what they consider and use as their property. Indebted people are at an increased risk of becoming depressed, committing crimes, abusing alcohol and drugs, and committing suicide.
1.1.3 Dichotomy of side-by-side existing economic models
Capitalism led to a dichotomy between two development models that still exist side by side.
In one model individuals or small groups of people produce something or provide services based on their skills, knowledge, ideas and goals. Their work often reflects their values, ethical goals such as improving aspects of daily life, and satisfaction with their work is generally more important than earning more than a decent income. Family shops, small manufacturers and other entrepreneurs, teachers and health care professionals work in this model: the producers and service providers use their skills and knowledge without secrecy. Highly specialized professional service providers may find ways of improving techniques; they then may teach others to incorporate the new ideas in their work and advancements spread. In a family business, improvements are generally visible and soon copied by others. Entrepreneurs with novel ideas still benefit from a reputation as leaders in the field. Their success is hardly threatened as others follow their lead. They generally treat their employees well leading to a stable, productive workforce. Thousands of small businesses do well because they adapt to local conditions, work on improvements and often develop techniques that make them leaders in their niche. Professionals and small businesses working in this model usually earn a decent income and they enjoy work satisfaction and relative freedom, though some may not survive hard times (particularly if they are indebted).
Universities worldwide operate according to these principles. Much basic and highly specialized research has been made available to academicians, engineers, and entrepreneurs worldwide. The researchers are generally acknowledged and may earn awards, but they never earn profits.
The other model, the capitalist corporate model, is much more visible and assumed to be the driving force for progress. A person may start a business based on a good idea, for instance an improvement of a generally known product, but then sells the business to investors or a large corporation. The investors promote the idea and, if successful, create a network of producers and distributors. The founder is no longer in control. Patents are sought to protect profits by barring others from copying the product or service. Progress through further development is limited to the patent holder and inhibited by the investors’ greed. Improvements of products are often delayed until their patent is to expire or a competing product becomes similarly attractive. Often, rather than improving deficient products, more money is invested in misleading advertisements. In medicine, rather than developing new medications, diagnostic tools and treatment devices and then promoting them to universities worldwide, many inventions have been patented and investors sell to maximize profits: expensive enough to reach a large profit margin, but cheap enough to sell the product widely. In the U.S. car market, new, relatively cheap safety and fuel saving devices are rarely available in basic models, until competing brands offer similar devices in their less expensive models. Consequently, advanced products and services are accessible to many in the highly industrialized world but most of the poor cannot afford them.
Large corporations are not as efficient as expected because of complex administrative structures, divergent priorities and inflexibility. Their philosophy of the workforce being expendable and to be exploited often interferes with achieving high quality work.
Modern capitalist economies failed to recognize non-profit corporations that produce for societies valuable goods and services, either selling what they produce at production cost or leaving all profits within the enterprise, using them to do furhter research and devlopment work and/or to educate employees and people benfitting from their experise. In capitalist countries likie the U.S., such non-profit corporations should be tax-free and donations to them tax-detuctable. Governments should promote such priavet corporations that may work for governments as contractors, building infrastructure, offering education and health care, etc.
1.1.4 Misconceptions regarding capitalism
There are many myths concerning capitalism. Capitalism was not the cause of the accelerating progress in sciences and technologies – capitalism developed concurrently. Excellent educational institutions and small entrepreneurs are most effective in promoting progress; large corporations tend to block progress, often lobbying against imposing standards of safety and efficiency; and financial institutions’ primary goal is to skim profits from people’s productivity. While some degree of economic freedom of entrepreneurs is important for progress, limits that protect the interests of individuals and society at large are essential.
Capitalist economies may be assumed to be akin to democratic governance, but most corporations are not decentralized and governed in a dictatorial way, and many capitalist countries were and are autocratic. Large corporations exercise more centralized power than most government agencies; and corporations’ lobbying often interferes with democratic processes. Rather than consumers influencing progress, “voting” with their choices, corporations work on shaping people’s wishes by compellingly advertising what is enticing and most profitable rather than what improves quality of life. Advertisements are often misleading and much relevant information is unavailable to consumers. Economic growth (a rise in the gross domestic product) has been a primary goal of most political parties and there is a widespread belief that it is closely related to improved quality of life. Often it is not.
While Western societies made enormous progress in many fields, modern capitalism is fundamentally flawed. Capitalist economies are inherently unstable. Successful corporations easily move towards a relative monopoly position, which destroys many smaller businesses and greatly reduces incentives for further improvements. On the other hand, effective competition minimizes the profits that are needed for research and development. Capitalist economies have largely ignored needs of people with low income, except that small lenders often profit from their plight. Individuals can, theoretically, choose products and services they buy and jobs they accept, however, choices are usually limited, particularly for the poor.
An additional problem is that the appearance of stable progress greatly encourages reckless speculating and lending. The consequence has been frequent credit crisis, recessions and government bailouts of financial institutions. Because of the political power of financial institutions and lack of economists’ understanding of the problems, there have rarely been appropriate regulations to rein in parasitic banks, security traders, etc. Regulations from the 1930s that were quite effective were later misunderstood, considered obsolete and abolished. Immense suffering has been caused by these failures of governments3.
Free markets and incentives to develop new enterprises are vital for progress. However capitalism misguided people’s inventiveness and entrepreneurial aspirations; it has not eradicated poverty. Capitalism has led to a widening gap between rich and poor. Since capitalism does not work in the interest of societies, governments took steps to soften its negative impacts. Welfare agencies and safety nets were established. Laws address the abuse of employees, hazards of products and production processes, etc. Laws restrict and regulate corporations, and particularly European economies are considered “mixed” rather than capitalist. Today government agencies address air and water pollution, product safety, and conditions of workers. However, problems remain; industries and investors continuously fight governments, and industrialized countries have failed to adequately control pollution and greenhouse gas production, even if steps have been taken. They have not created viable models of development for underdeveloped countries.
It is clear that global capitalism in its present form is not an answer to the world’s grave problems. Allocation of resources based on free market principles often works against the interests of the poor within democratic countries and in the Third World. Governments often worsen the situation by supporting the interests of large corporations and financial institutions, and they distort free market forces. Global capitalism has led to dire ecological damage4. Its effects are unpredictable. However, it dominates the world and suppresses existing and developing alternatives.
There is a lack of guidance by leading economists: rather than a science pointing the way to better economic institutions, leading economist appear divided along party lines, and we must ask whether economics has even become a science. Most economists, including federal reserve chair person Allan Greenspan, were unable to recognize the flawed, dangerous trading, the inherent dangers in speculating with borrowed money, etc. which led to the 2007-08 and previous less severe economic crisis. While some economists saw dangers, and economic historians pointed out a cyclicity of crisis in the recent centuries, there was certainly no agreement among the Nobel Prize winning economists. There is not even agreement on what the role and nature of money should be. Sciences are to create broadly accepted models that explain processes and also have predictive value. Modern macroeconomics fails both tests.
1 Research summarized by Burkhard Bigle in “The Height Gap,” The New Yorker, April 5, 2004, pp 38-45.
2 Thomas Picketty, in Capital au XXIe siècle, 2013 [Capital in the Twenty-First Century, 2014] describes the in capitalism inherent propensity of private rates of return remaining, for long periods, larger than growth of income and output; wealth accumulated in the past tends to grows more rapidly than output and wages.
3 Many economics writers describe the grave danger of a worse collapse of the financial system in the late 2010s due to leveraged speculating in derivatives, the unregulated, irresponsible ‘shadow banking system,’ and they see how ‘financial services’ became self-serving and parasitic; among others:
Joseph Stieglitz: Freefall, 2010
Niall Ferguson: The Ascent of Money, 2008
James Rickards: The Death of Money, the Coming Collapse of the International Monetary System, 2014;
Bob Ivrey: The Seven Sins of Wall Street, 2014
Felix Martin: Money, the Unauthorized Biography, 2014
Mohamed A. El-Erian: The Only Game in Town, 2016.
4 Vandana Shiva, Indian physicist and activist, expressed in many publications and interviews the destructive effects of economic globalization, as it is led by large corporations. GATT, patent laws and treaties regularly support corporations and disregard the will and needs of people. Compare also:
John Cassidy: “Master of Disaster – A leading economist says the protesters have a point about the I.M.F.,” The New Yorker, July 15, 2002.
Joseph Stiglitz: Globalization and Its Discontents, 2002, W. W. Norton & Company, Inc. (http://books.wwnorton.com/books/Author.aspx?id=5944).
George Soros: On Globalization, 2005, PublicAffairs Books