Russia: Reversing Economic Polarization and Poverty

August 11, 2011
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Policy Conclusions for Russia (Part 2)

Read Part 1

The most obvious caused poverty is by debt. And the largest category of personal debt in today’s world is mortgage debt to obtain a family home of one’s own. The price of homes rises when taxes are lowered (or shifted off property and onto employees), because more rental value is left for new buyers to pledge to banks for loans to buy the property on credit. From America to much of Europe, families have to take on a lifetime of debt in order to obtain housing of their own. The winning bidder for property is whoever pays the most of the site’s rental value as interest. So the banks end up with the rent. This is why the financial sector has grown so rich, and also why debtors have so little money remaining to spend on goods and services. So markets shrink and economies fall into recession.

The second problem impoverishing labor from North America to Europe is the tax shift off wealth (especially off finance, real estate and monopolies) onto employees and consumers.

These two problems can be solved simultaneously by following what classical economists recommended: basing the tax system on “free lunch” income: land rent and monopoly rent, while keeping as many natural monopolies as possible in the public domain to provide services at subsidized rates or freely (as in the case of roads, water, etc.).

It may seem counter-intuitive to say that rising real estate taxes will lower housing prices, but it is easy to explain. A major reason why real estate prices have soared is the fact that the tax collector has relinquished its tax obligation. The high point of land taxation in England, for example, was in the Doomsday Book ordered by William the Conqueror. The idea was that land ownership would be the tax base. Increasingly, landlords fought back to “free” themselves of this tax. These efforts forced governments to tax sales and income of labor and industry. The result was that lower property taxes “freed” land rent to be pledged to the banks for mortgages, while shifting the tax burden onto the production-and-consumption economy.

This tax shift had a major negative impact on the national interest. Taxing the land and monopolies leaves less to be pledged for bank loans, and hence keeps down the price of housing, office building and other debt-financed rent-yielding assets. But taxing labor and industry (via sales taxes, income taxes, etc.) raises the cost of living and doing business. So this tax shift makes economies less competitive internationally.

A third cause of poverty is the impositions of economic austerity programs, such as long have been imposed by the IMF and other Washington Consensus agencies. Austerity facilitates a “take the money and run” strategy by the financial interests to bail out – to move their money abroad, or to lower costs in the short run. This hurts the national economy in the longer run.

The particular manner in which privatization has been handled (without price regulation and with tax deductibility for interest payments and “false” offshore charges) is a fourth cause of polarization – again, at the cost of undercutting economic competitiveness. American business economists of the late 19th century explained that the nation could become more competitive by treating public infrastructure investment as a “fourth factor of production” alongside labor, capital and land (Simon Patten’s words). Its “return” did not take the form of income (wages, profits or rent), but rather the degree to which it would lower the national price structure.

By contrast, privatization in a financialized manner adds on pseudo-costs. These technologically unnecessary charges are headed by the credit borrowed to buy the asset from the government, high payments to management, and most of all, stock options and capital gains. In effect, privatizers install “toll booths” across the economy to extract economic rent.

Policy conclusions to alleviate poverty

The wealth of any nation is its population. It is wasteful to reduce families to poverty. The aim should be to make them more productive. The economy is an overall system, and this requires an economy-wide regulatory and tax structure so as to steer wealth seeking in ways that add to national output and promote the national interest, not that benefit the rich at the expense of the poor.

So what I would like to hear at the conference is how best to avoid poverty, in ways that will promote the national interest by freeing the economy from turning the poor into economic overhead. My recommendations for Russia involve remedies along the following lines that I would like to see discussed:

1. At present, taxes fall on the economy’s lowest-income groups – mainly on consumer goods and on wages. By increasing the cost of living and doing business, this squeezes employees and employers alike. To avoid this fiscal cause of poverty, we must ask what kind of taxes steer wealth into the most productive lines, by lowering the economy’s cost of doing business, and preventing “negative-sum” predatory economic activities that impoverish the population? More specifically, is a tax shift onto land rent and monopoly rent (as Dmitri Lvov at Russia’s Academy of Sciences advocated in the 1990s) preferable to sales and income taxes?

2. At present, debt service is absorbing a larger share of personal incomes and corporate cash flow than ever before. This leaves less for spending on consumption and investment, and therefore shrinks markets. To avoid this financial cause of poverty, how can the banking and financial system be structured to fund the creation of new capital rather than merely to transfer ownership rights to property and companies already in place?

3. The shift to privatization has built in financing charges (as companies and assets are bought and sold on credit), high executive salaries and stock options into the price of basic services. By contrast, the U.S. economy got rich by providing these services at subsidized user fees or freely, so as to minimize costs. The aim of classical economics was to bring price in line with (minimum necessary) cost value. Financial charges and “economic rent” add to “empty” pricing without cost value. How can the most basic costs of living be minimized, by public subsidy or direct provision – much like sidewalks and roads, health care and other basic infrastructure services? And in general, how can the financial, real estate and monopoly overhead be minimized to make economies more competitive?

4. When governments are prevented from creating central banks to finance their deficit spending, the public sector must pay banks to do this. Yet central banks from the Bank of England to the U.S. Federal Reserve were created to finance the government deficit and thereby minimize the interest charges on the public debt. By contrast, the European Central Bank is prohibited from providing this basic function, and hence is not a “real” central bank. To minimize the financial cost of government spending, what is the most appropriate role for central banks to fund government deficits, rather than paying interest to commercial banks for electronic keyboard credit creation that government agencies can provide themselves? In other words, to what extent should governments finance their own operations, rather than giving a free lunch to commercial banks for the credit-creating privilege?

5. From the early Enlightenment to the flowering of classical political economy into Marxism in Europe and institutional analysis in America, the aim of economics was to free economies from unnecessary overhead, and provide a guide to public investment and tax policy in the national interest. This is the body of reform that led the Progressive Era to steer industrial development to raise labor productivity and upgrade production. Keynesian economics sought to stabilize economies with public spending, in the context of “euthanasia of the rentier.”

Today’s neoliberal economics, by contrast, is a program of economic shrinkage with a redistribution of wealth and income to the rentier classes. To assess the effects on economic growth and national interest, what is the most appropriate body of economic theory to be taught, to steer national policymaking? Has neoliberal economic philosophy disabled government policy by denying the classical distinction between productive and unproductive (parasitic) investment, credit and modes of wealth seeking? How best can economies prevent “rent-seeking” extractive activities by monopolists and the banks behind them?

Back in 1945-46 when the IMF and World Bank were being formed, the Soviet economy was excluded because Western planners worried that its economy was free of the rent and interest charges that “free market” economies had. The thrust of classical economics was precisely to free economies from these rentier charges, treating them as an economic overhead. Yet the advice given to Russia since 1991 has led to maximizing the financial, real estate and monopoly overhead that Western countries rose to dominance by freeing themselves from.

Can Russia get the best of both worlds by freeing its economy from technologically unnecessary charges and rentier tolls paid to special interests? Such expenditures prevent the economy from developing. That is the basic cause of poverty – and hence of national decline. Now that neoliberal financial lobbyists have turned Progressive Era economic reforms upside down, it is necessary to “reform the reformers” in order for Russia to rebuild its economy in the way that made the U.S. and Western Europe so successful during their economic takeoffs.

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