Kumhof and Ranciere are Mostly Right but They Oversimplify One Thing

February 6th, 2011
in Op Ed

Derrylby Derryl Hermanutz who has contributed to GEI previously on topics related to theory of money and relationships between current events and economic history and philosophy.

Kumhof and Ranciere basically begin their analysis of financial crisis cycles with the "commercial revulsion" scenario of JS Mill, where investors gain a growing share of the national income and eventually the producing and consuming economy grinds down to recession due to dearth of working class incomes to support consumption that purchases production.

Follow up:

In Mill's scenario, investors blow their money on loser speculations which recirculates the money and drives the economy out of depression. In Kumhof and Ranciere's scenario, which is the modern world of credit money rather than the gold money world of Mill, investors respond to the lack of demand in the economy and to their falling returns on capital by "lending" money to the increasingly income-impoverished workers so the workers can keep buying and keep the profits and the loan interest payments coming in. Of course this increases worker debt to income ratios until the workers break and we get a crisis.

K and R divide the population into 2 classes, investors and workers.  About 5% of the population is investors and the other 95% is workers.  They note that when the crisis hits and loan defaults soar, bailing out the supply side, the investors, merely adds to the future tax burden of the workers and makes a final crisis/collapse even more certain. So they advocate bailing out the workers, the demand side.

K and R attribute the increasing income and wealth inequality (that leads to crisis) to an ongoing change in "bargaining power" between investors and workers. Clearly, in so many words, they are talking about legislative and regulatory measures that favor capital over labor. They don't go as far as I do and actually advocate creating new money and giving it to households, but they do advocate changing the tax burden to take money from the rentiers and leave more in the hands of workers. They advocate taxing land rents, financial rents, and natural resources, very much consistent with the views of the classical economists who sought to liberate the productive sectors from the economically destructive predations of the rentiers.

They note that capital taxes will merely induce capital flight, as we already saw with hamfisted nanny statism that sought to saddle the productive business sector with all the costs of ensuring little Timmy and Tammy are safe and warm at work, which drove American production offshore and starved the US of real investment along with all the domestic production, employment and incomes, and profits (not to mention taxes on these) that flow from having your own real working domestic economy.

There's a big difference between "real" capitalists who actually put the economy to work and create real economic value, and "rentier" capitalists who merely funnel the financial wealth of the economy into their own pockets. Real capitalism is a positive sum value creating process that simultaneously produces goods and pays out the earned incomes that can purchase those goods. Real capitalism generates economic production and prosperity. Rentierism is a zero sum redistribution of wealth from the productive sector to the financial sector. Rentierism generates billionaires and paupers and ultimately financial and economic collapse. So I'm all in favor of shifting the tax burden onto the rentiers and lightening the load on the producers.

As illuminating as the K and R study is, I feel there is one shortcoming.  There should be more than two economic classes considered. It would be a mistake to include resources extraction in the rentier category.  A group of people who "accidentally" gained control of Alberta's government in 2006 (long story, but we're fixing the problem) pandered to leftist pressure and introduced an "Our Fair Share" increase on royalties against our oil and gas sector. In a province with a $200 billion GDP, they expected to extract an additional $1.4 billion in annual royalties. It was a catastrophe.

The plan was announced in 2007 and the new rates were to come into effect on January 1/09. But in 2008 a funny thing happened. Land sales for new exploration rights, which had been over $1 billion annually, plummeted to around $100 million. Meanwhile our neighboring provinces of Saskatchewan and British Columbia, who had been decreasing their royalties and taxes to compete with what had long been "The Alberta Advantage", each saw their land sales rise by hundreds of millions of dollars to record levels for both provinces.  "Our" oil and gas sector became "their" oil and gas sector. Alberta's Stelmach government was the best thing that could have happened to Brad Wall and Gordon Campbell, who saw their economies boom at our expense. Needless to say, Stelmach's gang was compelled to abandon their tax grab and restore the old longstanding and realistic royalty regime.

Land sales is only the beginning of government revenue from oil and gas, and any other natural resource development. These guys buy rights intending to exploit them, so I'm guessing that our billion dollar reduction in land sales lost us $7 - 10 billion in subsequent investment in exploration and production, which would eventually generate some new royalties. Meanwhile the province and the federal government are collecting payroll and income taxes from all the workers on the exploration and development projects, and corporate taxes from all the companies. Alberta and Canada were raking in a killing on Alberta's oil and gas investments and production, and all it took was $1.4 billion too much of "our fair share" to kill it.

Developing natural resources is a very capital intensive, long time horizon, and risky business. The resource sector is extremely sensitive to regulatory and royalty uncertainty, and highly responsive to punishments as Alberta's vanishing explorers demonstrated. So while I agree with K and R's analysis of the causes of the current crisis, and I agree generally that the solution requires restoring a larger share of national income to the 95% of the population who make a living by working and whose consumption that is enabled by their earned incomes comprises 71% of GDP, I can't agree with lumping natural resources into the "rentier" category. Exxon is not a 'rentier'. They are a big profitable producer of an essential resource.

If you kill your resource extraction sector with regulatory and royalty creep, all you'll have left is your financial sector and "services". Try building houses and cars and computers with money and manicures and massages, after your mining sector has abandoned your greedy ass and you have no more raw materials.

Aside from the one inference that would place resource development and extraction companies (and possibly other producers as well) in the same class with financial rentiers, Kumhof and Ranciere have done a masterful job of modeling the financial cycle and have written a paper that should be studied by all those who think they know everything there is to know about the financial crisis.

Related Articles

Inequality, Leverage and Crisis by Michael Kumhof and Romaine Ranciere

The Real Cost of China’s Non Performing Loans by Michael Pettis


Devil’s Bargain by William H. Gross


The New Feudalism by Derryl Hermanutz



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  1. Paul Hanly says :

    "Try building houses and cars and computers with money and manicures and massages, after your mining sector has abandoned your greedy ass and you have no more raw materials."

    But they do have raw materials, they just haven't extracted them yet. In fact they have saved, particularly in USD when you look at the current price of most commodities. Extracting all your resources and selling them in the short to medium rather than the long term decreases security, wealth (once the materials are extracted and sold the wealth is gone if invested in depreciating assets like housing, SUV's and flat screens, or even roads, bridges and airports).

    Nauru and its guano/phosphate is the classic example of the effects of overly fast resource extraction.

    Limiting resource extraction through pricing mechanisms is a valid long term strategy for intergenerational equity of citizens.

  2. Derryl Hermanutz, Correspondent (Member) Email says :

    Even if I was advocating sucking out all natural resources at breakneck speed, which I am not, the pace of resource extraction runs up against natural economic limits. There is a limit to the number of specialist contractors and equipment and skilled workers in any segment of the extraction industries and when too many projects try to start at once contract and labor prices soar so high that the projects become uneconomic and projects get cancelled or put on the back burner. This was happening to new Alberta tarsands projects in the years before the crash of 2008. "Green" (i.e. inexperienced) contractors and green labor make all the rookie errors and are very inefficient, so you can't just bring a bunch of new guys into the field and expect them to get the job done. There's a learning curve, and everybody has to climb the steep slope before they really know what they're doing and can make money at it.

    On the front end, there is coming to be a shortage of experienced petroleum and mining engineers, as the old guys are either retiring or dying and there has not been a steady stream of new guys coming into the field to take the torch from them. Young guys prefer nice clean computer work in an office in "civilization", preferably in the financial sector where pay is very high. Resources are out in the hard old bush, and that's where good engineers are needed. But you can't get "good" without doing your time in the bush and paying attention. Economic activity is "physical", and you're going to get your hands dirty doing it. But young workers don't want to get their hands dirty and this is creating a problem.

    Commodity prices are notoriously cyclical and when they are down, new land sales and resource development is down. True, the economic viability of the largest multi billion dollar projects like new tarsands plants or potash mines or copper mines is calculated across many commodity price cycles as these projects will produce for many decades, but if there is significant present day evidence that there will be demand weakness and low prices in the global economy in the next few years or decade these projects do not go ahead at this time.

    These are just a couple of the natural limits to growth of the extraction industries. In addition we have the thing that keeps Bill Gates awake at night. He worries that right now some guy is working in his garage designing a revolutionary technology that will make Windows as obsolete as a buggy whip franchise. There is currently major effort devoted to replacing fossil fuels as our primary source of energy. Personally I don't put much faith in "magic solutions", but I cannot deny the possibility that somebody might come up with a Tesla-like solar solution that will make our "burning fuels" obsolete. In the early 20th century fossil fuels were referred to as "solar power", because it is the stored solar power in these ancient plants that is released when we burn fossil fuels. If somebody figures out an efficient and cost-effective way to capture today's solar power, and a utilities-scale battery technology to store the energy for all the times 'when the sun don't shine', then within the next few decades the oil producing economies could find their main economic resource rendered economically worthless.

    Nobody can predict the future. Extrapolation of present trends, as any seasoned market investor will tell you, is a fool's game, because trends change and shift into reverse. Reality is complex, not linear. "Make hay while the sun shines", and produce your resources when there is a profitable demand for them. As far as we are capable of knowing, that's the best advice we can follow. And in fact, that's the principle that determines the pace of resource extraction.

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