Kumhof and Ranciere are Mostly Right but They Oversimplify One Thing

by 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.

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.

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