Abstract
Capitalism is notoriously known to be prone to crises, referred to as recessions and depressions. This chapter discusses how institutions govern the production processes in a social division of labour and how the functionality of these institutions determines whether these production networks fail and cause an economic crisis. The chapter provides an overview of developments in economic history from this perspective. In particular, in this view the “Great Panic of 2008” can be understood as an institutional crisis in the financial networks of the global division of labour. This chapter also looks at the state of the global economy after 2008 and considers possible future trajectories for institutional economic development.
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Notes
- 1.
Here I refer to Phillips (2008), Akerlof and Shiller (2009), Stiglitz (2010), Johnson and Kwak (2010), Varoufakis (2011), Harari (2014), Haegens (2015), Mason (2015), Roberts (2016) and Harvey (2017). Many of these books put the financial crash of 2007/2008 in a historical perspective and some of them are completely focused on human history and development. Many of these authors propose a historical view that is not founded on a neo-classical economic perspective. The reason is that this perspective actually does not make a lot of sense when it comes to explaining human (economic) history in general and the crisis of 2007/2008 in particular.
- 2.
The most contemporary example of such institutional innovation is the emergence of the internet and its usage since the early 1990s. Initially the internet only had a marginal effect on economic performance, but more recently its use has expanded into a more developed source of economic wealth creation through information gathering, cloud computing and the Internet of Things. Information technology is now clearly causing fundamental changes in the governance system of our contemporary global economy.
- 3.
From a biological point of view, human evolution originated earlier than 70,000 years ago; approximately 100,000–280,000 years ago. Initially, DNA analysis by paleoanthropologists confirmed that there was a common human ancestor, who originated from Africa. Through DNA this human was identified as a female, “Mitochondrial Eve” (Cann et al. 1987). Later, Tishkoff et al. (2009) used data from alternative sources—not just mitochondrial DNA—to conclude that the Angola–Namibia border region near the Atlantic Ocean is likely to be near the geographical point of origin of modern human genetic diversity. This origin was founded in an ancestral tribe, rather than a single ancestor.
- 4.
Bowles and Choi (2013) point out that the agricultural revolution seems to a chicken-and-egg problem; technology and institutions evolved in tandem. Most problematic here is that agriculture was initially not more productive than traditional foraging (Bowles 2011). The emergence of property rights therefore cannot be explained as an institutional response to promote and protect these more productive activities. Rather, Bowles and Choi (2013) point to a coevolution of property rights and farming: farming requires a system of property rights, which is not viable in a foraging economy; property rights required farming and farming required property rights.
- 5.
“Res Publica” translates from Latin to the “public thing” or “public cause”.
- 6.
Compared with the medieval guild system, a collegium was a much more open and localised association. It did not regulate the entry of new workers into the profession, in this regard being more akin to a (local) union or representative association. I refer to Epstein (1991) and Beard (2015) for more details.
- 7.
There are some doubts about whether the Yersinia pestis bacillus was indeed solely responsible for the epidemic. Descriptions of contemporaries do not fully conform with the known disease patterns that it causes. Since the epidemic occurred nearly 700 years ago, we might never know what the exact cause was.
- 8.
The 1381 Peasants’ Revolt in England is well known and acts as a prime example of this new-found awareness among peasants.
- 9.
For example, bread was produced through a chain of a farmer producing wheat; a miller grinding the wheat into flour; and a baker converting the flour into a loaf of bread. Of course, bread requires more intermediary inputs, such as yeast and butter, and capital assets such as a mill and an oven. This shows that a chain in the social division of labour has a tree-like structure with multiple product chains leading to the producer of the final consumption good. This example also reflects the fundamentally urban nature of a horizontal social division of labour.
- 10.
The notion of the world-system in the social theory set out by Immanuel Wallerstein (2011a,b,c,d) has similarities to the notion of a socio-economic space as a theoretical construct to address questions concerning and developing models of economic wealth creation processes. Wallerstein’s notion of the world-system is less institutional in nature and incorporates more political elements into its construction.
- 11.
Again I emphasise that this list is far from a complete typology. For a more comprehensive view of institutional change after 1650, I refer to Allen (2011), who includes discussion of unexpected institutional change during the industrial revolution.
- 12.
The cultural historian Jonathan Israel has promoted forcefully the viewpoint that Spinoza put forward the most comprehensive and logically sound philosophy of all these early thinkers (Israel 2001). From this viewpoint, Spinoza should therefore be recognised as the most influential of the Enlightenment thinkers, and his ethical philosophy founded the framework for thought that is still dominant in our secular societies. I also refer to Nadler (2011) for an elaborate discussion of the impact of Spinoza’s work on European society.
- 13.
For a complete discussion of the rise of the sovereign nation-state as the main platform in the capitalist economy, I refer to Spruyt (1994). He explores the feudal roots of the state and the concept of sovereignty.
- 14.
Remarkably enough, the exception to this is the UK, which developed a form of government that for a long time was still founded on control by landed aristocratic families. This evolved over time into a system that gives peerages to economically successful business leaders and capitalists. In the USA and continental Europe, however, the landed aristocracy was simply abolished in the nineteenth century and an open government of direct democracy was implemented.
- 15.
Ultimately, throughout the second half of the nineteenth century and the twentieth century this had a negative impact owing to the alienation that accompanied this vertical deepening of the social division of labour. This alienation gave rise to worker dissatisfaction.
- 16.
This neglects the costs of other aspects of the daily operations of an economic agent in a production chain. In particular, one’s operations have to be financed, thus calling for the accessing of means of finance. Large corporations can command access to the capital and financial markets much easier than small operators. One of the accompanying institutional innovations of industrialisation was the introduction of corporate shares and bonds to finance large industrial enterprises.
- 17.
A further increase in transaction efficiency will diminish the reason for larger operations and reduce the need for vertically structured social divisions of labour. This is the case in the contemporary global economy—based on information technology and highly efficient logistic systems—in which the self-employed individual is on the rise. This is the essence of the network economy as discussed above.
- 18.
A very important branch of Enlightenment philosophy was cultivated through the work of a number of Scottish philosophers, including David Hume, Adam Ferguson and Adam Smith. This period of Scottish Enlightenment was rooted in the relative well-developed economy in Scotland in the second half of the eighteenth century.
- 19.
- 20.
Keen (2011, 2017) presents an explanation of the Great Panic of 2008 based on the theories put forward by Minsky (1986); that indebtedness is single most important factor to determine the stability of an economy. This is clearly a non-institutional viewpoint that does not incorporate the health of the social division of labour. I recognise that indebtedness is a measure that indicates the healthy functioning of the social division of labour. However, indebtedness should be assessed as a consequence of the institutional dysfunction of the economy rather than its cause.
- 21.
This is illustrated by the fact that since the prolonged recession after 2008, the UK economy has grown only through the expansion of this sector and that the manufacturing sector of the UK economy has actually declined during this period.
- 22.
A standard nineteenth-century term for a banking or financial crisis is that of a “panic”. Two severe historical downturns stand out in a long list of financial panics and recessions. The first one is the Great Panic of 1873, which caused a sequence of three severe economic depressions. An economic depression from 1873 to 1878 was followed by an economic recession from 1882 to 1885 and a severe economic depression from 1893 to 1899. This extraordinarily recessionary period is also known as the Long Depression. The second one is actually the financial crisis of 2008: our current economic predicament is very similar to the Long Depression.
- 23.
This sequence of boom–bubble–bust cycles should not be confused with what is known as a business cycle. A business cycle is a much more mild and regular feature of the capitalist market economy, expressing the normal pattern of business. Business cycles are recognised as regular features of a normally developing economy. The boom–bubble–bust cycles I refer to are much more severe in nature and result in strong downturns of the economy.
- 24.
These list are available from Wikipedia, in particular at ‘‘ http://en.wikipedia.org/wiki/ List of economic crises’’ and ‘‘ http://en.wikipedia.org/wiki/ List of banking crises’’.
- 25.
A major anomaly in the given list is the event listed as the stock market collapse on Monday, 19 October 1987, also known as Black Monday in 1987. This compares with Black Monday in 1929, and it stands out as the most singular stock market crash in the history of the New York Stock Exchange (NYSE): the Dow-Jones industrial average plunged more than 22% in that single day. Uncharacteristically, this single-day collapse was not followed by an economic downturn. Instead, it fizzled out and had no lasting effects on the real economy, unlike the similar scenario in 1929.
- 26.
The bankruptcy of Jay Cooke & Co. was caused by a failure to sell $300 million in bonds to finance the expansion of the US railway system by the Northern Pacific Railway company.
- 27.
Dishonesty and fraud are very strong triggers for the loss of trust in a society’s economic institutions. In general, (Akerlof and Shiller 2009, Chapter 3) refer to corruption as one of the animal spirits that guide economic decisions. Later in this book I will show that corruption is indeed directly related to institutional trust; as such it strongly undermines its formation and sustenance in economic institutions. For further details see the detailed account in Johnson and Kwak (2010).
- 28.
The Great Depression has much less in common with the current ongoing Great Trust Crisis than the Great Panic of 1873. Indeed, at its foundation there was a collapse of the NYSE, but not a major financial trust crisis as was the case in 1873 as well as in 2008.
- 29.
Concerning unsustainable unemployment rates, I also refer here to the situation in Spain and Greece in which more than 25% of the labour force has been unemployed during the ongoing Eurozone depression since the sovereign debt crisis of 2010–2011.
- 30.
- 31.
This special position is also expressed in the fact that (investment) banks paid out and continue to pay out very large bonuses to their employees. This bonus craze further deepens existing income inequalities and shows the supremacy of the financial sector in comparison with manufacturing sectors. This in turn feeds the deterioration of economic trust in the economy as a whole.
- 32.
These income inequalities have been increasing since the Carter era in the late 1970s. Real income for working-class families have not increased and have even decreased over this period. As a consequence, working-class families have financed their expenditures more and more through credit in the form of home mortgages, consumer loans and credit cards (Piketty 2014).
- 33.
It mainly refers to the static market price of a commodity. Usually this is a purely theoretical notion that cannot truly be measured and does not exist in neo-classical market theory. However, in terms of the institutional-network economic perspective developed in Chap. 1, the “true” value could be interpreted as the labour value of these commodities, while the network prices of these commodities far exceeded those labour values.
- 34.
There is also a third government-supported enterprise, the Government National Mortgage Association (Ginnie Mae), that is involved in the support of mortgage provision in the USA. Fannie Mae was founded in 1938. The original Fannie Mae corporation was partitioned into a new Fannie Mae and Ginnie Mae in 1968. Freddie Mac was created in 1970 to support the secondary mortgage market.
- 35.
During the Great Depression the Glass-Steagall act legally required the separation of retailing and investment in US financial institutions. The bank in the 1950s mortgage provision network is, therefore, purely a retail bank. It had no relationship with any investment bank and therefore had no access to capital markets. During the 1990s the Glass-Steagall legislation was revoked and banks were allowed to merge. This was pursued vigorously, resulting in banking institutions that consisted of both retail and investment branches.
- 36.
This is a standard effect of the introduction of specialisation into the economy, as first discussed in length by Smith (1776). Specialisation taps into increasing productivity owing to more advanced knowledge and productive ability. This in turns allows production activities to be decomposed into specialised tasks, resulting in much higher output level. Thus, an increasing return to specialisation results in overall increasing returns to scale for the economy as a whole (Buchanan 2008).
- 37.
These major consumer credit agencies operate internationally. Consumer credit ratings are assigned on a global basis using identical indicators of financial health of the potential debtor.
- 38.
It should be emphasised that the credit agencies discussed here are only the ones that assess the risk of providing credit to an individual person or a family. These agencies are not the ones that assess the risk of investment objects traded to investors operating on the financial asset markets. These credit agencies are subject to discussion in the following pages.
- 39.
An agency relationship is the relationship between two parties—a so-called principal and an agent—in which one party (the principal) has a goal that can be achieved by the execution of a task or service by a specialist (the agent). In this case the client has the goal of obtaining a mortgage that can be achieved through the services of a licensed broker, who can place the mortgage contract with a bank. Obviously, the client is the principal and the broker is the agent in this agency relationship. Similarly, the bank has the goal of obtaining good mortgage contracts, which can be identified by the broker assessing the various prospects before him. In this case the bank is the principal and the broker is again the agent.
- 40.
In the past, credit agencies were publicly owned, mainly by the investors themselves. Under that ownership structure, the credit agencies operated under correct incentives and provided correct assessments of investments traded on financial assets markets. Indeed, these agencies are more profitable if their paying clients, the investors, are happy with their performance. Recently, however, these agencies were acquired by the major investment banks. Hall (2009) describes that this changed the incentives drastically; Moody’s now operated on behalf of its owners rather than the investors.
- 41.
It is illustrative to consider what intermediaries are required to make a trade on the NYSE or the NASDAQ market. Normally, one has to think of a chain of three or four intermediaries: one’s financial adviser, her brokerage firm, a related brokerage firm at Wall Street and finally the actual corner trader on the floor of the NYSE. All these intermediaries levy fees on the trade of the stock on the NYSE. This constitutes a very significant portion of the possible gains one tries to make from the trade. This results in very high returns to the financial brokers and small gains for the investors.
- 42.
I emphasise here that the invisible hand metaphor only played a very minor role in Adam Smith’s work; it mainly featured in his “Moral Sentiments” (Smith 1759). However, the misunderstanding about what the invisible hand notion exactly entailed in his philosophy spread throughout twentieth-century neo-classical economics and, in fact, became one of its cornerstones (Ingrao and Israel 1990; Grampp 2000).
- 43.
For a good account of Schumpeter’s theory I refer to the excellent biography of Schumpeter, McGraw (2007), that centres on this issue.
- 44.
For example, when Hurricane Ike approached the Texas coast in 2008, many people in the south-east USA were panicked into expecting severe gas shortages. The result was a run on gas stations on the day before the hurricane made landfall. Reserves were depleted and a true panic emanated; that day gas prices rose significantly and stayed much higher than the trend, which was downward in the rest of the country. This (small) gas panic was the result of negative reporting in the media to which people responded strongly, even though there has been no historical precedent for such gas shortages in the recent past. Even when in 2005 hurricanes Katrina and Rita brought major destruction to the oil industry in Louisiana and Texas, such shortages did not result. This local gas panic in the fall of 2008 can therefore be categorised as “fully irrational”.
- 45.
Fischer’s quantity theory of money—expressed through the famous equality MV = PQ (Fischer 1930)—predicts that if money reserves M increase, the overall price level P will increase as well. However, in the platform economy that does not seem to be the case. Inflation is minimal, and without extreme quantitative easing by western central banks it might well be deflation that will mark this economic era.
- 46.
The most extreme case of fiat money creation was the 1923 episode of hyperinflation in Germany. The German government saw itself forced to pay the mandated war reparations through the printing of Reichsmarks. The result was a complete collapse of the German monetary system and economy (Fergusson 1975).
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Gilles, R.P. (2018). Of Bubbles and Crises: A History of Wealth Creation. In: Economic Wealth Creation and the Social Division of Labour. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-319-76397-2_2
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