The Real Economy

A constitutional economic policy - Part 3
Filling in operational gaps

Hector McNeill¹
SEEL

People need a constant flow of income to meet their needs. This has become more evident during the Covid-19 epidemic as a result of social distancing and the severity of the levels of infection impacting global supply chains, availability of needed goods and employment in the United Kingdom. There is therefore a sound logic in the government providing funds to tide people over this difficult period. The problem is that these funds are a mix of donations and loans to employers and to furloughed individuals. Others are taking loans to help them pay bills.

There is a danger in the majority confusing these payments with quantitative easing which, in terms of macroeconomic policy, had a different objective. The government appears to be allowing people to confuse the two perhaps to gain support for the notion of quantitative easing in a time of need.

But it is important to understand the difference and why QE did not work over the last decade to do what was intended. It is important to understand the reason for failure of QE because there is an urgent need to adjust macroeconomic policy on this front to help pay for the Covid-19 outlays.

This article explains how.

Due diligence on loan advances

The failure rate of international economic development loans is around 35% or a loss of around $75 billion annually. Many loans are advanced to businesses by banks who are paying more attention to the collateral used to guarantee a loan than to the quality of the intended commercial use of the loan and any expected rate of return. Mortgage seekers sometimes exaggerate their ability to repay. The sub-prime mortgage crisis starting in 2007 leading to the 2008 financial crisis, was caused in good part by banks not applying adequate due diligence and permitting loan issuance against very small, or even no deposits.

Productivity

Currently a considerable amount of work is being invested in the development of analytical tools by the OQSI² to support the design of projects that take into account uncertainty issues so as to increase the probability of projects and investments achieving what is stated in investment proposals. However, collaborative work at SEEL³ has demonstrated that unless the macroeconomic policy framework is supportive of private green fields investments and investments to expand business activities, many reasonable investments can fail. The challenge is to maintain a macroeconomic framework that guarantees the removal of constraints on innovation, higher productivity and the drive towards expanded market penetration with lower prices output leading to a general rise in real incomes and real economic growth. Macroeconomic policy needs to provide the right type of incentives to avoid the type of distortion created by low interest rates resulting in a surge of funds into asset markets. The current system operating under a hybrid Keynesian-Monetarist system of centralized top-down setting of interest rates and monetary volume targets is based on a constitutional anarchy. The term constitutional anarchy refers to a specific state defined in constitutional economics as the absence of a balanced assessment of gaps and needs across the constituency and economic sectors and, as a result the resulting "policy decisions" result in a policy that is not responsive to the vast range of conditions facing constituents and economic units. The absence of a constitutional framework for decision analysis on macroeconomic policy has resulted in a very inefficient system in terms of government resources as a result of the resulting depressed return on investments in the real economy.

It is therefore necessary for funds to be assigned in such a way that funds are used to earn more in return than the interest charges. On the other hand, interest rates need to be at a level to encourage savings so that companies can accumulate funds to invest that do not carry interest rate charges during setup and implementation phases.

RIO Real Income Objective policies

One of the main objectives of Price Performance Policy, one of the real incomes approach policy options, is to maximize the likelihood of achieving projected investment returns by using the price performance ratio (See, PPR) as a measure of ongoing performance and the price performance levy (See, PPL) as an incentive for managers to lower their price performance ratio so as to lower the amount paid to the price performance levy with the possibility of reducing this to zero. Companies that apply this marginal investment approach can end up with an immediate return on their investment management through the levy repayment which ends up as a bonus. Their lowering of the price performance ratio means their prices, within the existing conditions of the sector concerned, will be highly competitive and the likelihood of market penetration and higher revenues is increased.

The important aspect of this policy framework is that it is a dynamic process of public choice secured through agreements between management and work forces according to the specific conditions facing each firm. This is an operational basis because attempting to carry out a procedure for public choice at the national level, across different sector, would make it virtually impossible to establish a set of centralized policy instrument values to satisfy all circumstances; this is the enduring mistake of Keynesian-Monetarism. First of all here is no public forum for public choice and secondly the forum where choices are made lies somewhere between the Treasury and the Bank of England which only give consideration to interest rates and projected money volumes. These have always been adjusted up or down in an arbitrary manner as far as the majority of enterprise needs are concerned; it could not be otherwise.

Covid-19 hand outs and adjusting the government's balance sheet

The RIO Real Incomes Objective approach can greatly assist enterprises raise their rates of growth and real incomes while raising the purchasing power of the currency and the real incomes of consumers as wage earners. RIO does away with corporate taxation and the constraints of corporate taxation codes that isolate wages as a cost item. The current set up creates a strong management incentive to reduce the rate of wage rises. However, by encouraging significant rises in real incomes, government revenue-seeking activities can be realigned to depend more on circulation taxes and personal income taxation. By basing economic growth on the overall national economic turnover and on the personal incomes of corporate ownership, shareholders, executives and wage earners, the government's balance sheet can be brought back into positive territory through an increasing revenue and to the extent that the government would be in a position to cancel obligations for the repayment of loans under the Covid-19 schemes. This has no connection to the Laffer Curve which made no allowance for productivity and was a simplistic static analysis. Raising the real value of government revenue, as in the case of revenue of any individual or sector, is fundamentally linked to levels of productivity

Moving from the AD to the PAC model

The government needs to terminate its faith in "exogenous" money the basic lubricant of the monetarists command and control mechanism over "demand". Keynes thought that one up to respond to a depression somewhat similar to that caused by Covid-19; his injection of government money is what the Chancellor has been doing to help. However, Keynes forgot about the actual cause of the depression which was a speculative frenzy caused by money based on debt changing asset values while the fundamental levels of productivity declined, because then, as now, there were no policy-based incentives to encourage companies to raise productivity.

Jean Baptist Say explained how a stable economy generates, on the basis is endogenous money, savings and investment in more productive activities that enable workers to be paid more, leading to a rise in real consumption - what monetarists call "demand". The sum total of funds flowing into consumption is generated by the production units on the supply side and real incomes growth and national growth comes from innovation leading to higher productivity, lower prices and rising real incomes. The aggregate demand (AD) model has cause enormous instability over the last century as a result of the introduction of excessive levels of exogenous money. The requirement is to return to the production, accessibility and consumption (PAC) model, largely based on endogenous money.

The current misinterpretation of Say's Law and the PAC Model is simply that it was the way in which the early industrial growth occurred and the period 1945 through 1965 which saw unprecedented growth in real incomes in the United Kingdom largely on the basis of an economy Say would have approved of. The problem with increasing exogenous money is to find returns on investment which need to be higher and because of he scale of exogenous money injections it is not possible to find a sufficient number of investment projects offering the levels of return necessary. This is exacerbated by the fact that AD-based policies have never provided sufficient support through incentives for this to be the case.

RIO, founded on the PAC model, helps raise productivity through positive incentives, something Keynes appeared to have overlooked, just as the same detail was overlooked by the monetarists; the Keynesian-Monetarist (KM) combo never provided productivity incentives; "investing" in public works on the basis of dubious Cost Benefit Analyses has never generated for the working economy adequate returns; this can be achieved,m but not under KM policies.

How to introduce this policy

In 1981 I circulated a monograph on the real incomes approach Price Performance Policy to representatives of the main UK political parties. This is covered in the Botequim - 26th March ,2020, where I state,

".... I had circulated a bare bones proposition to all UK political parties i.e. at the time Conservative, Liberal and Labour.

Richard Wainright, the Liberal Party Economics Spokesman, was the one of the only people who demonstrated in his questions to have obviously read and understood the proposition and to have reflected on it in practical terms. He was reticent, he said, not because of the logic but more on the practical point of,

"If we propose this and win the election, we will then be faced with the problem of having to implement it!"

Additional feedback at that time from a senior manager from KMPG, caused me to contemplate Wainright's statement which essentially related to the magnitude of attempting to change the whole macroeconomic policy approach but also the additional issue of how companies can collect and report on PPR and PPL in the absence of corporate taxation accounts.

On the question of introduction, it is clearly not a good idea to attempt to introduce this country-wide in order to avoid the sort of disaster with the Poll Tax in Scotland. It is more sensible to seek volunteer companies who would be prepared to try the system out on the basis of a compensation contract with government. So within a given sector, a certain number of companies could volunteer to operate under the policy for a set period, perhaps no more than two years. The volunteer basis is quite important in that only companies that see a potential advantage in operating under RIO Real Income Objective policies would enter the scheme. No commercial company would do so unless they thought there was a potential advantage to their market position.

On the question of data collection, the internet and modern programming methods and extremely powerful online databases makes this a fairly easy system to set up. Both the calculation of PPRs and PPLs can be real time and all that is needed is a trading floor over which auditors can have oversight of transactions recorded in an Accumulog (a form of block chain database). Confidentiality issues, while being important, are less so because there would be no corporate taxation for participants.

On the issue of how shareholder, owners, executives and wage-based employees manage their interests under such a scheme, I will cover this in the next article in this series.

¹ Hector McNeill is the Director of SEEL-Systems Engineering Economics Lab.

² OQSI-Open Quality Standards Initiative.

² SEEL-Systems Engineering Economics Lab.

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