Friday, 4 January 2013

A Closer Look at Social Credit

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Social credit is an interdisciplinary distributive philosophy developed by C. H. Douglas (1879–1952), a British engineer, who wrote a book by that name in 1924. It encompasses the fields of economics, political science, history, accounting, and physics. Its policies are designed, according to Douglas, to disperse economic and political power to individuals. Douglas once wrote, "Systems were made for men, and not men for systems, and the interest of man which is self-development, is above all systems, whether theological, political or economic."[1] Douglas said that Social Crediters want to build a new civilization based upon "absolute economic security" for the individual, where "they shall sit every man under his vine and under his fig tree; and none shall make them afraid."[2][3] In his words, "what we really demand of existence is not that we shall be put into somebody else's Utopia, but we shall be put in a position to construct a Utopia of our own."[4]
It was while he was reorganising the work at Farnborough during World War I that Douglas noticed that the weekly total costs of goods produced was greater than the sums paid out to individuals for wages, salaries and dividends. This seemed to contradict the theory put forth by classic Ricardian economics, that all costs are distributed simultaneously as purchasing power. Troubled by the seeming disconnect between the way money flowed and the objectives of industry ("delivery of goods and services", in his view), Douglas set out to apply engineering methods to the economic system.
Douglas collected data from over a hundred large British businesses and found that in every case, except that of companies heading for bankruptcy, the sums paid out in salaries, wages and dividends were always less than the total costs of goods and services produced each week: consumers did not have enough income to buy back what they had made. He published his observations and conclusions in an article in the English Review where he suggested: "That we are living under a system of accountancy which renders the delivery of the nation's goods and services to itself a technical impossibility."[5] He later formalized this observation in his A+B theorem. Douglas proposed to eliminate this gap between total prices and total incomes by augmenting consumers' purchasing power through a National Dividend and a Compensated Price Mechanism.
According to Douglas, the true purpose of production is consumption, and production must serve the genuine, freely expressed interests of consumers. In order to accomplish this objective, he believed that each citizen should have a beneficial, not direct, inheritance in the communal capital conferred by complete access to consumer goods assured by the National Dividend and Compensated Price.[6] Douglas thought that consumers, fully provided with adequate purchasing power, will establish the policy of production through exercise of their monetary vote.[6] In this view, the term economic democracy does not mean worker control of industry, but democratic control of credit.[6] Removing the policy of production from banking institutions, government, and industry, Social Credit envisages an "aristocracy of producers, serving and accredited by a democracy of consumers."[6]
The policy proposals of social credit attracted widespread interest in the decades between the world wars of the twentieth century because of their relevance to economic conditions of the time. Douglas called attention to the excess of production capacity over consumer purchasing power, an observation that was also made by John Maynard Keynes in his book, The General Theory of Employment, Interest and Money.[7] While Douglas shared some of Keynes' criticisms of classical economics, his unique remedies were disputed and even rejected by most economists and bankers of the time. Remnants of Social Credit still exist within social credit parties throughout the world, but not in the purest form originally advanced by Major C. H. Douglas.

Contents

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[edit] Economic theory

[edit] Factors of production and value

Douglas disagreed with classical economists who divided the factors of production into only land, labour and capital. While Douglas did not deny these factors in production, he believed the “cultural inheritance of society” was the primary factor. Cultural inheritance is defined as the knowledge, technique and processes that have been handed down to us incrementally from the origins of civilization. Consequently, mankind does not have to keep “reinventing the wheel”. “We are merely the administrators of that cultural inheritance, and to that extent the cultural inheritance is the property of all of us, without exception.”[8] Adam Smith, David Ricardo and Karl Marx claimed that labour creates all value. While Douglas did not deny that all costs are ultimately due to labour charges of some sort (past or present), he denied that the present labour of the world creates all wealth. Douglas was careful to distinguish between value, costs and prices. He claimed that one of the factors leading to a misdirection of thought in terms of the nature and function of money was economists' obsession over values and their relation to prices and incomes.[9] While Douglas recognized "value in use" as a legitimate theory of values, he also claimed that values were subjective and not capable of being measured in an objective manner. Thus, he rejected the idea that the role of money is to act as a standard, or measure, of value. Douglas believed that the role of money is to act as a medium of communication by which consumers direct the distribution of production.

[edit] Economic sabotage

Closely associated with the concept of cultural inheritance as a factor of production is the social credit theory of economic sabotage. While Douglas believed the cultural heritage factor of production is primary in increasing wealth, he also believed that economic sabotage is the primary factor decreasing it. The word wealth derives from the Old English word wela, or "well-being", and Douglas believed that all production should increase personal well-being. Therefore, production that does not directly increase personal well-being is waste, or economic sabotage.
The economic effect of charging all the waste in industry to the consumer so curtails his purchasing power that an increasing percentage of the product of industry must be exported. The effect of this on the worker is that he has to do many times the amount of work which should be necessary to keep him in the highest standard of living, as a result of an artificial inducement to produce things he does not want, which he cannot buy, and which are of no use to the attainment of his internal standard of well-being.[10]
By modern methods of accounting, the consumer is forced to pay for all the costs of production, including waste. The economic effect of charging the consumer with all waste in industry is that the consumer is forced to do much more work than is necessary. Douglas believed that wasted effort could be directly linked to confusion in regards to the purpose of the economic system, and the belief that the economic system exists to provide employment in order to distribute goods and services.
But it may be advisable to glance at some of the proximate causes operating to reduce the return for effort ; and to realise the origin of most of the specific instances, it must be borne in mind that the existing economic system distributes goods and services through the same agency which induces goods and services, i.e., payment for work in progress. In other words, if production stops, distribution stops, and, as a consequence, a clear incentive exists to produce useless or superfluous articles in order that useful commodities already existing may be distributed. This perfectly simple reason is the explanation of the increasing necessity of what has come to be called economic sabotage ; the colossal waste of effort which goes on in every walk of life quite unobserved by the majority of people because they are so familiar with it ; a waste which yet so over-taxed the ingenuity of society to extend it that the climax of war only occurred in the moment when a culminating exhibition of organised sabotage was necessary to preserve the system from spontaneous combustion.[11]

[edit] Purpose of an economy

Douglas claimed there were three possible policy alternatives with respect to the economic system:
1. The first of these is that it is a disguised Government, of which the primary, though admittedly not the only, object is to impose upon the world a system of thought and action. 2. The second alternative has a certain similarity to the first, but is simpler. It assumes that the primary objective of the industrial system is the provision of employment. 3. And the third, which is essentially simpler still, in fact, so simple that it appears entirely unintelligible to the majority, is that the object of the industrial system is merely to provide goods and services.[12]
Douglas believed that it was the third policy alternative upon which an economic system should be based, but confusion of thought has allowed the industrial system to be governed by the first two objectives. If the purpose of our economic system is to deliver the maximum amount of goods and services with the least amount of effort, then the ability to deliver goods and services with the least amount of employment is actually desirable. Douglas proposed that unemployment is a logical consequence of machines replacing labour in the productive process, and any attempt to reverse this process through policies designed to attain full employment directly sabotages our cultural inheritance. Douglas also believed that the people displaced from the industrial system through the process of mechanization should still have the ability to consume the fruits of the system, because he suggested that we are all inheritors of the cultural inheritance, and his proposal for a national dividend is directly related to this belief.

[edit] The creditary nature of money

Douglas criticized classical economics because many of the theories are based upon a barter economy, whereas the modern economy is a monetary one. Initially, money originated from the productive system, when cattle owners punched leather discs which represented a head of cattle. These discs could then be exchanged for corn, and the corn producers could then exchange the disc for a head of cattle at a later date. The word “pecuniary"[13] comes from the Latin pecunia, originally and literally meaning "cattle" (related to pecus, meaning "beast").[14] Today, the productive system and the monetary system are two separate entities. Douglas demonstrated that loans create deposits, and presented mathematical proof in his book Social Credit.[15] Bank credit comprises the vast majority of money, and is created every time a bank makes a loan.[16] Douglas was also one of the first to understand the creditary nature of money. The word credit derives from the Latin credere, meaning "to believe". "The essential quality of money, therefore, is that a man shall believe that he can get what he wants by the aid of it."[17]
According to economists, money is a medium of exchange. Douglas argued that this may have once been the case when the majority of wealth was produced by individuals who subsequently exchanged it with each other. But in modern economies, division of labour splits production into multiple processes, and wealth is produced by people working in association with each other. For instance, an automobile worker does not produce any wealth (i.e., the automobile) by himself, but only in conjunction with other auto workers, the producers of roads, gasoline, insurance, etc. In this view, wealth is a pool upon which people can draw, and money becomes a ticketing system. The efficiency gained by individuals cooperating in the productive process was coined by Douglas as the “unearned increment of association” – historic accumulations of which constitute what Douglas called the cultural heritage. The means of drawing upon this pool is money distributed by the banking system.
Douglas believed that money should not be regarded as a commodity but rather as a ticket, a means of distribution of production.[18] "There are two sides to this question of a ticket representing something that we can call, if we like, a value. There is the ticket itself – the money which forms the thing we call 'effective demand' – and there is something we call a price opposite to it."[18] Money is effective demand, and the means of reclaiming that money are prices and taxes. As real capital replaces labour in the process of modernization, money should become increasingly an instrument of distribution. The idea that money is a medium of exchange is related to the belief that all wealth is created by the current labour of the world, and Douglas clearly rejected this belief, stating that the cultural inheritance of society is the primary factor in the creation of wealth, which makes money a distribution mechanism, not a medium of exchange.
Douglas also claimed the problem of production, or scarcity, had long been solved. The new problem was one of distribution. However; so long as orthodox economics makes scarcity a value, banks will continue to believe that they are creating value for the money they produce by making it scarce.[19] Douglas criticized the banking system on two counts:
  1. for being a form of government which has been centralizing its power for centuries, and
  2. for claiming ownership of the money they create.
The former Douglas identified as being anti-social in policy.[20] The latter he claimed was equivalent to claiming ownership of the nation.[21] According to Douglas, money is merely an abstract representation of the real credit of the community, which is the ability of the community to deliver goods and services, when and where they are required.

[edit] The A + B theorem

In January 1919, A Mechanical View of Economics by C.H. Douglas was the first article to appear in the New Age, edited by A.R. Orage, critiquing the methods by which economic activity is typically measured:
It is not the purpose of this short article to depreciate the services of accountants; in fact, under the existing conditions probably no body of men has done more to crystallise the data on which we carry on the business of the world; but the utter confusion of thought which has undoubtedly arisen from the calm assumption of the book-keeper and the accountant that he and he alone was in a position to assign positive or negative values to the quantities represented by his figures is one of the outstanding curiosities of the industrial system; and the attempt to mould the activities of a great empire on such a basis is surely the final condemnation of an out-worn method.
In 1920, Douglas presented the A + B theorem in his book, Credit-Power and Democracy, in critique of accounting methodology pertinent to income and prices. In the fourth, Australian Edition of 1933, Douglas states:
A factory or other productive organization has, besides its economic function as a producer of goods, a financial aspect – it may be regarded on the one hand as a device for the distribution of purchasing-power to individuals through the media of wages, salaries, and dividends; and on the other hand as a manufactory of prices – financial values. From this standpoint, its payments may be divided into two groups:
Group A: All payments made to individuals (wages, salaries, and dividends).
Group B: All payments made to other organizations (raw materials, bank charges, and other external costs).
Now the rate of flow of purchasing-power to individuals is represented by A, but since all payments go into prices, the rate of flow of prices cannot be less than A+B. The product of any factory may be considered as something which the public ought to be able to buy, although in many cases it is an intermediate product of no use to individuals but only to a subsequent manufacture; but since A will not purchase A+B; a proportion of the product at least equivalent to B must be distributed by a form of purchasing-power which is not comprised in the description grouped under A. It will be necessary at a later stage to show that this additional purchasing power is provided by loan credit (bank overdrafts) or export credit.[6]
Beyond empirical evidence, Douglas claims this deductive theorem demonstrates that total prices rise faster than total incomes when regarded as a flow.
In his pamphlet entitled "The New and the Old Economics", Douglas describes the cause of "B" payments:
I think that a little consideration will make it clear that in this sense an overhead charge is any charge in respect of which the actual distributed purchasing power does not still exist, and that practically this means any charge created at a further distance in the past than the period of cyclic rate of circulation of money. There is no fundamental difference between tools and intermediate products, and the latter may therefore be included.[22]
In 1932, Douglas estimated the cyclic rate of circulation of money to be approximately three weeks. The cyclic rate of circulation of money measures the amount of time required for a loan to pass through the productive system and return to the bank. This can be calculated by determining the amount of clearings through the bank in a year divided by the average amount of deposits held at the banks (which varies very little). The result is the number of times money must turnover in order to produce these clearing house figures. In a testimony before the Alberta Agricultural Committee of the Alberta Legislature in 1934, Douglas said:
Now we know there are an increasing number of charges which originated from a period much anterior to three weeks, and included in those charges, as a matter of fact, are most of the charges made in, respect of purchases from one organization to another, but all such charges as capital charges (for instance, on a railway which was constructed a year, two years, three years, five or ten years ago, where charges are still extant), cannot be liquidated by a stream of purchasing power which does not increase in volume and which has a period of three weeks. The consequence is, you have a piling up of debt, you have in many cases a diminution of purchasing power being equivalent to the price of the goods for sale.[23]
According to Douglas, the major consequence of the problem he identified in his A+B theorem is exponentially increasing debt. Further, he believed that society is forced to produce goods that consumers either do not want or cannot afford to purchase. The latter represents a favorable balance of trade, meaning a country exports more than it imports. But not every country can pursue this objective at the same time, as one country must import more than it exports when another country exports more than it imports. Douglas proposed that the long-term consequence of this policy is a trade war, typically resulting in real war – hence, the social credit admonition, “He who calls for Full-Employment calls for War!”, expressed by the Social Credit Party of Great Britain and Northern Ireland, led by John Hargrave. The former represents excessive capital production and/or military build-up. Military buildup necessitates either the violent use of weapons or a superfluous accumulation of them. Douglas believed that excessive capital production is only a temporary correction, because the cost of the capital appears in the cost of consumer goods, or taxes, which will further exacerbate future gaps between income and prices.
In the first place, these capital goods have to be sold to someone. They form a reservoir of forced exports. They must, as intermediate products, enter somehow into the price of subsequent ultimate products and they produce a position of most unstable equilibrium, since the life of capital goods is in general longer than that of consumable goods, or ultimate products, and yet in order to meet the requirements for money to buy the consumable goods, the rate of production of capital goods must be continuously increased.[24]

[edit] The A+B theorem and a cost accounting view of Inflation

The replacement of labour by capital in the productive process implies that overhead charges (B) increase in relation to income (A), because "'B' is the financial representation of the lever of capital”.[6] As Douglas stated in his first article, "The Delusion of Superproduction":[25]
The factory cost – not the selling price – of any article under our present industrial and financial system is made up of three main divisions-direct labor cost, material cost and overhead charges, the ratio of which varies widely, with the "modernity" of the method of production. For instance, a sculptor producing a work of art with the aid of simple tools and a block of marble has next to no overhead charges, but a very low rate of production, while a modern screw-making plant using automatic machines may have very high overhead charges and very low direct labour cost, or high rates of production. Since increased industrial output per individual depends mainly on tools and method, it may almost be stated as a law that intensified production means a progressively higher ratio of overhead charges to direct labour cost, and, apart from artificial reasons, this is simply an indication of the extent to which machinery replaces manual labour, as it should.
If overhead charges are constantly increasing relative to income, any attempt to stabilize or increase income is met with rising prices. If income is constant or increasing, and overhead charges are continuously increasing due to technological advancement, then prices, which equal income plus overhead charges, must also increase. Further, any attempt to stabilize or decrease prices must be met by falling incomes according to this analysis. As the Phillips Curve demonstrates, inflation and unemployment are trade-offs, unless prices are reduced from monies derived from outside the productive system. According to Douglas's A+B theorem, the systemic problem of rising prices, or inflation, is not "too much money chasing too few goods", but is the increasing rate of overhead charges in production due to the replacement of labour by capital in industry combined with a policy of full employment. Douglas did not suggest that inflation cannot be caused by too much money chasing too few consumer goods, but according to his analysis this is not the only cause of inflation, and inflation is systemic according to the rules of cost accountancy given overhead charges are constantly increasing relative to income. In other words inflation can exist even if consumers have insufficient purchasing power to buy back all of production. Douglas claimed that there were two limits which governed prices, a lower limit governed by the cost of production, and an upper limit governed by what an article will fetch on the open market. Douglas suggested that this is the reason why deflation is regarded as a problem in orthodox economics because bankers and businessmen were very apt to forget the lower limit of prices.

[edit] Compensated price and national dividend

Douglas proposed to eliminate the gap between purchasing power and prices by increasing consumer purchasing power with credits which do not appear in prices in the form of a price rebate and a dividend. Formally called a "Compensated Price" and a "National (or Consumer) Dividend", a National Credit Office would be charged with the task of calculating the size of the rebate and dividend by determining a national balance sheet, and calculating aggregate production and consumption statistics.
The price rebate is based upon the observation that the real cost of production is the mean rate of consumption over the mean rate of production for an equivalent period of time.
Real\ Cost(Production) = M* \cfrac{\int_{T1}^{T2}dC/dt\, dt}{\int_{T1}^{T2}dP/dt\, dt}
where M = Money distributed for a given programme of production, C = consumption, P = production
The physical cost of producing something is the materials and capital that were consumed in its production, plus that amount of consumer goods labour consumed during its production. This total consumption represents the physical, or real, cost of production.
True Price ($) = Cost ($)* \cfrac {Consumption ($) + Depreciation ($)}{Credit ($) + Production ($)}
where Consumption = cost of consumer goods, Depreciation = depreciation of real capital, Credit = Credit Created, Production = cost of total production
Since fewer inputs are consumed to produce a unit of output with every improvement in process, the real cost of production falls over time. As a result, prices should also fall with the progression of time. "As society's capacity to deliver goods and services is increased by the use of plant and still more by scientific progress, and decreased by the production, maintenance, or depreciation of it, we can issue credit, in costs, at a greater rate than the rate at which we take it back through prices of ultimate products, if capacity to supply individuals exceeds desire.".[6]
Based on his conclusion that the real cost of production is less than the financial cost of production, the Douglas price rebate (Compensated Price) is determined by the ratio of consumption to production. Since consumption over a period of time is typically less than production over the same period of time in any industrial society, the real cost of goods should be less than the financial cost.
For example, if the money cost of a good is $100, and the ratio of consumption to production is 3/4, then the real cost of the good is $100(3/4)=$75. As a result, if a consumer spent $100 for a good, the National Credit Authority would rebate the consumer $25. The good costs the consumer $75, the retailer receives $100, and the consumer receives the difference of $25 via new credits created by the National Credit Authority.
The National Dividend is justified by the displacement of labour in the productive process due to technological increases in productivity. As human labour is increasingly replaced by machines in the productive process, Douglas believed people should be free to consume while enjoying increasing amounts of leisure, and that the Dividend would provide this freedom.

[edit] Critics of the A + B theorem and rebuttal

Critics of the theorem, such as J.M. Pullen, Hawtrey and J.M Keynes argue there is no difference between A and B payments. Other critics, such as Gary North, argue that social credit policies are inflationary. "The A + B theorem has met with almost universal rejection from academic economists on the grounds that, although B payments may be made initially to “other organizations,” they will not necessarily be lost to the flow of available purchasing power. A and B payments overlap through time. Even if the B payments are received and spent before the finished product is available for purchase, current purchasing power will be boosted by B payments received in the current production of goods that will be available for purchase in the future."[26]
A.W. Joseph replied to this specific criticism in a paper given to the Birmingham Actuarial Society, "Banking and Industry":
Let A1+B1 be the costs in a period to time of articles produced by factories making consumable goods divided up into A1 costs which refer to money paid to individuals by means of salaries, wages, dividends, etc., and B1 costs which refer to money paid to other institutions. Let A2, B2 be the corresponding costs of factories producing capital equipment. The money distributed to individuals is A1+A2 and the cost of the final consumable goods is A1+B1. If money in the hands of the public is to be equal to the costs of consumable articles produced then A1+A2 = A1+B1 and therefore A2=B1. Now modern science has brought us to the stage where machines are more and more taking the place of human labour in producing goods, i.e. A1 is becoming less important relatively to B1 and A2 less important relatively to B2.
In symbols if B1/A1 = k1 and B2/A2 = k2 both k1 and k2 are increasing.
Since A2=B1 this means that (A2+B2)/(A1+B1)= (1+k2)*A2/(1+1/k1)*B1 = (1+k2)/(1+1/k1) which is increasing.
Thus in order that the economic system should keep working it is essential that capital goods should be produced in ever increasing quantity relatively to consumable goods. As soon as the ratio of capital goods to consumable goods slackens, costs exceed money distributed, i.e. the consumer is unable to purchase the consumable goods coming on the market."
And in a reply to Dr. Hobson, Douglas restated his central thesis: "To reiterate categorically, the theorem criticised by Mr. Hobson: the wages, salaries and dividends distributed during a given period do not, and cannot, buy the production of that period; that production can only be bought, i.e., distributed, under present conditions by a draft, and an increasing draft, on the purchasing power distributed in respect of future production, and this latter is mainly and increasingly derived from financial credit created by the banks." [27]
Incomes are paid to workers during a multi-stage program of production. According to the convention of accepted orthodox rules of accountancy, those incomes are part of the financial cost and price of the final product. For the product to be purchased with incomes earned in respect of its manufacture, all of these incomes would have to be saved until the product’s completion. Douglas argued that incomes are typically spent on past production to meet the present needs of living, and will not be available to purchase goods completed in the future – goods which must include the sum of incomes paid out during their period of manufacture in their price. Consequently, this does not liquidate the financial cost of production inasmuch as it merely passes charges of one accountancy period on as mounting charges against future periods. In other words, according to Douglas, supply does not create enough demand to liquidate all the costs of production. Douglas denied the validity of Say's Law in economics.
While John Maynard Keynes referred to Douglas as a “private, perhaps, but not a major in the brave army of heretics,[28] he did state that Douglas “is entitled to claim, as against some of his orthodox adversaries, that he at least has not been wholly oblivious of the outstanding problem of our economic system.”[28] While Keynes said that Douglas’s A+B theorem “includes much mere mystification”, he reaches a similar conclusion to Douglas when he states:
Thus the problem of providing that new capital-investment shall always outrun capital-disinvestment sufficiently to fill the gap between net income and consumption, presents a problem which is increasingly difficult as capital increases. New capital-investment can only take place in excess of current capital-disinvestment if future expenditure on consumption is expected to increase. Each time we secure to-day’s equilibrium by increased investment we are aggravating the difficulty of securing equilibrium to-morrow.
[28]
The criticism that social credit policies are inflationary is based upon what economists call the quantity theory of money, which states that the quantity of money multiplied by its velocity of circulation equals total purchasing power. Douglas was quite critical of this theory stating, "The velocity of the circulation of money in the ordinary sense of the phrase, is – if I may put it that way – a complete myth. No additional purchasing power at all is created by the velocity of the circulation of money. The rate of transfer from hand-to-hand, as you might say, of goods is increased, of course, by the rate of spending, but no more costs can be canceled by one unit of purchasing power than one unit of cost. Every time a unit of purchasing power passes through the costing system it creates a cost, and when it comes back again to the same costing system by the buying and transfer of the unit of production to the consuming system it may be cancelled, but that process is quite irrespective of what is called the velocity of money, so the categorical answer is that I do not take any account of the velocity of money in that sense."[29] The Alberta Social Credit government published in a committee report what was perceived as an error in regards to this theory: “The fallacy in the theory lies in the incorrect assumption that money 'circulates', whereas it is issued against production, and withdrawn as purchasing power as the goods are bought for consumption."[30]
Other critics argue that if the gap between income and prices exists as Douglas claimed, the economy would have collapsed in short order. They also argue that there are periods of time in which purchasing power is in excess of the price of consumer goods for sale.
Douglas replied to these criticisms in his testimony before the Alberta Agricultural Committee:
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