Credit = Growth

Over the years there have been many theories put forth as to how to solve society's economic and social problems. The most popular have included state ownership of industry, state support of social programs and their opposites: private ownership of industry, charity and private initiative of social programs.

I'm going to propose a thesis that economic growth leads to a rising standard of living for all, and that the secret to success is access to credit. To make the case clearer, I'm going to make some broad brush claims. The details aren't as important as the trends.

The story of credit started with the Dutch East India Company in 1602. This was the first firm to issue shares and thus raise capital. Before this the world was organized around wealth through land and gold.

In the agricultural period farming was mostly a family affair. Workers had just as much land as they could farm. They depended on their labor and that of their family and some farm animals. This meant that there was essentially no way to accumulate enough wealth to expand their holdings. Without the means to produce in excess there was also no reason for anyone to provide credit - how would they pay it back? As a result, societies remained essentially static for hundreds of years. This same pattern still exists in much of the third world, although there is some slight amount of credit provided for the purchase of farm machinery. I do not consider lending money in advance of harvest as true credit, since the funds are for operational use, not expansion.

Even in the industrialized world of today we can see examples where lack of credit results in a sector that does not grow economically. A good example is the black underclass in the US. Banks will not lend to such people to create small businesses. If they persist, it is usually through loans from family or friends. Contrast this with several of the immigrant communities that exist in the same neighborhoods. For example, in NYC, both the Korean and Pakistani immigrants have access to credit sources and entrepreneurial advice created by their communities. This has led to a large number of Korean owned vegetable markets, and Pakistani owned newsstands. As a result these groups have made rapid economic progress and are now following the "American Dream" of moving to the suburbs and sending their children to college.

There are other examples of how access to credit can change the economic situation. The most notable is the concept of "micro credit", which has become popular in several third world countries. By lending small amounts of money to small business, many run by women, they are able to leave the farm and enter the world of commerce and manufacturing. Results have been remarkable. Similarly, US Indian communities that have been able to get credit to build casinos have been able to use the profit from the enterprise to improve the lives of the tribe. The access to the money generated has led to new housing, improved schools and other beneficial results. These things just didn't happen before the credit and entrepreneurship coincided.

The concept of credit has to exist at the same time as the concept of entrepreneurship. If a society does not permit the creation of independent firms willing to take risks then supplying credit is pointless. China is a good example. It was only after the Communist Party relaxed its hold on private ownership that the economy started expand. Much early private ownership was via foreign investment. Since the government wasn't willing to cede control these early deals were joint ownerships. This still continues, but much expansion is now financed from internal banking resources. The restrictions on what type of enterprises can be started have also been essentially eliminated. Credit plus entrepreneurship yields growth.

The counter example can be seen in the banana republics. For hundreds of years small ruling oligarchies controlled a mostly agricultural economy. They made deals with foreign investors (United Fruit being the most notable), but development was restricted to just those commodities being exported. There was no credit mechanism outside of the ruling families and, thus, the peasant class did not improve economically. In recent decades there has been a shift towards more populist leaders and there have been some attempts to expand the economy beyond agricultural exports. This is still a work in progress. It will have to be seen whether these new leaders can establish credit mechanisms locally which don't depend upon the priorities of foreign owners.

So access to credit allows for new economic activity. Even if this is restricted to just a few at first it has a knock on effect. Those who start new businesses can afford to send their children to school, and hire additional workers. The ability to use mechanized equipment allows them to leverage the available labor. Wages paid exceed the yield of subsistence farming (if they didn't the workers would stay home). And thus begins the whole cycle of growth.

Societies with no credit system stagnate, or as shown above, those within a society who don't have access to credit remain poor. Notice that no mention was made of the type of government or economic "system". A centralized government like China can permit the use of credit, as can a democratic government like the US. Notice that credit doesn't even require "capitalism". There can be economic policies where credit is supplied by government-owned banks and the nominal ownership of the firm remains with the state. The issue then becomes one of what happens with the "profits".

For an enterprise to be successful it must earn more than its expenses. One of its expenses is the cost of the credit (interest). But, this is no different that any other business expense such as labor, raw materials, or facilities. If the firm was financed solely by loans to the entrepreneur then he gets to keep all the profits. If it was financed by selling shares, then the shareholders get the profit. If the shareholders are the state then the state gets the profit. If the government is organized along the ideas of "free enterprise" then the state can recapture some of the profit via taxes.

It is not the organization of the government which makes societies successful or not, it is the ability for independent creativity backed by adequate credit. The economic philosophers such as Marx, or Adam Smith, or Henry George, seeing the problems the excesses of corporate power and concentration, blamed the system. What was really wrong, and still is in many regions today, is that the balance of power between the three major groups of society (owners, workers, government) was skewed. When owners are too strong you get Dickensian England. When workers are too strong you get featherbedding. When government is too strong you get Soviet-style central control or fascism. The cure is to ensure that all three sectors have enough strength to keep things running efficiently and equitably. How to insure against greed and the excesses of power is a topic for another day.

The rapid rise in population and the stress it is putting on the natural environment leads to the need for another factor to be considered when evaluating whether a society is successful or not. This factor is the impact of growth on the planet itself. None of the traditional groups have any economic reason to be concerned with the problem of the commons. The results of depleting natural resources, and polluting the environment, don't figure in their calculations. And the planet doesn't have an economic power base to enter into the trade offs in commerce. It is good that there are those becoming aware of these issues, but so far they have only been able to appeal to people's sense of shame and fairness. This is inadequate when dealing with real world investment issues. Even global efforts like the Kyoto accords have been shown to have no enforcement teeth. How to give a voice to Mother Nature will be the challenge of the next few decades.

When a society has reached the level where it has enough for everyone to live comfortably (even if it hasn't distributed its wealth equitably), then it needs to start to transition into a steady-state mode. Growth has to be replaced by sustainability. Entrepreneurship can still exist but must be aimed at improving the quality of life, or doing old things more efficiently, or doing new things in place of old things. Even the ecological economists are not prepared to deal with this issue yet.