by
Gary North
Tea Party Economist

Recently
by Gary North: Leadership:
Missing in Action

“Centralization
induces apoplexy at the center and anemia at the extremities.”
~ Lamenais

The present
political system is clearly insane. It suffers from schizophrenia.
Around the world, almost no one trusts the politicians, yet almost
everyone votes for incumbent politicians who promise to reform the
government.

Voters now
suspect (correctly) that all Western governments are headed for
bankruptcy because of the pension programs and government-funded
medicine, yet these two programs are politically untouchable. Voters
demand them.

For four decades,
soft-core critics of the pension/Medicare systems have come to voters
with this announcement: “The two systems can be reformed, but we
must act now. If we delay, they will bankrupt the government.” Yet
the systems are never reformed.

Then, a decade
later, the next group of optimistic reformers comes forward with
this same promise: “The systems can be reformed if we just act now.”
Nobody believes them. Nobody should. If the programs really can
be reformed “if we act now,” then the previous warnings were mere
scaremongering. There really was no hurry. So, Congress asks rhetorically:
“Why should we believe that we need to hurry now?” Result: the systems
never get reformed. Congress kicks the can.

THE
GREAT DEFAULT

The federal
government really is headed for default. The numbers don’t lie.
This fact produces pessimism in some circles. People who look at
the numbers conclude, accurately, that the federal government will
not muddle through this crisis. All over the world, national governments
will not muddle through. They will no longer be able to kick the
can.

I have good
news and bad news. The bad news first. If you are dependent on the
government for your old age security, you have only one hope: an
early death. The good news: when Washington’s checks bounce, the
bureaucrats will have to go into another line of work. Millions
of them. All over the world.

I am now going
to present a scenario that is not widely shared. The process that
undergirds it is not widely recognized. Yet this process is relentless.

If I am correct
about it, judgment day is coming. Not the final judgment. A liberating
judgment.

There are
self-proclaimed optimists who say Medicare will muddle through.
Similarly, there are self-proclaimed optimists who say the present
Keynesian system will muddle through. These people are in fact pessimists.
They argue that moral evil and economic irrationality can be made
to work. That is a pessimistic message. Fortunately, they are wrong.

People will
muddle through. The Keynesian system won’t. Neither will the finances
of the people who have bet the farm on the Keynesian system’s ability
to muddle through.

THE
LAW OF EMPIRES

Empires disintegrate.
This is a social law. There are no exceptions.

The first
well-known social theorist to articulate this law was the prophet
Daniel. He announced it to King Nebuchadnezzar. You can read his
analysis in Daniel 2. Verses 44 and 45 are the key to understanding
the law of empires.

The Roman
Empire is the model. But there is a serious problem here. There
are at least 210
theories of why it fell. There are so many that even my 1976
Ron Paul office colleague Bruce Bartlett gets credit for one of
them – on
Wikipedia, no less. He has made the big time!

In any case,
Rome did not collapse. It wasted away over several centuries, wasting
the treasure of its citizens along with it.

I suppose
there were highly educated people who came to the voters in the
late Roman republic and said something like this: “Unless decisive
action is taken now, Rome will go bankrupt.” If so, they were right.
But it took a lot longer than they thought.

These days,
it does not take nearly so long.

An empire
grows at first almost unconsciously. No one goes to the powers that
be and says, “Hey! Why don’t we create an empire?” It is more like
the person who says this: “I’m not greedy. All I want is to control
the land contiguous to mine.”

In military
affairs, there are economies of scale. An army of warriors makes
conquest cost-effective. There are also taxation advantages. An
army of tax collectors makes tax collection cost-effective. “Hand
over your money” is more effective. Pretty soon, you’ve got an empire.

But there
is a law of bureaucracy that applies to empire. At some point, it
costs more to administer the bureaucracy than the bureaucracy can
generate through coercion. Then the empire begins to crack. It cannot
enforce its claims.

So, the growth
of empire has economics at its center: economies of scale. The fall
of empire also has economics at its center: economies of scale.

I think this
process is an application of the law of increasing returns. In the
initial phase of the process, adding more of one factor increases
total output. But, as more of it is added, another law takes over:
the law of decreasing returns.

Example: water
and land. Add some water to a desert, and you can grow more food.
Add more water, and you can grow a lot more food. There is an accelerating
rate of returns. The joint output is of greater value than the cost
of adding water. But if you keep adding water, you will get a swamp.
The law of decelerating returns takes over. Add more water, and
the land is underwater. You might as well have a desert.

This law applies
to power. Add power, and you generate more income. But if you keep
adding power, expenses of the bureaucracy will begin to eat up revenues.
Resistance will also increase: internal and external. The system
either implodes or withers away.

With only
one exception in history – the Soviet Union in 1991 –
empires have not gone out of business without bloodshed.

In the case
of the Soviet Union, the senior politicians privatized the whole
system in December 1991. They handed over the assets to what immediately
became the ultimate system of crony capitalism. They divvied up
the Communist Party’s money and deposited it in individual Swiss
bank accounts. The suicide of the USSR was “Vladimir Lenin meets
David Copperfield.” Now you see it; now you don’t. In the history
of Marxism, no event better illustrates Marx’s principle of the
cash nexus. It seduced Lenin’s vanguard of the proletariat.

Notice the
pattern of empire. It begins slowly, building over centuries: the
Roman Empire, the Russian Empire, the French Empire. Then the empire
either erodes or else it is captured by revolutionaries, as was
the case in France (1789-94) and Russia (1917). But this only delays
the reversal. It does not overcome it.

THE
MODERN NATION-STATE

Economies
of scale shaped the development of the modern nation-state. In 1450,
the governments of Western Europe were small. They controlled little
territory. They were remnants of the medieval world, which had been
far more decentralized.

By 1550, this
had begun to change. The beginnings of the modern nation-state were
visible.

Tax revenues
flowed into the centralizing kingships. Trade was growing. Revenues
were increasing. Weaponry was advancing. All of this had been going
on for half a millennium. But, like an exponential curve, the line
began to move upward visibly around 1500.

Maritime empires
grew: Spain, Portugal, England. They challenged each other on the
seas. Then came the Netherlands and France. The fusion of naval
power and trade monopolies lured nations into competition for trade
zones. The idea of free trade was centuries away, except in the
academic enclave of the school of Salamanca.

The law of
increasing returns was evident in this process. It paid rulers to
tax more and extend the jurisdiction of the nation-state at the
expense of local governments internally and foreign governments
externally. The benefits accrued mostly to the political hierarchy
and its system of connected families.

Economies
of scale drove the process. The division of labor favored centralization.
Local units of civil government could not compete.

Let me give
an example from the field of historiography. The historian of colonial
America can write about lots of topics: immigration, technology,
family structure, town planting, economic development, intellectual
trends, and so forth. He writes about the issues of life that affected
people’s daily lives. He cannot write about national politics until
after May of 1754: the “battle” of Jumonville Glen.

The Battle
of Jumonville Glen is unknown to all historians except specialists
in colonial America. This is a pity, because that battle was the
most important military event in the history of the modern world.
It literally launched the modern world. It led to (1) the French
Indian War (Seven Years’ War), (2) the Stamp Act crisis, (3) the
American Revolution, (4) the French Revolution, (5) Napoleon, (6)
nationalism, (7) modern revolutionism, (8) Communism, (9) Fascism,
and (10) the American Empire. It was started by Virginia militia
Major George Washington, age 22.

Before the
ratification of the U.S. Constitution, it is both possible and wise
to write about America without tying the narrative to politics.
After 1788, every textbook writer is drawn like a moth to the flame:
Presidential elections. He cannot narrate the text without hinging
everything on the outcome in the four-year system of national covenant
renewal-ratification.

We are fast
approaching a day of judgment. It has to do with economies of scale.
It has to do with the law of decreasing returns.

The best account
of this process is a book by Israeli military historian Martin van
Creveld: The
Rise and Decline of the State (Cambridge University Press,
1999). He traces the history of the Western nation-state from the
late Renaissance until the late twentieth century. He argues that
there will be a break-up of nation states and a return of decentralization.
I have discussed
this here.

CAPITALIST
PRODUCTION

Another manifestation
of the economies of scale is the development of the factory system.
In 1750, most production was home-based. Most people lived on farms.
Most farms were close to self-sufficient.

Cities were
few and far between. They were located on the coasts or along great
waterways. They were based on trade. Perhaps 10% of the West’s population
lived in cities.

This began
to change around 1800 in Great Britain. It may have been in 1780.
It may have been in 1820. But the economy began to change. No one
has a plausible explanation for why it happened, but it changed
the history of man’s lifestyle as nothing else ever has. The economy
began to grow at 2% per annum, compounded.

This process
soon spread to the United States. The world began to be overwhelmed
by a wave of gadgets.

This process
was driven by price competition. A few business owners got rich
by serving the needs of the masses. The masses got richer. They
got more productive.

The feature
most hated by the older producers was capitalism’s relentless service
of the poorer buying public. The division of labor is limited by
the extent of the market, Adam Smith had correctly observed, and
in order to use the newer, more specialized techniques of production,
capitalists had to broaden their markets. The most efficient means
of gaining access to new markets was price competition.

All of the
British troops who marched off to India and the Far East in a quest
for new markets in the day of England’s “glory” never matched the
market-broadening effects of a 25% discount at home. The producer
who could not match this discount steadily was forced out of the
market, that is, was forced to give up control of scarce economic
resources that could better be used to satisfy the demands of the
public in the hands of more efficient producers.

How could
poor, uneducated buyers compete against the entrenched wealth of
the English landed aristocracy? How could their meager purchases
compete against the wealthy man’s competition for the services of
producers? How could some dust-covered miner hope to bid scarce
economic resources away from the men of wealth? Simply because there
were so many of them!

As capitalist
techniques of production steadily increased the output of the laboring
classes, the poor became slightly but steadily less poor. A few
pennies here, a few yards of cloth there, multiplied a million times
over: no aristocracy on earth was rich enough to withstand this
relentless economic pressure of slightly less poor men, when so
many of those men were being created by the labor markets of England.

As individuals
they were poor, especially before 1840, but they were not so poor
as they had been in 1780, and here was the new fact of life for
producers using the older methods of production.

Men who could
not afford fine wool suits could now afford a cheap cotton one,
and very rapidly it became obvious to English entrepreneurs that
it would pay more dividends to start producing hundreds of thousands
of cotton garments than a few thousand high-priced wool or silk
ones.

What served
as the economic liberation of a whole class of people, anti-free
market aristocrats saw as a form of bondage, the grinding servitude
of the factory, with its time schedules, long hours, routinized
production, and child labor. What they resolutely refused to see
was what would have been the fate of these masses under the old
system of production: famine and death. It was Ireland, not England
and Scotland, that suffered the famine of 1848-50, and it was Ireland
which had not seen the “plague” of factory production.

John Ruskin,
the conservative literary critic of the mid-nineteenth century,
summarized the case against capitalism. Ironically, his words were
put on mass-produced cards and inserted into mass-produced picture
frames for display on the walls of the highly popular Baskin-Robbins
ice cream parlors (31 flavors): “There is hardly anything in the
world that some man cannot make a little worse and sell a little
cheaper, and the people who consider price only are this man’s lawful
prey.” I saw this in a store in 1973. I have not seen one lately,
I never go into a Baskin-Robbins store. The chain is nearly invisible
today.

Conservative
social critics saw not only the hard conditions of the factory system
– hard in comparison with the life of social criticism, but
not in comparison with low productivity subsistence (or less than
subsistence) farming – but they also saw the initial effects
of mass-produced goods. They were cheap in price and cheap in quality
– again, in comparison to the quality standards of the educated
social critic.

Those who
did appreciate the new clothes, better housing, and preferable working
conditions seldom wrote tracts; they simply went to work and spent
their money. Undoubtedly, there was a standardization of production.
However, as the productivity of laborers increased, and as their
wages increased, this standardization was left behind for those
coming up – Irish immigrants, for example – and variety
began to be an economic possibility.

This indicates
the nature of capitalism’s powers of social transformation. At first,
price competition expands the market. New groups gain access to
goods not previously available to them, either because prices were
too high before, or because the products did not even exist.

As participants
in the production process, workers add to other people’s wealth.
Producers are buyers; step by step, as output per unit of input
increases, as a result of the specialization of production, the
wealth of all the participants increases. The initial expansion
of buying alternatives itself expands as productivity increases.
Some producers may specialize in producing for this newly improved
buying public; others may branch out and aim at the still excluded
buyers – the next level down.

Henry Ford’s
Model T – “available in any color, as long as you want black”
– made the automobile available to the masses. But as everyone’s
wealth increased as a result of capitalist methods of production-distribution
(the two are basically the same process), large numbers of men wanted
some other color.

Ford failed
to recognize this phenomenon of modern capitalism, and his resistance
to change – in this case an upgrading of quality and choice
– led to the triumph of General Motors in the 1920s. GM offered
more brands and more choices within these brands.

GM’s dominance
did not last. The company went bankrupt in 2009. It took a government
bailout to save it – and the defrauding of bond holders.

The factory
is scaling down in the United States, even as it is getting gigantic
in China. Smaller, computerized specialized steel factories have
replaced the old steel factories. The old factories are empty. They
cannot compete.

We live on
the cusp of a new era of manufacturing: 3D production. We
will have factories on our desks.

Mass production
reduces costs. Production initially is centralized. The era of the
factory replaces the era of homespun. The economies of scale take
over. This is phase one: the law of increasing returns to centralization.

This does
not last. The law of decelerating returns takes over at the factory.
The era of the factory is replaced. The economies of scale favor
local production. I write this on a $500 computer using a $50 word
processing program.

When you think
“economies of scale,” think “Post Office.”

CONCLUSION

I could apply
this analysis to the history of urbanization: from villages to towns
to huge cities to the suburbs. Urban historian Jack Lessinger has
chronicled this in a series of books.

The
economies of scale no longer favor centralization. They favor decentralization:
in manufacturing, in education, in urban development, in finance,
in politics, and even in military affairs. Non-state resistance
movements hold the advantage today. So does the terrorist cell.
If the urban West is ever threatened by weaponry, it is more likely
to be from a home-brew biological weapon than from a nuclear device.

Small may
not be beautiful, but it surely is efficient. You don’t see a virus.
You can see a mushroom cloud.

For those
of us who dread the centralization of anything, our boats have begun
to come in.

No ship will
come in. Its model is the Titanic.

May
19, 2012

Gary
North [send him mail]
is the author of Mises
on Money. Visit http://www.garynorth.com.
He is also the author of a free 20-volume series, An
Economic Commentary on the Bible.

Copyright ©
2012 Gary North

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