General Equilibrium

Economic Equilibrium for the Purpose of Sustainable Social Welfare

An Article in the Compendium of Market-Based Social-Ecological Economics

Key issues in view of the neoliberal crisis:
How can we guarantee employment and fair income?
How can we protect the environment effectively?
How should we shape the economic globalization?
What should the economic sciences contribute?
What must be the vital tasks of economic policy?
How can we legitimize economic policy democratically?

Click here for the list of all articles: Compendium
Click here for the German-language version: Allgemeines Gleichgewicht

Table of Contents

  1. Overview
  2. Clarification of Terms and Interrelationships
  3. A Sustainable Paradigm of Globalization
  4. Far-Fetched Historical Back Reference
  5. Prerequisites for a Dynamic Equilibrium

1. Overview

Under the current neoliberal conditions of open markets, all measures aimed at achieving an economic equilibrium for the benefit of society and the environment are doomed to fail for systemic reasons. This applies both to countries with a surplus of their trade and services balances and to countries with a deficit. Both imbalances are interdependent, add up to zero worldwide and are a notorious symptom of the neoliberal system. In surplus countries, the imbalance is caused by one-sided export-oriented economic policies, while the deficit countries are at the mercy of export pressure in open markets, so that their import volume exceeds that of their exports. In both groups of countries, the imbalance weakens domestic economic cycles and ultimately leads to unemployment, poverty and environmental pollution.

In short, with reference to the trade and services balance it is the dependent employees and the environment who foot the neoliberal bill equally throughout all countries.

Export-oriented means that a country’s economy is dominated by entrepreneurial players whose pursuit of expansion and profit is one-sidedly focused on global export markets. Their strategy presupposes that the markets in the importing countries are unregulated (open) and that no rules are imposed on them domestically that aim for trade and services equilibrium.

The imbalances are caused by the »constraints« that arise in predatory competition in open global markets. In order to survive in their markets, companies must constantly reduce their costs, which they do primarily by concentrating their production geographically with the intent to streamline and automate all processes of the value chain as much as possible.

In the process of productive concentration, economic power and capital are at the same time concentrated in fewer and fewer hands, who tend to dictate their demands to economic policy and thus consolidate the export orientation. This process goes hand in hand with the economic desertification of peripheral regions and, due to lack of regulation and for the purpose of reducing corporate costs, also with a decline in social and ecological standards. Germany is the outstanding example of this.

As already mentioned, the successful export orientation of some countries causes the import dependence of other countries, that is, the two developments are mutually dependent. On a global scale the sum of the surpluses in the trade and services balances of export-oriented countries are offset by the sum of the deficits in the trade and services balances of import-dependent countries of exactly the same scope, i.e. surpluses and deficits add up to zero worldwide.

2. Clarification of Terms and Interrelationships

BalanceOfPayments04The figure shows the interrelationships of the foreign trade balance sheets. The balance of payments summarises the sub-balances; the most important are the current account, which in turn includes the trade and services balance, and the capital account, which, when narrowly defined, is called financial account and then includes only transactions in financial instruments. The sum of all sub-balances of the balance of payments is by definition always zero because each incoming payment is matched by an outgoing payment of the same amount. In particular, the large items, i.e. the current account on the one hand and the capital account on the other, move in opposite directions. If, for the sake of simplicity, only the large items of both the current account and the capital account are considered, a positive balance from exports and imports of goods and services (a surplus of the current account) is always offset by a negative balance of exports and imports of capital (a deficit of the capital account) of roughly the same amount, and vice versa.

Trade and Services Balance

These two balances are, as the largest items, crucial for the overall current account balance. The trade balance includes exports and imports of tangible goods, while the services balance includes exports and imports of intangible goods. An export of services occurs, for example, if a foreigner makes use of domestic tourism services, because in that case the foreigner benefits from the services just like he would from an exported physical good, while the monetary value for the service flows into the domestic economy; conversely, a service is imported if, for example, a national resident makes use of foreign tourism services, because in that case the national resident benefits from the service just like he would from an imported physical good, while the monetary value for the service flows abroad.

A foreign trade equilibrium is the medium-term balancing of the sum of the trade and services balance, which is indispensable to avoid permanent imbalances and dependencies in foreign trade. An equilibrium also exists in the case of a surplus in trade in goods and a deficit in trade in services, and vice versa, as long as the totals of all exports and imports are balanced.

Capital Balance

The capital account records capital movements with other countries. Capital exports (bank transfers abroad) have a negative impact on the balance sheet and capital imports (bank transfers from abroad) have a positive impact. To avoid misunderstandings, a deficit in the capital account does not mean that a country has to meet urgent payment obligations abroad, but rather that it is able to export surplus capital from a surplus in its current account abroad to invest it profitably there. Conversely, a surplus in the capital account means that a country is dependent on imports of capital due to a deficit in its current account, i.e. it must take on debt to meet its domestic and foreign trade payment obligations.

Risky Global Imbalances

Current account surpluses lead to capital account deficits mainly because export-oriented countries have no need to invest their incoming capital domestically. This is why they invest the capital abroad (export it), thereby exacerbating the imbalances of their trading partners. The debt of import-dependent foreign countries then results from the sum of the liabilities of imports of goods, services and capital. A trade-off of the imbalances would only be possible in the long run through higher exports of the import-dependent countries or lower imports of the export-oriented countries, followed by the corresponding capital transfers. However, the increases in current account and capital account imbalances in the neoliberal system prevent trade-offs, which is ideally reflected in Germany’s extraordinary current account surplus.

This results in an increasing interdependence between debtor and creditor countries. Debtor countries are dependent on ongoing capital imports to pay for their imports of goods and services and their domestic liabilities, mainly social benefits, and creditor countries are virtually forced to export this capital to debtor countries on an ongoing basis so that these countries can pay for their imports.

To put it in a nutshell, this means that the creditor countries are forced to finance their own exports via the detour of capital exports if they do not want to crash the neoliberal system with its devilish dependencies – and crashing the system means crashing their own economy at the same time.

The prospects of the creditor countries to ever be able to enforce their claims against the debtor countries are more than slight. Above all, because there are no pledgeable securities for the claims against a default risk that creditors could access as a substitute. In order to avoid or eliminate this dilemma, an approach has evolved on a global scale that only serves to provisionally maintain the neoliberal system, but of course does not guarantee its continued existence: Namely the predominant method in the world economy used by the USA to finance its excessive imports as well as its domestic investments and obligations with the issue of dubious US Treasuries (government bonds), which the USA is still able to do because of its economic power and innovative ability and the US dollar as the world’s reserve currency and anchor of the world economy. But it is to be noted that this method is used contrary to any economic reason both by the US and its trading partners.

To date (2018), the debt of the USA with its trading partners has increased to 21 trillion US dollars, which is more than the annual economic output of the country, and the mountain of debt is getting bigger every day. The largest creditors are China and Japan, each with claims of around USD 1.2 trillion, while Germany holds US treasuries worth »only« USD 90 billion. That means, the US allows part of its excessive lifestyle to be financed from abroad. They simply live on credit and can thus afford an annual current account deficit of around 500 billion dollars (for which US President Trump in his ignorance now blames the trading partners of the US).

Under Trump, the issuance of US treasuries has further accelerated mainly in order to plug holes in the US budget caused by tax cuts with which Trump has been trying to boost the US economy – however, experience shows that tax cuts are not successful in the long term.

If the largest creditors would decide to sell a critical amount of the treasuries – causing the demand to weaken accordingly -, the US would be forced to raise interest rates on the treasuries in order to maintain its required level of debt. At the same time, however, higher interest payments would increase the deficit of the US budget and severely restrict the country’s standard of living, which illustrates how powerful the instrument is that US creditors hold in their hands. But because of the quasi indissolubly interdependencies in the neoliberal system between debtor and creditor countries the latter would only use this instrument in an unimaginably extreme situation since they would harm themselves in that their export volumes would immediately decline.

As export-oriented and import-dependent countries continue to stabilize the system through their mutual blockade and inability to act, the chances are dwindling to initiate the necessary transition to a sustainable global economic system in good time before the global economy plunges into a crisis.

Risky Imbalances in the Eurozone

Target2Balances01Since the financial market crisis of 2008, the euro zone has used its own method to make up for the diverging current account balances between the northern and southern euro countries. Since the crisis took its course, the countries of the South have not been in a position to finance their imports and repay their debts, particularly due to their high deficits vis-à-vis Germany. To close the capital gap, at least the bulk of it, the northern central banks have been and are still granting their southern counterparts unsecured overdraft credits (so-called Target2 credits) within the European System of Central Banks (ESCB) by means of unusually extreme money creation, quasi by means of the printing press. The chart shows the accrued balances up to May 2018. As the largest creditor country, Germany is approaching claims amounting to almost one trillion euros. Starting in 2010, the deficit countries were granted further credit from the EU rescue packages. These credits were also unsecured and again financed by the countries of the North.

The interdependencies within the euro zone between countries with current account surpluses and those with deficits are as indissoluble as the dependencies in the global dollar area. But although European profiteers are aware of the injustices of the neoliberal system, they do not want to give up their privileges – which have been wrested from economic policy makers – even in the face of omnipresent social and ecological devastations. Therefore, the governments of the euro creditor countries will sooner or later have no choice but to gradually cancel the debts of the debtor countries.

It should be noted however that the capital transfers made possible by exceptional money creation have mitigated the worst effects of the neoliberal predatory competition in the deficit countries. In this way, a minimum of justice has been and is being established in the euro zone, but without enabling the deficit and the surplus countries to gear their domestic economic structures towards full employment, equal distribution and environmental protection. To put it more precisely: due to the concentration of power and capital in the neoliberal system countries are not able to decentralize and democratize their structures in order to directly make local players responsible for the impacts of their economic transactions. Countries wishing to develop in a sustainable way have only one option: they must leave the euro zone!

General Economic equilibrium

The foreign trade equilibrium is one of the prerequisites for a general economic equilibrium (also called macroeconomic equilibrium). In a market economy the latter is given if the savings and investment plans of all economic entities match up with regard to their scope and the planned supply and demand also match up. In other words, if all market participants – households, workers and enterprises – can perfectly realize their individual benefit and profit targets and if at the same time – guided by economic policy – they use the natural resources sustainably and contribute to social welfare (as a supplement see the article Sustainable Social Welfare.

In the broadest sense, a general economic equilibrium also includes the criteria mentioned in the German Stability and Growth Act (StWG) of 1967. There it says: »The measures are to be taken within the framework of the market-economy system in such a way that they contribute at the same time to price level stability, high employment, foreign trade equilibrium and steady and adequate economic growth

In the German StWG, adequate economic growth was understood to mean the incentives to invest in further development and progress with a view to utilize the production capacity as fully and consistently as possible. In 1967, however, further development and progress were still primarily put at the service of volume growth.

3. A Sustainable Paradigm of Globalization

Under a sustainable globalization paradigm, the incentives for growth must satisfy qualitative criteria, i.e. economic growth must be socially beneficial and ecologically compatible.

In other words: (1) economic growth must generate social returns, which manifest themselves in general participation in economic life and a fair share of the economic result for every citizen, i.e. in full employment, a limited performance-related income spread and social benefits for persons not in active employment, and (2) economic growth must cause no or the least possible environmental costs (damage to the environment); repair of existing damage can euphemistically be referred to as environmental returns.

The collective maximization of benefits and profits, which is granted to market participants in an ideal state of equilibrium, results in an optimal utilization of production capacities on the supply side, an optimal satisfaction of needs on the demand side, full employment on the labor market, and an allocation of all factors of production that is geared towards sustainability and is both optimal for businesses and the national economy (see also the article Factors of Production).

4. Far-Fetched Historical Back Reference

GleichgewichtJPG01The notions of how a general (macroeconomic) economic equilibrium should be established are still under the influence of the Scottish moral philosopher Adam Smith (1723 to 1790) and his metaphor of the »invisible hand«, which attributes to the market system the ability to balance itself into long-term equilibrium without government intervention solely through the self-interested activities of market participants. Recently, this metaphor has been interpreted as if any economic policy regulation and control were superfluous, here especially with reference to the global »market liberalization« dictated by self-interest. However, the neoliberal practice clearly shows us that the invisible hand on its own is not able to prevent monopolistic structures and cost transfers to the general public, and to make public goods available to the extent necessary, and, in particular, to ensure sustainable use of resources and high levels of employment, including a performance-related equal distribution of wealth and income in society (see as a supplement the article Economic Externalities).

4. Prerequisites for a Dynamic Equilibrium

Whether a market economy basically strives for equilibrium – even in the case of external (exogenous) influences such as a »creative« shock caused by new technologies or a »corrosive« shock caused, for example, by a lack of raw materials – depends on whether it is based on an equilibrium-oriented economic order.

In detail, a dynamic equilibrium is achieved through measures

  • which provide for a large number of suppliers and demanders to prevent monopolistic structures,
  • which provide nationwide for diverse subsidiary economic structures to bring the labor demand of enterprises in line with the labor supply of the working population,
  • which allow progressive taxation of income and assets in order to ensure equal distribution in line with the welfare optimum,
  • which ensure a technological development that effects an increase in socially and ecologically oriented productivity,
  • which link the development of wages and purchasing power to the development of productivity and thus keep economic cycles going,
  • which guarantee a price formation mechanism that incorporates (internalizes) the social and environmental costs of entrepreneurial activities into prices,
  • which maintain a competitive mechanism committed to social and environmental progress,
  • which ensure adequate price stability within the framework of monetary policy,
  • which make market developments transparent for all participants, and
  • which ensure a well balanced current account (foreign trade and service balance) based on constructive international competition through bilateral trade agreements on exchange rates, tariffs and trade volumes.

Above all, these goals presuppose an economic policy-driven decentralization (actually subsidiarization) of economic structures to avoid territorial concentration and to offer all economic players the opportunity to participate in economic activity as producers (entrepreneurs or employees) and consumers at all times, i.e. to contribute their skills and satisfy their needs.

Because this prerequisite is not fulfilled under the regime of the neoliberal globalization, national economies are currently unable to even come close to achieving the ideal state of equilibrium – and even the above mentioned German Stability and Growth Act (StWG) of 1967 cannot make an effective contribution under these conditions.

In addition I recommend the articles Economic Globalization, Economic Pricing, Economic Subsidiarity, Full Employment and Market and Market Economy.

Note on the COVID-19 Pandemic

The pandemic has noticeably revealed the significant weaknesses of the neoliberal economic system for everyone, above all the shortage of medical, but also other products, caused by disruptions in the absurdly networked value and supply chains across the globe.

The analyses of the neoliberal system as well as the principles and practical procedures based on them for building a sustainable system, which are presented in this compendium, thereby obtain an unexpected topicality. Now is the time to seize the opportunity and build up economic policy pressure to enforce the development of an economic order that is sustainably oriented towards social and ecological welfare.

The following article refers to the targeted arguments contained in the Compendium: COVID-19 and Globalization

Click here for the German-language version: Allgemeines Gleichgewicht.

%d bloggers like this: