A Brief History of the Modern Economy (and Its Current State)
I define the contemporary Modern economy as one with an economically proactive government and a central bank, with the production and distribution of goods and services dominated by capitalism (defined in turn as mass production of goods and services for sale in geographically extended markets). My purpose here is to sketch out how we got to this macroeconomic arrangement and to sum up its current state in that context.
For as long as civilization has existed, governments have been economically proactive. Whether isolated communities, city-states, empires, feudal dominions, or nation-states, all governments have always sought to enhance the performance of the existing economy of the pertinent geopolitical unit. To do so is to increase wealth, which is a form of power. An economy that is performing well also helps ‘the people’. Even the most cynical, most ruthless ruler likes it when maintaining that rule is easier rather than harder, and an economy that is doing well will always help with that.
For present purposes we can say that the Modern economy came into existence with the advent of the central bank. Banking is as old as civilization, and governments have always (though not constantly) borrowed money. The first Modern central bank came into existence in Sweden in 1668. The second was established in The Netherlands (1679 ), and the third in Great Britain (1694).
The Modern central bank is a quasi-governmental body established to be the government’s bank and to oversee the rest of the banking system. It can be more passive or more proactive regarding the performance of the economy as a whole. Whether central banks have actually acted more proactively or not, a mandate to seek to maximum growth (therefore income, employment, and tax revenues) commensurate with ‘acceptable’ inflation has been part of their official raison d’etre, whether specified in their charters or not.
During World War II the need for central governments to manage — even micromanage — nations’ economies was obvious. After the war less total ‘management’ continued. Governments engaged in deficit spending and tax cuts to boost total demand. Central banks acted as needed to support the deficit spending of governments.
In that scenario those deficits were intended to be temporary. The idea was to give the economy a boost but to repay the borrowed money with the resultant increased tax revenues. Starting in the second half of the 1970’s the improbability of repaying the debts that were being accumulated was becoming increasingly obvious. That was exacerbated by an ideological commitment from ‘conservatives’, not only to resist higher tax rates even for that purpose, but to reduce tax rates, especially on higher incomes, corporations, and capital gains. Deficits have soared.
In that political environment the primary responsibility for proactive ‘management’ of the economy has increasingly fallen to central banks. In the contemporary Modern economy it manages the funding of whatever spending the central government undertakes beyond whatever revenues it happens to take in while at the same time doing what it can to fulfill its broader responsibilities. The tradeoff has become keeping interest rates as low as possible commensurate with acceptable inflation.
The final piece of the puzzle is capitalism. It got its start in England in the late 1700’s. Following repeated (unsuccessful) anti-capitalist upheavals in Europe in the first half of the 1800’s and the American Civil War in the first half of the 1860’s, it had a clear field for expansion.
As Marx predicted, capitalism suffered a crisis from which it could not recover. We call that crisis the Great Depression. Government spending, financed by debt, ended that economic fiasco. Capitalism has been explicitly dependent on governments and central banks ever since.
Actually, capitalism’s independence from government prior to the Great Depression is easy to overstate. The period between its ascendancy and its demise (in that form) was dominated by developments in transportation, especially ships, which went from wood to iron to steel, and railroads. Governments were hugely helpful in both cases, as customers and (effectively, if not formally) partners. [Vehicles powered by the internal combustion engine and transportation in the form of flight would also boost capitalism with much help from governments, but mostly after the Depression.]
We must also note that the historical tendency of capitalism is deflation, not inflation. It tends to over-produce, such that supply exceeds demand, leading to lower prices — but without external stimulus to boost demand that leads to lower profits, less output, more unemployment, etc. in downward spiral. That is why capitalism has really always depended on governments and their (formal) economic partners, central banks, to provide economic stimulus.
Historically, inflation has existed here and there — including hyperinflation — but the ‘natural’ tendency of capitalism is towards deflation. At present, even with governments and central banks in almost every nation doing almost all they possibly can to inflate the economy, that historical tendency towards deflation is threatening to prevail.