Exchanging goods and services and trading with money have allowed humans to survive and shape the natural environment. An important idea in economics is the concept of free-market trading, where buyers and sellers set fair prices. Market participants agree on trading constraints and rules of commerce, but these are often challenging to enforce and lead to many intermediaries who add extra costs. In particular, capital markets often fail to set fair prices and are expensive to operate. When capital markets become inefficient, investment drops, productivity drops, and the price of goods and services increases.
Climate change and other global environmental factors impact human economic activity. We need capital to fund investments to address humanity's existential crises. It would be ironic if capital that helped humans survive and prosper became the cause of humankind's extinction.
Free Market Operations
Two parties will trade when it is in both their interests. The seller makes a profit, and the buyer gets the goods at a lower price than they can get them in other ways. Both seller and buyer are better off with the sale than without it.
In a free market with many buyers and many sellers, the market adjusts the price. However, free markets sometimes fail to set a price where both sellers and buyers are better off. Markets fail more often when the production of goods requires large amounts of capital. They often fail because of the failure of capital markets to supply funds to those who need them the most.
Failure takes many forms, and the current Australian housing market is an example of a failing market to make the best use of resources. The average price of existing houses has increased by 30% over the past two years. Homes designed for four people have one or two people residing in them. On any given night, 10% of all dwellings are vacant. New buyers on average incomes cannot afford to buy houses, yet Australia has had a drop in population due to Covid19 and a boom in dwelling refurbishment and construction. The Australian house market failure is a Private Capital market failure.
Private Capital distributes capital through capital markets. Unfortunately, no private capital market can set a fair price because buyers with more capital can always outbid those with less even though the value to those with less capital is greater. It means those who need it less get it, while those who need it more don’t. The market is also closed to some buyers and sellers, and the rules and costs are different and depend on the wealth of participants. These market characteristics mean the Private Capital market will not give the most efficient distribution of capital.
One solution is to remove the need for Private Capital Markets to distribute funds. Instead, use Public Capital with multiple criteria to select buyers. Price is only one criterion.
Public Goods are goods to which everyone has access. Public Capital is available to everyone at the same price and conditions. One form is the right to buy Public Goods at a discount. Everyone who pays upfront and purchases goods at a discount gets the same discount, and the approach is available to everyone. If any seller will accept the prepayments and makes them transferrable Public Capital can replace Private Capital Markets.
When a consumer buys something, they pay for the knowledge used to create the product, and they pay for the cost of production. These are also called the fixed and marginal costs or the capital and operating costs. Typically the seller receives payment for all their operating costs and a percentage of the capital costs as the capital remains in the company. The seller also puts a profit margin on both the capital and the operating costs.
Public Capital fixes the return on investment. It requires less money to operate as it is a small addition to the payments system. Instead of investors taking the risk, buyers take most of the risk as future higher prices. But, that is a risk a buyer already carries. Importantly Public Capital removes the cost of operating capital markets, lowering the risk.
When investors receive Public Capital back, they receive the earned discount with their capital. However, the capital still exists in the business and transfers to the buyer. Buying goods and services where the price includes a capital component distributes Public Capital and serves the transfer function of capital markets.
The Arithmetic of Public Capital
Public Capital removes the need for extra money to give a return on investment for long-lasting capital intensive goods and services.
Assume there is a community of ten people who collectively decide to use Public Capital to finance their homes. They form a cooperative to purchase ten homes of average $500,000. They go to a Superannuation Fund with pensioner clients who want indexed allocated pensions for the next 20 years of $100,000 each year. The Superfund finds five pensioners who each have $1,000,000 and, with their money, buys $5,000,000 of Public Capital from the buyer community. The buyer community pays each pensioner $100,000 indexed each year for twenty years.
Using traditional capital, an Australian Superfund provides pensioners who invest $1,000,000 with an indexed annuity of $100,000 for ten years compared to twenty years with Public Capital.
If the same community of ten people went to a bank to borrow money at 5% to purchase the same set of houses, the community would have to pay the bank $400,120 each year for 20 years or a total of $8,024,250. The cost to the buyer is $3,024,250 more than Public Capital.
Public Capital removed the cost of renting money to transfer assets. The Superannuation Investors and the community share the savings. Investors received more money, and buyers paid less with Public Capital financing.
Who loses when we change to Public Capital?
Some parts of the finance industry lose because many capital markets are not needed. However, the lenders — like banks can purchase Public Capital. Instead of investors purchasing houses they can purchase Public Capital and get an indexed stream of income.
Capital markets will not disappear, and they will still exist and work as they do today. But, they will become less important and act as an alternative to Public Capital.
The most significant gain comes from investment capital transferring at least double the rate of Private Capital. It means we have less stationary money held in overpriced assets.
Increased investment and operating Public Capital enterprises will employ displaced people with marketable skills. There will be more investment with the same amount of money, so the move to Public Capital creates few losers.
In summary, most investors win, and all buyers win. Speculators, derivatives traders, and money launderers are the main losers.
The Public Service and Public Capital
Public Capital works well with the Public Service and regulated industries. For example, electricity markets funded with Public Capital will drop the price of electricity by 30% and provide the investment to rewire Australia within a few years. The energy regulator will no longer need to set electricity prices just the discount on Public Capital.
Governments can use prepaid taxes as Public Capital to finance any Public Service Capital works. Governments can create the funds and sell them to those in society who need to pay taxes. Instead of private banks getting the return on money creation, the government finances Public works with Public Capital which will reduce the need for some tax.
Private Capital compared to Public Capital.
Private Capital is an excellent tool for building empires and large fortunes. It says that the owner of capital is entitled to all the earnings from its use. It means that when an owner of capital sells goods, the profit from capital goes to the owner, and the buyer of goods gets lower prices and can use the lower prices to accumulate capital of their own and become a capitalist themselves.
However, that is not the way it turns out. Only people who already have capital can get loans, and the interest on loans is greater the less capital a person has. The owner of capital gets a return on capital use, and the capital retains its ability to earn more money. It is a magic pudding with limited public access and is only available to a few.
It leads to distortions in the economy where the rich get richer, investment stagnates, assets inflate in value, and we have a society that consumes more limited resources.
Alternatively, Public Capital is built around the idea of profiting by consuming less and making better use of resources. Giving everyone equal access to Public Capital and equal returns will generate at least twice as much investment to reduce costs by getting more value from the same amount of physical resources.
With rule changes, governments can finance all Public investments with Public Capital. It will double the amount invested and turn society into a circular economy. Governments can start this tomorrow with all the Public Assets under their control or regulations.
Most recognise that our economic system is delivering perverse outcomes. Doing more of the same with Private Capital cannot address the problems. By contrast, Public Capital puts the financial system in sync with ideas of a regenerative, circular or doughnut economy. Its widespread use might provide enough investment to keep a liveable planet.