The Dark Matter in Economics
The discovery of physical dark matter has gotten wide attention. Unfortunately, the discovery of economic dark matter has still not penetrated into mainstream economics
September 1, 2006
Fred Foldvary, Ph.D.
Economist

Physicists have suspected since the 1930s the existence of stuff they call dark matter, material that is not visible to ordinary observation. Dark matter has great significant effects for the behavior of galaxies and the expansion of the universe.

In August 2006, astronomers announced that they had detected direct evidence of the existence of dark matter, based on the effects of collisions among galaxies. Douglas Clowe at the University of Arizona in Tucson and other colleagues, using NASA's Chandra X-ray Observatory and other telescopes, examined a cluster of galaxies named 1E0657-56, where the center of mass has shifted, implying that dark matter is located in that space. In the X-ray spectrum, they could see two huge clouds of dust in between the galaxy clusters, remaining from the collision of two original clusters. These dust clouds are much more massive than the galaxies. These findings will be published in The Astrophysical Journal Letters.

Astronomers had deduced that the gravitational properties of galaxies could not be explained just from visible material. They hypothesized that some `dark matter' must also exist to create the mass that would have that effect. So the actual observation of the effects of dark matter is a discovery of cosmic importance.

Economics too has its invisible dark matter. There are phenomena in the economy which cannot be explained by the visible spectrum of transactions. For example, from 1975 to 2005, the gross domestic product (GDP) of the USA grew by more than three percent per year, after adjusting for inflation. Yet the median family income (where half are higher and half lower) only grew at a .8 percent rate. Where to did the rest of the growth go?

Economists proposed the existence of economic dark matter to explain the difference. Economic dark matter grew at a rate of over seven percent from 1975 to 2005, soaking up most of the economic growth. Economists, however, not being as candid as astronomers, call this mysterious substance "capital." They say that the growth that did not go to family income was a "return to capital."

But that is not a satisfactory explanation, because the return on financial capital such as treasury bonds, after taxes and inflation, has been much less than seven percent. Some stocks have grown at 7 percent or more, but then that growth needs to be explained.

Another economic puzzle has to do with profits. Economists recognize that in competitive enterprise, companies only earn a normal profit, just enough to pay for average returns to inputs, namely land, labor, and capital goods. Yet the revenue from selling goods is much higher than the costs of production for many firms. Where to does this revenue go?

Economists say the revenue goes to a "producer surplus." This surplus, however, does not really go to the producers, the entrepreneurs, owners of firms, workers, or producers of capital goods. The answer, again, is economic dark matter, which soaks up the surplus.

But where is this economic dark matter? What is it? Who owns it? Where does it show up in GDP? Why can't we see it?

Recently, several geoclassical economists - Mason Gaffney, Nicolaus Tideman, Fred Harrison, Michael Hudson, and others - have uncovered where economic dark matter has been hiding. It turns out that the dark matter that soaks up the surplus and much of the gain from economic growth is the economic rent of land.

Actually, the existence of economic dark matter was proposed over a hundred years ago by the American economist Henry George. He discovered the "law of wages," whereby the general wage level of an economy is set at the margin of production, the least productive land. George theorized that since the supply of land is fixed, when the economy becomes more productive, wages rise somewhat as the margin becomes more productive, but the extra productivity of super-marginal land goes to land rent. Wages rise by less than productivity because enterprise also has to pay for the better capital goods, but the rent can rise by the amount of productivity.

We cannot directly observe economic land rent because it is not the financial amount paid by a tenant to a landlord, but the greatest amount that a tenant would pay for the use of only the land, not including the building or the labor services of a landlord. Just as astronomers detected the existence of physical dark matter from its effects, the above-mentioned economists have detected and measured economic land rent from its effects. These effects are hidden in interest, profits, and capital gains. The dark matter that is rent amounts to some 20 percent of national output, and greatly effects the business cycle, the distribution of income, and economic growth.

Mason Gaffney has shown that lack of recognition of economic dark matter was deliberate, as the landed interests did not want the public to know that rent has been soaking up the economic gains. So they merged land into "capital," where rent hides in "returns to capital," and indeed they call the whole system "capitalism."

Socialists too have contributed to the confusion, based on the mistaken "labor theory of value." Karl Marx said that all value comes from labor, so the surplus must be wages unfairly expropriated by "capitalists." Henry George correctly identified the surplus as land rent, as in a market economy, labor is fully compensated for its productivity, although that productivity can be artificially depressed by taxation and land speculation that pushes the margin to lower levels.

The discovery of physical dark matter has gotten wide attention. Unfortunately, the discovery of economic dark matter has still not penetrated into mainstream economics. So the public is still in the dark about why family income has not grown as much as the economy, and economic science does not confront the contradiction of a producer surplus that does not go to producers!

The greatest dark matter is in the human mind. True enlightenment consists of illuminating intellectual dark matter to eliminate ignorance in ethics, governance, and economics. Let us hope that the detection of physical dark matter will inspire people to also uncover the dark matter in social and economic life as well.

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Fred Foldvary, Ph.D.
Economist

FRED E. FOLDVARY, Ph.D., is an economist and has been writing weekly editorials for Progress.org since 1997. Foldvary's commentaries are well respected for their currency, sound logic, wit, and consistent devotion to human freedom. He received his B.A. in economics from the University of California at Berkeley, and his M.A. and Ph.D. in economics from George Mason University. He has taught economics at Virginia Tech, John F. Kennedy University, Santa Clara University, and currently teaches at San Jose State University.

Foldvary is the author of The Soul of LibertyPublic Goods and Private Communities, and Dictionary of Free Market Economics. He edited and contributed to Beyond Neoclassical Economics and, with Dan Klein, The Half-Life of Policy Rationales. Foldvary's areas of research include public finance, governance, ethical philosophy, and land economics.

Foldvary is notably known for going on record in the American Journal of Economics and Sociology in 1997 to predict the exact timing of the 2008 economic depression—eleven years before the event occurred. He was able to do so due to his extensive knowledge of the real-estate cycle.