Rethinking economics in the backwater

September 16, 2014

Almost 1000 people attended the three-day Rethinking Economics meeting in New York, the follow-up to the recent RE meeting in London (see my post Rethinking Economics is an organisation set up by mainly postgraduate economics students concerned at the failure of mainstream economics to grasp the reasons behind the global financial collapse and its failure to open up the curriculum in university economics departments to economic thinking beyond mainstream neoclassical or ‘orthodox’ Keynesian ideas.

There seems to a huge interest among young economics students and academic economists to break with the ‘closed shop’ of mainstream thinking. And the New York chapter of Rethinking Economics was able to get some ‘big hitters’ from mainstream and heterodox economics to make presentations or join discussion panels. The whole thing was live streamed across the globe.

Watching online, we were greeted with a panel composed of leading Keynesian guru and Nobel prize winner, Paul Krugman; Willem Buiter, now chief economist at Citibank and former professor at the LSE; and James Galbraith, son of the legendary JK Galbraith and one of the few heterodox professors of economics in a university post.

The eminent three were asked why mainstream economic theory failed to forecast the global crisis and why it had struggled to explain it. Krugman said he held to the view that mainstream economic theory with its models of markets, representative economic agents and equilibrium analysis was still useful, but was inadequate without recognising that economic reality was lot ‘messier’.

Willem Buiter seemed to go further when he reckoned that what was wrong with mainstream economics was that it assumed equilibrium from the start and then added in ‘frictions’, ‘instability’ or ‘imperfection’. It ought to start by assuming ‘chaos’ and then build in content and form to develop useful theory. This seemed so vague as to be useless. But to be fair, this was panel discussion without the chance to develop arguments in detail.

In a recent post on his New York Times blog, Krugman explained his position on models and theory better
The famous Keynesian model of the macro economy is the IS-LM model (investment=savings on one side and liquidity preference and money supply on the other). The IS–LM model attempts to explain the relationship between interest rates and real output. The intersection of the IS and LM curves is the ‘general equilibrium’ where there is simultaneous equilibrium in both money and ‘real’ markets. In this model, the equilibrium is not met (and crises occur) if savings exceed investment causing a lack of effective demand and/or liquidity preference exceeds money supply and causes a rise in the price of money (interest rates) that makes equilibrium growth unviable.

Many heterodox or post-Keynesian economists deny this was Keynes’ view of a monetary economy and that he was much more concerned with instability, irrational expectations and uncertainty as the explanation of financial crises. Krugman argues that Keynes may have been interested in uncertainty as a cause of financial instability but his real contribution was to show that a capitalist economy can establish an equilibrium where underemployment is permanently established and to restore full employment requires intervention to lower interest rates and/or boost investment. That is the value of the IS-LM curve model. All else is too vague.

Krugman’s position at Rethinking Economics has come in for some strong criticism by ‘post-Keynesians’ like Philip Pilkington and Lars Syll ( and

It has become an interminable debate between orthodox Keynesians and neoclassical economics on whether there has to be some ‘exogenous’ intervention to get going a capitalist economy that has slipped into permanent stagnation or lack of effective demand; or whether the market can right itself through changes in wages and prices of assets.

As James Galbraith put it in his contribution, mainstream economics is divided between ‘freshwater economists’ (those based in Chicago like Lucas, Fama (see my paper The causes of the Great Recession) etc who reckon that a ‘free market’ can solve all) and ‘saltwater economists’ (those based in the East Coast universities like Yale, MIT, Harvard and Columbia who follow Keynes in reckoning the capitalist economy needs the help of fiscal and monetary authorities to put a modern economy in depression back on an ‘even keel’).

Galbraith said he was in neither camp. He was part of ‘backwater economics’, those economists of the heterodox tradition that saw modern capitalism as full of inherent flaws that required institutional change and radical surgery to deal with recurrent crises and rising inequality, for example. It was backwater economics, because it was ignored or excluded by the mainstream camps. There were hardly any heterodox economists in university posts anywhere and yet it was some of these economists who were the only ones to predict the financial crash and ensuing Great Recession. Galbraith referred and pointed to Steve Keen in the audience who had predicted the crisis (see my post, subsequently lost his job in Western Australia and only just been appointed head of economics at the radical heterodox University of Kingston, London.

Galbraith wanted economics to return to a study of economic history and institutions and not get bogged down in economic models and maths without any political economy. That brings me to Marxian economics. Marx’s economics is ‘political economy’, or to be more exact, Marx made a critique of political economy, or the ‘mainstream economics’ of the early 19th century. Marx was not afraid of, or opposed to, using models or maths to explain the laws of motion of capitalism. But the main task of Capital and Marx’s other economic writings was to expose the flaws in the economic theory of the great ‘classical’ economists like Adam Smith and David Ricardo who had tried to analyse the nature of the capitalist mode of production objectively, if from the point of view of the rising capitalist class. Marx also aimed at exposing the apologetic ‘vulgar’ economists like Malthus and others who just wanted to propagandise the necessary role of the capitalist class and the market economy.

This was part of the theme Professor Richard Wolff ( presented in the only presentation on Marxian economics in three days at Rethinking Economics – as in London, the New York conference was dominated by either orthodox Keynesians or ‘post-Keynesian’ speakers. Marxist economics remains the real backwater.

In an excellent account, Wolff explained that Marx made a critique of the ideas of Smith and Ricardo, developing their labour theory of value into a theory of exploitation that explained why capitalism, in overthrowing feudalism and supposedly establishing ‘liberty, equality and fraternity’ (to use the slogan of the French revolution), did no such thing. One class system of exploitation had been replaced by another, only the mode of production and social exploitation had changed.

For Wolff, this was the decisive insight of Marxian economics that had to be denied by mainstream economics. From the 1870s onwards, an honest objective critique of capitalist flaws was replaced by apologia. And a counterrevolution in economics began, with the labour theory of value and exploitation dismissed and ridiculed (and relegated to the backwater), to be replaced by ‘utility’ theory, marginal productivity and equilibrium markets. Austrian economist Bohm Bawerk did the demolition job on Marxist theory and Jevons, Walras and others developed the ‘neoclassical’ propositions and theory that still define the mainstream (including Keynesianism). For an excellent account of the major differences between Marxian economics and classical and neoclassical economics, see Alan Freeman’s paper (Freeman on Marx’s theory). And also read Wolff and Resnick account in their book on comparative economic theories (

As Wolff said, there is no real alternative to economics in universities that does not assume the capitalist mode of production is here to stay. The split in mainstream economics in the 1930s was product of the Great Depression and the rise of a labour movement demanding change. Thus Keynesian economics reared its theoretical head in recognising that capitalism had serious flaws (at a macro level) that must be addressed by intervention (even extreme interference in markets on occasion) in order to save capitalism from itself. Such an approach has never been fully adopted by the majority of mainstream economics and after the 1970s , Keynesian ‘intervention economics’ was dropped in place of a return to free markets, particularly in labour, with globalisation and financial deregulation.

There was a certain naivety in the work of Rethinking Economics that things can change. Marxian economics, let alone heterodox economics, will remain a ‘backwater’ in academic institutions because these things are not decided by the strength of ideas (contrary to Keynes’ view) but the economic and social power of the ruling class.

Paul Krugman has commented that “hardly anyone predicted the 2008 crisis… but more damning was the widespread conviction among economists that such a crisis couldn’t happen. Underlying this complacency was the dominance of an idealized vision of capitalism, in which individuals are always rational and markets always function perfectly.”

But it was not just the failings of mainstream theory; there was a deliberate ideological need to defend capitalism and the status quo: “Clearly, economics as a discipline went badly astray… But the failings of economics were greatly aggravated by the sins of economists, who far too often let partisanship or personal self-aggrandizement trump their professionalism. Last but not least, economic policy makers systematically chose to hear only what they wanted to hear. And it is this multilevel failure — not the inadequacy of economics alone — that accounts for the terrible performance of Western economies since 2008.”

As one tweeter on the meeting commented, “arguing with economists about ‘rethinking economics’ is like arguing for abortion with the Pope in front of the College of Cardinals”.

Crises and their Resolution

September 15, 2014

The Resolution Foundation in the UK does important economic and statistical analysis in highlighting the exploitation of labour, inequalities in wealth and income and failures of the welfare system to defend the poor ( It recently hosted the UK book launch of House of Debt, with both authors (Mian and Sufi) on stage alongside Martin Wolf, the Keynesian FT columnist and Stephanie Flanders, formerly the BBC economics editor, but now taking a pay packet from JP Morgan, the American investment bank. (see

It was standing room only to hear praise heaped from those present on Mian and Sufi’s book, increasingly regarded in the mainstream as important an explanation of the global financial crisis and the ensuing Great Recession as Thomas Piketty’s book, Capital in the 21st century is seen by the leading mainstream economists as offering the best explanation for the growing inequality of wealth and income in the major economies.

I have critiqued Mian and Sufi’s book in a recent post ( For them, it is excessive debt that was the cause of the US housing bust, the banking crash and then the recession. The answer is to introduce measures that control excessive credit and all will be well.

I criticised this view from two angles: the first was that Mian and Sufi provided no real explanation for why debt got excessive except that central banks let it happen through a lack of regulation. As I argued in my post, behind the rise in debt and the subsequent collapse is a crisis in the profitability of capitalist production. Not surprisingly, this explanation is ignored by Mian and Sufi and, of course, by the likes of Wolf and Flanders.

The second point is that Mian and Sufi’s solution to future excessive debt is to get creditors and debtors to share the risk of any default, thus making the bankers more careful about lending to people who cannot pay it back.  This policy would be a major interference in the free market for credit and in the profits of the financial system and has as much chance of being adopted as Piketty’s policy to reduce inequality through a global wealth tax.

Both the House of Debt and Capital in the 21st century deliver the worst of both worlds – they don’t identify the real cause of crises and inequality in modern capitalism, but at the same time offer utopian and unrealistic policies to solve these problems because they want to sustain the capitalist mode of production. So it is no surprise that Keynesians like Wolf, the economists of the Resolution Foundation and subtle supporters of the financial system like Flanders and her mentor Larry Summers, reckon the House of Debt has the answer.

Wolf himself has just published his book, The Shifts and the Shocks: What We’ve Learned—and Have Still to Learn—from the Financial Crisis (see an interview with Wolf in In it, he argues, as do the Keynesian wing of mainstream economics, that the cause of the Great Recession “was a savings glut (or rather investment dearth); global imbalances; rising inequality and correspondingly weak growth of consumption; low real interest rates on safe assets; a search for yield; and fabrication of notionally safe, but relatively high-yielding, financial assets.” There is little explanation for the occurrence of these bad things, or why they keep recurring over the history of capitalism, except to lay the blame on lack of banking regulation.

So, while Wolf backs Mian and Sufi’s policy answer, he also calls for a return to the deep regulation of the US Glass-Steagall Act of the Roosevelt era that broke up huge universal banks so that none were ‘too big to fail’ (i.e. would cause a systemic collapse). Wolf demands that banks hold more capital (equity) on their books from investors, so that they can withstand any future crises. But such ‘heavy’ regulation has already been bypassed or rejected by national governments, the IMF, the BIS and the World Bank. So again Wolf’s explanations of crises and policy prescriptions are both wrong and utopian at the same time.

World economy: getting back to trend?

September 14, 2014

The latest high frequency indicators of economic activity in the major economies suggest that global economic growth picked up a little in the summer. Based on my measures of the so-called purchasing managers indexes (PMIs), business activity in both the advanced capitalist economies and the so-called emerging economies is up from a weaker first quarter.

Business activity indexes

This would suggest a global annualised growth rate of about 3.0-3.5% for 2014. That’s better than the first quarter by some way, but still below the rate achieved in the recovery from the Great Recession in 2010.

Global PMI

And, as has been documented in this blog and in many other places, the economic recovery from the Great Recession has been the weakest of all recoveries from slumps since the second world war. Since the end of the Great Recession, world industrial production growth has averaged only 40% of the rate achieved before the Great Recession and only 60% of the long-term average. The productive sectors of world capitalism are crawling along.

And that conclusion also applies to the US, the economy that has achieved the best recovery of the all major capitalist economies (G7) since 2009. The US GDP is still 5% pts below its ‘full potential’, even though it has been the US economy that has led the way in this ‘recovery’. The last set of US GDP and employment figures, as I outlined in a previous post (, suggest that the US economy is expanding at little more than about 2% a year, well below the post-war average of 3.3% and even more behind the pre-crisis rate.

However, there is more talk among mainstream economists that the US, at least, is now on a path of sustainable ‘normal’ growth, something I questioned in a recent post

Gavyn Davies, former chief economist at Goldman Sachs and now a columnist for the FT, reckons that the US recovery now looks sustainable. Davies recognises that global financial crashes and slumps combine to limit and delay economic recovery, but: “such recoveries are slower than normal in their early phases, and they therefore take much longer to bump into supply constraints. On average, such shocks are followed by economic recoveries that last for 8-9 years, as compared to 5 years for the present US recovery. At about the current stage of the recovery, they actually tend to speed up a bit.” And he quotes the work of his old employer, Goldman Sachs, which shows that the US economy could at last be about to head back to the trend growth rate of the past (see graph below).

Wolrd recovery cycle

The evidence of the weekly US economic indicator ECRI would also suggest that the US economy might be reaching a lift-off point.


But these activity surveys are the only evidence that I can find for Davies’ assertion. US business investment shows little sign of a significant pick-up and corporate profits have actually stopped rising.

US business investment level

Employment growth remains lacklustre and real wages for average Americans are flat at best. Indeed, the latest Federal Reserve survey of household finances shows that median family incomes in the US have dropped so much in real terms since the Great Recession that they are now no higher than they were 16 years ago!

US median family income

So a Keynesian-style demand boost for the US economy from household spending looks unlikely. If consumption and business investment remain in the doldrums, so will the US economy.

The United Nations Commission for Trade and Development (UNCTAD) just released its annual report on the global economy. UNCTAD remains gloomy about a return to normal ( UNCTAD concludes “six years after the onset of the global economic and financial crisis, the world economy has not yet established a new sustainable growth regime. With an expected growth between 2.5 and 3 per cent in 2014, the recovery of global output remains weak.” It points out that “international trade remains lacklustre. Merchandise trade grew at close to 2 per cent in volume in 2012−2013 and the first few months of 2014, which is below the growth of global output. Trade in services increased somewhat faster, at around 5 per cent in 2013, without significantly changing the overall picture. This lack of dynamism contrasts sharply with the two decades preceding the crisis, when global trade in goods and services expanded more than twice as fast as global output (at annual averages of 6.8 per cent and 3per cent respectively).

UNCTAD, being an institution that is somewhat ‘off message’ compared to the IMF and the World Bank, calls for coordinated global action by governments to reverse ‘market liberalism’, reduce inequality and follow the prescriptions of Pope Francis (see my post,!

Don’t hold your breath.

Scotland: yes or no?

September 4, 2014

With two weeks to go, the latest polls suggest that the upcoming referendum vote on independence for Scotland could be close, although the average of all polls still suggests that Scots will vote no to independence. It’s going to be a big turnout though.

In this post, I want to try to analyse the arguments for and against independence mainly from the point of view of whether an independent capitalist Scotland would be better for the Scottish working class in economic terms, and for that matter the rest of the British working class, than remaining in the Union with the rest of the UK.


But first let’s start with the principles. A united world in a fair and equal federation or commonwealth of states would be the most beneficial to the majority. It would mean sharing resources, culture and ideas to the benefit of all through a democratic process. So, a federation of the old nation states of the British Isles would be better, in principle, for the majority who live by their labour and not by profit and ownership of capital. But this implies a socialist federation.

Of course, if any nation wants to stay separate, or to become separate, from such a union, then that is up to them. They should be able to decide in a free and fair vote. And a union or federation of nation states that is not equal and is more of an oppressive union of the large and powerful over the small is not good news – and this is the model of all capitalist federations. On the other hand, staying separate as a ‘nation’ for the sake of it is an antiquated and backward idea in human social development, and particularly for working people. It also ensures the continuation of the capitalist mode of production.

The decision for yes to independence or no should not be based on whether Scotland needs to be a nation – it is one, in geography or territory and, to some extent, in culture, although that has been diluted over centuries with the gaelic language almost dead and ‘scots’ seriously reduced. Catalonia in Spain, also possibly considering independence from Spain, is more of a nation in that sense, as it still has its own living language. But then Ireland is clearly a nation, but uses English. And the Scots clearly consider themselves a nation.


And yet there is little difference in attitudes between the majority of English and Scots. Polls show that Scots have similar views to the rest of the UK when it comes to welfare, immigration, benefits, unemployment and public spending. Summarising the data from social attitudes surveys, Lindsay Paterson of Edinburgh University writes: “These differences, though generally placing Scotland to the left of England, are not so huge as to signal a fundamental gulf of social values.” Most people in the UK did not vote for the Conservatives in 2010. Most people in Scotland did not vote for the SNP at the Holyrood elections in 2011.

For the English working class (if we can talk about such a thing), the issue is clear. It is much better for the English if the Scots stay within the Union as an important part of the electoral and industrial struggle against the pro-capitalist parties. Only the most reactionary of the English working class favour independence for Scotland – i.e. ‘getting rid of the moaners north of the border’. In all polls on the issue, those south of the border favour the Scots staying, including those Scots living south of the border.

The reality

Of course, in the real world, principles do not apply. The Union of Scotland with England and Wales first became a reality under absolute monarchy, with succession of James VI of Scotland to the English throne in 1603, although the parliaments of the English and Scottish aristocratic elite remained separate. Formal Union with the ending of the Scottish parliament was established by decrees from both parliaments in 1707. Article 1 of the Act of Union of 1707 states that: “the two kingdoms of Scotland and England shall on the 1st of May and for ever after be united into one kingdom by the name of Great Britain.”

The Union was forced on the Scottish ruling class by economic circumstance. Its wild speculative schemes to set up a ‘colony’ in Panama (ironically raised as model for an independent Scottish currency now – see below) as a pale shadow of English colonial development, had bankrupted the Scottish economy. The Scottish ruling elite then agreed to a ‘merger’. Actually, the majority of the English ruling class was opposed to the Union as they thought it was too costly to bail out the Scots (similar to the arguments about Scottish bank failures now). But Union was forced through by the strategists of the rising English capitalist class and backed by the budding urban bourgeois of the Scottish lowlands. It was opposed by the rural highlanders and chiefs who wished to preserve their clan system and looked to a reactionary Catholic monarch, then in exile, as a saviour from English/Scottish capitalist takeover.

But let’s return to now. The question for the Scottish working class is whether having an independent capitalist government operating out of Edinburgh is better than having a British government operating from Westminster – for their living standards, control over production and distribution, defence and security, health, housing and education.

It will be a pro-capitalist government, whether Scottish Nationalist or Scottish Labour. The SNP see their vision of an independent Scotland as one where banks and big business continue to accumulate profits and capital; and where land ownership is the most concentrated in the developed world (half of Scotland’s land is owned by just 500 people).  “We are now six years into an SNP government which has done absolutely nothing legislatively about the most concentrated, most inequitable, most unreformed and most undemocratic land ownership system in the entire developed world”, Jim Hunter, Land Reform Review Group.

An independent Scotland will retain the Queen and the British monarchy as the official head of state, the (English) pound will remain the currency, a ‘nuclear deterrent’ is still accepted and the armed ‘defence’ of the country will remain in the hands of others (NATO). Private education and health sectors will remain (and even increase), and housing will continue to be dominated by private landlords and construction companies, with the public housing playing little role. And the SNP wants Scotland to join the EU, a reactionary ‘free market’ based union, but with all the ‘opt-outs’ that were ‘won’ by the Thatcher government for the UK (something that will not be granted). And the EU is now imposing severe public spending targets on its members.

That part of the Scottish business class that favours independence is pleased with this vision. “The SNP is patriotic, well organised and has prominent business support just like the old SUP. My suspicion is that, whatever he says publicly, Alex Salmond is well aware of his potential support from the patriotic right wing in Scotland, which is why he was so keen to back the Scottish regiments and abandon opposition to Nato. Whatever happened to the Scottish Tories? They turned into Scottish Nationalists. You read it here first”, says Jim Walker, a hedge fund adviser., And “It will be fascinating to observe Scotland becoming more Thatcherite while pretending not to do so. “ says another City economist Andrew Smithers, in the FT.

So it’s a moot question whether much will change for the working people of Scotland. But let’s consider the economics of it.

The oil

The mainland (excluding offshore energy) Scottish GDP per head is almost bang on average for the UK as a whole. If it included all the oil, Scotland’s GDP per head is about 18% above average. Unemployment, inequality, growth and the structure of the economy is closer to the UK average than in Northern Ireland, London or northeast England. Over a long-period, real GDP growth has been a touch slower than England’s.

Scotland’s exports to the rest of UK (rUK) account for 70% of its exports. Exports to Scotland account for 11% of rUK exports. So Scottish capitalism is heavily integrated into British capitalism, more so than Canada into the US. In 2012, Scottish exports to rUK amounted to £48bn while rUK exports to Scotland were £59bn. So an independent Scotland would run a trade deficit with its main trading partner, the rUK, thus requiring investment or credit funds from ‘abroad’ to fill the gap.

Scottish exports

Scotland would be a small capitalist state dependent on trade with rUK and little possibility of reducing that dependence. Now it could be argued that Scottish capitalism would have more flexibility and it’s true that some small states sometimes do better economically than large ones. But small states are also more vulnerable to the vicissitudes of global financial and production crises like the Great Recession, as the experience of the Baltic states, Ireland, Portugal, Greece, Iceland and Cyprus has shown in the last six years. They have suffered far more than Scotland did as part of the UK.

Energy-rich Norway has one of the highest living standards in the world, it remains outside the EU and has huge financial reserves. Could an independent Scottish capitalist state become another Norway? Well, if we analyse the projections for future oil and gas production in the North Sea, the answer is no.

Even if Scotland were to gain rights to 90% of UK energy revenues through taxing the multinational oil and gas companies after independence, most forecasts suggest a decline in those revenues over the next decade or more. Forecasting revenues is extremely difficult given that volatility in prices, fluctuations in output and oil industry investment have a direct impact on the tax take. Technological advancement and policy reform could help turn marginal fields into profitable ones. An independent Scotland would depend on oil for 18% of its wealth, yet North Sea production has been falling 6% a year for the past decade.

Professor Rowthorn from Cambridge has pointed out how oil price uncertainty was “one of the strongest arguments against independence”. Over the next 25-30 years, most estimates are that North Sea oil revenues will decline whatever happens to the price of oil. David Phillips, a senior research economist at the Institute for Fiscal Studies think-tank reckons that “even with a geographic share [of revenues], Scotland’s finances get worse by the middle of this decade”.

The Aberdeen-based billionaire Sir Ian Wood, former head of oil services supplier Wood Group, who in the past year has led a government-commissioned review into how best to exploit the North Sea’s remaining resources, has also warned of a sharp tail-off in production from 2030. Sir Ian acknowledged that as many as 24bn barrels of oil equivalent may remain, but he suggested 15-16.5bn as a more likely total – compared with the more than 40bn extracted since the 1970s. Oil & Gas UK puts the range between 12-24bn. The Department of Energy and Climate Change reckons UK oil production will decline from 43m tonnes this year to 23m a year by 2030.

If you assume that the oil price will rise from $102 a barrel in 2015 to $160 by 2040, in other words, stay much the same in real terms, then revenues from the North Sea will not rise in real terms at best and probably will fall. Robert Chote, chairman of the OBR, predicted a sharp fall in UK oil and gas receipts from £6.1bn in 2012-13 to £3.5bn by 2018-19, with far steeper declines after that. The UK culled total revenues of £4.7bn from the North Sea in 2013-14.

oil revenues

Public finances

And this brings us to government finances under an independent Scotland. The latest Scottish official figures show that, if calculated on the same basis as the rest of the UK, a so-called per capita basis – with oil revenues shared equally across the UK – Scotland’s public sector had a budget deficit of 13.3% of GDP in 2012-13, the latest year for which figures are available. That compares with 7.3% for the UK as a whole; the Scottish deficit is nearly twice as large. Even with 90% oil, Scotland’s budget deficit in 2012-13 was 8.3% of GDP, bigger than that for the whole of the UK. Indeed, it has been bigger on that basis for the past 25 years. The Institute for Fiscal Studies reckons that, over time, a Scottish government will run bigger fiscal deficits than the UK over the next 50 years.


This is because Scotland will have a population that ages more than the rest of the UK, so pension and health costs will rise more. Also public spending per head in Scotland is 10% higher (maybe for the best reasons). Yet the SNP plans to cut corporate taxes for business to attract more investment, so relying on foreign capital to boost growth and jobs.

So it is not going to be easy for a Scottish government to maintain slightly higher levels of public spending for Scots than south of the border without running larger fiscal deficits that will have to be financed by borrowing (issuing Scottish government bonds) from the City of London and elsewhere. The energy revenue stream has varied between 5-22% of Scottish tax receipts over the last 20 years, averaging around 12%. Managing such violent swings, with such a large fiscal deficit as a starting point, would be no easy task. The government will face rising interest costs on that borrowing compared to the cost of borrowing by the Westminster government, perhaps an interest rate premium of 50 to 100 basis points, potentially more. Scotland would also inherit a significant proportion of UK government debt. This is what the SNP wants to negotiate.

Also, if Scotland joins the EU as a separate member, it will be subject to the severe fiscal austerity targets now being imposed on the likes of Greece, Portugal, Spain and others by the EU under its fiscal pacts. That threatens the ability of the government to sustain better health and education services as well as welfare benefits, especially if corporate taxes are being cut at the same time. Already, it has been revealed that current Holyrood control of the health service has led to significant privatisation of contacting services, just as in England. A major study by the Nuffield Trust in April suggested the performance of the health service in Scotland had improved in relation to England. But the policies that had made the difference were UK-wide – such as waiting list targets – not the result of devolved decision-making.

The currency

The cost of borrowing by a Scottish government raises the issue of Scottish banks and the role of the Bank of England, which has been a major issue of debate between the yes and no camps. Scotland’s banking assets – in practice the potential liabilities of an independent Scottish government in the event of independence – are a staggering 1,100% of GDP. Scotland has a potential banking liability of Icelandic proportions and much bigger than those (700% of GDP) which almost bankrupted the Irish economy. This oversized banking sector will shrink as the likes of Lloyds and others take their Scottish base away (with the loss of jobs and income), but RBS apparently plans to stay. Ironically, this is 86%-owned by the Westminster government and regulated by the Bank of England (BoE).

Under a proper currency union of Scotland and rUK using the pound, the BoE would set interest rates independently of government and parliament. So a Scottish government would still have no say over the basic interest rate, which would be determined by unelected BoE members using just the inflation rate of the UK as a guide. Scotland would remain under the grip of the City of London and the fluctuations of economy and the financial sector of rUK, as before.

A sterling monetary union is the Scottish Government’s preferred option for an independent Scotland (new report). So this would mean accepting the interest rate decisions of the BoE and allowing fiscal control to remain with Westminster or the EU, just as happens now in the UK. These would include submitting budgetary plans to Westminster, accepting some continuing oversight of its public finances by UK authorities and limiting the degree of tax competition between Scotland and the rest of the UK.

But so far, all three major parties south of the border say that the Bank of England should not act as ‘lender of last resort’ to Scottish financial institutions after independence if they get into trouble. Of course, a Scottish government can adopt the pound as its currency without being part of currency union with rUK, or the credit backing of the BoE. This is what Panama does with the US dollar. But then Scottish capitalism is on its own if things go wrong in the night with its banking system or if inflation takes off north of the border. That risk means that the City of London will want to charge more to lend to a Scottish government and corporations because of the extra risk involved.

The only faction of pro-capitalist economists who think that the Panama solution would be best is the extreme ‘free market’ Adam Smith Institute. Research director Sam Bowman, commented “the ‘Panama option’ may be his best bet for an independent Scotland… emulating Panama could give an independent Scotland a remarkably robust financial system because Scotland’s banks could not depend on an unlimited central bank lender of last resort.” No central bank for Scotland would be good news.

It’s true that other ‘currency pegs’ (as they are called) have been successfully sustained over lengthy periods. Hong Kong’s link to the US dollar has been maintained since 1983 and the exchange rate between the Danish krone and the euro has been fixed since the formation of the Eurozone. But these are separate currencies from the dollar and the euro. And the Hong Kong Monetary Authority has accumulated massive dollar reserves. The Scottish situation would be different. Scotland could presumably expect to receive a pro rata share of Britain’s gold and foreign exchange reserves. But the £10bn or so that Scotland might expect would be hopelessly inadequate to defend a fixed exchange rate from speculative attack.

Alternatively, a variable exchange rate between Scots and English pounds would be a mess. The queues at the bureau de change at Edinburgh’s Waverley railway station would be the most visible result. More important, Scottish households and companies would have to decide how to denominate their assets and liabilities and choose the currency in which they wished to trade. This is what Hungarians and Poles found after taking out ‘cheap’ euro mortgages and watching their income in forints and zlotys to service them plunge.

Three models

We could sum up the future of an independent Scottish state from three possible models. The first is that Scotland becomes an energy-rich Norway with huge oil and gas revenues, staying outside of the EU, with the highest living standards in the world and huge reserves for a rainy day. This is not possible for Scotland with declining North Sea output and revenue in real terms and the need for multinational investment in energy technology.

Second, it could become an Ireland based on a low corporation tax and incentives for multinationals to come and invest. Ireland achieved this in its Celtic tiger period, but mainly because it was part of the EU and the Eurozone, as well as having access to the UK market. This will not be possible for Scotland as Ireland has already occupied that space and Scotland would have to be in the EU as well (possibly at a time when the UK withdraws!). To get into the EU, Scotland would probably have to agree to join the Eurozone at a certain point (that’s what every new member must now agree to), thus dropping the pound, for rule by the ECB and the EU fiscal pact.

The third model is Iceland: a small independent state with a high standard of living relying on fishing and bauxite mineral mines, outside the EU and with the ability to devalue its own currency in crises. However, Iceland is only the size of Coventry and it did not escape the global financial crisis either.

Both Ireland and Iceland were brought their knees by an oversized banking sector that took ‘hot money’ and relent it recklessly to destruction. The banks were bailed out in Ireland at huge and continuing cost to Irish households. Iceland was forced to devalue, creating sky-high inflation and it had to negotiate a deal for repaying lost bank deposits with the UK and Holland, again at a huge loss to the living standards of its small community (see my post, Scotland would face the same issue.

At best, the majority of the Scottish people will find little difference under Holyrood than under Westminster and it could be worse if a global crisis erupts again. Scotland as a small economy, dependent on multinationals for investment, still dominated by British banks and the City of London and without control of its own currency or interest rates, could face a much bigger hit than elsewhere in terms of incomes and unemployment.

So independence would not bring dramatic economic improvement to the majority of Scots; indeed, it could mean a worse situation. But then the decision on independence is not just a question of the economy and living standards. That brings us back to the issue of the Scottish and English/Welsh (and Irish) working class sticking together in the struggle against British capital. Will an independent Scottish capitalist state strengthen that in any way?

If the vote is yes, I’ll look at the repercussions for the UK and Europe in a future post.

Ukraine: a grim winter ahead

August 31, 2014

As the war along Ukraine’s borders takes a new turn, with Russian incursions on the south-east coast and NATO preparing a new ‘expeditionary force’, Ukraine’s economy heads fast down a black hole. New President Poroshenko, one of Ukraine’s feuding oligarchs (in his case, the confectionery king), has dissolved parliament and called elections for 26 October. The election will probably lead to the removal of all the old supporters of the ousted pro-Russian former president still in parliament. They have been blocking attempts by the current caretaker prime minister Arseniy Yatsenyuk to carry out the dictates of the IMF under the $17bn ‘reform’ programme agreed last April.

In return for IMF money to meet foreign debts and fund the state (for arms mostly), the Kiev government agreed to huge cuts in public spending, pensions and welfare and, above all, to privatise state agencies and raise energy charges for heating and fuel by over 40%, a total reduction of government spending of 6.75% of GDP. The government agreed to these draconian measures because there was no alternative. As Yatsenyuk said, while the IMF deal would mean hardship for the people and be unpopular, he was prepared to conduct ‘suicide politics’.

Yatsenyuk was so frustrated by parliament’s lethargy in agreeing the IMF measures that he threatened to resign, forcing a collapse of the government. The measures were finally passed, but not before the economy minister Pavlo Sheremeta also threatened to resign in anger at delays in implementing the IMF ‘reforms’. “We need to change this whole paradigm: the system, the people, the processes,” Sheremeta said.

The problem for the pro-IMF government and its foreign investor supporters is that the economy is on its knees and the targets set by the IMF will not be met. In addition, the war is destroying the country’s infrastructure. For example, an $80m food processing plant, opened in 2000 by Cargill, was one of the first big greenfield investments into independent Ukraine. It was abandoned by the US agriculture group’s employees after being stormed by pro-Russian gunmen. Now it has been destroyed by fire.

The latest data indicate that the Ukrainian economy has contracted almost 5% yoy so far this year, the IMF’s forecast for the whole year. The final contraction for 2014 is likely to be 8% in real terms, even if the war should subside.

Ukraine GDP.jpg

The loss of Crimea alone has cut Ukraine’s GDP by 3.7%. The rebel provinces of Donetsk and Lugansk account for about 16% of GDP and 25% of exports.

An energy crisis looms for the winter. Russia’s Gazprom, which provides more than half the country’s gas, stopped supplies in June. The government has been paying fuel subsidies equivalent to 7.5% of GDP. Its energy intensity – the ratio of energy used to economic output – is twice that of Russia and ten times the OECD average. Reducing this huge waste of energy is part of the IMF plan. Carl Bildt, Sweden’s foreign minister, reckons: “If Ukraine improved its energy efficiency to reasonably EU levels, I doubt it would need to import any energy at all.” The resources to do this through better management of heating, insulation and control of private energy companies are not there, of course.

The IMF wants to cut public spending so that government debts do not rise so much that foreign lenders, including the IMF itself, won’t get their money back. You can see how much Ukraine will owe to the IMF by 2018 in the graph below.  Public sector debt-to-GDP will double towards 87% by 2018, as taxation of the rich oligarchs is non-existent. Ukraine owes $3bn to Russia itself and Moscow can demand immediate repayment.

Ukraine FX debr

As I argued in my last post on Ukraine (, the falling value of the hryvnia only makes the debt on foreign currency terms worse. The IMF’s own risk assessment warns that if the hryvnia falls to 12.5/$, then the stresses on bank balance sheets would require a bailout of at least 5% of GDP. The currency is currently weaker than that, at 13/$.

Ukraine currency

The IMF issued a statement before the weekend congratulating the Kiev government on trying to meet its demands: “Overall, economic policies have generally been implemented as agreed in the program, as the Ukrainian authorities have persisted in taking difficult measures despite the volatile political situation.” But despite the imposition of severe austerity measures, the IMF is worried that it will still go pear-shaped: “However, the conflict in the eastern part of the country is taking its toll on the economy and society, and compensatory measures will be critical to achieve key program targets agreed for 2014 and beyond. The program remains highly challenging and continues to hinge crucially on the assumption that the conflict will subside in the coming months.”

As Christine Lagarde, the IMF’s managing director, said: “Downside risks to the program remain very high. The program success hinges on a timely resolution of the conflict in the East, as well as on the authorities’ strong policy performance and adherence to the planned reform.”

What is the IMF answer to the worsening economic situation? More austerity. Lagarde (now under investigation for corruption herself) called on the government to “(i) take steps to accumulate international reserves, (ii) tighten the fiscal stance in 2015–16 relative to the initial program targets, and (iii) step up efforts to put Naftogaz on a sound financial footing by improving bill collections and adjusting energy prices as needed.”

It is almost certain that the IMF will have to cough up more money to tide Ukraine over or Ukraine will default on its debts and obligations to foreign governments and investors. A “reprofiling” policy is being discussed by the IMF board. This would ‘stretch out’ any repayments but leave the overall debt untouched – still a default and restructuring but a ‘soft one’.

There is an alternative to the Kiev government policy of capitulating to the IMF. A socialist government would take over the interests of the oligarchs who stole Ukraine’s wealth in the first place. It would seize those funds to meet the needs of ordinary people on heating, education and public services. It would revoke the debts owed to Russian and Western banks and demand that the IMF write off its loans so that Ukraine could start without the heavy burden of debt. Ukraine remains a key agricultural exporter and also a low-cost steel producer. If the banks and major export sectors were in the government’s hands and not those of oligarchs (and foreign private equity companies in the future), then a national plan could be implemented.

Also, it would offer to discuss with genuine representatives of the Russian-speaking eastern areas a proper federation and autonomy, a guarantee of rights in education and language. The aim would be to reassure the Russian-speaking areas with economic and political support, rather than the alternative of war that Poroshenko and Putin promote. Instead, Ukraine’s people, both in the west and east, face a grim and increasingly deadly winter.

The US recovery, the Long Depression and Pax Americana

August 29, 2014

Revised figures for growth in the US economy in the second quarter of this year were released yesterday. Most analysts were pleased as the rise in real GDP in Q2 2-14, was revised up from a 4.0% annualised rate to 4.2%. The drop in real GDP for the first quarter of this year was confirmed at -2.1%. When compared to the prior quarter, the new measurement is up about 6.3% pts from the -2.1% contraction rate for the 1st quarter of 2014. This is the largest positive quarter to quarter improvement in GDP growth in 14 years.

The reason for the slight rise in the revised figure was that business investment (i.e. investment by companies in new equipment, offices and technology as opposed to residential investment by household buying houses) was revised up from 5.5% to a 8.4% annual rate of growth. At the same time, the first figures for corporate profits in the second quarter were announced. Profits rose $155bn compared with a drop in profits of $202bn in the first quarter of this year.

So it would appear that the US economy is now growing quite strongly and the terrible first quarter was really just due to a ‘bad winter’ as was argued by the mainstream at the time. But looking at quarterly rates of growth (annualised) may be useful to show how an economy is doing from one quarter to the next. But it does not show the trend of activity. For that, it is better to compare year-on-year growth. And here the story is less exciting.

After the revisions, the US economy in real terms has grown 2.4% compared to this time last year. Not bad, and certainly better than anywhere else among the top economies, apart from maybe the UK. But growth in the first quarter was only 1.9% yoy, so in summing up, in the first half of this year, the US economy expanded in real terms by 2.2%.  But as you can see, this growth rate is pretty much in line with the trend since end of the Great Recession.

US real GDP

Indeed, the current rate of 2.2% yoy for H1 2014 compared with the average rate of growth since mid-2009 of 2.0%, hardly higher; and with the average in the credit boom between 2002 and the onset of the Great Recession of 2.6% yoy. And the current rate is still one-third below the long-term average rate in the post-war period for the US economy of 3.3% a year. So, not so great. Indeed, US GDP per-capita is 9.8% below the pre-recession trend (graph below from Doug Short).

US real GDP per cap

Also to get the real GDP figure, the official stats assume an annualized quarterly inflation of 2.15%. Yet during the second quarter, the seasonally adjusted inflation index rose at a 3.53% annualized rate. If that inflation rate were used to deflate nominal GDP growth, the Q2 growth rate would be 2.9% not 4.2% and real growth would be close to 2%, with per-capita GDP growth (after taking into account a growing population) just 1.1%.

And this recovery does not feel like one to most Americans. Real annualized per-capita disposable income is now $37,481, up only 2.19% in total since the second quarter of 2008 — a miserable 0.36% annualized growth rate over the past six years. And that’s the average – for most Americans disposable income has fallen. Of course, the forecasts are for a huge pick-up in the rest of this year to take US growth up to 3% or more and so start to change the whole picture – we shall see.

The US economy is clearly stuck in below-trend growth.  I have called the period since 2008 a Long Depression and it now seems that even some of the mainstream Keynesian economists are prepared to use a similar term.  Brad de Long has now noticed that the US “did not experience a rapid V-shaped recovery carrying it back to the previous growth trend of potential output.( Indeed, the recession trough in 2009 saw the US real GDP level 11% lower than the 2005-2007 trend. Today it stands 16% below (see De Long’s graph below).   Cumulative output losses relative to the 1995-2007 trends now stand at 78% of a year’s GDP for the United States, and at 60% of a year’s GDP for the Eurozone.

Dropbox 20140825 Financial Crisis to Great Recession to Lesser Depression to Greater Depression htmlDropbox 20140825 Financial Crisis to Great Recession to Lesser Depression to Greater Depression html

De Long goes on: “A year and a half ago, when some of us were expecting a return to whatever the path of potential output was by 2017, our guess was that the Great Recession would wind up costing the North Atlantic in lost production about 80% of one year’s output–call it $13 trillion. Today a five-year return to whatever the new normal might be looks optimistic–and even that scenario carries us to $20 trillion. And a pessimistic scenario of five years that have been like 2012-2014 plus then five years of recovery would get us to a total lost-wealth cost of $35 trillion.”

De Long concludes that “At some point we will have to stop calling this thing “The Great Recession” and start calling it “The Greater Depression”. When?”  How about now?

As for business investment, which has been performing really badly since the Great Recession, optimism was expressed at the upward revision in the second quarter data. But the yoy rise in business investment at 6.4% was only slightly higher than the post-recession average of 6.1% and business investment as a share of GDP is still lower than it was before the Great Recession.

In my opinion, sustained growth that would be close to the trend average would require a significant rise in the rate of business investment. And business investment growth depends in turn on the movement in corporate profits.

The latest corporate profits figures are really not encouraging on that basis. The data show that corporate profits have been falling in the first half of this year compared to the first half of 2013. As the figure below shows, business investment tends to follow the direction of corporate profits (CPBT) with a lag. As I have shown before, and as the graph below confirms, US corporate profits went negative some six to nine months before the credit crunch began in mid-2007 that kicked off the global financial collapse in 2008 and the Great Recession. Indeed, US real GDP did not contract until mid-2008. In reverse, corporate profits began to rise in mid-2009 well ahead of investment (some nine months later) and GDP. Profits lead investment.

US profits and investment

The latest data for corporate profits, if sustained in the next few quarters, would suggest that business investment will eventually drop towards zero. Again ,we shall see.  A further decline in the mass of corporate profits will depend on whether the profitability of capital, and in particular, the rate of return on new investment, falls or not. The best data on this will not be available until November, but I shall try to make some forecasts in a future post. If that happens, then it could herald a new recession by the end of 2015.  But we are getting ahead of ourselves.

Talking of the US rate of profit, I have been looking again at the long-term trajectory of the profitability of US capital. Dumenil and Levy made an estimate of the US rate of profit a la Marx going back to 1870 ( Recently, as part of his analysis of the ‘world rate of profit’, Esteban Maito also made an estimate of the US rate of profit over the same period (see His data are exactly the same, because he takes his figures directly from Dumenil and Levy.

Dumenil and Levy measured the US rate of profit using current cost estimates for fixed capital and excluded variable capital (the cost of labour). This is not the best way theoretically to do it (see my paper, Using historic costs for fixed assets and including variable capital would be the closest to the rate of profit a la Marx. Using current costs can distort the level and direction of the rate of profit for periods of time, as Andrew Kliman has pointed out ( But as Deepankar Basu has shown, over a very long period of time, these distortions will tend to disappear as the impact of inflation or deflation on fixed asset values is ironed out (see BASU capmeasure).

If we take D-L’s data as the best we have for the rise of American capitalism from 1870 into an imperialist power in the 20th century, what it shows is that, over the whole period, there is actually a slight trend upward in the US rate of profit, not down. We can see why in the graph below.

US profitability since 1870

In the post-Civil War boom, a rising American capitalist economy had very high rates of profit. The Depression of the 1880s drove that down sharply. Then there was a recovery that peaked at a lower level in the mid-1890s before falling again. World War 1 got the rate up a bit with a rise to a new peak in 1924. The decline after that presaged the Great Depression of the 1930s. World War 2 pushed the US rate of profit into the stratosphere and signalled a new hegemonic role for US imperialism and the age of Pax Americana. World wars are great for profitability, particularly for the US.  The US rate of profit is still higher than in the inter-war period. Indeed, only the post-civil war boom period of 1870s saw higher rates. WW2 transformed the US ROP and its global power status.  So US capital has had a higher ROP in the last 70 years since 1945 than it did in the 60 years before 1945.

The drop in profitability post-1965 coincided with revolutions in Europe: Spain, Greece, Portugal; in Vietnam, Latin America and parts of the Middle East; as well as intensified class struggle in France, the US and the UK. A rising rate of profit in the so-called neoliberal era of the 1980s and 1990s coincided with reaction, the collapse of the Soviet Union, the end of the cold war and a brief New World Order around US dominance.

But since the late 1990s, the US rate of profit has stagnated at best, now engendering a long depression in growth and investment, as discussed above.  Pax Americana has waned too (as the failure of US imperialism’s objectives in Vietnam, Somalia, Iraq, Afghanistan, Syria and Ukraine show).  American hegemony is increasingly difficult to sustain as the profitability of American capital stagnates or falls.


Getting off scot-free

August 27, 2014

The banks and bankers that triggered or caused the global financial crash with their reckless drive for grotesque profits continue to get away with the consequences of their actions.  The latest fine by US regulators on the Bank of America was a whopping $17bn.  But, as has been pointed out by various bloggers and the Economist, it was not really so whopping.  That’s because of the $17bn fine, for selling misleading mortgages to poor householders and distributing rubbish mortgage bonds to customers and investors, only $9bn is in cash.  The rest is an amount reckoned to be equivalent to revising mortgages for householders in difficulty.  That’s something that should have been done anyway by the banks.  Instead, the US Justice department has done sweetheart deals with the banks so that they can count part of the fine as providing the service they ought to have done before.

The ratio of these corrections to cash is 89% in the case of the Bank of America deal; 44% for the JP Morgan fine of $13bn and 56% for the Citigroup deal of $7bn.  The non-cash element keeps rising in every new deal.  So it seems that bankers can avoid prosecution for offences that have devastated millions of livelihoods (loss of homes, jobs, savings etc) and can get a special deal with the authorities that increasingly does not involve even cash but simply a form of corporate ‘community service’.  It’s time the banks were a public service and not money-making sharks designed to fleece the public (see my posts, and

Not one banker in the US has faced a criminal charge out of the global financial crash while the fines are piddling compared to the estimated trillions of dollars lost by their customers and investors.  And the fines will come out of the profits of the current shareholders, not from the gargantuan salaries and pensions of the chief executives (many of whom have done a runner) or even from the original shareholders.  And the bulk of the settlements will be tax deductible.  For destroying trillions in wealth and thousands of jobs, banks will get a write-off.  And this is after former Fed Chairman Ben Bernanke, recently described the crisis in the banking system as worse than in the Great Depression: “September and October of 2008 was the worst financial crisis in global history, including the Great Depression….Of the 13 most important financial institutions in the United States, 12 were at risk of failure within a period of a week or two.”  This is how far the bankers had destroyed America’s credit system.

The deals with the US Justice Department for JP Morgan or Bank America also mean that all the scandals are buried and won’t be revealed to the public – unlike the scandals revealed with HSBC’s laundering of Mexican drug cartel money or BNP’s laundering of cash for Iran and warlords in Sudan etc – all against US law.  So US bankers are getting off scot-free with not even a slur on their characters, let alone a charge.  After ‘fining’ Bank of America $17bn, the public will not know why.

Getting out of a Jackson Hole

August 24, 2014

Every August, the great and august among central bankers and strategists of the world economy meet as guests of the Kansas City Federal Reserve for an economic symposium at Jackson Hole, Wyoming, a ski resort under the Teton mountains. After the planes, helicopters and limos have transported them all to the luxurious lodge, the participants make and hear presentations and speeches on the economic issues of the day.

This year, the theme was ‘labour market dynamics’, in other words, the strategists of capital (mainly US capital) were considering whether labour markets in the major economies were sufficiently ‘flexible’ to reduce the high levels of unemployment engendered by the Great Recession and to look for the causes and solutions to the very slow recovery of employment. (

In one paper, mainstream economists, Steven Davis and John Haltiwanger, of the University of Chicago and University of Maryland, reckoned that “the US economy became less dynamic and responsive in recent decades.” And the reason was too much government regulation. They calculated that the fraction of workers required to hold a government-issued licence to do their jobs rose from less than 5% in the 1950s to 29% in 2008. Adding workers who require government certification, or who are in the process of becoming licensed or certified, brings the share of workers in jobs that require a government-issued licence or certification to 38% as of 2008, they say. So the slow recovery from high unemployment is the fault of government regulation and not the market economy.

In contrast, Giuseppe Bertola, economics professor at EDHEC Business School, reckoned that it was more government action, not less, that was needed to get unemployment down. Bertola argued that some job protection and unemployment assistance may offer a positive ‘trade-off’ not only for the individuals receiving them but also for the economy as a whole. What was needed was not more ‘flexibility’, but more ‘rigidity’! “Rigidities can be beneficial in imperfect economies, where the flexibility that employers like is the other face of the precariousness that workers fear,” he wrote. Bertola cited the German model of work-sharing through reduced hours, made possible by strong cooperation between labour unions and large corporations, as having allowed unemployment to remain lower in Germany than in the United States during the crisis–and to come down consistently since.

Bertola’s line is not welcomed by the mainstream in analysing the causes of high unemployment. Indeed, in another paper for Jackson Hole, Jae Song, an economist at the Social Security Administration and Till von Wachter, a professor at the University of California, Los Angeles argue that the problem of long-term unemployment does not really exist. “In contrast to the behavior of long-term unemployment, long-term non-employment behaved similar in the Great Recession” to previous recessions, they say. So the level of permanent unemployment is no worse than before and there is no need to wait to tighten monetary policy. The economy is not permanently damaged and indeed is ready to go.

To sum up, the mainstream economists at Jackson Hole generally found that the US unemployment situation was not too bad and any unemployment left was due to too much government regulation and lack of flexibility. So there would be no problem if the Federal Reserve ended its quantitative easing measures and started hiking interest rates. The US economy would cope and ‘return to normal’ without any serious repercussions.

Janet Yellen is not so sure. Both Janet Yellen, the first woman head of the Federal Reserve and Mario Draghi, the first Italian head of the European Central bank, made speeches on the state of the economy, the pace of ‘recovery’ (or otherwise) and what they as central bankers would do about it with monetary measures. The US Federal Reserve board members are split on whether the US labour market has recovered sufficiently for the Fed to start raising interest rates and ‘return to normal’. For the hawks (still in a minority), the rapid decline in the unemployment rate shows that ‘slack’ in the economy is disappearing so the Fed should ‘tighten’ monetary policy soon. For the doves (led by Yellen), the low rate of wage growth suggests there’s plenty of slack and tightening should wait.

In her Jackson Hole speech, however, Yellen seemed to less sure about the slow pace of ‘recovery’ ( She dithered. As one commentator noted, she used “1 coulds, 20 buts, 11 woulds, 7 mights and a magnificent 56 ifs.” The doves argue that the huge drop in the labour participation rate, which measures how many of those of working age actually have a job, showed that there many people who wanted a job, but had just given up looking and so were not counted among the unemployed but should be. And many of those working are in part-time or temporary jobs (see my posts on this, In other words, the labour market was still slack.

Labour participation

But Yellen presented a new argument for the hawks. She cited a paper by the San Francisco Fed that argued during the Great Recession wages were not cut by most firms, but now that recovery is under way, employers are holding back on pay rises. This was a form of “pent-up wage deflation.” At some point, as the labour market ‘tightens’, this will end and wages would then rise quite rapidly. So maybe the Fed should pre-empt the impact on inflation by raising interest rates sooner than originally planned.

But this assumes that rising wages from the end of ‘pent-up wage deflation’ would cause higher inflation. It depends on how the value of the national product is shared between the owners of capital in profit and labour in wages. Way back in 1865, Marx dealt with this issue in a debate inside the International Workingmen’s Association eventually published in a pamphlet entitled, Value, Price and Profit. Marx argued that wages can rise without any effect on prices if profits fall. Indeed, that would be the usual result. (

In mainstream economic terms, we can pose it this way. There has been a huge divergence between productivity growth and wage growth since the 1980s in the US and elsewhere. Profit shares as part of value added have rocketed to record highs. Indeed, it is estimated that wages in real terms could rise 10% to restore the gap with current productivity growth, a measure of the non-inflationary leg room from a rise in wages now.

Productivity and wages


Of course, such a wage rise would hit profits and that is the real problem for capitalism, not inflation. If companies cannot raise prices to compensate because of weak demand for their goods and services and strong competition nationally and internationally (prices are rising just 1% a year in international traded goods), then profit share will fall and the mass of profits will also probably fall, triggering a new slump in investment. After all, despite the massive rise in profit share, US corporate profits are now starting to drop. A 10% wage rise would be a last straw.

corporate profits

In the Great Depression of the 1930s, wages recovered sharply but inflation of prices did not. What the rise in wages did do was contribute to a fall in profitability (as Marx posed in Value, Price and Profit), engendering a new slump in 1937. And the Fed helped to tip the economy into a slump by hiking interest rates to stem ‘inflation’. See my post

Wages and inflation in 1930s

Even the Federal Reserve finds little connection between wage rises and inflation (see a new paper by some Chicago Fed economists ( “We do find that wages are sensitive to economic activity and the level of slack in the economy, but our forecasting results suggest that the ability of wages to help predict future inflation is limited. Thus, wages appear to be useful in assessing the current state of labor markets, but not necessarily sufficient for thinking about where the economy and inflation are going.”

Yellen is not sure what would happen. If the Fed were to tighten too soon, it could abort the recovery and send the economy back into a new slump. On the other hand, if inflation starts rising then interest rates will have to be hiked even if the price is a new recession. But Yellen does not know which.

The problem for the ECB appears to be different. The Eurozone economy shows no sign of ‘recovery’ whatsoever and the risk is more that it will slip into an outright deflationary depression, something that the southern Eurozone states of Greece, Portugal, Italy and Spain are already experiencing. The average inflation rate for the whole area is already near zero and the Eurozone is beginning to look like Japan in its stagnation of the 1990s that Abenomics is trying to end (see my post,

In his speech, Mario Draghi talked about taking action to provide more credit for the banks and companies and keep interest rates near zero for much longer – the opposite of Yellen’s musings (

He hinted at new measures similar to that of the Fed, namely quantitative easing, i.e. buying up government bonds through the printing of more euros. “The risks of doing too little outweigh the risks of doing too much,” he said.

So the prospect for 2015 (the seventh year since the Great Recession began) is of the Fed tightening credit and raising interest rates and of the ECB doing the opposite. The risks are aborting the relative US economic recovery and/or the collapse of the Eurozone into outright depression (see my post,

Capitalism: stagnation or hypochondria?

August 22, 2014

Are the major capitalist economies now stuck in a state of long-term stagnation? The idea that capitalism has been in a ‘secular stagnation’ since the end of the Great Recession was first raised by Larry Summers, the former Treasury secretary under President Clinton, ex Goldman Sachs economist, then Harvard University scholar and general all-round super star mainstream economics expert. And Summers’ idea has been enthusiastically adopted by Paul Krugman, doyen of Keynesian economics.

The term ‘secular stagnation’ was first coined by the Keynesian economist, Alvin Hansen, in 1938, when he predicted that after the war, modern economies would stagnate because of a crisis of underinvestment and deficient aggregate demand. Investment opportunities had significantly diminished in the face of the closing of the frontier for new waves of immigration and declining population growth. So, according to Hansen, the US was faced with a lower natural rate of growth to which the rate of growth of the capital stock would adjust through a permanently lower rate of investment.

This turned out to be wrong, as in the post-war period, the major capitalist economies experienced a ‘golden age’ of relatively fast real GDP growth, rising employment and incomes as the teeming population of emerging economies were sucked into the capitalist mode of production, the unemployed of Europe were put to work and American capital was used to finance investment globally. And all this was possible because of the record level of profitability for capital in the US during the war.

I criticised this idea of secular stagnation in a post last year ( Hansen was wrong and his idea of secular stagnation has recently been described by leading neoliberal Chicago economist Steve Williamson as “the delusions of a hypochondriac rather than the insightful diagnosis of a celebrated economist.” Nevertheless, the idea has been revived by Summers and now various strands of argument around this theme have been published in an e-book called, Secular stagnation: facts, causes and cures ( with all the leading proponents of the idea contributing.

The reason that Hansen’s idea of ‘secular stagnation’ and its revival by Summers has gained new traction is because it is obvious to all observers that, since the end of the Great Recession, the world capitalist economy is struggling at below trend growth and employment and, above all, with very low investment levels, keeping ‘effective demand’ inadequate just as Hansen predicted would happen in the post-war period.

So maybe Hansen’s idea is right now? As the editors of the e-book put it: “Six years after the Global Crisis exploded and the recovery is still not going well. Pre-Crisis GDP levels have been surpassed, but few advanced economies have returned to pre-Crisis growth rates despite years of near-zero interest rates. Worryingly, the recent growth is fragranced with hints of new financial bubbles.”

There are two basic arguments for secular stagnation in the e-book. There is the argument that what drives economic growth are the factor inputs for production i.e. more and higher quality labour, more and better technology and that unfathomable extra factor of innovation and human ingenuity. Back in the 1960s, Robert Solow developed a factor model of economic growth that concluded that the main driver of growth was this last factor, called total factor productivity (TFP), which was measured as the residue in the contribution to growth after taking into account the impact of capital and labour inputs. Solow reckoned that 80% of growth was accounted for by ‘human ingenuity’ or TFP. A modern study by Hsieh and Klenow found that we can account for 10-30% in income differences across countries by differences in human capital, about 20% by differences in physical capital, and 50-70% by differences in TFP.

Now, according to Robert Gordon (in the e-book), TFP growth has been in long term decline since the 1970s in the major capitalist economies – they are just getting more unproductive and unable to take the productive forces forward at the same pace in the past. “US real GDP has grown at a turtle-like pace of only 2.1% per year in the last four years, despite a rapid decline in the unemployment rate from 10% to 6%.”

I have discussed Gordon’s thesis before ( and it remains a worrying one for the future of the capitalist mode of production. Gordon is at pains to say that he is not expecting future TFP growth to drop away post the Great Recession, but simply return to the slow rate of TFP growth experienced after the end of golden age between 1950-70. That’s enough to keep economic growth low, along with other factors. “US economic growth will continue to be slow for the next 25 to 40 years – not because of a slowdown in technological growth, but rather because of four ‘headwinds’: demographics, education, inequality, and government debt.” The population is stagnant, life expectancy is increasing rapidly. The mass education revolution is complete, no further increase in the average US education level is to be expected. The rising share of the top 10% of the income distribution has deprived the middle class of income growth since 1980 and the gloomy outlook for public debt makes current public services unsustainable.

Gordon’s pessimism about capitalism is attacked in the e-book by Joel Mokyr who reckons that Gordon underestimates human ingenuity and the impact of technology. After all, modern capitalism since the ‘industrial revolution’ has dramatically expanded the productivity of labour, as Marx recognised as early as 1848 in the Communist Manifesto. Indeed, capitalism is growth driven by technological progress. Right now, says Mokyr, there is much important scientific advance happening right under our noses and much of the effects of current and future innovations on economic welfare may not be measured well. For example, information has become much more accessible in myriad ways that make us better off, but not all of that is captured in GDP. The contribution of IT to our wellbeing is not evident from the productivity statistics because the way “we measure GDP and productivity growth is well designed for the wheat-and-steel economy. It works when pure quantities matter; it does not for measuring the fruits of the IT revolution.” The key is that the development of high value-added services by Google, Microsoft, Amazon, Facebook and the like require relatively little investment. Summers makes a similar point in noting that WhatsApp has a greater market value than Sony but required next to no capital investment to achieve it.

This is the optimistic view that capitalism will come through with a new burst of innovation that will boost TFP growth as it has done in the past, at least in the post-war golden age. Gordon retorts sarcastically that “techno-optimists” like Mokyr “are whistling in the dark, ignoring the rise and fall of TFP growth over the past 120 years. The techno-optimists ignore the headwinds, seeming ostrich-like in their refusal to face reality. ”  They claim that GDP is fundamentally flawed because it does not include the fact that information is now free due to the growth in internet sources such as Google and Wikipedia. But says, Gordon, TFP growth sagged decades before the popularisation of smart phones and the internet.  And GDP has always been understated. Henry Ford reduced the price of his Model T from $900 in 1910 to $265 in 1923 while improving its quality. Yet autos were not included in the CPI until 1935.  Indeed, the most important omission from real GDP was the conquest of infant mortality, which by one estimate added more unmeasured value to GDP in the 20th century, particularly in its first half, than all measured consumption.

No says, Gordon, “Future generations of Americans who by then will have become accustomed to turtle-like growth may marvel in retrospect that there was so much growth in the 200 years before 2007, especially in the core half century between 1920 and 1970 when the US created the modern age.”  For Gordon, the golden age of American imperialism in the mid-20th century is over and will not return.

This particular debate about long-term economic growth has little to with the original theory behind ‘secular stagnation’ proposed by Hansen and taken up again by Summers and Krugman. The issue for them is a permanent lack of ‘effective demand’, not the failure of capitalism to innovate. Capitalism can grow faster if only investment and consumption rise faster. But capitalism is stuck below its true potential because, despite interest rates being reduced to near zero, the real rate necessary to boost demand is still too high. As Krugman puts it: “Secular stagnation is the proposition that periods like the last five-plus years, when even zero policy interest rates aren’t enough to restore full employment, are going to be much more common in the future…And Summers adds: “We may well need, in the years ahead, to think about how we manage an economy in which the zero nominal interest rate is a chronic and systemic inhibitor of economic activity, holding our economies back below their potential.”

So what’s the answer? Increase government spending and print money. This may create credit ‘bubbles’. But “bubbles are an alternative way for society to deal with excess saving when fiscal policy does not take up the challenge. Buying bubbly assets with the intention of selling them at a later date is an alternative route of saving for future consumption. When nobody wants to invest because r is below g, and hence buys bubbly assets, the price of these assets goes up, yielding windfall profits to their sellers who are therefore able to increase their consumption. This additional consumption restores the balance between supply and demand for loanable funds on the capital market”.

So we need to print money, give it to speculators in financial assets and when they make profits from speculation, they will spend. In other words, give the already rich even more money to spend! Summers recognises that this could produce a new contradiction. If we deliberately create bubbles “this might involve substantial financial instability.” But the choice is between the risk of financial instability or having permanently high unemployment. Great!

Summers’ argument came under deflected criticism from the current governor of the Reserve Bank of India and former IMF chief economist, Raghuram Rajan. He criticised the idea of more quantitative easing or ‘unconventional’ monetary boost as endangering the capitalist economy: “We are taking a greater chance of having another crash at a time when the world is less capable of bearing the cost,” Rajan told the Central Banking Journal. “Investors are counting on “easy money” being available for the foreseeable future and thinking they can sell before everyone else does; They put the trades on even though they know what will happen as everyone attempts to exit positions at the same time,” he said. “There will be major market volatility if that occurs.”

Now Rajan has ‘form’. This week, the annual Jackson Hole economic symposium in the US is taking place with all the world’s leading central bankers and other top economic strategists meeting to discuss how to handle the faults of capitalism. Back at the 2005 symposium, two years before the global financial crash began, Rajan presented a paper warning of the coming crisis. ( Rajan argued that the structure of financial-sector compensation, in combination with complex financial products, gave bankers huge cash incentives to take risks with other people’s money, while imposing no penalties for any subsequent losses. Rajan warned that this bonus culture rewarded bankers for actions that could destroy their own institutions, or even the entire system, and that this could generate a “full-blown financial crisis” and a “catastrophic meltdown.” When Rajan finished speaking, Summers rose up from the audience and attacked him, calling him a “Luddite,” dismissing his concerns, and warning that increased regulation would reduce the productivity of the financial sector. (Ben Bernanke, Tim Geithner, and Alan Greenspan were also in the audience.)

It seems that the debate has not moved on between those Keynesians who prefer the risk of another financial crash in trying to avoid high unemployment and those mainstream economists who want ‘financial stability’ over more jobs. That’s Rajan’s position (see my post

Neoliberal economist Steve Williamson dismisses the Summers’ thesis and solution as so much hot air. He reckons that, far from getting the government to print money indefinitely to raise inflation (Summers wants a 4% inflation rate target compared to the usual 2%) and so get the real rate interests down to achieve lower unemployment, all that will do is lead to financial ‘moral hazard’ and the same financial bust that the major economies have just come out of. For Williamson, it is would be better to restore interest rates to ‘normal’ levels and let the market economy do its good work. Secular stagnation is just hypochondria: capitalism is fine.

This sums up the essence of the division among mainstream economics about the future of capitalism. Most think that capitalism will eventually ‘return to normal’ (see my post,
without ‘unconventional policies’ and new technology will drive things forward. Summer and Krugman reckon that cannot be done without permanent government intervention to drive down real interest rates through more inflation and speculation. Gordon thinks the productive powers of capitalism are exhausted and only permanent government intervention to foster human ingenuity through education and research can help. Not a pretty picture on the whole.

The problem with the thesis of secular stagnation is that it does not address the heart of the issue. It either considers the problem for capitalism to be one of lower productivity growth (supply) or one of the wrong monetary policy and too high interest rates (demand). But the heart of the issue is the capitalist mode of production: production for profit by the private owners of the means of production. Profitability and its potential lies at the heart of whether capitalism will go into new crises or stay stagnating.

At a presentation to the Communist University summer school in London this week (, I raised the issue of whether capitalism would eventually come out of the current Long Depression and so avoid ‘secular stagnation’. I argued that it could do so if profitability could be restored to levels not seen the late 1990s at the very least (see my paper, A world rate of profit (roberts_michael-a_world_rate_of_profit). That would require major deleveraging of private sector debt (still not completed) and probably another slump or two to liquidate and devalue costly unproductive assets. It’s not so much ‘stagnation’ that capitalism faces, but yet more violent economic upheavals that will destroy capital values and, of course, the lives and livelihoods of millions across the globe.

The myth of the return to normal

August 14, 2014

The latest economic data for the main capitalist economies is not encouraging for the optimists that the world economy is set to resume normal service.

Last week, we had the first estimate for US GDP for the period April to June (see my post, ). The US economy has been the better-performing top economy over the last few years. But even here, real GDP growth was just 2% yoy, well below the long-term average since 1946 of 3.3% a year.

The recovery has been weak.  In the five years after the Great Depression troughed in 1933, US nominal GDP (that’s before inflation is deducted) rose 52%. In the five years since the end of the Great Recession in mid-2009, US nominal GDP has risen only 18%.  The gap between US nominal GDP and where it would have been without the Great Recession remains wide – and even getting wider.

US nominal GDP

Indeed, US economic growth appears to be in secular decline. In the 1980s and 1990s, the US economy generated nearly 40 quarters where GDP was 4% or higher on an annualised quarter or quarter basis (not yoy). But there have been just seven of these “hypergrowth” quarters since 2000, if you include the last quarter. But that will be revised down when the huge rise in stockpiles of goods that were included in the 4% quarterly figure are reduced. So US real GDP growth was less than 2% yoy last quarter.  And yesterday, figures for American spending in shops came out and they were not pretty either. Retail sales were flat in July and the yoy rate slowed from 4.3% in June to 3.7% in July.

Things are far worse elsewhere. The data from the Eurozone are appalling. Industrial production has been shrinking for some time, down 1.1% in May over April and another 0.3% down in June over May. Today, the figures for real GDP growth for April to June came out – and there was little or no growth. The French economy was flat for the whole of the first half of 2014, while business investment fell 0.8% in the latest quarter. The French government has accordingly reduced its previously optimistic forecast for real GDP growth of 1.1% for this year to 0.5%. France may be lucky to see even that.

Even more worrying, the key economy in the area, Germany, contracted in the second quarter, falling 0.2% from April to June. If you put this together with a contraction in Italy already reported and growth of just 0.5-0.6% in the Netherlands, Spain and Portugal and yet another contraction in Greece, the whole Eurozone area failed to grow at all in the last quarter and rose just 0.7% over the last 12 months.

Japan too is a very poor shape, refuting the hopes and talk that Abenomics could turn the Japanese economy around (see my post, The huge hike in sales tax imposed by the Abe government in April, brought in to try and reduce the Japanese government’s large budget deficits and debt, has led to a collapse in consumer spending much greater than expected. In Q2’14, Japan’s GDP fell at an annualised rate of 6.8%, the biggest fall since the 2011 earthquake and tsunami. Japanese households cut their spending by 18.7% on an annualised basis! And businesses cut investment by 9.7% annualised. Indeed, investment in new machinery is down 3% from this time last year. Housing investment fell by 35%! And this GDP figure included a 4% rise in the stockpile of goods. If this is excluded, then the contraction was even worse.

Japan GDP

Now supposedly, the UK economy is the shining star in these clouds of doom elsewhere. I have had already cast some doubt about the nature and sustainability of the apparent pick-up in economic growth in the British economy (see my posts, and

At his press conference at the Bank of England yesterday on the release of the BoE’s quarterly inflation report, our overpaid governor Mark Carney raised his growth forecast for 2014 from 3.4% to 3.5%. A positive boom! But even the BoE recognised that this could be a one-off. Its own forecast for growth in future years is lower.  Carney claimed that the ‘recovery was broad-based’, but this is difficult to justify, when we see that GDP per person is still well below the 2007 peak, that manufacturing output is even further down and above all, average real wages continue to decline.

Indeed, nominal pay for employees (that’s before the impact of inflation and taxes) fell in the period April to June by 0.2% (black line in graph below). And yet inflation is rising by 1.9% yoy (yellow line in graph below). So wages are being outstripped by prices in the shops, in utilities and other daily expenses. Average real incomes have been falling since the Great Recession and there is little sign of any ‘recovery’ for most British households. Indeed, the Bank of England actually reduced its forecast for wage growth this year to just 1.25% from a previous 2.5%. Real wages will continue to fall.

UK real wages

On the other hand the BoE expects the official unemployment rate to fall further towards 5.5%, but this rate would be still higher than before the Great Recession – that will be the new normal for jobs in the UK.

UK unemployment

In previous posts, I have discussed why the UK unemployment has fallen even though economic growth has been weak since the Great Recession. But the key consequence of this has been the abysmal state of productivity per worker in the UK, which remains well below pre-crisis levels. More people in Britain have been getting jobs, but nearly half of these are in self-employment where incomes are generally lower than in full-time employment and where productivity (value per worker) is poor, even though many self-employed work long hours 9for little reward). Large corporations are flush with cash but unwilling to invest in new technology or R&D that could boost productivity.

UK productivity

Flat productivity growth plus even employment growth of 1% a year (very strong, but achieved in the six years before the Great Recession), means long-term real GDP growth of just 1% a year – and that’s assuming no new recessions or slumps. No return to normal there.


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