The dilemma of the mainstream

Mainstream economists and politicians in the main capitalist economies are in a dilemma.  They could not come up with a convincing explanation of why there was a financial collapse and the ensuing Great Recession.  When former Chairman of the US Federal Reserve, Alan Greenspan, was asked in the US Congress, right in the middle of the slump, if he could explain what had happened, he responded, “I am in a state of shocked disbelief.” He was questioned: “In other words, you found that your view of the world, your ideology was not right, it was not working (House Oversight Committee Chair, Henry Waxman). “Absolutely, precisely, you know that’s precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well”.  The conventional wisdom was unable to explain the huge disruption in modern capitalism. Now mainstream economics is in a dilemma. They are not sure what to do to fix it.

Larry Summers is a longstanding mainstream economist, a former US treasury secretary under President Clinton and now the Eliot professor at the elite Harvard University.  So he ought to know if anybody does what to do.  Writing in the Financial Times (14 October), Summers explains the dilemma: “While there is agreement on the need for more growth and job creation in the short run and on containing the accumulation of debt in the long run, there are deep differences of opinion both within and across countries as to how this can be accomplished. What might be labelled the ‘orthodox view’ attributes much of our current difficulty to excess borrowing by the public and private sectors, emphasises the need to contain debt, puts a premium on credibly austere fiscal and monetary policies, and stresses the need for long-term structural measures rather than short-term demand-oriented steps to promote growth… The alternative ‘demand support view’ also recognises the need to contain debt accumulation and avoid high inflation, but it pushes for steps to increase demand in the short run as a means of jump-starting economic growth and setting off a virtuous circle in which income growth, job creation and financial strengthening are mutually reinforcing. International economic dialogue has vacillated between these two viewpoints in recent years.”

Which approach is right? That is the basis of the debate on the fiscal multiplier that erupted among economists after the IMF report on the world economy released last week (see my recent post, The smugness multiplier, 14 October 2012). As John Mauldin, a global investment analyst, put it baldly: “There is indeed considerable disagreement throughout the world on what policies to pursue in the face of rising deficits and economies that are barely growing or at stall speed. Both sides look at the same set of realities and yet draw drastically different conclusions. Both sides marshal arguments based on rigorous mathematical models “proving” the correctness of their favorite solution, and both sides can point to counterfactuals that show the other side to be insincere or just plain wrong.   One side argues that the cure for too much debt is yet more debt, while the other side seemingly argues that the cure for a lack of growth is to shrink the economy. It is as if one side argues that the cure for a night of drunken revelry is a fifth of whiskey while the other side prescribes a very-low-calorie diet of fiber and veggies.” (

The dilemma is between the need to contain expanding debt that can eat into available funds for future investment and the need to reverse collapsing growth as it already eating into ‘demand’.  In a way, the issue of the size of the fiscal multiplier is really a red herring.  As Mauldin says: “if you either cut government spending or raise taxes, you are going to reduce GDP over the short run (academic studies suggest the short run is 4-5 quarters). To argue that raising taxes or cutting spending has no immediate effect on the economy flies in the face of mathematical reality.” In that sense, the Austerians are badly wrong.  Cutting government spending and/or raising taxes to reduce government deficits at the same time as households are slowing their spending in order to pay off debt (or because they have defaulted on their mortgages) and businesses are either refusing to invest or cannot do so, must reduce GDP growth.  If every sector is cutting back or slowing down, that must reduce GDP growth. The evidence of the last four years proves that.

But where the Keynesians are wrong is to ignore the truth that there is a limit to how much money a government can borrow (“to suggest there is no limit puts you clearly in the camp of the delusional” – Mauldin). Just look at the way both private and public sector debt has mushroomed, in the last 15 years in particular, to unprecedented heights. The graph shows public debt, but it was the same story for private debt up to 2006.

It is no accident that this rise in debt (what Marx calls fictitious capital) coincides with the downward trend in profitability on the major capitalist economies.  Since the mid-1990s, the average rate of profit in the top seven capitalist economies fell 5% to 2008 (at the start of the Great Recession) while private and public sector debt to GDP rose over 30%.  The rise in fictitious capital hid the underlying crisis in capitalist production up to 2008.

The Keynesians think that the crisis in capitalist production is simply one of insufficient spending or ‘effective demand’.  So the government must step in to fill the gap if the private sector cannot deliver.  But is the lack of spending not caused by a lack of income?  As Mauldin hints: “The problem is not merely one of insufficient spending: the key problem is insufficient income. By definition, income has to come before spending. You can take money from one source and give it to another, but that is not organic growth.” What Mauldin does not specify is that ‘organic growth’ (i.e. growth not based on fictitious capital) under the capitalist mode of production depends not on income as such but on the share that goes to profit. If that is insufficient,then organic growth based on productive investment will not materialise, whether the government spends more or less.

Mauldin gropes towards the nub of the dilemma for mainstream economics:“While deficit spending can help bridge a national economy through a recession, normal business growth must eventually take over if the country is to prosper. Keynesian theory prescribed deficit spending during times of business recessions and the accumulation of surpluses during good times, in order to be able to pay down debts that would inevitably accrue down the road. The problem is that the model developed by Keynesian theory begins to break down as we near the event horizon of a black hole of debt. “

The debt is now just too high to expect more borrowing to deliver enough new investment and growth to contain it. Keynesians sometimes seem to argue that debt does not matter and more borrowing is not a problem, at least not for now.  And yet all the analysis of all the historical evidence shows that once debt gets up to 85-100% of GDP, whether it is private or public debt, economic growth slows sharply to well below a trend level that can sustain employment or encourage investment (see recent studies by Reinhart and Rogoff, McKinsey and the IMF).  And that is where we are right now.

The Austerians complain that the Keynesian view that debt does not matter (at least for now) is just passing on the problem of paying for the servicing of that rising debt (repayments and interest) to future generations.  So there will be low growth, stagnation and crisis down the road.  This has led to a rather stale debate within mainstream economics between Austerians and Keynesians on whether there is burden for future generations (see

The result of this debate has been summed by arch-Keynesian, Simon Wren-Lewis (see his blog site, He concludes “government debt can be a burden on future generations … and is also likely to reduce future output, so we should really worry about the size of government debt in the longer term”  SWL then adds his important Keynesian proviso “but none of these worries applies when the economy is demand constrained as it is right now.”  But SWL adds the reason for capitalist production to be worried about mounting government debt.  If it diverts available saving away from “productive capital”, then it crowds out that capital.  In other words, if more government borrowing is spent on unproductive activities like welfare, it reduces spending on productive things building new homes or infrastructure. But this problem only arises when there is not enough savings to go round (“when investment in capital is governed by savings”). Exactly!  As households do little saving, we are really talking about business ‘savings,’ or profit.  If there are insufficient profits for investment and then government borrowing diverts some of this into buying government debt, that crowds out ‘productive investment’, i.e.investment for profit.  Then “we should be concerned” about the long run impact of government debt.

More or less government spending?  More or less debt?  Which is the best way?  Mainstream economists don’t know, or at least are divided. A recent survey of 60 leading US economists (Foreign Policy Survey on the economy, November 2012 issue, asked them: if we are ever going to get out of this slump, what will it take?  The general view was ‘don’t know’.  About 30 of these ‘leading economists’ reckoned President Obama’s limited fiscal stimulus package had been successful in avoiding a Great Depression, but another 28 thought it had just made things worse for the deficit and debt, while 3 did not know.  They were asked what was the reason for the slow economic recovery in the US; 31% said it was “uncertainty” and 26% said it was weak aggregate demand.  The rest thought it was too much debt, a failure to deal with the budget deficit or a weak housing market.  In other words, all sorts of explanations.  When you put nine economists in a room, you get ten answers (and two from Keynes).

It’s a sad irony that in the midst of this crisis in macroeconomic policy, with no progress from same theories and divisions in mainstream economics as in the 1930s between ‘New Deal’ policies and the orthodox ‘Treasury view’, this year’s Nobel prize for economics goes to two economists who never thought of these issues but instead engaged in the application of mathematical game theory to so-called microeconomic problems. Alvin Roth and Lloyd Shapley are awarded the prize for showing how game theory can be applied to ‘non-market’ situations like matching pupils to their selected schools in the most efficient way that does not require pricing.  This may be a useful mathematical contribution to problems in a non-monetary economy, but it’s not political economy.

Eugene Fama is the arch representative of mainstream neoclassical economics.  He was the ‘inventor’ of the Efficient Markets Hypothesis, which claims that if markets are left to themselves and markets agents have enough information, then an economy will perform efficiently and without disruption. Well, after the Great Recession, he too was asked what went wrong.  He replied casually, “We don’t know what causes recessions. I’m not a macroeconomist, so I don’t feel bad about that! We’ve never known. Debates go on to this day about what caused the Great Depression. Economics is not very good at explaining swings in economic activity”. 

Mainstream economics has no contribution to make on the major causes of economic crisis and slump and what to do about it.  So it’s better to find algorithms that can help match doctors with hospitals, or pupils with schools than to find a coherent approach to the crises of capitalist production.  In this area, the very justification of capitalism is under the microscope.  So let’s ignore it.


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17 Responses to “The dilemma of the mainstream”

  1. Catherine MacArthur Says:

    I really enjoyed reading this piece. Thank you.

  2. Systemic Disorder Says:

    “Economics is not very good at explaining swings in economic activity.” Well, that about says it all. If the neoclassical economists were correct in their fairy tales, there would never be any recessions. You can’t predict what can’t occur, which explains why Greenspan et al. told us that stock-market and real-estate bubbles would last forever.

  3. Mike Ballard Says:

    Real wages have been flat for a few decades now. Just think what the rate of profit would have been had workers incomes kept up with their ever increasing productivity! Whew! Maybe the ‘lack of effective demand’ would disappear, if the market aka the working class had real wages to buy commodities they produce. But then, of course, those trillions of dollars in stimulus wouldn’t be sloshing around in the accounts of finance capitalists who are basically ‘investing’ some of their low interest gains in higher interest bonds e.g. Australian government bonds while they wait out the ‘creative destruction’ of industrial capital so that the whole damn process can begin again, maybe in the coming ’20s.

  4. frank Says:

    “But this problem only arises when there is not enough savings to go round (“when investment in capital is governed by savings”). Exactly! As households do little saving, we are really talking about business ‘savings,’ or profit. If there are insufficient profits for investment and then government borrowing diverts some of this into buying government debt, that crowds out ‘productive investment’, i.e.investment for profit.”

    This is confused and factually incorrect.

    Business profits can either be spent on investment or saved (‘hoarded’) by a refusal to invest. The purpose of austerity polcies is to drive up profits and drive up the rate of profit. This has been partly successful, especially with regard to the former.

    In the US the nominal Gross Operatng Surplus has risen by $610bn between 2009 and 2011, a rise of over 12%. At the same time investment (GFCF) has risen by a nominal $90bn, a rise of 5% (+3.5% in real terms). That is, profits have risen but a greater proportion of them have been saved, not invested.

    As a result there are sufficient profits to fund investment and lead a recovery. If the same proportion of profits (51.5%) were directed to investment in 2011 as occured in 2007 there would have been a $692bn increase in investment, raising GDP directly by 4.6% (more if ‘multipliers’ are factored in).

    The difficulty is that the profits remain in the hands of those who mainly refuse to invest them, because the profit rate is insufficiently high. What is therefore required is a policy to wrest control of the profits from capital and to invest them, which could be done by the state.

  5. Warren Ward Says:

    In the latest edition of Internation Socialism, Joseph Choonara describes your blog as magnificent Michael. Hear, hear.

    • Cameron Says:

      Thank you for the reference. Choonara claims this:
      “Roberts also appears to accept the idea of “super-exploitation”, by which he means that workers in less developed countries receive less than the value of their labour power and that there is appropriation of surplus value from poorer nations by richer ones. The first concept implies a single universal standard for the value of labour power; the second seems to suggest exploitative relations between nations, as opposed to classes. I remain sceptical about such approaches.”
      Me too. Any comments? Thanks.

      • michael roberts Says:

        I may come back to this subject in a future post. Suffice it to say that I think ‘globalisation’ has been a counter-acting factor to the tendency of the rate of profit to fall in the last 25 years. But the main factor within globalisation has been the extra (absolute) surplus value created from exploiting a much larger labour force, brought into the orbit of capitalist accumulation in places like China. The extra value appropriated from paying wages below the the value of labour power (super-exploitation) is less important, and I think my paper that Choonara refers to, says that. Also, I dont think I imply that the main contradiction of globalisation is one between nations rather than classes in my paper, either.

      • Cameron Says:

        Thanks for the clarification.
        I believe paying below the value for a period is possible but not on a permanent basis unless LTV is not operating anymore.
        Choonara is right. This blog is magnificent. I advertise it any opportunity I get.

  6. aziago Says:

    Excellent article, as usual in this blog….
    My regards to Professor Michael Roberts and please keep up this work.

  7. paulc Says:

    I would just concur with others who are applauding this blog. The articles are a a good antidote to the standard media mantra and Marxist views rarely get an airing.

    One point. The following comment:
    “And yet all the analysis of all the historical evidence shows that once debt gets up to 85-100% of GDP, whether it is private or public debt, economic growth slows sharply to well below a trend level that can sustain employment or encourage investment (see recent studies by Reinhart and Rogoff, McKinsey and the IMF).”

    I looked back over Krugman’s critique of the Rogoff paper in particular. He argues that really it is just the case of three examples ‘Belgium, Ireland, and Italy’ upon which the Rogoff paper really rests and suggests this is too flimsy a dataset on which to base such sweeping conclusions regarding the 90% red line on debt to GDP whereupon the proverbial roof falls in.

    • michael roberts Says:

      There are many other studies apart from Reinhart and Rogoff, including a brand new one by the IMF in it latest World Economic Outlook, chapter 3 . It identifies 26 episodes where public debt to GDP levels went above 100% from a database of its member states going back to 1875! The study concludes that “countries that crossed the 100 percent threshold typically experienced lower GDP growth than the advanced economy average. In this respect at least, these results are consistent with the findings of Reinhart and Rogoff (2010).”

      But the IMF goes on “there is no simple relationship between debt and growth. In fact, our subsequent analysis emphasizes that there are many factors that matter for a country’s growth and debt performance. Moreover, there is no single threshold for debt ratios that can delineate the “bad” from the “good.”

      I am working a new paper on this subject.

  8. Mark Says:

    Hi Michael. I just wanted to congratulate you on your blog and your book which I have just finished reading – I find both extremely enlightening. I was wondering, if you were considering a new subject for your next blog, or perhaps a later one, you may wish to comment on the contents of this article from a Marxist perspective, or failing that, maybe you could give some quick thoughts as a reply. Many thanks and please keep up the great work. Mark. –

    • michael roberts Says:

      Ill read it more thoroughly, but if the state insists on 100% reserve backing (ie it provides the money and the banks have a debt) for all loans issued by commercial banks, that would constitute a significant tightening of credit control. BUT loans are demand-led and the underlying cause of crises lies in production sector and not the banking sector. So the impact on any crisis in capitalist production would now fall on the state as a whole rather than on the commercial banks. But as we have seen in this financial collapse, in the end, banks that were too big to fail had to bailed out by the state. So either way, the burden would be on the state without any of the profits from banking activities going to the state. The scheme does not achieve democratic control and ownership of the banks within a national plan of production. But Ill think about it more.

  9. ‘This house believes that capitalism has failed’ Says:

    [...] 4. Quoted from ‘The Dilemma of the Mainstream’ on Michael Roberts’s blog: [...]

  10. bill gorrell Says:

    You lost me about halfway through when you claimed current and higher debt is bad and won’t stimulate growth. What about 1946? Doesn’t that year’s debt/GDP ratio raise your eyebrows? Didn’t that ratio precede the greatest economic times in history? Why should I care about what an “investment analyst” named Mauldin thinks? Debt is often an investment. If I go into debt to by a house to live in fine. If I go into debt for a vacation, that’s not good. If we add debt to create infrastructures appropriate for the future, great. If we spend on the military or environmentally unsustainable technology it’s bad.

    • michael roberts Says:

      Bill, you raise important points. I’m working on a paper on whether debt matters and it aint easy! Suffice it to say for now, that the thing about the 1946 debt levels for the US and the UK were that they were public debt. Debt for capitalists was not high and above all profitability rates were sky high thanks to the Great Depression and war destroying capital values, while workers saved rather than spent. Once the transformation from military to civilian production was made, a huge boost to investment and growth ensued, along with rising inflation, These were the factors that drove the public debt to GDP ratio down.

      That situation does not apply now. Both private and public sector debt are at record levels in the post war period and profitability in the productive sectors of the economy are low. So the ability of the capitalist economies to drive down debt to GDP levels is poor (on the contrary). But do they need to?

      You say if more borrowing and debt were spent on productive investments, then it does not matter. Apart from the fact that governments are not doing that at all, only those capitalist sectors that get government contracts to build or make things will gain; the rest of the capitalist sector does not, unless profitability rises across the board. That depends on what is happening in the capitalist sector as a whole. Of course, if government investment completely replaced capitalist investment, it would be a different story – but then we would not have capitalism.

      In this situation, if nothing is done about rising debt, debt servicing costs will eat into capitalist profits, household consumption and government budgets, lowering profitability and growth. That is the dilemma.

  11. K Vijayachandran Says:

    Bulk of the new investments are financed mostly by social security funds or the future earnings of the working people and profits on capital has been playing an increasingly marginal role. Funds managers call the shots and not the stock markets. Massive growth and rapid expansion of the Soviet economy had demonstrated this possibility in decisive manner. Prof Galbraith had written profusely on the similarity or converging tendencies of the two apparently divergent systems of economic management. His theories were rejected by both sides of the ideological divide under the then existing cold-war environment.
    Under the impact of economic reforms and restructuring, the role of the State as the custodian of the future earnings of common people has been drastically eroded by a new breed of funds-managers, whose sole expertise is in speculation. And, they are least accountable to the real stake-holders of the funds they manage, and then to the society at large. This is the fundamental problem facing the capitalist system which cannot create a class of socially and morally committed class of funds managers.

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