More confusions on the recovery

Dean Baker is one of the few economists who predicted a financial collapse in the US that would arise from the excessive credit and property boom that got under way from 2002 onwards (http://deanbaker.net/).  He is now in great demand by the labour movement to speak on their behalf against austerity and neoliberal policies.  So it is always worth considering his arguments on the Great Recession and the subsequent weak economic recovery.

Baker has just delivered a broadside against journalist Robert Samuelson (http://www.washingtonpost.com/opinions/robert-samuelson-the-end-of-macroeconomics-magic/2013/04/21/7408d628-a924-11e2-a8e2-5b98cb59187f_story.html). He is not to be confused with Paul Samuelson, doyen of mainstream economics from the 1960s onwards.  But journalist Robert has much the same views as Paul would have had on the current mess.  And Dean Baker is very critical.  Dean says that  Samuelson has no real explanation for what is going on. Dean describes Samuelson’s position as “we don’t know what to do, so we just can’t do anything. All those suckers who are unemployed or seeing stagnant wages, well we just don’t know. And the fact that those on the top are getting rich with 60-year high shares of national income, well what can we do about that? It’s just too confusing.”

Ho, ho, says Baker, “While Samuelson may be very confused by economics, those who understood their intro econ have little difficulty explaining the current situation. The housing bubble was driving the economy prior to its collapse. The collapse eliminated more than $600 billion in demand from residential construction and more than $500 billion in demand from consumption. There was also demand lost from a collapse of a smaller bubble in non-residential construction and from state and local government cutbacks forced by a loss of tax revenue. This is not complicated and it was predicted.”

This is a little harsh on Samuelson who is really describing the poor state of mainstream economics.  Yes, mainstream economics predicted no crisis, could not explain it when it happened and don’t know what to do to recover.  But is Baker’s ‘uncomplicated’ description of the causes adequate?  Was the crisis just a “housing bubble”?  Was it just a collapse in demand?  There was a major housing and real estate bubble in the US at the end of 1980s.  That led to a collapse in the savings and loans banks.  But it did not lead to anything like the Great Recession.  The hi-tech stock market crash of 2000 led to just a mild recession in 2001. Baker’s explanation of a housing bubble gone wrong suggests that with a judicious bit of control by central banks and government over reckless lending and some government stimulus when aggregate demand tumbled, the Great Recession could have been avoided.  Indeed, some Keynesians argue that it was the collapse in aggregate demand that led to the financial crisis not the other way round (http://macromarketmusings.blogspot.ca/2013/04/the-ongoing-dereliction-of-duty.html).

Baker goes on against Samuelson: “Samuelson gets just about every basic fact wrong. He tells us that consumers aren’t spending because they are reluctant to take on more debt. Actually consumers are spending at very high rates. The savings rate is much lower now than it was at any point in the 1960s, 1970s, and 1980s. It is only high when compared to the bubble driven consumption of the late 1990s stock bubble and the housing bubble of the last decade. 

Baker is right that consumption has stayed strong and is not the cause of the weak recovery.  But a fall in consumption was also not the cause of the slump in the first place, as I have shown in many previous posts (http://thenextrecession.wordpress.com/2013/03/12/investment-not-consumption-profitability-not-demand/).  Indeed, Baker’s own graph shows just that consumption held up right to the start of the Great Recession and has recovered since the trough.

Baker continues: “Samuelson also tells us that firms aren’t investing because the environment is uncertain. That’s a nice story, but the data says the opposite. Firms actually are investing. Spending on equipment and software as a share of GDP is almost back to its pre-recession level. This is very impressive since there are still large amounts of excess capacity in many sectors of the economy. If there is any mystery it would be why investment is so high, not why it is low.”

But Baker’s argument about investment is just not true.  As his graph shows, equipment and software investment has been in decline as a share of GDP since the early 200os (unlike consumption) and remains below the peak of 2007, by about 7%.  Moreover, the pace of increase in investment in equipment and software has slowed from over 12% yoy in 2011 to under 5% a year now.  That suggests investment to GDP will not rise from here.  And Baker has just picked out equipment investment.  Sure, this is the core of business investment but when you add in investment in plant (structures), total business investment as a share of GDP remains well below the peak of 2007, 11% down.  Investment in ‘big ticket’ long-term plant is still down 28% from its peak.  As I have shown in previous posts (http://thenextrecession.wordpress.com/2012/11/30/us-its-investment-not-consumption/), it is the collapse in investment that is at heart of the capitalist slump.

Baker is on firmer ground when he ridicules the confusions of those like Lorenzo Bini Smaghi, a former member of the ECB’s executive board,  who said “We really don’t understand what’s happening in advanced economies; monetary policy [policies affecting interest rates and credit conditions] has not been as effective as we thought.’  But is Baker right in his explanation? “Actually we know very well what’s happening. Governments…. cut spending and raised taxes. It turned out that contractionary fiscal policy was more contractionary than the IMF had anticipated. Fortunately the IMF did research on this issue, so the world knows that austerity was responsible for slower growth even if Samuelson is confused.”  So according to Baker, the very weak recovery is down solely to the adoption of the policies of austerity and nothing else.  Well, again, in this blog, I have shown that austerity (i.e cuts in government spending and higher taxes) have not been the main cause of the weak recovery.  At best, it can take the blame for half of the failure to recover (see Gavyn Davies (http://blogs.ft.com/gavyndavies/2013/04/21/great-recession-and-not-so-great-recovery/). In reality, there is little correlation between austerity policies and low growth.

Baker chides Samuelson for claiming that conventional economic policy (cuts in interest rates and increased liquidity) at least avoided another Great Depression as in the 1930s.  “Avoiding a second Great Depression is now the mark of success? This is a bit like going to the doctor complaining of chronic headaches. After 4 months of failed treatment the doctor tells you that at least you’re not dying of cancer. That’s better than the alternative, but what does this have to do with the time of day.”   Baker’s trump card is his argument that “The first Great Depression was caused by a decade of failed economic policy. We could have ended the depression at any point if we were prepared to provide the sort of massive stimulus that eventually came about as a result of World War II. Since we have known for 70 years how to avoid a prolonged depression, seeing an economist boast that we are not having a decade of double-digit unemployment is too pathetic for words.”

According to Baker, the answer to the crisis is staring Samuelson in the face: just adopt Keynesian policies, which if they had been adopted “at any point” in the 1930s, the depression would have ended.  Really?  Roosevelt attempted something along those lines from 1932 in the New Deal, but as soon as he took his foot off the Keynesian pedal in 1937, the US economy slipped straight back into slump.  Sure, the advent of the war produced huge government spending (on arms) and established full employment.  Baker hints that such ‘stimulus’ could be done now without ‘military Keynesianism’ i.e a war.  His fellow Keynesian Paul Krugman seemed to think it might need a war – see his last book, End depression now! and my post (http://thenextrecession.wordpress.com/2012/05/27/krugman-and-depression-economics/).  Anyway, it was not Keynesian-style stimulus that was adopted by the US government from 1941.  Instead, it was the complete takeover and planning of production of capitalist industry by government decree for the war effort. Workers went into the army or they were forced into ‘saving’ their wages in war bonds. Wages were held down and profits more than doubled.

Government handed over those workers’ savings (war bonds) to capitalist industry to produce weaponry. The rate of profit, which in 1940 was still  well below its peak of 1929 before the crash, now jumped to new highs.  So full employment and rising investment (in arms) was achieved through the restricted consumption of the masses and record high profits.  Keynesianism did not end the depression ‘at any point’.  It was war that restored profitability (see my post, http://thenextrecession.wordpress.com/2012/08/06/the-great-depression-and-the-war/).

Further confusion reigns among those economists who use the Keynesian-Kalecki profits equation to explain what is happening to the economy.   I have commented on this before in a previous post (http://thenextrecession.wordpress.com/2012/06/13/keynes-the-profits-equation-and-the-marxist-multiplier/). The same investment outfit, GMO that trumpeted this equation before has become puzzled at why US corporate profits are at record highs and yet US investment remains very low (http://www.gmo.com/websitecontent/GMO_QtlyLetter_1Q2013.pdf). According to author, Ben Inker, “Investment used to be a good barometer for profit, the two used to be closely correlated. Since 1987, this is no longer the case. In fact, it’s almost like less investment is leading to more profit.”  But Inker goes on: “Since 2000, investment has fallen off to levels lower than we have ever seen apart from the Great Depression and yet profitability has risen to an all-time peak.”  There is a mistake in Inker’s graphic, but the story is there below:  investment and profits were highly correlated up to 1987 and then not – indeed negatively correlated since 2000.

Investment and profits

Inker’s explanation for this puzzle is to fall back on the Kalecki equation.  Let me outline the thinking behind this yet again.  It goes that in an economy:  investment = savings.  Savings are made up of corporate savings (profits), government savings (budget surpluses), household savings (from workers incomes) and foreign savings (the economy’s external deficit with foreigners).   But which direction do things go?  Is it from savings to investment or from investment to savings?  Keynes-Kalecki says that investment is the exogenous variable while savings is the dependent variable.  As Inker puts it: “Historically, the major driver of the ebb and flow of profits has been the ebb and flow of investment”.   On this approach, if investment is a given (and is low), then corporate profits (savings) should be low.  They can only be at a record high because governments are dissaving (running huge deficits),  households are saving very little and foreigners are not sending much savings to the US  (the current account deficit is low).  As Inker says: “This has been possible because other pieces from the Kalecki equation have kicked in in a way we haven’t seen before.”

But this is confusing.  Investment is not the independent variable in a capitalist economy, profits are.  Or to be more exact, the exploitation of labour power and the private appropriation of the value created as profit is the key process.  Profits are not ‘created’ by investment.  That is a normative disguise of vulgar neoclassical economics that seeks to hide the class struggle taking place between labour and capital.  Profits are the product of the exploitation of labour power.  US corporate profits are at a record high because the wage share in national output has been suppressed and the rate of exploitation has rocketed.

So let’s turn the causation round the Marxist way.  If profits are the given and investment is the dependent variable, then the reason that investment is low must be that these profits are being spent elsewhere or being held in cash.  They are going into paying down old debt, into speculative financial assets, like government and corporate bonds, into buying stocks or increasing dividends to shareholders and buying back shares.  In other words, the bulk of these profits are not going into productive investment but into capitalist consumption.  Or profits are being hoarded as cash, which amounts to the same thing.

I have outlined this phenomena in previous posts. The divergence between corporate profits and investment after 1987 is not some puzzling new development.   It is precisely from the 1980s that corporate America invested its profits increasingly into the financial and real estate sectors to increase profitability and away from manufacturing and other productive sectors.  That explains why the Kalecki correlations cracked.

US manufacturing profits to GDP

Capitalists are now investing less in productive assets because returns from such investment are too low and because they need to pay down some of the debt built up before the financial crash.  Returns from productive investment remain lower than speculating in financial markets.  So if profits fall, capitalist investment will fall, unless capitalist consumption (investment in non-productive assets) is reduced. And profits are set to fall, as I have shown in a previous post (http://thenextrecession.wordpress.com/2013/04/24/the-two-rrs-and-the-weak-recovery/).  The rate of exploitation of labour power has reached its maximum and US corporate profit margins are dropping off.

US profit growth

The corporate debt burden remains high and any rise in interest costs would eat into profitability.

debt-payments

Austerity is not the full or even the main story of the weak recovery.  And low capitalist investment is not a confusing puzzle.  The weak recovery is because the profitability of productive assets is too low and a large share of profits in the US is being diverted into unproductive financial assets (again).  So productive investment is low, employment growth is weak and real wages are falling.

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8 Responses to “More confusions on the recovery”

  1. sartesian Says:

    I don’t think your claim that capitalists are investing less in part because they need to pay down debt is accurate. Taking advantage of low interest rates, non-financial corporations engaged in record amounts of corporate bond offerings post 2009.

    And this isn’t because they’re low on cash. According to the he March 19 Financial Times, Moody’s estimates cash hoard of US non-financial companies doubled between 2007-2012. Cash levels, home and abroad top $2 trillion. Liquid resources of non-financial corporations now sufficient to cover all debt repayments due for the next 5 years.

    Problems with profitability determining investment? Absolutely. Debt levels? Not hardly.

    • paulc Says:

      “I don’t think your claim that capitalists are investing less in part because they need to pay down debt is accurate. Taking advantage of low interest rates, non-financial corporations engaged in record amounts of corporate bond offerings post 2009.”

      Only this week Apple sold bonds to the tune of $17bn even with cash of $145bn on its balance sheet.

      The FT reported:
      “Apple sold bonds worth $17bn on Tuesday, the world’s largest corporate debt sale, as the iPhone maker raised capital to finance a $100bn cash return to shareholders.

      Apple, which had no debt before Tuesday’s sale, has taken advantage of low interest rates to fund its return of $100bn to shareholders over the next three years.

      The cash splurge is designed to appease investors concerned about slowing sales growth and comes a week after Apple reported its first year-over-year drop in net income in almost a decade.”

      Why? Only $45bn of its cash is in the US. The rest is in sunnier climes. The FT explain why they don’t use this money to fund its giveaway;
      “Repatriating foreign reserves would be costly due to tax implications.”

  2. Joseph Says:

    I would agree with Sartesian’s assessment above. What major corporations find themselves in debt? I know hardly any.

    My question to you would be what the solution is? The problem is the profitability of productive assets being too low: how do we change this?

    • michael roberts Says:

      Sartesian is right that large corporations are mostly cash rich. But small enterprises are not. Indeed, they are struggling to cover servicing their debts with any profits. And overall, corporate debt to GDP is high, so if corporate profits were to turn down and interest rates to rise, then larger corporations would not find it so rosy. Interest rates look likely to stay low in this low inflation environment, but corporate profits may well turn this year. Under capitalism, the only way the profitability of productive assets can be raised if the rate of exploitation cannot be raised further is by a new slump that cuts the costs of production and the value of the stock of capital.

      • sartesian Says:

        Except the plight of the small enterprises is part of the “recovery” of capital… so not to be too jaded and cynical a New Yorker, but who cares about the “small enterprises”– not the bourgeoisie where the largest non-financial companies account for what? about 75% of the non-financial GDP?

        Corporate debt is “high” relative to what? Relative to cash, and cash like securities on hand? Uh.. no, it is not.

        I think corporate profits will drop this year, or at least the rate of growth will drop, and the larger corporations won’t find it so rosy, but that lack of color will have nothing to do with debt. It will have everything to do with profit.

        As for the solution to the barrier to capitalist expansion that capitalist expansion already is?

        Abolition and overthrow of the capitalist system; that is to say overthrow of the bourgeoisie by a proletarian revolution…

        Or….

        Destruction of capital, that is to say living and objectified labor by the bourgeoisie.

  3. MK Says:

    How would you then comment fact, that some states are doing better then others after the crisis. What are reasons for that? For example Latin America states like Ecuador http://www.guardian.co.uk/commentisfree/2013/feb/15/rafael-correa-ecuador-elections?CMP=twt_gu

    • sartesian Says:

      Some capitals always do better than other capitals. Ecuador? In a word, petroleum. Petroleum exports account for 1/2 of all export earnings, and 1/3 of tax revenues. Ecuador produces about 500,000 barrels/day, exporting 2/3 of that, with 60% or about 200,000 going to the US (down from 276,000 b/day in 2005).

      In addition, I believe Ecuador has benefited from the sale of mineral (ore) rights. If the slippage in metals prices continues, things won’t be quite as rosy.

  4. duvinrouge Says:

    I think the key point is Baker & other non-Marxists lack any understanding of a crisis of overproduction, let alone any problems with profitability. This is because they have the wrong concept of value, money & prices.
    They cannot comprehend that aggregate prices can exceed aggregate values due to credit money. This means that recorded profits include future claims on labour time that may not be realised.
    The credit crunch of 2007 turning into the full financial crisis of 2008 was about debt saturation & the subsequent recession was an attempt by the law of value to bring prices back into line. But governments & central banks, acting on behalf of their class, couldn’t allow the destruction & devaluation of capital values to occur without a fight. Hence by bad debts being, in part, moved onto the government books we have a sovereign debt crisis & an unaffordable welfare state.
    The class struggle is now in the open as governments & bosses attack workers’ standards of living & prevent fictitious profit rates turning negative.
    But all they are doing is postponing & increasing the severity of the eventual depression. They may or may not talk themselves into an artificial ‘recovery’ in the immediate future, or a surprise event may bring about phase of crisis. Either way capitalism is broken & class consciousness is changing.
    It is a pretty amazing time in history.

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