Michael Heinrich, Marx’s law and crisis theory

Michael Heinrich is an exponent of what is known as the ‘New German Reading of Marx’, which interprets the theory of value that Marx presents in Capital as a socially specific theory of  ‘impersonal social domination’. He is a collaborator on the MEGA edition of Marx and Engel’s complete works and has published several philological studies of Capital. He has also authored a work on Marx’s theory of value, The Science of Value, which is forthcoming in the Historical Materialism book series. And recently he has published An Introduction to all Three Volumes of Capital as his first full-length work to appear in English.

I am not going to do a critique of Heinrich’s views on the theory of value, as this has been done by Guglielmo Carchedi in his book, Behind the Crisis (see chapter 2).  But I am moved to respond to a recent article of Heinrich’s in the American Monthly Review, entitled Crisis theory, the law of the tendency of the rate of profit to fall and Marx’s studies in the 1870s (monthlyreview.org-Crisis_Theory_the_Law_of_the_Tendency_of_the_Profit_Rate_to_Fall_and_Marxs_Studies_in_the_1870s__Mont).

In this article, Heinrich makes the following points: 1) Marx’s law is inconsistent because its categories are indeterminate; 2) it is empirically unproven and even unjustifiable on any measure of verification; 3) Engels badly edited Marx’s works to distort his view on the law in Capital Vol 3; 4) Marx himself in his later works of the 1870s began to have doubts about the law as the cause of crises and started to abandon it in favour of some theory that took into account credit, interest rates and the problem of realisation (similar to Keynesian theory); 5) Marx died before he could present these revisions of his crisis theory, so there is no coherent Marxist theory of crisis.

I am working with G Carchedi on a more thorough response to Heinrich’s arguments, so I shall deal with just some of these points in this post – and more briefly.  First is Heinrich’s claim that Marx’s law of the tendency of the rate of profit to fall (LTRPF) is illogical and inconsistent.  In other words, the conclusions that Marx draws do not lead logically from his assumptions.  The LTPRF, the ‘law as such’, says that the rate of profit will tend to fall over time because the organic composition of capital (the ratio of the value of constant capital to variable capital) will tend to rise faster than the rate of surplus value (the ratio of surplus value to variable capital). This flows from the basic equation of profitability, s/c+v, where c/v rises faster than s/v because Marx’s value theory argues that only labour power creates value. So if the value of constant capital (machinery, plant, raw materials etc) rises faster than the value of variable capital (the value of labour power and the only creator of value), then the rate of profit will fall, other things being equal. 

But other things are not always equal.  Marx allowed for counteracting factors to offset the impact of a rising organic composition of capital on the rate of profit.  First, a rise in the rate of exploitation could overcome the effect on the rate of profit of a rising organic composition of capital; and second, the ‘cheapening of the elements of constant capital’ (due, for instance, to technical advances lowering the costs of reproducing labour power) would tend to retard the growth of the organic composition itself.

Now Heinrich says that “Marx assumes that the fall in the rate of profit derived as a law in the long-term outweighs all counteracting factors. Yet Marx does not offer a reason for this.” And Heinrich says the ‘law as such’ is unsubstantiated because“contrary to a widespread notion, the increase in the rate of surplus value as a result of the increase in the productivity (of labour) is not one of the counteracting factors but rather one of the conditions under which the law as such is supposed to be derived, the increase in c occurring precisely in the course of the production of relative surplus value that leads to an increasing rate of surplus value”. The rate of surplus value could rise faster than the organic composition of capital and so the law as such does not prove that the rate of profit will tend to fall over time.  The law is thus ‘indeterminate’. 

Heinrich reaches this conclusion because he does not accept the method by which Marx focuses on the relation between the organic composition and the average rate of profit (ARP) to show that, if the former rises, the latter falls.  In the ‘law as such’, Marx holds the rate of surplus value constant.  But this is a common scientific procedure. First, we must establish the inverse relation between the capital composition and the ARP.  Then we can let the rate of exploitation fluctuate.  So the rate of exploitation becomes one of the counter-tendencies.

And, contrary to Heinrich’s claim, Marx does explain why the rate of surplus value cannot permanently outstrip the rise in the organic composition of capital.  If two workers can be substituted for 24 workers through mechanisation, total surplus value will eventually be less than the capital advanced, despite the sharp rise in the rate of surplus value from the increase in productivity of the two workers compared the 24 workers.  That’s because “the same influences which raise the rate of surplus value (even a lengthening of the working time is the result of a large-scale industry) tend to decrease the labour power employed by a certain capital, it follows that they also tend reduce the rate of profit”.  (Marx).

Heinrich rejects this argument:“we cannot exclude the possibility that the capital used to employ the two workers is smaller than that required to employ twenty-four” Heinrich says the numerator (surplus value) in the rate of profit formula may well fall because the variable capital that creates value has shrunk, but so will variable capital in the denominator.  Constant capital may have increased due to mechanisation, but the rate of profit only falls if the rise in constant capital is greater than the fall in variable capital in the denominator It depends on “Whichever of the two quantities changes more rapidly – and we do not know that.” 

The first thing to say here is that if constant capital rises to at least match the fall in variable capital, then the denominator will not fall.  And this will usually be the case in the process of capital accumulation. That’s because increasing the rate of surplus value can only be achieved by methods that also increase the value of the constant capital employed in relation to the number of workers engaged in the production process.  So the organic composition of capital will increase.  And it will increase faster than the rate of surplus value, the larger that rate of surplus value becomes.  So even if the rate of surplus value rises faster than constant capital to begin with, eventually it will increase more slowly as variable capital shrinks as a share of new value. If the capital composition rises, while the variable capital falls by the same amount as the constant capital rises, then the rate of surplus value must rise much more percentage-wise for the rate of profit to remain the same (or to rise). Whether the capital composition grows at an increasing or at a decreasing rate, the rate of surplus value must grow at an increasing rate to keep the rate of profit from falling.  This is the reason why, at a certain point, the counter-tendency (the rise in the rate of surplus value) cannot overcome the tendency (the increase in the rate of growth of the capital composition).

To repeat: a rising organic composition of capital will eventually produce a downward move in the rate of profit even when the rate of surplus value is rising faster to begin with.  The rate of surplus value rises over time if wages do not rise as fast as the productivity of labour.  But as the rate of surplus value rises, it rises at an ever slower rate as it approaches its limit which is the full appropriation of the product of living labour (wages plus surplus value).  So no matter how fast the rate of surplus value rises, the rate of profit will eventually fall at a rate asymptotic to the fall in the ratio of the product of living labour (wages plus surplus value) to total constant capital (fixed and circulating).  And that is because, as the organic composition of capital rises over time, it reduces the relative amount of living labour produced.  So even if surplus value moves towards one and wages move towards zero, the rate of profit will eventually fall. 

Now this is not some mathematical trick, although the argument can be spelled out more elegantly using maths. Maths is only as good as the assumptions that you begin with.  Maths can take you logically to any conclusions or outcomes that flow from the assumptions. And Marx’s law has two key assumptions: 1) that only labour (or labour power) can create value and 2) as a general rule the value of mechanisation will outstrip growth in the cost of the labour force i.e. the organic composition will rise.  Marx draws these assumptions from the reality of the capitalist process of accumulation. So, as long as we assume that the basic trend in capitalist accumulation is for the organic composition of capital to rise, then a rising rate of surplus value cannot permanently counteract any tendency for the rate of profit to fall.  If Marx’s two assumptions about the mode of capitalist production are wrong, then Marx’s law is wrong.  But starting from these two assumptions, Marx’s law is determinate. 

As for Heinrich’s argument that Marx’s law cannot be empirically proved or refuted, this is bizarre.  We can measure the rate of profit in capitalist economy using Marxist categories and test the law against its components. I and a host of other scholars have done just that for various national economies and even for the world capitalist economy (see lots of my posts).  And that includes Marx himself.  He looked for empirical verification for his law. Marx’s law, just like any other scientific law, can be refuted and empirical analysis is necessary to confirm or refute it. Does the rate of profit fall over a long period as the organic composition rises?  Does the rate of profit rise when the organic composition falls or the rate of surplus value rises more than the organic composition increases?  Does the rate of profit recover if there is sharp fall in the organic composition of capital through the destruction of value of capital?  The answers to each of these empirical questions is yes. The statistical correlations and measures of significance between Marx’s variables (organic composition and the rate of exploitation etc) and the outcome (the rate of profit) have been shown to be high and significant.

Here are some examples for the UK and the US economies that I analysed quickly for this post. Between 1963 and 1975, the UK rate of profit fell 28%, while the organic composition of capital rose 20% and the rate of surplus value fell 19%.  Between 1975 (when the UK rate of profit troughed) and 1996, the UK rate of profit rose 50%, while the organic composition of capital rose 17%. The rate of profit rose because the rate of surplus value rose 66%, faster than the rise in the organic composition of capital.  Finally, from 1996 to 2008, the rate of profit fell 11%, as the organic composition of capital rose 16% but the rate of surplus value was flat.  All these three phases are compatible with Marx’s LTRPF.  Indeed, over the whole period, 1963 to 2008, the organic composition of capital rose 63%, while the rate of surplus value rose 33%, so the rate of profit fell on a secular trend.

In the case of the US economy, the rate of profit fell 24% from 1963 to a trough in 1982, because the organic composition of capital rose 16% and the rate of surplus value fell 16%.  Then the rate of profit rose 15% to a peak in 1997, because although the organic composition of capital rose 9%, it was outstripped by a rise in the rate of surplus value of 22%.  From 1997 to 2008, the rate of profit fell 12%, because the organic composition of capital rose 22%, outstripping the rate of surplus value, up only 2%.  Again, all three phases fit Marx’s law, when the organic composition of capital rose faster than the rate of surplus value, the rate of profit fell and vice versa.  Over the 45 years to 2008, the US rate of profit fell secularly by 21% because the organic composition of capital rose 51% while the rate of surplus value rose just 5%.  The rate of profit was negatively correlated with the organic composition at -62%, while there was no significant correlation with the rise in the rate of surplus value.

Second, there are empirical studies of Marx’s law that show that it is a reasonable predictor of future events, including the recent Great Recession of 2008-9. These studies show that when the rate of profit starts to fall, a crisis or economic slump will occur some time thereafter and, even more specifically, the recession begins when the mass of profit falls as a result of the falling rate of profit.  This is predictive value is more than we can say about any studies that aim to justify empirically alternative explanations of crises based on the ‘problem of realisation’ (consumption or investment) or on high interest-rates or lack of credit, Keynesian-style.

Again, I looked at the UK economy. Since 1963 there have been four major economic recessions of slumps: 1974-5, 1980-2, 1990-2 and 2008-9.  In each recession, the rate of profit peaked and started to decline at least one year before the slump began.  And each recession was accompanied by (or coincided with) a fall in the mass of profit in successive years.  Similarly, if we look at the US economy, there were five recessions or slumps after 1963: 1974-5, 1980-2, 1990-2, 2001 and 2008-9.  In each case, the rate of profit peaked at least one year before, but on most occasions up to three years before. And on each occasion (with the exception of the very mild 2001 recession), a fall in the mass of profit coincided with the slump, with the biggest fall (over 7%) in the Great Recession. So there is a body of evidence to support the view that Marx’s law does operate in a capitalist economy and that it is the key (underlying) factor in booms and busts. 

We can derive a coherent theory of crisis from Marx’s works based on his LTRPF, his views on credit and banking (fictitious capital) and on world markets and imperialism.  Of course, there is plenty of work to be done in developing Marx’s theory of crisis in relation to modern developments and, as Marx did, we are learning more each day.  But Marx’s LTRPF remains the most robust explanation of capitalist crises and something way superior to alternative Keynesian and other mainstream economic explanations, which signally failed to explain the Great Recession.

Inequality: there’s no stopping it!

In the New York Review of Books this week, Paul Krugman wrote a piece on why austerity was taken up and why it has failed.  In passing he commented “It’s also worth noting that while economic policy since the financial crisis looks like a dismal failure by most measures, it hasn’t been so bad for the wealthy. Profits have recovered strongly even as unprecedented long-term unemployment persists; stock indices on both sides of the Atlantic have rebounded to pre-crisis highs even as median income languishes. It might be too much to say that those in the top 1 percent actually benefit from a continuing depression, but they certainly aren’t feeling much pain.”  (http://www.nybooks.com/articles/archives/2013/jun/06/how-case-austerity-has-crumbled/)

Indeed that is the case. In its latest update on inequality of income in the 33 mature capitalist economies, the OECD revealed that inequality has continued to rise since the Great Recession troughed.  Income inequality in the OECD countries – excluding the mitigating effect of the welfare state – increased more in the first three years of the financial crisis to the end of 2010 than in the previous 12!  Although overall “take home” inequality (i.e after tax and benefits) did not rise sharply between 2007 and 2010, the richest 10% of the population still did better than the poorest 10% over this period in 21 of the 33 countries analysed by the OECD.  The differences were most acute in those countries where household incomes dropped the most. In Spain and Italy, the income of the top 10% was fairly stable even after taxes, while the income of the bottom 10% fell about 14% and 6% respectively.  So government policies of austerity fell solely on the poor and not the rich.

Back in 2011, the OECD did a very comprehensive report on income inequality entitled ironically, Divided we stand. The report concluded that the gap between rich and poor had widened considerably over the three decades to 2008, when it reached an all-time high.  The OECD data were confirmed by the IMF in its paper last September (Income inequality and fiscal policy) that found inequality of income has also widened in the same period (see my post, http://thenextrecession.wordpress.com/2013/03/06/the-end-of-chavismo/).

The new OECD data now show that the global economic crisis of 2008 squeezed average household incomes in most countries and inequality increased in the following three years to 2011, despite taxes and transfer measures by governments.  Over these three years, real incomes in the OECD fell 2% on average per year, driven down by higher unemployment and falling real wages from work.  The fall was greatest in that Keynesian poster model, Iceland, where household ‘market income’ was down 12% per year between 2007 and 2010 (see my post, http://thenextrecession.wordpress.com/2013/04/28/icelands-electors-how-ungrateful/).  ‘Keynesian’ Iceland was followed by the ‘Austerian’ peripheral Eurozone households like Greece, Spain and Ireland, which took hits of 6-8% per year.  US household income fell slightly more than the OECD average of 2% a year.  Just a few countries had no fall at all: the households of Germany, Canada, Sweden and Poland.

This decline in household income was not shared out equally.  On the contrary, as measured by the gini coefficient (which is gauged at zero when everybody has the same income and 1 when one person has all the income, inequality rose across the OECD between 2007 and 2011 by 1.3% points to a new high.   Indeed, ‘market income’ inequality rose by more in those years than in the previous 12 years!

The biggest rise in inequality was experienced by Ireland, Spain, Japan, Greece and France and Iceland.  Again, US inequality increased more than the OECD average. The most unequal place in the OECD was Chile.   The gap between the rich and the poor has widened since 1980s but much more so in the UK and the US than the OECD average.  Indeed, the US gini coefficient is one of the highest in the OECD and the highest of the large capitalist economies. The UK’s is not far behind.

The UK and Italy are more unequal than the US before taxes and benefits, but after, the US is more unequal, showing the bias of tax and welfare is towards the richer in the US.

It’s the European ecom0mies that tend to have more equality as measured by the gini coefficient.  France and Germany’s gini is still below the OECD average although Germany’s rose sharply after the euro was founded.  But even in these economies the gini ratio is about .28, well short of equality.

It is still the case that the top 10% of income earners receive ten times more income than the bottom 10% in the OECD – and that’s after tax and transfers.  That ratio is over 15 times in the US, only surpassed by Chile and Mexico at 27 times.  This inequality is also expressed in the levels of relative poverty in the OECD.  About 11% of the OECD population has less income than half their national median incomes.  That poverty measure is very high in the US, at 17% in 2010.  Poverty rates rose most in the Great Recession in the peripheral Eurozone countries, as you might expect.

As I outlined in my last post (http://thenextrecession.wordpress.com/2013/05/15/europe-deep-in-the-mire/), Britons have become poorer than their counterparts in a host of other rich economies, sliding from fifth to 12th on a global list of wealth based on disposable incomes.  While the spare cash available to households in most advanced economies grew at a similar pace between 2005 and 2011, disposable incomes in countries such as France and Australia rose at a faster rate than the UK, as price pressures weighed on the average Briton’s disposable income.  Households in Canada – Belgium, Sweden, Austria and Switzerland also became richer than those in the UK.  The average per head disposable income in the UK was $27,927 in 2011, compared with £26,050 in 2005. In the US, the figure has has risen from $34,373 to $39,658 over the same period.The pound lost a quarter of its value in 2008, which pushed up prices on imports at a far faster rate here than in other large industrialised economies.

As the rich have gotten richer, people across Europe have noticed and they do not like it. A strong majority (a median of 77%) of Europeans surveyed think that the current economic system generally favours the wealthy. This includes an overwhelming 95% of the Greeks, 89% of the Spanish and 86% of the Italians. Even seven-in-ten (72%) Germans, who have fared economically better than other European, think so.  The vast majority of all Europeans (85%) surveyed overwhelmingly agree that the gap between the rich and the poor has increased in the past five years.  And they are right.

I have argued before in previous posts that, contrary to the views of many leftist economists, rising inequality was not the cause of the Great Recession of 2008-9 or the ensuing Long Depression now being experienced in the mature capitalist economies of the OECD
(see my posts: http://thenextrecession.wordpress.com/2012/05/21/inequality-the-cause-of-crisis-and-depression/ and
http://thenextrecession.wordpress.com/2011/10/21/1-versus-99/).

But it is clear that the rich are not suffering from this depression, as Paul Krugman says.  The immediate crisis of the banking collapse was resolved by bailing out the bankers with workers’ taxes and welfare payments. And the economic ‘recovery’ is being made on the backs of workers’ jobs and real incomes, while the stock markets boom and profits soar at the expense of employment.

The graph below that US corporate profit per employee has risen dramatically since the trough of the Great Recession (it’s the red line going down – an inverse left-hand scale) so that total corporate profits have reached new heights.  Cutting labour costs rather than boosting growth through investment or expanding sales has been the cause of profits boom since 2009.

It’s socialism for the rich and capitalism for the poor.

Europe deep in the mire

European capitalism remains deep in the mire.  In the first quarter of this year, Eurozone GDP fell 0.2%, according to figures out today – and that was worse than expected. The Eurozone economy has contracted by 1% in the first quarter from the year before, marking the longest recession since the introduction of the single currency in 1999.  Italian GDP fell by 0.5%, the seventh straight quarter of decline. This makes the current Italian recession the longest on record. Portugal fell 0.3%, producing a decline of nearly 4% from last year, and making ten consecutive quarterly declines.

Most worrying, French GDP shrank by 0.2%.  Investment fell a further 0.9%, after 0.8% in the fourth quarter.  Exports fell and construction output fell.  Revisions to previous quarterly data meant the country avoided a ‘triple dip’ recession, but the economy has shrunk in three of the past four quarters.  Germany managed to grow, but only barely (graph below). First-quarter GDP grew 0.1%, up from a downwardly revised contraction of 0.7% in the fourth quarter of last year.  Investment continued to fall.  Dutch GDP shrank by 0.1% and Spain has already reported a 0.5% contraction.

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Outside the Eurozone, the UK grew slightly in the first quarter.  And the Bank of England has now revised up its growth forecast for the current second quarter to 0.5% (graph below).  But this forecast assumes that there is zero to positive quarterly growth in the Eurozone in the current quarter.  Fat chance!

For some time, the UK government has been crowing that employment is much better then in the rest of Europe despite ‘austerity’.  Well, the latest UK jobs figures are starting to rain on that sunny idea.  The UK unemployment rate rose 0.1% pt to 7.8% in the first quarter from the quarter previous and the employment rate simultaneously dropped by 0.2% to 71.4% of the working age population compared with the last quarter of 2012.  And even worse, British households took another hit to real incomes as total pay growth was just 0.4%, while annual inflation is currently at 2.8%, so eating further into real wages.   Indeed, since 2005 Britain has fallen from 5th to 12th in the OECD’s ranking of countries by household disposable income. That’s bigger fall than anyone else in the top 10.

Europe’s depression is increasing the centrifugal forces that threaten to break the Eurozone up.  We all know that about the British scepticism towards the euro and the European Union, with talk of referendum to leave the EU.  But that disillusionment is now even worse in some Eurozone countries.  According to a Pew center survey, just 26% of Brits believe that economic integration has strengthened the economy, but only 22% of French, 11% of Italians, 11% of Greeks and 37% of Spanish voters do.  Of the large countries, only the Germans still think EU integration has been good for their economy – and even then, only just over half do (54%).   The findings also reveal disaffection with the EU among all groups, including the young.   That’s especially so in France, where there now less French support for the EU than among Brits!

The depression in Europe is destroying people’s livelihoods, reducing their confidence that governments can do anything about it and increasing their opposition to the existing institutions of ‘European’ capitalism built up over the last 6o years.   Europe’s political elite is in real trouble.

Spain: the return of the Inquisition

I’ve been thinking about the state of the Spanish economy in advance of a visit there soon to speak at the ‘anti-capitalist left (IA)’ summer school. 

There were huge demonstrations across Spain on May Day.  Hundreds of thousands of young people, trade unionists and unemployed protested about the collapse of the Spanish economy and the policies of the Rajoy government in making the majority pay for the failure of a tiny minority who own and control the Eurozone’s fourth-largest economy.  The rate of unemployment hit 27%, the first time since records began. That’s six million Spaniards without work in a population of 47m. Youth unemployment (15-24 years) has reached an astronomical 55% – only Greek youth are in a worse position for employment.

Spain’s right-wing government announced that the unemployment rate would stay above 25% until at least 2016.  And for the first time, permanent employment has started to fall as much as temporary employment in this deep economic recession that began in 2008, while long-term unemployment has doubled since 2008.  (Note all graphs below are from official IMF and EU Commission sources except those on the rate of profit which are my calculations.)

And this unemployment rate would be even higher except that Spaniards are on their bikes and cars and leaving the country to look for work elsewhere in Europe or even Latin America.  The rate of net emigration has reached 250,000 a year, draining the economy of some of the most educated and productive young Spaniards.  Average wages are plummeting, down nearly 6% in 2012 in nominal terms (i.e. before inflation).  Wages fell at a 14% annualised rate in the last quarter of 2012.  Deducting inflation and real wages are down nearly 9% last year as the government hikes VAT and other taxes.

While this misery engulfs the 99%, the remaining top 1% of Spaniards continues to do well.  The Spanish stock market is booming and government bond prices are recovering fast.  Backed by ECB funding to Spain’s banks, interest rates are falling and those with cash are engaged in speculative trading in financial assets.  While this new credit bubble blows, no cash is getting to where it is needed, to help small and medium business (SMEs) to fund the businesses and invest more to restore employment.  Spain’s SMEs are suffering more than anywhere in Europe (except Greece).  The banks are not lending to them.

And yet it was Spain’s greedy and corrupt banks that triggered the crisis in the first place.  Spain is the largest of those states in Europe forced to take financial support from the Euro leaders in order to ‘save’ its banks from going bust.  Spain’s banks crashed because of the collapse in the huge property bubble that was behind Spain’s apparent boom from 2002 onwards.  Spanish bankers lived the good life with grotesque pay packets and bonuses (as elsewhere), but many acted corruptly in organising sweetheart deals for reckless developers and in funding political parties that allowed them to do what they wanted without any regulation.  Rajoy’s People’s Party is accused of taking money from developers to fill its campaign funds and add to MPs’ salaries.

The former head of the Bank of Spain, Miguel Angel Fernandez Ordonez, was forced to resign in a scandal.  And the CEO of Spain’s largest and most powerful international bank, Santander, stepped down to try and avoid criminal charges.  He had been sentenced to six months in 2009 on charges of making false accusations when chairman of Banesto bank in the early 1990s. but was pardoned by the Socialist government in 2011.  In 2012, Banco Santander chairman Emilio Botin and 11 of his relatives were investigated over possible income and wealth tax evasion – with Swiss bank accounts with the notorious money launderer, HSBC.  Again the case was dropped.  And worst of all, Rodrigo de Rato, a former economy minister in a previous Conservative (PP) government and ex-managing director of the International Monetary Fund, had to resign as head of the mortgage lender Bankia that went bankrupt, costing the taxpayer €20bn.

The restructuring and recapitalisation of Spain’s banks was estimated to cost €56bn.  Some of this has been found by defaulting on debts to some bond holders (€13bn) and €2bn was raised in new equity.  But that left €41bn.  After refusing to recognise that there was even a problem, finally the government had to go cap in hand to the European Stability Mechanism (ESM) for the money.  This has dramatically raised the deficits and debt for the public sector, which the government and the Euro leaders are insisting must be paid for by draconian austerity measures of higher taxes and huge cuts in government services and welfare benefits.  And it looks as though more money for the banks will be needed, because the banks still have massive non-performing loans on their books from bankrupt real estate developers and construction companies.  Bad debts are just 8% of loans to industry, but 26% of loans to construction companies and 30% for loans to buy real estate for development. 

Spain’s much heralded economic boom saw 3.5% real growth per year during the 1990s, but stopped being based on productive investment for industry and exports in the 2000s and turned intoa housing and real estate credit bubble, just Ireland’s Celtic Tiger boom did.  House prices to income peaked at 150%, nearly as high as Ireland.  It has fallen back to 120% now, but Ireland has dropped to 85%.  Household debt reached 90% of GDP.  Non-financial corporate debt including that of the developers reached 200% of GDP, the highest in the OECD.

Housing construction doubled from 1995 to 2007 reaching 22% of GDP in 2007!  Investment in real estate then fell from12.5% of GDP in 2006 to 5.3% at end of 2012 and below the historic low of 7% in 1997.  Oversupply of housing is now around 700,000 units.  Sales of new homes have dropped from 400k in 2007 to 115k in 2012.  It would take six years to clear the backlog.  House prices are down 31% in nominal terms and 38% in real terms, but there is still some way to go.  Irish house prices fell 60%. During the property boom, credit grew at 20% a year, way faster than nominal GDP at about 7% a year.  But lending collapse from 2008.  The private sector has deleveraged its debt by 15% of GDP since the peak of 2008.  But debt is still well above accepted international level of 160%. 

This is seriously holding back economic recovery.  Capitalists won’t invest if they have to meet heavy debt burdens. And Spanish corporations are most indebted among the major economies.

An IMF study showed that “countries with boom-bust cycles typically have deep recessions and sluggish recoveries, with GDP remaining 9-10% below the pre-crisis trend for 5-10 years” (IMF 2009).  Deleveraging can take 5-6 years in high income OECD economies and require around 20-30% pts of debt to GDP reduction.  Housing crises preceded by a build-up of household debt cuts GDP by 4% at least over five years (IMF WEO Sept 2009 and Aspachs-Bracons, Jodar-Rosell, Gual “perspectives de deaspalancamiento en Espana, La Caixa Vol m23, 2011. IMF WEO May 2012).

Much of the funding for the property boom came from abroad, mainly other European banks, greedy to get a piece of the property cake.  Spanish household savings and corporate profits were not nearly enough to fund the boom and all those consumer purchases that it enabled.  Costs of production rocketed and the real price of Spanish exports rose 20% from 2000 to 2009, increasingly pricing them out of world markets. So Spain’s external deficit with the rest of Europe and the world mushroomed.  The current account deficit reached 10% of GDP in 2007 and net international liabilities (debt and equity) hit 92% of GDP, well above the recommended prudent level of 35% for a growing emerging economy.  Gross external debt is now 160% of GDP, with nearly half in short-term loans.  External debt interest to foreign banks sucks up 2.5% of GDP each year.  Spanish banks and companies can only borrow from the ECB now.  Borrowing from Eurosystem rose from 6% in 2010 to 12% of GDP in 2012.  The Bank of Spain has net liabilities to the Eurosystem at 30% of GDP. This is a huge burden. And this is a burden that cannot be borne because of the hidden Achilles heel of Spanish capitalism: the long-term decline in its profitability.

Spanish capitalism was not a great success under the military rule of Franco. Profitability fell from the great heights of the golden age of post-war capitalism, as it did for all other capitalist economies from 1963 onwards, in a classic manner, with the organic composition of capital rising nearly 30%, while the rate of surplus value fell by about same. Eventually that led to the fall of Franco and, for a while, Spanish capitalism reversed the decline as foreign investment flooded in to set up new industries, relying on a sharp rise in the rate of exploitation brought about by plentiful surplus labour and a system of temporary employment contracts (while freezing permanent employment), the so-called dual labour policy. 

The rate of exploitation rose over 50% to 1996, accompanied by the foreign-led investment boom in the 1990s.  This drove up the ratio of capital to labour (by 19%), as German and other capitalist companies relocated to Spain in search of cheaper labour and higher profits. That eventually put renewed pressure on the rate of profit.  From 1996, profitability dropped sharply as the wages (blue line below) squeezed profits (red line) in the boom of the 2000s.

Spanish capitalists switched to investing in property and riding on the cheap credit boom that disguised weakening profitability in the productive sector. The Spanish economic ‘miracle’ came to a sorry end in the Great Recession, which in turn led to the property bubble burst, bringing about the banking crash. Indeed, it was in that order, unlike the US and the UK. 

The aim of ‘austerity’ and high unemployment is to restore Spanish profitability. It’s a modern capitalist form of the Spanish Inquisition on the people. Corporate revenues dropped by €3bn in 2012 (a 0.5% drop), but there was a €17bn (5%) cut in wages to employees, so profits rose by €6bn. Unit labour costs fell by 3.5% in 2012 as labour laws have been introduced to make it easier to sack permanent staff and end the dual labour system – an ironic reversal of neo-liberal policies. The aim, of course, is not to provide rights for temporary workers but to end them for permanent workers – levelling down.

Spanish capitalism has failed and is now on its knees. But the previous socialist government’s answer was not to replace it, but instead to bail it out with taxpayers’ money and people’s jobs.  This policy was continued with renewed enthusiasm by the right-wing government.  But bailouts and austerity is not working.  The government cannot meet its fiscal targets despite ever more measures of austerity. Last year’s government deficit was 10.6% of GDP when the bank recapitalisation is included and 7.1% without it.  This year’s shortfall is projected at 6.3% rather than the EU’s previous target of 4.5%. The EU is allowing Spain to relax its targets. But even so,  next year, the deficit is expected to be 6.9%, the year after 6.6% and so on with very little further progress thereafter.  By 2018, Spain will have by far and away the worst structural deficit of any advanced economy, including other such well known fiscal basket cases as the UK and the US. The general government gross debt is forecast to rise from 84.1% of GDP last year to 110.6% in 2018. No other advanced economy has such a dramatically worsening outlook. Spain is the marker for the failure of austerity – this modern Inquisition.

The government continually revises down its forecasts for growth.  In 2012, the economy contracted by 1.4% and another 1.5% decline is expected this year, making a contraction of 6% since 2009, or a difference of 20% compared to trend growth!  The IMF reckons that economic growth in Spain between 2015 and 2018 will average around 1.5% annually.  This forecast represents a significant downward revision from earlier optimism.  And it’s still too optimistic.

This terrible depression is also beginning to break up the Spanish state.  Regional governments are deeply in debt and are being asked to make huge cuts. Richer regional areas with their own nationalist interests, as in Catalonia and the Basque country, are making noises about separation from Madrid.  The centrifugal forces that are raising the odds of a euro break-up are also doing the same to Spain itself. 

Can lower wages and high unemployment eventually make Spanish exports more competitive and so restore growth through exports?  Spanish exports in real terms are up €26.3 bn from 2007 (+10%) but its imports are €64.4 billion lower (-20%).  So lower wages and the cost of labour are helping trade, but this change in net trade has been paltry relative to the complete collapse of investment of €108 billion (-36% in real terms).  The Spanish depression is a result of the collapse in capitalist investment (see green line in graph below).  To reverse that requires a sharp rise in profitability. And until investment recovers, the depression will not end.

PM Rajoy has rejected the idea of the Socialist opposition leader Alfredo Perez Rubalcaba that unused funds from the ESM bank bailout be used  to fund job creation because it would mean more borrowing.  Left Unity proposes to reduce unemployment to the EU average (which would require creating 3.4M jobs), to almost double the minimum wage and the lowest pensions, and to use the nationalised banks to lend to SMEs. It claims it could fund these measures by making ‘taxes more progressive’ and ‘curbing corporate tax dodging and the underground economy’.  There’s good intention here, but wishful thinking.  A much more radical restructuring of Spanish economy would be required, namely the replacement of the old order with the new.

Sure, when unit labour costs are driven down sufficiently, enough weak companies are bankrupted  and exports are cheap enough , then corporate profitability will rise from the ashes of millions of unemployed, much lower living standards, decimated pensions and destroyed public services that have been burnt at the stake of capitalist accumulation.  The Spanish inquisition will eventually have done its job after years more misery.

The cat is stuck up a tree: how did it get there and how do you get it down?

 

 

The IMF has just held a conference of big hitting mainstream economists to evaluate the efficacy of economic theory and policy in dealing with the financial crash and the ensuing Great Recession.  The title of IMF meeting tells it all: “Rethinking Macro Policy II: First Steps and Early Lessons”.  Apparently,  some five years after the crisis broke, the world’s leading macroeconomists (Krugman was not there) are taking their ‘first steps’ and drawing ‘early lessons’ on what happened and how to avoid another disaster in the future.  It reminds me of those politicians who when faced with an avoidable calamity that has hurt many people eventually respond by saying they will start a thorough investigation into what happened and it’s early days, but eventually they will come up with proposals to ensure that “it can never happen again”.

David Romer is the Herman Royer Professor of Political Economy at University of California, Berkeley. That’s a very prestigious economics post and Romer is a leading economist  and author of a standard textbook in graduate macroeconomics as well as many influential economic papers, particularly in the area of the revisionist version of Keynes’ theory, taught in most universities, namely New Keynesian economics
(see my post, https://thenextrecession.wordpress.com/2013/04/03/keynesian-economics-in-the-dsge-trap/).  He is also the husband and close collaborator of the US President’s Council of Economic Advisers former Chairwoman Christina Romer.

What did he conclude from the IMF conference?  Well, “the relatively modest changes of the type discussed at the conference, and that in some cases policy makers are putting into place, are helpful but unlikely to be enough to prevent future financial shocks from inflicting large economic harm….Given the record for just one country over a third of a century, the idea that large financial shocks are rare, and that we therefore should not worry greatly about them, seems fundamentally wrong….I think the right conclusion to draw is that financial shocks are likely to be both frequent and hard to predict – not just in their timing but in their form.”  (http://www.voxeu.org/article/preventing-next-catastrophe-where-do-we-stand).

So Romer tells us that what he has learned is that ‘financial shocks’ are not rare but ‘frequent and hard to predict’.  You don’t say!  But it’s hardly encouraging to know that one of the world’s leading economists cannot tell us when and how ‘financial shocks’ can take place.  Mainstream economics couches all their analysis of crises in terms of ‘shocks’ to the system, implying that the capitalist process of accumulation and the play of markets is really a stable, steady equilibrium process, but is sometimes subject to ‘shocks’ from outside (exogenous).  This is what is ‘unpredictable’, like meteors from the sky (although astronomical theory can now make quite good predictions on the likelihood of a meteor hitting the earth!).  So what’s the answer to these unpredictable but frequent ‘shocks’?  Romer tells us that “the first approach is to reform the financial system so that the shocks that it sends to the real economy are much smaller.  I do not know the answers to these questions, but it seems to me that they deserve serious analysis.“  Ah! Reform of the financial system, yes.  What reform? Uh, don’t know.  That’s helpful.

Romer assumes that the Great Recession was caused by shocks to the financial system and it was nothing to do with the capitalist production process itself.  So not only are crises caused by an outside shock, they are restricted to the financial sector in an otherwise stable system.  But even in this restricted area for reform, Romer sees little progress: “Yet radical redesign of the financial system was largely missing from the conference.  After five years of catastrophic macroeconomic performance, ‘first steps and early lessons’ – to quote the conference title – is not what we should be aiming for. Rather, we should be looking for solutions to the on-going current crisis and strong measures to minimise the chances of anything similar happening again. I worry that the reforms we are focusing on are too small to do that, and that what is needed is a more fundamental rethinking of the design of our financial system and of our frameworks for macroeconomic policy.”  Indeed.

However, Romer’s jaundiced view was countered by other eminent economists at the IMF do.  The chief economist of the IMF, Olivier Blanchard, the man who has pushed IMF thinking away from outright ‘austerity’ towards more a Keynesian ‘stimulus’ view with the IMF’s ‘correction’ on the impact of fiscal multipliers (see my post, https://thenextrecession.wordpress.com/2012/10/14/the-smugness-multiplier/) weighed in (http://www.voxeu.org/article/rethinking-macroeconomic-policy).  Blanchard claimed that progress was being made.  “Rethinking and reforms are both taking place. But we still do not know the final destination, be it for the redefinition of monetary policy, or the contours of financial regulation, or the role of macroprudential tools. We have a general sense of direction, but we are largely navigating by sight.”  By this I think he really means that we are navigating blind, as there is no theory of what direction to take!  Indeed, Blanchard sums up: “There is no agreed vision of what the future financial architecture should look like, and by implication, no agreed vision of what the appropriate financial regulation should be.”  No vision at all.

That brings us to George Akerlof (http://www.voxeu.org/article/cat-tree-and-further-observations-rethinking-macroeconomic-policy).  Another Nobel prize winner (jointly with George Stiglitz – see below) and another professor at Berkeley.  Akerlof is married to Jane Yellen, head of the San Francisco Fed and the likely successor to Ben Bernanke.  Yes, it is all very incestuous!  Akerlof is regarded highly as a ‘behavioural’ economist (see my paper, The causes of the Great Recession), who with Robert Shiller wrote a book that argued that the crisis was the result of uncertainty in among consumers and investors leading to unpredictable movements in ‘animal spirits’ (another Keynesian term).  Shiller, by the way, recently published a book, Finance and the Good Society, in which he argues that, even after the crisis, rather than condemning finance, we need to reclaim it for the “common good” (see the interview in May 2012 (http://voxeu.org/vox-talks/finance-and-good-society).  So we must be nicer to banks (see my post, http://thenextrecession.wordpress.com/2012/08/09/five-years-on/) .

But how does Akerlof view the nature of the crisis?  Well “my view is that it’s as if a cat has climbed a huge tree. It’s up there, and oh my God, we have this cat up there. The cat, of course, is this huge crisis. And everybody at the conference has been commenting about what we should do about this stupid cat and how do we get it down.”  But Akerlof is really quite happy with the way things have gone since 2007. He reckons that mainstream economics stood the test of the crisis by successfully advising politicians to bail out the banking system and so avoid a great depression as in the 1930s.  It was this policy of ‘a finger in the dyke’ that avoided a tsunami.

All the ensuing unemployment, the collapse in investment and GDP and the sharp reduction in living standards should be balanced against this ‘success’ of saving the banks from themselves. “We should have led the public to understand that we should measure success not by the level of the current unemployment rate, but by a benchmark that takes into account the financial vulnerability that had been set in the previous boom”   The trouble is that the public does not see it like that and so is not aware how clever economists have really been. “We economists have not done a good job of explaining that our macro-stability policies have been effective. There is, of course, good reason why the public has a hard time listening. They have other things to do than to become macroeconomists and macroeconomic historians (!).  In sum, we economists did very badly in predicting the crisis. But the economic policies post-crisis have been close to what a good, sensible ‘economist-doctor’ would have ordered. Those policies have come directly from the Bush and Obama administrations, and from their appointees. They have also been supported by the Congress.  The lesson for the future is that good economics and common sense have worked well. We have had trial and success. We must keep this in mind with policy going forward. “  So speaks the husband of the future head of the Federal Reserve.

Well, Akerlof’s former joint Nobel prize winner, Joseph Stiglitz, does not seem quite so sanguine (http://www.voxeu.org/article/lessons-north-atlantic-crisis-economic-theory-and-policy).  Stiglitz makes the important point that, contrary to the economists above, the capitalist mode of production is not one of perfect stable growth occasionally hit by ‘shocks’.  Stiglitz puts it:“standard models had focused on exogenous shocks, and yet it’s very clear that a very large fraction of the perturbations to our economy are endogenous.  There are not only short run endogenous shocks; there are long run structural transformations and persistent shocks. The models that focussed on exogenous shocks simply misled us – the majority of the really big shocks come from within the economy.”  

Stiglitz points out that after five years or more of crisis, slump and weak recovery,”in terms of human resources, capital stock, and natural resources, we’re roughly at the same levels today that we were before the crisis. Meanwhile, many countries have not regained their pre-crisis GDP levels, to say nothing of a return to the pre-crisis growth paths. In a very fundamental sense, the crisis is still not fully resolved – and there’s no good economic theory that explains why that should be the case.”

Exactly!  Mainstream economics did not predict the crisis (and even denied it could happen), could not explain how the cat got up the tree and now has no clear answer about what to do about getting the cat down, short of saying that ‘it should never happen again’.   Stiglitz’s explanation of the crisis and the subsequent weak recovery is better, but still flawed.  For him, “some of this has to do with the issue of the slow pace of deleveraging. But even as the economy deleverages, there is every reason to believe that it will not return to full employment…. This is more than just a balance sheet crisis. There is a deeper cause: The United States and Europe are going through a structural transformation. There is a structural transformation associated with the move from manufacturing to a service sector economy. Additionally, changing comparative advantages requires massive adjustments in the structure of the North Atlantic countries.”

So the crisis is really due to the mature capitalist economies getting ‘too mature’ or past their sell-by-date.  This is a view that I developed from a Marxist perspective (see my post, https://thenextrecession.wordpress.com/2012/09/12/crisis-or-breakdown/).  But Stiglitz does not see that this long-run ‘structural problem’ has anything to do with a system of capitalist accumulation for a profit, but to do with the ‘switch from manufacturing to a service sector’.  Really?  This switch has been going on for decades as far back as 1945 – can this be the reason for the failure of mature capitalist economies in 2008?

So how do we get the cat out of the tree?  Well, according to Stiglitz: “It should be clear that we could have done much more to prevent this crisis and to mitigate its effects. It should be clear too that we can do much more to prevent the next one. Still, through this conference and others like it, we are at least beginning to clearly identify the really big market failures, the big macroeconomic externalities, and the best policy interventions for achieving high growth, greater stability, and a better distribution of income.  To succeed, we must constantly remind ourselves that markets on their own are not going to solve these problems, and neither will a single intervention like short-term interest rates. Those facts have been proven time and again over the last century and a half.   And as daunting as the economic problems we now face are, acknowledging this will allow us to take advantage of the one big opportunity this period of economic trauma has afforded: namely, the chance to revolutionise our flawed models, and perhaps even exit from an interminable cycle of crises.”

Thus Stiglitz reckons that mainstream economics has the tools to solve recurrent crises of capitalism and make the system work ‘once we revolutionise our flawed models’.  But it requires some form of government intervention that is more than just monetary policy by the Fed.  Unfortunately, there is no sign that mainstream economic models are being ‘revolutionised’ or that politicians want more government intervention instead of ‘less government’.  Stiglitz says that “we are beginning to clearly identify the best policy interventions for achieving high growth”.  Really? I don’t see mainstream economics doing any such thing in economies dominated by the capitalist sector, which only grows if it is profitable enough.

These divisions in macroeconomics were highlighted by the recent terrible scandal of the ‘two RRs’
(see my post, https://thenextrecession.wordpress.com/2013/04/17/revising-the-two-rrs/)
over the errors and distortions in their famous paper that suggested that once public debt to GDP gets above 90% in any economy, subsequent economic growth is likely to be 2% pts lower than if the debt ratio is lower than 90%.

Carmen Reinhart and Kenneth Rogoff have now published an errata to their 2010 paper on public debt and growth, acknowledging more errors in the figures, but leaving their basic conclusion unchanged.  In the errata, the two RRs correct the mean averages for growth from 1946 to 2009 that were originally criticised by Robert Pollin and his co-authors at the University of Massachusetts, Amherst.   But they also argue that the corrections do not affect their most up-to-date work, which still shows a slowdown in growth when debt hits 90% of GDP.  “The point is, whichever way you slice it you have lower growth rates by about 1 percentage point,” Ms Reinhart said (note not 2% pts any more). Their latest set of data, which includes more countries and more years of data, still finds a drop in median growth from 2.8% to 1.8% when debt hits the 90% threshold.  In response, the HAP authors wrote a new criticism point out that these median figures were also affected by the same error. Pollin says he accepts that there are different ways to weight the numbers but a conclusion should be robust. “The two RRs results are entirely dependent on using their particular methodology”.  And so it goes on.

You can see why this debate has become so intense.  The Austerians have used the two RRs data to ‘prove’ that austerity is necessary to get debt down and restore economic growth.  Now the Keynesians are triumphant that the evidence has been ‘proved’ false. When I wrote about this before, I pointed out that there were other papers that reached similar conclusions to the two RRs, namely that high debt will lead to lower growth.  But the BIS paper covered not just public debt but also private debt, as did the IMF paper.  And that’s important, because it makes sense that high corporate debt will have a dampening effect on corporate investment, the key driver of growth in a capitalist economy.  Public debt does not have the same direct effect, although ot can lead to increased taxation on profits and eventually ‘crowd out’ lending to the private sector by driving up interest rates – although this does not apply right now.  

And of course, the issue of causality remains unanswered: does high debt lead to low growth or is it vice versa?  So does the cat get in the tree because the ladder of credit gets it up there and then it can’t come down when the ladder of the credit falls over.  Or is that the cat got up the tree and the ladder of credit had to be extended too far and then fell over, so the cat could not get down?  Either way, the cat is still up the tree.  Maybe we should just cut the tree down.

 

Boom or crawl?

Stockbrokers and financial analysts were ecstatic yesterday when the famous Dow Jones stock index for the 30 top companies in the US passed its all-time high and went above 15,000.   It was another landmark in the current rally in financial assets around the globe.   The only way is up – it seems.  The Dow index was at 14,000 just 66 days ago and is now up by 129% since the 2009 trough.  The other US stock index, the S&P-500 reached all-time highs earlier last month.  And the UK index, the FTSE 100, also doing well.  Graphs from Doug Short’s website.

But does this imply that the world capitalist economy is now finally making a significant recovery in growth, investment and jobs after the Great Recession?  Well, the first thing to say is that the US stock market is still in a bear market, despite its recent spectacular rally.  When inflation is stripped out of the equation, the S&P-500 index is up 89% from its 2009 low but it is still 22% below its 2000 peak, which kicked off a bear market in equities that has lasted 13 years and bear markets in the past have lasted anything between 15-20 years
(see my post, https://thenextrecession.wordpress.com/2013/03/30/its-still-a-bear-market/).

This stock market boom does not reflect an anticipation of sustained economic recovery.  It really indicates the massive amount of credit that has been created by central banks around the world.  The monetary authorities have cut interest rates to near zero, the latest reductions being that of the ECB (-25bp) and Australia’s RBS (-25bp) in the last week.  And the major central banks continue to ‘print’ money through so-called ‘quantitative easing’, the most recent and ambitious being the programme of the Bank of Japan to print as much money as it can to drive up inflation (not growth)!

Most of this credit is not finding its way into the ‘real economy’, however.  Instead it is fuelling a bubble in financial assets, such that even the governments of economies in deep recession, like Italy, Spain or Portugal and Slovenia, can sell their bonds into the market at reduced interest rates (see my post, https://thenextrecession.wordpress.com/2013/03/04/you-cant-make-a-horse-drink-2/).

While the US stock market explodes upwards, the latest quarterly earnings results of top 500 US companies reveal a less rosy picture.  Sure, corporate profits remain near all-time highs but 44% of US firms reported lower than expected sales, with revenue growth slowing.  Cost-cutting and refusing to invest significantly remains the main way that US companies have sustained high profits.  But corporate profit growth has slowed to a trickle, so stock market investors may be in for a rude awakening soon.

And the story on activity in the real economy is little changed, despite the stock market’s view.  Sure, the UK avoided a ‘triple -dip recession’  according to the data for the first quarter of this year, but real GDP growth is unlikely to be more than 1% this year.  And sure, US jobs growth in April was in line with a trend of slowly reducing unemployment, but mainly through the creation of part-time and temporary jobs.

Actually, the US economy took a slight downturn, according to the measure of business activity I have developed from the US ISM data for manufacturing and services activity.  The combined ISM index shows that the US is still in low-growth mode and, if anything, turning down.

A more high-frequency indicator is that provided by the ECRI.  Their weekly indicator for the US confirms that the low growth mode is in place, although the ECRI  suggests a slight uptick in April.

But what is really interesting is that the world economic activity indicator from Markit PMI dipped in April and is now only just above the 50 threshold for showing economic expansion.  For the first time,  the world PMI score is below that of the US, Japan, the UK and China combined.  It seems that, outside these major economies, the expansion of activity is slowing.  Of course, the Eurozone remains depressed and contracting.

The stock market may be booming, but the world capitalist economy is still crawling.

Keynes: being gay and caring for the future of our grandchildren

Apparently, right-wing Harvard Professor and author Niall Ferguson says John Maynard Keynes didn’t care about future generations because he was gay and didn’t have children.  Speaking at the Tenth Annual Altegris Conference in Carlsbad, Calif., in front of a group of more than 500 financial advisors and investors, Ferguson responded to a question about Keynes’ famous philosophy of self-interest versus the economic philosophy of Edmund Burke, who believed there was a social contract among the living, as well as the dead. Ferguson asked the audience how many children Keynes had. He explained that Keynes had none because he was a homosexual and was married to a ballerina, with whom he likely talked of “poetry” rather than procreated. The audience went quiet at the remark.  Ferguson, who is the Laurence A. Tisch Professor of History at Harvard University, and author of The Great Degeneration: How Institutions Decay and Economies Die, says it’s only logical that Keynes would take this selfish worldview because he was an “effete” member of society. Apparently, in Ferguson’s world, if you are gay or childless, you cannot care about future generations nor society.

Ferguson’s remarks not only reveal a level of puerile homophobia but even more a complete ignorance about Keynes’s ideas and interests.  Anybody who reads this blog knows that Keynesian ideas come in for a bashing at regular intervals.  But to argue that Keynes was not interested in the prospects for future generations (let alone whether being gay is relevant) has not read Keynes.  Back in 1930 at the depth of the Great Depression, John Maynard Keynes made a short lecture to students at Cambridge University.   Later in 1931, this lecture was revised and published as a short essay, Economic Possibilities for Our Grandchildren, in his Essays in Persuasion.

When formulating the final draft of his essay, Keynes commented “The fact is — a fact not yet recognized by the great public — that we are now in the depth of very severe international slump, a slump which will take its place in history amongst the most acute ever experienced” (Harrod 1972, p. 469, quoted on p. 2).  But even so, JMK wanted to convince his student audience, many of whom were under the influence of Marxist ideas at the time, that they should be optimistic about the future potential of the capitalist mode of production.  In his view, as argued in the essay/lecture, capitalism would have progressed so that by 2030 the standard of living would be dramatically higher; people would be liberated from want and would work no more than fifteen hours a week, devoting the rest of their time to leisure and culture.  So, contrary to Ferguson, Keynes did look ahead beyond ‘the long run when we are all dead’ for his generation to the interests of ‘our grandchildren’, despite being gay, effete and only interested in poetry, according to Niall Ferguson, who probably considers himself a red-blooded male who plays rugby and never goes to the ballet.

JMK started his lecture by saying that the words: “We are suffering just now from a bad attack of economic pessimism. It is common to hear people say that the epoch of enormous economic progress which characterised the nineteenth century is over; that the rapid improvement in the standard of life is now going to slow down – at any rate in Great Britain; that a decline in prosperity is more likely than an improvement in the decade which lies ahead of us.  The prevailing world depression, the enormous anomaly of unemployment in a world full of wants, the disastrous mistakes we have made, blind us to what is going on under the surface to the true interpretation. of the trend of things. For I predict that both of the two opposed errors of pessimism which now make so much noise in the world will be proved wrong in our own time – the pessimism of the revolutionaries who think that things are so bad that nothing can save us but violent change, and the pessimism of the reactionaries who consider the balance of our economic and social life so precarious that we must risk no experiments.  In quite a few years – in our own lifetimes I mean – we may be able to perform all the operations of agriculture, mining, and manufacture with a quarter of the human effort to which we have been accustomed.”  Thus Keynes wanted to convince his students that the terrible depression of capitalism in the 1930s would be rectified and capitalism would prove to be greatest show on earth.  But he also wanted to refute the pessimism of the right-wing (like Ferguson now) who attacked Keynes for his ‘unorthodox’ experiments in economic theory and policy.

Well, as we head towards 2030, was JMK right?  Has capitalism taken human civilisation forward economically since 1930?   JMK reckoned that GDP would quadruple in the lifetime of the Cambridge students he was talking to and would rise eight times by 2030.  Well, that prediction may have been close for some advanced capitalist economies.  But it was too optimistic for the world economy as a whole.

Anyway, it’s not GDP that matters, it is GDP per head. So if we assume that a Cambridge student of 20 years in 1930 lived another 60 years (relatively generous for life expectancy then), did real GDP per head quadruple by 1990?  Well, according to the invaluable Angus Maddison studies, in 1930 real GDP per head in the JMK’s Britain was $5441 (PPP basis).  It reached $8240 in 1960 and then $16430 per head in 1990.  So there was a tripling of per capita GDP in the UK’s real GDP.  Not bad – but by no means four times higher.  And if we look at the world economy as a whole (something JMK does not explicitly distinguish from the advanced economies), then world per capita GDP rose only about 2.5 times by 1990.  JMK was far too optimistic.

Keynes’s second prediction was for a rise of real GDP by eight times from 1930 to 2030.  “Let us, for the sake of argument, suppose that a hundred years hence we are all of us, on the average, eight times better off in the economic sense than we are to-day. Assuredly there need be nothing here to surprise us.”  Again JMK seems to consider that the advanced economies constitute the whole world’s population.  But was he right anyway?  Were the British or American people eight times better off in 2030?   Well, world real GDP rose from $4.5trn in 1940 to about $50trn now.  But per capita real GDP was $1958 in 1940 and reached $7614 in 2008.  That’s much less than four times.  As for the population, there has been an explosion.  In 1940, there were 2.2bn people in the world.  It looks as though it will reach 8.4bn in 2030.  Assuming a generous 3% growth in real world GDP from now until 2030, something that many reckon will not be achieved, world GDP will be about $97trn then.  That gives a per capita level of $11770 compared to $1958 in 1940, or a rise of six times.

You might argue this is quibbling.  After all, a six-fold rise in per capita GDP from 1940 to 2030 is still amazing in the history of human social organisation.  But capitalism will not meet the targets expected by Keynes.  And can we assume that we will not experience major wars or depressions in the next 20 years that could bring the outcome even lower?

Like Marx, Keynes looked to solve the ‘economic problem’ of scarcity and toil.  The difference was that Keynes reckoned it could be done under the capitalist mode of production, as the only possible way: “I draw the conclusion that, assuming no important wars and no important increase in population, the ‘economic problem’ may be solved, or be at least within sight of solution, within a hundred years. This means that the economic problem is not – if we look into the future – the permanent problem of the human race.”  But the capitalist mode of production, like other class societies, cannot avoid wars and it has not avoided famine and poverty for the majority of the world.  Within a decade, Britain was engaged in a world war that killed millions of armed and unarmed people and destroyed the livelihoods of millions of others.  And since 1945, there has not been a day where there has not been armed conflict somewhere in the world, even in this period of relative ‘world peace’ between the major powers both during and after the so-called cold war.

Moreover, in his address, Keynes totally ignores inequalities of income and wealth.  Per capita income for a country is merely an average.  The majority do not reach that average (if it is a mean average).  Although average living standards have continued to rise, the living standards at the bottom of twenty percent of the income distribution have stagnated or declined for the last 30 years. Inequality of income and wealth was at a high in 1930 after the 1920s credit and stock market bubbles, back to levels not seen since Victorian times.  The post-war recovery and the welfare state with its higher tax rates did reduce inequalities in the major capitalist economies for a while.  But the neo-liberal period of reaction from the mid-1970s onwards, discussed much in this blog, pushed inequalities back to new heights, especially in the US and the UK right up to the point of the Great Recession.  Now we are in a very similar state economically and socially, in terms of equality, as we were when Keynes made his speech.  So no change at all there.

Then there is the issue of work and leisure.  Keynes argued that “for the first time since his creation man will be faced with his real, his permanent problem – how to use his freedom from pressing economic cares, how to occupy the leisure, which science and compound interest will have won for him, to live wisely and agreeably and well.”  Keynes predicted superabundance and a three-hour day – the socialist dream, but under capitalism.  Well, the average working week in the US in 1930 – if you had a job – was about 50 hours.  It is still above 40 hours (including overtime) now for full-time permanent employment.  Indeed, in 1980, the average hours worked in a year was about 1800 for the the advanced economies.  Currently, it is about 1800 hours – so again, no change there.

Keynes reckoned that once the economic problem had been solved the terrible morality of money-making (the root of all evil) could be dispelled. “The love of money as a possession – as distinguished from the love of money as a means to the enjoyments and realities of life – will be recognised for what it is, a somewhat disgusting morbidity, one of those semi-criminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease. All kinds of social customs and economic practices, affecting the distribution of wealth and of economic rewards and penalties, which we now maintain at all costs, however distasteful and unjust they may be in themselves, because they are tremendously useful in promoting the accumulation of capital, we shall then be free, at last, to discard.”  Here Keynes believed that the flaw in capitalism, the instability and inefficiency of finance capital, would gradually disappear.  There would be the euthanasia of the rentier (the coupon-clipping money capitalist) and thus no need for the replacement of the capitalist mode of production itself.  Once there was control of population growth, an end to wars and a trust in science and technology, then the rate of accumulation would balance between production and consumption and there would be no more recessions and depressions.  It was a sort of utopianism that Marxism is usually accused of.

For Keynes, no major revolution in the social mode of production was necessary, as long as economic specialists like himself could be taken seriously: “the economic problem.. should be a matter for specialists – like dentistry. If economists could manage to get themselves thought of as humble, competent people, on a level with dentists, that would be splendid!”  This ‘humble’ plea for the role of economics and economists was necessary in 1930 because in the depth of the depression, so many were disillusioned with economists who had failed to predict the crash and the slump, could not explain how it had happened afterwards, and had no policies to solve it, except to accept the punishment (the Ferguson solution).  Again no change there!  Maybe Niall Ferguson should try dentistry rather than economics or history to learn some humility.

Addendum:  Niall Ferguson eats humble pie and apologises: 

During a recent question-and-answer session at a conference in California, I made comments about John Maynard Keynes that were as stupid as they were insensitive.  I had been asked to comment on Keynes’s famous observation “In the long run we are all dead.” The point I had made in my presentation was that in the long run our children, grandchildren and great-grandchildren are alive, and will have to deal with the consequences of our economic actions.  But I should not have suggested – in an off-the-cuff response that was not part of my presentation – that Keynes was indifferent to the long run because he had no children, nor that he had no children because he was gay. This was doubly stupid. First, it is obvious that people who do not have children also care about future generations. Second, I had forgotten that Keynes’s wife Lydia miscarried.  My disagreements with Keynes’s economic philosophy have never had anything to do with his sexual orientation. It is simply false to suggest, as I did, that his approach to economic policy was inspired by any aspect of his personal life. As those who know me and my work are well aware, I detest all prejudice, sexual or otherwise.  My colleagues, students, and friends – straight and gay – have every right to be disappointed in me, as I am in myself. To them, and to everyone who heard my remarks at the conference or has read them since, I deeply and unreservedly apologize.  Niall Ferguson.

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.

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.

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.

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

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.

Iceland’s electors: how ungrateful!

Five years after Iceland’s economic collapse, early returns in the parliamentary election reveal that voters are favouring the return of a centre-right government, originally blamed for the nation’s financial woes.  Electors are about to oust the Social Democrats despite their apparent adoption of Keynesian-style policies of capital controls and devaluation, so lauded by leading Keynesian economists and even elements of the IMF.

Iceland, a small volcano-dotted North Atlantic island with a population of just 320,000, went from economic ‘wunderkind’ to financial basket case almost overnight back in 2008 when its main commercial banks collapsed within a week of one another.  The value of the country’s currency plummeted and inflation and unemployment soared. Iceland was forced to seek bailouts from Europe and the International Monetary Fund.

Many Keynesians put Iceland’s response to this crisis forward as the model for policy. The government opted for devaluation, capital controls and renegotiating foreign debts.  Paul Krugman (http://krugman.blogs.nytimes.com/2012/07/08/the-times-does-iceland/) described the results thus: “the relevance of the Icelandic sort-of miracle… What it demonstrated was the usefulness of devaluation (and therefore of having your own currency), and the case for temporary capital controls in an emergency. Also the case for letting creditors of private banks gone wild eat the losses.  Iceland did not engage in fiscal stimulus; it didn’t have to, given the kick from a huge depreciation of the currency.  And more broadly, Iceland is a dramatic demonstration of the wrongness of conventional wisdom in these times. .. Iceland broke all the rules, and things are not too bad.“

But it seems Icelanders do not agree that things “are not too bad”.  As I explained before, the success of the Social Democrat government in restoring Iceland’s economy on capitalist lines is a bit of myth (see my post, http://thenextrecession.wordpress.com/2013/03/27/profitability-the-euro-crisis-and-icelandic-myths/).  You see, the government tried everything it could to bail out its corrupt bankers with taxpayers money.  But when the electorate was having nothing of it, eventually  it did nationalise them  but then privatised them again in record time. Two out of the three collapsed major banks in Iceland are now owned by their creditors, not the state.  The government negotiated a deal to pay back Dutch and British depositors that would have crippled the economy for decades.  The deal was rejected again and again by the Icelanders, although payback terms were eventually reached, Cyprus-style.  But Iceland’s much lauded recovery model involving devaluation of its currency coupled with capital controls is now a drag on growth.   Iceland is growing at 2%, faster than much of Europe. But the IMF had originally forecast annual growth of around 4.5% through 2011-2013. It now is under half that.

Many Icelanders say they do not ‘feel’ even this modest growth. Outside booming private sector fishing and tourism, businesses complain of stagnation.  Some 80% of households are swamped in housing loan debts indexed to inflation. Investment is under 15% of GDP, a record low in Europe! Real incomes have dropped sharply for Icelandic households as their debt is index-linked to inflation. Pretax gross income of the average Icelander has decreased by 18.3% since 2007 in Icelandic kroner. Measured in dollars, however, the fall is 42.7% since 2007.

The centre-right pro-market parties taking over summed up the reaction of voters to Keynesian policies: they “were introduced to a plan that would bring us quicker out of the crisis than has been the reality,” said possible future PM Benediktsson. “People are now looking forward and asking themselves… what kind of a plan is the most likely one to bring more growth, more job creation, to close the budget deficit, and have Iceland grow into the future?,” he said.   The answer of the right is a return to the free market and some juicy handouts.  The Progressives are promising to write off some mortgage debt, taking money from foreign creditors. Benediktsson’s Independence Party is offering lower taxes and the lifting of capital controls that he says are hindering foreign investment.

So a government pledged to the return of ‘free market’ policies and ending capital controls, encouraging foreign investment and lowering corporate taxes will take over.  Mainstream economists who support the new government claim that capital controls are strangling the economy and Iceland needs to deregulate (again!):  “The capital controls violate EU laws regarding the principle of the four freedoms – free movement of goods, capital, services, and persons. The free movement of capital is prevented by the controls.”  say two Icelandic economists based in the UK (http://www.voxeu.org/article/capital-controls-cyprus-and-icelandic-experience).

What is behind these arguments is the aim of the capitalist sector in Iceland to restore profitability and remove the restrictive measures imposed by the state over the corrupt banking system.  Now that the majority of Icelanders have paid for last slump with their living standards, it’s time to return to business as usual.  As I argued in that post (op cit), restoring profitability is key for economic recovery under the capitalist mode of production.  So which pro-capitalist policy has done best on this criterion?  Austerity internal devaluation (Greece) or Keynesian currency devaluation (Iceland)?

Iceland’s rate of profit plummeted from 2005 and eventually the island’s property boom burst and along with it the banks collapsed in 2008-9.  Devaluation of the currency started in 2008, but profitability in 2012 remains well under the peak level of 2004, although there has been a slow recovery in profitability from 2008 onwards.  Greece’s profitability stayed up until the global crisis took hold and then it plummeted and only stopped falling last year.  Profitability in ‘austerity’ Greece and ‘devaluing’ Iceland is now about the same relative to 2005 levels.  So you could say that either policy has been equally useless.

That’s the problem with either pro-capitalist policy.  The capitalist mode of production remains and the ‘whole crap’ (as Marx called it) just starts all over again.  The social democrats at first tried impose IMF austerity and then opted for Keynesian devaluation, which created galloping inflation that increased household debt and the cost of living.  The bankers escaped retribution and the banks were returned to the private sector.  A proper default on Iceland’s debt was never implemented because this small island still has to trade with a capitalist Europe and its banks.  And the social democrats did not help themselves by saying the solution now was to join the euro!

The two RRs and the weak recovery

The scandal of the Rogoff and Reinhart ‘affair’ (see my post, Revising the two RRs, http://thenextrecession.wordpress.com/2013/04/17/revising-the-two-rrs/) rumbles on among mainstream economists.  The issue of their ‘mistakes’ and biases has moved onto whether any economic research is being done at all on a proper scientific basis.  As Noah Smith (http://noahpinionblog.blogspot.co.uk/2013/04/the-reason-macroeconomics-doesnt-work.html) pointed out: “While this particular error is squarely in the lap of Rogoff and Reinhart, I think it is symptomatic of a broad failure to ensure that empirical results are replicable, which is the “gold standard by which the reliability of scientific claims are judged” (National Research Council, 2001).  The lack of replicability of empirical models in economics should be an embarrassment to a field that has been trying (mistakenly, in my view) to catch up with the big boys in the natural sciences”.  Apparently, even those journals that have policies requiring submission of data do not seem to have particularly compelling incentives for authors to actually cooperate.  In this 2007 paper, Daniel Hamermesh pointed out that the editor of JMCB sought data sets and documentation from authors with accepted papers in that journal, but only got about one-third of them.

Smith does not think the two RRs did their research in order to prove austerity was right; no, it was down to useless data.  “I don’t think it’s politics (mostly). I don’t think it’s the culture of consensus and hierarchy. I don’t think it’s too much math or too little math. I don’t think it’s the misplaced assumptions of representative agents, flexible prices, efficient financial markets, rational expectations, etc.  Fundamentally, I think the problem is: uninformative data.” 
Noah Smith concludes that “After the financial crisis, a bunch of people realized how little macroeconomists do know. I think people are now slowly realizing just how little macroeconomists can know. There is a difference.” 

Well, it’s true that economic analysis often faces difficulty with its data.  There are not many data points to use in judging whether the Kondratiev economic cycle of 50-60 years exists or not, for example – something I have been struggling with in my research.  But it is not all as hopeless as Smith reckons.  Can we tell if profits lead investment rather than vice versa? – a bit like the question of causality in the RR debts: does high debt lead to low growth or vice versa?   Well, luckily for Marxist economic research, we can get somewhere with the question of profits and investment.  My own research in my book, The Great Recession, provided some proof that profits led investment in the US in analysing its booms and slumps in the post-war period.  But even better work has been done since by Jose Tapa Granados in his brilliant paper: Does investment cal the tune? (does_investment_call_the_tune_may_2012__forthcoming_rpe_), where he uses 252 quarterly data points for the Us economy to show a high correlation between profits and investment and, more important, statistical significance of the causal direction that profits lead investment.  G Carchedi also has an upcoming piece of research based on US data with a similar number of data points.

However, Mark Thoma reckoned that what comes out of the R&R debacle is that “The biggest problem in macroeconomics is the inability of econometricians of all flavors (classical, Bayesian) to definitively choose one model over another, i.e. to sort between these imaginative constructions. We like to think or ourselves as scientists, but if data can’t settle our theoretical disputes – and it doesn’t appear that it can – then our claim for scientific validity has little or no merit.   Unfortunately, the time period covered by a typical data set in macroeconomics is relatively short (so that very few useful policy experiments are contained in the available data, e.g. there are very few data points telling us how the economy reacts to fiscal policy in deep recessions). The point is that for a variety of reasons – the lack of experimental data, small data sets, and important structural change foremost among them – empirical macroeconomics is not able to definitively say which competing model of the economy best explains the data.

Well, yes, choosing the ‘right model’ or, if you like, the best set of assumptions (or priors) for a model is very important.  If you start with the Keynesian model assumptions that consumption drives income and that drives investment, as most DSGE models do (see my post, http://thenextrecession.wordpress.com/2013/04/03/keynesian-economics-in-the-dsge-trap/), then, in my view, you are not going to get very far in explaining capitalist ‘business cycles’ with however much data you have.  None of the DSGE models include profits or profitability as a variable, so they cannot really explain much.  There is a great piece of Marxist research to do here in ‘modelling’ the ‘business cycle’ with profits as the main causal variable.  Unfortunately, no Marxist economist is ensconced in a university with a team of students to develop and crunch the numbers.

So we are left where we are.  That brings me to what mainstream economists are thinking right now about the state of the world economy.  They are in total confusion.  This week’s batch of global economic indicators was grim.  Business indicators in the key ‘growth’ economies of the US, China and Germany all slowed sharply, while Europe’s indicators remain mired in recession mode.

The economic recovery in the advanced economies since 2009 has been very weak.  The IMF published some graphs that show how weak this recovery has been in the advanced capitalist economies (constituting about 55-60% of world GDP) compared to previous recoveries from slumps.   In the graphs, the red lines represent the current cycle in the advanced economies, the blue lines represent the average of three earlier recessions (1975, 1982 and 1991), and the index numbers are centred on the year before the recessions started. An abnormally deep recession in 2008/09 has been followed by an abnormally weak recovery, so real GDP per capita is now 10 per cent below the levels indicated by previous cycles (Panel A).

Is the cause of this weak recovery the implementation of the policies of fiscal austerity,as the Keynesians claim?  Gavyn Davies in his FT blog (http://blogs.ft.com/gavyndavies/2013/04/21/great-recession-and-not-so-great-recovery/) considered the question by looking at these graphs.  He concluded that “fiscal policy has been tightened everywhere to control public debt, which is much higher than “normal”, so real public spending is about 14 per cent below the cyclical norm (B). With fiscal policy tightening, the whole burden of supporting demand has fallen on monetary policy, so nominal interest rates have fallen to zero (C) and the central banks have resorted to sizeable increases in their balance sheets (D).”  

So stock markets are booming (see my post, http://thenextrecession.wordpress.com/2013/03/30/its-still-a-bear-market/), rising on a wave of central bank power money being pumped into the banks.  But companies that are cash-rich are hoarding their money and don’t invest. The result is that all this ‘wall of money’ goes into buying shares and bonds and even property.  So financial and real estate markets are booming again and the old cycle of credit-fuelled unproductive speculation is rearing its very ugly head once again – to the increasing worry of the IMF and the national monetary authorities.

Would the global recovery have been stronger if fiscal policy had tightened less rapidly than has actually occurred?  Paul Krugman certainly thinks so (http://www.nytimes.com/2013/04/22/opinion/krugman-the-jobless-trap.html?_r=1&): “The main reason our economic recovery has been so weak is that, spooked by fear-mongering over debt, we’ve been doing exactly what basic macroeconomics says you shouldn’t do — cutting government spending in the face of a depressed economy.  It’s hard to overstate how self-destructive this policy is. “  Radical Keynesian and MMT theorist (see my post, http://thenextrecession.wordpress.com/2012/04/27/effective-demand-liquidity-traps-and-debt-deflation/, Randall Wray is even more adamant:  “As I argued in another piece (http://www.levyinstitute.org/pubs/ppb_111.pdf), in a depressed economy, you need fiscal expansion. “

But Gavyn Davies is not quite so sure that fiscal austerity is the cause of the weak recovery. “Since the short term fiscal multiplier is almost certainly not zero, the answer to this question is clearly “yes”, but it is hard to ascribe the whole of the shortfall in GDP growth to this single factor.  If real government expenditure had performed as normal in this recovery, this would have resulted in spending being about 5 percentage points of GDP higher than it is now, so the fiscal multiplier would have needed to be about 2 in order to explain the whole of the 10 per cent growth shortfall. This seems implausibly high. Furthermore, monetary policy would have been tighter in such fiscal circumstances, and there would have been a somewhat greater (if still small) risk of fiscal crises in some economies. Therefore the Not-So-Great Recovery is not just a fiscal story.”

Indeed, despite the exposure of the two RRs, many stick to the view that the build-up of excessive public sector debt before the Great Recession that must now be deleveraged is still part of the problem.  In his blog, James Hamilton (http://www.econbrowser.com/archives/2013/04/reinhartrogoff.html) said “The main reason that I personally am concerned arises from the fact that, for any level of the interest rate, a higher debt load means that the government will permanently need to spend more money just to pay the interest on the debt.  In any case (despite the revised data of the two RRs) you would still conclude that higher debt loads are associated with slower growth in the postwar advanced economy data set, just as they were in the postwar emerging economy data set, just as they were in the centuries-long individual country data sets, and as also was found to be the case in separate analyses of yet other data sets by Cecchetti, Mohanty and Zampolli (2011), Checherita and Rother (2010), and the IMF (2012), among others.”

Right-wing mainstream economist John Taylor also opposed the idea that austerity (public sector spending cuts and tax rises) was the cause of failure to grow whatever the scandal of the two RRs.   “The discovery of errors in the Reinhart-Rogoff paper on the growth-debt nexus is already impacting policy….offered as a reason why the U.S. should stop worrying about budget reform and consolidation and start worrying about austerity.    But the claims about austerity in the current budget proposals are exaggerated. Consider the recent House budget proposal which balances the budget in 10 years without raising taxes by gradually reducing the growth of spending.  It would reduce federal outlays as a share of GDP by 3.1 percentage points over the next decade (from 22.2% in 2013 to 19.1% in 2023).  Critics label it austere, but this is less spending restraint than the 4.1 percentage point reduction in outlays as a share of during the 1990s (when spending fell from 22.3% in 1991 to 18.2 % in 2000).   With this spending restraint, the 1990s were a very good decade for economic stability and growth, and they left the budget in balance.  The same can be said for the next decade. The benefits of properly addressing the debt and deficit problems are enormous and the costs are surprising small.” 

So austerity is not causing a problem because there isn’t any, but if you do it, it will help in the long term!  Taylor’s argument is weakened when you realise that the reason that spending as a share of GDP fell in the 1990s was because real GDP growth was much stronger than post-2009.  If the US economy had been growing at the 1990s average, then the fall in government spending as a share of GDP now would be much greater and quicker – and austerity would look very severe.  So is it austerity that enables growth or growth that enables austerity?  Here we go again.

Gavyn Davies goes on to blame the banking system and the failure to boost credit as the cause of weakness.   I don’t see how this follows.  There has been a huge expansion of credit.  This has ended up in the banking system, to be used to buy financial assets and start a speculative boom.  Money has not got through to the real economy not mainly because the banks are crippled in their ability to lend but mainly because there is no demand to borrow from overleveraged small businesses and cash-rich large businesses – you can’t make a horse drink (see my post, http://thenextrecession.wordpress.com/2013/03/04/you-cant-make-a-horse-drink-2/).

If central bank largesse is merely fuelling another financial bubble and not real GDP growth or even inflation, then another crisis could be on its way.  That’s the worry of some mainstream economists.  The last credit bubble from 2002-7 apparently was deliberately started or allowed to happen as the only way to get the modern capitalist economy going.  According to Transcripts of the Fed’s internal meetings March 16, 2004, Donald Kohn, a longtime Fed staffer who later became the Fed’s vice chairman, said that the credit bubble was “deliberate and a desirable effect of the stance of policy.” According to Kohn, the Fed’s strategy was to: “boost asset prices in order to stimulate demand.”

Indeed, in a recent speech, Nayarana Kocherlakota, the president of the Minneapolis Federal Reserve Bank, reckons that the Fed “will only be able to achieve its congressionally mandated objectives by following policies that result in signs of financial market instability.”   So the Fed is incapable of lowering the unemployment rate without creating more bubbles.  Kocherlakota said that the Fed needed real interest rates to be “unusually low for a considerable period of time” and that this would lead to “unusual financial market outcomes” including “inflated asset prices, high asset return volatility and heightened merger activity.”   John Taylor commented that surely there must be a better way.

Well yes, there is.  What caused the Great Recession was a collapse in capitalist investment, not excessive public sector debt, and what is causing the slow recovery is the lack of renewed investment.  Look at these graphics from John Ross’ blog (http://ablog.typepad.com/keytrendsinglobalisation/2013/04/investments-failure-to-recover.html).

In constant price dollar PPPs, the form in which the OECD publishes the statistics, OECD GDP in the 4th quarter of 2012, the latest available data, was $625bn above its level in the 1st quarter of 2008. Government expenditure was $326bn above its 4th quarter 2008 level, net exports $482bn above, and personal consumption $659bn above. However fixed investment was $700bn below its 4th quarter 2008 level.  It is therefore clearly the depression of fixed investment that remains the key weakness in the advanced economies.

The trend can also be seen clearly in the quarterly percentage change in the domestic components of GDP in each quarter between the 1st quarter of 2008 and the 4th quarter of 2012. Personal consumption  continues to recover – being 2.8% above its 1st quarter 2008 level. Government consumption is 5.0% above its 1st quarter 2008 level – although this has essentially remained static since 2010, and is now mildly falling, reflecting various austerity policies. The key problem is that fixed investment remains –8.8% down.

This is not to deny that austerity has not played a role in the weak recovery.  The great supporter of austerity, the UK government, has just announced that it scraped through in meeting its borrowing target for the fiscal year 2012-013.  But it only did so by slashing public sector investment spending at a time when private sector investment is still at lows.  As Jonathan Portes explained in his blog: “most of the deficit reduction has come from cutting public sector net investment (spending on schools, roads, hospitals, etc) roughly in half. Pretty much all the rest came from tax increases (note that the investment cuts and tax increases were both, to a significant extent, policies inherited from the previous government). And we can see when it happened – between 2009-10 and 2011-12.  But these sources of deficit reduction stopped in 2011-12, because the government belatedly realised that cutting investment was a major mistake and that the economic imperative was actually to do precisely the opposite (not that there was much investment left to cut); and it stopped putting up taxes overall. So we can see also what’s happened since – with the impact of the weak economy on tax receipts reducing revenues, the deficit has been flat and is projected to stay flat.”  Austerity was not working and has now been abandoned.

But why did investment collapse in the first place?  That would help us look at how it might be revived.  I have argued many times on this blog that there are two reasons.  The first is that profitability in the main capitalist economies dropped after 2006 , heralding the Great Recession of 2008-9.  And the rate of profit in most economies has not recovered to pre-crisis levels (in the US it has  – just).  So there is no ability or desire to raise investment.

The second reason was the huge build-up of private sector debt before the crisis  (see my post http://thenextrecession.wordpress.com/2013/02/25/deleveraging-and-profitability-again/).  So we are not talking about the Reinhart and Rogoff story of public sector debt, but at the private sector.  This overhang of ‘fictitious capital’ still restricts the ability or willingness of households to spend as they pay down debt or default on their mortgages and for companies (not just banks) to invest when their returns only just cover the servicing of their debts (zombie operations).  Only low interest rates have kept many firms in business, even in the US (graph).

Pumping money into the financial sector is not working to restore sufficient investment growth to get unemployment down and households to spend.  Although fiscal austerity has played a role in delaying the recovery of investment, the real cause lies in the capitalist sector itself (see my post,http://thenextrecession.wordpress.com/2013/02/10/why-is-there-a-long-depression/).  In that sense, the scandal of the two RRs does not provide sufficient ammunition for Keynesians to suggest that more government spending will cure the economy, get growth up and public debt down.  If the lack of investment is the problem, what is needed is for a plan of public investment for jobs, the environment and in technology that does not depend on raising the profitability of the corporate sector, indeed, aims on replacing it.