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.

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.

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!

Meeting Keynes Meadway

My recent article for the Socialist Review (What’s wrong with the Keynesian answer to austerity?, http://www.socialistreview.org.uk/article.php?articlenumber=12273.) has provoked a mild ripple of debate within leftist economic circles in the UK.  In particular, James Meadway, the lively leftist economist, has sprung to the defence of Keynesian ideas in the struggle against ‘austerity’.  He commented on my piece critically and referred to a blog post he did last October explaining how Marxists like me are too hard on Keynesians (http://faithfultotheline.wordpress.com/2012/10/09/keynes-keynes-and-keynes/).  Meadway’s main argument is that you should not tar with the same brush leftist or so-called post-Keynesians like himself (I think he is) that are anti-capitalist in their objectives with the so-called New or ‘bastardised’ Keynesian views of people like Paul Krugman that stick to sustaining capitalism and basically follow all the old neo-classical economic models (see my recent post, http://thenextrecession.wordpress.com/2013/04/03/keynesian-economics-in-the-dsge-trap/).

Of course, it is true that there is a spectrum of views within the Keynesian economics fold – there was back in the 1930s and early 1940s.  There were communists or socialists like Joan Robinson and Michel Kalecki whose ideas have been developed by post-Keynesians like the brilliant Engelbert Stockhammer, Ozlem Onaran and other Kalecki followers (for more see, http://hussonet.free.fr/postk.htm).  But the vast majority of economists who consider themselves Keynesians do not espouse the view of the post-Keynesians and are much closer to the position of Krugman in the US, or Richard Layard or Malcolm Sawyer (http://www.classonline.org.uk/pubs/item/fiscal-austerity-the-cure-which-makes-the-patient-worse) in the UK.  Let me remind you of The Manifesto for Economic Sense that Krugman and Layard wrote back in summer 2012 as their way forward to solve the economic crisis.  On my blog, I re-edited it as A Socialist Manifesto to show the strong differences between Keynesian and Marxist policies against austerity (http://thenextrecession.wordpress.com/2012/07/03/a-manifesto-for-socialist-sense/).    Have a look.

Within the Marxist or socialist spectrum, there are also many different strands.  Divisions are great about what Marx ‘meant’ and what is the ‘Marxist theory of crisis’.  Indeed, I would say that my own set of views is probably a minority opinion within the Marxist school of economics, which is led by the likes of Gerard Dumenil, David Harvey, Richard Wolff or Michael Lebowitz.  The majority of Marxists look to underconsumption or overproduction, inequality, financialisation or financial instability as the main causes of crises under modern capitalism, and not to profitability and fictitious capital, as I do.  And I am not even dealing with the wide range of views on imperialism, the euro single currency and so on.

But having said there is wide range of views within Keynesian and Marxist economics, that does not mean that we cannot draw a line in the sand both theoretically and policy-wise over the differences between a Marxist view of the capitalist economy and even the radical post-Keynesian one.  In my view, there are qualitative differences between Keynesian and Marxist view of what is happening in a capitalist economy and what to do about it.

James Meadway says in his post (op cit) that a “radical Keynesian” programme in this case would mean *hugely* more than just “governments spending more money”: it would include, inter alia, the overhaul of the financial system, the democratic direction of investment, and so on. Keynes himself – to come to the third confusion –at least toyed with this, concluding his General Theory with a call for the “euthanasia of the rentier” and the “socialization of investment”. Keynes was unabashedly, unashamedly pro-capitalist and elitist (retaining, for example, his Presidency of the Royal Eugenics Society right up until his death); nonetheless he identified circumstances in which in order to save capitalism it was necessary to destroy it. It is this tension in his work that the radical left needs to play up to, rather than smothering: that the (correct) insights of Keynes (in aggregate demand, in the dysfunctionality of finance) need bringing out and the contradictions need exacerbating. The anti-capitalist elements should be brought to the fore. A blanket dismissal of “Keynesianism” as such cannot do this.

But that’s just the problem.  Keynes ‘toyed’ with ideas like the ‘socialisation of investment’ but in the final analysis – and it is in the analysis – he remained in the pro-capitalist camp.   His vague ‘socialisation’ never even got as far as the programme of the Labour Party at the time for ‘the common ownership fo the commanding heights of the economy’, let alone workers’ control or democracy.  As Meadway says, Keynes was very elitist and a great supporter of ‘bourgeois values’.   And his ‘euthanasia of the rentier’ implies only some gradual natural phasing-out of the rent-seeking financial sector.  There was no call for the public ownership of the banks – indeed, I don’t hear that from the lips of many post-Keynesians now.

In a recent post (op cit), I pointed out the positive contribution that Keynesian theory has made to economics.  But there are three things that distinguish Keynesian theory (in all its forms) from the Marxist one and thus decide the issue for me on what”s wrong with it.  The first is that Keynes does not break from the neoclassical model of perfect markets and factors of production.  There is no theory of value based on the exploitation of labour power.  That is a fundamental error in understanding the laws of motion of capital.

That leads to the second reason.  For Keynes, profit is not the independent variable driving investment, employment and growth.  On the contrary, profit does not appear in Keynes’ calculation, except as a dependent variable of investment.  Keynes gets it the wrong way round.  His macro aggregates hide the exploitative nature of the capitalist system and thus also miss its Achilles heel, profit.  Even his foray towards profitability in his discussion of declining returns on capital is conceived in neoclassical marginalist terms i.e. the ‘marginal efficiency of capital’, not profit from labour power.   Thus Keynesian policies for more government spending to boost ‘aggregate demand’ pay no attention to the impact of such spending on profitability.  So Keynesians cannot understand or explain why capitalists do not support more government spending even in a slump – it is irrational.  Don’t capitalists want to save capitalism?

And third, what also flows is the view that there is no flaw in the productive manufacturing sector of a capitalist economy.  Crises and slumps are caused by flaws in the financial sector.  The capitalist mode of production for profit through markets is basically fine.  As Meadway puts it, Keynes had “very roughly, in Marxist terms, a concern with the problem of realization and the issues raised by volume 2, rather than (as in more supply-side approaches) a concern with the problems of volume 3.”  Well, you cannot do without Volumes 1 and 3 that deal with exploitation and profitability.

The issue is not whether Marxists should work with Keynesians against the policies of austerity.  Of course, they should (although I am not sure some Keynesians will always work with Marxists!).  For my part, I’d work with President Obama or Nick Clegg if they opposed ‘austerity’ (but they don’t).  The issue I was looking at in the article in Socialist Review was whether Keynesian economics can show a way out of the fall in living standards and employment for the majority of people in the US and Europe, imposed (only partly) by austerity.  Also can Keynesian economics offer a way to end permanently the cycle of booms and slumps under capitalism?  I don’t think it can.

Keynesian economics in the DSGE trap

Mainstream Keynesian economics is caught in a trap of its own making, a bit like the Keynesian liquidity trap in a zero lower bound interest rate economy.  Let me explain.  In my view, there are two great merits of Keynes’ contribution to understanding an economy.  The first was a return to analysing an economy in its aggregate, not at the level of individual consumer’s or firm’s behaviour or preferences.  This meant that the fluctuations in a capitalist economy could be considered in their whole and not just ignored or dismissed. In other words, macroeconomics replaced microeconomics.

The second contribution was to assert that capitalist ‘free markets’ do not ‘clear’ and supply equals demand, at least at a macro level.  So the capitalist mode of production can be in equilibrium at less than full employment for some time.  Keynes saw this discovery as a refutation of the old economic rule, called Say’s Law, that supply always equals demand, namely that where there is seller there must be a buyer.  This law is still held to in one form or another by neoclassical and Austrian economics schools.  Keynes was attempting to break with the old adage of Thomas Carlyle, the reactionary Victorian anti-laissez faire writer that “Teach any parrot the words supply and demand and you’ve got an economist”.

For Keynes, Say’s Law was an example of the ‘fallacy of composition’, namely the false assumption that what is true for a part will also be true for the whole.  In macroeconomics, the other-things-being equal assumption of demand matching supply does not hold.  The ‘paradox of thrift’ is the traditional Keynesian example of the fallacy of composition.  The paradox states that if everyone tries to save more money during times of slump, then aggregate demand will fall and will in turn lower total savings in the population because of the decrease in consumption. The paradox is that total savings may fall even when individual attempt to save more and that increase in savings may be harmful to an economy.

But these great insights have been whittled away over the last three decades.  That’s for two reasons.  First, it became clear to mainstream economists that Keynesian economics did not work in explaining modern capitalism.  Keynes’ theory would suggest that if there is high unemployment, aggregate demand would be low and there would be over-supply, so inflation would be low or non-existent. Thus boosting demand by tax cuts and/or government spending could restore aggregate demand and reduce unemployment without generating inflation in prices of commodities.  Once full employment was reached, however, further stimulus could start to drive up inflation.  So there was a trade-off between inflation and employment.  This led to famous Phillips Curve that attempted to confirm this trade-off empirically.  Unfortunately, the experience of the 1970s demolished this theory, when the major economies had high unemployment and high inflation, or ‘stagflation’.

Neoclassical economics and monetarism regained the stage, with likes of Friedrich Hayek and Milton Friedman, who claimed that it was the interference of the state or central bankers that caused inflation and unemployment at the same time.  The adoption of these theories was not an accident because the strategists of capital needed theoretical support for the counter-revolution they launched against the welfare state and labour in order to reverse the squeeze on profits and profitability of capital in the latter part of the 1970s.

Now Marxist economics could have told both sides that they were looking in the wrong place for an explanation of stagflation.  If they had looked at the causes of falling profitability in the capitalist mode of production, that would have explained why fiscal stimulus and easy money was not restoring full employment but merely stoking up inflation.  Stagflation was the outcome of capitalist crisis plus Keynesian policy prescriptions, unlike the 1930s which was capitalist crisis without Keynesian stimulus.

The power of aggregate was now rejected.  As arch Keynesian Simon Wray-Lewis put it in his blog recently: “an empirically based aggregate model. You do not find macroeconomic papers like this in the better journals nowadays. Even if papers like this were submitted, I suspect they would be rejected. Why has this style of macro analysis died out?  … First, such models cannot claim to be internally consistent. Even if each aggregate relationship can be found in some theoretical paper in the literature, we have no reason to believe that these theoretical justifications are consistent with each other. The only way of ensuring consistency is to do the theory within the paper – as a microfounded model does. A second reason this style of modelling has disappeared is a loss of faith in time series econometrics.”  As Keynesian aggregate econometrics explained nothing, let us return to microeconomic theory.

This leads me to the other reason for Keynes’ original insights to be dropped.  Although Keynes had brought mainstream economic theory to the macro and the aggregate, he had never broken with neoclassical marginal utility and general equilibrium theory at the level of the micro.  He rejected any objective labour theory of value as a foundation for an explanation of economic processes.  He held to the neoclassical ‘belief” that starts with individual consumer preferences and moves onto markets clearing ‘anomalies’ before establishing an equilibrium of supply and demand. So any anomalies were external ‘shocks’ to the market system, not endogenous to the process of capitalist production and consumption.

Keynesian insights were reduced the infamous IS-LM curve that argued an unemployment equilibrium would not occur under capitalism unless there was ‘stickiness’ in wages or other ‘shocks’ to the market system.  In other words, market capitalism would not have slumps if labour did not resist wage cuts and government did not interfere.  This reduced Keynes to a Friedman-style monetarism where central banks ‘enrich thy neighbour’ (to use Ben Bernanke’s recent term – see http://www.federalreserve.gov/newsevents/speech/bernanke20130325a.htm) by controlling the money supply.

As Wren-Lewis puts it: “macro did produce a policy consensus (basically interest rate targeting by the Fed, with a Taylor Rule type objective function balancing growth stability and price stability), and yes, that policy consensus did help the world, by giving us the Great Moderation, which wasn’t perfect but was better than what came before”.  Really?  The Great Moderation, when supposedly fluctuations in economic growth and prices fell away during the 1990s, eventually gave way to the Asian crisis of 1998, the slump of 2001 and then the Great Recession.

Nevertheless, during the Great Moderation, mainstream Keynesian economics concentrated on explaining ‘business cycles’ or ‘fluctuations’ in an economy using ‘modern’ techniques of  modelling from what it called  ‘microfoundations’ .  Econometric analysis like the Phillips curve were ditched because such ‘correlations’ between employment and inflation had been proved wrong.  The job now was not to look at macro or aggregate data but to work out some ‘model’ that started with some premises of agent (consumer) behaviour or preferences and then incorporated some possible ‘shocks’ to the general equilibrium of the market and then considered the number and probability of possible outcomes.   Thus were born the Dynamic Stochastic General Equilibrium (DSGE) models.  They had equilibrium because they started from the premise that supply would equal demand ideally; they were dynamic because the models incorporated changing behaviour by individuals or firms (agents); and they were stochastic as ‘shocks’ to the system (trade union wage push, government spending action) were considered as random with a range of outcomes, unless confirmed otherwise).

This is now what most Keynesian economists spend their time doing.  Forget empirical evidence, forget macro data, find a ‘micro’ foundation (model) that might help to at least offer a guide to what possibly might happen.  Keynesians accepted the critique of neoclassical school, as presented by the Nobel prize winner Robert Lucas (“the problem of depressions has been solved”) that just looking at economic stats provided no theoretical base and thus was open to the distortion of spurious correlation.  You needed to have firm micro theory.  But as Lars Syll points out in his blog, those neoclassical micro foundations bear no relation to the real world: “Microfoundations allegedly goes around the Lucas critique by focusing on “deep” structural, invariant parameters of optimizing individuals’ preferences and tastes. ….. this is an empty hope without solid empirical or methodological foundation.”   As Lars adds: “The almost quasi-religious insistence that macroeconomics has to have microfoundations – without ever presenting neither ontological nor epistemological justifications for this claim – has put a blind eye to the weakness of the whole enterprise of trying to depict a complex economy based on an all-embracing representative actor equipped with superhuman knowledge, forecasting abilities and forward-looking rational expectation”.

But this is the hole that Keynesian economics has descended into.  And it is a hole because DSGE models have been proved to be worthless in explaining anything.  These models failed to predict before or explain after the Great Recession and are unable to explain the subsequent weak recovery, or Long Depression.  And it is not hard to see why.  There is a total absence of investment or profit as ‘shocks’ in these models.  Everything starts with consumer preferences; the arch consumer is king as in the neoclassical world and Keynesian aggregate demand is reduced to just consumption.  As the grand old man of the neoclassical aggregate production function, Robert Solow, commented on DSGE models:” a modern economy is populated by consumers, workers, pensioners, owners, managers, investors, entrepreneurs, bankers, and others, with different and sometimes conflicting desires, information, expectations, capacities, beliefs, and rules of behavior … To ignore all this in principle does not seem to qualify as mere abstraction – that is setting aside inessential details. It seems more like the arbitrary suppression of clues merely because they are inconvenient for cherished preconceptions … Friends have reminded me that much effort of ‘modern macro’ goes into the incorporation of important deviations from the Panglossian assumptions … [But] a story loses legitimacy and credibility when it is spliced to a simple, extreme, and on the face of it, irrelevant special case. This is the core of my objection: adding some realistic frictions does not make it any more plausible than an observed economy is acting out the desires of a single, consistent, forward-looking intelligence …”

The DSGE models’ capitulation to the concept of general equilibrium stands in contrast to  Keynesian ‘lack of effective demand’ at a macro level.  And as David Glasner puts it: “There is no market mechanism that leads, even in principle, to a general equilibrium. ….Nor is there any basis for assuming that, if a general equilibrium does exist, it is unique, and that if it is unique, it is necessarily stable.”   Chief economist at Citibank, Willem Buiter described the state of economics just before the Great Recession: “Research tended to be motivated by the internal logic, intellectual sunk capital and esthetic puzzles of established research programmes; rather than by a powerful desire to understand how the economy works – let alone how the economy works during times of stress and financial instability.; So the economics profession was caught unprepared when the crisis struck.”  He went on:”What happens in non-normal times, i.e. when markets break down, or when markets are not complete, agents are not rational, etc., was far down the agenda of important questions, partly because those who largely dictated the direction of research,did not think those questions were very important (some don’t even believe that policy can help the economy, so why put effort into studying it?).”

After the experience of the Great Recession even some leading Keynesians started to disown DSGE modelling, just as Keynesians had disowned econometrics after the 1970s.  Recently Larry Summers, former adviser to Clinton and Obama and a Harvard economist, complained: “In four years of reflection and rather intense involvement with this financial crisis, not a single aspect of dynamic stochastic general equilibrium has seemed worth even a passing thought.”  He moaned: “Is macro about–as it was thought before Keynes, and came to be thought of again–cyclical fluctuations about a trend determined somewhere else, or about tragic accidents with millions of people unemployed for years in ways avoidable by better policies? If we don’t think in the second way, we are missing our major opportunity to engage in human betterment. And inserting another friction in a DSGE model isn’t going to get us there. “

Of course, Summers preaches what he did not practise when an adviser to the Clinton Administration.  He opposed regulatory and prudential controls for financial markets and joined Fed Chairman Alan Greenspan and his political sponsor, former Treasury Secretary Robert Rubin in smearing CFTC Chairman Brooksley Born, so as to make the world safe for OTC derivatives.   Summers advised Obama “not to take ownership of the banks as he has a healthy skepticism about schemes involving large government action and an awareness of the possibilities of unintended consequences.”

The failure of DSGE models has led to some Keynesians to return to the macro and empirical analysis from the premise that markets do not ‘clear ‘ at the aggregate (Robert Gordon, http://faculty-web.at.northwestern.edu/economics/gordon/GRU_Combined_090909.pdf.)  That’s to the good, in my view.  But the reality is that Keynesian economics fell into the neoclassical DSGE trap because it accepted the neoclassical theory of value, denied any role for profit even in its aggregate analysis and relied in essence on the implausible belief that capitalist markets will ‘clear’ and some form of equilibrium will be the the norm, whether it is the Great Moderation of the neoliberal period or an inherent smoothness in the capitalist production process.  Keynesian economics failed to explain stagflation in the 1970s and the Great Recession in 2008.  That makes its prescriptions of monetary easing and fiscal stimulus in doubt as a way out of the Long Depression.

For more on the intricacies and failures of the DSGE nightmare,see Noahopinion at http://noahpinionblog.blogspot.co.uk/2013/03/the-swamp-of-dsge-despair.html

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Downgrading Osborne; degrading Britain

The UK’s finance minister (we Brits call him, in medieval terms, the Chancellor of Exchequer), George Osborne presented his 2013 budget for public finances today.  Last year, Osborne made a complete hash of it and had to reverse and back down on many measures for taxes and public spending measures that he announced.  More worryingly, he had to admit that his main targets, of eliminating the annual budget deficit and reducing the government debt ratio by 2015, could not be met.  He revised the date to 2017.  Today he has put it back yet another year.  The Chancellor’s ‘austerity’ plan is failing.

Indeed, that is what one of the credit agencies, Moody’s, concluded at the beginning of this year when it downgraded the UK’s government triple-A bond rating.  Moody’s reckoned the government could not meet its targets because the UK capitalist economy was still failing to recover from the Great Recession:  “the country’s current economic recovery has already proven to be significantly slower — and believes that it will likely remain so — compared with the recovery observed after previous recessions, such as those of the 1970s, early 1980s and early 1990s.” 

Instead of a declining government debt to GDP ratio, it would continue to rise until 2018.   But what did Osborne say back at the end of 2011?: “The UK is the only western country that has seen an improvement in its credit rating in the past 18 months. When this Government came to office, the country’s triple A credit rating was on negative watch, which is where it was put by the Labour party. I am delighted that it came off negative watch, but we must stay vigilant. The credit rating agencies have said that an abandonment of our deficit plan would definitely lead to a downgrade of the credit rating.”  Well, the deficit plan was not abandoned, but it still happened.

The right-wing London financial daily, City AM, described the UK economy in harsh capitalist terms: “The stark reality is that the UK is a busted flush: the deficit is increasing again, despite accounting shenanigans, and is being financed through quantitative easing in a dangerous game of financial pass the parcel; an army of zombie firms remain addicted to near-zero interest rates, forcing down productivity and preventing a Schumpeterian process of creative destruction and reallocation of capital and labour; the banking system remains squeezed; and the economy remains tied down by regulations, outdated planning laws and high tax.”   Such is the analysis of the UK capitalist economy from a source that wants to revive capitalism. The stark reality of the British economy is revealed in the figure for national income: stagnation.

As with other capitalist economies, recovery has been weaker in the UK after the Great Recession than in any other recovery from previous slumps.

So Osborne has had to admit that annual government borrowing will rise this year, not fall, as the government reduces its forecast for economic growth.  The Office for Budget Responsibility (OBR) now forecasts real GDP growth of just 0.6 per cent for 2013, down from the 1.2 per cent forecast in December.  It also revised down 2014 growth from 2 per cent to 1.8 per cent.  There were big upward revisions to the borrowing forecasts. This year, the government will borrow £114bn, falling to £108bn next year.  The OBR said Mr Osborne’s promise to have debt falling as a proportion of national income would not now happen until 2017/18, two years later than planned.  Indeed, in 2015, the UK government will have the worst budget deficit as % of GDP in the OECD!

What is the answer of the Chancellor?  Not to reduce the cuts in public spending, not to lower the overall burden of taxes and charges on average householders, but on the contrary to increase austerity measures.  Sure, there have been reductions in tax rates for corporations (Osborne boasted in his speech to parliament that the UK had cut corporation tax on profits more than any other major country); and sure, income tax thresholds will be raised in 2014 to take poorer households out of income tax. But the gains from these tax cuts go disproportionately to the richest income earners, as the graph below shows.

And although employer contributions to social security have been reduced by a special allowance, social security charges for employees will rise sharply, pension contributions will rocket and benefits will be decimated.  Indeed, the last VAT increase will cost the lowest-paid workers four times more than any gain from the £10,000 personal allowance, according to the TUC.  And by the time of the next election, low-paid workers with an average weekly income of £196 will be losing up to four times more per year from the government’s increase in VAT in January 2011 than they will gain from the raising of the personal tax allowance to £10,000. The gain from the tax allowance would be £1.09 a week, but the loss from the VAT increase is £4.26 a week.

At the same time, changes to the state pension will bring the exchequer a stealth windfall of almost £6bn a year from 2016-17, mostly paid by public sector employers and employees in the form of increased national insurance contributions.    Getting rid of the contracted-out rebate on state pension contributions will cost public sector employers £3.5bn a year.   And government departments will end pay progression in the next spending round.  So the government cuts corporate tax, but cuts wages in the public sector by removing contractual progression and replaces it with pay scales aligned with “performance”.   As Mark Serwotka, general secretary of the PCS public sector union, said: “Not content with cutting pay, pensions and working conditions, Osborne’s Treasury now wants to rip up civil service contracts to keep wages low for many years to come.”

Osborne made a gesture to those who are demanding more government spending on infrastructure projects to boost growth and employment (and this includes his own Business Minister, the Liberal Democrat Vince Cable).  The TUC estimated that the planned extra £3bn a year for infrastructure (and not starting until 2015) would “boost growth by a measly 0.06%”.  “Worse still, funding it through departmental spending cuts will mean further reductions in public services,” said general secretary Frances O’Grady.

And nothing has changed in the inexorable reduction of basic welfare support for the poorest and most vulnerable in Britain.  The callous so-called bedroom tax on ‘social housing’ tenants who have an ‘extra bedroom’ is just one example.

As Michael Burke explained in a recent excellent article in the Guardian (http://www.guardian.co.uk/commentisfree/2013/feb/27/negative-interest-rates-not-answer-uk-economy?INTCMP=SRCH), “in reality, the government has a host of investment opportunities. A huge housebuilding programme would deal with a housing shortage which has been chronic and become acute, and put the construction sector back to work. The rents on affordable council homes could provide a yield way above the government’s long-term cost of borrowing (currently 3.3% for 30 years) and it would ease the spiral of house prices and rents generally. The government could invest in large-scale infrastructure, energy and transport projects, nationalising those firms which stood in the way. It could invest in education by scrapping fees and bringing back the education maintenance allowance. According to the OECD, the additional public return from each graduate is £55,000, far outweighing their cost of education.   It is rejecting these options because the purpose of “austerity” is not growth or deficit-reduction, but boosting the profits of the private sector. Government policy is to reduce its own investment in these areas, and others like health, so that the private sector can reap the benefits.”

As Michael says, another scandal is the failure of the private sector build enough homes for people to live in at reasonable rents.  Annual housing construction is at its lowest since the 1920s.

Yet all that the government offers is a subsidy scheme for ‘first-time’ buyers of homes on their deposits to reverse falling ‘home ownership’, while applying severe reductions in housing benefit for the poorest working families.

The government is sticking with austerity and it is not working.  But let’s be clear.  Austerity is not the only or even the main cause of the stagnating economy.  As I have noted in several previous posts, one recent study found that the relatively tougher fiscal adjustment in the UK compared to the US has contributed slightly less than half the 5% pt difference in real GDP growth between the two countries over the last three years (see G Davies, J Antolin-Diaz, Why is the US economic recovery stronger?, Fulcrum Research, November 2012).  The real cause is the failure of the ‘rentier’ economy that is British capitalism.  Productivity in productive sectors of the economy is stagnant and investment has collapsed.  Holders of capital are accumulating cash, sending it abroad or buying financial assets.  But they are not investing.  So the real economy stagnates and the authorities can do nothing about it because the capitalist sector dominates.  Government debt is being downgraded as Britain’s public sector is being degraded.

So what are the alternatives to this degradation that Osborne is presiding over?  For the Keynesians, it is more investment through “any structural reforms that might encourage higher investment by the private sector” (Martin Wolf at the FT) plus a “once in a lifetime opportunity for higher public investment.“  Instead, the government plans to cut government investment by 50% until 2018 and net investment (after maintenance) will cease to rise in real terms at all, reaching just 1% of GDP!

The reason that UK companies are not investing at home is that corporate profitability is still well below its peak in 2007 and, even more significant, the ROP in the productive sector of the economy, manufacturing, continues its steady decline from 1997, and now hitting lows not seen since the the recession of the early 1990s.

If we compare the UK’s official data for the rate of profit with the Eurostat’s AMECO data, we get a similar story. The UK rate of profit is down 15-20% from a peak in 2007.

Part of the reason for this is that not sufficient capital has been devalued to raise the ROP despite the Great Recession.  But also, even the mass of profit generated is marking time.

Not surprisingly, UK companies are on an investment strike and business investment as a share of total  profit is near its all-time low.

Instead of investing in the British economy, British companies are investing abroad or paying higher dividends to shareholders or buying back their shares to boost share prices.   This is the reason why the easy monetary policy of the Bank of England, whether it is near zero interest rates or massive buying of government and corporate debt from the banks (QE),  is not working to boost growth.  QE has already been larger, relative to GDP, in the UK (22 per cent) than in either the US (13 per cent) or the Eurozone (4 per cent). It has helped mop up 46 per cent of the massive issuance of UK sovereign bonds over the past five years.  But QE has crippled savers, who are losing an estimated £65bn a year in interest forgone, while sterling has lost 17.2 per cent of its purchasing power thanks to inflation.

There is desperate talk among mainstream economists to introduce negative interest rates or get the Bank of England to target ‘nominal GDP growth’ rather than inflation.  But neither of these measures will work if capitalists don’t want to invest. Britain is a distorted rentier capitalist economy that is oriented towards unproductive investment and away from investment to increase resources and social need.  London’s share of the UK’s economic output has just reached an all-time high of 21.9 per cent, dominated as it is by financial services, professional services and other non-productive sectors.  Vast parts of modern Britain now host only relatively small amounts of private sector producers and depend on the state.

George Osborne and this coalition government continue to feed that distorted economy to attract financial investment with corporate tax cuts paid for by reducing welfare spending, decimating public services, eating away at the health service and state schooling and starving productive sectors of funds, while British companies send their profits abroad for better returns.  This is a lost decade.

Workers, punks and the euro crisis

I’ve just got back from Slovenia, where I gave a lecture on the Euro crisis to the Institute of Labour Studies (http://dpu.mirovni-institut.si/roberts2013.php).  The Institute was set up by a group of  economics  students who support a Marxist analysis.  They are doing a great job in trying to develop Marxist economic theory by inviting leading Marxist scholars and writers to do lectures or participate in conferences.  The Institute is really a spin-off from Slovenia’s unique Workers and Punks University (http://www.dpu.si/), a sort of alternative university formed by radical young people to present an alternative to conventional educational institutions and dominant ideas that there is no alternative to the current society.  The Institute is funded by the Peace Institute in Slovenia, leftist parties and think tanks in Europe.  Anyway, they asked me to present a lecture on the Euro crisis, to coincide with their enterprising launch of a new Slovenian translation of Marx’s Capital Volume 1.

The subject of the lecture could not have been more apt, because tiny Slovenia, a nation of 2 million people wedged along the Alps, between Italy to the west and Austria to the north, is the only Balkan (ex-Yugoslav) country to be in the Eurozone.  Slovenia has been relatively more prosperous than the other Balkan states and avoided the internecine wars that took place between Croatia, Serbia, Bosnia and Kosovo after the collapse of the ‘communist ‘ Yugoslav federation.  It entered the EU and the Eurozone with great hopes of going forward.  Then the global economic crisis erupted from 2007 onwards. Slovenia seemed to avoid the worst for a while.  But now it has been hit with tremendous damage.  The economy is in a deep recession that began in 2011.  The response of all the political parties has been austerity – under the direction of the EU institutions.  That has been a disaster and eventually Slovenians had had enough.  Last November there were huge demonstrations demanding an end to austerity and a plague on all the political leaders.  This heightened when it was found that both the leaders of the centre-right and centre-left appeared have been involved in corruption scandals.

The Slovenian economic crisis is very similar to that of Ireland.  Slovenia’s state-owned banks had been engaged in massive loans to Slovenian companies, mainly in construction and real estate, stimulating a huge commercial property boom that came crashing down when the global economic slump began.  And just as in Ireland, it has been found that the politicians were in collusion with builders and developers to promote a crazy credit boom, taking a slice of the action for their troubles.

For a while this was covered up, but with unpaid loans now reaching 20% of all lending, the banks are close to bust.  A bailout of the banks is now on the agenda and Slovenia needs at least €5bn by the summer to do it to avoid collapse. Of course, the EU and IMF came up with the usual ‘Irish solution’, which was to hive off all the bad debts into a ‘bad bank’  which the taxpayer must ‘own’, while the cleansed banks are given funds to recapitalise, with the aim of selling them off to foreigners or others as soon as possible.  The Slovenian government will then be left with a public sector debt that will have risen from 23%of GDP in 2008 to 70% by 2017, a massive burden on taxpaying Slovenians.

And the level of debt built up in the credit boom has destroyed the ability of the banks to provide more credit and companies funds for new investment.  Non-residential capital investment has fallen by nearly 6% of GDP since 2007, as the Slovenian capitalist sector went on strike or bust.  That drop is second only to Ireland in the Eurozone.  The depression is mega-sized for such a small country.

Since  the protests began, various coalition governments have come and gone.  As I delivered my lecture, a new left-leaning coalition was being endorsed with a female premier, Alenka Bratusek, who is supposedly an ‘expert on finance’.  The new coalition is now faced with finding the money to bail out the banks or going into an EU-IMF ‘Troika ‘ programme as now Cyprus will shortly.  Bratusek says she can deliver economic growth and fiscal austerity at the same time – if so, that will be a first in this euro crisis.  Of course her aim is not really to relieve the burden of Slovenians, but as she says, but to “reassure financial markets” with a program of “three key things: overhaul of the banks; consolidation of public finances in a way that not hurt growth (!); and better management of state assets (does this mean privatisation?)”.

And the Euro crisis continues elsewhere.  As I write, the EU leaders have just decided on a Troika bailout programme for Cyprus, where the banks have been driven to the wall through acting as a conduit for Russian oligarchs’  ‘hot money’ flows.  Cyprus’ economic boom prior to the crisis was based entirely on providing a safe haven for illicit Russian funds, laundering them so they could then be sent back into Russia ‘clean’.  Cyprus attracted $119.7bn of Russian “investment” in 2011 while itself transferring $129.9bn to Russia the same year, equivalent to more than five times the island’s annual output, according to Global Financial Integrity, a US-based money laundering watchdog. Raymond Baker, GFI’s director, said the amounts reflected “round-tripping” of illicit funds exported from Russia to companies based in Cyprus. The funds then flowed back as legitimate investment.

“I don’t think Cyprus has cleaned up its act. It’s still a centre for disguised entities and for money of suspect origin,” Mr Baker said. “I think the amount of legitimate Russian money coming into Cyprus would be minuscule.”    Cypriot banks used these deposits to invest all over the place: in Greek assets (!) and in property all over Europe.  Now these assets are worthless and they are bust and yet they must meet their obligations to the Russian depositors.  The EU leaders were divided about what to do: they did not want to bail out Russian mafia, but they did not want to set a precedent by reneging on bank debts in case this was used by anti-austerity movements, as in Slovenia, to do the same.  Under pressure from the IMF, the EU leaders have decided that the Russian depositors must take a 10% ‘haircut’ on their deposits, so that of the €17bn needed, only €10bn will now come from the Troika.  Even so, that is a huge burden for Cypriots, equivalent to 40% of annual GDP.  This will be agreed to by Cyprus which has just elected a centre-right president pledged to do so, after throwing out a ‘Communist’ president who was also imposing austerity.

And so it goes on.  Italy is politically paralysed and cannot yet form a government because nobody wants to grasp the nettle of imposing more austerity on an electorate that voted by a large majority against it.  And in Greece, the right-wing coalition government twists and turns with the Troika about how to meet the fiscal targets without imposing even more severe measures that could break up the coalition and engender new elections that could return an anti-Troika leftist party to power.  The government is being asked to sack 150,000 public servants over the next three years, putting all of them on 40% pay right now, along with lots of other measures designed to squeeze yet further the population which has already lost 30% of real incomes.  A deal will be reached with the hope of the government that Greeks will just continue to bear the burden until the Greek economy starts to recover.

But with the Eurozone still in recession this year, even France is getting into trouble.  The French official GDP target for this year was 0.8% but this has now been lowered to +0.2-0.3%. This compares to +0.1% EC forecast. In 2012 growth was zero.   The French budget deficit is seen officially at -3.7% of GDP this year from -4.6% in 2012 (both French government and the EC).   This failure will increase the stresses between Germany and France over meeting EU long-term fiscal targets to get deficits and debt down.  All the bailout countries are getting ‘more time’ to meet their targets.  But without growth, it cannot be done.

And that is what my lecture dealt with: why this is so difficult for the EU leaders to achieve.  The title of the lecture was The euro crisis is a crisis of capitalism. I could have added “and not a crisis of the euro”. In other words, even if  the euro was to collapse and EMU states returned to running their own monetary and currency policies, the crisis would not go away and may even be worse.  That’s because the euro crisis is the product of the failure of the capitalist mode of production globally.  It has had the worst impact on the weaker capitalist economists like Greece, Portugal or Slovenia, but it has hit all.

In my view, that is the point that must be remembered.  The crisis is only partly a result of the policies of austerity being pursued, not only by the EU institutions, but also by states outside the Eurozone like the UK.  If that is right, then alternative Keynesian policies of fiscal stimulus and/or devaluation where possible,will do little to end the slump and will still make households suffer income losses.

Austerity means a loss of jobs and services and thus income.  Keynesian policies will mean a loss of real income through higher prices, a falling currency and eventually rising interest rates.  Take Iceland, a country outside the EU, let alone the Eurozone.  Devaluation, or Keynesian-style ‘beggar-thy-neighbour policies have still meant a 40% decline in average real incomes in dollar terms and nearly 20% in krona terms since 2007.

The Euro crisis is product of the slump in global capitalism and the subsequent failure to recover is the same.  Profitability in most capitalist economies is still well below the peak of 2007 (the US is the only exception) and for economies like Italy and Slovenia it is still heading downwards.

In the lecture, I correlated profitability with growth since the trough of the Great Recession (graph below).  The trend line is positively sloped.  Estonia and Ireland have seen the biggest recovery in profitability (through austerity and cutting wages and living standards for the population, along with massive emigration of the unemployed).  As a result, they have had the best GDP recoveries – such as they are.  Where the recovery in profitability has been weak or non-existent, real GDP has contracted the most since 2009.

The correlation between profitability and growth is much better than between government spending and growth.  Countries where government spending to GDP has increased since 2009 (i.e. Keynesian-style stimulus) like Japan and Slovenia (until now) have not grown at all (see graph below), while there are many countries that applied austerity and reduced government spending to GDP after 2009 and they have achieved some growth.  There is no real correlation between growth and austerity (the trend line is almost flat), whatever Keynesian multipliers might indicate (see my post, The smugness multiplier, http://thenextrecession.wordpress.com/2012/10/14/the-smugness-multiplier/).

And the build-up of debt, not just for banks, but also for the non-financial capitalist sector is exerting downward pressure on the ability of capitalist economies to recover quickly, even after cutting jobs, closing down businesses and ending investment to reduce the cost of capital.  The more the growth in private sector debt before the crisis, the smaller the recovery has been.  The IMF graph below shows how the level of private debt has held down the recovery.  Balance sheet stress is heavier on the weaker EMU states and the financial centres of the UK and the US.

Of course, there are special features involved in the euro crisis.  Capitalism is a combined but uneven process of development.  It is combined in the sense of extending the division of labour and economies of scale and involving the law of value in all sectors, as in ‘globalisation’.  But that expansion is uneven and unequal by its very mode as the stronger seek to gain market share over the weaker.  Yet the Euro project aimed at integrating all European capitalist economies into one unit to compete with the US and Asia in world capitalism.  But one policy on inflation, one short-term interest rates and one currency for all is not enough to overcome the centrifugal forces of capitalist uneven development, especially when growth for all stops and there is a slump.

The aim from 1999 with the Eurozone was that the weaker economies would converge with the stronger in GDP per capita, fiscal and external imbalances.  But instead, as the IMF explained in a recent paper (http://blog-imfdirect.imf.org/2013/02/15/europe-toward-a-more-perfect-union/): “During the years that followed the euro’s introduction, financial integration proceeded rapidly and markets and governments hailed it as a sign of success. The widespread belief was that it would benefit both south and north—capital was finally able to flow to where it would best be used and foster real convergence. But in fact, a lasting convergence in productivity did not materialize across the European Union. Instead, a competitiveness divide emerged. As the financial crisis gripped the euro area in 2010, these and other problems came to the fore…. In fact, there has been little absolute real convergence in the euro area. Those euro area countries that had low per capita incomes in 1999 did not have the highest per capita growth rate”.  The graph below rises up from left to right, instead of being flat.

As I show in the lecture, the global slump has dramatically increased the divergent forces within the euro, threatening to break it apart.  The fragmentation of capital flows between the strong and weak Eurozone states has exploded.  The capitalist sector of the richer economies like Germany have stopped lending directly to the weaker capitalist sectors in Greece and Slovenia etc.  As a result, in order to maintain a single currency for all, the official monetary authority, the ECB and the national central banks have had to provide the loans instead.  The Eurosystem’s ‘Target 2′ settlement figures between the national central banks reveals the huge divergence within the Eurozone, although in recent months there has been some reversal back towards convergence.

Those who wish the preserve the Euro project like the EU Commission, the majority of EU politicians and most capitalist corporations, recognise that the only way to do so is extend the process towards more integration.  That means a ‘banking union’ so that all the banks in the Eurozone are subject to control by the Euro institutions like the ECB and not national government regulators.  And, above all, by the establishment of a full ‘fiscal union’, so that taxes and spending are controlled by Eurozone institutions and deficits in one EMU state are automatically met by transfers from surplus states.  That is the nature of a federated state like Canada,  the US or Australia. These transfers reach 28% of US GDP compared to the controlled and conditional transfers under EU budgets and bailouts of less than 10% of one state’s GDP.

The Eurozone does not have such a fiscal union.  Instead, after much kicking and screaming, the Germans and the EU agreed to set up some fiscal transfer funds, the EFSF and now the ESM.  But these are not automatic fiscal union transfers; they are contingent on meeting fiscal targets in a Troika program and national governments can still set their own budgets.  So there is growing opposition in Germany to shelling out cash for what they see as wayward countries who cannot get their public finances in order.

The IMF summed up the challenge for European capitalism in 2013: “2012 was a year of balancing on the edges of cliffs and precipices for Europe. 2013 needs to be a year of climbing mountains—doing the long and hard work of restoring competitiveness across economies to restore growth and making steady progress on completing the architecture of the monetary union.”

But can it be done?  Is there time and will?  Yes, austerity could eventually deliver the required reductions in budget deficits and debt.  But already there have been years of austerity and very little progress has been achieved in meeting these targets and, more important, in reducing the imbalances within the Eurozone on labour costs or external trade to make the weaker more ‘competitive’.  That could take many more years.  Can the people of Greece, Portugal, Spain, Italy, Cyprus, Slovenia and Ireland endure more years of austerity, creating a whole ‘lost generation’ of unemployed young people, as has already happened in Greece and will happen in Spain, Italy, Portugal and Slovenia?

The electorate is losing patience and is angry as the election turnout and vote in Italy shows and the events in Slovenia.  The EU leaders and strategists of capital need economic growth to  return quickly or further political explosions are likely.  And yet, given the current level of profitability, that may take too long before, perhaps, the world economy drops into another slump.  Then all bets are off on the survival of the euro.

My lecture is on You tube at http://www.youtube.com/watch?v=IaWHNaSRzmY&feature=youtu.be

A lot of people fell asleep.

 

Investment not consumption; profitability not demand

Boy, are the Keynesian economists boiling mad!  Jeffrey Sachs is regarded as a ‘liberal’ or progressive economist in favour of government action to boost the economy and employment.  He came out last week with an article attacking the basic tenets of Keynesian economics and their policy prescriptions for the US economy
(http://www.huffingtonpost.com/jeffrey-sachs/professor-krugman-and-cru_b_2845773.html).  Sachs denied that there were any beneficial effects for the US economy from the short-term fiscal stimulus packages that Obama introduced.  Indeed Sachs was worried that they would only boost public debt to levels that would stop the economy getting back into long-term sustained growth.

Sachs called the doyen of Keynesianism, Paul Krugman, a ‘crude Keynesian’, for advocating just short-term fiscal stimulus rather than longer-term remedies for the current depression.   Sachs says “I have argued against short-term stimulus packages. Krugman has supported them, and indeed argued that they should have been even larger. I have been against temporary tax cuts and temporary spending programs, believing that instead we need a consistent, planned, decade-long boost in public investments in people, technology, and infrastructure.”   Thus Krugman is a crude Keynesian because, says Sachs, “he takes a simplistic and inadequate version of the Keynesian economic approach as his guide for budget policy. Keynes himself was far subtler. In 1937, with British unemployment still around 10 percent, Keynes wrote: “But I believe that we are approaching, or have reached, the point where there is not much advantage in applying a further general stimulus at the centre.” He believed, for example, that more structural policies were needed to address the continued unemployment.*”

Sachs says that crude Keynesianism has failed because “recovery is impeded by structural factors. These structural components are not susceptible to a Keynesian diagnosis or to a Keynesian remedy…and Krugman seriously and repeatedly downplays these structural changes occurring in the U.S. economy. He repeatedly emphasizes that we suffer a demand shortfall, pure and simple, one easily remedied by more stimulus. Yet it’s increasingly hard to reconcile many features of the U.S. economy with this view.”   Sachs cites the long term problems of the US economy as “large-scale offshoring of jobs, large-scale automation of jobs, decline in demand for low-skilled workers, skill mismatches, broken infrastructure, and rising global energy and food prices. These require various kinds of targeted public investment spending, not simply aggregate demand.”

For Sachs, the problem is that fiscal spending that is not aimed at getting ‘structural’ improvements and just at boosting ‘demand’ will not work and the resulting debt from extra public borrowing will damage the economy ‘down the road’ when interest rates start rising.  Sachs emphasises that “The U.S. needs productive public investments, not wasteful spending. We need to modernize our infrastructure, retool our energy system, make our cities more resilient, and help to train a new productive labor force. “

With this approach, Sachs is really expressing the concerns of America’s capitalist sector that Keynesian-type fiscal stimulus will merely drive up debt servicing costs without restoring growth.  If there is to be government spending, let it be on industrial investment and not on welfare payments or public services.   So there is a vested interest behind Sachs’ criticism of Krugman.

It has produced a barrage of responses from leading Keynesian economists.  First, Krugman himself,  taking a line of the innocent victim, answered: “I don’t know what’s happened to Jeff Sachs. He’s been critical of “crude Keynesianism” throughout this crisis, without ever explaining what’s crude about viewing a huge slump in aggregate demand through a Keynesian lens. So his position has been a mystery.” (http://krugman.blogs.nytimes.com/2013/03/08/i-guess-its-a-form-of-flattery/).

Mark Thoma, a strong Krugman publicist, got really upset (http://economistsview.typepad.com/economistsview/2013/03/crude-sachsism.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+typepad%2FKupd+%28Economist%27s+View%29).
Replying to Sachs, point by point, he retorted: “Take your time, no need to hurry (other than the millions of people who are unemployed and struggling to make ends meet). Krugman and others (like me) say that yes, of course, shovel-ready infrastructure is the first choice, and of course we need to make progress on our long-run issues. But while we are getting that done, why the hell wouldn’t we want to do whatever it takes to alleviate the suffering in the shorter-run?…. because of problems that might happen “later this decade” we should let people suffer now.”  And again on Sachs’ position:  “We all agree on the need to address the long-run issues, and I have called for infrastructure spending again, and again, and again as a way to help the economy is both the short and longer runs. But that doesn’t mean we should ignore other policies — money spent on things other than infrastructure — that might help people in the short-run. Short-run multipliers are sufficiently large, there is substantial cyclical unemployment, and our debt problems are not immediate.”

Arch-Keynesian professor at Cambridge University, Simon Wren-Lewis (http://mainlymacro.blogspot.co.uk/2013/03/the-unlikely-friends-of-austerity.html) also weighed in: “perpetuating and mis-diagnosing the crisis is precisely what those who want to use debt scare stories to reduce the size of the state are trying to do.”  Sachs was really taking the old line of neoclassical economics: “More fundamentally, it is the line promoted – consciously or unconsciously – in almost every textbook that economic downturns are ultimately self correcting… what I see at the moment is very simple. We have demand deficiency, and the normal means of correcting it is broken. We luckily have a backup system, but the levers of that system are being pushed in the wrong direction.”   In other words, we need more fiscal stimulus of any sort not less, as Sachs seems to be advocating.

Kevin Drum was equally upset at Sachs, but he was also unsure what to do (http://www.motherjones.com/kevin-drum/2013/03/any-way-you-cut-it-weve-got-big-economic-problems): “our biggest problem going forward is indeed structural. Unfortunately, I have my doubts that we have any solutions for the structural problems that bedevil us. Sachs offers up a fairly conventional liberal prescription—lots of investment in infrastructure and education, paid for by carbon taxes and various taxes on the rich—and I don’t have any problem with that. I don’t think Krugman does either.  I’m all for rebuilding our infrastructure, and a strong focus on renewable energy would certainly help reduce our vulnerability to oil shocks. But it will happen only slowly, and only if the entire rest of the world does the same thing. At the same time, improvements in technology will be good for productivity, but are going to put increasing numbers of people out of work for good. Better infrastructure won’t really help that. I’m not sure what the answers are.”  Oh dear.

Dean Baker, another tireless opponent of austerity, inequality and neoliberal policies, also launched into Sachs ( http://www.cepr.net/index.php/blogs/beat-the-press/the-strange-attack-of-jeffrey-sachs-on-paul-krugman?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+beat_the_press+%28Beat+the+Press%29).

Baker dismissed the argument that fiscal stimulus will lead to a debt problem: “it is just difficult to see the case for the horror story of the debt that Sachs wants to portray. The markets clearly do not see the problem or they would not be lending the government huge amounts of debt at very low interest rates. Furthermore, we know many examples of other countries, or the U.S. at other times, that have been able to have much larger debt to GDP ratios without any notable problem borrowing money.”   And Baker made a telling point on the structural problems that Sachs promoted, claiming that Sachs missed the main one: “The main reason for the projected slowdown in potential GDP is the slowing of labor force growth. This is partly the result of the retirement of the baby boom cohort and in part the end of the period in which women were entering the labor force in large numbers.” 

But Baker then assumed that this demographic deficit poses no problem. “Neither development poses a crisis in any obvious way or suggests a structural flaw in the economy.”    Yet as Marxist economics would tell you, that should be cause for concern for the capitalist mode of production.  Only labour power can create value, so, other things being equal, a declining labour force will mean less surplus value generation.  As the employed population shrinks so does the total amount of value (unless hour of works are extended or new technology drives up the rate of exploitation).  And in the US, the ratio of employed to those not working in the total population has been falling fast.

This dispute among mainstream Keynesians might seem rather arcane and irrelevant.  But I think it raises some useful pointers on the weaknesses in the Keynesian understanding of the crisis and its policy prescriptions to end the Long Depression in the major capitalist economies.  Can the slump be ended just by more government spending through more borrowing or will that merely boost debt levels and distract from dealing with ‘long term structural problems’ in capitalist economies like the US?

First, as for the efficacy of short-term fiscal stimulus, I refer to my previous post (The smugness multiplier) on the effect of Keynesian-type fiscal multipliers
(http://thenextrecession.wordpress.com/2012/10/14/the-smugness-multiplier/).

The evidence shows that the short-run approach is limited, at best.  For example, as I noted in another post, one study found that the relatively tougher fiscal adjustment in the UK compared to the US has contributed slightly less than half the 5% pt difference in real GDP growth between the two countries over the last three years (see G Davies, J Antolin-Diaz, Why is the US economic recovery stronger?, Fulcrum Research, November 2012).  So US fiscal stimulus only did so much.

Second, the Great Recession was not caused by a slump in ‘effective demand’, especially consumption demand.  It was caused by a slump in investment.   As one capitalist chief, Fred Smith, the CEO of FedEx, recently observed “The only thing that’s correlated 100% with job creation – and particularly good job creation – is business investment. It’s our reduced level of capital investment that has produced our low GDP growth rates and our high unemployment.”  And if that is the case, then monetary injections through QE or more welfare spending will do little to help drive investment up.  

Investment analyst John Hussman makes a similar point (http://www.hussmanfunds.com/wmc/wmc130304.htm): “I’ve often noted that recessions aren’t simply a time when total demand falls short. They are usually a time where the mix of goods and services that is demanded becomes out of line with the mix of goods and services supplied by the economy. In order to get that mix back in line, it’s not enough to simply “stimulate demand” – it’s important to encourage innovation and investment in areas where needs aren’t being met, and to allow the transition and reallocation of resources away from areas that are no longer in demand.”  

As Hussman points out, the correlation between 8-quarter growth in US gross domestic investment and 8-quarter growth in non-farm payroll employment is 80%, with payroll growth lagging investment growth by about 6 months. Notably, that correlation is not driven by linear trends, but instead by a close match between cyclical movements of both, with employment lagging investment activity.  But growth in gross domestic investment has turned lowerand so is moving in the wrong direction if job creation is an objective of economic policy. “All of the QE in the world will not help this situation, but will instead continue to distort investment decisions away from productive allocation of capital and toward brute speculation in financial assets”.

Hussman singles out a key flaw in the Keynesian approach: ” Because savings and investment must be equal, and Keynes has already assumed that investment is fixed, the attempt by individuals to save a greater portion of their income cannot actually result in a greater amount of total savings. Instead, other things being equal, GDP must fall. There may be a million individual private decisions that produce this result, but in the end, savings must equal investment.  The Keynesian solution to this is to offset the desired increase in private savings with a decrease in government savings. Keynesians typically want savings rates to be as low as possible, on the assumption that spending automatically generates production. Keynesian theory really doesn’t embody the notion of scarcity and economic tradeoffs very well, and both government spending and investment enter the model like any other class of spending, with little attention to the productivity of that spending over time.  

So Keynesian “attempts to “stimulate” the economy by suppressing savings and increase consumption, or by pursuing “beggar thy neighbor” exchange rate policies are weak options compared to policies that encourage productive investment, research, and development. A nation’s “standard of living” is reflected by the amount of goods and services that its people can consume as a result of their efforts. A nation’s “productivity” is reflected by the amount of goods and services that its people can produce as a result of their efforts. Ultimately, one cannot increase for long without the other. Robust domestic investment provides the foundation for both.  The only sustainable course to a higher standard of living is to encourage productive investment. “

In an excellent series of articles (http://socialisteconomicbulletin.blogspot.co.uk/),
Michael Burke has shown exactly how a slump in investment has been the main reason for the failure of the UK economy to recover.  The UK government’s policies of austerity have played their role precisely because they have been mainly aimed at reducing government investment.  Unless long-term productive investment is restored, modern capitalist economies will not recover however much extra money is injected or extra government spending takes place.  This is the point behind Sachs’ criticism, however badly put.  He was more perceptive in a recent article in the FT (Today’s challenges go beyond Keynes, 17 December 2012), when he said: “Unlike the Keynesian model that assumes a stable growth path hit by temporary shocks, our real challenge is that the growth path itself needs to be very different from even the recent past.”

But what do Hussman or Sachs mean by ‘productive investment’.  Under capitalism, productive investment is not aimed at delivering extra output for an economy to use; instead productive investment must deliver more profit, with extra output as a secondary outcome.  The Marxist theory of crisis reckons that slumps or recessions are caused by a collapse of investment, an investment strike.  The investment strike happens because it has been no longer profitable for capitalist to invest and so they stop, lay off labour and reduce production and that ‘multiplies’ through the economy as workers lose their jobs and incomes.  Until sufficient profitability returns, capitalist will hoard their cash or increase dividends to their shareholders or buy back shares rather than invest in new equipment or employ more staff.

That is the missing ingredient from both the analysis of Sachs and his Keynesian opponents: profitability.  The evidence that profits drive investment is now well documented.  See the excellent analysis of Tapia Granados, often mentioned in this blog (see http://thenextrecession.wordpress.com/2012/06/26/profits-call-the-tune/).  Recognise the close connection between past profitability and future expectations of profit on investment, as analysed for the US economy in Andrew Kliman’s book, The failure of capitalist production.  See the recent paper by Andrew Kliman and Shannon Williams on US profitability and investment (http://akliman.squarespace.com/writings/).  And in my book, The Great Recession, even I managed to present evidence for profits driving investment.  This is ignored by neoclassical and Keynesian economics alike.

You can’t make a horse drink

The Keynesians are split:  they are split on the effectiveness of monetary and fiscal policy on reigniting the capitalist economy and on whether the size of an economy’s outstanding debt (both public and private) matters or not.  The more conservative wing is worried that the current talk of monetary policy aiming at targeting, not inflation, but nominal GDP growth, along with other ‘unconventional’ measures beyond quantitative easing like having negative interest rates (see my post, http://thenextrecession.wordpress.com/2013/02/21/helicopter-money-and-the-chicago-plan/) is dangerous and might lead to higher inflation and interest rates and thus choke off any sustained economic growth; or even reproduce another credit bubble and financial crash.

A representative of this conservative wing, Paul Ormerod,  put it this way in a recent article (http://www.paulormerod.com/): “So-called Keynesians demand an increase in both public spending and the public sector deficit. What might Keynes himself have said about the current situation? “ Well, says Ormerod, “For Keynes, a crucial policy aim during a slump was to have a low long term rate of interest.  Without it, recovery would just not happen.”   If governments start borrowing too much on top of existing high levels of debt, they risk driving up the cost of that borrowing as lenders demand more interest on their loans.  That lowers the value of existing government bonds and becomes “a powerful depressant of private sector spending, both corporate and individual”.  Ormerod invokes the increased uncertainty this generates – the ‘confidence fairy’, as more radical Keynesians dismiss it: “the less confident you are about your view, the less you will spend.  High interest rates add to uncertainty and undermine confidence.”   So, according to Ormerod, “we might end up even worse off and with a higher deficit to boot.  Policy at the moment is much more about psychology rather than the mechanistic calculations of so-called Keynesians.”  Ormerod claims that Keynes would agree with him and not with the radical wing.

A similar criticism of the more radical wing of Keynesianism has been mounted by the eminent octogenarian Nobel economics prize winner, Robert Solow.  Solow has been a perceptive critic of neoclassical economics and the Austerians.  But in a recent piece, he urges caution on the question of ignoring the size of ‘national debt’ (http://www.nytimes.com/2013/02/28/opinion/our-debt-ourselves.html).  His main points are that if foreigners own most of that debt, then that puts the value of the national currency in jeopardy if these foreign investors switch to other country’s assets.  That is less likely to happen for the US because of the role of the dollar as the world’s main reserve currency, but it cannot be ignored.

If the debt is mainly owed to other citizens of the same country, then through inflation and the shifting of the burden of servicing that debt into the future, it can be made manageable now.  But the real problem, Solow reckons, is that rising debt “soaks up savings that might go into useful private investment. Savers own Treasury bonds because they are seen as safe, default-free assets, and the government can borrow at lower rates than corporations can. If there were less debt, and fewer bonds for sale, savers seeking higher returns would invest in corporate bonds or stocks instead. Business investment would expand and be more profitable.”   This is not a problem right now as too much austerity is the issue, but it could become one further down the road.

Comments like these from fellow Keynesians have produced hot responses from the more radical wing.  Randall Wray is one of the leading exponents of Modern Monetary Theory (MMT), which argues that a government can spend just as much as it likes because it can create money to pay for it; so there is no issue of default and no likelihood of rising interest in the current environment of excess capacity in production, high unemployment and cash hoarding by corporations (see my post,
http://thenextrecession.wordpress.com/2012/04/21/paul-krugman-steve-keen-and-the-mysticism-of-keynesian-economics/).

He laid into Solow (http://www.economonitor.com/lrwray/2013/02/28/six-facts-about-our-debt-corrections-to-robert-solows-op-ed/#sthash.OE1yTLPx.dpuf).  “Solow is a “neoclassical synthesis” Keynesian, the type of Keynesian economics that used to be taught in the textbooks. He was also on the wrong side of the “Cambridge controversy”, as the main developer of neoclassical growth theory.”  Wray answers Solow point by point.  But what is revealing is on nearly every point that Solow raises, Wray does not really dispute: foreigners owning debt, Treasury printing of money for debt, inflation as a way of reducing the real value of debt and the burden of servicing debt to bondholders for the rest of the economy.

Indeed, as this debate goes on, the evidence is mounting up on whether rising debt (public or private) really does matter in the growth of a capitalist economy.  In a recent meeting of the US Federal Reserve in San Francisco, new papers were presented that seem to back up the view of the conservative wing (http://erevents.frbsf.org/conferences/130301/agenda.php).   Christopher Hanes looked at the impact of monetary policy.  He found that “our statistical analysis shows that higher debt levels would likely lead to higher interest rates, thereby raising budget deficits and debt levels, which in turn would raise interest rates further.  Government bond rates shoot up and a funding crisis ensues. A fiscal crunch not only hurts economic growth because interest rates could rise to unprecedented levels but also because it could make it difficult for the Federal Reserve to control inflation.  Unsustainable fiscal policy can force a central bank to pursue inflationary policies, which is known as fiscal dominance.  If the central bank does not monetize the government debt, then interest rates will rise sharply, causing the economy to contract.  Indeed, without monetization, fiscal dominance may result in the government defaulting on its debt, which would lead to a significant financial disruption, producing an even more severe economic contraction.  Hence the central bank will in effect have little choice and will be forced to purchase the government debt by printing money, eventually leading to a surge in inflation.“

So if the government expands its borrowing to try and shore up the economy, it will cause interest rates to rise and choke off growth, unless the borrowing is done simply by printing more money (just as the more radical wing of Keynesians are now advocating).  But if that policy is adopted, it will ‘eventually lead to a surge in inflation’.  Neither way of boosting government spending can avoid damaging the capitalist sector. Indeed, another paper that looked at the impact of nominal GDP targeting in the Great Depression, found that it did not work.

But where Wray is really rankled is by Solow’s assertion that rising public debt “soaks up saving that might go into useful public investment”.  Wray is convinced this is nonsense and runs directly against Keynes’ own view.  Marxists argue interminably about what ‘Marx really meant’.  So do the epigones of Keynes.  And it is just as difficult to know what the great bourgeois economist meant, as he is contradictory and ambiguous.  But whatever Keynes thinks, Wray puts forward a clear view:  “Investment creates saving. Budget deficits create saving. You need the spending before you get the income that you then decide to save.”   This is the Keynesian view that consumption leads the economic process.  From extra spending, we get extra employment and investment and then extra income and saving.  As I have explained in numerous posts (http://thenextrecession.wordpress.com/2012/06/13/keynes-the-profits-equation-and-the-marxist-multiplier/), this analysis of the dynamics of the capitalist economy is flawed because it denies any role for profit in driving investment (and beneath that, the role of exploitation) and assumes that there is just an economy, not a capitalist economy, in the same way as neoclassical theory does.

The reality is the opposite of the Keynesian equation:  under capitalism, it goes from profits to investment to employment to consumption (and saving).  Indeed, in Keynesian terms, savings do drive investment, if we mean corporate savings or profits.  If profitability (relative to existing capital stock) is not high enough and profits (savings) by the corporate sector are hoarded (as now), then investment will not recover sufficiently to restore growth, employment and spending by consumers (workers).  In that situation, no amount of monetary easing or expansion or increase in debt will restore economic recovery.  You can take  a horse to water, but you can’t get it to drink.  It will require the replacement of private investment for profit with public investment for need.

And so pro-capitalist monetary policy remains on the horns of a dilemma, between wanting to boost growth through investment with low interest rates, while also avoiding reviving a new credit bubble and accelerating inflation.  As Ben Bernanke put it this week in his address to those central bankers in San Francisco.  “Let me finish with some thoughts on balancing the risks we face in the current challenging economic environment, at a time when our main policy tool, the federal funds rate, is near its effective lower bound. On the one hand, the Fed’s dual mandate has led us to provide strong support for the recovery, both to promote maximum employment and to keep inflation from falling below our price stability objective. One purpose of this support is to prompt a return to the productive risk-taking that is essential to robust growth and to getting the unemployed back to work. On the other hand, we must be mindful of the possibility that sustained periods of low interest rates and highly accommodative policy could lead to excessive risk-taking in some financial markets. The balance here is not an easy one to strike. “

Indeed!  So far, the effect of Bernanke’s easy money policy has not been to restore significant investment growth or employment, but to take bond and equity prices towards all-time highs in a new financial bubble.  The horses are not drinking so the cash is going elsewhere.

The other Mario and the other Marx

Mario Monti may have been defeated in Italy’s general election and will not be prime minister by the time this March is over, but the other Italian super Mario is still in place.  Mario Draghi is head of the European Central Bank and responsible for ensuring that Italian capitalism does not go bust.  He stands ready to pump cash into Italian government bonds if financial markets should desert Italy over the next few months and force a new Euro crisis.

So how does Mario see his role as the lender of last resort and, as Atlas-like, the supporter of European capitalism? Well, Mario gave a speech on Tuesday in Bayern, Munich, the home of BMW and the heart of conservative Catholic Germany.  He told his audience at the Catholic Academy, at the time of the resignation Pope Benedict (“a great son of Bavaria”) that the Pope had been very concerned about the ‘ethical’ nature of modern capitalism, and so was he, Mario.  Mario was particularly concerned about the ethical role of the ECB during “the economic and financial crisis that now extends into its fifth year.”

Mario noted that “the crisis has dented people’s confidence in the capacity of markets to generate prosperity for all. It has strained Europe’s social model. Alongside the accumulation of staggering wealth by some, there is widespread economic hardship. Entire countries have been suffering from the consequences of misguided past actions – but also from market forces that are sometimes beyond their control.”   So Mario asked the question of himself and the audience: “what is the right framework for reconciling free enterprise and individual profit motives with concerns for the common good and solidarity with the weak?”  

The answer, Mario, tells us is not to rely on the ‘invisible hand of the market’ to solve all; we need an ethical approach, something that Adam Smith, the father of political economy, was also concerned about.  As a Jesuit, Mario follows that Catholic order’s “fundamental guiding principle: our striving for excellence had to be paired with integrity and a moral message – an ultimate sense of purpose in the service of social justice and fairness….Ultimately, we must be guided by a higher moral standard and a profound belief in creating an economic order that serves every person.”

So who does Mario turn to in the current crisis for a guiding hand towards a ‘moral capitalism’?  “Here I find myself in the company of Marx. Not Karl, but Reinhard. Cardinal Reinhard Marx has rightly insisted that “the economy is not an end in itself, but is in the service of all mankind.”  

At this point, let me tell you who Cardinal Reinhart Marx is.  He is the Archbishop of Munich who wrote a book at the depth of the Great Recession entitled “Das Kapital: A Plea for Man”, named after Karl’s work but designed to reject Karl’s ideas.  Reinhart Marx wants a market economy that is “kinder to the weak and downtrodden” instead of “heaping even more rewards on those who behave immorally.”   As we review the results of the global slump, the grotesque greed of the rich and cruel realities of austerity in Greece, Italy, Spain, Portugal and elsewhere on the ‘weak and downtrodden’ , we would hope that Reinhart can tell us how to reconcile the ‘free market’ and capitalism with “the welfare of the world”.  Unfortunately, I have to tell you that Reinhart in his book provides no answers, except vague platitudes.  At least, he does not repeat the line of the head of Goldman Sachs, Lloyd Blankfein, who when asked whether it was right for his investment bank to make huge amounts of money and deliberately sell financial products to customers knowing they were toxic, Blankfein, as the chief vampire squid of capitalism (but a very devout man), replied that he was “doing God’s work”.

Anyway, Mario went on to explain to his Catholic audience how he applied Reinhart’s ethical principles to his job at the ECB.  You see, Mario told them, the main job of the ECB is establish ‘price stability’ and achieving that was “the basis for a just and fair society. It is a common good for all Europeans.”  And of course, it is true that if there is no inflation, households obtain full purchasing power on what they earn and do not see their savings eroded.  That’s important for those that live on the interest of past savings.  However, the ECB can hardly claim that the current low level of inflation (and even deflation) in Europe is down to the work of Mario and his colleagues.  It is the result of the total collapse of ‘effective demand’ as the Keynesians would put it, or down to a strike by capitalist investment (as we followers of Karl, not Reinhart, might put it).  Balanced against the ‘moral good’ of low inflation lies the ‘moral bad’ of extreme unemployment, collapsing public services and falling real incomes. How do we reconcile these apparent contradictions in a ‘moral way’?

Mario recognises that the ECB was failing.  It was failing to get all the liquidity (money) that it had pumped into the hands of bankers onwards to the wider economy: “our low interest rates have simply not been getting through to people in some parts of the euro area.”  Something  had to be done.  So we come to the great ethical policy of Mario Draghi:  Outright Monetary Transactions (OMT).  OMT is the proposed tool of the ECB to buy the bonds of governments that have been deserted by the ‘free market’.  The ECB will buy as much as is necessary to shore up these governments so they can meet their obligations at reasonable rates of interest and keep economies going.

So far this ‘ethical’ measure has not had to be used because financial markets are still expecting Eurozone governments to enforce austerity.  But moral Mario is ‘concerned’.  After all, “economic adjustment is coming at a heavy social cost.”  Euro area GDP is currently lower than it was in 2008. Almost 19 million people are unemployed – more than the population of the Netherlands.  “Unemployment is a tragedy. It squanders the vitality of our workers. It prevents people from playing a full and meaningful part in society. It induces a sense of hopelessness, which drains the inspiration from our young.”

So what is the moral path out of this slough of despond?  For Mario, it is ‘reform’.  By this, Mario does not mean replacing the ‘free market’ with an organisation of society that benefits the majority who create the wealth, as Karl Marx would have it.  He means a bigger role for the ‘free market’, namely “reforms that make doing business easier. That guarantee that those who owe taxes actually pay taxes. That ensure that public services actually serve the public.”  In practice, these are ‘reforms’ that reduce labour’s rights to work; lower pensions; reduce public services and privatise the rest.

Mario says “it is wrong to claim that countries are undertaking reforms only to please the markets or to satisfy the demands of technocrats in Brussels, Frankfurt or Washington. They are doing it for their own benefit.”  Really?  Who are the ‘reforms’ that attack the incomes of workers and pensioners and the ‘social wage’ beneficial to?  To the majority or to rich tiny minority?  Are the economic policies of the ECB and Eurozone governments that Mario supports really “in the service of humanity” ?

Are they what the good Cardinal Marx would recognise as ‘moral’?   “Capitalism without humanity, solidarity and justice has no morals and no future,” the Cardinal wrote.   Unfortunately for Cardinal Marx and Mario, the history of capitalism cannot be divorced from inhumanity, class division, injustice and immorality – as even the last five years has confirmed.  So it has no future.