Abenomics: a Keynesian neoliberal

Japan has revised up its first-quarter real GDP growth to 1% quarter over quarter.  So the Japanese economy expanded at an annualised rate of 4.1% between January and March, the fastest rate recorded by any G7 economy.   Does this mean that ‘Abenomics’ is working? Well, not so far.  After all, this quarterly GDP figure does not tell the story.  The annualised 4.1% growth was only a recovery from a 3.6% fall in the second quarter of 2012.  Indeed, year on year GDP growth in Japan in the 1st quarter was only 0.2%, the lowest since the 4th quarter of 2011.  So no real pick-up yet.

As John Ross pointed out in his latest post (http://ablog.typepad.com/keytrendsinglobalisation/2013/06/abenomics.html), Japan’s real GDP is still below its peak back at the end of 2007.

In a previous post (http://thenextrecession.wordpress.com/2013/02/14/japans-lost-decades-unpacked-and-repacked/) I discussed the great experiment of the Abe government in trying to restore economic growth by applying all Keynesian remedies at once – monetary and fiscal stimulus along with a very sharp depreciation of the currency against its major trading rivals.   In that post, I argued that Keynesian policies in the 1990s did not work for Japan and they probably won’t work in this decade either.

Will I be proved wrong?  I doubt it.  But what is interesting about ‘Abenomics’ is that it is not just ‘Keynesian’ in approach but also ‘neoliberal’.  Japan’s economic growth was relatively better in the 2000s up to the Great Recession and the tsunami than in the 1990s.  That was because Japan’s corporate profitability improved. It did so because the then neo-liberal government of prime minister Koizumi opted for the restructuring of the banks, privatisation of state agencies and higher taxes on consumption.  This produced a short revival in profitability, at the expense of average living standards, reduced pensions and worse work benefits.

So it is the success or otherwise of Abe’s new neoliberal policy that will decide whether Japan’s capitalist economy can get going.  We’ve had a Y10.3tn ($105bn) fiscal stimulus package in January and a new regime at the central bank that is now committed to buying billions of dollars of Japanese government bonds.  Now we are going to have the ‘third arrow’ of deregulation, cutting corporate taxes, privatisation and a reduction of labour and pension rights.  This is the real programme for driving up profitability.  The government aims to relax rules governing the sale of non-prescription drugs, allow selected cities to experiment with lower taxes and deregulation and ‘liberalise’ the power sector.

The Keynesian-style policies create a contradiction that even some Keynesians realise: it’s the level of Japanese government debt.  What will happen if Japan’s ultra-low interest rates start to rise?  Will that not cause a sharp rise in debt servicing costs and thus eat into funds for investment?  This question is usually posed by Austerians, but it seems that some Keynesians are concerned too.  As Noah Smith put it in his blog (http://noahpinionblog.blogspot.co.uk/2013/06/the-zero-upper-bound.html): “if monetary expansion can only cause the kind of recovery where interest rates rise, Japan is in deep shiitake….  Japan’s only options will be stagnation, default or hyperinflation. “

Indeed other ‘moderate’ Keynesians like Brad de Long are confused about whether Japan’s monetary experiment will work anyway (http://delong.typepad.com/sdj/2013/06/confusion.html).  “I’m sufficiently confused. I don’t have much confidences in my priors. My priors seven years ago were that Central Banks could push nominal GDP to whatever path they wanted through normal policy tools” but now “we really should be worrying about are the “unknown unknowns” of debt accumulation–just as nobody understood the systemic risks produced by subprime. And “unknown unknowns” are, by definition, unknown…. so I have very serious doubts about my ability to analyze the situation we are in. Whenever I cast myself back in time and think how confident I was ten years ago, and how wrong my first response is, maybe I should give up this business and stop pretending I have knowledge. Because certainly I would not have thought we would be here now.”

Dear, oh dear!  What worries de Long is not that Japanese debt is too high but that financial markets will panic: “there is a good equilibrium out there, an equilibrium which would support considerably more government debt than we have…. But that markets should recognize this doesn’t mean that markets will recognize this. It doesn’t mean that we know that markets won’t get scared of additional deficit spending and tip us over into fiscal dominance.”  Paul Krugman and Dean Baker dismiss De Long’s worries.  For them, the Japanese experiment must be supported as it is going to prove that Keynesian-style policies of monetary injections and fiscal stimulus will work.  Abe himself is hedging his bets on Keynesian policies, as he is also going to try to force through typical ‘supply-side’ neoliberal measures.  Krugman and Baker say little about those.

Japan now has a policy recipe that the IMF in its new anti-austerity mode would approve: fiscal and monetary stimulus along with reducing the power of labour and government regulation.  So Japan’s experiment combines all known mainstream economic potions in one bottle to take on the ‘unknown unknowns’.  Watch this space.

Profits across the pond

Turkey: can’t see the trees for the woods

The explosion of protest over the last week in Turkey began when people tried to stop the pulling down of trees in Gezi Park as part of a government plan to replace the park with yet another shopping centre that would include yet another mosque, the demolition of the secular Ataturk cultural centre and its replacement with an Ottoman-era military barracks.   This was no accident of history really, because the loss of green spaces to development has been increasingly objected to by wide layers of Turks – working class and middle class.  According to the OECD,  33% of Turks feel they lack access to green spaces, much more than the 12% average of OECD European countries and the highest level of dissatisfaction in the region.

But Turkish capitalism has been on the move and, as far as the ruling AK party and domestic and foreign capital is concerned, nothing must stand in its way (including trees).  Turkey wants to move up the ladder of the rich club of the OECD and is still vying to join the EU by the end of decade.  At the same time, the government is autocratically trying to impose an Islamic style state superstructure onto this capitalist expansion, with strict rules on alcohol, religious observance, dress and the subjugation of women, Iran-style.  Up to now, the AK party has been riding high, winning election after election, enabling it to cut the former Ataturk secular military down to size and disperse the secular opposition of corrupt middle-class parties.  The AK was backed in this by the huge urban poor of the cities where it had carefully built a base over a decade or more.  But, of course, on obtaining unchallenged power, it has now become the tool of big business and foreign capital (despite the occasional rift over policy).  The government increasingly sees itself as a regional power able and willing to intervene in the various clashes of the region: Iran. Palestine and more recently, Syria.

On the surface, it would appear that Turkish capital is moving on and up without much problem.  And it is true that economic growth has accelerated in recent years while foreign investment has flooded in to exploit a labour force coming into the urban areas from the impoverished countryside – a classic emerging capitalist development.   But this apparent economic success is still founded on the shaky young legs of a weak capitalism and is also weighed down by corruption, religious backwardness and scant regard for human rights and laws.  Inequality of income, as measured by the gini coefficient, according to the IMF, is around 40, making it higher than the US, the most unequal of the advanced capitalist economies and the highest in emerging Europe, apart from Russia.

It’s no surprise that Turkey is ranked 154th in Reporters Without Borders’ Press Freedom Index. Not only is the country “currently the world’s biggest prison for journalists”, media bosses fire journalists because of pressure from the government.  And prosperity is a relative thing and of course, not for all.  More than 48% of the working-age population aged 15 to 64 has a paid job, a figure much lower than the OECD employment average of 66% and the lowest rate in the OECD.   People in Turkey work 1 877 hours a year, more than the OECD average of 1 776 hours.  In Turkey, however, 46% of employees work very long hours, by far the highest rate in the OECD where the average is 9%.

Around 67% of people say they are satisfied with their current housing situation, much less than the OECD average of 87% and the lowest level amongst OECD countries. On Turkey, the average home contains 0.9 rooms per person, less than the OECD average of 1.6 rooms per person and one of the lowest rates across the OECD. In terms of basic facilities, 87.3% of people in Turkey live in dwellings with private access to an indoor flushing toilet, less than the OECD average of 97.8% and the lowest rate across OECD countries.

The best-performing school systems manage to provide high-quality education to all students. In Turkey, the average difference in results, between the 20% with the highest socio-economic background and the 20% with the lowest socio-economic background is 106 points, higher than the OECD average of 99 points. This suggests the school system in Turkey mainly provides higher quality education for the better off.

Total health spending accounts for 6.1% of GDP in Turkey, more than three points below the average of 9.5% across OECD countries. At $913 in 2008, Turkey’s level of health spending per person is the lowest in the OECD, where the average is of $3268.   In Turkey, only 61% of people say they are satisfied with water quality. This figure is the lowest in the OECD, where the average satisfaction level is 84%, and suggests Turkey still faces difficulties in providing good quality water to its inhabitants.

The Great Recession hit Turkish capitalism just as hard as elsewhere.  The answer of the government (against IMF advice) was to let loose a huge credit boom to fuel domestic demand.  This pushed the inflation rate to double digits and widened the current account deficit to 10% of GDP (the second largest in the world in dollar terms) in 2011, exposing Turkey to the risks of capital flow reversal at a time of continued global uncertainty.  External financing needs are around 25% of GDP so that Turkish banks rely on short-term foreign borrowing. Turkey has jumped from an agricultural to services economy within two decades and the recession weakened the manufacturing base.  Conglomerates like Eczacibasi and Zorlu have built huge shopping malls in the past few years rather than investing in their core businesses.

In the last two years, the economy slowed, driven by weakening domestic demand.  Turkey remains prone to boom-bust cycles driven by foreign capital flows.  The health of global imperialism is still the overriding factor in Turkey’s own growth.  The national saving rate has fallen dramatically over the last 15 years, from 25% of  GDP in the late 1990s to less than 15% now. This decline has been larger than in any G-20 country over this period and stands in stark contrast to the experience in peer emerging economies.  So Turkey is forced into making its labour force competitive to attract more FDI flows into the tradable sector. At around 2.0% of GDP, FDI inflows are still below the G–20 EM average , with most flows tilted toward unproductive sectors such as banking and  real estate.

Between 2003 and 2011, real GDP growth averaged 5.3% a year, but the unemployment rate remained in double-digits, thus creating a reserve army of labour to exploit.  The deficit on trade and income with other countries was over 5% of GDP on average.  But these were the good years for Turkish capitalism.  Economic growth is expected to slow to less than 4% a year for the rest of this decade, at best, while the external deficit will widen to 7.5% of GDP.   The boom of the last decade was partly based on real estate, credit and services and construction and less and less on manufacturing, exports and investment.

That’s because the profitability of Turkish capital has declined as the expansion of the labour force began to slow.  The decline was visible during the 1990s. It was no accident that the AKP won landslide victory with the backing of big business in the 2002 elections  just one year after its foundation.  Under the AKP, profitability made a dramatic recovery (albeit based partly on unproductive investment).  The Great Recession brought a new reversal and this time the recovery in profitability has faltered.  Although profitability recovered to the previous peak by early 2010, since then it has taken a tumble and is still below the peak before the Great Recession.

The green shoots in the woods of Turkish capitalism are not so healthy that the government can continue to pull up the trees.

The euro recovery: half full or half empty?

The OECD has just issued its half-yearly forecast for economic growth.  It reckons that world real gross domestic product (GDP) will increase by just 3.1% this year and by 4% in 2014. Across the OECD countries, GDP is projected to rise by a meagre 1.2% this year and by 2.3% in 2014, while growth in non-OECD countries will rise by 5.5% this year and 6.2% in 2014.    In the US, activity is projected to rise by 1.9% this year and by a further 2.8% in 2014.  However, GDP in the euro area is expected to decline by 0.6% this year and then turn up just 1.1% in 2014, while in Japan GDP is expected to grow by 1.6% in 2013 and 1.4% in 2014.

These forecasts are more or less repeated by the IMF in its spring estimates. What stands out is that the mature capitalist economies are crawling along while the developing capitalist economies are growing at a reasonable lick.  But the Eurozone area of 18 nations shows no sign of recovery from the Great Recession, with southern Europe deep in depression.   The Euro leaders met last Monday and agreed that France, Spain, Greece etc could have more time to meet their fiscal targets on government budgets and debt because economic recovery was non-existent.  So the pace of austerity was eased by the Euro leaders.  But it’s still the message.  As ECB President Mario Draghi recently maintained: “There was no alternative to fiscal consolidation, even though, we should not deny that this is contractionary in the short term. In the future there will be the so-called confidence channel, which will reactivate growth; but it’s not something that happens immediately”.   Clearly not!

Christian Noyer, governor of the Bank of France, also echoed Draghi in saying that austerity was necessary to encourage the ‘confidence fairy’ to make an appearance: “Over a certain threshold, which our country has probably crossed, any increase in public spending and debt has extremely negative effects on confidence.”  In other words, recovery is possible only if capitalists become confident that it will happen and that apparently depends on getting budget deficits and debt down.  Why? Well, because “the old model doesn’t work any more”, namely traditional Keynesian efforts to boost demand by encouraging spending.  Noyer added that France had to move away from public policies “overly concerned with preserving the jobs of the past” and allow for ‘liberalisation’ that could help future job creation.

And there we have it.  As I have argued many times in this blog, the aim of austerity is not just to reduce public debt and government spending as such, but to restore the profitability of the capitalist sector.  As Draghi puts it, “that’s why structural reforms are so important, because the short-term contraction will be succeeded by long-term sustainable growth only if these reforms are in place.”  And that’s why when the Euro leaders relaxed the pace of austerity for several governments, they did so on the condition that ‘supply-side reform’ was stepped up, namely cuts in job security,wage levels and ‘protected’ industries along with more privatisation.  That is the real aim of austerity: more neoliberal policies to restore the capitalist sector.

But is austerity working to achieve this?   Well recently, JP Morgan economists put together some measures of progress: the amount of deleveraging achieved in public and private sector debt; more competitive prices for trade by the distressed states; making it easier to hire and fire employees; opening up ‘markets’, more privatisations and interestingly, progress on reducing democratic and constitutional obstacles in various states to imposing neoliberal policies.

JPM concluded that the Eurozone was only halfway there in this neoliberal recovery programme (The Euro area adjustment: about halfway there, 28 May 2013).  For example, on the fiscal austerity targets, Italy was 75% on the way, Spain just 38%, Greece 97%, Ireland just 26% and Portugal 55%.  Longer term austerity targets (meeting the Fiscal Compact in 2030) were more or less along the same distance.

Wage cuts and reductions in labour costs had gone further, with Ireland and Portugal having done enough, Greece a little further to go (after a 30% cut in living standards!) and Spain still another 25% to go.

But when it came to ‘structural reform’ i.e. reducing the size of the public sector, selling off state assets, reducing labour and pension rights, lower corporate taxes etc, progress had been much slower.  Apparently, Italy, Greece, Spain and Portugal were still way less oriented to allowing the capitalist sector free rein than the likes of the Netherlands or Ireland.

JPM’s estimate of progress on the neoliberal programme is more realistic than the talk in financial markets that the likes of Greece or Ireland have ‘turned the corner’.  Take Greece.  The three parties in the coalition over the last year have stuck rigidly to the EU-IMF fiscal adjustment program. They have been awarded with an upgrade in the evaluation of Greek sovereign debt as a result by financial markets.  Greece’s upgrade to B- comes almost a year to the day from the downgrade Greek sovereign debt to CCC, i.e. junk.  So the ‘confidence fairy’ has shown itself from the undergrowth.  But it is nowhere near enough to talk about the Greek crisis being over.

All the Euro bailout funds to Greece have gone on paying off Greece’s creditors, namely other European banks, pension funds and speculative hedge funds, the latter have made a killing as Greek debt interest rates have fallen as a result.  But the real economy remains in a mess.  The economy has had 19 consecutive quarters of contractions.

About 1.3 million Greeks are out of work, some 400,000 families have nobody earning an income, about 300,000 workers have employers who have not paid them for months and thousands have left the country to seek work, while the forces of neo-Nazism grow stronger. About 800,000 or so long-term unemployed have lost any access to benefits and free healthcare.  Public services, such as health, have been ravaged, while the incessant rise in taxes has put terrible pressure on even the healthiest of businesses.

People in Greece worked 2,032 hours a year in 2011, considerably higher than the OECD average of 1,776 hours.  By contrast, the Germans, clocked in on average 1,413 hours a year.  Yet the average annual disposable household income in Greece is €15,800, way less than the OECD average of €17,820 a year.  On indicators used of the OECD’s better life index, Greece ranks 30^th out of 36 countries. In the EU, only crisis-ridden Slovenia ranks worse. Portugal came in at 28.

Small businesses in Greece are paying an interest rate of around 7% for credit assuming they can even get a loan from the country’s semi-comatose banking system.  In contrast, similar firms in Germany borrow at half that rate.  The current account deficit may have shrunk by about 7% pts of GDP but this been achieved largely on the back of a substantial fall in imports rather than a significant rise in exports.  Even the dreaded Troika  admitted in analysing the impact of its austerity programme that: “The rich and self-employed are simply not paying their fair share, which has forced an excessive reliance on across-the-board expenditure cuts and higher taxes on those earning a salary or a pension.”

Recovery in Greece depends on a return of investment in industry and key services.  But there is little sign of that.  In 2012 investment fell by 20% from the already ridiculously low levels of 2011. And the government is predicting a further fall in investment in 2013.

So if austerity is only half working at best to restore capitalism in the Eurozone, what is the alternative?  Well, there is another that is gaining prominence, especially within the distressed Euro states like Portugal, Greece and Italy.  It is the Keynesian alternative of leaving the euro and restoring a devalued national currency. For example, in Portugal, economist Joao Ferreira do Amaral has published a book urging Portugal to exit the euro.  This has become a best seller and is backed not just by the Communist Party but also endorsed by the Supreme Court President!  The book argues that austerity won’t work and the divergence between rich Germany and poor Portugal will only get wider if the current government’s policy is maintained.  The only answer is to exit the Eurozone and for Portugal to restore its escudo as in the 1990s.

The claim of these ‘exit’ supporters is that the cost of exiting the euro to the economy will be much less than the continuing cost of austerity imposed by the Euro leaders on the likes of Portugal or Greece.  These arguments are presented more theoretically by a new paper from Heiner Flassbeck and Costas Lapavitsas (Systemic_Crisis).  Flassbeck is  a former Vice Minister of Finance under left Social Democrat Oskar Lafontaine and seems to have formed an alliance with ostensible Marxist economist Lapavitsas to argue the case for exiting the euro as the only solution.  In doing so, they seem to have arguments very similar to those of many neoliberals like Dr Werner Sinn, now a leader of the new ‘exit party’ in Germany that calls for a return to the mark.  Lafontaine has also moved to this viewpoint.  So there is an alliance between some nationalist neoliberals and Keynesians for an exit policy.

The problem that I have with this exit policy is that it is a bit like the position of  the Irish Republican Army (IRA) on the issue of Irish unity.  The IRA argued that first we must end ‘the border’ that divided north and south Ireland and then we can adopt socialist policies.  Yet Ireland is still divided and still capitalist and the former leaders of the IRA now work within the existing two regimes for social change – a reversal of their old position.  The euro exit is also a ‘two-stage’  theory: first, we must exit the euro as the top priority and then we can talk about socialist policies to end the crisis.  I am sure that Lapavitsas and Amaral want to adopt policies for public ownership of the banks and major industrial sectors, public investment and a plan for Europe, but I think they obscure the battle against austerity by emphasising euro exit and devaluation as the major cure.  Surely, this is a diversion.

Why? Well,as I said in a  previous post
(http://thenextrecession.wordpress.com/2013/03/16/workers-punks-and-the-euro-crisis/), it is because the euro crisis is a crisis of capitalism and not a crisis of the euro. In other words, even if  the euro were to collapse and EMU states returned to running their own monetary and currency policies, the crisis would not go away and may even get 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 economies.  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 also 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 (see my post, http://thenextrecession.wordpress.com/2013/03/27/profitability-the-euro-crisis-and-icelandic-myths/).  If not Iceland, then Argentina in 2001 is dug up as a successful ‘exit’ strategy.  Argentina ended the peso’s peg with the dollar and devalued, apparently escaping its depression.  But for Greece it is not just a question of breaking a peg with the euro.  It will have to introduce a new drachma.  Would this new currency issued by an effectively bankrupt state have any exchange value whatsoever? Will the Russians accept a Cypriot pound in exchange for oil, and the Americans drachma in exchange for medicines?  Greece, which, unlike Argentina, is not a net exporter of raw materials with rising prices and so has little to support any new currency. Greeks can print as much as they like of it, but will they be able to buy electrical appliances, cars or even foods produced abroad with it?

And anyway, Argentina did not escape its crisis by breaking the peg with dollar.  Guglielmo Carchedi and I are just about to publish a paper (The long roots of the present crisis: Keynesians, Austerians and Marx’s law) that will show that it was not competitive devaluation that restored Argentina’s growth after the 2001 crisis, but default on state debt caused by the previous destruction of productive capital.  Argentina’s recovery was fuelled neither by devaluation nor by redistribution policies, but by the re-creation of previously destroyed private capital in the private sector with a low organic composition; a rising rate of exploitation; and improved efficiency. This is the cause—rather than Keynesian policies—of Argentina’s economic revival.

The euro project was unique in one way.  It was designed to achieve integration and convergence among various European capitalist states but without establishing a full federal union of Europe, with one government, one budget, one set of tax laws and one banking system. For a while, it seemed to work until the crisis came, although even in the boom years, there was more divergence than convergence.

Can the euro’s halfway house now survive?  It is clearly not going towards some federal union of European states, whatever the claims of the nationalist sceptics of UKIP or Front National.  A united states of Europe under capitalism is not on the agenda.  But the halfway house could lumber on if economic growth returns.  But growth depends on investment.  And investment has collapsed and not just in the weaker capitalist economies of the Eurozone.

The figure above is from Greek Default Watch (http://www.greekdefaultwatch.com/2013/05/the-eurozone-since-2007-in-one-image.html).  The first column shows real GDP indexed at 100 in 2007.  The Eurozone as a whole by 2012 remained below the level of 2007.  And most Eurozone economies are still well below their 2007 levels – Greece is down 21%.  The next columns show the changes in GDP since 2007 by expenditure sectors.  The drop in GDP is really a factor of Germany growing (+€85 billion) but without a supporting cast to offset the declines in Italy (-€102 billion), Spain (-€40 billion) and Greece (€42 billion). On a net basis, Italy’s decline accounts for the bulk of the decline in the overall Eurozone, while Germany’s gain offsets the decline in Greece and Spain and the rest of the union is more or less even.

The Eurozone has a clear investment problem: investment rose in only one of the 17 countries (Luxembourg).  The issue of external competitiveness that the Keynesian exit economists emphasise, just like the neoclassical neoliberals is less important.  For the seven countries whose 2012 GDP was higher than in 2007, net exports made a big difference in only three cases; of the ten countries where GDP declined, net trade made a material contribution in seven, but this was not enough to offset the decline in investment. In other words, the problem for the weaker Euro capitalist states is not external competitiveness, but investment— it’s a very conventional capitalist crisis.

And as I have shown in previous posts, investment under capitalism depends on restoring profitability.  Yet, with the exception of Ireland, all the peripheral EMU economies still have much lower rates of profit than their peaks before the global crisis of capitalism hit. With the exception of Italy, profitability did recover in 2012, while in the case of Ireland, profitability turned round as early as 2010.

It’s a halfway house.  Austerity is working but very slowly.  Last Monday, ECB Board member Jörg Asmussen denied that there is a “Euro Crisis”, though he admitted Europe has ‘a decade of “adjustments” ahead.  Can the euro project survive another five or more years of austerity?  Is it half full of success or half empty?

There is a third way out of the Eurozone’s crisis: a socialist option.  That would involve Eurozone governments renegotiating and writing off public sector debt owed to the banks and other financial entities.  To pay for the losses that the banks incur, rich bank share and bond holders would be liquidated and Europe’s big 30 banks would be taken into public ownership.  They would become part of a Europe-wide New Deal to start public investment projects that could deliver jobs and housing and new technology. Governments would share Europe-wide revenues from each according to their abilities and to each according to their needs – as in a proper political and fiscal union based on common ownership and under a democratically endorsed plan for growth and welfare.

Of course, such a ‘Soviet Europe’ is not on the agenda and is thus utopian.  But then exit from the Eurozone by ‘oppressed states’ is also not on the agenda of any government in the Eurozone or even in the main opposition parties.  So it is equally ‘utopian’ with the added problem that it would not solve anything.

Leaders of Leftist parties like Syriza from Greece, IU from Spain, Front de Gauche in France etc have been meeting to discuss a joint programme for the Euro 2014 elections (http://www.publico.es/456053/la-izquierda-europea-se-pone-en-marcha-para-conquistar-bruselas).  Will that programme adopt the vision I expressed above or not?  If not, then we are faced with years (decade?) of more austerity.

Heterodox economics: where are you?

I thought this diagram from the Louis-Auguste Blanqui Facebook site was a pretty good description of the various strands of economic thought on crisis theory.  Marx is put bottom left and I would put myself there too.

It is an interesting course that this American anti-capitalist group is doing:  http://crisistheory4anticaps.wordpress.com/

Michael Heinrich, Marx’s law and crisis theory

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Inequality: there’s no stopping it!

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Spain: the return of the Inquisition

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

More confusions on the recovery

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Iceland’s electors: how ungrateful!

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

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

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

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

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

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

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

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

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

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