A war economy?

If all country pandemics were the same, then the figure below would be how this pandemic will come to an end.  The start-to-peak ratio of Covid-19 infections for all countries would be 40-50 days. Many countries are not yet near the peak point and there is no guarantee that the peak will be at the same time point, if mitigation and suppression methods (testing, self-isolation, quarantine and lockdowns) are not working similarly.  But ultimately, there will be a peak everywhere and the pandemic will wane – if only to come back next year, maybe.

What is clear is that the lockdowns in so many major economies have and will deliver a humungous slump in production, investment, employment and incomes in most economies.  The OECD sums up the picture best.  The impact effect of business closures could result in reductions of 15% or more in the level of output throughout the advanced economies and major emerging-market economies. In the median economy, output would decline by 25%…. “For each month of containment, there will be a loss of 2 percentage points in annual GDP growth”.

Looking back in my book, The Long Depression, I found that the loss of GDP from the beginning of Great Recession in 2008 through the 18 months to the trough in mid-2009 was over 6% of GDP in the major economies.  Global real GDP fell about 3.5% over that period, while the so-called emerging market economies did not contract (because China continued to expand).

In this pandemic, if the major economies are locked down for two months and maybe more (China’s Wuhan lockdown will not be relieved until next week; so that’s more than two months), then global GDP is likely to contract in 2020 by more than in the Great Recession.

Of course, the hope is that the lockdowns will be short-lived.  As OECD general secretary Gurria said, “we don’t know how long it’s going to take to fix unemployment and the closures of millions of small businesses: but it’s wishful thinking to talk about a quick recovery.”  Clearly the idea of President Trump that America can get back to business by Easter Sunday is not realistic.

Nevertheless, on that hope that lockdowns will be short-lived and because they have no other choice if the pandemic is to be suppressed, pro-capitalist governments have thrown the kitchen sink at their economies in order to avoid the worst.  The first priority has been to save capitalist businesses, especially the large companies.  So central banks have cut their policy interest rates to zero or below; and they have announced a myriad of credit facilities and bond purchasing programmes that dwarf the bailouts and quantitative easing measures of the last ten years.  Governments have announced loan guarantees and grants for businesses at amounts never seen before.

Globally, I calculate that governments have announced fiscal ‘stimulus’ packages of around 4% of GDP and another 5% of GDP in credit and loan guarantees to the capitalist sector.  In the Great Recession, fiscal bailouts totalled only 2% of world GDP.

If we take the $2trn package agreed by the US Congress, way more than during the global financial meltdown in 2008-9, two-thirds of it will go in outright cash and loans that may not be repaid to big business (travel companies etc) and to smaller businesses, but just one-third to helping the millions of workers and self-employed to survive with cash handouts and tax deferrals.

It’s the same in the UK and Europe with the pandemic packages: first, save capitalist business; and second, tide over working people. The payments for workers laid off and the self-employed are only expected to be in place for two months and often people won’t receive any cash for weeks, if not months.  So these measures are way short of providing sufficient support for the millions that have already been locked down or have seen their companies lay them off.

It really is naïve, if not ignorant, of Nobel prize winning economists like Joseph Stiglitz, Chris Pissarides or Adam Posen to praise such schemes as the UK’s governments, just because it is “more generous” than the one in the US.  “The U.K. deserves credit for really reversing its austerity and being very ambitious and coherent,” said Posen, who was a financial crisis-era policy maker at the BOE. “The wish-list in terms of design, size, content and coordination — all is terrific.”  British arch-Keynesian Will Hutton summed up the mood: “a Rubicon has been crossed. Keynesianism has been restored to its proper place in British public life.” Even the erstwhile Austerians joined the chorus of praise, including former austerity UK Chancellor, George Osborne.

The British and American public also seem to be convinced that the packages are generous, as the latest polls suggest a pick-up in support for the mendacious President Trump and ‘Operation Last Gasp’ Prime Minister Johnson.  It seems everywhere incumbent rulers have gained support during the crisis.  That may not last, however, if the lockdowns continue and slump begins to bite deep.

The reality is that the money being shifted towards working people compared to big business is minimal.  For example, the UK package offers an 80% of wages payout for employees and self-employed.  But that is actually no more than the usual unemployment benefits ratio offered by many governments in Europe.  The UK had a very low benefit ratio that is now being raised to the European average and then only for a few months.  And even then there are millions who will not qualify.

Moreover, none of these measures will avoid the slump and they are way insufficient to restore growth and employment in most capitalist economies over the next year.  There is every possibility that this pandemic slump will not have a V-shaped recovery as most mainstream forecasts hope for.  A U shaped recovery (ie a slump lasting a year or more) is more likely.  And there is a risk of a very slow recovery, more like a bent L-shape, as is appearing in China, so far.

Indeed, mainstream economics is not sure what to do.  The Keynesian view is presented to us by Lord Skidelsky, Keynes’ biographer.  Skidelsky pointed out that the lockdowns were the opposite of the typical Keynesian problem of ‘deficient demand’.  Indeed, it is a problem of deficient supply as most productive workers have stopped work. But Skidelsky does not see it that way.  You see, he reckons that it is not a ‘supply shock’ but a problem of ‘excess demand’.  But ‘excess demand’ is the mirror of ‘scarce supply’.  The question is where do we start: surely it starts with the loss of output and value creation, not with ‘excess demand’?

Skidelsky tells us that “a recession is normally triggered by a banking failure or a collapse in business confidence. Output is cut, workers are laid off, spending power falls and the slump spreads through a multiplied reduction in spending. Supply and demand fall together until the economy is stabilised at a lower level. In these circumstances, Keynes said, government spending should rise to offset the fall in private spending.”

Readers of my blog know well that I consider, that while a recession may be “triggered” by a banking failure or “a collapse in business confidence”, these triggers are not the underlying cause of recurring crises in capitalism.  Why do banking failures sometimes not cause a slump and why do businesses suddenly have a collapse in confidence?  Keynesian theory cannot tell us.

Skidelsky goes on that if the crisis is one of “excess demand”, then we need to reduce demand to meet supply!  I would have thought it would be better to get out of this slump by raising output to meet demand, but there we go.  Skidelsky points out that “It is not that business wants to produce less. It is forced to produce less because a section of its workforce is being prevented from working. The economic effect is similar to wartime conscription, when a fraction of the workforce is extracted from civilian production. Production of civilian goods falls, but aggregate demand remains the same: it is merely redistributed from workers producing civilian goods to workers conscripted into the army or reallocated to producing munitions. What happens today will be determined by what happens to the spending power of those made compulsorily idle.”

Really? In the war economy, everybody is still working – indeed during the second world war, there was in effect full employment as the war machine was pumped up.  Currently we are heading for the biggest rise in unemployment in a few quarters in economic history.  This is no war economy.

Skidelsky reminds us that Keynes’s solution in the war economy of ‘excess demand’ was to propose an increase in taxation.  “In his pamphlet How to Pay for the War (1940). civilian consumption, he said, had to be reduced to release resources for military consumption. Without an increase in voluntary saving, there were only two ways to reduce civilian consumption: inflation or higher taxes.”  “The solution he and the Treasury jointly hit on was to raise the standard rate of income tax to 50 per cent, with a top marginal rate of 97.5 per cent, and lower the threshold for paying taxes. The latter would bring 3.25m extra taxpayers into the income tax net. Everyone would pay the increased taxes which the war effort demanded, but the tax payments of the three million would be repayable after the war in the form of tax credits. There would also be rationing of essential goods.”

Wow!  So Skidelsky’s answer to the current slump is to raise taxation, even for those at the bottom of the income scale in order to stop them spending too much and causing inflation!  He finishes by saying that the pandemic “should deepen our understanding of what it is to be a Keynesian.”  Indeed.

The current situation is not a war economy, as James Meadway says.  When the so-called Spanish flu pandemic hit, it was right at the end of the first world war.  That pandemic claimed 675,000 lives in the US and at least 50 million worldwide.  The flu did not destroy the US economy.  In 1918, the year in which influenza deaths peaked in the US, business failures were at less than half their pre-war level, and they were lower still in 1919 (see chart). Driven by the wartime production effort, US real GDP rose by 9% in 1918, and by around 1% the following year even as the flu raged.

Of course, then there were no lockdowns and people were just left to die or live. But the point is that, once the current pandemic lockdowns end, what is needed to revive output, investment and employment is something like a war economy; not bailing out big business with grants and loans so that they can return to business as usual.  This slump can only be reversed with war time-like measures, namely massive government investment, public ownership of strategic sectors and state direction of the productive sectors of the economy.

Remember, even before the virus hit the global economy, many capitalist economies were slowing fast or already in outright recession.  In the US, one of the better performing economies, real GDP growth in Q4 had fallen to under 2% a year with forecasts of further slowdown this year.  Business investment was stagnating and non-financial corporate profits had been on downward trend for five years.  The capitalist sector was and is in no shape to lead an economic recovery that can lead back to full employment and rising real incomes.  It will require the public sector to lead.

Andrew Bossie and J.W. Mason have just published a perceptive paper on the experience of that public sector role in the war-time US economy. They show that all sorts of loan guarantees, tax incentives  etc were offered by the Roosevelt administration to the capitalist sector to begin with.  But it soon became clear that the capitalist sector could not do the job of delivering on the war effort as they would not invest or boost capacity without profit guarantees.  Direct public investment took over and government-ordered direction was imposed.

Bossie and Mason found that from 8 to 10 percent of GDP during the 1930s, federal spending rose to an average of around 40 percent of GDP from 1942 to 1945. And most significant, contract spending on goods and services accounted for 23 percent on average during the war.  Currently in most capitalist economies public sector investment is about 3% of GDP, while capitalist sector investment is 15%-plus. In the war that ratio was reversed.

I had shown the same result in a post of mine back in 2012.  I quote: “What happened was a massive rise in government investment and spending.  In 1940, private sector investment was still below the level of 1929 and actually fell further during the war.  So the state sector took over nearly all investment, as resources (value) were diverted to the production of arms and other security measures in a war economy.”  Keynes himself said that the war economy demonstrated that “It is, it seems, politically impossible for a capitalistic democracy to organize expenditure on the scale necessary to make the grand experiments which would prove my case — except in war conditions.”

The war economy did not stimulate the private sector, it replaced the ‘free market’ and capitalist investment for profit.  To organize the war economy and to ensure that it produced the goods needed for war, the Roosevelt government spawned an array of mobilization agencies which not only often purchased goods but closely directed those goods’ manufacture and heavily influenced the operation of private companies and whole industries.

Bossie and Mason conclude that: “the more—and faster—the economy needs to change, the more planning it needs. More than at any other period in US history, the wartime economy was a planned economy. The massive, rapid shift from civilian to military production required far more conscious direction than the normal process of economic growth. The national response to the coronavirus and the transition away from carbon will also require higher than normal degrees of economic planning by government.”

What the story of the Great Depression and the war showed was that, once capitalism is in the depth of a long depression, there must be a grinding and deep destruction of all that capitalism had accumulated in previous decades before a new era of expansion becomes possible. There is no policy that can avoid that and preserve the capitalist sector. If that does not happen this time, then the Long Depression that the world capitalist economy has suffered since the Great Recession could enter another decade.

The major economies (let alone the so-called emerging economies) will struggle to come out of this huge slump unless the law of market and value is replaced by public ownership, investment and planning, utilising all the skills and resources of working people.  This pandemic has shown that.

Lockdown!

According to AFP estimates, some 1.7 billion people across the world are now living under some form of lockdown as a result of the coronavirus. That’s almost a quarter of the world population.  The world economy has seen nothing like this.

Nearly all economic forecasts for global GDP in 2020 are for a contraction of 1-3%, as bad if not worse than in the Great Recession of 2008-9.  And forecasts for the major economies for this quarter ending this week and the next quarter are coming in at an annualised drop of anything between 20-50%! The economic activity indicators (called PMIs), which are surveys of company views on what they are doing, are recording all-time lows of contraction for March.

US composite PMI to March 2020

This is all due to the lockdown of businesses globally and isolation of workers in their homes. Could the lockdowns have been avoided so that this drastic ‘supply shock’ would not have been necessary in order to cope with the pandemic?  I think it probably could.  If governments had acted immediately with the right measures when COVID-19 first appeared, the lockdowns could have been averted.

What were these right measures?  What we now know is that everybody over the age of 70 years and/or with medical conditions should have gone into self-isolation.  There should have been mass testing of everybody regularly and anybody infected quarantined for up to two weeks.  If this had been done from the beginning, then there would have been fewer deaths, hospitalisations and a quicker dying out of the virus.  So lockdowns could probably have been avoided.

But testing and isolation was not done at the beginning in China.  At first there was denial and a cover-up of the virus risk.  By the time the Chinese authorities acted properly with testing and isolation, Wuhan was inundated and a lockdown had to be applied.

At least the Chinese had the excuse that this was a new virus unknown to humans and its level of infection, spread and mortality was not known before. But there is no excuse for governments in the major capitalist economies. They had time to prepare and act.  Italy left it too late to apply testing and isolation so that the lockdown there was closing the doors after the virus had bolted.  Their health system is now overloaded and can hardly cope.

There were some countries that did adopt mass testing and effective isolation.  South Korea did both; and Japan where 90% of the population wore masks and gloves and washed, appears to have curbed the impact of the pandemic through effective self-isolation without having a lockdown.

Similarly, in one small Italian village amid the pandemic, Vo Euganeo, which actually had Italy’s first virus death, they tested all 3000 residents and quarantined the 3% affected, even though most had no symptoms.  Through isolation and quarantine, the lockdown there lasted only two weeks.

At the other extreme, the UK and the US have taken ages to ramp up testing (which is still inadequate) and get the vulnerable to self-isolate.  In the US, the federal government is still not going for a state-wide lockdown.

Why did the G7 governments and others fail to act?  As Mike Davis explains, the first and foremost reason was that the health systems of the major economies were in no position to act.  Over the last 30 years, public health systems in Europe have been decimated and privatised. In the US, the dominant private sector has slashed services in order to boost profits.  According to the American Hospital Association, the number of in-patient hospital beds declined by an extraordinary 39% between 1981 and 1999. The purpose was to raise profits by increasing ‘census’ (the number of occupied beds). But management’s goal of 90% occupancy meant that hospitals no longer had the capacity to absorb patient influx during epidemics and medical emergencies.

As a result, there are only 45,000 ICU beds available to deal with the projected flood of serious and critical corona cases. (By comparison, South Koreans have more than three times more beds available per thousand people than Americans.) According to an investigation by USA Today “only eight states would have enough hospital beds to treat the 1 million Americans 60 and over who could become ill with COVID-19.”

Local and state health departments have 25% less staff today than they did before Black Monday 12 years ago. Over the last decade, moreover, the CDC’s budget has fallen 10% in real terms. Under Trump, the fiscal shortfalls have only been exacerbated. The New York Times recently reported that “21 percent of local health departments reported reductions in budgets for the 2017 fiscal year.”  Trump also closed the White House pandemic office, a directorate established by Obama after the 2014 Ebola outbreak to ensure a rapid and well-coordinated national response to new epidemics.

The for-profit nursing home industry, which warehouses 1.5 million elderly Americans, is highly competitive and is based on low wages, understaffing and illegal cost-cutting. Tens of thousands die every year from long-term care facilities’ neglect of basic infection control procedures and from governments’ failure to hold management accountable for what can only be described as deliberate manslaughter. Many of these homes find it cheaper to pay fines for sanitary violations than to hire additional staff and provide them with proper training.

The Life Care Center, a nursing home in the Seattle suburb of Kirkland, is “one of the worst staffed in the state” and the entire Washington nursing home system “as the most underfunded in the country—an absurd oasis of austere suffering in a sea of tech money.” (Union organiser).  Public health officials overlooked the crucial factor that explains the rapid transmission of the disease from Life Care Center to nine other nearby nursing homes: “Nursing home workers in the priciest rental market in America universally work multiple jobs, usually at multiple nursing homes.” Authorities failed to find out the names and locations of these second jobs and thus lost all control over the spread of COVID-19.

Then there is big pharma.  Big pharma does little research and development of new antibiotics and antivirals. Of the 18 largest US pharmaceutical companies, 15 have totally abandoned the field. Heart medicines, addictive tranquilizers and treatments for male impotence are profit leaders, not the defences against hospital infections, emergent diseases and traditional tropical killers. A universal vaccine for influenza—that is to say, a vaccine that targets the immutable parts of the virus’s surface proteins—has been a possibility for decades, but never deemed profitable enough to be a priority.

I have argued in previous posts that COVID-19 was not a bolt of the blue.  Such pandemics have been forecast well in advance by epideomologists, but nothing was done because it costs money.  Now it’s going to cost a lot more.

The global slump is here.  But how long and how deep will it be?  Most forecasts talk about a short, sharp drop followed by a quick recovery.  Will that happen?  It depends on how quickly the pandemic can be controlled and fade away – at least for this year.  On 8 April, the lockdown in Wuhan will be lifted as there are no new cases.  So, from the emergence of virus there in January, it will be about three months, with a lockdown of over two months.  It also seems that the peak of the pandemic may have been reached in Italy which has been in full lockdown for only two weeks.  So perhaps in another month or two, Italy will be freed.  But other countries like the UK are just entering a lockdown phase, with others still facing exponential growth in cases which may require lockdowns.

So it seems that an end to the global supply shock is unlikely before June, probably much later.  Of course, the production collapse could be reversed earlier if governments decide not to have lockdowns or to end them early.  The Trump administration is already hinting at lifting any lockdown in the next 15 days ‘to get the economy going’ (at the expense of more deaths etc); but many state governors may not go along with that.

Even if economies do bounce back in the second half of 2020 as the lockdowns are ended, there will still be a global slump.  And it is a vain hope that recovery will be quick and sharp in the second half of this year.  There are two reasons to doubt that. First, the global economy was already slipping into recession before the pandemic hit.  Japan was in recession; The Eurozone was close to it and even US growth had slowed to under 2% a year.

And many large so-called emerging economies like Mexico, Argentina and South Africa were already contracting. Indeed, capital was flooding out of the global south to the north, a process than has now accelerated with the pandemic to record levels.  With the collapse in energy and industrial metal prices, many commodity-based emerging economies (Brazil, Russia, Saudi Arabia, Indonesia, Ecuador etc) face a huge drop in export revenues.  And this time, unlike 2008, China will not quickly return to its old levels of investment, production and trade (especially as the trade war tariffs with the US remain in place).  For the whole year, China’s real GDP growth could be as low as 2%, compared to over 6% last year.

With the collapse in energy and industrial metal prices, many commodity-based emerging economies (Brazil, Russia, Saudi Arabia, Indonesia, Ecuador etc) face a huge drop in export revenues.  And this time, unlike 2008, China will not quickly return to its old levels of investment, production and trade (especially as the trade war tariffs with the US remain in place).  For the whole year, China’s real GDP growth could be as low as 2%, compared to over 6% last year.

Second, stock markets are jumping back because of the recent Fed credit injections and the expected huge US Congress fiscal measures.  But this slump will not be avoided by central bank largesse or the fiscal packages being planned. Once a slump gets under way, incomes collapse and unemployment rises fast. That has a cascade or multiplier effect through the economy, particularly for non-financial companies in the capitalist sector.  This will lead to a sequence of bankruptcies and closures.

And corporate balance sheets are dangerously frail. Across the major economies, concerns have been rising over mounting corporate debt. In the United States, against the backdrop of decades-long access to cheap money, non-financial corporations have seen their debt burdens more than double from $3.2 trillion in 2007 to $6.6 trillion in 2019.

A recent paper by Joseph Baines and Sandy Brian Hager starkly reveals all.   For decades, the capitalist sector has switched from investing in productive assets and moved to investing in financial assets – or ‘fictitious capital’ as Marx called it. Stock buybacks and dividend payments to shareholders have been the order of the day rather than re-investing profits into new technology to boost labour productivity. This particularly applied to larger US companies.

As a mirror, large companies have reduced capital expenditure as a share of revenues since the 1980s.  Interestingly, smaller companies engaged less in ‘financial engineering’ and continued to raise their investment.  But remember the bulk of investment comes from the large companies.

The vast swathe of small US firms is in trouble.  For them, profit margins have been falling.  As a result, the overall profitability of US capital has fallen, particularly since the late 1990s.  Baines and Hager argue that “the dynamics of shareholder capitalism have pushed the firms in the lower echelons of the US corporate hierarchy into a state of financial distress.”  As a result, corporate debt has risen, not only in absolute dollar terms, but also relative to revenue, particularly for the smaller companies.

Everything has been held together because the interest on corporate debt has fallen significantly, keeping debt servicing costs down.  Even so, the smaller companies are paying out interest at a much higher level than the large companies. Since the 1990s, their debt servicing costs have been more or less steady, but are nearly twice as high as for the top ten percent.

But the days of cheap credit could be over, despite the Fed’s desperate attempt to keep borrowing costs down.  Corporate debt yields have rocketed during this pandemic crisis.  A wave of debt defaults is now on the agenda.  That could “send shockwaves through already-jittery financial markets, providing a catalyst for a wider meltdown.”

Even if the lockdowns last only a few months through to the summer, that contraction could see hundreds of small firms go under and even some big fish too.  The idea that the major economies can have a V-shaped recovery seems much less likely than a L-shaped one.

The ’emerging market’ slump

Forecasts of a global slump in the rest of 2020 are coming in droves from mainstream economists – it’s now the consensus that there will be a contraction in global real GDP in at least two consecutive quarters (Q1 and Q2), in the wake of COVID-19 pandemic and the ‘lock down’ in response.

The International Institute of Finance (IIF), the research body of international banks, now reckons that the US will contract by annualised 10% by end-June and Europe by 18%.

Deutsche Bank economists reckon that the first half of 2020 will experience the worst slump since the 1930s.  “The quarterly declines in GDP growth we anticipate substantially exceed anything previously recorded going back to at least World War II.”  Oxford Economics reckons the US economy will contract at annual rate of 12% by end-June.

But the mainstream remains optimistic.  All forecast a sharp recovery in the second half of 2020.  China is recovering fast, the argument goes, and by September the major capitalist economies will bounce back, once the pandemic subsides or the authorities are able to contain it (as they appear to have done in China, Korea and Japan).

But even if that optimistic scenario is born out, the hit to economies will mean no growth at all globally over the whole year.  And that is after 2019, which saw a significant slowdown to near what the IMF calls a ‘stall speed’ of 2.5%.  The Chinese economy, which has been hugely hit by the virus and the lockdown, was slowing even before the coronavirus crisis. That means even a powerful stimulus programme in China would struggle to boost global growth.

And this is the point that I want to emphasise – there is much talk about fiscal and monetary measures to alleviate the slump in the advanced capitalist economies.  But there is little talk about the devastating hit to the billions in the so-called ‘Global South’.  Many larger economies there were already in a recession – Mexico, Argentina, South Africa etc.  And now the double-whammy of a collapse in commodity prices, particularly energy, will hit many ‘global south’ economies depending on staple commodities as their main exports. It is the sharpest fall in commodity prices since 1986.

Crude oil price $/b

There has already been a flight of capital from these countries, partly rich nationals getting their money out and partly foreign investors doing the same. The outflow due to COVID-19 is much faster than any previously.  An ’emerging market’ slump is already here and will intensify.

Everywhere corporate debt has soared during the long and weak ‘expansion’ since 2009.

The growth in debt has been fastest in the so-called developing economies. As economists at the World Bank point out, “most of the increase in debt since 2010 has been in emerging market and developing economies (EMDEs), which saw their debt rise by 54 percentage points of GDP to a record high of about 170% of GDP in 2018. This increase has been broad-based, affecting around 80% of EMDEs.”

Debt in emerging market and developing economies, 1970-2018

Note: Aggregates calculated using current U.S. dollar GDP weight and shown as a 3-year moving average. Gray vertical lines represent start of debt waves in 1970, 1990, 2002, and 2010. Dashed lines refer to emerging market and developing economies excluding China.

As the World Bank guys say, “Despite the sharp rise in debt, growth in these economies has repeatedly disappointed, and they face weaker growth prospects in a fragile global economy. In addition to their rapid debt build-up, they have accumulated other vulnerabilities, such as growing fiscal and current account deficits and a riskier composition of debt”.

Growth and debt

Note: Total debt (in percent of GDP) and real GDP growth (GDP-weighted average at 2010 prices and exchange rates) in in emerging market developing economies.

Much of this debt is denominated in US dollars and as that hegemonic currency increased in value as a ‘safe haven’, the burden of repayment will mount for the dominated economies of the ‘south’. The level of EM corporate ‘hard currency’ debt is significantly higher now than in 2008. According to the IMF’s October 2019 Financial Stability Report, the median external debt of emerging market and middle-income countries increased from 100 per cent of GDP in 2008 to 160 per cent of GDP in 2019.

And there is little room to boost government spending to alleviate the hit. The ‘developing’ countries are in a much weaker position compared with the global financial crisis of 2008-09. In 2007, 40 emerging market and middle-income countries had a combined central government fiscal surplus equal to 0.3 per cent of gross domestic product, according to the IMF. Last year, they posted a fiscal deficit of 4.9 per cent of GDP.  The government deficit of EMs in Asia went from 0.7 per cent of GDP in 2007 to 5.8 per cent in 2019; in Latin America, it rose from 1.2 per cent of GDP to 4.9 per cent; and European EMs went from a surplus of 1.9 per cent of GDP to a deficit of 1 per cent.

The pandemic risks creating a global depression for EMs.  The IMF’s recent announcement that it stands ready to mobilise up to $1tn of lending will do little. First, only $50bn can be deployed to emerging markets and only $10bn to low-income members.  Meanwhile outward capital flows from EM since the onset of the pandemic have already reached over $50bn.

The impact on billions of people from the global slump and the collapse in commodity prices will be severe.  The International Labour Organizaton (ILO) has just published: COVID-19 and world of
work: Impacts and responses (wcms_738753).

Initial ILO estimates point to a significant rise in unemployment and underemployment in the wake of the virus. Preliminary ILO estimates indicate a rise in global unemployment of between 5.3 million (“low” scenario) and 24.7 million (“high” scenario) from a base level of 188 million in 2019. The “mid” scenario suggests an increase of 13 million (7.4 million in high-income countries). “Though these estimates remain highly uncertain, all figures indicate a substantial rise in global unemployment.” For comparison, the global financial crisis of 2008-9 increased unemployment by 22 million.

Underemployment is also expected to increase on a large scale. And as witnessed in previous crises, the shock to labour demand is likely to translate into significant downward adjustments to wages and working hours.  The loss in labour incomes could reach $3.4trn!  “At this point, a preliminary estimate (up to 10 March) suggests that infected workers have already lost nearly 30,000 work months, with the consequent loss of income (for unprotected workers). Employment impacts imply large income losses for workers. Overall losses in labour income are expected in the range of between 860 and 3,440 billion USD. The loss of labour income will translate into lower consumption of goods and services, which is detrimental to the continuity of businesses and ensuring that economies are resilient.”

Working poverty is also likely to increase significantly. The strain on incomes resulting from the decline in economic activity will devastate workers close to or below the poverty line. The growth impacts of the virus used for the unemployment estimates above suggest an additional 8.8 million people in working poverty around the world than originally estimated (i.e. an overall decline of 5.2 million working poor in 2020 compared to a decline of 14 million estimated pre-COVID-19). Under the mid and high scenarios, there will be between 20.1 million and 35.0 million more people in working poverty than before the pre-COVID-19 estimate for 2020.

There are few or no ‘safety nets’ in these countries. The hit to working people in the advanced capitalist countries from a global slump, even if short-lived, will be severe, especially after years of austerity and wage suppression. But for the billions in the ‘developing’ countries, it will be devastating.

Engels’ pause and the condition of the working class in England

On this day, 15 March 1845, Friedrich Engels published his masterpiece of social analysis, The Condition of the Working Class in England.  This year is the 200th anniversary of Engels’ birth.  Below is a short (rough) extract from my upcoming book on the contribution that Engels made to Marxian political economy. 

Engels was just 24 years old when he wrote the Condition.  He had already developed left-wing ideas when he was despatched to England at the end of 1842 to work in the family firm of Ermen and Engels, manufacturers of sewing thread in Manchester. He arrived in England only weeks after the Chartist general strike of 1842 which, despite its eventual failure, had demonstrated the potential power of the workers. The strike’s centre was in Manchester and the surrounding areas of Lancashire and Cheshire, the areas of textile production. England was by far the most advanced industrial economy in the world, having been the scene of the Industrial Revolution. It was already leading the world in the production of cotton, coal and iron. Its working class was also the most advanced in the world, organised through the Chartist movement.

Engels was horrified at the poverty and misery that he saw in Manchester. The city had grown up around the cotton industry and was a mass of filthy slums. Infant mortality, epidemic diseases and overcrowding were all facts of life. Up to a quarter of the city’s population were immigrant Irish, driven there by even worse conditions in their own country. Poverty had existed in the old towns and rural areas – as it had done in Germany – but the growth of the big cities exacerbated and accentuated these conditions.

The new working class soon accounted for the mass of the population, as capitalist methods of manufacturing destroyed many of the old artisan or middle classes, turning the bulk of them or their children into workers. The needs of manufacturing industry led to the building of factories and mills and there was rapid urbanisation.’ Industrial towns then developed into the great cities that Engels observed when he first visited England.

In the evenings and weekend when not working for his father’s firm, Engels went with his new girlfriend and factory worker, Mary Burns, to various working-class districts.  In the book, he describes in great detail the condition of life in these cities, using a variety of contemporary press reports, official investigations and even diagrams of the back-to-back houses which formed the early Manchester slums. Engels summed up the position of the poorest. “In 1842 England and Wales counted 1,430,000 paupers, of whom 222,000 were incarcerated in workhouses – Poor law Bastilles the common people call them. – Thanks to the humanity of the Whigs! Scotland has no poor law, but poor people in plenty. Ireland, incidentally, can boast of the gigantic number of 2,300,000 paupers.”

But Engels’ book is much more than reportage of the terrible conditions in which workers lived. Woven into it is an economic analysis of capitalism which Marx and Engels later developed, but which even at this stage was central to the book’s analysis. Engels starts by looking at how the industrial revolution transformed the old ways of working to such an extent that it created a whole class of wage labourers, the proletariat. The introduction of machinery into the production of textiles, coal and iron turned the British economy into the most dynamic in the world, creating a mass of communications networks – iron bridges, railways, canals – which in turn led to more industrial development.

Engels describes the very nature of the capitalist system. The competition between capitalists leads them to pay their workers as little as possible, while trying to squeeze more and more work from them: ‘If a manufacturer can force the nine hands to work an extra hour daily for the same wages by threatening to discharge them at a time when the demand for hands is not very great, he discharges the tenth and saves so much wages. This leads in turn to competition between workers for jobs, and to the creation of a pool of unemployed who can be pulled into the workforce when business is booming and laid off again when it is slack”. The existence of this reserve army of unskilled and unemployed workers – especially among the immigrant Irish in the cities of the 1840s – holds down the level of wages and conditions for all workers.

Engels developed a theory of wages.  It was the intraclass competition between workers that was “the sharpest weapon against the proletariat in the hands of the bourgeoisie,” which explains “the effort of the workers to nullify this competition by associations.”  In the absence of union counterpressure, the advantage is with the employing class, which “has gained a monopoly of all means of existence,” and “which is protected in its monopoly by the power of the state.”  That unionisation helps to sustain real wage levels and the share of labour in output has since been borne out by many studies.

And ahead of Marx, Engels began to explain how workers were exploited despite receiving a ‘fair day’s pay for a fair day’s work’.  Engels: “The bourgeoisie “offers [the proletarian] the means of living, but only for an ‘equivalent,’ for his work,” and it “even lets him have the appearance of acting from free choice, of making a contract with free, unconstrained consent, as a responsible agent who has attained his majority,” though he is “in law and in fact, the slave of the bourgeoisie.” Thus “the worker of today seems to be free because he is not sold once for all, but piecemeal by the day, the week, the year, and because no one owner sells him to another, but he is forced to sell himself in this way instead, being the slave of no particular person, but of the whole property-holding class”.  Later Marx would fully develop this notion into the category of ‘labour power’ as the object of purchase by employers.

Another brilliant concept developed by Engels was to anticipate Marx’s general law of accumulation and its dual nature.  On the one hand, the introduction of new machinery or technology leads to the loss of jobs for those workers using outdated technology.  On the other hand, the new industries and techniques could create new jobs.  Again, this debate over the impact of technology and jobs is topical with the advent of robots and artificial intelligence now.

Engels describes domestic spinning and weaving under conditions of “constant increase in the demand for the home market keeping pace with the slow increase of population.”  The “victory of machine-work over hand-work” – reflecting the competitive advantage of the new technologies – entailed “a rapid fall in price of all manufactured commodities, prosperity of commerce and manufacture, the conquest of nearly all the unprotected foreign markets, the sudden multiplication of capital and national wealth”; and also “a still more rapid multiplication of the proletariat” and “the destruction of all property-holding and of all security of employment for the working-class”.  So industrialisation and the introduction of machinery destroy small businesses and self-employment and drive people into large workplaces where jobs appear as companies with better technology and lower costs can gain market share at home and abroad.

Empirical evidence supports Engels’ thesis. Carl Frey reckons that the early inventions of the Industrial Revolution were predominantly labour-replacing: “If technology replaces labour in existing tasks, wages and the share of national income accruing to labour may fall. If, in contrast, technological change is augmenting labour, it will make workers more productive in existing tasks or create entirely new labour-intensive activities, thereby increasing the demand for labour.”

The divergence between output and wages, in other words, is consistent with this being a period where technology was primarily replacing labour. Artisan workers in the domestic system were replaced by machines, often tended by children—who had very little bargaining power and often worked without wages. “The growing capital share of income meant that the gains from technological progress were very unequally distributed: corporate profits were captured by industrialists, who reinvested them in factories and machines”.

There was a growing gap between wages and productivity growth as workers were displaced by new technology and nominal wages were kept stagnant,  Robert Allen has characterised the period, particularly after the end of the Napoleonic Wars up to the time that Engels arrived in Manchester as the ‘Engels pause’.

However, Engels also offers the other side of the coin.  There are “other circumstances” at play including re-employment generated by the reduced costs resulting from new technology: “The introduction of the industrial forces already referred to for increasing production leads, in the course of time, to a reduction of prices of the articles produced and to consequent increased consumption, so that a large part of the displaced workers finally, after long suffering, find work again in new branches of labour.”

Engels vehemently rejected the Malthusian explanation.  Population growth is a response to growing employment opportunities, not vice versa: But this argument is not an apology for capitalism, because new jobs don’t last: “as soon as the operative has succeeded in making himself at home in a new branch, if he actually does succeed in so doing, this, too, is taken from him, and with it the last remnant of security which remained to him for winning his bread.”

And he carefully notes the views of workers themselves: “that wages in general have been reduced by the improvement of machinery is the unanimous testimony of the operatives. The bourgeois assertion that the condition of the working-class has been improved by machinery is most vigorously proclaimed a falsehood in every meeting of working-men in the factory districts.”

Was Engels (and the workers he talked to) right about the lack of growth in real wages in 1840s Britain?  Economic historians since, on the whole, agree. ‘Engels pause’ has been confirmed. As per capita gross domestic product grew, real wages of the British working class remained relatively constant.

The two main studies of ‘real wages’ show that they were more or less flat from 1805-1820, a period of economic depression in England.  There was a pick-up in the 1830s.  But the ‘hungry forties’ as they were called, saw a significant fall in real wages, mainly because of rising food prices that were not expunged until the abolition of the Corn laws in 1846.  And during the forties there were two slumps, in 1841 and 1847, with Engels’ study straddling both. By 1847 real wages had been stagnant at best for over ten years.

Engels’ conclusion was that the main cause of low wages was the power of employers over non-unionised workers, the threat of machinery and the industrial cycle under capitalism.  This conclusion still holds 175 years later.

It was the virus that did it

I’m sure when this disaster is over, mainstream economics and the authorities will claim that it was an exogenous crisis nothing to do with any inherent flaws in the capitalist mode of production and the social structure of society.  It was the virus that did it.  This was the argument of the mainstream after the Great Recession of 2008-9 and it will be repeated in 2020.

As I write the coronavirus pandemic (as it is now officially defined) has still not reached a peak.  Apparently starting in China (although there is some evidence that it may have started in other places too), it has now spread across the globe.  The number of infections is now larger outside China than inside.  China’s cases have trickled to a halt; elsewhere there is still an exponential increase.

This biological crisis has created panic in financial markets. Stock markets have plunged as much 30% in the space of weeks.  The fantasy world of every rising financial assets funded by ever lower borrowing costs is over.

COVID-19 appears to be an ‘unknown unknown’, like the ‘black swan’-type global financial crash that triggered the Great Recession over ten years ago.  But COVID-19, just like that financial crash, is not really a bolt out of the blue – a so-called ‘shock’ to an otherwise harmoniously growing capitalist economy.  Even before the pandemic struck, in most major capitalist economies, whether in the so-called developed world or in the ‘developing’ economies of the ‘Global South’, economic activity was slowing to a stop, with some economies already contracting in national output and investment, and many others on the brink.

COVID-19 was the tipping point.  One analogy is to imagine a sandpile building up to a peak; then grains of sand start to slip off; and then comes a certain point with one more sand particle added, the whole sandpile falls over. If you are a post-Keynesian you might prefer calling this a ‘Minsky moment’, after Hyman Minsky, who argued that capitalism appears to be stable until it isn’t, because stability breeds instability.  A Marxist would say, yes there is instability but that instability turns into an avalanche periodically because of the underlying contradictions in the capitalist mode of production for profit.

Also, in another way, COVID-19 was not an ‘unknown unknown’.  In early 2018, during a meeting at the World Health Organization in Geneva, a group of experts (the R&D Blueprint) coined the term “Disease X”: They predicted that the next pandemic would be caused by an unknown, novel pathogen that hadn’t yet entered the human population. Disease X would likely result from a virus originating in animals and would emerge somewhere on the planet where economic development drives people and wildlife together.

Disease X would probably be confused with other diseases early in the outbreak and would spread quickly and silently; exploiting networks of human travel and trade, it would reach multiple countries and thwart containment. Disease X would have a mortality rate higher than a seasonal flu but would spread as easily as the flu. It would shake financial markets even before it achieved pandemic status. In a nutshell, Covid-19 is Disease X.

As socialist biologist, Rob Wallace, has argued, plagues are not only part of our culture; they are caused by it. The Black Death spread into Europe in the mid-14th century with the growth of trade along the Silk Road. New strains of influenza have emerged from livestock farming. Ebola, SARS, MERS and now Covid-19 has been linked to wildlife. Pandemics usually begin as viruses in animals that jump to people when we make contact with them. These spillovers are increasing exponentially as our ecological footprint brings us closer to wildlife in remote areas and the wildlife trade brings these animals into urban centers. Unprecedented road-building, deforestation, land clearing and agricultural development, as well as globalized travel and trade, make us supremely susceptible to pathogens like corona viruses.

There is a silly argument among mainstream economists about whether the economic impact of COVID-19 is a ‘supply shock’ or a ‘demand shock’.  The neoclassical school says it is a shock to supply because it stops production; the Keynesians want to argue it is really a shock to demand because people and businesses won’t spend on travel, services etc.

But first, as argued above, it is not really a ‘shock’ at all, but the inevitable outcome of capital’s drive for profit in agriculture and nature and from the already weak state of capitalist production in 2020.

And second, it starts with supply, not demand as the Keynesians want to claim.  As Marx said: “Every child knows a nation which ceased to work, I will not say for a year, but even for a few weeks, would perish.” (K Marx to Kugelmann, London, July 11, 1868).  It is production, trade and investment that is first stopped when shops, schools, businesses are locked down in order to contain the pandemic.  Of course, then if people cannot work and businesses cannot sell, then incomes drop and spending collapses and that produces a ‘demand shock’.  Indeed, it is the way with all capitalist crises: they start with a contraction of supply and end up with a fall in consumption – not vice versa.

Here is one mainstream (and accurate) view of the anatomy of crises.

Some optimists in the financial world are arguing that the COVID-19 shock to stock markets will end up like 19 October 1987.  On that Black Monday the stock market plunged very quickly, even more than now, but within months it was back up and went on up.  Current US Treasury Secretary Steven Mnuchin is sure that the financial panic will end up like 1987. “You know, I look back at people who bought stocks after the crash in 1987, people who bought stocks after the financial crisis,” he continued. “For long-term investors, this will be a great investment opportunity.”  “This is a short-term issue. It may be a couple of months, but we’re going to get through this, and the economy will be stronger than ever,” the Treasury secretary said.

Mnuchin’s remarks were echoed by White House economic adviser Larry Kudlow, who urged investors to capitalize on the faltering stock market amid coronavirus fears. “Long-term investors should think seriously about buying these dips,” describing the state of the U.S. economy as “sound.”  Kudlow really repeated what he said just two weeks before the September 2008 global financial crash: “for those of us who prefer to look ahead, through the windshield, the outlook for stocks is getting better and better.”

The 1987 crash was blamed on heightened hostilities in the Persian Gulf leading to a hike in oil prices, fear of higher interest rates, a five-year bull market without a significant correction, and the introduction of computerized trading.  As the economy was fundamentally ‘healthy’ so it did not last.  Indeed, the profitability of capital in the major economies was rising and did not peak until the late 1990s (although there was a slump in 1991).  So 1987 was what Marx called a pure ‘financial crash’ due to the instability inherent in speculative capital markets.

But that is not the case in 2020.  This time the collapse in the stock market will be followed by an economic recession as in 2008.  That’s because, as I have argued in previous posts, now the profitability of capital is low and global profits are static at best, even before COVID-19 erupted.  Global trade and investment have been falling, not rising.  Oil prices have collapsed, not risen.  And the economic impact of COVID-19 is found first in the supply chain, not in unstable financial markets.

What will be the magnitude of the slump to come?  There is an excellent paper by Pierre-Olivier Gourinchas that models the likely impact.  He shows the usual pandemic health diagram doing the rounds. Without any action, the pandemic takes the form of the red line curve, leading to a huge number of cases and deaths.  With action on lockdowns and social isolation, the peak of the (blue) curve can be delayed and moderated, even if the pandemic gets spun out for longer.  This supposedly reduces the pace of the infection and the number of deaths.

Public health policy should aim to “flatten the curve” by imposing drastic social distancing measures and promoting health practices to reduce the transmission rate. Currently Italy is following the Chinese approach of total lockdown, even if it may be closing the stable doors after the virus has bolted.  The UK is attempting a very risky approach of self-isolation for the vulnerable and allowing the young and healthy to get infected in order to build up so-called ‘herd immunity’ and avoid the health system being overwhelmed.  What this approach means is basically writing off the old and vulnerable because they are going to die anyway if infected and avoiding a total lockdown that would damage the economy (and profits).  The US approach is basically to do nothing at all: no mass testing, no self-isolation, no closure of public events; just wait until people get ill and then deal with the severe cases.

We could call this latter approach the Malthusian answer. The most reactionary of the classical economists in the early 19th century was the Reverend Thomas Malthus, who argued that there were too many ‘unproductive’ poor people in the world, so regular plagues and disease were necessary and inevitable to make economies more productive.

British Conservative journalist Jeremy Warner argued this for the Covid-19 pandemic which ‘primarily kills the elderly’. “Not to put too fine a point on it, from an entirely disinterested economic perspective, the COVID-19 might even prove mildly beneficial in the long term by disproportionately culling elderly dependents.” Responding to criticism ‘Obviously, for those affected it is a human tragedy whatever the age, but this is a piece about economics, not the sum of human misery.’ Indeed, that’s why Marx called economics in the early 19th century – the philosophy of misery.

The reason that the US and British governments won’t impose (yet) draconian measures, as in China eventually and now in Italy (belatedly) and elsewhere, is because it will inevitably steepen the macroeconomic recession curve. Consider China or Italy: increasing social distances has required closing schools, universities, most non-essential businesses, and asking most of the working-age population to stay at home. While some people may be able to work from home, this remains a small fraction of the overall labour force. Even if working from home is an option, the short-term disruption to work and family routines is major and likely to affect productivity. In short, the best public health policy plunges the economy into a sudden stop.  The supply shock.

The economic damage would be considerable. Gourinchas attempts to model the impact. He assumes that relative to a baseline, containment measures reduce economic activity by 50% for one month and 25% for another month, after which the economy returns to the baseline. “That scenario would still deliver a massive blow to headline GDP numbers, with a decline in annual output growth of the order of 6.5% relative to the previous year. Extend the 25% shutdown for just another month and the decline in annual output growth (relative to the previous year) reaches almost 10%!”  As a point of comparison, the decline in output growth in the U.S. during the 2008-09 `Great Recession’ was around 4.5%. Gourinchas concludes that “we are about to witness a downturn that could dwarf the Great Recession.”

At the peak of the Great Recession, the US economy was shedding jobs at the rate of 800,000 workers per month, but the vast majority of people were still employed and working. The unemployment rate peaked at `just’ 10%. By contrast, the coronavirus is creating a situation where – for a brief amount of time – 50% or more of people may not be able to work. The impact on economic activity is comparatively that much larger.

The upshot is that the economy, like the health system, faces a ‘flatten the curve’ problem. The red curve plots output lost during a sharp an intense downturn, amplified by the economic decisions of millions of economic agents trying to protect themselves by cutting spending, shelving investment, cutting down credit and generally hunkering down.

What to do to flatten the curve?  Well, central banks can and are providing emergency liquidity to the financial sector. Governments can deploy discretionary targeted fiscal measures or broader programs to support economic activity. These measures could help `flatten the economic curve’, i.e. limit the economic loss, as in the blue curve, by keeping workers paid and employed so they can meet bills or have bills delayed or written off for a period.  Small businesses could be funded to ride out the storm and banks bailed out, as in the Great Recession.

But a financial crisis is still a high risk.  In the US, corporate debt has risen and is concentrated in bonds issued by the weaker companies (BBB or lower).

And the energy sector is being hit with a double whammy as oil prices have plunged. Bond risk premia (the cost of borrrowing) have rocketed in the energy and transport sectors.

Monetary easing certainly won’t be enough to flatten the curve.  Central bank interest rates are already near, at or below zero.  And the huge injections of credit or money into the banking system will be like ‘pushing on a string’ in its effect on production and investment. Cheap financing won’t speed up the supply chain or make people want to travel again. Nor will it help corporate earnings if customers aren’t spending.

The main economic mitigation will have to come from fiscal policy. The international agencies like the IMF and World Bank have offered $50bn. National governments are now launching various fiscal stimulus programmes.  The UK government announced a big spend in its latest budget and the US Congress has agreed an emergency spend.

But is it enough to flatten the curve if two months of lockdown knock back most economies by a staggering 10%?  None of the current fiscal packages come anywhere near 10% of GDP.  Indeed, in the Great Recession, only China delivered such an amount.  The UK government’s proposals amount to just 1.5% of GDP maximum, while Italy’s is 1.4% and the US at less than 1%.

There is a chance that by the end of April we will have seen the global total number of cases peak and begin to decline.  That is what governments are hoping and planning for.  If that optimistic scenario happens, the coronavirus will not disappear.  It become yet another flu-like pathogen (which we know little about) that will hit us each year like its predecessors.  But even two months lockdown will incur huge economic damage. And the monetary and fiscal stimulus packages planned are not going to avoid a deep slump, even if they reduce the ‘curve’ to some extent.  The worst is yet to come.

UK budget: too little, too late

Rishi Sunak, the ex-hedge fund UK Chancellor, has presented the first budget of the Johnson government.  The first thing is that the government is increasing spending by £30bn this fiscal year (of which £12bn is for handling the coronavirus outbreak) and plans to spend £175bn more than previously in this parliament.

The government’s policy decisions increase the budget deficit by 0.9 per cent of GDP on average over the next five years and add £125 billion (4.6 per cent of GDP) to public sector net debt by 2024-25.  All this borrowing is intended to achieve 2.8% p.a. real growth in current public service spending, after a decade of cuts. In effect, the Sunak budget is reversing all the cuts that previous Conservative governments made under Cameron, Osborn & Co.

This may be the “largest sustained fiscal loosening” since the pre-election budget in 1992, according to the Office for Budget Responsibility (OBR).  But all it does is stop the beating up of public services, local authorities and welfare that the government applied in the last ten years of misery.  Ironically, after attacking those like the Labour Party, who demanded an end to austerity and increased government spending as being ‘profligate’, now the Johnson government announces the biggest fiscal spend nearly 30 years!

As Jeremy Corbyn said in parliament: “The government’s boast of the biggest investment since the 1950s is frankly a sleight of hand. It’s in fact only the biggest since they began their slash and burn assault on our services, economic infrastructure and living standards in 2010. Having ruthlessly forced down the living standards and life chances of millions of our people for a decade, the talk of levelling up is a cruel joke.”

Of course, there are very good reasons why the Johnson government must do this.  First, Brexit has already cost the economy £26bn a year in slowing growth since the 2016 referendum, and the government will still be shelling out a net annual £11bn to the EU during this parliament.  The OBR put it like this: “We estimate that the economic effects of the referendum vote have so far reduced potential output by around 2 per cent, relative to what would have happened in its absence. Part of this reflects lower net inward migration, but mostly it reflects weaker productivity growth on the back of depressed business investment and the diversion of resources from production towards preparing for potential Brexit outcomes. Real business investment has barely grown since the referendum, whereas our March 2016 forecast assumed it would have risen more than 20 per cent by now.”

And second, global growth was already slowing fast, reducing the trade prospects for a weak UK economy.  And finally, there is the coronavirus ‘shock’ that has still to affect the economy over the next six months or so, at least.

Sunak says he’ll invest an extra £175bn over next 5 years, which he says OBR calculates will add 0.5%pt to GDP growth.  But all that does is compensate for the reduction in growth forecasts that the OBR has already made for the next few years.  UK economic growth is optimistically forecast at a pathetic 1.1% this rising only to 1.8% next year.  And this forecast takes into account the extra government spending – but not the impact of virus epidemic on production and investment.  Moreover, the forecasts for real GDP growth in 2022 are just 1.5%; 2023 1.3% and 2024 just 1.4%. So that’s on average less than 1.5% a year during this parliament, and that assumes no global slump either.

This shows that the biggest fiscal spend in nearly 30 years is way too little and too late.  With such poor growth figures, there is no way that with annual budget deficits rising to 2.8% of GDP in 2022, it will not lead to a rise in the public sector debt ratio.  But even if a rise is avoided, the debt ratio will still be double where it was before the Great Recession in 2008.  Ten years of cuts to lower the debt burden have totally failed.

Sunak says he is increasing investment in R&D to a record £22bn a year. As a percentage of GDP, he says, it will be the highest in nearly forty years – higher than the US, China, France and Japan. Public investment will be the highest it has been in real terms since 1955.  But that is not saying much, as UK public sector investment has been falling for decades and is way below the OECD average.

If it works out, government investment as a share of GDP will rise from under 2% to 3%. Business investment is about 15% of GDP, so raising government investment from 2% to 3% will hardly make a difference if, in a slump, capitalists reduce their investment by say 25%, or 3% of GDP.  Anyway, capitalists are just not investing enough to improve the productivity of labour.  The OBR notes that “persistent weakness of productivity growth has prompted us to lower our steady-state assumption again. We now assume growth of 1.5% a year, down from 2%.”

And what about measures for working people?  The living wage is to be raised to two thirds of median earnings by 2024. That means £10.50 an hour in four years time – still way below what really is a living wage.  And there is no end to the iniquitous universal credit scheme for welfare benefits or any rise in the welfare spending cap.

There is to be a doubling of investment in flood defences over the next six years to £5.2bn protecting over 300,000 properties.  But that does not even restore the 50% real cut in flood defences and the fire service over the last ten years, which has meant huge damage to thousands of homes from regular floods.

And talking of extreme weather and climate change, fuel duty is to be frozen.  So given the recent sharp drop in oil prices, there is every incentive for increased fossil fuel spending.  The decade-long freeze and fast-rising public transport fares have caused an extra 5 million tonnes of greenhouse gas emissions by encouraging people to abandon public transport in favour of their car. Luckily, the virus and the global recession is likely to do more in reducing carbon emissions than the budget!

Sunak talks of carbon capture and storage (CCS) as the sort of climate change technology where the UK should be excelling and says he will spend £800m to establish two or more CCS clusters by 2030.  Apart from the fact this spend is tiny over 10 years, CCS is not a proven or effective way of reducing emissions, while the fossil fuel companies go untouched.

Austerity may be over, strictly defined, but the misery of the last ten years cannot be reversed.  This budget will prove to be too little, too late, when the global slump comes.

Let’s get fiscal!

How to grease the aching wheels of a sickening world capitalist economy?  Let’s get fiscal is the universal cry of economists and policy makers.  The COVID meltdown and impending global recession is forcing authorities to consider fiscal stimulus.

Monetary policy is running out of ammunition and was not working anyway in restoring business investment, productivity and growth even before the virus epidemic. The US Federal Reserve cut its policy rate (the floor for all interest rates) by ½% last week and plans more cuts. It has some room to do so.  The European Central Bank (ECB) may follow this week and perhaps the Bank of England too. But these banks have already got their policy rates near zero, so they don’t have much more to offer. The Bank of Japan has been at zero for years. The Fed cut had no effect at all in stopping the meltdown in global stock markets: all it did was to weaken the US dollar.

So the cry is out for fiscal stimulus: i.e. increased government spending and tax cuts through deficit borrowing on budgets.  The IMF, OECD, World Bank etc are clamouring for governments to take action.  The IMF has offered $50bn in emergency funding.  The stricken Italians announced a $4bn injection, which will mean that the annual budget deficit will break Eurozone fiscal cap rules.  The new UK government presents its budget this week and will surely increase spending even if the ‘golden rule’ of balancing current expenditure with taxes is broken.  The US Congress passed a bill to provide funding for dealing with the virus and there may be more infrastructure plans soon, though the Trump administration has been running significant budget deficits already after its corporate tax cuts.  Even the fiscally prudent German government has announced increased spending.

But will any of this make a difference?  Will running fiscal deficits and increasing spending avoid a global recession or even reduce significantly the impact on jobs, incomes and trade?  That’s certainly what the Keynesians and post-Keynesians (including those in the Modern Monetary School) expect.  Take Paul Krugman, the world’s most popular Keynesian economist.  In his New York Times blog, he tells us that is it time for permanent fiscal stimulus.  Let’s get fiscal!

“I hereby propose that the next U.S. president and Congress move to permanently spend an additional 2 percent of GDP on public investment, broadly defined (infrastructure, for sure, but also things like R&D and child development) — and not pay for it.”  Krugman points out that monetary policy won’t work because the US economy is now in “a liquidity trap, that is, a situation in which monetary policy loses most of its traction, much if not most of the time. We were in a liquidity trap for 8 of the past 12 years; the market now appears to believe that something like this is the new normal.” Funny that he should point this out after initially advocating cheap money getting Japan out of its ‘lost decade’ back in 2000.

Anyway, the point is that “conventional (or even unconventional? MR) monetary policy doesn’t work in a liquidity trap, but fiscal policy is highly effective. The problem is that the kind of fiscal policy you really want — public investment that takes advantage of very low interest rates and strengthens the economy in the long run — is hard to get going on short notice.” So what we also need is “fiscal stimulus, like the one advanced by Jason Furman, basically involve handing out cash — a good idea given the constraints.”  But such ‘helicopter money’ is limited in effect over time as it goes into consumers’ pockets when we need “to invest in the future.”

So Krugman’s answer is to keep “investment-centered stimulus in place all the time. It would cushion the economy when adverse shocks hit.” through permanent budget deficits with spending on infrastructure and emergencies.  No need to worry about rising public debt, even though it is hitting over 100% of GDP in the US and servicing costs are already sucking funds from public services.  You see, interest rates are so low that servicing the debt is no problem.  Even at 100% of GDP and nominal interest rates of 2%, the interest cost is half that of nominal growth (real plus inflation) of 4% in the US economy.  So “in the long run, fiscal policy is sustainable if it stabilizes the ratio of debt to GDP. Because interest rates are below the growth rate, our hypothetical economy can in fact stabilize the debt ratio while running persistent primary deficits (deficits not including interest payments.)”.  So we can run a deficit of 2% to spend on a public investment program without driving up the debt burden.  “My permanent-stimulus plan would raise the debt/GDP ratio to only 150 percent by the year 2055. That’s a level the UK has exceeded for much of its modern history”.  So that’s all right then.

Krugman goes on in the usual Keynesian way that the ‘multiplier’ effect on growth from increased spending would more than pay its way: “the extra public investment will have a multiplier effect, raising GDP relative to what it would otherwise be. Based on the experience of the past decade, the multiplier would probably be around 1.5, meaning 3 percent higher GDP in bad times — and considerable additional revenue from that higher level of GDP.”

The problem with this argument is manifold.  First, it assumes that US economic growth can be sustained at 2% in real terms with inflation of 2%.  In a slump, that nominal rate will dive and so the debt to GDP ratio will rise sharply. That could lead to increased debt servicing costs even with interest rates on bonds so low.

Second, there is no evidence that ‘permanent’ deficits work to stimulate the capitalist economy.  Krugman advocated such a policy for Japan and Japan has run permanent deficits for 20 years, but Japan has failed to sustain real GDP growth – indeed it was entering yet another slump just before the epidemic hit. Will increased government spending save the airlines, energy companies and other travel-based operations from collapse. How will it stop the dramatic fall in the oil price, leading to a collapse in investment in shale and energy companies across the world?

Some argue lower fuel prices will boost consumer spending, as would government cash handouts to households.  But if you are told not to travel, cheaper pump prices are not going to do much.  And what is also forgotten is that two-thirds of transactions in a modern capitalist economy are business to business, not business to consumers.  So what matters is the investment and trading decisions of businesses.  If your company sacks you because of a slump in profits, having a cash handout from the government is unlikely to stimulate you to buy more things and services.

Krugman advocates an extra 2% points of government investment through deficit financing. If implemented, that would take government investment to GDP in the US to about 5% – a post-war high. And yet business and real estate investment is 15-20%.  If that were to fall by 25% in a slump, the downward impact would be double Krugman’s stimulus package.  So unless there was a huge shift from capitalist to state investment, such deficit spending would be insufficient to reverse or avoid a slump in capitalist investment. Only China has ever adopted such a sufficiently large use of government investment in an economy and succeeded in reducing or avoiding a slump – as it did in 2008-9.

Krugman and most Keynesians only ever talk about fiscal stimulus in the G7 economies. Is it feasible to expect all those so-called emerging economies to resort to fiscal stimulus?  The global trade and investment slowdown has already hit emerging economies, several of which have slipped into outright slumps. Emerging markets face a serious “secular stagnation” problem. Growth in almost all cases has been far lower in the last 6 years than in the 6 years leading up to the Great Recession. And in Argentina, Brazil, Russia, South Africa and Ukraine, there has been no growth at all. Emerging markets (EMs) that in 2019 grew less than developed markets were Brazil, Uruguay, Turkey, South Africa, Ecuador, Mexico, Saudi Arabia and Argentina. EMs that barely outgrew developed markets were Russia, Nigeria and Thailand. Running huge budget deficits in these countries is condemned by the likes of the IMF and would probably induce a massive run on national currencies by foreign investors.  Instead governments there are imposing more austerity measures.

Most important, it is not correct to assume that the Keynesian multiplier (the ratio of the unit increase of real GDP from a unit increase in real government spending) is high at all.  There are many studies that put it at below 1 i.e. a 1% pt rise in government spending adds less than 1% pt in real GDP growth.  Just see all these studies:

https://voxeu.org/article/fiscal-multipliers-during-european-sovereign-debt-crisis

https://voxeu.org/article/fiscal-multipliers-and-fiscal-positions-new-evidence

https://voxeu.org/article/government-spending-multipliers-and-business-cycle

https://voxeu.org/article/world-war-ii-america-spending-deficits-multipliers-and-sacrifice

As I have argued in previous posts, the key to restoring economic growth is investment and that depends on profitability.  In a predominantly capitalist economy, raising the profitability of capital has a much higher impact on growth (the Marxist multiplier) than government spending (the Keynesian multiplier).  http://gesd.free.fr/carch12.pdf.  Indeed, more government spending based on more debt or taxation can threaten the profitability of capital.  The blockage to government spending may not be from high and rising public debt when interest rates are near zero; but the blockage to business investment may well be from high and rising corporate debt when profitability of capital is low and falling.

Monetary easing has failed, as it has done before.  Fiscal easing, if adopted, will also fail.  A recession wipes out weaker capitalist companies and lays off unproductive workers.  The cost of production then falls and those companies left after the slump have higher profitability as the incentive to re-invest.  Capitalism can only get out of a recession by the recession itself.

Disease, debt and depression

As I write the coronavirus epidemic (not yet declared pandemic) continues to spread.  Now there are more new cases outside China than within, with a particular acceleration in South Korea, Japan and Iran.  Up to now more than 80,000 people infected in China alone, where the outbreak originated. The number of people who have been confirmed to have died as a result of the virus has now surpassed 3,200.

As I said in my first post on the outbreak, “this infection is characterized by human-to-human transmission and an apparent two-week incubation period before the sickness hits, so the infection will likely continue to spread across the globe.”  Even though more people die each year from complications after suffering influenza, and for that matter from suicides or traffic accidents, what is scary about the infection is that the death rate is much higher than for flu, perhaps 30 times higher.  So if it spreads across the world, it will eventually kill more people.

And as I said in that first post, “The coronavirus outbreak may fade like others before it, but it is very likely that there will be more and possible even deadlier pathogens ahead.” That’s because the most likely cause of the outbreak was the transmission of the virus from animals, where it has probably been hosted for thousands of years, to humans through use of intensive industrial farming and the extension of exotic wildlife meat markets.

COVID-19 is more virulent and deadly than the annual influenza viruses that kill many more vulnerable people each year.  But if not contained, it will eventually match that death rate and appear in a new form each year.  However, if you just take precautions (hand washing, not travelling or working etc) you should be okay, especially if you are healthy, young and well-fed.  But if you are old, have lots of health issues and live in bad conditions, but you still must travel and go to work, then you are at a much greater risk of serious illness or death.  COVID-19 is not an equal-opportunity killer.

But the illnesses and deaths that come from COVID-19 is not the worry of the strategists of capital.  They are only concerned with damage to stock markets, profits and the capitalist economy.  Indeed, I have heard it argued in the executive suites of finance capital that if lots of old, unproductive people die off, that could boost productivity because the young and productive will survive in greater numbers!

That’s a classic early 19th century Malthusian solution to any crisis in capitalism.  Unfortunately, for the followers of the reactionary parson Malthus, his theory that crises in capitalism are caused by overpopulation has been demolished, given the experience of the last 200 years.  Nature may be involved in the virus epidemic, but the number of deaths depends on human action – the social structure of an economy; the level of medical infrastructure and resources and the policies of governments.

It is no accident that China, having been initially caught on the hop with this outbreak, was able to mobilise massive resources and impose draconian shut-down conditions on the population that has eventually brought the virus spread under control.  Things do not look so controlled in countries like Korea or Japan, or probably the US, where resources are less planned and governments want people to stay at work for capital, not avoid getting ill.  And poor, rotten regimes like Iran appear to have lost control completely.

No, the real worry for the strategists of capital is whether this epidemic could be the trigger for a major recession or slump, the first since the Great Recession of 2008-9.  That’s because the epidemic hit just at a time when the major capitalist economies were already looking very weak.  The world capitalist economy has already slowed to a near ‘stall speed’ of about 2.5% a year.  The US is growing at just 2% a year, Europe and Japan at just 1%; and the major so-called emerging economies of Brazil, Mexico, Turkey, Argentina, South Africa and Russia are basically static.  The huge economies of India and China have also slowed significantly in the last year.  And now the shutdown from COVID-19 has pushed the Chinese economy into a ravine.

The OECD – which represents the planet’s 36 most advanced economies – is now warning of the possibility that the impact of COVID-19 would halve global economic growth this year from its previous forecast.  The OECD lowered its central growth forecast from 2.9 per cent to 2.4 per cent, but said a “longer lasting and more intensive coronavirus outbreak” could slash growth to 1.5 per cent in 2020.  Even under its central forecast, the OECD warned that global growth could shrink in the first quarter. Chinese growth is expected to fall below 5% this year, down from 6.1% last year – which was already the weakest growth rate in the world’s second largest economy in almost 30 years. The effect of widespread factory and business closures in China alone would cut 0.5 percentage points from global growth as it reduced its main forecast to 2.4 per cent in the quarter to end-March.

Elsewhere, Italy endured its 17th consecutive monthly decline in manufacturing activity in February. And the Italian government announced plans to inject €3.6bn into the economy. IHS Markit’s purchasing managers’ index for Italian manufacturing edged down by 0.2 points to 48.7 in February. A reading below 50 indicates that the majority of companies surveyed are reporting a shrinking of activity. And the survey was completed on February 21, before the coronavirus outbreak intensified in Italy. There was a similar contraction of factory activity in France, where the manufacturing PMI fell by 1.3 points to 49.8. However, manufacturing activity increased for the eurozone as a whole in February, as the PMI for the bloc rose by 1.3 points to 49.2, but still under 50.

The US, so far, has avoided a serious downturn in consumer spending, partly because the epidemic has not spread widely in America.  Maybe the US economy can avoid a slump from COVID-19.  But the signs are still worrying. The latest activity index for services in February showed that the sector showed a contraction for the first time in six years and the overall indicator (graph below) also went into negative territory.

Outside the OECD area, there was more bad news on growth. South Africa’s Absa Manufacturing PMI fell to 44.3 in February of 2020 from 45.2 in the previous month. The reading pointed to the seventh consecutive month of contraction in factory activity and at the quickest pace since August 2009. And China’s capitalist sector reported its lowest level of activity since records began. The Caixin China General Manufacturing PMI plunged to 40.3 in February 2020, the lowest level since the survey began in April 2004.

The IMF too has reduced its already low economic growth forecast for 2020.  “Experience suggests that about one-third of the economic losses from the disease will be direct costs: from loss of life, workplace closures, and quarantines. The remaining two-thirds will be indirect, reflecting a retrenchment in consumer confidence and business behavior and a tightening in financial markets.”  So “under any scenario, global growth in 2020 will drop below last year’s level. How far it will fall, and for how long, is difficult to predict, and would depend on the epidemic, but also on the timeliness and effectiveness of our actions.”

One mainstream economic forecaster, Capital Economics, cut its growth forecast by 0.4 percentage points to 2.5 per cent for 2020, in what the IMF considers recession territory. And Jennifer McKeown, head of economic research at Capital Economics, cautioned that if the outbreak became a global pandemic, the effect “could be as bad as 2009, when world GDP fell by 0.5 per cent.” And a global recession in the first half of this year is “suddenly looking like a distinct possibility”, said Erik Nielsen, chief economist at UniCredit.

In a study of a global flu pandemic, Oxford University professors estimated that a four-week closure of schools — almost exactly what Japan has introduced — would knock 0.6 per cent off output in one year as parents would have to stay off work to look after children. In a 2006 paper, Warwick McKibbin and Alexandra Sidorenko of the Australian National University estimated that a moderate to severe global flu pandemic with a mortality rate up to 1.2 per cent would knock up to 6 per cent off advanced economy GDP in the year of any outbreak.

The Institute of International Finance (IIF), the research agency funded by international banks and financial institutions, announced that: “We’re downgrading China growth this year from 5.9% to 3.7% & the US from 2.0% to 1.3%. Rest of the world is shaky. Germany struggling to retool autos, Japan weighed down by 2019 tax hike. EM has been weak for a while. Global growth could approach 1.0% in 2020, weakest since 2009.”

What are the policy reactions of the official authorities to avoid a serious slump?  The US Federal Reserve stepped in to cut its policy interest rate at an emergency meeting. Canada followed suit and others will follow.  The IMF and World Bank is making available about $50 billion through its rapid-disbursing emergency financing facilities for low income and emerging market countries that could potentially seek support. Of this, $10 billion is available at zero interest for the poorest members through the Rapid Credit Facility.

This may have some effect, but cuts in interest rates and cheap credit are more likely to end up being used to boost the stock market with yet more ‘fictitious capital’ – and indeed stock markets have made a limited recovery after falling more than 10% from peaks.  The problem is that this recession is not caused by ‘a lack of demand’, as Keynesian theory would have it, but by a ‘supply-side shock’ – namely the loss of production, investment and trade. Keynesian/monetarist solutions won’t work, because interest rates are already near zero and consumers have not stopped spending – on the contrary. Jon Cunliffe, deputy governor of the Bank of England, said that since coronavirus was “a pure supply shock there is not much we can do about it”.

And as British Marxist economist Chris Dillow argues, the coronavirus epidemic is really just an extra factor keeping the major capitalist economies dysfunctional and stagnating. He lays the main cause of the stagnation on the long-term decline in the profitability of capital. “basic theory (and common sense) tells us that there should be a link between yields on financial assets and those on real ones, so low yields on bonds should be a sign of low yields on physical capital. And they are.”  He identifies ‘three big facts’: the slowdown in productivity growth; the vulnerability to crisis; and low-grade jobs. And as he says, “Of course, all these trends have long been discussed by Marxists: a falling rate of profit; monopoly leading to stagnation; proneness to crisis; and worse living conditions for many people. And there is plenty of evidence for them.”  Indeed, as any regular reader of this blog will know.

And then there is debt.  In this decade of record low interest rates (even negative), companies have been on a borrowing binge.  This is something that I have banged on about in this blog ad nauseam.  Huge debt, particularly in the corporate sector, is a recipe for a serious crash if the profitability of capital were to drop sharply.

Now John Plender in the Financial Times has taken up my argument.  He pointed out, according to the IIF, the ratio of global debt to gross domestic product hit an all-time high of over 322 per cent in the third quarter of 2019, with total debt reaching close to $253tn. “The implication, if the virus continues to spread, is that any fragilities in the financial system have the potential to trigger a new debt crisis.”

The huge rise in US non-financial corporate debt is particularly striking.  This has enabled the very large global tech companies to buy up their own shares and issue huge dividends to shareholders while piling up cash abroad to avoid tax.  But it has also enabled the small and medium sized companies in the US, Europe and Japan, which have not been making any profits worth speaking of for years to survive in what has been called a ‘zombie state’; namely making just enough to pay their workers, buy inputs and service their (rising) debt, but without having anything left over for new investment and expansion.

Plender remarks that a recent OECD report says that, at the end of December 2019, the global outstanding stock of non-financial corporate bonds reached an all-time high of $13.5tn, double the level in real terms against December 2008. “The rise is most striking in the US, where the Fed estimates that corporate debt has risen from $3.3tn before the financial crisis to $6.5tn last year. Given that Google parent Alphabet, Apple, Facebook and Microsoft alone held net cash at the end of last year of $328bn, this suggests that much of the debt is concentrated in old economy sectors where many companies are less cash generative than Big Tech. Debt servicing is thus more burdensome.”

The IMF’s latest global financial stability report amplifies this point with a simulation showing that a recession half as severe as 2009 would result in companies with $19tn of outstanding debt having insufficient profits to service that debt.

So if sales should collapse, supply chains be disrupted and profitability fall further, these heavily indebted companies could keel over.  That would hit credit markets and the banks and trigger a financial collapse.  As I have shown on several occasions, the profitability of capital in the major economies has been on a downward trend (see graph above from Penn World tables 9.1).

And the mass of global profits was also beginning to contract before COVID-19 exploded onto the scene (my graph below from corporate profits data of six main economies, Q4 2019 partly estimated).  So even if the virus does not trigger a slump, the conditions for any significant recovery are just not there.

Eventually this virus is going to wane (although it might stay in human bodies forever mutating into an annual upsurge in winter cases).  The issue is whether the ‘supply shock’ is so great that, even though economies start to recover as people get back to work, travel and trade resumes, the damage has been so deep and the time taken so long to recover, that this won’t be a quick one-quarter, V-shaped economic cycle, but a proper U-shaped slump of six to 12 months.

Marx’s law of profitability at SOAS

Last week I gave a lecture in the seminar series on Marxist political economy organised by the Department of Development Studies at the School of Oriental and African Studies (SOAS).  The Marxist Political Economy series is a course mainly for post-graduates and has several lecturers on different aspects of Marxian economics. Course Handbook – Marxist Political Economy 2019-20 (8)

Mine was on Marx’s law of the tendency of the rate of profit to fall.  Not surprisingly, the department team has noticed that I am apparently ‘obsessed’ by this law, at least according to critics of it.

Anyway, I thought it might be useful to go through my lecture in a post, with the accompanying slides referred to.  So here goes. (Marx’s law of the tendency of the rate)

I started by saying that Marx considered the law of the tendency of the rate of profit to fall as “peculiar to the capitalist mode of production” along with “the progressive development of the social productivity of labour.”  They go together: rising productivity and falling profitability.  (Slide 2).

Indeed, Marx’s law is the direct opposite of what Thomas Piketty, author of Capital in the 21st century claimed was Marx’s view.  Piketty reckoned that “Marx’s theory implicitly relies on a strict assumption of zero productivity growth over the long run” and that “Marxist analysis emphasises the falling rate of profit – a historical prediction that has turned out to be quite wrong.”  Indeed, Marx’s law is ignored by mainstream economics (except for getting wrong like Piketty) and also is either ignored or rejected by so-called heterodox economics.

Moreover, even most Marxist economists consider it irrelevant or wrong for any critique of capitalism. I referenced top MEGA scholar, Michael Heinrich: “A few manuscripts from the late 1860s and 1870s suggest that Marx had doubts about the ‘law of the tendency of the rate of profit to fall’, which he no longer mentioned after 1868.“  And then the world’s most famous Marxist economist, David Harvey: “I find Heinrich’s account broadly consistent with my own long-standing scepticism about the general relevance of the law”.  Indeed, it is only a minority of Marxists who consider, like Alan Freeman, that “Marx’s LTRPF remains the only credible competitor left in the contest to explain what is going wrong with capitalism.” (Slide 3).

In contrast, I argued that Marx’s law of profitability is both theoretically valid, empirically supported and relevant to the critical analysis of modern capitalism.  But the law is only valid if two other laws of motion of capitalism that Marx held to are also valid. (Slide 4).

The first is the law of value.  The law of value says that the value of commodities depends on the amount of human labour exerted on producing commodities, as measured by the socially necessary labour time involved.  At one level, it is self-evident, “as any child knows” that nothing is produced to use or sell unless humans go to work to do it.  (Slide 5).

Under the capitalist mode of production, commodities are produced for sale, in a particular social relation.  The capitalist starts with money and the ownership of the means of production.  With that money he/she buys the technology and raw materials to make a new product for sale and employs the workers to do so.  Both that technology and workers are commodities to buy for the capitalist.  But only the workers produce the new commodity for sale on the market for a new amount of money.  And that end product must be worth more in labour time that invested by the capitalist and more in money than spent.  There must be a profit to make it worthwhile.  That profit comes from the surplus value appropriated by the capitalist over above the value paid for labour power.  M- C- P- C’- M’ (Slide 6)

Marx’s theory of value reveals that more value is created only by human labour power and a surplus is extracted by the capitalist because he/she owns and controls the means of production; and that value is realised by sale in markets.  The law of value is theoretically sound and indeed has been empirically supported, namely that total prices of commodities in an economy are closely correlated with total hours of labour time applied. (Slide 7)

The second law is Marx’s general law of accumulation. Competition among capitalists forces them to continue to expand their production in order to accumulate more profit or be driven out of business by others.  Competition drives each individual capitalist to increase the productivity of labour ie lower their costs of production. (Slide 8)

As capitalists spend more of their profits on means of production to boost the productivity of labour and reduce costs, the ratio of the value of means of production compared to the value of the labour power employed tends to rise.  Marx called this ratio the organic composition of capital. It is a law in capitalist economic expansion that the organic composition of capital will rise. (Slide 9)

The law is empirically valid. (Slide 10); fixed capital per worker rises over the long term.

But there is a dual nature to the accumulation process under capitalism.  On the one hand, there is a tendency to increased unemployment from technology shedding labour.  On the other hand, new technology creates new jobs.  Everything then depends on the momentum of the industrial cycle: “the general movement of wages is exclusively regulated by the expansion and contraction of the industrial reserve army and this corresponds to the periodic alternations of the industrial cycle”. Marx (Slide 11) Accumulation can drive down labour’s share in new value but also lower the price of future investment. (Slide 12).

In sum, the organic composition of capital (C/V) rises over time.  This means increased centralisation and concentration of capital. Rising C/V creates a reserve army of labour and technological unemployment. The size of reserve army will vary cyclically with the strength of accumulation.  This law can be empirically verified and has been in many studies. (Slide 13)

This brings us the main message of the lecture.  The first two laws of motion lead to the third law: the law of the tendency of the rate of profit to fall.  The first law says that only labour creates value.  The second says that capitalists will accumulate more capital over time and this will take the form of a faster rise in the value of the means of production over the value of labour power i.e. a rising organic composition of capital. (Slide 14) For Marx, the third law of profitability is “in every respect the most important law of modern political economy and the most essential for understanding the most difficult relations. It is the most important law from the historical standpoint. It is a law, which despite its simplicity, has never before been grasped and even less consciously articulated.” (Slide 15)

The law has a simple formula (Slide 16).  The capitalist starts with money to invest in:

Means of production (fixed capital) and raw materials (circulating capital) = constant capital (c)

Labour force to produce the commodities paid in wages.  But the labour force produces more value than it is paid in wages; so it is called variable capital (v).

The labour force produces commodities that contain surplus value over and above its own value in wages paid = surplus value (s)

The rate of profit is thus S/(C+V).  If we divide this formula by the value of labour power (V), we get s/v//c/v+1.  In other words, the rate of profit falls if C/V rises faster than S/V and vice versa.  (Slide 17)

Marx argues that rising C/V is the tendency which will generally rule and operate over time and rising S/V is a countertendency (induced by the tendency) that can curb, or slow or occasionally reverse the tendency.  If the tendency prevails, the rate of profit will fall  – and most of the time it does.  That is Marx’s law. (Slide 18)

This law has been subject to criticism from the start when it was first revealed in the 1890s in Volume Three of Capital.  (Slide 19)

There are two main critiques.  The first is the so-called ‘transformation problem’. In Volume Three, Marx shows how the values of commodities as expressed in socially necessary labour time are modified in competition for sale of those commodities.  There is price for the commodity in the market, but different producers have different efficiencies – some produce the commodity for sale in less labour time than others.  And they do so because they invest more in labour-saving technology as expressed in a higher organic composition of capital.  Through competition in the market, a production price is established.  At that production price, the more efficient producers make more profit.  They do so because in the market there is a transfer of value from the less efficient to the more efficient and profitability tend to an average across the economy.

Values are turned into prices of production by this competitive process.  Market prices will oscillate around production prices, which are also continually changing due to changes in technology and the organic composition of capitals.  But in Marx’s transformation, total value in the economy (in labour time) is still equal to total price of production (which is value modified by average profitability) and total surplus value is equal to total profit.  So value, the labour time exerted, is still the basis of prices in a capitalist economy. (Slide 20)

Marx’s transformation of values into prices was rejected and attacked by many Marxists.  Bortkiewicz argued that the inputs in values (c+v) on the value side of Marx’s table are really prices of production. In Marx’s formula, the value of the inputs before the equalization differ from the prices of production for the same commodities after the equalization of profit rates. But surely, says Bortkiewicz, the same commodities must be bought and sold as prices of production and not as values.  So Marx’s formula is incorrect and indeterminate. But if we ‘correct’ Marx’s transformation using simultaneous equations, total value no longer equals total price and/or total surplus value does not equal total profit.  So there is a logical inconsistency in Marx’s solution.  Value in labour time is no longer proven as the basis of prices. (Slide 21)

The reply to this critique is that Marx’s transformation is temporal.  The Bortkiewicz critique removes the temporal aspect completely.  Let us say that production starts at t1 and goes to t2.  The output produced during t1-t2 is then sold at t2, the end point of t1-t2.  Then t2 becomes also the initial point of the next production period, t2-t3. The output of t1-t2 has become the input of t2-t3. It exits one period and it enters with the same value in the next period.  Instead, the Bortkiewicz critique holds to the absurd notion that the output of one period is the input of the same period. That’s what simultaneous equations do; remove time. (Slide 22)

The second critique of Marx’s law is that is that new technology would never be introduced by a capitalist if it did not raise profitability.  Indeed, Marx says in Volume Three of Capital that “No capitalist ever voluntarily introduces a new method of production, no matter how much more productive it may be, and how much it may increase the rate of surplus-value, so long as it reduces the rate of profit.”  So Okishio says that “A profit-maximising individual capitalist will only adopt a new technique of production if it reduces the production cost per unit or increases profits per unit at going prices.  So capitalist accumulation must lead to a rise in the rate of profit, not a tendency to fall – otherwise why would any capitalist invest in new technology?” (Slide 23)

The reply to that is this argument is a fallacy of composition – to use the Keynesian term of logic.  Yes, the first capitalist to introduce a new technology will gain extra profit – at the expense of the other capitalists who have not.  The second capitalist will then introduce it and also gain some profitability (but not as much as the first did) at the expense of the other less efficient ones.  But once all capitalists adopt the technology, the extra profitability for introducing it will have dissipated.  And because the organic composition of capital (C/V) is likely to have risen, the rate of profit across all producers will have fallen compared to before.  As Marx says: ”Competition makes it general and subject to the general law. There follows a fall in the rate of profit — perhaps first in this sphere of production, and eventually it achieves a balance with the rest — which is, therefore, wholly independent of the will of the capitalist.” (Slide 24)

And there is one more retort to the critics of the law.  It is empirically supported.  Over decades, there has been a secular decline in the profitability of capital across all the major economies – if you like, the world rate of profit has fallen –  but not in a straight line, because there have been periods where the counteracting factors to the tendency have been stronger.  But over the history of modern capitalism, the rate of profit has fallen. (Slide 25)

Marx’s law is not only secular (namely a long-term tendency for profitability to fall).  The law also helps explain the cyclical recurrence of booms and slumps in capitalist production and investment. (Slide 26) The operation of counter-tendencies transforms the breakdown into a temporary crisis, so that the accumulation process is not something continuous, but takes the form of periodic cycles. (Slide 27)

The rate of profit can be falling but the total or mass of profit in the economy can be rising.  Indeed, that will be the usual situation as capitalists expand investment and production to increase profits as the profitability of each new unit of investment begins to drop.  This is what Marx called the double-edge law of profit. (Slide 28) So the mass of profit can and will rise as the rate of profit falls, keeping capitalist investment and production going. But as the rate of profit falls, eventually the increase in the mass of profit will decline to the point of what Marx called ‘absolute over-accumulation’, the tipping point for crises.

Thus Marx’s law of profitability provides an underlying explanation of the cycle of boom and slump that occurs periodically in capitalism. (Slide 29)

In sum:

The law of value:  only labour creates value.

The law of accumulation: the means of production will rise to drive up the productivity of labour and to dominate over labour.

The law of profitability: the first two laws create a contradiction between rising productivity of labour and falling profitability for capital. This can only be reconciled by recurring crises of production and investment; and, in the long term, by the replacement of capitalism. (Slide 30).

That was the lecture.  Questions from the seminar attendees were many and perceptive.  Here are a few.

Are there no other factors that cause crises in capitalism apart from profitability?

What is the difference between the organic composition of capital and the technical composition of capital that Marx refers to?

Does not the law suggest that there is no economic policy within capitalism that can stop recurring crises? 

If so, do the crises go on forever or will it come to a total breakdown at certain point?

I’ll leave the reader to consider these answers, if there are any answers.

G20 and COVID-19

The finance ministers and central bankers of the top 20 economies in the world met this weekend in Riyadh, Saudi Arabia.  The G20 finance summit had a lot to ponder.  First, there was the coronavirus epidemic.  Would it turn into a pandemic?  Would the impact of global growth, trade and investment be so severe as to tip the world economy into recession in 2020?  Also, what is to be done about curbing and reducing greenhouse gas emissions with the world’s temperatures continuing to rise towards an increase above that set by the last international climate change agreement?  Finally, is there nothing to be done about high and rising inequality of wealth and income and continued shift of profits by multi-nationals and rich oligarchs into ‘tax havens’?

The Saudi Arabia G20 communique provided no answers to any of these questions.  At Riyadh, IMF managing director, Kristalina Georgieva, having previously announced a reduction in IMF forecasts for global growth to just 2.9%, now added a further reduction due to COVID-19.  She reckoned that the epidemic will likely cut 0.1% from global economic growth to 2.8%, the lowest rate since the end of the Great Recession over ten years ago.  And it would drag down growth for China’s economy to 5.6% this year from 6.0% previously forecast.  “In our current baseline scenario, announced policies are implemented and China’s economy would return to normal in the second quarter. As a result, the impact on the world economy would be relatively minor and short-lived,” she said. But even that could be optimistic.  “But we are also looking at more dire scenarios where the spread of the virus continues for longer and more globally, and the growth consequences are more protracted,”

French Finance Minister Bruno Le Maire said in Riyadh. “The question remains open whether it will be a V-shape with a quick recovery of the world economy, or whether it would lead to an L-shape with a persistent slowdown in world growth.” He said the V-shaped scenario was more likely.

As the ministers met, the latest data on COVID-19 suggested that China was getting the epidemic under control.  It reported a sharp fall in new deaths and cases of the coronavirus, but world health officials warned it was too early to make predictions about the outbreak as new infections continued to rise in other countries.  “Our biggest concern continues to be the potential for COVID-19 to spread in countries with weaker health systems,” WHO chief Tedros Adhanom Ghebreyesus said.  The U.N. agency is calling for $675 million to support most vulnerable countries, he said, adding 13 countries in Africa are seen as a priority because of their links to China.

The Chinese authorities put on an optimistic air.  Chen Yulu, a deputy governor of the People’s Bank of China, said policymakers had plenty of tools to support the economy, and were confident of winning the war against the epidemic. “We believe that after this epidemic is over, pent-up demand for consumption and investment will be fully released, and China’s economy will rebound swiftly,” Chen told state TV.

Other commentators are less convinced that China can recover quickly from shutting down industry, stopping tourism and keeping millions at home.  Zhu Min, a former deputy managing director of the International Monetary Fund, reckoned that COVID-19 could slash US$185 billion off China’s economy in January and February.  Dips in tourism and consumer spending could reduce first-quarter growth by three or four percentage points, according to Zhu Min, While online spending – particularly on education and entertainment services – would offset some of the losses, the total drain on the economy over the period could be as much as 1.38 trillion yuan, said Zhu. Based on figures from China’s National Bureau of Statistics, that would represent about 3.3 per cent of the country’s total retail sales in 2019.

Car sales, fell by 20.5 per cent year on year in January, their largest monthly dip in 15 years, according to figures from the China Passenger Car Association.  And sales in the first two weeks of February fell 92 per cent from the same period of 2019, mainly due to showroom closures. Over the whole of 2020, the coronavirus epidemic could cost China 1 million car sales, or about 5 per cent of its annual total, the industry group said. “The falling consumption in the first quarter could knock down growth by three or four percentage points,” Zhu said. “We need a strong rebound, and that needs 10 times as much effort.”

Chen Wenling, chief economist at the China Centre for International Economic Exchanges, a Beijing-based think tank, said this week that even if national production returned to 80 per cent by the end of February, first-quarter growth would still be less than 4.5 per cent. By comparison, China’s economy grew by 6.4 per cent in the first three months of 2019.

What to do?  At Riyadh, Japan’s answer was to call for increased government spending.  Finance Minister Taro Aso called on G20 countries with ‘fiscal space’ (like Germany) to ramp up spending to help the global economy.  “I told the G20 ministers that the spread of the coronavirus epidemic … could have a serious effect on the global economy,”  Aso pointed out that Japan has deployed fiscal spending quite a bit, so wants other countries with fiscal room to do the same.  This is ironic when it is realised that Japan’s permanent annual budget deficits do not appear to have saved the economy from dropping into recession, even before the effects of COVID-19 epidemic hit.

But don’t worry. Aso claimed that Japan continued to recovery moderately as a tight job market and rising household income offset some of the weaknesses in exports and output. “At this stage, I don’t think risks to Japan’s economy have suddenly heightened sharply.”  That is wishful thinking.

As I have argued in many posts before, fiscal stimulus is likely to have a negligible effect on achieving economic recovery once a slump sets in and the capitalist sector stops investing and consumers stop spending (as much).  That’s because government spending outside of welfare transfers is no more than 10% of most economies’ GDP and government investment (as opposed to spending on public services) is no more than 3% of GDP compared to 15-20% of GDP invested by the capitalist sector. It will take a huge increase in government investment to have an effect.

Moreover, the ability and willingness of governments to resort to such huge fiscal injections are limited.  Gavyn Davies in the FT is sceptical: “the next global recession may result in a merging of what has traditionally been viewed as the two separate wings of macro policy, fiscal and monetary. It is a difficult question of political economy whether the central bank or the treasury is better placed to lead the design of an effective policy response in this environment. Japan has been in this position for several years and has so far failed to cut the Gordian knot.  Policymakers in the US and Europe should be thinking well in advance about how they can co-operate both internationally and domestically to produce a better outcome. There is no sign of this happening yet.”

Perhaps only one country is capable to doing that.  Given the size of the state sector and government control in China, a fiscal boost can have much more effect, as it did during the 2008-9 Great Recession, when China continued to grow while virtually every other economy went into a slump or slowed drastically.  The Chinese government is ready to spend and invest big time to turn things round once the virus epidemic fades.

Even so, if China’s growth slows sharply for a couple of quarters, that will only add to the woes of the major economies.  The latest economic activity indexes for the major advanced capitalist economies make sombre reading.  Japan’s business activity indexes in February showed a significant fall below the stasis level of 50. Japan’s manufacturing PMI dropped to 47.6 in February 2020 from 48.8 in the previous month. The latest reading was the steepest pace of contraction in the manufacturing sector since December 2012. And the services PMI declined to 46.7 in February from 51.0 in the previous month. This was the steepest contraction in the service sector since April 2014, So the overall index fell to 47.0 from 50.1 in January. Again, this was the steepest contraction in private sector activity since April 2014. Japan is clearly in a slump.

Eurozone private sector activity showed a slight improvement in February. The overall ‘composite’ PMI in the Euro Area increased to 51.6 in February from 51.3 in January. This slight improvement was due mainly to German manufacturing, which is still contracting – but at a slower pace. The Eurozone is still growing, but at a snail’s pace.

The UK’s manufacturing activity in February jumped into mildly positive territory, up to 51.9 from 50.0 in January. This was a ten-month high, which is not saying much as the index was over 55 three years ago. The services sector index weakened a little in February but still showed modest growth at 53.3. So the overall ‘composite’ index was unchanged at 53.3. That means the UK economy is growing but very modestly in the first quarter of 2020.

But the big shocker was the US.  The US economic activity indicator went below 50, signalling a contraction in the economy for the first time since the PMI survey began in 2014. The overall ‘composite’ indicator fell to 49.6 in February from 53.3 in January. The manufacturing index also fell to 50.8 from 51.5 in January. But the real bad news was the fall in the larger services sector, which dropped to 49.4 from 53.4. It seems that the US is joining Japan and the Eurozone in stagnating or even contracting in Q1 2020, and China has yet to report on the full economic impact of the coronavirus outbreak.

Other G20 economies are also on the cusp.  Australia’s index was below 50 in February; South Africa too.  We await data on the others.

In my last post on COVID-19,  I commented: “it could be a trigger for a new economic slump because the world capitalist economy has slowed to near ‘stall speed’. The US is growing at just 2% a year, Europe and Japan at just 1%; and the major so-called emerging economies of Brazil, Mexico, Turkey, Argentina, South Africa, and Russia are basically static. The huge economies of India and China have also slowed significantly in the last year and if China takes an economic hit from the disruption caused by 2019-nCoV, that could be a tipping point.”

Up to now, the world’s stock markets have ignored this risk, convinced that zero or negative interest rates for borrowing and speculating would continue, thanks to the US Federal Reserve, and also in expecting the epidemic to dissipate by the end of this current quarter, so the ‘business as usual’ can be resumed.  But with the outbreak picking up outside China and the likely slow economic recovery by China, the stock fantasists may be overoptimistic.  And remember, global corporate profits are stagnant along with business investment, the main cause of the global slowdown.

As for the other issues discussed by the G20 ministers: climate change, inequality and tax havens, forget it.  Nothing was agreed.  For the first time, the final G20 communique included a reference to climate change “to examine the implications of climate change on financial stability”.  It was ok to worry about the impact on financial assets and stock markets, but the US vetoed any mention of the impact on the world economy and people.

Nothing happened on inequality because the European countries could not agree on a common tax strategy on global tax avoidance.