Why is there a long depression?

In his latest post, Keynesian economist, Noah Smith considered the question of why there has been such weak recovery in the world economy since the Great Recession ended in mid-2009 (http://noahpinionblog.blogspot.co.uk/2013/02/on-iatrogenic-explanation-of-post.html).  Smith takes this up by criticising the comments of leading neoclassical economist John Cochrane, who attacked Keynesian explanations of the crisis and the subsequent weak recovery.

Cochrane was withering about the Keynesian explanation: “a spontaneous outbreak of thrift, to the point of valuing the future a lot more than the present, seems a bit of a strained diagnosis for the fundamental trouble of the US economy.  That a bit more thrift is a great danger to the economy, rather than the long awaited return to normal after decades of debt-financed consumption, seems strained as well.”   He went on: “The question before us is not really why consumption fell so drastically in 2008 and 2009. The question is, why did consumption get stuck at so low a level starting in 2010?  This question and controversy is much like those surrounding the Great Depression. The controversy there has not been about why the stock market crash and recession happened in the first place. (Though perhaps it should, as we really don’t know much about that process.)  The controversy is, why did the US get stuck so low for so long? Was it bad monetary policy (Friedman and Schwartz), bad microeconomic policy, war on capital and high marginal tax rates (Cole, Ohanian, Prescott, etc.), or inadequate fiscal stimulus (Keynesians)?”   Cochrane goes onto to dismiss the Keynesian explanation of the crisis as “unexpected negative shocks” as less than convincing.

I won’t go into the ins and outs of the arguments here – you can read it yourself if you want.  But Smith responds to Cochrane’s criticisms by saying that: “I think that, while there are definitely problems with the New Keynesian interpretation of the world, there are even more problems with the idea that government policy (and far-sighted citizens who guessed government policy years in advance) caused our long post-crisis stagnation. My intuition says the most likely explanation – unfortunately – is that there are some very deep things about how economies work that no macro model yet encompasses.”

The inference here is that Keynesian explanation of the ‘post-crisis stagnation’ (namely “unexpected negative shocks”) is inadequate,but then so is the neo-classical one (that government policies stopped the market economy from ‘cleansing’ or restoring  the system).  So Smith concludes that neither neoclassical nor Keynesian  mainstream macroeconomics has an explanation for the current stagnation, or depression as I prefer to call it.  That’s not surprising really as mainstream economics had no explanation for the Great Recession in the first place (see my paper, The causes of the Great Recession, The causes of the Great Recession).

While Smith and Cochrane struggle to explain the stagnation, Keynesian guru Paul Krugman seems to be staggering towards a more ‘Marxist’ explanation.  He calls his latest post on profits and business investment, “a note to himself” (http://krugman.blogs.nytimes.com/2013/02/09/profits-and-business-investment/).  In the post, he notes how far out of line corporate profits and business investment have got.  It seems that, despite the recovery in US business profits since the trough of the recession, business has not been restored and corporations appear to be hoarding cash rather than investing.

Readers of this blog will already be aware of this ‘investment strike’ as it has been taken up on many occasions (https://thenextrecession.wordpress.com/2011/11/25/us-investment-strike/).  But even though Krugman has started to look to the relation between profits and investment as the cause for the stagnation/depression, he still has no real explanation for this ‘cash hoarding’.

In my blog, I argue that a Marxist explanation gets to the heart of things.  There are two main reasons why the world capitalist economy has subsided into what I call a Long Depression, like that of the 1880s and 1890s in the US and the UK; or the Great Depression of the 1930s (although with some differences).  The first is that the profitability of the accumulated capital in the major economies has been in secular decline and has not been restored to the level reached before the Great Recession of 2008-9 (see my paper, The world rate of profit, (roberts_michael-a_world_rate_of_profit)
and several posts (https://thenextrecession.wordpress.com/2012/01/04/the-uk-rate-of-profit-and-others/).

World rate of profit

Sure, in the US the total level  of profits has surpassed the previous pre-crisis peak, but not the rate of profit.  And in many other advanced capitalist economies, even the mass of profit has not reached the previous peak.  We don’t have to look for uncertain and ‘unexpected negative shocks’ or ‘government interference in the market’s pricing of labour and capital’ to explain the stagnation.  There just ain’t enough profit to get capitalists to invest at previous levels.

And that leads me to the second reason for the depression.  The recovery after the great slump has been hampered and curbed by the dead weight of excessive debt built up in the so-called neo-liberal period after the early 1980s and particularly during the credit and property bubble from 2002.  The ‘normal’ way that capitalism resumes a period of expansion in the cycle of boom and slump is for dead and unprofitable capital to be devalued or even liquidated in a slump through bankruptcies, takeovers and higher unemployment (lower wage bills).  Profitability is then restored and expansion resumes.  However, in this Long Depression, the level of debt (what Marx called fictitious capital) circulating is still so large that it is takes a very long time to ‘deleverage’ and reduce the burden of debt against profit.  Indeed, I reckon it will probably require a new slump to do so.

Moreover, we can connect these two reasons if we add financial capital to tangible assets and then see where profitability is.  I attempted this in a recent paper, Debt matters, that I presented at last November’s’ London Historical Materialism conference, with mixed success (Debt matters).  Alan Freeman has also published a recent paper which attempts to recalibrate the rate of profit in the UK and the US by including debt or fictitious capital (freeman13).  The results are still unsatisfactory, in my view.  Nevertheless, there is no doubt that the extent of the fictitious capital in the world economy is contributing to the inability of capitalism to recover from the Great Recession quickly.

What is interesting here is that the level of debt in the world economy has not fallen despite the Great Recession, the banking crash and bailouts.  Deleveraging is not really happening, at least not to any great extent.  According to Gerard Minack of the investment bank, Morgan Stanley (If it can’t happen, it won’t happen), developed economy non-financial sector leverage continues to rise.  Non-financial sector debt includes all debt held by governments, households and corporations.  It excludes financial sector debt.  Non-financial sector debt in the US, Europe and Japan (G3) is now over 285% of GDP compared to 275% at the start of the Great Recession.  It’s true that business debt to GDP has fallen a little and in some countries like the US, so has household debt.  But government debt has rocketed as governments bailed out the banks and were forced to borrow more to spend more on unemployment and social benefits in the slump while tax revenues dropped.  Financial sector debt did fall too, by 20% from its peak.  But if we add up all debt – non-financial and financial – in the G3, it fell from 409% of GDP to 379% of GDP in September 2011, but has now risen back to 400%.  So not much deleveraging there.

NF debt

In fact, Minack points out that the US is the only economy that has seen any deleveraging and that largely reflects mortgage defaults in the household sector. Moreover, new dollar-denominated debt issuance is at an all-time high and very high relative to US GDP. The high gross issuance is in part to refinance existing debt at lower rates, although there are pockets where leverage is rising (such as student loans).

Debt issuance

Minack reckons that this failure to deleverage and indeed even a rise in debt has been made possible because interest rates are very low, thanks to the efforts of central banks to push the floor on rates of interest down to zero.  So the cost of servicing the high debt is relatively low, for now.  The key sector for capitalist growth is the business sector.  In the US, corporate debt is near all-time highs, although down from the peak in 2008.  But debt service payments as a percent of GDP have fallen to near four decade lows (and by $150bn from the 2007 peak).

Debt payments

The average effective interest rate paid on the entire stock of US debt is at the lowest level since at least 1960. But the underlying issue of too much fictitious capital is revealed by another measure: gross interest payments relative to GDP, an economy-wide measure of the debt-service burden.  This rate remains well above pre-1980 levels and the gap between the average interest rate paid (interest payments relative to the stock of debt) and the debt service burden (interest payments relative to GDP) is widening because of rising leverage (the debt-to-GDP ratio).


The current low-growth world is a reflection of the burden of still high debt levels on the cost of borrowing relative to potential return on capital and thus on growth.   The job of a slump (to devalue assets, both tangible and fictitious) has not yet been achieved.  And if interest rates should start to rise, that could easily trigger a new slump. as the cost of servicing corporate and government debt would rise to unsustainable levels.   That is what the monetarists (Bernanke) and the Keynesians are worried about.

The research on how long it takes to deleverage after a credit and financial boom and bust is now well established.  Kenneth Rogoff and Carmen Reinhart have done a number of historical studies on the issue over the past few years.  This has provoked debates with Keynesians like Paul Krugman, who deny that it is necessary to deleverage when an economy is in deep depression.  On the contrary, more government spending through borrowing can restore growth and that will eventually enable debt levels to fall, as happened after the second world war.  I have discussed these arguments many times before in previous posts (https://thenextrecession.wordpress.com/2012/04/14/the-austerity-debate/).  The point is that these criticisms of Reinhart and Rogoff’s work do not change the empirical results, whatever the causal direction.  In historical case after case, high debt levels are associated with financial crashes and then with low growth often for up to a decade or more.

In a recent paper, Debt overhangs: past and present, Reinhart, Reinhart and Rogoff  identified major public debt ‘overhang episodes’ in the advanced economies since the early 1800s, characterised by public debt to GDP levels exceeding 90% for at least five years.  They found that these overhang episodes were associated with growth over 1% lower than during other periods.  And among the 26 episodes looked at, 20 lasted more than a decade especially if the post-war episodes are excluded.  The length of these overhang periods suggests that the debt has not risen because of any recession causing economic growth to slow, but on the contrary, the recession continues because of the debt build-up.  And the three RRRs find that “the growth effects are significant even in the many episodes where debtor countries were able to secure continual access to capital markets at relatively low real interest rates. That is, growth-reducing effects of high public debt are apparently not transmitted exclusively through high real interest rates.”  So the problem is not the Keynesian liquidity trap, but the Marxist fictitious capital burden.

Even more compelling is recent research by the mainstream but unorthodox economist at the Bank of International Settlements, Claudio Borio.  Along with William White, back in the early 200s, Borio presented evidence to suggest that when credit gets very high relative to trend GDP growth over a period, there was an 80% chance of financial crash (see the paper, The financial cycle and macroeconomics: What have we learnt? borio395).  Borio and White predicted the financial crash of 2007, one of the few economists to do so .  Now Borio has claimed to have identified what he calls a ‘financial credit cycle’, similar to the cycle of boom and slump in capitalist economies, or to the pr0fit cycle that I have identified (see my book, The Great Recession).   Borio argues that “it is not possible to understand business fluctuations and  the corresponding analytical and  policy challenges without understanding the financial cycle.”  

Borio points out that, as traditionally measured, the business cycle (by which he means the cycle of boom and slump in modern capitalist economies) involves frequencies from 1 to 8 years . By contrast, he finds that there is a financial cycle in seven industrialised countries since the 1960s of around 16-18 years.  The length of this cycle is similar to 16-18 year profit cycle that I have identified for the US economy (with slightly different lengths for other capitalist economies), although with different times for turning points.

Borio does not want to accept that the financial cycle is a recurrent, regular feature of the economy. “Rather, it is a tendency for a set of variables to evolve in a specific way responding to the economic environment and policies within it. The key to this cycle is that the boom sets the basis for, or causes, the subsequent bust.”  That implies that if macroeconomic policies are used to avoid deleveraging, like fiscal expansion or easy money, then the length of the cycle could be extended, only for a bigger collapse later.  That may be the story now.  In that sense, the neoclassical argument of Cochrane may have some validity, but, of course, not his solution, namely leaving the market to its own devices.

Indeed, Borio argues that Keynesian fiscal expansion policies designed to get economies out of this depression don’t work when the financial cycle operates: “If agents are overindebted, they may naturally give priority to the repayment of debt and not spend the additional income: in the extreme, the marginal propensity to consume would be zero.  Moreover, if the banking system is not working smoothly in the background, it can actually dampen the second-round effects of the fiscal multiplier: the funds need to go to those more willing to spend, but may not get there.”

I hope to deal with this thorny issue of cycles in capitalism in an upcoming research paper for this summer. In the meantime, if Borio’s evidence proves robust, then it suggests that the bottom of the current financial cycle is still to come. But the end of deleveraging will only be reached after a new slump in the global economy.

11 thoughts on “Why is there a long depression?

  1. OK with your first reason for the “long recession”– profit rates; but not your second– debt or “fictitious capital” or whatever. It’s not too much “fictitious capital” that burdens accumulation– but too much “real capital”– real masses of means of production which cannot exploit labor at an intensity that offsets the decline in profit rates.

    “Fictitious capital” is just plain old derivative to the process of reproduction, not causal. In good times or bad.

    Certainly US non-financial corporations are hardly impeded by debt– sitting on about $2 trillion in cash in the US– nobody knows for sure how much is parked “outside” the US– most in US accounts of foreign subsidiaries.

    1. So exactly how are the claims of debt and fictitious capital depleting the total available surplus, and “crowding out” or otherwise interfere with the recovery from the “long recession”?

      Lack of revenues, declining profits– all that gets absorbed and reflected in the real decisions of businesses, but “fictitious capital” claims? Sorry, it seems to me all that is is the reworking of the shopkeepers’ lament about being refused a loan from the bank, and takes us back to the nonsense about “liquidity crises.”

      Or… you can take the underconsumptionist argument that the “debt burden” and the “debt service” prevent consumers from spending enough to lift the economy out of its recession.

      The non-financial 500 largest companies in the US, which account for about 3/4 of industrial output, IIRC, are cash rich. If they took on additional debt, it’s only because rates are so low. I’d like to see any evidence, on a broad basis, that “fictitious capital” claims on real surplus value have throttled an economic recovery.

      Just ain’t happening.

  2. I should add that a very good example of lack of investment (both PME and R&D investment) is New Zealand. It’s long been substantially lower than the OECD average, and the public sector (government and higher education) provide the bulk of R&D investment because the private sector won’t/can’t. What has happened in NZ is that the large-scale defeat of the union movement in the early 1990s means that employers have simply rleied mainly on increasing absolute surplus-value. It’s interesting looking at the productivity graph of Australia and NZ. Growth was pretty equal, then from the early 1990s (when the Employment Contracts Act codified the defeat of the worknig class), NZ productivity growth falls notably behind because the capitalists here relied largely on making workers work harder, longer, etc.

    Anyone interested in the New Zealand example should check out the NZ-based blog, Redline: http://rdln.wordpress.com/

    In the meantime, Michael thanks for another excellent piece. We have a link on Redline to this blog and we reprint a lot of your stuff, with due credit and links of course.


    1. Yes. Cutting real wages and increasing the intensity of labour are also ways of increasing relative surplus value and an alternative to increasing the productivity of labour. Absolute surplus value is only increased by extending the length of the working day.

      1. NZ workers now work longer hours than workers in practically any of the advanced capitalist countries – and have fewer public holidays.

        The intensity of labour (speed-up) is an interesting one. Back in 1997 I read a fascinating account by someone who had been working in a big whiteware factory in NZ who vividly described the effects of speed-up. At the same time I was part of a ‘Capital’ study group and we were right in the midst of the section of volume one that looks at absolute and relative surplus-value. And there it was – the explanation of why speed-up is used. (There seems to be some dispute among Marxists these days about whether this is absolute or relative surplus-value, but I agree with you that it is relative surplus-value).

        When you say increasing the intensity of labour (is) an alternative to increasing the productivity of labour, I assume you actually mean without investing in new constant capital – after all, speed-up does increase the productivity of labour; it’s a particularly brutal way of doing so and there are also physical limits to it.

        If anyone would like a copy of the pdf of stuff on the whiteware factory – the work process was called ‘the Nissan way’, but it has other names as well – I’m happy to send it on. Needless to say, the union was fully complicit in it.



      2. I think it probably is important to put wage cuts, speed-ups and reorganisation of the labour process in the same category as productivity growth (via spending on fixed capital), i.e. relative surplus value.

        For an individual capitalist, profitability is to be achieved by any means and they are equally valid – if they deliver. And they certainly have in the UK where real wages, after rising around 2% a year from 2003 to 2009, have been hit hard and are today back to the level of 2003. We are living through a second neo-liberal push. Cost cutting has resulted in two trends since the recovery in 2009-10: profitability has been broadly maintained and at the same time growth has been flat or low over the period.

        But the method of increasing relative surplus value have different limits. Investing in productivity growth will eventually lead to a falling rate of profit, though the timescale may be long due to countervailing factors. The period of profitability through wage cuts is vicious and effective but likely to be much shorter as it’s dependent on organised labour swallowing it – as is generally the case in the UK at the moment – and avoiding a deep recession that will hit the profitability of the whole capitalist class. Hence the IMF and OECD champion austerity but caution the over-zealous at times.

  3. Meant to add:

    The issue is the “real” capital– the expanded means of production, the alteration of the relation between the technical and living components of reproduction, between necessary and surplus labor on which, in Marx’s words, “everything depends.”

    Fixed asset accumulation in the US has continued since 2007, and that is slowing the rate of growth of profit recovery from the 2009 lows.

  4. sartesian wrote:
    “The non-financial 500 largest companies in the US, which account for about 3/4 of industrial output, IIRC, are cash rich. If they took on additional debt, it’s only because rates are so low. I’d like to see any evidence, on a broad basis, that ‘fictitious capital’ claims on real surplus value have throttled an economic recovery.

    “Just ain’t happening.

    That’s very interesting. In NZ we also had the case some years back where a sector of capitalists were just sitting on funds, not investing although they had funds. It was hard to find out what they were doing with it – you can only spend so much on big houses and yachts. The National Business Review said these particular capitlaists were just ‘resting’ their funds, which I thought was quite funny. Like something out of a Monty Pyhton sketch.

    So what do you think they are doing with all this cash?


  5. Oops, that comment above should just be Phil, not Admin. Turned up as admin because I was logged into a blog on which I’m an Admin.


  6. Due to the Roman legal framework for private property and the mechanistic legal rationale of innovation, most aspects of technical progress are not subject to property law. They cannot become private property and personal property is not legally property at all. Therefore there is a first mover disadvantage for investment in productive capacity via technical progress because improvements can immediately be copied by competitors who don’t have to pay the R&D penalty. This is why technical progress is typically developed by the public sector and then given freely to the private sector. The political power struggle between powerful owners of private property and democracy has resulted in a weakening of public R&D which in turn reduces opportunity for private sector investment.

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