Archive for December, 2015

Top ten posts of 2015: Market turmoil, Greece,Mason, Varoufakis and Marxist crisis theory

December 31, 2015

Here is my usual resume of the top ten most read posts on my blog in 2015.

Topping the list was my post in August, Market turmoil, which picked up on the plunge in global stock markets.  It seems that blog followers were keen to note that, as I said in that post, the “big truth” about the global ‘economic recovery’, such as it is since 2009, is that it had been mainly based, not on investment in productive sectors to raise productivity and employment, but in fictitious capital, (buying back shares, buying government and corporate bonds and property).  Cheap and unending money from central banks through their quantitative easing (QE) programmes has restored the banking system, but not the productive part of capitalist economies.  Debt has not been reduced overall but extended in the corporate sectors of the major economies.  There is still a huge layer of fictitious capital, as Marx called it.  It appears that global investors are beginning to realise that the ‘recovery’ is fictitious and is based only on yet another credit-fuelled mirage. Markets continued to be weak through to the end of the year.

Also in the top ten was a post made slightly earlier in August about the demise of the so-called emerging economies.  In The emerging market crisis returns, I made the point that for the first time since the emerging market crisis of 1998, the so-called BRICS economies (Brazil, Russia, India, China and South Africa) were in trouble, as well as the next range of ‘developing’ economies like Indonesia, Thailand, Turkey, Argentina, Venezuela etc.

Previously rising commodity prices in oil, base metals and food had led to fast growth in many of these economies.  But now the commodity boom had collapsed.  Commodity prices have fallen by 40% since 2011.  This was another indicator of the long depression and deflationary pressures in the world economy.  Alongside rising debt was falling profitability and weak consumer demand in emerging markets outside China.

But the most popular posts were those on the huge economic and political crisis in Greece, which dominated the thinking of many in the first half of 2015.  The leading Greek post was my critique of Greece’s economic star, Yanis Varoufakis, an erudite heterodox economist with Marxist leanings who briefly became finance minister in Greece’s leftist Syriza government.  My post took up what I considered were inconsistencies in his Marxist economic thinking.  Varoufakis considers himself an “erratic Marxist”. I argued that he was more the former than the latter.

Several other posts on Greece made the top ten in 2015.  First, there was the post I wrote before Syriza won the Greek general election last January, called, Syriza, the economists and the impossible triangle.  It was a review of the ideas of the now current Syriza finance minister, Euclid Tsakalotos who took over from Varoufakis.  I argued that the key issue was reducing the huge public debt that Greece had incurred from previous bailouts.  Tsakalotos’ position appeared to be that a compromise would be reached with the EU leaders to reduce that.

But as I write today, nearly 12 months later, such a compromise has not occurred.  On the contrary, Greek debt is still rising and growth has not been restored, while the Syriza government imposes further measures of austerity to meet the demands of the Troika.  In the post, I posed what some have called the impossible triangle: namely could Syriza 1) stay in power, 2) reverse austerity and 3) stay in the euro?  Surely, one or more of these aims would have to go?  It was the second.  I predicted that Syriza would split under the pressure but that Greece would still be in the Eurozone by January 2016.

Readers of my blog also followed two further posts on Greece.  In March, I posted Greece: Keynes or Marx?, in which I took a look at the position being taken by Costas Lapavitsas, a leading member of the Left Platform in Syriza and a Marxist economist from SOAS in London University, then a newly-elected Greek MP.  Lapavitsas had strong criticisms of Varoufakis and PM Tsipras.  But I took him to task for leaning on Keynesian rather than Marxist policies for the way out for Greece. I also criticised his Keynesian-style solution that leaving the Eurozone and devaluing must be done first before socialist measures could be considered.  Read this post again to see what you think and whether you agree with Lapavitsas or me.

Then there was my post in July after the Greek people, against all the odds, had voted 60% to reject the Troika bailout and austerity in a referendum.  The post posed the question: what now?  I said there were three possible economic policy solutions. There was the neoliberal solution demanded by the Troika.  This is to keep cutting back the public sector and its costs, to keep labour incomes down and to make pensioners and others pay more. This was aimed at raising the profitability of Greek capital and with extra foreign investment, restore the economy.

There was the Keynesian one, boosting public spending to increase demand, introducing a cancellation of part of the government debt and leaving the euro to introduce a new currency (drachma) that is devalued by as much as is necessary to make Greek industry competitive in world markets.  I argued that this would not work.

The third option was a socialist one that recognises that Greek capitalism cannot recover to restore living standards for the majority, whether inside the euro in a Troika programme or outside with its own currency and no Eurozone support. The socialist solution was to replace Greek capitalism with a planned economy where the Greek banks and major companies are publicly owned and controlled and the drive for profit is replaced with the drive for efficiency, investment and growth.

Although posts on Greece were prominent in the top ten, the most popular were theoretical ones around the issues of the theory of crises under capitalism and its long-term future, expressing the interest in these issues among many blog followers.  The most popular of all posts after stock market turmoil and Yanis Varoufakis was the one on Paul Mason’s new book, Post-capitalism.

Mason argued that capitalism is set to be replaced by ‘postcapitalism’ for three reasons. First, there is an information revolution which is creating a society of abundance in information, making a virtually costless and labour-saving economy. Second, this information revolution cannot be captured by the capitalist market and the big monopolies. And third, already the ‘post-capitalist’ mode of production, based on free ownership and cooperation in information, is emerging from within capitalism, just as capitalism emerged from within feudalism.

In my post. I commended Mason’s optimistic vision for a post-capitalist world but reckoned Mason ignored the two sides of technical advance under capitalism.  Yes, one side suggests the potential for a super abundant, low labour time world.  But the other suggests inequality, class struggle and regular and recurrent crises.  Postcapitalism’ cannot emerge without resolving this contradictions generated by capitalism.  Mason’s book and the seeming rise of robots and artificial intelligence continue to provoke debate among Marxists. And in August and September, I did three posts on the rise of robots.

Another key debate among Marxist economists, namely the nature and causes of crises in capitalism, led to a post in June in the top ten. Entitled There is a long term decline in the rate of profit and I am not joking!, it took up the issues of debate among Marxist economists at a special Capitalism Workshop in London last May which included several Marxist economic luminaries.  Marx’s law of profitability came in for a hammering for its relevance to crises, both theoretically and empirically.  The papers presented at that Workshop will be published as a series of chapters in a special edition of Science and Society in 2016.

As a follow-up to that debate and to the one that I had with Professor Heinrich in Berlin in the same month, I recently posted a short essay called A Marxist theory of economic crises in capitalism that presented my arguments for relying Marx’s law of the tendency of the rate of profit to fall as the basis for explaining recurrent and regular slumps under capitalism.  That got into the top ten.

Finally, the theme of rising inequality of wealth and incomes in the major capitalist economies remains a subject of keen interest among blog readers, and for the third year running, the post on the latest measure of global wealth inequality as provided by Credit Suisse’ annual report made the top ten.  Yes, the top 1% of wealth holders in the world own nearly 50% of all the wealth (properties, land, companies, shares and cash) globally.  Such is the result of 250 years of capitalist ‘progress’: no real change in overall inequality seen in previous class societies.

Finally, let me thank all my (now thousands) of blog followers for their interest in the blog this year and also to those who have made comments on my posts (sometimes favourably, but often critically).  During 2015, I had over 400,000 viewings of posts on the blog and over 185,000 different visits to the blog.

The blog aims to provide information on the world economy, discuss and develop economic theory and research from a Marxist point of view and comment on economic policy with the aim of replacing capitalism with a new stage of human social organisation, socialism.  The task continues.

Also remember, you can follow my Facebook site here, where I cover day-to-day items of interest.

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You can get my Essays on Inequality here.

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or Kindle version for US:
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And hopefully, in the early part of 2016, my new book, The Long Depression, will be out for you all to consider, criticise and review.

http://www.haymarketbooks.org/pb/The-Long-Depression

Best for the New Year.

The Marxist theory of economic crises in capitalism – part two

December 29, 2015

In the first part of this double post, I dealt with whether Marx had a coherent theory of crises or not. I reckoned that Marx’s theory was based on his law of the tendency of the rate of profit to fall and that this law was realistic and coherent.  I also argued that Marx did not dispense with this law in his later works that some have claimed and it remains the best and most compelling theory of regular and recurrent economic crises in capitalism.  In this second part, I shall provide some empirical evidence from modern capitalist economies to support this view.  This completes what is really just a short essay on Marxist economic crisis theory – as I see it – with much left out.

Does Marx’s law fit the facts?

Some Marxist critics of Marx’s law of profitability reckon that the law cannot be empirically proven or refuted because official statistics cannot be used to show Marx’s law in operation.  But there are plenty of studies by Marxist economists that show otherwise.  The key tests of the validity of the law in modern capitalist economies would be to show whether 1) the rate of profit falls over time as the organic composition of capital rises; 2) the rate of profit rises when the organic composition falls or when the rate of surplus value rises faster than the organic composition of capital; 3) the rate of profit rises, if there is sharp fall in the organic composition of capital as in a slump.  These would be the empirical tests and there is plenty of empirical evidence for the US and world economy to show that the answer is yes to all these questions.

For example, Basu and Manolakos applied econometric analysis to the US economy between 1948 and 2007 and found that there was a secular tendency for the rate of profit to fall with a measurable decline of about 0.3 percent a year “after controlling for counter-tendencies.”  In my work on the US rate of profit, I also found an average decline of 0.4 percent a year through 2009. And here is a figure by G Carchedi for the rise in the organic composition of capital (OCC) in the industrial sector of the US since 1947 versus the average rate of profit (ARP).  It tells the same story.

US ARP and OCC (i.e. C/V)

ARP

There is a clear inverse correlation between a rising organic composition of capital and a falling rate of profit.

Can Marx’s law explain crises?

How does Marx’s law of profitability work as an explanation and forecast of slumps in capitalist economies?  The law leads to a clear causal connection to regular and recurrent crises (slumps).  It runs from falling profitability to falling profits to falling investment to falling employment and incomes.  A bottom is reached when there is sufficient destruction of capital values (the writing off technology, the bankruptcy of companies, a reduction in wage costs) to raise profits and then profitability.  Then rising profitability leads to rising investment again.  The cycle of boom recommences and the whole ‘crap’ starts again, to use Marx’s colourful phrase.  There is a cycle of profit alongside the long-term tendency for the rate of profit to fall.

Profit cycle

The evidence of this causality between profit and investment is available.  Jose Tapia Granados, using regression analysis, finds that, over 251 quarters of US economic activity from 1947, profits started declining long before investment did and that pre-tax profits can explain 44% of all movement in investment, while there is no evidence that investment can explain any movement in profits.  I find a higher ‘Granger causality’ of 60% from annual changes in profit and investment (unpublished) and a correlation of 0.67 for the period since 2000.  And see this by G Carchedi (Carchedi Presentation).

In the period leading up to the Great Recession 2008-9, we can see the causality visually for US profits, investment and real GDP in the graphic below.  The mass of US corporate profit peaks in mid-2006, investment and GDP follows two years later.  Profits turn back up in late 2008 and investment follows one year later.

profits lead

There are two basic regularities shown by the data: that a change in profits tends to be followed next year by a change in investment in the same direction; and that a change in investment is usually followed in a few years by changes in profits in the opposite direction.  Thus we have a cycle.  From these results, the “regularity” of the business cycle, and the fact that profitability stagnated in 2013 and declined in 2014 (and now the mass of profits in 2015) after growing between 2008 and 2012, it can be concluded with some confidence that a recession of the US economy, which will be also part of a world economic crisis like the Great Recession, will occur again in the next few years.

And Marx’s law of the tendency of the rate of profit to fall makes an even more fundamental prediction: that the capitalist mode of production will not be eternal, that it is transitory in the history of human social organisation. The law of the tendency predicts that, over time, there will be a fall in the rate of profit globally, delivering more crises of a devastating character. Work has been done by modern Marxist analysis that confirms that the world rate of profit has fallen over the last 150 years.  See the graph below (data from Esteban Maito and ‘doctored’ by me).

world rate of profit Maito

Maito’s data for the 19th century have recently been questioned (DUMENIL-LEVY on MAITO), but in a recent work using different sources and countries, I find a similar trend for the post-1945 period globally (Revisiting a world rate of profit June 2015).  And earlier groundbreaking work by Minqi Li and colleagues, as well as by Dave Zachariah, show a similar trend.

As Maito concludes: “The tendency of the rate of profit to fall and its empirical confirmation highlights the historically limited nature of capitalist production. If the rate of profit measures the vitality of the capitalist system, the logical conclusion is that it is getting closer to its endpoint.  There are many ways that capital can attempt to overcome crises and regenerate constantly. Periodic crises are specific to the capitalist mode of production and allow, ultimately, a partial recovery of profitability. This is a characteristic aspect of capital and the cyclical nature of the capitalist economy. But the periodic nature of these crises has not stopped the downward trend of the rate of profit over the long term.  So the arguments claiming that there is an inexhaustible capacity of capital to restore the rate of profit and its own vitality and which therefore considers the capitalist mode of production as a natural and a-historical phenomenon, are refuted by the empirical evidence.”

So the law predicts that, as the organic composition of capital rises globally, the rate of profit will fall despite counteracting factors and despite successive crises (which temporarily help to restore profitability).  This shows that capital as a mode of production and social relations is transient.  Capitalism has not always been here and it has ultimate limits, namely capital itself.  It has a ‘use-by-date’.  That is the essence of the law of profitability for Marx.

Alternative theories

This is not to deny other factors in capitalist crises.  The role of credit is an important part of Marxist crisis theory and indeed, as the tendency of the rate of profit to fall engenders countertendencies, one of increasing importance is the expansion of credit and the switching of surplus value into investment in fictitious capital rather than productive capital to raise profitability temporarily, but with eventually disastrous consequences, as The Great Recession shows (The Great RecessionDebt matters).

Alternative theories of crisis like underconsumption, or the lack of effective demand, are taken from theories from the reactionary Thomas Malthus and the radical Sismondi in the early 19th century and then taken up by Keynes in the 1930s and by modern inequality theorists like Stiglitz  and post-Keynesian economists.  But lack of demand and rising inequality cannot explain the regularity of crises or predict the next one.  These theories do not have strong empirical backing either (Does inequality causes crises).

Professor Heinrich, after concluding that Marx did not have a theory of crisis and dropped the law of profitability, does offer a vague one of his own: namely capital accumulates and produces more means of production blindly.  This gets out of line with consumption demand from workers.  So a ‘gap’ develops that has to be filled by credit, but somehow this cannot hold up things indefinitely and production then collapses.  Well, it is a sort of a theory, but pretty much the same as the underconsumption (overproduction) theory that Heinrich himself dismisses and Marx dismissed 150 years ago.  It seems way less convincing or empirically supported that Marx’s own theory of crisis based on the law of profitability.

No other theory, whether from mainstream economics or from heterodox economics, can explain recurrent and regular crises and offer a clear objective foundation for the transience of the capitalist system.

Why not Marx’s law of profitability?

Finally, why do Professor Heinrich and others like Professors David Harvey, Dumenil and Levy and many other Marxist economists, want to dish Marx’s law of profitability as a theory of crises?

Obviously, they think it is wrong.  But all these alternative theories have one thing in common.  They suggest a way out of crises within the capitalist system. If it’s due to underconsumption, then spend more by government; if it’s due to rising inequality; then correct that with taxation; if it’s too much credit or instability in the financial sector, then regulate it.  None of these leads to policies or actions to replace the capitalist mode of production at all but merely to correct or improve it.  They lead to reformist strategies i.e. there no need to replace the capitalist mode of production with common ownership of the means of production and democratically controlled planning for need (socialism).

Then socialism becomes a moral issue to end poverty and inequality not an objective necessity if human society is to achieve freedom from toil.  That’s a reformist view, but not Marx’s.  Actually even these small changes that preserve capitalism might still require revolutionary action in the face of fierce opposition by capital – so why stop at reform?

The Marxist theory of economic crises in capitalism – part one

December 27, 2015

Last May, at the Marx ist Muss conference in Berlin, I debated with Professor Michael Heinrich on whether Marx had a coherent theory of crises under capitalism that could be tested empirically.  Heinrich’s view, best expressed in an article he had written for Monthly Review Press in 2014, was that Marx did not have a coherent theory of crisis and, anyway, it cannot be tested as we only have official capitalist statistics.  For something to read during this ‘Xmas week’, here is a revised version of my speech in that debate.  The first part deals with the question of whether Marx had a coherent theory of crises or not.

Why do we care about the theory of crises? 

Those active in the struggles of labour against capital internationally may wonder why some like me spend so much time turning over the ideas of Marx and others on why capitalism has regular and recurrent slumps and financial crashes.  We know they do, so let’s just get on with ending capitalism through struggle and put aside the minutae of theory.

Well, there is good reason to understand the theory, because good theory leads to better practice. Yes, we know that capitalism has regular and often deep economic crises.  These cause huge damage to people’s livelihoods and stop human social organisation moving towards a world of abundance and out of scarcity and toil.  And crises are indications of the contradictory and wasteful nature of the capitalist mode of production.

Before capitalism, crises were products of scarcity, famine and natural disasters.  Now they are products of a profit-making money economy; they are man-made and yet appear to be out of the control of man; a fetishism.  Above all, crises show that capitalism is a failing system despite the great strides in the productivity of labour that this mode of production has generated in the last 200 years or so.  It will have to be replaced if humankind is to progress or even survive as a species.  So it matters.

Did Marx have a coherent theory of crisis? 

What is it?  It is a matter of intense debate among Marxists.  There are various interpretations. Crises of capitalist production are due ‘underconsumption’, a lack of spending by workers who do not have enough to spend; or due to ‘disproportion’, the anarchy of capitalist production means that production in various sectors can get out of line with others and production can just outstrip demand; or it’s the lack of profitability in an economic system that depends on profit being made for private owners in order for investment and production to take place.  In my view, the latter argument is the one that is both the best interpretation of Marx’s theory and also the one that is logical and fits the facts.

Some argue that Marx did not have a coherent theory of economic crises, and that was especially the case with Marx’s law of profitability.  The argument goes that a reading of Marx’s works: Capital, Theories of Surplus Value and the Grundrisse, shows that Marx’s law of the tendency of the rate of profit to fall is inconsistent and illogical.

For example, the law argues that the value of means of production (machinery, offices and other equipment) will, over time, rise relative to the value of labour power (the cost of employing a labour force) – a rising organic composition of capital, Marx called it.  As value (and profit) is only created by the power of labour, then the value produced by labour power will, over time, decline relative to the cost of investing in means of production and labour power.  The rate of profit will tend to fall.

But some Marxist critics say that this assumes that rate of surplus value (profit relative to the cost of employing labour power) will be static or rise less than the organic composition of capital.  And there is no logical reason to assume this – indeed, the very rise in the organic composition will involve a rise in the rate of surplus value (to raise productivity), so the law is really indeterminate.  We don’t know whether it will lead to a fall or a rise in the rate of profit.

But this is to misunderstand the law and how Marx posed it.  The law ‘as such’ is that a rising organic composition of capital will rise and, assuming the rate of surplus value is static, the rate of profit will fall.  But this is only a ‘tendency’ because there are ‘ countertendencies’, including a rising rate of surplus value, the cheapening of the value of means of production, wages being forced below the value of the labour power, foreign trade and fictitious profits from financial speculation.  But these are ‘countertendencies’, not part of the ‘law as such’ precisely because they will not overcome the law (the tendency) over time.

As Marx said: “They do not abolish the general law.  But they cause that law to act rather as a tendency, as a law whose absolute action is checked, retarded and weakened by counteracting circumstances.… the latter do not do away with the law but impair its effect.  The law acts a tendency.  And it is only under certain circumstances and only after long periods that its effects become strikingly pronounced.”

Marx argues that the law is based on two realistic assumptions: 1) the law of value operates, namely that value (and surplus-value) is only created by living labour and 2) capitalist accumulation leads to a rising organic composition of capital.  These assumptions (or ‘priors’ in modern statistical language) are not only realistic: they are self-evident.

First, the law of value.  The production of what Marx called ‘use values’ (things and services we need) is necessary to create value.  But even a child can see that nothing is produced unless living labour acts.  “Every child knows a nation which ceased to work, I will not say for a year, but even for a few weeks, would perish.”, Marx to Kugelmann July 11, 1868.

The rising organic composition of capital is also self-evident.  From hand tools to factories, machinery, space stations, there is a huge increase in labour productivity under capitalism as a result of mechanisation.  Yes that creates new jobs for living labour but it is essentially a labour-shedding process.  While each unit of a new means of production might contain less value (due to the lower price of production of that technology) than a unit of an older means of production, usually the old is replaced by new and different means of production, or by a new system of means of production that contains more total value than the value of the means of production they have replaced.

As Marx explains in the Grundrisse: “What becomes cheaper is the individual machine and its component parts, but a system of machinery also develops; the tool is not simply replaced by a single machine but by a whole system… Despite the cheapening of individual elements, the price of the whole aggregate increases enormously”. As Marx put it: ‘It would be possible to write quite a history of the inventions made since 1830, for the sole purpose of supplying capital with weapons against the revolts of the working class.’ (Marx, 1967a, p. 436).

Higher productivity is not the aim of capitalist investment; it is higher profit.  And to achieve that, capital needs higher productivity and labour-shedding new means of production. Was Marx right that capitalist investment leads to a higher organic composition of capital over time?  He sure was.  Look at this graph.

Picture1

It shows a steady rise in the value of means of production (machinery etc) relative to the value of labour (measured in labour time) in the US since 1947.  It also shows rising productivity (the labour time taken to produce one unit of things or services – LT).  This is for the UK since 1855, as measured by Esteban Maito).  So we have a rising organic composition of capital (VKxH) and a rising productivity of labour (falling LT) and a decline in the rate of profit over time (ROP).  This is Marx’s law as such.

There are counter-tendencies but they do not overcome the tendency, the law as such, indefinitely.  Why?  Well, first, there is a limit to the rate of surplus value (24 hours) and there is no limit to the expansion of the organic composition of capital.  Second, there is a ‘social limit’ to a rise in the rate of surplus value, namely labour (workers’ struggles) and society (social legislation and custom) set a minimum ‘social’ living standard and hours of work etc.  This is the essence of class struggle under capitalism.

Did Marx drop his law of profitability as a theory of crises?

In a letter to Engels as late as 1868, over ten years after he first developed the law, Marx said that the law “was one of the greatest triumphs over the asses bridge of all previous economics”.?

But many Marxist critics reckon that Marx dropped this law as relevant as he did not seem to refer to the law after he expounded it in the late 1860s and looked more at the role of credit in crises (as Keynes and modern heterodox economists now do).  Moreover, Engels, in editing Marx’s manuscripts after his death into Volumes 2 and 3 of Capital, made far too much of Marx’s law; indeed distorting Marx’s views on this.

Back in 1978, Jerrold Seigel had a look at the manuscripts.  Yes, Engels made significant editorial changes to Marx’s writing on the law as in capital Volume 3.  He divided it into three chapters 13-15; 13 was ‘the law’; 14 was ‘counteracting influences’ and 15 described the ‘internal contradictions’ (the combination of the tendency and countertendencies).  Engels shifted some of the text into Chapter 13 on the ‘law as such’ when in Marx’s manuscript they came after the counteracting factors in Chapter 14.  But in doing so, Engels does not overemphasise the importance of the law – on the contrary, Engels actually makes it appear that Marx balances the countertendencies in equal measure with the law as such, when the original order of the text reemphasises the law after talking about counter-influences.  So, as Seigel puts it: “Engels made Marx’s confidence in the actual operation of the profit law seem weaker than Marx’s manuscript indicates it to be.” (Seigel, Marx’s Fate: The Shape of a Life, Princeton, Princeton University Press, 1978, p339 and note 26).

Fred Moseley and Regina Roth recently introduced a new translation into English of Marx’s four drafts for Volume 3 by Ben Fowkes, where Marx’s law of profitability is developed and shows how Engels edited those drafts for Capital (Moseley intro on Marx’s writings). Moseley concludes that the much maligned Engels did a solid job of interpreting Marx’s drafts and there was no real distortion. “One can, therefore, surmise that Engels’ interventions were made on the basis that he wished to make Marx’s statements appear sharper and thus more useful for contemporary political and societal debate, for instance, in the third chapter, on the tendency of the rate of profit to fall.”

From 1870, Engels had moved from Manchester to London.  So Marx and he met together as a matter of routine, usually daily. Discussions could go on into the small hours. Marx’s house lay little more than 10 minutes walk away … and there was always the Mother Redcap or the Grafton Arms.  As late as 1875, Marx was playing with calculations of the rate of surplus value and the rate of profit.  If Marx had really dropped the law as his most important contribution to understanding the contradictions of capitalism, would he not have mentioned it to Engels?

In the second part of this blog post, I shall look at the empirical support for Marx’s law of profitability as a theory of crises under capitalism.

The US rate of profit revisited

December 20, 2015

We now have the latest data from the US Bureau of Economic Analysis (BEA) going up to 2014 in order to work out a ‘Marxian rate of profit’ for the US economy.  So I have revisited the data in order to bring things up to date.  All the data behind the following graphics are available on request (and see the pdf version for the appendix on sources and methods for each graphic, US rate of profit revisited).

I have not looked at this since the end of 2013, so it is high time to see where the US rate of profit has gone since then and draw some conclusions.

Now how to measure the rate of profit in a ‘Marxian’ way is a matter for continual debate and this post will not go over ground dealt with before.  Instead, I refer you my paper on measuring the rate of profit in different ways and also previous posts that deal with this issue.

The main argument over how to measure the rate of profit has been whether to use historic costs (HC) for valuing the stock of fixed assets held by the capitalist sector in an economy or whether it is okay or better to use current or replacement costs.  I won’t go into the arguments again – they are covered in the papers and posts already cited.

But it would be interesting to revisit the work of Andrew Kliman (AK) (see his book, The failure of capitalist production) and replicate his way of measuring the US rate of profit with the latest data.  This I have tried to do this faithfully in the first graphic here (Figure 1).

Figure 1. US rate of profit (Kliman measure).

US rate of profit (Kliman)

AK’s key arguments were that the US rate of profit since the end of 1945 has ‘persistently fallen’ and that there was no real consolidation or recovery in the so-called neo-liberal period from the late 1970s onwards.  The revisited data support those conclusions – except that there appears to be a recovery in profitability from the end of the trough of 2001 up to 2014.  Also, on the AK measure, there was a peak in 2006 which has not been breached since, even after the Great Recession ended in 2009.  Indeed, the trough of 2001 was not surpassed on the downside by the trough of 2009 in the Great Recession.  On the AK measure, US profitability has been stagnating (but no longer falling) at post-war lows since the late 1980s-early 1990s. Or if you like, the US rate of profit is no lower than it was 20 years ago.

The majority of Marxist economists reject the historic cost (HC) measure for the rate of profit (wrongly in my view) and instead use current costs (CC) for the value of fixed assets.  How does the current cost measure shape up then?  In the second graphic (Figure 2), we can see that there is similar secular fall in the US rate of profit since 1945 but the rate of profit stays high in the 1960s and then plummets to a trough in the early 1980s before consolidating and even rising to the late 1990s.  Since 1997, it has been more or less flat at post-war lows, although we see in both measures (HC and CC) that the rate of profit stopped rising in 2012 and has fallen in the last two years.

Figure 2. US rate of profit measures compared

US rate of profit compared

Interestingly, there is little difference in the trajectory of the HC and CC measures from the early 1990s: except that the CC measure goes to a new low in the 2009 Great Recession over the 2001 mild recession and the AK-HC measure does not.  But the similar trajectory since the early 1990s could be because the main factor that divides their results, the impact of inflation on fixed assets, has diminished sharply in the last 20 years (see Basu).

Both the above measures look only at the corporate sector and also do not include variable capital in denominator for the rate of profit.  I reckon that is better to look at the profitability of the whole economy (not just the corporate sector) to get a better overall picture of profitability (I have presented my arguments for this in the paper already cited above).  But also there is no reason to leave out variable capital so that Marx’s traditional measure of profitability (surplus value/constant capital plus variable capital – s/c+v) is sustained.  Nearly all Marxist economists reckon that we should drop variable capital in the equation due to issues over the measurement of the turnover of variable capital.  I won’t go into the arguments here, but I think that this omission is not necessary.  In an unpublished paper G Carchedi and I explain why – here is a short version of that (Measuring variable capital and turnover for the rate of profit).

Anyway, on my measure (using both historic and current costs), the US rate of profit from 1946 to 2014 looks like this (Figure 3).

Figure 3. US rate of profit – whole economy measure

US rate of profit whole economy

Again, there is a clear secular decline since the end of WW2.  On the CC measure there appears to be a ‘neoliberal’ recovery after 1982, but stagnation on the HC measure up to the early 1990s and then a recovery.  The recovery on both measures is very mild compared to the fall in the 1970s.  There is a peak in 1997 on the CC measure which has not been surpassed since.  On the HC measure, the peak is 2006, again not surpassed since.  There is a very close movement in the rate of profit on both measures since the 2006 peak and, on both measures, the rate of profit appears to have peaked and fallen back since 2012.

Marx’s law of profitability says that the organic composition of capital (the value of the means of production relative to the value of wages) will tend to rise over time and this tendency explains the tendency of the rate of profit to fall.  The major counteracting tendency is a rising rate of surplus value as profits outstrip wages relatively.

If we break down the composition of the US rate of profit since 1946, Marx’s law is confirmed: the organic composition of capital has risen steadily (with some periods of reversal) and the rate of profit has fallen.  The fall is not due to a fall in the rate of surplus value, which has risen during the period.  The inverse correlation between the organic composition and the rate of profit is -0.77.  That’s higher than the positive correlation between the rate of surplus value and profitability, at +0.60.

If we compare the changes in the rate of profit (ROP) with the changes in the organic composition of capital (OCC) and the rate of surplus value (ROSV), the Marxist story is again confirmed.  Between 1945 and 2014, the US rate of profit (whole economy measure) falls 24% while the organic composition of capital rises 69% and the rate of surplus value just 2%.  Between 1965 and 1982, when the ROP falls 21%, the OCC falls too by 1.5% and the ROSV falls sharply by 22% (in effect, there is a relative increase in OCC versus ROSV).  Between 1982 and 1997 when the ROP rises 10%, the OCC rises nearly 7% and ROSV rises even more by 14%.  After 1997, the ROP falls slightly by 1.6%, as the OCC rises faster (11.7%) than the ROS (7.4%).

Figure 4. The change in the US rate of profit (ROP) compared to the change in the organic composition of capital (OCC) and the rate of surplus value (ROSV), %

US rate of profit composition

Finally, let us look more closely at what has been happening since the end of the Great Recession in 2009, using the more frequent data on profits and fixed assets provided by the US Federal Reserve.  The data are not entirely compatible with the official BEA data used above but it is quarterly in frequency and takes us up to mid-2015.  So it has something to tell us.

The Fed measure shows the US rate of profit as the net operating surplus in non-financial corporate businesses (so it excludes the financial sector and the rest of the economy).  I’ve measured it against net tangible assets.  This is what it shows (Figure 5).  There is a recovery in profitability after the early 1980s, but from the late 1990s, profitability has been pretty flat although very volatile.  Profitability peaked in 2010 and has been falling since to mid-2015 although it is still higher than in the 1980s.  But the movement now is clearly down.

Figure 5. US non-financial corporate rate of profit (Fed measure) %

US rate of profit Fed measure

What can we conclude from all this?

First, the secular decline in the US rate of profit since 1945 is confirmed and indeed, on most measures, profitability is close to post-war lows.  Second, the main cause of the secular fall is clearly a rise in the organic composition of capital, so Marx’s explanation of the law of the tendency of the rate of profit to fall is also confirmed.  Third, profitability on most measures peaked in the late 1990s after the ‘neoliberal’ recovery.  Since then, the US rate of profit has been static or falling.  And fourth, since about 2010-12, profitability has started to fall again.

The fall in the rate of profit in the US has now given way to a fall in the mass of profits (Figure 6).

Figure 6. US corporate profits(adjusted for depreciation) % yoy

US corp profits

If this trend continues, then as I have shown elsewhere, investment will follow downwards and, with it, the US economy.  Watch this space.

The Fed “on the path of sustainable improvement”

December 17, 2015

So the Fed finally bit the bullet and decided to hike its policy rate from 0.25% to 0.50%.  It also suggested that it would continue to raise its rate by another 1% point in 2016 and further 1% point in 2017 to reach 3.5% by the end of the decade.

The Fed’s policy rate sets the floor for all borrowing rates in the US economy and further afield for credit in dollars for many economies.  So this is an important policy move.  It would appear that the era of cheap money, QE and ‘unconventional’ monetary policy is over – at least for the US.  The Fed now expects US annual inflation to rise from near zero now to 2% (on its measure of consumer spending) by 2019.  That means real interest rates (after deducting inflation) will rise from zero to 1.5%, if these projections hold.  That’s clearly a tighter money policy.

That tighter policy showed its effects straight away as US banks started hiking their borrowing rates while holding down what they pay savers for their deposits – so an immediate boost to bank profits.

Stock markets rose on the news of the Fed hike.  That was because investors were relieved that the uncertainty was over and now they knew what was coming and it did not look too bad.  They were encouraged by the comments of Fed chief, Janet Yellen, who claimed that the US economy “is on a path of sustainable improvement.” and “we are confident in the US economy”, even if borrowing rates rise.

This was ironic because just before the Fed hiked its interest rate, the figures for US industrial production in November came and they showed the worst fall since December 2009 at the end of the Great Recession.  Industrial production and manufacturing output are now contracting at 1% a year rate.

image004

This is partly due to the collapse in energy production as oil prices plummet, but not entirely.  It seems that the manufacturing of things in the US is weakening badly, given a strong dollar making exports difficult, and because of low profitability in the productive sectors.  It’s true that manufacturing is just 15% of the US economy but growth in this important productive sector has spillover effects into the wider economy, as many ‘services’ depend on manufacturing industries. So a sharp slowdown in this productive sector will hurt.

The Fed reckons that US real GDP growth will zoom along without any slump at the ‘break-neck’ speed of 2% a year from now on.  This is some 40% below the post-war average growth rate and even slightly lower than the sluggish pace of the last five years.  Yet Yellen calls this “sustainable improvement”!

So despite recent weak manufacturing and retail sales data, near zero inflation and real GDP growth stuck at around 2% a year, the Fed is starting to raise interest rates.  Why? It’s a mixture of things.

First, US unemployment is now relatively low (although still above pre-crisis levels) and the Fed fears workers will gain bargaining power and may be able to drive up wages as a result and cause inflation. But there is little sign of that given that most of the new jobs are in low-paid sectors, part-time or temporary contracts.

Second, the central bank would like to ‘regain control’ of monetary policy and ‘normalise’ things.  When interest rates are zero, then the Fed has no control over interest rates in general.  With positive rates, it can exert some control.  It even says that if things go wrong, it can cut rates when they are positive which it cannot do when they are zero.  This is a weird argument.  It’s like saying it is best if I cut my wrists now so they can start healing earlier, rather than holding off as I am going to have to do it some time.

Finally, there is a (vain) belief that the US economy is reaching full capacity and is ready to invest and grow steadily for the foreseeable future.

Well, not everybody agrees.  Stock markets may be happy for now with the Fed move but many mainstream economists are not, especially the Keynesians.  Paul Krugman considers it a big mistake and the Keynesian-influenced British newspaper, The Guardian, called it “premature and risky”.

Just before the Fed meeting, leading Keynesian economist and big wheel former US Treasury secretary Larry Summers wrote in the FT that it would be silly to hike rates because there were long term factors in the global economy that would keep real interest rates low; namely weak global growth, slowing population growth, rising savings rates, poor productivity growth and a cap on the improvement in the human capital skills.  This is the basis of what some economists like Summers and Robert J Gordon have called ‘secular stagnation’.  To hike rates in an environment of permanent stagnation was a mistake.

In his FT piece, Summers refers to a paper by two Bank of England economists with approval for his secular stagnation thesis.  Global interest rates and secular growth – BoE   The paper presents the argument for expecting real interest rates to stay low or even fall further because: the world economy will slow; inequality of incomes within major economies will rise driving up saving and lowering consumption growth; the education and skills of the global workforce will fail to improve much; and the great technological revolution of robots and AI will fail to deliver higher productivity growth.  “Although there is a great deal of uncertainty, if we add up all the factors analysed above, we think we can come up with a reasonable case for why global growth could slow by up to 1pp over the next decade or so.”

The BoE paper reckons that the global labour supply growth is in the midst of a sharp slowdown. Labour supply growth has already slowed by between 0.5pp and 1pp since the mid-1980s and looks set to slow further. In the near-term, other labour market dynamics could offset this trend. A sustained rise in labour force participation driven by: rising female participation; better education (to reduce skills mismatch); or better healthcare (to reduce long-term sickness); could all mitigate the fall. “But such factors can only postpone the decline in labour force growth – not prevent it from occurring.”

The paper notes that a key driver of global economic growth in the past decades has been productivity catch-up in the so-called emerging economies.  As countries accumulate more capital and improve efficiency by adopting the latest technologies from overseas, productivity per worker rises.  But the economists show that this is somewhat of an illusion:  “history reveals a pattern that is anything but smooth over the past. Between 1980 and 2010, GDP per capita growth in the US was actually faster than the average across the rest of the world in 15 out of 30 years – so the rest of the world spent just as long falling further behind the frontier as catching up.”

The BoE paper dismisses the optimistic view of a robot-led technological breakthrough and sides with the pessimistic view of Robert J Gordon on future low gains in productivity from an ICT boom: “Overall, our reading of the above arguments is that Gordon’s characterisation of recent history and the near-future is the most compelling. US productivity growth has been weak since the 1970s, was lifted temporarily by the ICT boom, but has since fallen back. In the absence of clear advances in technology, it seems reasonable to assume this trend will continue going forward – particularly given the recent weakness in productivity globally.”

Amazingly the paper, along with Summers, reckons that regulation of the banks and the new capital requirements since the Global Financial Crash are too tight and do not allow the banks to help the real economy.  In the past, in the face of tighter prudential policy, monetary policy could have been loosened to maintain growth. But in the future, if monetary policy is more constrained, then this mix of tighter prudential policy and looser monetary policy may not be available – so changes in prudential policy could have more significant impacts on growth.”  So regulation of banking, whether ‘light’ or ‘strict’ does not work to get financial resources into an economy.  It’s another argument for public ownership and control of banking.s-time-to-take-over-the-BanksLR.pdf.  That’s something that does not seem to be on the agenda of any major leftist group.

This really is a dismal picture of the capitalist future over the next couple of decades.  Summers concludes that the major capitalist economies will thus just stumble along trying to boost the economy with credit bubbles, then suffer financial busts and drop back again.

So the Fed may think the US economy is heading for ‘sustainable improvement’ but some Bank of England economists don’t.  And none of these forecasts take into account the high probability of a new slump or economic recession before this decade is out.  I have already weighed up the likelihood of that in previous posts.

Suffice it to say that faster economic growth depends on higher and ‘sustainable’ productive investment but that is not taking place because profitability in the major economies is still too low (indeed it is near post-1945 lows), while debt, particularly corporate debt is too high.  And now it is likely to get more expensive to service as the Fed raises dollar borrowing rates.

cost of capital

As former Fed Chair Ben Bernanke explained recently in a moment of clarity, the low real interest rates that Summers is all worked up about are really a product of low profitability.  “The state of the economy, not the Fed, is the ultimate determinant of the sustainable level of real returns. This helps explain why real interest rates are low throughout the industrialized world, not just in the United States.”

In the BoE paper, the two economists point out that the rate of return on capital has fallen since the early 1990s, but not by as much as the ‘risk free interest rate’ – so that the cost of borrowing for risky investment has increased by around 100bps.   In other words, the cost of borrowing to invest has stayed up while profitability on investment has fallen, squeezing the ‘profitability of enterprise’ and lowering the incentive to invest.  The BoE paper refers to the IMF World Economic Outlook April 2014 where the IMF finds that “investment profitability has markedly declined in the aftermath of the global financial crisis, particularly in the euro area, Japan, and the United Kingdom.”

Profitability of investment

Back in 1937, the US Fed concluded that the US economy had sufficiently recovered then to enable it to start raising interest rates.  Within a year, the economy was back in a severe recession that it did not recover from until America entered the world war in 1941.  The Fed then had failed to take into account the weak profitability of US capital and its unwillingness to invest for growth.  It’s an argument I presented more than a year ago, but it’s still relevant now.  Will history repeat itself?

Kuznets, Piketty, Marx and human development

December 14, 2015

A new index of human development (HDI) has been created.  The origins of the HDI are found in the annual Development Reports of the United Nations Development Programme (UNDP). These were devised and launched by Pakistani economist Mahbub ul Haq in 1990 and had the explicit purpose “to shift the focus of development economics from national income accounting to people-centered policies”.

Human well-being is widely viewed as a multidimensional phenomenon of which income is only one facet.  Human development defined as “a process of enlarging people’s choices” (UNDP 1990, p. 10), namely, enjoying a healthy life, acquiring knowledge and achieving a decent standard of living provides a long-run view of human well-being.

The Historical Index of Human Development (HIHD) covers up to 157 countries from the mid-19thcentury – before large-scale improvements in health helped by the diffusion of the germ theory of disease and in primary education began – to 2007, the eve of the Great Recession.

Social dimensions have driven human development gains across the board over the long run. Longevity accounts for the larger share during the first half of the 20th century.  Persistent gains in lower mortality and higher survival were achieved as infectious disease gave way to chronic disease, which was experienced in developing regions from 1920 to the 1960s.

Medical technological change – including the diffusion of the germ theory of disease (1880s), new vaccines (1890s), sulpha drugs to cure infectious diseases (late 1930s) and antibiotics (1950s) – has been a main force behind the major advancement in longevity and quality of life. Economic growth also contributed to expanding longevity through nutrition improvements that strengthened the immune system and reduced morbidity and public provision of health.

What the index reveals is that there were substantial gains in world human development from the mid-19th century as the world economy industrialised and urbanised, but especially over the period 1913-1970.  The major advance in human development across the board took place between 1920 and 1950, which resulted from substantial gains in longevity and education.

According to the index, although the gap between the advanced capitalist economies and the ‘Third World’ widened in absolute terms; in relative terms, there was a narrowing.  The Russian revolution from the 1920s and the Chinese one after 1947 led to fast industrialisation and a sharp improvement in health and education for hundreds of millions.  The second world war killed and displaced millions, but it also laid the basis for state intervention and the welfare state that had to be accepted by capital after the war, during the so-called ‘Golden Age’.

But after 1970, the gap in human development widened once again with globalisation, rising inequalities and the capitalist neo-liberal counter-revolution.  Only China closed the gap.  Since 1970, longevity gains have slowed down in most emerging economies, except China, and all the world regions have fallen behind in terms of the longevity index.

What is significant to me is the parallel connection between economic growth, narrowing inequality and human development between 1920-1970 and the reversal of those trends since 1970. Branco Milanovic has done major work on measuring inequality of income per head between countries and regions (rather than inequality within an economy).  He confirms the results of the human development index.  He finds that in the 1970s and 1980s, inequality between countries did not worsen.

inequality index

It was the benign view of Simon Kuznets that when capitalist economies ‘take off’ and industrialise, inequality of incomes will rise, but eventually, as economies ‘mature’, income inequality declines.  Thus we have a ‘bell curve’ of inequality and human welfare.

Kuznets curve

But the evidence of modern capitalism in the last 40 years is the opposite. In the past 25 years, Milanovic finds what he calls ‘twin peaks’, rapid growth in middle-income countries, fast growth in top income countries and a slipping behind in low-income countries. Some claim that this means inequality is narrowing for all.  But the falling inequality between nations that Milanovic finds (and now lauded by various right-wing economists and even some Keynesians) is almost entirely due to the stupendous growth of China which has taken hundreds of millions out of poverty.CHINA PAPER July 2015

China has raised 620 million people out of internationally defined poverty. Its rate of economic growth may have been matched by emerging capitalist economies for a while back in the 19th century when they were taking off‘. But no country has ever grown so fast and been so large (with 22% of the world‘s population) – only India, with 16% of the world‘s people, is close. In 2010, 87 countries had a higher per capita GDP than China, but 83 were lower. Back in the early 1980s, three-quarters of the world‘s people were better off than the average Chinese. Now only 31% are. This is an achievement without precedent.  Take out China and inequality between the top income countries and others has widened.

Rising inequality between countries and a worsening human development index all kicked in from the 1990s onwards as capital spread its tentacles into emerging economies (globalisation) and public sector spending on health prevention and care and on education was cut back (neoliberalism); all to reverse the low levels of profitability for capital reached globally in the early 1980s.

This connection between growth, human development and inequality between countries is also confirmed by the change in inequality of wealth and income within most economies after 1970 that Thomas Piketty and others have recorded and tried to explain.

As Piketty has shown, there is an inherent tendency for inequality of wealth to worsen as capitalism expands: Piketty’s now famous formula that r (the rate of profit for capital) will outstrip g (the rate of growth in output).  But sometimes, this tendency is overcome by counter-tendencies as between 1913-1950, when g rose faster than r and inequality fell.

The idea of an inherent tendency with counter-tendencies smacks of the dialectical method of analysis that Marx adopted for his own laws of motion of capitalism.  Piketty misunderstood or dismissed Marx’s laws and provided his own, but at least he recognised the method – now trashed by our modern Marxian economists.

What Piketty finds is the opposite of Kuznets’ bell curve – a U-shape as the decline in inequality of wealth for the brief inter-war and early post-war period gives way to a degree of inequality not seen since the late 19th century – and according to the human development index, the end of catching up of the most of the world in health, longevity and education.

Piketty capital

Economic growth, higher incomes and wealth, development in health and education: all are key to human ‘progress’.  The evidence shows that in the last 30 years or so, progress has slowed significantly and the gap between the very top (whether measured by country or top 1% within a country) and the rest has widened, not narrowed.

inequality in DM

Inequality in EM

Piketty and Marx are refuting Kuznets and the apologists of capital.

A poisonous concoction

December 8, 2015

Crude oil prices have hit a seven-year low after last week’s decision in Vienna of OPEC, the oil cartel, not to put any limit on oil production next year.

Oil price

Demand for oil has slowed sharply and oil stocks have built up to a record 3bn barrels while oil tankers circle the waters around refineries in the US and Europe unable to unload because there is no demand.

oil stocks

At the same time, the prices of important raw materials like iron ore and copper hit new lows. The transport of these resources in ‘bulk carriers has collapsed, as measured by the so-called Baltic dry index, now at a 30-year low.

Baltic dry

As a result, the large so-called emerging economies like Russia, Brazil and South Africa, where exports are mainly energy and other raw materials for the industrial and consumer economies of the mature capitalist world, slipped into economic recession, with their currency values collapsing.  The largest consumer of these raw materials was China, but that economy has seen a significant slowdown in real GDP growth and is stockpiling its own steel, iron ore and copper, or trying to dump them abroad at low prices.

In a previous post in the summer, I pinpointed this growing crisis for the previously booming ‘emerging economies’.  Their booming economies took off through the exports of raw materials and energy.  They financed the boom by borrowing at very cheap rates in dollars from the banks of the West.  But now with the collapse of their exports and falling prices, these debts are going to become much more difficult to pay back.

Financial firms in developing economies repaid a net $15 billion of international debt in the third quarter, while nonfinancial companies issued just $6 billion in new debt.  Both figures were the lowest since the beginning of 2009, according to a report by the Bank of International Settlements (BIS).  Emerging market companies are starting to default more often than US borrowers, the first time that’s happened in years.

Next week, the US Federal Reserve is planning to raise its policy rate for the first time in almost a decade.  So the cheap debt that the emerging economies have borrowed will get more expensive to service.   The face value of dollar-denominated emerging-markets sovereign and corporate debt has roughly tripled since the beginning of 2009, to $1.7 trillion, according to Bank of America Merrill Lynch index data. These emerging nations are just starting to feel the weight of their mountain of debt.

The BIS report reckons that the cost of borrowing in these emerging economies is very sensitive to Fed interest rates.

BIS and debt

When in 2014, the Fed decided to end its quantitative easing measures (printing money), this caused what was called a ‘taper tantrum’ in emerging economies, where stock and bond markets plunged in value.  Now the BIS says “There have also been signs that EM local currency yields are increasingly sensitive to developments in the United States. The post-crisis era has been characterised by strong international spillovers from US bond yields to emerging markets, even when those countries were at different stages of the business cycle.  And this effect seems to have strengthened over time. A simple rolling regression of an EME bond index on US 10-year Treasury yields suggests that the potential for spillovers is larger now than it was during the taper tantrum”.

The BIS is worried that these tighter financial conditions “may also increase financial stability risks”. Average credit-to-GDP ratios in the major EMs has risen by close to 25% since 2010. “Despite low interest rates, rising debt levels have pushed debt service ratios for households and firms above their long-run averages, particularly since 2013, signalling increased risks of financial crises in EMEs.  Debt service ratios will inevitably increase even further when lending rates start to rise. Any further appreciation of the dollar would additionally test the debt servicing capacity of EME corporates, many of which have borrowed heavily in US dollars in recent years.

If emerging economies get into a debt crisis with companies defaulting and banks going bust, the mature capitalist economies will not avoid the impact. As it is, corporate debt has risen sharply in the US and Europe as companies there have taken advantage of cheap loans to stack on cash.  But as corporate profit growth has slowed to a trickle in the last year, corporate defaults and debt downgrades have risen, and this is before the Fed hikes its rate.

More than $1tn in US corporate debt has been downgraded this year as defaults climb to post-crisis highs, underlining investor fears that the credit cycle has entered its final innings.  Much of the decline in ‘fundamentals’ has been linked to the significant slide in commodity prices, with failures in the energy and metals and mining industries making up a material part of the defaults recorded thus far.

US downgrades

Some 102 companies have defaulted since the year’s start, including 63 in the US. Only three companies in the country have retained a coveted triple A rating: ExxonMobilJohnson & Johnson and Microsoft, with the oil major on review for possible downgrade. A large portion of the lowest quality debt issuers will face “severe refinancing challenges” by 2018 as cash flow generation remains weak, Matthew Mish, a credit strategist with UBS, noted.

When we look at overall global business activity, as measured by the so-called purchasing managers indexes (PMIs), there was a slight pick-up in November as emerging economies (red line) stopped contracting (on average).  But the world PMI (green line), while showing expansion, is still lower than it was at the beginning of 2014.

PMIs November

And, of course, my key measure of the future health of world economy, profits, continue to paint a dismal picture.  Corporate profits in the five major economies of the US, Japan, Germany, Eurozone and the UK, are now contracting (on average) for the first time since the Great Recession.

Global corporate profits

Another disconcerting factor is the world economy could already be growing slower than the official figures show.  The IMF estimates that global gross domestic product (GDP) rose about 3.1% in 2015.  Yet when the IMF data for world gross national product (GWP), which includes earnings from overseas trading and income, it appears from the IMF’s own figures that the world economy contracted in nominal terms by 5% this year.

This contradictory data was considered in a recent paper.  Peter van Bergjik, the author, concluded that some of the divergence between world GDP and GNP could be explained by statistical errors and currency deviations from the dollar’s value.  But that would not be enough to fill the gap in the data.  Van Bergijk concludes “that the official IMF forecasts for real GPP are likely to be too optimistic as has also been the case in the past. Analysing the IMF’s track record over a 20-year period, the Independent Evaluation Office (2014) reports that real economic growth has been overestimated, especially in periods of global crisis. Further downward revisions of the real economic growth rate are therefore to be expected.”

I have commented on the possibility of a new global recession in previous posts.  My view is that it is due and will take place in the next one to three years at most.  Some mainstream economists are now forecasting a more than 50% chance for 2016.  Citibank economists reckon that there is a 65% chance in 2016.

Recession probability

This doom-mongering is dismissed by others.  Bill McBride from Calculated Risk  trashed those recession mongers who think it is on the cards for next year. Says McBride: “For the last 6+ years, there have been an endless parade of incorrect recession calls. The manufacturing sector has been weak, and contracted in the US in November due to a combination of weakness in the oil sector, the strong dollar and some global weakness. But this doesn’t mean the US will enter a recession. The last time the index contracted was in 2012 (no recession), and has shown contraction a number of times outside of a recession. Looking at the economic data, the odds of a recession in 2016 are very low (extremely unlikely in my view). “

Maybe it won’t be in 2016.  But the factors for a new recession are increasingly in place: falling profitability and profits in the major economies and a rising debt burden for corporations in both mature and emerging economies.  And the Fed set to hike the cost of borrowing in dollars.  It’s a poisonous concoction.

Self-correcting economies and macro management

December 2, 2015

The Keynesians have a problem.  Why has it taken so long to recover from the slump of 2008-9 even after central banks have applied Keynesian-style unconventional monetary policies?  The answer from Britain’s leading Keynesian Simon Wren-Lewis and from America’s top Keynesian, Paul Krugman, is that capitalist economies in slumps are not self-correcting.

So we need central banks to apply easy money policies, especially when an economy is in a ‘liquidity trap’, where everybody holds cash and won’t spend.  And when interest rates are at zero (zero-bound) and nothing happens, we then need ‘unconventional’ monetary policies like quantitative easing (printing money to buy government bonds from banks) or negative interest rates (charging banks for holding cash).

But even these policies are not working.  The major economies are still growing well below previous trend growth rates and many still have not got their GDP per head levels back above pre-global crash levels.  Indeed, a recent analysis by Eichengreen and O’Rourke shows that this Long Depression is even worse than the Great Depression, at least when measured by industrial output.

Global industrial output from start of Great Depression and Great Recession

Slow recovery

Krugman points out that a new paper by former IMF chief Olivier Blanchard and others finds that recoveries can take a long time for ‘self-correction’ of up to six years – pretty close to what has happened since the end of the Great Recession.  As Krugman puts it: “The long run is pretty long, in other words; we might not all be dead, but most of us will be hitting mandatory retirement.”  I’m already there.

So this is not a good advert for the success of Keynesian-style easy money policies.  The retort of Simon Wren-Lewis is that if you think monetary policy is useless, what if a central bank hiked interest-rates at the depth of slump?  Don’t you think that would damage an economy?  So macroeconomic policy does matter.  Or as another Keynesian, Nick Rowe, puts it: “The most dangerous idea in macroeconomics is that monetary policy doesn’t matter”. 

Now I’m sure that hiking interest rates when profits for corporations and house prices are falling would be hugely damaging.  But this is like saying that pulling on a string (hiking rates or reducing money supply) will pull an economy down when it’s already down.  But it does not follow that pushing on a string (cutting rates or increasing money supply) will make an economy go forward – as QE has proved.

In a way, Marx’s theory of crisis is ‘self-correcting’.  Capitalism is never in permanent crisis; slumps do not last forever.  If capital values (means of production and labour) are cut enough to restore profitability through bankruptcies of weaker capitals and unemployment, then eventually those stronger capitals will start to invest again.  However, in a depression, with low profitability and high debt, that could take a long time.

Nevertheless, the Keynesians still look to show that macro policy can turn even a depression around and we don’t have to wait for ‘self correcting’ factors like profitability.  Economics graduate Matthew Rognlie is a rising star in mainstream economics, recently feted by the likes Krugman and others for his trashing of Thomas Piketty’s conclusion that inequality was set to rise over the next decades unless there is policy action.

Now Rognlie has been turning out fast some new academic papers. One recent paper argues that the Great Recession was triggered by speculative over-investment in housing – an Austrian economics explanation, as he says.  But the Great Recession and the subsequent weak recovery show that, without macro management, economies may not self-correct as the Austrians believe.  That’s because the loss of income for householders defaulting on their homes spills over into demand for real investment and spending.

In another paper, Rognlie tell us that unconventional monetary policy (negative interest rates) can work in restoring investment and consumer demand as long as the demand for money is ‘elastic enough’.  The trouble is that this does not seem to be the case in a depression – there’s no demand to spend money however much you create, if there is no profit in it.

What was also odd was that this debate among the Keynesians made little mention of the main Keynesian policy: more government spending to restore economic growth.  Krugman, Wren-Lewis, Rowe and Rognlie were only concerned with the efficacy of easy monetary policy.  Yet this is the Keynes of the Treatise on Money written in 1931.  After five more years of depression in the 1930s, Keynes then wrote The General Theory in which he recognised the failure of easy money policies and proposed fiscal spending instead, and even the ‘socialisation of investment’, as necessary to end the depression.

Ironically, there is a new report out which updates the analysis of the IMF economists of a few years ago who reckoned that they underestimated the ‘multiplier effect’ of austerity (fiscal contraction) on growth. At the time, this was made quite a fuss of by leftists within the labour movement, as it seemed to prove that austerity was the cause of the Great Recession and the ensuing depression.

In this blog, on several occasions, I have thrown some cold water over this conclusion and the role of the Keynesian multiplier.  Well, the new analysis shows that the size of fiscal multiplier was not underestimated after all. “The authors do not find convincing evidence for stronger-than-expected fiscal multipliers for EU countries during the sovereign debt crisis (2012-2013) or during the tepid recovery thereafter.” 

So the original IMF estimates were right that the multiplier effect of more or less government spending on growth was small and not larger during the period of ‘austerity’ policies adopted by various European governments since 2009.  Keynesian monetary policy appears to have made little difference in restoring economic growth and incomes since 2009 and Keynesian fiscal policy would not either.