Investment, investment, investment

This blog continually hammers home the view that it is investment not consumption that is the key to economic growth.  Fluctuations in business investment in a predominantly business, profit-making economy decide, in the first analysis, whether output expands or contracts; whether there is a boom or slump.  This view is contrary to that of Keynesian economics, which although it appears to recognise that investment plays an important role, sees investment and consumption spending (domestic demand) as driving employment, output and incomes and profit – in that order – not vice versa.

And Keynesian economists often forget about the role of investment and talk as though all that matters is consumption spending.  This is also the view of neoclassical economics, when they consider the big macro questions of boom or slump (which they seldom do).  The consumer is king (or queen) and, as it is the largest component of national output or expenditure, then it decides.

However, being the largest component of national spending does not make consumption the ‘swing factor’ in growth.  That is investment, particularly business investment.

This is something most socialist economists forget too, with the honourable exceptions of Michael Burke in the UK and John Ross based in China.  See Michael Burke’s past posts and the latest post by John Ross, where he shows the powerful importance of capital investment (both in fixed and circulating constant capital) compared to ‘innovation, design and management’ as expressed in the nebulous concept of ‘total factor productivity’.

Also I have shown empirically that it is investment (particularly business investment) that is the swing factor.  In all US economic recessions since 1945, it is investment that has fallen one year before the slump in GDP begins, while in nearly every recession, consumption spending continues (in the few exceptions where there was a fall in consumption prior to a recession, it was small).

US consumption and investment

In a recent article in Bloomberg, leading Keynesian blogger Noah Smith has suddenly noticed the role of investment.  As he puts it: “The U.S. seems to be out of ideas for economic growth. The main argument appears to be over redistribution — tax rates, the size of the welfare state, free college. Protectionism is also making a comeback; Bernie Sanders would restrict trade and punish Wall Street, while Republican candidates would curb immigration. These are mostly debates about the size of the pie. But what about growing it?”  Indeed, the concentration of economists of all hues, mainstream and heterodox has been on financialisation, inequalities of income and wealth and on ‘austerity’, not on the motors of economic growth.

US business investment

He goes on: “So what else is there? Looking around, I see the glimmer of a new idea forming. I’m tentatively calling it “New Industrialism.” Its sources are varied — they include liberal think tanks, Silicon Valley thought leaders and various economists. But the central idea is to reform the financial system and government policy to boost business investment.”  He concludes that “Business investment — buying equipment, building buildings, training employees, doing research, etc. — is key to growth. It’s also the most volatile component of the economy, meaning that when investment booms, everything is good.”  Exactly!

Smith then considers the issue of why “net U.S. business investment has been more or less in decline for decades”.  Smith is not sure why.  He poses a number of possible reasons: “This could be happening because investors don’t see much of a future for American businesses, and are thus choosing to get out while the getting is good. On the other hand, it could mean that investors are simply thinking in the short term and are more interested in quick cash grabs than in pushing companies to maximize their long-term value.” He concludes that maybe governments need to ‘force’ businesses to invest by “using regulatory, financial and tax policies to push businesses toward greater real investment”.

The trouble with this conclusion is that it fails to get to the heart of why US business investment growth has been declining. There is clear evidence provided by international agencies like the ECB, investment banks like JP Morgan and Goldman Sachs and by new mainstream economic studies that the main factor behind the gyration of business investment is profitability and profits.

For example, the EU Commission in a recent report noted that non-residential investment (which excludes households buying houses) fell as a share of GDP and the main reason was “a reduced level of profitability.” The EU report makes the key point that “measures of corporate profits tend to be closely correlated with investment growth” and only companies that don‘t need to borrow and are cash-rich can invest—and even they are reluctant. The Commission found that Europe‘s profitability “has stayed below pre-crisis levels.”

Similarly, the Bank for International Settlements (BIS), the central bankers’ association (and dominated by Austrian economics), believes that “the uncertainty about the economic outlook and expected profits play a key role in driving investment, while the effect of financing conditions is apparently small.”  The BIS dismisses the consensus idea that the cause of low growth and poor investment is the lack of cheap financing from banks or the lack of central bank injections of credit. Instead, the BIS looks for what it calls a “seemingly more plausible explanation for slow growth in capital formation,” namely, “a lack of profitable investment opportunities.”  According to the BIS, companies are finding that the returns from expanding their capital stock “won’t exceed the risk-adjusted cost of capital or the returns they may get from more liquid financial assets.” So they won‘t commit the bulk of their profits into tangible productive investment. “Even if they are relatively confident about future demand conditions, firms may be reluctant to invest if they believe that the returns on additional capital will be low.” Indeed.

A recent empirical study by mainstream economists, Kothari, Lewellen and Warner find a close causal correlation between the movement in US business investment (Capx in graph below) and business profitability (NI in graph).  As readers know from this blog and in other work by Marxist economists, that the US non-financial corporate rate of profit fell secularly from the 1950s, reaching a low in the mid-1980s and then consolidating or rising a little after that.  The mainstream authors find the same.

Capex and NI

They also find that investment growth is highly predictable, up to 1½ years in advance, using past profits and stock returns but has little connection to interest rates, credit spreads, or stock volatility. Indeed, profits and stock returns swamp the predictive power of other variables proposed by others like Noah Smith. Profits show a clear business-cycle pattern and a clear correlation with investment. The data show that investment grows rapidly following high profits and stock returns—consistent with virtually any model of corporate investment—but can take up to a year and a half to fully adjust.  They conclude that “we find no evidence that investment drops following a spike in aggregate uncertainty, contrary to the predictions of many models with irreversible investment.”

Finally, the authors found that “at least three-quarters of the investment decline in the Great Recession can be thought of as a historically typical drop given the behavior of profits. Problems in the credit markets may have played a role, but the impact on corporate investment is arguably small relative to a decline in investment opportunities.”

So all the alternative explanations of crises offered by monetarists, Keynesians and post-Keynesians have no empirical backing.  The Marxist one of investment being driven by profitability does.  This suggests that it is the profitability of capital that is decisive for the recovery or otherwise from an economic recession or depression.  If that is the case, then trying to regulate or tax businesses may well reduce investment if it affects profitability.  This suggests that there is no escape from the capitalist solution: a massive devaluation of the value of capital (both in means of production and the labour force) through an economic recession or slump.

21 Responses to “Investment, investment, investment”

  1. jclarkpolecon Says:

    Commented on here in case you’d prefer that to on facebook itself

    Investment from Money Capital is secondary to the capital-labour relation and the forces of production (aka surplus value) no?

    Unless you point to a particular part of this cycle of material reproduction/valorisation process?

  2. Rod Alexander Says:

    Hi Bob, Great post as always, thanks. there’s a minor (but significant) drafting error. In the paragraph starting, ‘For example…’ I think you’re attempting to make the point that the recent EU Commission report noted that non-residential investment (which excludes households buying houses) has reduced [from x to y OR remained low since 2007] as a share of GDP and the main reason was“a reduced level of profitability. Thanks as always for sharing your insight. Rod Date: Fri, 19 Feb 2016 14:12:25 +0000 To: rodalexander21@hotmail.com

  3. Charles A Says:

    “Smith then considers the issue of why ‘net U.S. business investment has been more or less in decline for decades’. ” The steps are profit -> investment -> GDP. This sequence backs up the question to, why the change in profit?

  4. Boffy Says:

    Michael,

    You say,

    “So all the alternative explanations of crises offered by monetarists, Keynesians and post-Keynesians have no empirical backing.”

    That seems a strange conclusion from everything you have said prior to that statement. Marx’s concept of crisis is of a crisis of overproduction. That is a crisis in which there is too much investment, not too little, but everything you have set out is a description of why the amount of investment is slight, not too great!

    Marx’s description of such a crisis is one where this huge level of investment, associated with boom conditions, and high levels of profits, as for example existed in the early 1840’s, leads to such an expansion in the quantity of use values thrown on to the markets that they cannot be sold at prices high enough to reproduce the capital consumed in their production, so that capital, in effect did not act as capital, did not self expand.

    Those are the kind of boom conditions, which create a crisis of overproduction that Marx describes in Capital III, Chapter 6 and 15, for example. He gives a similar description in his analysis of the expansion of credit under these boom conditions, and how it leads to speculation, in later chapters.

    For example, in Chapter 30 Marx sets out his theory of crisis in summary. He says, assume there are only workers and capitalists; ignore accidental effects, such as fluctuations in market prices, due to temporary changes in supply and demand. This latter is not insignificant because with the high degree of interrelatedness of the economy, especially as developed by credit, any fluctuation in market prices in one sphere, that prevents the reproduction of capital, or causes a disproportion and misallocation of capital, can have a consequence for the whole economy. But, Marx, having noted this discards it to show how the very process of production leads to crisis. He also discounts the effects of all the frauds and swindles previously outlined, which credit also facilitates.

    “Then, a crisis could only be explained as the result of a disproportion of production in various branches of the economy, and as a result of a disproportion between the consumption of the capitalists and their accumulation. But as matters stand, the replacement of the capital invested in production depends largely upon the consuming power of the non-producing classes; while the consuming power of the workers is limited partly by the laws of wages, partly by the fact that they are used only as long as they can be profitably employed by the capitalist class. The ultimate reason for all real crises always remains the poverty and restricted consumption of the masses as opposed to the drive of capitalist production to develop the productive forces as though only the absolute consuming power of society constituted their limit.” (p 484)

    What does this mean? In Theories of Surplus Value, Marx cites Ricardo, who described a situation of glut arising from an increase of profits. The idea is basically this. The capitalists increase profits by squeezing wages, so the workers have less to spend, so consumption falls. At the same time, prompted by these higher profits, capitalists themselves devote a larger portion of their profits to investment in additional production, rather than they do to increasing their own consumption. This doesn’t mean capitalists absolute consumption levels fall, only the relative proportion.

    The consequence is that more goes into investment, in additional production, at the same time that workers have relatively less to spend, and when capitalists choose to spend relatively less on consumption. In other words, the supply of consumption goods rises, as the demand for consumption goods falls, or at least relatively. Marx concludes,

    “This is indeed the secret basis of glut.”

    (Theories of Surpllus Value, Part 3)

    Unlike in the past, therefore, where crises arose because of the inability to produce enough to meet society’s needs, capitalist crises are almost never the consequence of being unable to produce enough. They are nearly always a consequence of producing more than can be bought at prices that reproduce the capital consumed in their production, given the distribution that naturally results from capitalist production. Millions of people do not starve in the world because there is insufficient food, but because they cannot afford to buy the food that is available at prices that would produce profits, whilst millions more do not demand that food because they already have more than enough, and often waste what they have. Thousands of people in Britain are unable to buy a house, not because there are too few houses, but because their incomes are not sufficient to buy the houses that are for sale at current prices, whilst others have more than enough wealth or income to be able to bid the prices of houses up to these levels, and to own more than one house, to hold on to land and houses in a speculation of being able to sell later at an even higher price.

    “A real lack of productive capital, at least among capitalistically developed nations, can be said to exist only in times of general crop failures, either in the principal foodstuffs or in the principal industrial raw materials.” (p 484)

    In other words, then, if we consider the economy in terms of the two department model set out by Marx in Capital II, capital attempts to increase its profits by squeezing wages, thereby reducing I(v) and II(v), and consequently the demand for Department II output. It could compensate for this if demand for consumer goods from I(s) and II(s) rose proportionately. But, as Marx has set out in the quote above, and on previous occasions, the purpose of capitalist production is not to increase the consumption of capitalists, but to increase profits and accumulation.

    Capitalists, rather than increasing their unproductive consumption, increase their investment in Department I goods. So, demand from I(s) and II(s) for consumption goods do not rise, at least by as much as I(v) and II(v) falls. In the meantime, I(c) and II(c) rises, as the additional funds are invested in accumulation. But, the only purpose of expanding the production of capital goods, utlimately, is to produce more consumer goods. There is no point investing capital in producing more cotton, umless there is an increased demand for yarn, cotton cloth and cotton textiles.

    The consequence then, as Marx describes, is that a crisis must arise “… as the result of a disproportion of production in various branches of the economy, and as a result of a disproportion between the consumption of the capitalists and their accumulation.” (p 484)

    This is the heart of all capitalist crises, as capital drives to increase profits, so as to increase accumulation, which means an increased production of constant capital, which simultaneously involves a relative decrease in the demand for the consumption goods that constant capital is destined to produce.

    Capital attempts to expand production without limit, without regard for the fact that the market that production is destined for, can only grow within limits, determined by capitalist distribution itself.

    But, the situation you have described is the opposite of all this. What you have described are conditions under which rather than capital investing without concern as to whether the future output can be sold profitably, it does the opposite, it under invests. Rather than lading to a crisis, therefore, of overproduction it leads rather to the opposite!

  5. Henry Says:

    “Millions of people do not starve in the world because there is insufficient food, but because they cannot afford to buy the food that is available at prices that would produce profits, whilst millions more do not demand that food because they already have more than enough, and often waste what they have. Thousands of people in Britain are unable to buy a house, not because there are too few houses, but because their incomes are not sufficient to buy the houses that are for sale at current prices, whilst others have more than enough wealth or income to be able to bid the prices of houses up to these levels, and to own more than one house, to hold on to land and houses in a speculation of being able to sell later at an even higher price.”

    These are permanent features of a capitalist system, they are not indicators of a capitalist crisis, unless we were to say that capitalism is the crisis!

    Marx and Engels made clear that the long term trends in profit rates were the primary and underlying factor in determining the frequency and intensity of crises. For example, when Engels claimed that capitalist crises would become more frequent and more intense.

    The reason I would argue that Engels was wrong was a) a lack of appreciation of Monopoly and Oligopoly conditions and b) the failure to understand that the massive shift in the organic composition of capital between the late 18th and early 19 century called for a punctuated theory of capitalist development and not a linear one.

  6. sartesian Says:

    As a public service, I’ll sum up Boffy’s various contributions for clarity’s sake, and then Michael can just cut and paste them as a comment to everyone of his posts, saving Boffy and the rest of us from the tedium that Boffy’s repetition compulsion inflicts on the reader.

    1. 2008 was just like 1847– that is to say, a financial crisis, a credit crunch. When liquidity was restored through easing of banking requirements the underlying strength” of the capitalist economy reasserted itself and expansion resumed.

    2. However, unlike post-1847, the massive expansion of liquidity since 2008 hasn’t restored growth. This is because of mistaken fiscal policies of the states, which although such policies did not cause the monetary crisis, somehow prevents its resolution.

    3. Meanwhile, the massive expansion of liquidity has fed, encouraged, stimulated the accumulation of fictitious capital and the asset values of such fictitious capital, and real estate. Fictitious capital is usually deemed to be made up of credit instruments, commercial paper, bills, notes, bonds, structured investment vehicles such as asset-backed securities, collateralized debt obligations etc.

    4. The current contraction of the stock markets is triggered by… the prospects for strong growth in the economy. This prospect devalues the fictitious capital because the demand for money-capital on the part of “productive” capitalists exceeds supply, raising interest rates.

    5. However, although (4) above seems to portend another liquidity, or credit crunch, that would be an incorrect lesson from the analogy with 1847. Actually it means that credit and debt markets, and the equity markets will see an increase in activity, including share offerings, bond issues etc.

    6. Although (5) above seems to contradict both (4) [and the implications of (3) above], that too is the incorrect lesson.

    7. The correct lesson is that co-ops are already displacing capitalist property arrangements, and despite the fact, that the co-op assets are greatest in the financial, insurance, and real estate sectors– exactly those where “fictitious capital” activity is concentrated– thinking that co-ops are just another fantasy construct imported from planet Boffy would also be the incorrect lesson.

    Michael– feel free to copy and paste at will.

  7. Mike Ballard Says:

    If the market just had all that money sloshing around in the tax sheltered accounts of the bourgeoisie…..

    The market is us. Overproduction? The capitalists can’t sell what they would have their wage-slaves produce and therein lies the crisis of profitability.

  8. billjefferies Says:

    The recession will be this year, and if not, then next year, and if not then the year after that.
    Hey I’m finally getting the hang of this forecasting lark!

    • sartesian Says:

      Good point. And the underlying strength of the economy will manifest itself this year, and if not, next, and if not, then the year after that, unless some idiot government adopts austerity plans… or if it’s actually the winter of the long wave upturn, so that the downturn in the upturn signifies a modification of the duration of the long wave, or perhaps the breaking up of the long wave into a bunch of shorter waves…in which case, wave good-bye.

      Got it now, Bill. Between us, we’ve got everything covered.

    • Boffy Says:

      Bill,

      You’ve not quite got it, yet, because remember that the rate of profit continually falls, and has been falling from the inception of capitalism 500 years ago, and is now no doubt, thereby next to zero – ZRP, or zero rate of profit. As you must know by now, crises of overproduction, which are apparently the same as recessions or stagnation, despite Marx specifically distinguishing between the two, are caused by this falling rate of profit, which is why capitalism is in a permanent state of crisis, or is it recession, or is it growth.

      Apparently, all these conditions are thereby the same and so you can always forecast “the next recession”, because capitalism is continually in such a recession, even when it is experiencing growth!

      Makes you wonder why Marx bothered writing all that stuff, and spending so much time on giving precise distinctions between these different categories, and phases of the cycle. Still you can understand why people who want to simply believe in such a permanent crisis as an article of faith, have no time for the arduous task of reading what he said, and prefer to rely on their articles of faith, and object when someone actually cites that work to them that they claim to base their dogma upon.

      • sartesian Says:

        El Bofforino: “Apparently, all these conditions are thereby the same and so you can always forecast “the next recession”, because capitalism is continually in such a recession, even when it is experiencing growth!

        Makes you wonder why Marx bothered writing all that stuff, and spending so much time on giving precise distinctions between these different categories, and phases of the cycle.”

        You know, I always thought that Marx never even used the term “recession” in referring to contraction, or decline, or impairment of capital accumulation, but I wasn’t really sure, so I searched the Marxist Internet Archives, and it turns out I was wrong, Marx used the term, in describing a period of capital’s cycle, exactly ONCE– when writing in the Neue Rheinische Zeitung in 1850 in an article where Marx is analyzing the basic reality underlying the political turbulence.

        In that same article BTW Marx traces the real origins of the panic in England, and the crises in Europe, not to a monetary crisis or a credit crunch as Boffy would have anyone who hasn’t read Marx believe but to overproduction, particularly as a result of the railroad mania which fueled “overspeculation,” to excessive imports of colonial products, yielding both the overproduction in steel and cotton in England and……revolution on the continent.

        You can read it for yourself here: https://www.marxists.org/archive/marx/works/1850/11/01.htm

        Says Marx, just to drive a stake through Boffy’s nonsense argument: ” As a symptom that the excess speculation which is caused by overproduction, and which precedes each crisis, will not be long in coming…”

        So Marx used the term “recession” once, and never took pains to distinguish it, in that single use, from “crisis,” or stagnation or whatever.

        Bofferino criticizing others: “arduous task of reading what he said…” He being Marx. The arduous task being actually comprehending what Marx said and not mistaking that for what you wish he had said.

        Look in the mirror Boffy. You’re a mess.

    • Henry Says:

      Pretty facetious comments.

      I know of no one who subscribes to what Boffy says.

      Does Bill’s objection to ‘Forecasting’ extend to the theory of cycles in general? After all Boffy can predict the long wave to the nearest day. Should we abolish all notions of a cycle and just say what will happen will happen and the only thing we know for sure is that we can’t predict what will happen with any absolute certainty so all notions of predictive analysis are fraudulent?

      Makes you wonder why Marx bothered with any of his analysis, after all, for all we know every year from now to eternity may be one of boom and growth. Hang on a minute, I see a contradiction…

      • sartesian Says:

        Presumably, Boffy subscribes to what Boffy says, particularly when he says the things that contradict each other, or that he makes up out of thin air.

  9. SimonH Says:

    You know you’re really not contributing much bill, on the other hand I suppose its better then the long posts of boffy where he must quote Capital vol 3 or Theories of Surplus Value or whatever.

  10. SimonH Says:

    Once again crudely reducing your opponents opinions boffy, tsk tsk. I’m surprised you didn’t use the term catastrophist as you are want to do so. As for dogma, you are the one who has reduced Marx’s work to dogma, quoting him like a theological scholar quoting the Bible. Some of us have chosen to build on Marx but for you it’s always the 1800s just with smart phones and other mod cons.

  11. Frank Kavanagh Says:

    The working class are meant to use these Marxist concepts to run a new society, now it’s called Dogma. In defence of the Boff, his views are an insurance policy, capitalism will go on unless the Working class defeats it.

  12. Henry Says:

    “In defence of the Boff, his views are an insurance policy, capitalism will go on unless the Working class defeats it.”

    Frank, you missed a bit from the Boff’s view, which is:

    “capitalism will go on unless the Working class defeats it. And given capitalism produces so much wealth and raises living standards so spectacularly, it doesn’t really matter if the workers defeat capitalism or not. Long live the productive capitalist!”

    This view is now called Marxist!

  13. Frank Kavanagh Says:

    Productive capital is better than Finance capital, Coops are better than Productive capital, Socialism is better than Coops, and it’s all better than Stalinism.

  14. Henry Says:

    “Productive capital is better than Finance capital, Coops are better than Productive capital, Socialism is better than Coops, and it’s all better than Stalinism.”

    How very scientific!

  15. Frank Kavanagh Says:

    I don’t have time to be a keyboard jockey, I’m off to read what Marx actually said about crisis of overproduction, disproportionality and underconsumption as well as the falling rate of profit.

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