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Corporate debt – the IMF gets worried

November 16, 2018

The IMF does not pull any punches in its latest post on the IMF blog.  It is really worried that so-called ‘leveraged loans’ are reaching dangerous levels globally.  These loans, usually arranged by a syndicate of banks, are made to companies that are heavily indebted or have weak credit ratings. They are called “leveraged” because the ratio of the borrower’s debt to assets or earnings significantly exceeds industry norms.  The level of these loans globally now stands at $1.3trn and annual issuance is now matching the pre-crash year of 2007.

With interest rates extremely low for years and with ample money flowing though the financial system, yield-hungry investors are tolerating ever-higher levels of risk and betting on financial instruments that, in less speculative times, they might sensibly shun.” says the IMF.  About 70% of these loans are in the US; so that is where the risk of a credit crunch is greatest.  And more than half of this year’s total involves money borrowed to fund mergers and acquisitions and leveraged buyouts (LBOs), pay dividends, and buy back shares from investor—in other words, for financial risk-taking rather than productive investment.

And even though corporate earnings in the US have risen sharply in 2018, the share of companies that have raised their debt to earnings above five times has reached a higher level than in 2007.

New deals also include fewer investor protections, known as covenants, and lower loss-absorption capacity. This year, so-called covenant-lite loans account for up 80% of new loans arranged for non-bank lenders (so-called “institutional investors”), up from about 30% in 2007.

With rising leverage, weakening investor protections and eroding debt cushions, average recovery rates for defaulted loans have fallen to 69% from the pre-crisis average of 82%. So any sizeable defaults would hit the ‘real’ economy hard.

Back in 2007, the debt crunch was exacerbated by the phenomenal growth in credit derivatives issued by non-banks, the so-called ‘shadow banks’, not subject to central bank controls.  Now again, it is in the shadow bank area that a debt crisis is looming.  These institutions now hold about $1.1 trillion of leveraged loans in the US, almost double the pre-crisis level.  On top of that are $1.2 trillion in high yield, or junk bonds, outstanding. The non-bank institutions include loan mutual funds, insurance companies, pension funds, and collateralized loan obligations (CLOs), which package loans and then resell them to still other investors. CLOs buy more than half of overall leveraged loan issuance. Mutual funds (which are usually bought by average savers through their banks) that invest in leveraged loans have grown from roughly $20 billion in assets in 2006 to about $200 billion this year, accounting for over 20% of loans outstanding.

All this debt can be serviced as long as earnings pour into companies and the interest rate on the debt does not rise too much.  Corporate earnings appear to be strong at least in the US.  In the latest quarter of reported company earnings, with 85-90% of companies having reported, US corporate earnings are up nearly 27% from the same period last year (although sales revenues are up only 8%).  US sales revenue growth is about 20% higher than in Europe and Japan but earnings growth is two to three times larger.  That tells you US earnings are being inflated by the one-off Trump corporate tax cuts etc.

Moreover it is earnings in the energy/oil sector that have led the way, as oil prices rose through the last year.  Recently, the oil price has taken a serious plunge as supply (production in the US) has rocketed. That’s going to reduce the contribution of the large energy sector to earnings growth.

Anyway, the reported earnings by companies in their accounts are really smoke and mirrors.  The real level of profits is better revealed by the wider data provided in the official national accounts.  And the discrepancy between the rise in profits as recorded there and the company earnings reports has not been as high since the dot.com bust of 2000, which eventually presaged the mild economic slump of 2001.  Reported US corporate earnings per share are rising fast, but ‘whole economy’ profits are basically flat.

The other moving part is the cost of borrowing.  The decade of low interest rates is over as the US Fed continues with its policy of hiking its policy rate.

The Fed policy sets the floor for all borrowing rates, not only in the US economy, but also abroad whenever borrowing dollars.

As I have explained in a number of posts, the Fed’s hiking policy will add to the burden of servicing corporate debt, particularly for those companies that have resorted to leveraged loans and junk bonds.  Herein lies the kernel of a future slump.

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Not before the sun burns out

November 12, 2018

This year’s Historical Materialism conference in London seemed well attended and with younger participants.  HM covers all aspects of radical thought: philosophical, political, cultural, psychological and economic.  But it’s economics that this blog concentrates on and so my account of HM London will be similar.

Actually, there did not seem to be as many economic sessions as in previous years, so let me begin with the ones that I organised!  They were the two book launch sessions: one on the new book, The World in Crisis, edited by Guglielmo Carchedi and myself; and the second on my short book, Marx 200, that elaborates on Marx’s key economics ideas and their relevance in the 21st century, some 200 years after his birth and 150 years since he published Volume One of Capital.

In the session on The World in Crisis, I gave a general account of the various chapters that all aim at providing a global empirical analysis of Marx’s law of profitability, with the work of mostly young authors from Europe, Asia, North and South America (not Africa, unfortunately). World in Crisis

As the preface in the book says: World in Crisis aims to provide empirical validity to the hypothesis that the cause of recurring and regular economic crises or slumps in output, investment and employment can be found ultimately in Marx’s law of the tendential fall in the rate of profit on capital.  My power point presentation showed one overall result: that wherever you look at the data globally, there has been a secular fall in the rate of profit on capital; and in several chapters there is evidence that the causal driver of crises under capitalism is a fall in profitability and profits.

In the session, Tony Norfield presented his chapter on derivatives and capital markets.  Tony has just published his powerpoint presentation on his excellent blog site here.  Tony traces the origin of the rise of derivatives from the 1990s to the instability of capital markets. Derivatives did not cause the global financial crash in 2008 but by extending the speculative boom in credit in the early 2000s, they helped spread the crash beyond the borders of the US and connecting the crash in the home markets to mortgages, commodities and sovereign debt.  Tony argued finance is now dominant in the controlling and distributing value globally but that still does not mean that finance can escape the laws of motion of capital and profitability.  On the contrary, finance intensifies the crisis of profitability.  So, in policy terms, acting to regulate or take over banking and finance will not be enough to change anything.

Brian Green stepped in to fill the slot for my fellow editor Guglielmo Carchedi who was unable to make the session.  Brian offered an intriguing new insight on how to measure the rate of profit on capital that could include circulating as well as fixed assets.  Most Marxists consider that it is impossible to properly measure circulating capital to add into the denominator in Marx’s rate of profit formula (s/(c+v)  Brian offers a method using national accounts to achieve this and, in so doing, he argued that a much more precise measure of the rate of profit can be achieved that will enable us to see more accurately any changes in profits and investment that would lead to a slump.

Some important questions were asked by the audience.  In particular, how can we connect Marx’s law of profitability (the rate of profit) with crises based on a falling mass of profit?  In Chapter One of the book, Carchedi and I show just that: that a falling rate of profit eventually leads to a fall in the mass of profit (or a fall in total new value) which triggers the collapse in investment.

Indeed, contrary to the view of Keynesians that a fall in household consumption triggers a crisis, it is investment that swings down, not consumption.  In the Great Recession, profits led investment which led GDP; consumption hardly moved.  Here is a graph showing the change in investment and consumption one year before each post-war slump in the US.

Another question was: why do bourgeois economists find a rise in the rate of profit from the early 1980s if Marx’s law is right?  The answer is two-fold: first, while Marx’s law holds that there will be a secular fall in profitability, it will not be in a straight line and there will be periods when the counteracting factors (eg. a rising rate of surplus value) to the law as such (a rising organic composition of capital) will be stronger.  And second, this was the case for the so-called neoliberal period from the early 1980s to the end of the century.  So mainstream measures, which always start at the beginning of the 1980s, miss part of the picture.

In the session on the book Marx 200, in my presentation, Marx 200 HM, I again outlined what I consider are the key laws of motion of capitalism that Marx revealed in his economic analysis: the law of value, the law of accumulation and the law of profitability.  The latter flows from the first two, so Marx’s theory of crises depends on all three laws being correct.  At the session, Riccardo Bellofiore of the University of Bergamo, kindly agreed to offer a critique of the book and my approach.  Riccardo considered that my emphasis on using empirical data and official statistics bordered on a ‘logical positivist’, undialectical method.  As Paul Mattick, the great Marxist economist of the 1950 and 1960s argued, it was impossible to use official data based only in fiat money terms to ascertain the changes in value in Marxist terms.  Moreover, my emphasis on data and economic trends was too ‘determinist’ and failed to take account of the role of working class struggle.  Not everything can be decided by economic forces, there was also the subjective role of the class and I was dismissing this.

Naturally I disagree.  It seems to me that ‘scientific socialism’ is just that: a scientific approach to explaining the irreconcilable contradiction within capitalism and why it needs to be and must be replaced with socialism if human society is to progress or even survive.  Marx recognised the role of empirical data in his backing up his theories and often attempted with the limited resources at his disposal to accumulate such (in Capital and elsewhere).   We cannot just assert that Marx’s laws of motion must be right because there are recurrent crises in capitalism – we have to show that it is Marx’s laws that lie behind these crises and not other explanations.  If correct, other explanations might (and do) mean that capitalism just needs ‘modification’ or ‘management’ (Keynes) or even better left alone (neoclassical and Austrian).

It is not determinist to argue that economic conditions are out of the conscious control of both capitalists and workers (an Invisible Leviathan) and the law of motion of capitalism will override the ability of people in struggle to irreversibly change their lives – without the ending of capitalism.  Class struggle operates continually, but its degree of intensity and the level of success for labour over capital will be partly (even mainly) determined by the economic conditions. Men make their own history, but they do not make it as they please; they do not make it under self-selected circumstances, but under circumstances existing” (Marx).

A number of other important issues were raised by the audience:  what about the three laws that Uno Kozo, the Japanese Marxist economist identified?  I cannot answer this one but there was a session at HM on just that with Elene Lange.

The other question that came up was again whether Marx’s law of profitability was really just a secular theory (ie long term) and basically irrelevant as offering any underlying cause of recurrent crises; or whether it was just a cyclical theory, explaining the ‘business cycle’ or ‘waves of capital accumulation’, and has nothing to say about the eventual demise or breakdown of capitalism.

It was Rosa Luxemburg’s view that it was the former – a very long-term tendency that was so long term that the ‘sun would burn out’ before a falling rate of profit would play a role in pushing capitalism into crises (Luxemburg made this remark sarcastically in reply to a Russian economist who suggested that Marx’s law of profitability might well be relevant).  On the other hand, many Marxist economists who do accept the relevance of Marx’s law of profitability in recurrent crises deny that it offers a prediction for the transient future of capitalism (ie capitalism cannot last forever).  In my view, the law is both secular and cyclical and I present arguments for this view in my book, The Long Depression.  And in the new book, The World in Crisis, there is evidence of both the secular view (Maito) and the cyclical view (Tapia).

Enough of my sessions, because it would be amiss not mention several good sessions on Latin America (Mariano Feliz, Angus McNelly); and looking back at Marx’s value theory
(Andy Higginbottom (Higginbottom2012JAPEpublished),
Heesang Jeon Value_Use_Value_Needs_and_the_Social_Div).
I shall be returning to these topics on my blog over the next period.

Finally, there was the Isaac Deutscher Memorial Prize awarded at HM for the best Marxist book of the year.  Last year’s winner was William Clare Roberts for his intriguing Marx’s Inferno: The Political Theory of Capital (Princeton UP).  For my initial thoughts on this work, see here. But last week, after hearing my namesake speak on the subject of the nature of freedom under socialism, I shall be returning to this subject in a future post.

The shortlist for 2018 was:

Sven-Eric Liedman, A World to Win: The Life and Works of Karl Marx (Verso)
Kim Moody, On New Terrain: How Capital is Reshaping the Battleground of Class War (Haymarket Books)
Kohei Saito, Karl Marx’s Ecosocialism: Capital, Nature, and the Unfinished Critique of Political Economy (Monthly Review)
Ranabir Samaddar, Karl Marx and the Postcolonial Age (Palgrave Macmillan)

America’s halfway house

November 7, 2018

The mid-term Congressional elections saw a swing to the opposition Democrats in the Lower House and the Republicans were ousted as the majority party.  This is a blow to President Trump who mounted a campaign based on fear of immigrant caravans flooding into the US from Latin America and supposed rising crime provoked by the Democrats. This line of attack did not work.  But the perceived strong US economy seems to have had the effect of consolidating Trump’s position in the Senate.  There the Republicans gained seats. Losing control of the lower house means that any further tax and financial handouts to big business and the rich are likely to be curtailed. But as the Republicans increased their hold on the Senate,Trump can expect to continue with his wild foreign policy outbursts and his ‘trade war’ with China.

Although there are more ‘progressive’, Sanders-type Democrats elected to Congress, the Democrat party remains a stalwart supporter of (and funded by) Wall Street and big business. As Democrat House leader Nancy Pelosi has made clear, “I have to say, we’re capitalist ― and that’s just the way it is”. She added that “However, we do think that capitalism is not necessarily meeting the needs with the income inequality that we have in our country.”  But she says nothing about how to reverse this income inequality (let alone wealth inequality).  Even the ‘left wing’ of the Democrats as led by Senator Elizabeth Warren, stay firmly in the capitalist camp – merely looking for ways to make it “accountable”.

So the Americans now face a second half of the Trump presidential term with little changed.  Except that there are increasing concerns that the supposed Trump economic boom is fast coming to an end. Back in August, I said that Q2 2018 would be the peak in US growth as the effect of Trump’s one-off cuts dissipate, with the impact of Trump’s protectionist policies on global growth to factor in.  “Economic activity is weakening again in Europe.  And then there is the emerging ‘emerging market’ debt crisis – Argentina, Turkey, Venezuela onto Brazil and South Africa.  So the last quarter is not going to be exceeded this quarter.”

And so it has proved.  Ex-Goldman Sachs chief economist and now writer for the UK’s Financial Times, Gavyn Davies delivered his latest global economic forecast.  Headlining the piece as “Global slowdown begins to look more troublesome”, Davies reckons the recent stock market ‘correction’ was “remarkable for its extent, the frequency of consecutive negative days, and the synchronised decline in all the major markets.”  Investors were becoming increasingly worried about a new global economic recession.

Davies goes on that “the flow of economic data suggest that there was indeed a decline in world activity in October.”  And he agrees with my own April conclusion that “the global growth rate clearly peaked late in 2017”.  He concludes that “the period of above trend average growth that was so powerful last year proved short-lived and now seems to have been mainly cyclical, rather than secular, in nature.”  Exactly.

Davies estimates that global economic growth has slowed from 5% in 2017 to just a 3% rate now, about 0.7% below the long-term trend.  China is slowing, Europe is slowing, only the US has been holding up.

Davies reckons the US is set to slow from here as Trump enters the next two years of his presidency.  However, Davies is still confident that world capitalism will be fine because “a significant slowdown in the US should be offset by rebound in China, Japan and the Eurozone” so that growth will get back on trend.

This optimistic view (which probably remains the consensus among mainstream economic views) is not supported by others.  John Mauldin put it simply in a recent post on his blog: “All good things come to an end, even economic growth cycles. The present one is getting long in the tooth. While it doesn’t have to end now, it will end eventually. Signs increasingly suggest we are approaching that point. Whenever it happens, the next downturn will hit millions who still haven’t recovered from the last recession, millions more who did recover but forgot how bad it was, and millions more who reached adulthood during the boom. They saw it as children or teens but didn’t feel the full impact. Now, with their own jobs and families, they will. Again, there’s no doubt—none, zero, zip—this will happen. The main question is when.”

Mauldin’s main argument for a fast approaching new recession is one spouted by the Austrian school of economics, represented in official circles by the Bank for International Settlements (BIS), an international research agency for the world’s central banks.  And the cause of the next recession for the BIS?  Burgeoning global debt and the cost of servicing that debt.  Mauldin points out the huge rise in public sector debt levels that Trumps tax cuts and big business handouts are creating. We are one recession away from having a $30 trillion US government debt total. It will happen seemingly overnight. And deficits will stay well above $1 trillion per year every year after that, not unlike now.”

I too have emphasised the rising level of debt both before the global financial crash and the Great Recession and after – contrary to the perception that I am just a ‘monocausal’ rate of profit man!  The high level of debt was a trigger for the crash of 2008-9; has been a depressing factor on the ability of the major capitalist economies to recover to previous rates of growth; and will be an important trigger in the next recession.

But it is corporate debt that is much more important as the motivator of a crash than the public debt that the neoclassical supporters of ‘austerity’ always look at.  Household and corporate debt is growing fast, too, and not just in the US.  Mauldin explains that US companies are significantly more leveraged now than they were ahead of the 2008 crisis. “We saw then what happens when the commercial paper market seizes up, and that was without a Fed in tightening mode. Now we have a central bank both raising short-term rates and slowly ending its crisis-era accommodations. Recent comments from FOMC members say they have no intent of stopping, either. A few high-profile junk bond defaults could ignite fears quickly.”  Everywhere now central banks are tightening liquidity (graph below of the top four central banks rate of money ‘printing’).

Mauldin warns: “There are trillions of dollars of low-rated corporate debt that can easily slide into the junk debt category in a recession. Since most public pension, insurance, and endowment programs are not legally allowed to own junk-rated debt, I can see where it could easily cause a debt crisis along the lines of the previous subprime crisis.”  

What the Austrians don’t explain is why rising corporate debt could become a trigger for a new crisis – apparently it is just a fact of life in capitalist expansion like having a wild party one night eventually turns into a long and painful hangover the next morning.  The Marxist explanation is that when the profitability of capital in the productive sectors of the economy falls away, then credit is no longer the handmaiden of investment-led growth but turns into an oppressive squeeze of profits and production. Credit helps to fuel a rising economy but increases the degree of the crash when it comes, and then slows the recovery as credit becomes debt that weighs down on revenues and profits.  Below is a table that shows how increased debt since the end of the Great Recession no longer helped real GDP growth but hindered it.

And that is the danger ahead.  As the BIS showed in a September report, there is a large number of what are called ‘zombie’ businesses in the major economies which do not earn enough profits to cover the interest on their existing debt.  So they cannot invest and grow but just become the ‘undead’.  Around 12-15% of all quoted companies in the major economies are in this position – and this before interest rates on debt have risen significantly.

So can Trump and the US economy avoid a recession in the next two years?  Davies reckons that the US can because the rest of the world will recover to faster growth.  But there is no evidence that profitability, investment and production are likely to pick up in 2019 in Europe, Japan or the rest of Asia.  On the contrary, look at the latest measure of business activity in the Eurozone – the so-called PMI.  The composite PMI came in at 53.1 in October 2018, the weakest growth rate in the private sector since September 2016 as manufacturing expansion eased to a near four-year low (PMI at 52.0 vs 53.2 in September) and services output rose the least since January 2017 (PMI at 53.7 vs 54.7 in September).

And just look at the state of the Italian economy, as Italy’s budget with the EU takes on a Greek-style battle.

Then there is the UK.  British capital is suffering from the uncertainties of Brexit.  British small and medium-sized British factories are braced for the worst profits outlook in at least nine years, according to a recent survey that showed companies putting investment plans on ice ahead of Brexit.

Globally, manufacturing output growth is dropping back fast to 2016 levels.

According to JP Morgan economists and their model, overall global growth slipped back to a 3% annual rate in October, after peaking at about 3.7% at the beginning of 2018.

And there are increasing signs that US economic growth has also peaked.  The latest real GDP report for Q3 2018 showed a 3.5% annual real GDP growth rate (or 3% up from the same period in 2016).  But 2.1% of that GDP growth was actually inventory building, ie stock not sold.  Eventually production will have to slow so that this stock can be run down. And the Atlanta GDP Now forecast for the fourth quarter of 2018 is 2.9%, a further slowing.

Also in Q3. US non-residential business investment grew only 0.8% annualized, a sharp deceleration from the first quarter’s 11.5% rate.  Capital spending had accelerated from a slump in 2015 because mining, oil and gas investment rebounded as energy prices rose. Excluding mining, oil and gas, business spending on structures such as offices, factories and stores did jump in the first quarter, perhaps because of the Trump tax cut, but then cooled.

Moreover, non-financial profits remain below 2014 levels and, as I showed in a recent post, the rate of profit on capital in the US last year was flat at best over 2016, and well below the level of 2014.

The slower the US economy grows and the more the Federal Reserve hikes interest rates, the more the squeeze will be on the capitalist corporate sector and its ability to service their debts. Economists at Goldman Sachs, who have compiled ‘financial conditions’ into a single index, estimate that easier financial conditions helped bolster growth throughout 2017, led by surging stocks. In 2018 that contribution ebbed, as stocks plateaued and then in recent weeks dropped. Combine flat to lower stocks with higher bond yields and a generally firm dollar, and Goldman estimates financial conditions are now subtracting from, rather than adding to, growth, and that drag will peak in mid-2019.

There is a simple macro accounting identity for Marxists (the opposite of the Keynesian):  Profits + Government surpluses = Investment and the Current Account. If profits are set to fall while Trump runs huge government deficits (6% of GDP), then investment must fall and the current account deficit (3% of GDP) must narrow. That means a collapse in production and imports – a slump.

Timing a recession is notoriously hard (I’ve tried!).  And this long, crawling depressive ‘recovery’ has defied the odds; as only one recovery on record (from 1991-2001) has lasted as long as a decade. But there will be no escape for American capitalism as Trump enters the second half of his presidential term.

The US rate of profit in 2017

November 2, 2018

Official data are now available in order to update the measurement of the US rate of profit a la Marx for 2017.  So, as is my wont, I have updated the time series measure of the US rate of profit.  If you wish to replicate my results, I again refer you to the excellent manual for doing so compiled by Anders Axelsson from Sweden,

There are many ways to measure the rate of profit (see http://pinguet.free.fr/basu2012.pdf).  As in last year, I have updated the measure used by Andrew Kliman (AK) in his book, The failure of capitalist production.

AK measures the US rate of profit based on corporate sector profits only and using the historic cost of net fixed assets as the denominator.  AK considers this measure as the closest to Marx’s formula, namely that the rate of profit should be based on the advanced capital already bought (thus historic costs) and not on the current cost of replacing that capital. Marx approaches value theory temporally; thus the price of denominator in the rate of profit formula is at t1 and should not be changed to the price at t2.  To do the latter is simultaneism, leading to a distortion of Marx’s value theory.  This seems correct to me.  The debate on this issue of measurement continues and can be found in the appendix in my book, The Long Depression, on measuring the rate of profit.

What are the results of the AK version of the rate of profit based on the US corporate sector?

There has been a fall in the rate of profit in 2017 from 24.4% in 2016 to 23.9% in 2017. Indeed, the US rate of profit on this measure has now fallen for three consecutive years from a post-crash peak in 2014.  This suggests that the recovery in profitability since the Great Recession low in 2009 is over.  The AK measure confirms Marx’s law in that there has been a secular decline in the US rate of profit since 1946 (25%) and since 1965 (30%).  But what is also interesting is that, on AK’s measure, the rate of profit in the US corporate sector has risen since the trough of 2001 and the Great Recession of 2009 did not see a fall below that 2001 trough.  Thus the 2000s appear to contradict the view of a ‘persistent’ fall in the US rate of profit.  I consider the explanation for this later.  But it is also true that the US rate of profit has not returned to the level of 2006, the registered peak in the neo-liberal period on AK’s measure. Indeed, in 2017 it was 17% lower than 2006.

Readers of my blog and other papers know that I prefer to measure the rate of profit a la Marx by looking at total surplus value in an economy against total productive capital employed; so as close as possible to Marx’s original formula of s/c+v.  So I have a ‘whole economy’ measure based on total national income (less depreciation) for surplus value; net fixed assets for constant capital; and employee compensation for variable capital – a general rate of profit, if you like.

Most Marxist measures exclude any measure of variable capital on the grounds that it is not a stock of invested capital but a flow of circulating capital that cannot be measured from available data.  I don’t agree that this is a restriction and G Carchedi and I have an unpublished work on this point.  However, given that the value of constant capital compared to variable capital is five to eight times larger (depending on whether you use a historic or current cost measure), the addition of a measure of variable capital to the denominator does not change the trend in the rate of profit.  The same result also applies to inventories (the stock of unfinished and intermediate goods).  They should and could be added as circulating capital to the denominator for the rate of profit, but I have not done so as the results would be little different.

On my ‘whole economy’ measure, the US rate of profit since 1945 looks like this. As for 2017, my results show a slight rise over 2016.  But the 2017 rate of profit is still 6-10% below the peak of 2006 and below the 2014 peak (as it is in the AK measure).

I have included measures based on historic (HC) and current costs (CC) for comparison.  What this shows is that the current cost measure hit its low in the early 1980s and the historic cost measure did not do so until the early 1990s.  Why the difference?  Well, Basu (as above) has explained. It’s inflation.  If inflation is high then the divergence between the changes in the HC measure and the CC measure will be greater.  When inflation drops off, the difference in the changes between the two HC and CC measures narrows.  From 1965 to 1982, the US rate of profit fell 21% on the HC measure but 36% on the CC measure.  From 1982 to 1997, the US rate of profit rose just 10% on the HC measure, but rose 29% on the CC measure.  But over the whole post-war period up to 2017, there was a secular fall in the US rate of profit on the HC measure of 28% and on the CC measure 28%!

There are many other ways of measuring the rate of profit.  And this was raised in an important and useful discussion in a workshop on the rate of profit (my rough notes on this are here) organised by Professors Murray Smith and Jonah Butovsky during my visit to Brock University, Southern Ontario, Canada two weeks ago.  Murray and Jonah have contributed to the new book, World in Crisis, edited by Mino Carchedi and myself.  In their chapter, they argue that a clear distinction must be made between the productive sectors of the capitalist economy ie where new value is created and the unproductive, but necessary, sectors of the economy.  The former would be manufacturing, industry, mining, agriculture, construction and transport and the latter would be commercial, financial, real estate and government.

Following the pioneering work of Sean Mage in the 1960s, Smith and Butovsky consider these socially necessary unproductive sectors as ‘overheads’ for capitalist production and so should be included in constant capital for the purposes of measuring the rate of profit. On their current cost measure, the US rate of profit has actually risen secularly since 1953.  However, looking at only the non-financial sector, Smith and Butovsky find that the US rate of profit peak of 2006 was some 50% below the peaks of the 1950s and 1960s, confirming Marx’s law.  Moreover, the strong rise in profitability recorded in all measures above can be considered as anomalous and based to a considerable extent on ‘fictitious profits’ booked in the finance, insurance, and real-estate sectors, and perhaps also by many firms operating in the productive economy.”  This is a similar conclusion reached by Peter Jones. He found that if you strip out ‘fictitious profits’, then the US corporate sector rate of profit actually fell from 1997 – see his graph below.

Recently, Lefteris Tsoulfidis from the University of Macedonia separated the rate of profit for the whole economy into a ‘general rate’ for all sectors and a ‘net rate’ for just the productive sectors.  Lefteris kindly sent me his data.  And this shows the following for the US general and net rate of profit from 1963 to 2015.

As in other measures, the US rate of profit is around 30% below 1960 levels but bottomed in the early 1980s with a modest recovery to the late 1990s in the so-called neoliberal period.  But interestingly, on Tsoulfidis’ measures, there was a decline, not a rise, in the rate of profit from 2000 leading up to the Great Recession.

I looked at the US non-financial corporate sector (which is not strictly the same as the Marxian definition of the ‘productive’ sector), using data from the Federal Reserve.  The net operating surplus over net financial assets is the measure I used for the rate of profit here.

This Fed measure shows that the US rate of profit peaked in 1997 to end the neo-liberal period and since then that rate has not been surpassed even in the credit-fuelled fictitious profits period from 2002 to 2006.  Indeed, after peaking post the Great Recession in 2012, the Fed measure has fallen consistently right up to mid-2018.  The Fed measure is quarterly and so provides a more up to date result.  On this measure, the US rate of profit remains 32% below its ‘golden age’ peak in 1966, again confirming Marx’s law.

Marx’s law is also confirmed because the driver of changes in US profitability depends on the relative movement of the two Marxian categories in the accumulation process: the organic composition of capital and the rate of surplus value (exploitation).  Since 1965 there has been the secular rise in the organic composition of capital of 21%, while the main ‘counteracting factor’ in Marx’s law, the rate of surplus value, has fallen over 4%.  Conversely, in the neo-liberal period from 1982 to 1997, the rate of surplus value rose 16%, more than the organic composition of capital (7%), so the rate of profit rose 9.5%.  Since 1997, the US rate of profit has fallen over 5%, because the organic composition of capital has risen over 14%, outstripping the rise in the rate of surplus value (5.4%).

One of the compelling results of the data is that they show that each economic recession in the US has been preceded by a fall in the rate of profit and then by a recovery in the rate after the slump.  This is what you would expect cyclically from Marx’s law of profitability.

Clearly a significant fall in the rate of profit is an indicator for an upcoming slump in investment and production in a capitalist economy.  Marx argued that a falling rate of profit would, for a while, be compensated for by an expansion of capital investment, so that the mass of profits would continue to rise.  But that could not last and eventually the fall in the rate of profit would lead to a fall in the mass of profits, which would engender ‘absolute overproduction’ of capital and a slump in production.  Marx explains all this clearly in Volume 3 of Capital, Chapter 15.  And that is what occurred in the Great Recession.

What is the situation now in the middle of 2018?  Well, US corporate profits are still rising, although non-financial profits are below the level at the end of 2014.

In a recent paper, G Carchedi identified three indicators for when crises occur: when the change in profitability; employment; and new value (v+s) are all negative at the same time.  Whenever that happened (12 times since 1946), it coincided with a crisis or slump in production in the US.  This is Carchedi’s graph.

My updated measure for the US rate of profit to 2017 confirms the first indicator is in place.  However, ‘new value’ had two quarters of decline in 2015 and one in 2017, but in the first two quarters of 2018 it has been rising; and employment growth continues.  So, on the basis of these three (Carchedi) indicators, a new recession in the US economy is not imminent as 2018 moves into the last quarter.

In sum, Marx’s law of profitability over the long term is again confirmed.  I am reminded that back in 2013, Basu and Manolakos did a highly sophisticated econometric analysis of Marx’s law for the US rate of profit, controlling for all the counteracting factors in the law like cheapening constant capital and a rising rate of surplus value.  They say “We find weak evidence of a long-run downward trend in the general profit rate for the U.S. economy for the period 1948-2007.”  By which they mean that there was evidence but it was not decisive. But they also found that a decline in the US rate of profit was “negative and statistically significant” ie the fall in the rate of profit was not random.  So “we find statistical evidence in favor of Marx’s hypothesis regarding the tendency of the general rate of profit to fall over time.”  Basu and Manolakos reckon there was an average annual 2% fall in the US rate of profit over the period.  In my own cruder calculations, I find exactly the same result for the period 1947-07 in the historic cost measure.

In conclusion, there has been a secular decline in US profitability, down by 28% since 1946 and 20% since 1965; and by 6-10% since the peak of 2006.  So the recovery of the US economy since 2009 at the end of the Great Recession has not restored profitability to its previous level.  Also, the driver of falling profitability has been the secular rise in the organic composition of capital, which has risen around 20% since 1965 while the main ‘counteracting factor’, the rate of surplus value, has fallen.

In 2017, the US rate of profit fell compared to 2016 on some measures (2%) or rose slightly on mine (1%).  All measures show that the US rate of profit in 2017 was 6-10% below the level of 2014.

Brazil’s Tropical Trump

October 29, 2018

The victory of Jair Bolsonaro as the new President of Brazil puts in the most far-right administration in the top 20 nations of the world.  Bolsonaro says he wants to crush ‘communism’, and restore ‘law and order’ by putting the military in control of the streets and stuffing the Supreme Court with his appointed judges.  He wants to loosen gun controls, crack down on gays and other ‘criminal’ elements, support President Trump’s policies and open up the economy and the Amazon forests to ‘proper exploitation’.

How was it possible that Bolsonaro won this election?  Well, his support was to be found in the burgeoning religious evangelical movement in Brazil, among the rich and small business sectors who have been militantly opposed to the rule of the Workers Party since 2002 under Lula and then Dilma, who they saw as taxing and regulating business for the benefit of low income families, and destroying family values.  But the biggest reason was that most Brazilians are fed up with rising crime, high unemployment and corruption by all politicians.

Bolsonaro is seen as the man to end corruption (of course that will turn out to be the opposite).  To the middle classes, the Workers Party is seen as ‘stealing’ the country.  Lula is still in custody for corruption (probably on trumped up charges and mainly to ensure he could not run in the election).  But Bolsonaro won mainly because of the disillusionment of the working class with the Workers Party.  After the collapse of commodity prices in resources and agriculture, the economy went into recession. The blame for this and corruption has been laid at the door of the Workers Party.

But Bolsonaro did not get the majority of the 147m Brazilians entitled to vote.  Although it is compulsory to vote in Brazil, around 30% spoilt their ballots or entered blank papers.  Also the Workers Party is still the largest party in the lower house of the Brazilian Congress, which has 30 different parties represented.  So it won’t be easy for Bolsonaro to get his most authoritarian measures passed democratically.

Most important remains economic policy.  As I have explained in previous posts, the Brazilian economy is in trouble.  Economic growth is stagnating at best.

Unemployment is near post-global crash highs.

Because the rich do not pay taxes and inequality of income and wealth is one of the highest in the world, the government does not raise enough revenue to avoid huge annual deficits.

As a result, Brazil’s public sector runs the largest debt to GDP among all emerging economies.

The solution of the rich and the Bolsonaro administration will be ‘austerity’, namely yet further cuts in public spending (many Brazilian state governments are already bust and starved of funds), privatisations and deregulation of industry and the banks – but, above all, the destruction of Brazil’s state pension scheme.

Stock and bond markets have risen on hopes Mr Bolsonaro will deliver on this.  These ‘neo-liberal’ policies will be pursued by Bolsonaro’s likely finance chief Paulo Guedes.  This University of Chicago-trained economist is co-founder of BTG Pactual, once the country’s biggest home-grown independent investment bank. Markets expect Guedes to maintain a freeze on fiscal spending introduced by current President Michel Temer. They also see him introducing formal autonomy for the central bank and allowing state-owned oil company Petrobras to set fuel prices at ‘market levels’.

On Sunday evening, following the victory of his putative future boss, Guedes said pension reform as well as slashing the “state’s privileges and waste” would be a priority for the new government.   So just as in the US, Brazilians will have ‘populist’ law and order talk from the President supposedly to stop crime, while introducing strident ‘neo-liberal’ reforms to help big business in Brazil and cut the share of income going to labour.

As I said in a post one year ago, the international agencies, foreign investors and Brazilian big business want an administration in power for four more years from 2018 to impose austerity, labour ‘flexibility’ and privatisations. That will drive up inequality further. Ironically, it won’t reduce the public sector debt because economic growth and tax revenues will be too low.  Indeed, the IMF forecasts debt will be much higher by 2020.

At the same time, more than half of Brazil’s population remain below a monthly income per head of R$560.  To cut this level of poverty to under 25% would require productivity four times as fast as the current rate. And there is no prospect of that under capitalism in Brazil.  That’s because the profitability of Brazilian capital is low and continues to stay low.

The profitability of Brazil’s dominant capitalist sector had been in secular decline, imposing continual downward pressure on investment and growth.

Brazil’s ruling elite face a difficult task in imposing control over its working class and cutting public spending and wages, and thus attracting significant foreign capital.  Brazilian capitalism will be stuck in a low growth, low profitability future with continuing political and economic paralysis.  And that is without a new global recession coming over the horizon.

Socialism and the White House

October 27, 2018

The Trump White House research team have issued a very strange report.  It’s called “The Opportunity Costs of Socialism,”.  It purports to prove that ‘socialism’ and ‘socialist’ policies would be damaging to Americans because the ‘opportunity costs’ of socialism compared to capitalism are so much higher.

What is strange and rather amusing is that the White House advisers to Trump deem it necessary to explain to Americans the failures of ‘socialism’ in 2018.  But when you delve into the report, it becomes clear that what is worrying the Trumpists is not ‘socialism’, but the policies of left Democrat Bernie Sanders for higher taxes on the rich 1% and the increased popularity of a ‘single-payer’ national health service for all.  The popularity of these policies threatens the Republican majority in Congress and also the wealth and income of big pharma corporations and Trump’s billionaire supporters.

What the White House means by socialism is apparently a national economy that is dominated and controlled by the state rather than the market. “Whether a country or industry is socialist is a question of the degree to which (a) the means of production, distribution, and exchange are owned or regulated by the state; and (b) the state uses its control to distribute the economic output without regard for final consumers’ willingness to pay or exchange (i.e., giving resources away “for free”).”

So the report has a wide and all-encompassing definition of ‘socialism’ that includes Maoist China (but not modern China it seems), the Soviet Union, Cuba and Venezuela and the Nordic ‘social democratic’ states.  The latter are bunched together with the former because Sanders lauds the latter and not the former.  Naturally this raises the question of whether any of these countries can be called ‘socialist’ ie a peasant-dominated Soviet Union in 1920 or China in 1950; or the family-owned corporate dominated economies of Sweden, Denmark and Norway.

The White House definition is not socialism or communism as proclaimed by Marx and Engels in the Communist Manifesto.  For them, Communism is a super-abundant society with no role for a state but only for the free association of individuals in common action and ownership of the products of labour.  Of course, such a world system does not exist and so cannot be compared with capitalism.  Instead, in effect, the White House is really trying to compare a planned national economy with a capitalist-dominated national market economy. But we should not be too harsh on the White House researchers: they are not going to know what socialism is; and their definition (that they got from the dictionary, apparently) is probably most people’s view.

Leaving that aside, what is wrong with all these ‘socialist’ states?  Well, “they provide little material incentive for production and innovation and, by distributing goods and services for free, prevent prices from revealing economically important information about costs and consumer needs and wants.”  In Maoist China and Stalinist Russia “their non-democratic governments seized control of farming, promising to make food more abundant. The result was substantially less food production and tens of millions of deaths by starvation.”  Thus socialism was a disaster.

From their definition, the White House report concludes: “The historical evidence suggests that the socialist program for the U.S. would make shortages, or otherwise degrade quality, of whatever product or service is put under a public monopoly. The pace of innovation would slow, and living standards generally would be lower. These are the opportunity costs of socialism from a modern American perspective.”

The White House report also claims that “replacing U.S. policies with highly socialist policies, such as Venezuela’s, would reduce real GDP at least 40 percent in the long run, or about $24,000 per year for the average person.”  And replacing the current US tax regime with that of the Nordic countries would increase the tax burden on Americans by $2,000 to $5,000 more per year net of transfers. “We estimate that if the United States were to adopt these policies, its real GDP would decline by at least 19 percent in the long run, or about $11,000 per year for the average person.”

The first argument of the White House report is that living standards are higher in the US compared to the ‘socialist’ Nordic states.  A most hilarious case study is presented for this claim: the cost of buying a pick-up truck in Texas compared to the cost in Scandinavia!

Well, a pick-up truck may be much more useful in Texas than Stockholm and, given that taxes on vehicles are lower in the US and fuel taxes are substantially lower, the argument that a pick-up truck costs much less than in the Nordic countries is irrefutable!  But does the more expensive truck in Norway compared to Texas prove that there is a higher ‘opportunity cost’ of living in ‘socialist’ Norway?  What about public transport, public services, health and education, unemployment and welfare benefits – things that the richer part of any capitalist country does not need or use as a ‘social wage’?  These things are not compared by the White House report.

The report points out that real GDP per capita is higher in the US than in the Scandinavian economies and in the non-oil part of Norway.  The data show this is true.  But all this shows is that Northern Europe started at a lower level when Marx wrote the Communist Manifesto.  Actually, if we look at real GDP growth per capita since 1960 (when Americans are told that they live in the greatest place on earth), US growth has fallen behind the most Nordic economies and for that matter, most European economies.  Indeed, since the early 1990s, real GDP per capita growth has been faster in Sweden than in the US.

And as for China, the growth rate has outstripped that of the US many times over since the 1990s, taking 800m people out of World Bank defined poverty.  No doubt the White House researchers would argue (although they don’t) that China turned ‘capitalist’ in the 1980s and this is why the economy has rocketed.  But this would be inconsistent with their view that a ‘socialist’ state is one where the state dominates and controls the free market economy.  For China must be the most state-directed major economy in the world, way more that the so-called ‘mixed economies’ of the Nordic countries.

Overall income is one thing but the distribution of that income is another.  Here the White House has to admit that “though the Nordic economies exhibit lower output and consumption per capita, they also exhibit lower levels of relative income inequality as conventionally measured.”  What is interesting here is that the US still has much higher inequality of wealth and income, but Nordic inequality has also risen much in the last 30 years as governments there adopted pro-business polices of reducing corporation and personal taxes (ie pro-market policies).

Indeed, as the White House report says, on some measures, the Nordic tax system is more accommodating to the top 10% than the US system – at least for personal tax: Lower personal income tax progressivity in the Nordic countries, combined with lower taxation on capital and on average only modestly higher marginal personal income tax rates on the right tail of the income distribution, means that a core feature of the Nordic tax model is higher tax rates on average and near-average income workers and their families. That is, contrary to the misperceptions of American proponents of Nordic-style democratic socialism, the Nordic model of taxation relies heavily not on imposing punitive rates on high-income households but rather on imposing high rates on households in the middle of the income distribution.”

This may be an attack on Sanders’ praise for the Nordic economies, but it seems to me that it proves how far away the Nordic states are now from ‘social democracy’, let alone ‘socialism’.  On the one hand, the White House report claims that ‘socialist’ states want to tax the rich harder (a la Sanders) but in reality they tax them less hard than in the US!

Of course, this is all smoke and mirrors.  All the data on inequality of wealth and income in the major advanced economies show that the US is the most unequal, both before and after tax; and that real disposable incomes for the average American family have hardly risen in 30 years while the top 1% have seen substantial rises.

The share of wealth held by the top 1% of earners in the US doubled from 10% to 20% between 1980 and 2016, while the bottom 50% fell from 20% to 13% in the same period.

But the main part of the White House report is to argue that privately-funded education and healthcare is more cost-effective than publicly-funded state schools or a national health service.  The report argues that paying for a US college education will bring a much bigger return in future earnings than it will in Norway, where there are no college fees.  What this implies, however, is that people in the US without higher education qualifications have no chance of earning decent incomes, while those without degrees in Norway do not earn much less than those that do!  So actually the opportunity cost of not having a college education in Norway is much lower.

Then there is healthcare.  According to the White House, ‘single payer’ health systems, as applied in nearly all advanced economies, are not as efficient and beneficial to health as America’s free market insurance company schemes, especially if Obama-care is excluded.  The proof? Well, old people in the US have to wait less time to be seen by a specialist than in single-payer systems, says the report.

Actually, American ‘seniors’ mostly receive Medicare, so they are on a single payer scheme when they get to see a specialist!

All healthcare systems are under pressure as people live longer and develop more illnesses in later life.  And they are under pressure because healthcare is not funded sufficiently compared to defence, business subsidies and tax cuts.  This applies to the US system too.

And if we look at an overall comparison of the efficacy of healthcare systems, the US scores badly.  The US health-care system is one of the least-efficient in the world.  America was 34th out of 50 countries in 2017, according to a Bloomberg index that assesses life expectancy, health-care spending per capita and relative spending as a share of gross domestic product.  “Socialist” Sweden is 8th and “Socialist” Norway is 11th.

Life-expectancy is a way of measuring how well, overall, a country’s medical system is working, which is why it is used in the index.  In the US, health expenditure averaged $9,403 per person, or a whopping 17.1% of GDP and yet life expectancy was only 78.9.  Cuba and the Czech Republic — with life expectancy closest to the US at 79.4 and 78.3 years — spent much less on health care: $817 and $1,379 per capita respectively. Switzerland and Norway, the only countries with  higher per capita spending than the US — $9,674 and $9,522 — had longer life expectancy, averaging 82.3 years.  Why? Well, the US system “tends to be more fragmented, less organized and coordinated, and that’s likely to lead to inefficiency,” said Paul Ginsburg, a professor at the University of Southern California and director of the Center for Health Policy at the Brookings Institution in Washington.

So the opportunity costs for the average American seem to be higher at least for basic public services like health and education than for the average Nordic ‘socialist’.

Correction?

October 25, 2018

The US stock market turned volatile this week and has now erased all the gains made up to now in 2018 in just a week or so.  So much for Trump’s boast that things for rich investors have never been better.  The fall in the US market has been matched by similar drops in the European and Asian stock markets.  The all-world index has had its worst performance since the Euro debt crisis of 2012.

Now this fall could just be what market traders call a ‘correction’ and not a full ‘bear market’, when the prices of shares enter a long and deep decline.  But it could be that investors are beginning to fear that the boost to profits and sales that the Trump tax cuts generated is soon to be over, while interest rates (the cost of borrowing to invest or buy back shares to boost prices) are rising significantly.

CitiBank’s ‘global economic surprise index’ — which measures how often data comes in better or worse than expected — has been in negative territory since April. That is the longest sub-zero stretch in four years.

A slowdown in growth is pretty clear in Europe, where the measures of business activity are showing a significant drop in the pace of expansion.  The IMF in its latest report has already signalled the coming slowdown but lowering its forecast for global growth by a couple of notches.  And within sectors, there are serious declines; the global materials sector (manufacturing basic inputs for production) is down 20%.  ECB chairman Mario Draghi said in his press conference yesterday that there was a “weaker momentum” in Europe, but this was just temporary and really just to do with German car sales and Italy’s budget.  Next quarter will be better.

And it is not just Europe that is slowing.  China’s growth rate has been slowing since 2014, as the government tries to reduce debt in local authorities and industrial firms.  In Q3 2018, the real GDP growth rate slowed to 6.5 per cent, the slowest reading since the 2009 post-crisis nadir.  Falling profitability and the trade war with the US is beginning to have some effect.

And South Korea also appears to be slowing down with Q3 real GDP growth of 2% being the slowest expansion rate in nine years.  Investment dropped 6.5%.

However, unlike the rest of the world, the US economy still looks better.  The latest business activity surveys showed steady expansion.

And globally, the price of copper – a good leading indicator of global activity – remains above the ‘recession’ level it fell to in the growth trough of 2015-6.

However, investors are beginning to fret that the corporate profits growth seen earlier this year is as good as it will get, given rising wage costs, interest bills and materials prices. Moreover, the impact of the 2018 tax cut will make this year’s results hard to beat in 2019.  The third-quarter results of 3M and Caterpillar, two US industrial bellwethers that reported last Tuesday, feed this concern. 3M cut its earnings forecasts. While Caterpillar’s profits beat forecasts, its warnings of rising materials costs rattled investors.

The US may have reached a new trade agreement with Mexico and Canada to replace the Nafta deal reviled by President Trump, but Washington remains at loggerheads with China, slapping $250bn of tariffs on Chinese goods and demanding sweeping changes to the country’s economic policies. After occasional hints of a thaw, the imbroglio appears to have reached an impasse. If there is no progress in the coming weeks, the Trump administration is expected to introduce another $200bn worth of tariffs — perhaps sanctioning all Chinese imports.

And investors remain on edge about the impact of rising interest rates on both fixed-income and equity markets. The Federal Reserve is expected to lift rates for a fourth time this year in December, and is slowly but surely shrinking its balance sheet, which has been stuffed with bonds acquired when combating the financial crisis.  Former Fed chair Janet Yellen sounded a warning that the planned hikes could cause a new financial bust as many companies have taken out what are called ‘leveraged loans’ which are subject to sharp changes in interest rates.  Yellen commented that “If we have a downturn in the economy, there are a lot of firms that will go bankrupt, I think because of this debt.  That would probably worsen a downturn.”  Indeed, it is estimated that nearly 20% of US firms are already finding the cost of servicing their debt greater than the earnings to cover it.

Yellen also pointed out what current Fed Chair Powell has observed, that it was not clear what the appropriate Fed policy interest rate should be to ensure full employment and moderate inflation; there was “genuine uncertainty”.  In other words, the Fed has no idea what it was doing in raising interest rates.

Other central banks are also trying to ‘normalise’ monetary policy and turn off the money flow. The European Central Bank plans to end its own bond-buying by the end of the year, and even the Bank of Japan is easing back on its monetary pedal. The net effect of this is what investors have dubbed “quantitative tightening”, a sea change in the global monetary environment since the financial crisis that bodes ill for markets in 2019.

Back at the beginning of October I wrote that if the Fed is wrong and the productive sectors of the US economy do not resume ‘normal growth’ (the average real GDP growth rate since 1945 has been 3.3% – so growth is not back there yet), the rising costs of servicing corporate and consumer debt could lead to a new downturn.  The first estimates of real GDP growth figures for the US in the third quarter to September are out tomorrow.

Most important, corporate profits, after a stellar two quarters are beginning to fall back.  If you strip out financial sector profits, then corporate profits are still below levels of 2014, even after Trump’s tax boost. And in the productive sectors of the economy, like manufacturing, they are falling quite sharply – as measured per employee.

The stock market is not always a harbinger of what happens in the ‘real’ economy, but it may be this time.

 

Keynes part 2 – internationalist or nationalist?

October 17, 2018

Was Keynes the great internationalist who aimed to make capitalism a stable system through macro management on a world scale?  This is Ann Pettifor’s claim in her recent paeon of praise to Keynes.  Keynes made his name in showing that the policies of penury on Germany after WW1 would be self-defeating for the interests of France and Britain.  And he supposedly was the promoter of “the construction of the international financial architecture at Bretton Woods in 1944. Politicians and economists (if not bankers) had finally come round and endorsed his theory and policies.” (Pettifor)

Well, yes he wanted to set up ‘civilised’ institutions to ensure peace and prosperity globally through international management of economies, currencies and money. But these ideas of a world order to control the excesses of unbridled laisser-faire capitalism were eventually turned into institutions like the IMF, World Bank and the UN Council, mainly used to promote the policies of imperialism, led by America. Instead of a world of ‘civilised’ leaders sorting out the problems of the world, we got a terrible eagle astride the globe, imposing its will.  Material interests decide policies, not clever economists.  Keynes, the internationalist, gave us the IMF’s penury on struggling emerging economies.

Moreover, Keynes was always more a representative of the interests of the British empire than an internationalist.  After all, he had been in the British civil service in India.  The biographer of Keynes, Lord Skidelsky, entitles the third volume of his biography, Keynes: Fighting for Britain.  At the post-war Bretton Woods meetings, he represented, not the world’s masses or a democratic world order, but the narrow national interests of British imperialism against outright American dominance. After the agreement, Keynes told the British parliament that the Bretton Woods deal was not “an assertion of American power but a reasonable compromise between two great nations with the same goals; to restore a liberal world economy”. Only two nations mattered, the interests of others were ignored.

Was Keynes an internationalist when it came to economics?  He started off as a ‘free trader’ with the traditional neoclassical view that free markets in trade would benefit all.  As an under-graduate he served as secretary of the Cambridge University Free Trade Association and argued for free trade in several debates.  “We must hold to Free Trade, in its widest interpretation, as an inflexible dogma, to which no exception is admitted, wherever the decision rests with us. We must hold to this even where we receive no reciprocity of treatment and even in those rare cases where by infringing it we could in fact obtain a direct economic advantage. We should hold to Free Trade as a principle of international morals, and not merely as a doctrine of economic advantage.”  By 1928, however, Keynes had altered his position by suggesting that “the free trade case must be based in the future, not on abstract principles of laissez-faire, which few now accept, but on the actual expediency and advantages of such a policy.”

The terrible experience of the Great Depression shifted his views further.  In private evidence given in 1930 before the UK’s government-sponsored Macmillan Committee on Finance and Industry, set up to offer economic advice to the British government at the onset of the Great Depression, Keynes proposed import tariffs on foreign goods and subsidies for domestic investment. When asked whether abandoning free trade was worth the potential ameliorative effects of protection, Keynes replied, “I have not reached a clear-cut opinion as to where the balance of advantage lies,” but he saw the merits of tariffs as an alleviation of the slump. “I am frightfully afraid of protection as a long-term policy,” he testified, “but we cannot afford always to take long views . . . the question, in my opinion, is how far I am prepared to risk long-period disadvantages in order to get some help to the immediate position.”

Before long, he went further towards protectionist measures.  In response to questions from the prime minister, Keynes indicated that he had “become reluctantly convinced that some protectionist measures should be introduced.” In a memorandum prepared in September 1930 for the Committee of Economists of the Economic Advisory Council, Keynes elaborated on the benefits of a tariff, which he now described as “simply enormous.” These benefits included solving the basic problem of the misalignment of money costs and the exchange rate: a tariff would raise domestic prices and reduce real wages toward their ‘equilibrium value’, while avoiding a disruptive fall in nominal wages (so real wages would fall without the working class noticing). A tariff would also “restore business confidence and create a favourable climate for new investment”, he stated, “but would not (unless poorly designed) trigger demands by trade unions for higher pay or have adverse employment effects.” Tariffs would thus help British capital against its competitors by squeezing the real incomes of British households. Keynes preferred devaluation of the currency but tariffs would also be necessary.

He now advocated ’beggar thy neighbour’ economic policies to help British capital against its rivals. By 1933 he wrote of his sympathy “with those who would minimise, rather than with those who would maximize, economic entanglements between nations. Ideas, knowledge, art, hospitality, travel-these are things which should of their nature be international. But let goods be homespun whenever it is reasonable and conveniently possible; and, above all, let finance be primarily national.”  However, once the depression and war was over, Lord Keynes in his last speech returned to his support for the theory of ‘free trade’ when he said that “separate economic blocs and all the friction and loss of friendship they bring with them are expedients to which one may be driven in a hostile world where trade has ceased over wide areas, to be cooperative and peaceful and where are forgotten the rules of mutual advantage and equal treatment. But surely it is crazy to prefer that.”

I think what this tells you is that Keynes was an internationalist and free trader when he thought it was in the interests of British capital, but in favour of protection and beggar thy neighbour policies when he thought it was in the interests of British capital. For him, there were only two ‘civilised’ nations, the US and the UK (as junior partner), who could lead the world.  Keynes never criticised the role of the British Empire, on the contrary, he saw it as a good thing and something to be preserved.

Europe as a rival to American imperialism came after Keynes’ death.  With the rise of Europe, British capital began to move towards the continent, joining the Single Market and the EU.  But British capital remained split about where to align.  Within the psyche of the British ruling elite (mainly smaller and domestic-based capital), there has remained a nostalgia for the Empire and a look back across the Atlantic ‘pond’.  With the demise of Europe’s economies after the Great Recession, the reactionary empire loyalists pushed for a break with Europe and a return to the ‘old order’ as junior partner to American imperialism that existed in Keynes’s day.

How would Keynes have reacted to this?  In my view, as he was at the time of Bretton Woods, Keynes was generally in favour of freer trade and international capital flows, as he thought it would be to the advantage of Anglo-American capital.  So he may have supported the UK’s entry into the EU, but not into the euro, because that would have taken away control over the currency and the option of devaluation.  What would Keynes’ view have been on Brexit?  Would Keynes have been a ‘leaver’ or ‘remainer’?  Probably the former as that is where his nationalist inclinations lay. But maybe the latter, as according to his economic rival of the 1930s, Friedrich Hayek, Keynes changed his ideas like he changed his shirts.  Keynes was an internationalist only as long as it did not conflict with the interests of British capital (or American imperialism) – pretty much the same position as Churchill.

Keynes was vehemently opposed to socialist internationalism.  Keynes saw all his policies as designed to save capitalism from itself and to avoid the dreaded alternative of socialism.  As he made clear: For the most part, I think that Capitalism, wisely managed, can probably be made more efficient for attaining economic ends than any alternative system yet in sight, but that in itself it is in many ways extremely objectionable. Our problem is to work out a social organisation which shall be as efficient as possible without offending our notions of a satisfactory way of life.”  So “the class war will find me on the side of the educated bourgeoisie.”  Was he a fighter for greater equality?  This is what he said. “For my own part, I believe that there is social and psychological justification for significant inequalities of incomes and wealth, but not for such large disparities as exist today. There are valuable human activities which require the motive of money-making and the environment of private wealth-ownership for their full fruition.“  This is Pettifor’s revolutionary.

Keynes reckoned that as capitalism expanded, it would, through more technology, create a world of abundance and leisure.  Because of that abundance, the return on lending money to invest would fall.  So bankers and financiers would no longer be necessary; they could be phased out (‘the euthanasia of the rentier’).  Well, that does not seem to be happening.  The followers of Keynes now argue that capitalism is being distorted by ‘financialisation’ and finance capital – and that is the real enemy.  What happened to the gradual phasing out of finance in late capitalism a la Keynes?

In contrast, Marx’s theory of finance capital did not foresee a gradual removal of finance; on the contrary, Marx described the increased role of credit and finance in the concentration and centralisation of capital in late capitalism.  Yes, the functions of management and investment become more separated from the shareholders in the big companies, but this does not alter the essential nature of the capitalist mode of production – and certainly does not imply that coupon clippers or speculators in financial investment will gradually disappear.

Keynes, the supposed radical opponent of neoclassical economics, according to Pettifor, reverted back.  In one of his last articles on the capitalist economy as the Great Depression ended and the second world war began, Keynes remarked that “Our criticism of the accepted classical theory of economics has consisted not so much in finding logical flaws in its analysis as in pointing out that its tacit assumptions are seldom or never satisfied, with the result that it cannot solve the economic problems of the actual world. But if our central controls succeed in establishing an aggregate volume of output corresponding to full employment as nearly as is practicable, the classical theory comes into its own again from this point onwards.” So once full employment is achieved, we can dispense with planning and ‘socialised investment’ and return to free markets and mainstream neoclassical economics and policy: “the result of filling in the gaps in the classical theory is not to dispose of the ‘Manchester System’ (‘free’ markets – MR), but to indicate the nature of the environment which the free play of economic forces requires if it is to realise the full potentialities of production.”

Indeed, economically, in his later years, he praised the very laisser-faire ‘liberal’ capitalism that his followers condemn now.  In 1944, he wrote to Friedrich Hayek, the leading ‘neo-liberal’ of his time and ideological mentor of Thatcherism, in praise of his book, The Road to Serfdom, which argues that economic planning inevitably leads to totalitarianism: “morally and philosophically I find myself in agreement with virtually the whole of it; and not only in agreement with it, but in a deeply moved agreement.”! And Keynes wrote in his very last published article, “I find myself moved, not for the first time, to remind contemporary economists that the classical teaching embodied some permanent truths of great significance…. There are in these matters deep undercurrents at work, natural forces, one can call them or even the invisible hand, which are operating towards equilibrium. If it were not so, we could not have got on even so well as we have for many decades past.”  Thus the ‘(neo) Classical’ economics of the ‘invisible hand’ and ‘equilibrium’ returned after all – the opposite of what Keynesian followers now stand for. Once the storm (of slump and depression) had passed and ‘the ocean’ was flat again, bourgeois society could breathe a sigh of relief.  So Keynes the radical turned into Keynes the conservative.

Yet the myth of Keynes, the radical and revolutionary, is preserved and promoted by the Keynesian left and continues to influence the labour movement (particularly its leaders) as the ‘alternative’ to neo-liberal, ‘austerity’ pro-market economics.  Why is this?  Well, there are theoretical reasons.

Keynesian macroeconomics assumes that capitalism works to develop the productive forces and meet the needs of people. The problem is that occasionally, there is a ‘technical malfunction’ (Paul Krugman).  For some reason (loss of confidence, or animal spirits?), capitalist investment gets stuck in a ‘hoarding of money’ mode that it cannot get out of (liquidity trap).  So it is necessary for government authorities to give it a ‘nudge’ with monetary and/or fiscal stimulus, and then all will be right again – until the next time!  Keynes liked to consider economists as dentists fixing a technical problem of toothache in the economy (“If economists could manage to get themselves thought of as humble, competent people on a level with dentists, that would be splendid”). And modern Keynesians have likened their role as plumbers, fixing the leaks in the pipeline of accumulation and growth.

What the Marxist analysis of the capitalist mode of production reveals is that capitalism cannot deliver an end to inequality, poverty, war and a world of abundance for the common weal globally, or indeed avoid the catastrophe of environmental disaster (something ignored by Keynes), over the long run.  That’s because capitalism is a mode of production driven by profit not need; exploitation not cooperation; and that generates irreconcilable contradictions that cannot be resolved by ‘technical macro-management’ of the economy.  It can only be resolved by replacing it.  In this sense, Marx, rather than Keynes, is closer to Darwin as a revolutionary in economics.

But there is another reason.  Geoff Mann, in his excellent book, In the long run we are all dead, offered an explanation. Keynes rules on the left because he offers a supposed third way between socialist revolution and barbarism, i.e. the end of civilisation as ‘we’ (actually the bourgeois like Keynes) know it.  In the 1920s and 1930s, Keynes feared that the ‘civilised world’ faced Communist revolution or fascist dictatorship.  Socialism as an alternative to the capitalism of the Great Depression could well bring down ‘civilisation’, delivering instead ‘barbarism’ – the end of a better world, the collapse of technology and the rule of law, more wars etc.

So Keynes aimed for some modest fixing of ‘liberal capitalism’, to make capitalism work without the need for socialist revolution.  There would no need to go where the angels of ‘civilisation’ fear to tread.  That was the Keynesian narrative.  This appealed (and still appeals) to the leaders of the labour movement and ‘liberals’ wanting change.  Revolution is risky and we could all go down with it: “the Left wants democracy without populism, it wants transformational politics without the risks of transformation; it wants revolution without revolutionaries”. (Mann p21).  But we shall indeed all be dead if we do not end the capitalist mode of production.  And that will require a revolutionary transformation. Tinkering with the supposed malfunctions of ‘liberal’ capitalism will not ‘save’ civilisation – in the long run.

Keynes: revolutionary or reactionary? – part one: the economics

October 14, 2018

Was Keynes a revolutionary in economic thought and policy?  Was he at least radical in his ideas?  Or was he a reactionary opposed to the interests of working people and a conservative in economic theory?  Ann Pettifor is a leading economic advisor to the British leftist Labour leaders, Jeremy Corbyn and John McDonnell.  She is director of Prime Economics, a left-wing economics consultancy and author of several books, in particular the recent The Production of Money.  And she has just won Germany’s Hannah Arendt prize for political thought – for focusing on “the political and societal impact of the current money production system, mainly operated by banks through digital lending” and as effective critic of “the global financial industry, which operates outside of the scope of political influence and democratic control”.

So Ann Pettifor is an undoubted battler against the austerity economics of the neoclassical school and a promoter of government measures to restore public services and boost the economy.  But to achieve that, she relies entirely on the theories and policies of JM Keynes and ‘Keynesianism’.  Recently she published a short article for the prestigious Times Literary Supplement, entitled The indefatigable efforts of J. M. Keynes. This is part of Footnotes to Plato, a TLS Online series appraising the works and legacies of the great thinkers and philosophers.

In this article, Pettifor compares Keynes’ theories as being as game-changing in economics as the discovery of evolution by Charles Darwin in biology.  In her view, Keynes ‘invented’ macroeconomics, the study of trends in economies at the aggregate level, escaping the stifling neoclassical obsession with microeconomics (the study of value and markets at the level of the individual unit).  She concurs with Keynes’s theory of money and his explanation of crises under capitalism as being caused by ‘hoarding’ money rather than spending it; and she praises his ‘internationalism’ in arguing for international financial institutions to control financial speculation and avoid instability in market capitalism.  She finishes with the concern that Keynes’ ideas and policies have been reneged on and rejected and there has been a return to ‘decadent’ capitalism, far removed from the golden age of the post-1945 period when Keynesian policies were applied to make capitalism work effectively for all.  She concludes with the call that “It is time to restore the revolutionary Keynes.”

Well, I beg to differ on this view of Keynes and Keynesian theories and policies.  For a start, it is inflated to suggest that Keynes’ ideas are on a par with those of Darwin.  Yes, there may be a few creationists who reckon that God designed the world and its living beings in his own image and preserved it accordingly.  But no sane person thinks this has any validity.  The evidence is overwhelming that Darwin was broadly right on the evolution of life.  But can we say that Keynes is broadly right about the laws of motion and trends in the capitalist economy?  I don’t think so – and I’ll briefly attempt to show why.

For a start, Pettifor is wrong when she says that ‘classical economics’ was microeconomics as we know it now.  The use of the term ‘classical’ used by Keynes bunched all the great early 19th century economists like Adam Smith, James Mill and David Ricardo and their grand studies of economies with the reactionary marginalist, subjectivist, equilibrium theories of the mid to late 19th century of Jevons, Senior, Bohm-Bawerk, Walrus and Mises. Keynes rejected the former while continuing to accept the microeconomics of the latter.  For the classical economists of the early 19th century capitalism, there was no distinction between the micro and the macro.  The task was to analyse the motion and trends in ‘economies’ and for that a theory of value was a necessary tool but not an end in itself.

Microeconomics became an end in itself as a way of combating the dangerous development in classical economy towards a theory of value that implied the exploitation of labour and conflicting social relations.  So the labour theory of value was replaced with the marginal utility of purchase by the consumer as a result.  ‘Political economy’ started as an analysis of the nature of capitalism on an ‘objective’ basis by the great classical economists.  But once capitalism became the dominant mode of production in the major economies and it became clear that capitalism was another form of the exploitation of labour (this time by capital), economics quickly moved to deny that reality.  Instead, mainstream economics became an apologia for capitalism, with general equilibrium replacing real competition; marginal utility replacing the labour theory of value; and Say’s law replacing crises.

Macroeconomics appears in the 20th century as a response to the failure of capitalist production – in particular, the great depression of the 1930s.  Something had to be done.  Keynes kept marginalist theory from his mentor, Alfred Marshall, but dynamically moved it beyond supply and demand among individual consumers and producers onto the aggregate. Mainstream ‘bourgeois’ economics could no longer rely on the comforting theory that marginal utility would equate with marginal productivity to deliver a general equilibrium of supply and demand and thus a harmonious and stable growth path for production, investment, incomes and employment.  The automatic equality of supply and demand, Say’s law, was now questioned.  It had to be recognised that capitalism was subject to booms and slumps, to (permanent?) disequilibria, and thus to regular crises.  And these crises had to be dealt with – to be ‘managed’.  That required macroeconomic analysis.  In a sense, bourgeois economics had to put back the economic clock to classical economics – the study of aggregate trends – but without returning to ‘political economy’, which recognised that economics was really about social structure and relations (class exploitation) and not a theory of ‘scarcity’ and ‘market prices’.

Contrary to Pettifor’s account, it only appeared that Keynesian macroeconomics had done the trick in saving capitalism.  In the ‘golden age’ of post-1948 capitalism, economic growth was strong, employment was full and incomes high.  So (macro) economics could appear to provide policies to ‘manage’ capitalism successfully.  But this was just a momentary illusion.  The golden age soon lost its glitter.  Keynesian theory and policy was exposed with the first simultaneous international recession of 1974-5 and was followed by the deep slump of 1980-2.  Remember these major collapses in production and investment internationally took place during the supposed operation of Keynesian policies of macroeconomic management, in Pettifor’s account.

Pettifor says the crises of late 20th century were the result of “the decision by public authorities the world over to abandon the regulation of credit creation and capital mobility after the 1960s and early 70s”, in other words, a lack of regulation over the reckless bankers.  But the question not answered is: why the strategists of capital dropped Keynesian-style management and control and opted for de-regulation etc if it was all working so well in the 1950s and 1960s?  The reason that pro-capitalist governments swung to monetarism and neoliberal policies was that Keynesianism had failed.  And it failed in the most important area for capitalism – in sustaining the profitability of capital.

The big change from the mid-1960s onwards up to the early 1980s was a collapse in the profitability of capital in the major economies leading to a succession of slumps in 1970, 1974 and then 1980-2.  This is what provoked capitalist theorists and policy makers to break with Keynes.  Public services, the welfare state, good wages and full employment could no longer be ‘afforded’ and, as Pettifor says, Keynesianism was seen to be “state interventionist, soft on government deficit spending.”  But all these policy reversals came after the slump of the 1970s before which finance capital was ‘regulated’, currencies were ‘managed’, trade unions had rights, the government could intervene fiscally, and there was little privatisation.  It was the failure of capitalist production and the inability of Keynesian ideas to work that caused the change in theory and policy, not vice versa.

Nevertheless, Pettifor argues, dropping Keynesianism was a mistake for the ‘powers that be’ because Keynes had all the answers to avoid crises and get capitalist economies going. You see Keynes had developed a “revolutionary theory” of money – his Liquidity Preference Theory.  This explained that crises occur when investors or holders of money do not spend it, but hoard it.  They do this for some subjective reasons – a lack of ‘animal spirits’, a loss of belief that any spending or investing will deliver sufficient return.  So a surplus of money builds up that is not spent.  The answer, claims Pettifor, is for the monetary authorities to intervene and drive down the cost of borrowing by ‘printing’ money, so that interest rates on borrowing fall below the perceived return on investing.  This will encourage money hoarders to invest.  Such policies are “still considered too radical to be acceptable today”.

In her book, The Production of Money, Pettifor tells us that “money is nothing more than a promise to pay” and that as “we’re creating money all the time by making these promises”, money is infinite and not limited in its production, so society can print as much of it as it likes in order to invest in its social choices without any detrimental economic consequences.  And through the Keynesian multiplier effect, incomes and jobs can expand.  And “it makes no difference where the government invests its money, if doing so creates employment”.  The only issue is to keep the cost of money, interest rates, as low as possible, to ensure the expansion of money (or is it credit?) to drive the capitalist economy forward.  Thus there is no need for any change in the mode of production for profit; just take control of the money machine to ensure an infinite flow of money and all will be well.

Well, capitalism is a monetary economy but it is not a money economy (alone).  Money cannot make more money if no new value is created and realized.  And that requires the employment and exploitation of labour power.  Marx said it was a fetish to think that money can create more money out of the air.  Yet this version of Keynesianism seems to think it can.  When central banks expand the money supply through printing ‘fiat’ money or creating bank reserves (deposits), more recently so-called ‘quantitative easing’, this does not expand value.  It would only do so if this money is then put to productive use in increasing the means of production or the workforce to increase output and so increase value.

But, as Marx argued way back in the 1840s against the ‘quantity theory of money’, just expanding the supply of ‘fiat’ money will not increase value and production but is more likely to inflate prices and thus devalue the national currency, and/or inflate financial asset prices.  It is the latter that has mostly happened in the recent period of money printing.  Quantitative easing has not ended the current global depression but merely sparked new financial speculation. This version of Keynesian economics is thus hardly ‘revolutionary’ or ‘radical’ at all, as it was adopted by all central banks after the Great Recession in 2008 and has failed to restore economic growth, productive investment and average incomes.

Actually, during the Great Depression of the 1930s, as it worsened, Keynes himself came to dispense with monetary solutions to the slumps and opted for fiscal stimulus and even proposed the ‘socialisation of investment’, a much more radical policy than the production of more money.  In his Treatise on Money, written in 1930 at the start of the Great Depression, Keynes argued that central banks would have to intervene with what we now call ‘unconventional monetary policies’ designed to lower the cost of borrowing and raise sufficient liquidity for investment. Just trying to get the official interest rate down would not be enough.  But by 1936 after five more years of depression (similar to the time since the Great Recession now), Keynes became less convinced that ‘unconventional monetary policies’ would work.  In his famous General Theory of Employment, Interest and Money, Keynes moved on.

Why did just the production of more money fail, according to Keynes?  The problem was that ““I am now somewhat sceptical of the success of a merely monetary policy directed towards influencing the rate of interest… since it seems likely that the fluctuations in the market estimation of the marginal efficiency of different types of capital, calculated on the principles I have described above, will be too great to be offset by any practicable changes in the rate of interest”.  And so Keynes moved on to advocating fiscal spending and state intervention to complement or pump-prime failing business investment.  Pettifor has latched onto that part of Keynesian macro theory and policy, monetary easing, to the neglect of fiscal stimulus, let alone the more radical policy of the ‘socialisation of investment’ (not even mentioned by Pettifor).  Thus Pettifor’s account of Keynes’s economics is at his least ‘revolutionary’.

Part Two to follow: Was Keynes a revolutionary internationalist or reactionary nationalist?

Climate change and growth – Nordhaus and Romer

October 9, 2018

It is both appropriate and Ironic that, on the day that William Nordhaus should get the Riksbank prize (also called Nobel) for his contribution to the economics of climate change, the top scientific body, the Intergovernmental Panel on Climate Change (IPCC), should release its latest update on global warming.  The report sets out the key practical differences between the Paris agreement’s two contrasting goals: to limit the increase of human-induced global warming to well below 2℃, and to “pursue efforts” to limit warming to 1.5℃.

The IPCC says that if we are to limit warming to 1.5℃, we must reduce carbon dioxide emissions by 45% by 2030, reaching near-zero by around 2050. Whether we are successful primarily depends on the rate at which government and non-state bodies take action to reduce emissions. Yet despite the urgency, current national pledges under the Paris Agreement are not enough to remain within a 3℃ temperature limit, let alone 1.5℃.

Rapid action is essential and the next ten years will be crucial. In 2017, global warming breached 1℃. If the planet continues to warm at the current rate of 0.2℃ per decade, we will reach 1.5℃ of warming around 2040. At current emissions rates, within the next 10 to 14 years there is a 2/3 chance we will have used up our entire carbon budget for keeping to 1.5C.  Global emissions of carbon dioxide, methane and other greenhouse gases need to reach net zero globally by around 2050. By 2050, 70-85% of electricity globally will need to be supplied by renewables. Investment in low-carbon and energy-efficient technologies will need to double, whereas investment in fossil-fuel extraction will need to decrease by around a quarter.

Although the Paris Agreement aims to hold global warming as close to 1.5℃ as possible, that doesn’t mean it is a “safe” level. Communities and ecosystems around the world have already suffered significant impacts from the 1℃ of warming so far, and the effects at 1.5℃ will be harsher still. Poverty and disadvantages will increase as temperatures rise to 1.5℃. Small island states, deltas and low-lying coasts are particularly vulnerable, with increased risk of flooding, and threats to freshwater supplies, infrastructure, and livelihoods.

Warming to 1.5℃ also poses a risk to global economic growth, with the tropics and southern subtropics potentially being hit hardest. Extreme weather events such as floods, heatwaves, and droughts will become more frequent, severe, and widespread, with attendant costs in terms of health care, infrastructure, and disaster response.

This is where William Nordhaus, a professor of economics at Yale University, comes in.  He pioneered the economic analysis of climate change. He is also a leading proponent of the use of carbon taxation to reduce emissions, a policy approach preferred by many mainstream economists.  Nordhaus’ contribution was to develop a model that could supposedly gauge the likely impact on economies from climate change.  Nordhaus constructed so-called integrated assessment models (IAMs) to estimate the social cost of carbon (SCC) and evaluate alternative abatement policies.

And this is where it becomes ironic.  Nordhaus’ IAMs have flaws that make them close to useless as tools for policy analysis. The IPCC pointed out  that estimates of losses resulting from a 2 °C increase in mean global temperature above pre-industrial levels ranged from 0.2% to 2% of global gross domestic product.  It admitted that the global economic impacts are “difficult to estimate” and that attempts depend on a large number of “disputable” assumptions. Moreover, many estimates do not account for factors such as catastrophic changes and tipping points ie where global warming gets out of control and damages economies much more quickly and deeper than forecast.

Most IAMs struggle to incorporate the scale of the scientific risks, such as the thawing of permafrost, release of methane, and other potential tipping points. Furthermore, many of the largest potential impacts are omitted, such as widespread conflict as a result of large-scale human migration to escape the worst-affected areas.

IAMs are also used to calculate the social cost of carbon (SCC). They attempt to model the incremental change in, or damage to, global economic output resulting from 1 tonne of anthropogenic carbon dioxide emissions or equivalent. These SCC estimates are used by policymakers in cost–benefit analyses of climate-change-mitigation policies.

Because the IAMs omit so many of the big risks, SCC estimates are often way too low. As the IPCC acknowledged2, published SCC estimates “lie between a few dollars and several hundreds of dollars”. These values often depend crucially on the ‘discounting’ used to translate future costs to current dollars. The high discount rates that predominate essentially assume that benefits to people in the future are much less important than benefits today.

These discount rates are central to any discussion. Most current models of climate-change impacts make two flawed assumptions: that people will be much wealthier in the future and that lives in the future are less important than lives now. The former assumption ignores the great risks of severe damage and disruption to livelihoods from climate change. The latter assumption is ‘discrimination by date of birth’. It is a value judgement that is rarely scrutinized, difficult to defend and in conflict with most moral codes.

The other role of IAMs — to estimate the costs of climate-change mitigation — also suffers from major shortcomings. The IPCC’s mitigation assessment concluded from its review of IAM outputs that the reduction in emissions needed to provide a 66% chance of achieving the 2°C goal would cut overall global consumption by between 2.9% and 11.4% in 2100. This was measured relative to a ‘business as usual’ scenario. But growth itself can be derailed by climate change from business-as-usual emissions. So the business-as-usual baseline, against which costs of action are measured, conveys a misleading message to policymakers that fossil fuels can be consumed in ever greater quantities without any negative consequences to growth itself.

The discount rate used to calculate the likely monetary damage to economies is arbitrary.  If we use a 3% discount rate, that means the current rise in global warming would lead to $5trn of economic damage (loss of GDP), but the cost in current money of global warming would be no more than $400bn, about what China spends on hi-speed rail.  So, on this discount rate, global warming causes little economic damage and thus the social cost of carbon (SCC) is only about $10/ton, so mitigation action can be limited.  This is what Nordhaus uses in his model.

But why 3%?  Nicholas Stern, of the famous Stern Review on climate change, took Nordhaus’ data and applied a 1.4% discount rate.  The SCC then rises to $85/ton – meaning that it costs economies $85 for every ton of Co2, or closer to $3trn now!  If you take a median range discount rate on likely damage, the SCC is probably about $50/t.  But the current carbon price is about $25/t.  So the social cost is not being ‘internalised’ in any market prices.

The argument about the discount rate exposes the argument about the future.  The IAMs assume that the world economy will have a much larger GDP in 50 years so that even if carbon emissions rise as the IPCC predicts, governments can defer the cost of mitigation to the future.  And if you apply stringent carbon abatement measures eg ending all coal production, you might lower growth rates and incomes and so make it more difficult to mitigate in the future.  Yes, that is what Nordhaus’ IAMs can lead us to conclude.

These models exclude the obvious and now empirically backed evidence that slower growth actually leads to less global warming.  Tapia Granados points out that “the evolution of CO2 emissions and the economy in the past half century leaves no room to doubt that emissions are directly connected with economic growth. The only periods in which the greenhouse emissions that are destroying the stability of the Earth climate have declined have been the years in which the world economy has ceased growing and has contracted, i.e., during economic crises. From the point of view of climate change, economic crises are a blessing, while economic prosperity is a scourge.”  Inexorable march toward utter climate disaster [f] (1)

And IAMs also exclude the feedback – namely that global warming leads to more natural disasters, droughts and floods and thus to massive disruption and migration of affected populations and thus a sharp reduction in GDP growth rates.  The world will not be much ‘richer’ in the next generation if global warming goes unchecked. Finally, as with all these neoclassical growth accounting models of which the IAM of Nordhaus is one, there is no allowance for recurring crises of production in capitalism or rising inequality of income and wealth.

Growth accounting is the mainstream version of explaining long-term economic growth.  Neoclassical theory assumes perfect competition and free markets and it assumes what it should prove that capitalist economic expansion will be harmonious and without crises as long as markets are free and competition is operating.

Applying these microeconomic assumptions to long-term growth was the province of factor productivity models, originating with Solow and Swan in 1956.  Based on marginal utility theory, each factor of production (capital and labour) contributed to growth according to its marginal productivity.  The problem with this factor accounting model was two-fold.

First, the nature of ‘capital’ could not be defined or measured – what was it: numbers of different machines or the present value of the interest rate for borrowing ‘capital’?  This led to the so-called Cambridge controversy, where the neoclassical school was confounded by those who showed that you needed a common measure of value (labour?), otherwise the definition of capital was circular (namely its marginal productivity was the rate of interest on borrowing, but the amount of capital was the present value of the rate of interest!).

The second problem was that adding up the marginal contributions of capital and labour factors to GDP growth would lead a ‘residual’; which was designated as ‘technical innovation’, the productivity growth of all the factors.  This appeared to be ‘exogenous’ i.e. from outside the market system of marginal productivity.  Mainstream economics had no explanation for technological innovation!

This is where the contribution of Paul Romer comes in.  He developed an “endogenous growth model”, where long-run economic growth is determined by forces that are internal to the economic system, namely the ‘knowledge’ incorporated in the workforce of an economy. Technological progress takes place through innovations, in the form of new products, processes and markets, many of which are the result of economic activities. Thus there are constant or increasing returns to factors, not diminishing marginal ones.  This theory became popular with many reformist economists and politicians – apparently, former adviser and minister in the British Gordon Brown Labour government, Ed Balls, was a keen promoter.

Actually Romer was not the first to come up with this ‘endogenous’ model.  That honour goes to the recently deceased Kenneth Arrow, the doyen of neoclassical economics.  Arrow recognised what any fool could see: that supply was affected by demand but also demand was affected by supply.  Innovation did not come out of the sky but from the drive of companies to grow (or in the case of Marxist theory, to make more profit and reduce labour costs). Of course, the mainstream version of growth theory did not consider profitability relevant to innovation but instead looked at aggregate output.

However, the endogenous model is little better (and may be even worse) than the exogenous model in explaining and accounting for long-term growth in economies.  Romer argues that the explanation for why some countries grow faster and get richer than others is not more investment in machines, or more labour power and skills; but more ‘ideas’. Whereas the old exogenous model predicted that growth would slow as new investment in skills and capital yielded diminishing returns, Romer’s New Growth Theory opened the window onto a sunnier world view: a larger number of affluent people means more ideas, so prosperity and population expansion might cause growth to speed up.

This is nonsense, of course.  Capitalism does not work like that.  ‘Ideas’ or innovations become the property of individual capitalist companies; IPRs, patents etc are applied.  The general distribution of innovation only takes place through the rough and tumble of competition and the battle for profit and market share.  Innovation under capitalism depends on profitability and if that is low or not there, or to be given to all, then it won’t be applied. As one critic has pointed out, Romer was very much a profit-making ‘entrepreneur’ himself, having founded and sold on an online economic teaching company – so no open spillover of ‘ideas’ there.

In a way, Romer recognises market forces and argues that governments need to intervene to foster technological innovation, for example, by investing in research and development and by writing patent laws that provided sufficient rewards for new ideas without letting inventors permanently monopolize those rewards.  Thus we must correct and manage the competitive struggle.

Romer is a professor of economics at New York University, but recently he became chief economist at the World Bank for a short and chequered period.  It was a surprising appointment for an organisation that is supposed to help poor countries end their poverty.  That’s because one of the conclusions that Romer took from his endogenous model of ‘knowledge’ was that developing countries would benefit from creating pockets within urban areas that are administered by a more advanced country, so-called ‘charter cities’. The advanced country would develop a small part of the country by introducing ‘good institutions’ and the benefits of development will spill over into the rest of the economy.

Romer’s ideal example was Hong Kong. Rather than seeing Hong Kong’s signing away to Britain as unjust or humiliating for China, Romer saw it as an ‘intervention’ that has done much more to reduce poverty than any aid program and at a much lower cost. Therefore, he concludes that the world needs more Hong Kongs.  The whole approach is that a country would gain from giving up sovereignty to a more advanced nation that can better administer its affairs.

But has China’s phenomenal growth over the last 40 years, taking 800m people out of World Bank-defined poverty, needed ‘charter cities’ and ‘knowledge’ kindly administered by ‘advanced ‘ economies like the US.  Indeed, keeping imperialism out of China is part of the reason for China’s growth success.  Romer actually persuaded the government of Madagascar to apply his development plan.  It led to massive popular uprisings against the President after he agreed to lease a part of Madagascar to a South Korean corporation for 99 years!

Both the long-term growth models of Nordhaus and Romer rest on neoclassical free market theory.  As Ben Fine pointed out nearly 20 years ago in his analysis of endogenous growth theory, it has “nothing to do as such with an economy as a whole, other than in the trivial sense of requiring at least two economic agents in order for exchange to arise. Indeed, often implicitly and sometimes explicitly, the literature takes a microeconomic theory and simply interprets it as macroeconomics…In short, endogenous growth theory is heavily implicated in the traditional and strengthening microeconomic foundations of neoclassical economics.” Romer himself has recognised the failure of mainstream economics in his paper The trouble with macroeconomics, In that paper he goes on to trash all macroeconomic models for being unrealistic in their assumptions.

Both Nordhaus and Romer start with neoclassical theory and apply it to analyse long-term growth.  Their contributions are therefore stunted for that reason.  Factor of production models do not explain growth – they leave ‘residuals’ and they cannot account for the nature of ‘capital’ – it’s either just things (machines) or accumulated interest.  And there is no connection between these models of growth and the reality of capitalist accumulation for profit and the recurring crises in investment and production in capitalist expansion.

Nordhaus and Romer are aware of these contradictions at the heart of capitalism. They know that ‘free markets’ bring pollution and global warming; and ‘markets’ will block innovation if left alone. But their answer is to manage capitalism and try to persuade governments to do so. As the world gets hotter faster, and growth gets slower, good luck with that.