Archive for the ‘Profitability’ Category

Kenneth’s three arrows

February 25, 2017

Kenneth J. Arrow has died at the age of 95.  He was an important mainstream economist.  He won a Nobel Prize as a mathematical theorist.  Indeed, Arrow was the epitome of the neoclassical general equilibrium theorists who came to dominate mainstream economics, with the avowed aim of using mathematics to deliver economic analysis and answers, in a mimic of mathematical physics.

Arrow was a close associate of that other great neoclassical and anti-Keynesian theorist, John Hicks.  They both aimed to use general equilibrium theory and math to show that markets and economic growth under capitalism could achieve equilibrium through supply and demand in ‘competitive markets’.

Interestingly, Arrow was uncle to a current Keynesian guru of ‘managed capitalism’, Larry Summers and also brother-in-law to that other icon of 1960s mainstream ‘Keynesian’ economics and the then textbook writer to university students, Paul Samuelson.  It’s a small world in the mainstream – although not as small as the Marxist economics world!

What did this ‘giant’ of mainstream economics theory contribute to our understanding of modern economies or the workings of firms and people in a ‘market economy’?  Math was Arrow’s forte.  “I think my biggest hopes were methodological — to apply new developments in mathematics to economics,” he told Challenge: The Magazine of Economic Affairs, in 2000.

There are three areas (arrows) that spring to mind.  The first was Arrow’s ‘proof’ that each individual’s desires or needs cannot be combined into a collective result where everybody gains or their needs are satisfied.  His conclusion as outlined in his famous monograph Social Choice and Individual Values , was that “If we exclude the possibility of interpersonal comparisons of utility, then the only methods of passing from individual tastes to social preferences which will be satisfactory and which will be defined for a wide range of sets of individual orderings are either imposed or dictatorial.”  In other words, it was impossible to deliver what ‘society’ needed from individual preferences as expressed through markets free of ‘unwanted alternatives’, at any time, and for all, unless the market is replaced by ‘dictatorship’.

You can already see the irony of this result.  The leading mathematical theorist of capitalist markets proves that markets cannot meet each individual’s needs without worsening the needs or desires of others, or abolishing itself! As one economist put it, Arrow “proved it was logically impossible for there to be a system of voting which is free of anomalies, no matter what kind of system it is…You can say, ‘There’s no really good way to run an election,’ but it is something else to prove it. . . . It’s like proving a bicycle cannot be stable.”

As developers of this ‘impossibility’ theorem, like Amartya Sen, went on to show, this also meant that there was no way that markets, perfectly competitive or not, could deliver equality of outcomes for each individual – no Pareto optimality.  Another way of putting this is to say that it is impossible to get ‘society’ to make a choice that leads to satisfaction for everyone.  As Sen said, “It is important to recognize that Arrow was not only establishing a theorem, he was opening up a whole subject to social choice.”

Democracy means making choices or plans that the majority want or need even if the minority loses out.  You may find this result self-evident and trite but apparently Arrow gives you a mathematical proof!  But it does not answer the social question: who is the majority and who is the minority?  And in the current world is it not the minority of the 1% and super-rich that get their needs met at the expense of the 99%?  Arrow’s theorem suggests that such inequality is the way of the world of markets.

Arrow’s second contribution was to the notorious foundation of neoclassical theory of capitalist market harmony, general equilibrium theory.  The principle of GE theory is that supply and demand in markets can be equalised and stabilised at a certain price, thus proving that capitalism is not inherently unstable as Marx had argued with his critique of Say’s law.  In a paper to the American Economic Association, Arrow states, “From the time of Adam Smith’s Wealth of Nations in 1776, one recurrent theme of economic analysis has been the remarkable degree of coherence among the vast numbers of individual and seemingly separate decisions about the buying and selling of commodities. In everyday, normal experience, there is something of a balance between the amounts of goods and services that some individuals want to supply and the amounts that other, different individuals want to sell. Would-be buyers ordinarily count correctly on being able to carry out their intentions, and would-be sellers do not ordinarily find themselves producing great amounts of goods that they cannot sell. This experience of balance indeed so widespread that it raises no intellectual disquiet among laymen; they take it so much for granted that they are not supposed to understand the mechanism by which it occurs.”

So the invisible hand of the market (Smith) can lead to harmonious equilibrium in markets where supply and demand are ‘cleared’.  Working with Gerard Debreu, the Arrow-Debreu theorem in 1954 supposedly provided a rigorous mathematical proof of a ‘market-clearing’ equilibrium — or the price at which the supply of an item is equal to its demand.   It became just what mainstream economics needed to ‘prove’, namely that a theory of value and price formation could be based on individual consumer choices and not on the labour theory of value as put forward by the classical economists and Marx.  “Their (neoclassical) theory of value and price formation was really a fundamental element of economics…It’s the ABCs of economics and economic theory.”, said one follower of Arrow.

But again, what is ironic about the Arrow-Debreu proof is that it shows markets have to be completely ‘perfect’ in the sense that no one participant can have extra knowledge or economic power over another and that there must be no restriction or distortion of price from outside.  The theorem has been applied in financial markets on the grounds that these are ‘perfect markets’ where everybody has the same power and knowledge.  Such an assumption, we now know after the global financial crash (in part the result of dysfunctional derivatives markets), is unrealistic to the point of disaster.

That the theorem of general equilibrium in capitalist markets is based on totally unrealistic assumptions is not a decisive critique, because Arrow recognised this.  Indeed, he drew the conclusion that the aim of policy should be to try to ‘correct’ and ‘manage’ any anomalies in markets to achieve something closer to ‘equilibrium’.  As he said, “You cannot get a full understanding of the behavior of any part of the economy without understanding its reaction on other parts.”

He applied this approach to health economics.  In his 1963 paper “Uncertainty and the Welfare Economics of Medical Care”, he found that the delivery of health care deviated in fundamental ways from the traditional competitive market and, for this reason, was a ‘nonmarket’ relationship.  For example, in a ‘perfect market’, the buyer and seller in theory have access to the same information about market price and value. However, in the health-care market, the supplier (doctor) commonly has a superior knowledge of the quality, provision and distribution of health-care services — all of which puts the consumer (patient) at a relative disadvantage.  This creates a problem of ‘information asymmetry’.

Consumers also do not always know when they will need health care until the moment they require it (as with a stroke or heart attack). So when consumers purchase insurance, the cost can be prohibitive.  And insurance companies worry that offering coverage to protect consumers against losses could create ‘moral hazards’, such as risk-taking and irresponsible behaviour (indeed!).

Again it may not surprise you to find that the world’s leading equilibrium economist found that markets are not fair in delivering basic needs like health to people because they are rigged or corrupt!  Of course, unfortunately, that has not led to the conclusion that healthcare should be publicly owned (single supplier) and delivered free at the point of use (public good) to be maximise people’s needs.  Indeed, Arrow never followed his own theoretical conclusion when asked to consider whether money damages could be measured and so awarded to people suffering environmentally from the activities of ‘more informed’ multi-nationals.

What is the decisive critique of the Arrow-Debreu theorem’s relevance to modern economies is that economies are not static systems but dynamic.  Yes, Marx said, supply does equal demand but really only by accident.   In theory, under ludicrous assumptions, markets clear all supply and meet all demand, but in reality, they hardly ever do. Markets keep moving away from equilibrium all the time.  Nothing stands still and there are ‘laws of motion’ that continually change ‘equilibrium assumptions’, making market economies inherently uncertain. These laws of motion (as developed by classical and Marxist economics) rather than the ‘principle of equilibrium’ are much more relevant to understanding the capitalist economy of production and investment for profit.

Arrow did venture into the realm of classical economics of a dynamic economy and proposed an endogenous growth theory, which seeks to explain the source of technical change as part of the process of accumulation and not ‘external’ to the movement of supply or being set by consumer demand.  Yes, I know, it is difficult to believe, but mainstream neoclassical theory argued that aggregate supply and demand in an economy were driven by separate forces (the preference of firms on the one hand and by consumers on the other).

Endogenous theory 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 neoclassical version of growth theory did not consider profitability relevant to innovation but instead looked at aggregate output.  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.

So Kenneth Arrow leaves us with three arrows to enrich our understanding of the economic world: 1) markets collectively can never properly deliver every individual’s needs; 2) markets cannot equate supply and demand except under the most unrealistic assumptions and 3) economic growth is not achieved by just meeting the demand of consumers but requires decisions of investors to innovate.  Ironically, none of the implications of these economic arrows have been accepted by the owners of capital and their politicians in practical policy.  To do so, would be to admit that capitalism does not work for the majority or even much of the time for the capitalists.

Apple and the cash pile story

February 8, 2017

The tech giant Apple has accumulated an enormous cash hoard of $246bn, larger than Sri Lanka’s estimated 2016 GDP. If Apple’s cash pile was its own public company, it would be the 13th largest in the world.  Much of this cash pile ($215bn) is held abroad to avoid paying the higher rate of corporation tax that the US applies.  For example Apple paid only 0.005 per cent tax in Ireland in 2014.  The EU Commission is trying to force Apple pay a proper tax amount to Ireland on the grounds that its profits in Europe have not been taxed properly because it accounts for its sales through Ireland.  The Irish government has sided with Apple in this dispute!

But Apple’s cash pile is not actually “cash” nor “on hand”. Apple has only about $16.7 billion in cash and equivalents on its balance sheet. The rest is stashed in long-term marketable securities, meaning Apple plans to let those funds — roughly $177 billion — accrue interest for more than a year.

Everybody notices the high cash hoards that some of the largest US companies are accumulating but do not notice that their debt has rocketed too.  Apple’s debt has exploded. It has $80bn in debt, which since 2012 is essentially an increase of $80bn. That’s right, a few years ago, Apple had near-zero debt levels and now has a solid $80bn worth.

apple-tax-bill

And while cash and securities pile up overseas, Apple is piling up debt in the US. Apple – even before this latest borrowing – had more debt than the telecom and cable companies which typically carry the most debt since they have stable cash flow and slow growth. The company currently sits on about $53.2 billion in long-term debt obligations as well as $32.2 billion in “non-current liabilities,” after executing a series of bond sales including the largest in history for a nonfinancial U.S. business, making it the fourth most-indebted company in the Standard & Poor’s 500.

apple-cash

By borrowing instead, Apple gets cash to pay dividends and buy back shares of stock without hauling its billions stored overseas back to the US, which could trigger a ‘tax event’.  Apple is a little more than three-quarters of the way through a $200 billion capital-return program that it believes will set a corporate record for stock buybacks. There is another $47 billion promised to shareholders. There is no doubt that Apple is raking in cash with its massive hardware sales and has plenty of ammunition for potential acquisitions. But Apple is actually borrowing to finance the promises it has already made.

And it’s the same story behind the so-called cash hoards that have built up in other very large US multi-national corporations.

cash-hoard

A recent study of multinational cash holdings found that “since corporate assets tend to grow over time, the dollar amount of cash holdings would grow even if the ratio of cash to assets stays constant.” And that is what has been happening.  Cash reserves have risen but cash to asset ratios have not.  “Using all non-financial and non-regulated public firms with assets and market capitalization greater than $5 million per year in the US, the average cash/assets ratio is 20.18% in 2009-2010 compared to 20.50% in the 2004-2006 pre-crisis period.” That’s down.

cash-to-asset

The median ratio is higher by 0.87% in 2009-2010 than in 2004-2006 and the asset-weighted ratio is higher by 0.74% in the recent period. That tells you large firms have increased their cash holdings more.  This confirms the recent OECD study that found that the huge profits gained since the end of the Great Recession have been mostly confined to the large companies: “just a few mega companies hold most of the cash while thousands of small and medium enterprises (SMEs) hold little cash and much more debt

The big rise in cash holdings took place in the global credit boom of the early 2000s. From 1998-2000 to 2004-2006, the average cash/assets ratio in US corporations increased by 3.77%, the median by 6.39%, and the asset-weighted average by 3.62%.  And this appears to be a US phenomenon.

The study found that cash/assets ratios increased across the world in the 2000s compared to the late 1990s. But the increase in average cash holdings across the world was smaller than the increase in the US. Indeed median cash holdings in the US in the late 1990s were lower than median cash holdings in foreign countries, but the opposite was true by 2010.  And after 2010, there is little evidence of an increase in average cash holdings for foreign firms.

Why have cash to asset ratios risen since 1998?  The study finds that cash holdings may have changed simply because firm characteristics have changed. If this were the case, there might be nothing abnormal about the large cash holdings of American firms in recent years. Bates, Kahle, and Stulz (2009) show that changes in firm characteristics explain much of the increase in cash holdings in the 1980s and 1990s.  US multinationals held comparable amounts of cash than purely domestic firms in the late 1990s, but now hold significantly more cash than similar purely domestic firms.

The tax treatment of remittances made it advantageous for multinationals to keep their earnings abroad. But the increase in cash holdings of multinationals is strongly related to their R&D intensity, so that multinationals with no R&D expenditures do not have an increase in abnormal cash holdings compared to domestic firms with no R&D expenditures. In sum, what this study shows is that cash hoarding is really confined to large hi-tech multinationals which keep cash for high risk R&D spending that burns cash, while borrowing and issuing debt to pay shareholders their dividends and buy back shares, as this is cheap and tax efficient.

This confirms previous studies such as that in the Journal of Finance (2009), Why firms have so much cash, which found that in order to compete, companies increasingly must invest in new and untried technology rather than just increase investment in existing equipment.  That’s riskier: “the greater importance of R&D relative to capital expenditures also has a permanent effect on the cash ratio. Because of lower asset tangibility, R&D investment opportunities are costlier to finance than capital using external capital expenditures. Consequently, greater R&D intensity relative to capital expenditures requires firms to hold a greater cash buffer against future shocks to internally generated cash flow.”  

So companies have to build up cash reserves as a sinking fund to cover likely losses on research and development.  This partly explains why there was a growing gap between cash held by corporations and investment in means in production between 1998 and 2008

Share prices, profits and debt

February 6, 2017
The world’s stock markets continue to hit the roof, particularly the US markets which have reached all-time highs.  ‘The Donald’ may dominate the headlines with his presidential decrees and tweets, but on the whole, financial investors remain optimistic.  As I showed in a previous post, there is a growing consensus among economists and investors that things are looking up and the world economy is set for a sustained recovery.

Take the latest forecasts from Gavyn Davies, former chief economist at Goldman Sachs and now running his own financial agency, Fulcrum.

He comments “One of the most important questions for 2017 is whether this bout of reflation will continue. My answer, based partly on the latest results from the Fulcrum nowcast and inflation models, is that it will continue, at least compared to the sluggish rates of increase in nominal GDP since the Great Financial Crash.” Moreover “The nowcasts continue to report strong growth across the board, with world activity now expanding at a 4.2 per cent annualised rate   Strong growth is especially apparent in the advanced economies, where the growth rate is now 3.0 per cent, a figure that is well above the long term trend of 1.8 per cent. Furthermore, activity growth is estimated to be above trend in all of the major advanced economies simultaneously: US (3.6 per cent), Eurozone (2.5 per cent), Japan (1.8 per cent) and the UK (2.5 per cent).”

So it is looking good.  However, as I did in my previous post, I must throw some cold water on this forecast for higher and sustained economic growth.  Sustained trend growth does not depend on consumption; it does not depend on more spending by households on goods and services financed by more borrowing or induced by higher share prices.  It depends on increased investment in production capacity leading to higher productivity growth. And that, in turn depends on better profits for the key corporate sector of an economy.  And as yet, there is little sign of that.

For example, in the data for the last quarter of 2016 for the US economy, any pickup in business investment was minimal.  US real GDP figures show an annualised rise of 1.9%. So real growth in 2016 was just 1.6% compared to 2.6% in 2015 – the slowest rate since the end of the Great Recession.  There was a bit more business investment after three quarters of decline. But business investment was still up only 0.3% yoy. The key sector of equipment investment was still falling by 3.6% yoy.

us-fixed-investment

As a result, productivity growth (that’s the increase in output per worker), is stagnant, especially in the key productive sectors like manufacturing.

us-manuf-prod

These are similar points to those made by John Ross in his latest post on the US economy, namely the myth of a strong economic recovery.

ross

Well, it could be argued: that’s the past.  As Gavyn Davies and others argue, things will be different this year.  Even ‘post-Brexit’ Britain is likely to record reasonable growth of 2% this year, say the Bank of England and other agencies, contrary to their doomladen forecasts after the referendum last summer.

But I say again, the key indicators are an increase in business investment and behind that, the driver of, an increase in corporate profits.  The figures we have for the third quarter of 2016 (general the latest) suggest a mild recovery in global profits from the slowdown experienced since 2014.  But it is not much to go on.

global-corporate-profits

The overall trend in US corporate profits has been down for over two years.  The graph below shows what has happened to earnings per share (EPS) for the top 500 companies in America.

casey-1

And behind this decline lies a fall in the record highs achieved in corporate profit margins (i.e. the share of profits in total output) from as early as 2011 – in other words, corporate profits rose but even more slowly than corporate sales or total output.  Some mainstream economists argue that this is good news because tighter margins will increase competition and reduce inequality.  But this is nonsense, as I argued in Jacobin last year.  I argued in that Jacobin piece, falling profits and profit margins herald a slump in investment and then a slump in production and employment.  JP Morgan and other investment bank economists have made the same point.

Corporate profit margins are still well above their historic average. In order for them to revert to their mean, they would have to fall to 9%, according to Casey Research.  The last time profit margins sunk that low, the US economy entered the Great Recession of 2008-9.

casey-2

As I showed in a recent post, profitability across the spectrum of the corporate sector in the major advanced capitalist economies remains weak and there is a sizeable section of that sector that are ‘zombie’ firms, unable to make any more profit than necessary to cover the servicing of their debts, let along invest in new productive technology to raise productivity and expand.

And behind that situation is the level of corporate debt, something ignored by the likes of Gavyn Davies.  As Austrian economist, William White puts it in a damning piece, “the question that all market observers ultimately have to answer today is whether the epic accumulation of global debt is sustainable. If it is not, as I believe, the next question is how to identify the signs indicating that excesses are becoming unsustainable and leading to breakage.”

Michael Lewitt points out that stock markets “are chasing the highest valuations in history.”  As the graph below shows, they still have some way to go to match the hi-tech bubble excess of 2000. But the US stock market is now at the same level of valuation as just before the 1929 crash.

valuation

And yet financial markets are not supported by strong corporate earnings and real GDP growth.  According to Factset, estimated non- GAAP earnings growth for S&P companies in 2016 was a paltry +0.1% (and GAAP earnings growth was negative). Revenues were up roughly 2.0%.  “Wall Street strategists trying to tempt investors into buying more stocks at these levels are playing with fire.” (Casey).

France: penned in

February 1, 2017

The victory of Benoit Hamon as the new leader of the ruling Socialist party in France sets the scene for an unpredictable outcome from the upcoming presidential election in April-May.

Hamon is a Corbyn-Sanders type left leader who defeated the right-wing Blairite-Clinton candidate in the socialist primary that saw nearly 2m vote.  He stands for cutting the working week, boosting the minimum wage and reversing various neo-liberal measures introduced by incumbent ‘socialist’ President Hollande, who is so unpopular (with 4% approval) that he decided to not to run again.

Hamon starts way behind in the public opinion polls, with about 15% of those voting likely to support him, but ahead of the ‘far left’ candidate Jean-Luc Melenchon with 10%.  The leader of the pack is Marie Le Pen, head of the (formerly openly fascist) racist, anti-immigrant, anti-EU Front National (NF), who is polling about 25%.  The centre-right, neo-liberal main capitalist party, the Republicans, have picked Francois Fillon, who wants to increase the working week, privatise more and cut public employees and services sharply.  Fillon, who has been caught in a scandal of paying his wife €800,000 as his ‘secretary’ from public funds for doing nothing, is polling about 22%.  Then there is the so-called centre candidate, a former right-wing ‘socialist’ minister, Emmanuel Macron, who is pro-EU, wants more neo-liberal policies etc.  He is getting about 21%.

So it’s all wide open.  As the French presidential election is over two rounds, with the top two in the first round then having a run-off, the most likely outcome is that Le Pen may get to the second round but then be roundly defeated by one of the others (in a second round any of the others are ahead against Le Pen by about 60-40).  So it is unlikely that France will vote in a racist Eurosceptic president.

But that does not rule out a new right-wing president who will try to boost profitability at the expense of labour, by raising the working week, imposing stringent labour laws, cuts in public services, pensions and have more privatisations.  That’s because French capital needs to act as it slips further behind its major partner in Europe, German capital.

The French economy picked up the last quarter of 2016, but it was a very modest recovery.  The French economy grew 1.1 percent in all of 2016, compared with 3.2 percent in Spain and 1.9 percent in Germany.  The unemployment rate remains stuck close to 10 percent compared to just 3.9% in Germany.

french-gdp

The reality is that French capital has been in trouble for some time.  The best estimate of the profitability of French capital in the last 50 years shows that after the profitability slump of the 1960s that all the major capitalist economies experienced, French capital made only a limited recovery in the so-called neo-liberal era.

french-rop

That was partly due to the failure of French industry to invest and compete in world markets and eventually in the Eurozone compared to Germany.  And it was also partly due to the stubborn militancy of French labour to allow cuts in wages and conditions and to preserve public services and benefits – France has the best national health service in the world and still relatively good social benefits and pensions (although these have been eaten away).  And it has an official 35-hour week which is enforced by the labour movement.

At the end of the 20th century, profitability peaked and began to fall again.  It is now at a post-war low.  As a result, French capital is struggling to compete.  Indeed, since the euro started in 1999, the profitability of French capital has plummeted 27% compared to a 21% rise in Germany.  Profitability is still down a staggering 22% since the peak just before the global financial crash in 2007 – that’s way more than the decline in Germany or the Euro area average.

change-in-rop

As a result, investment, particularly business investment, has stagnated in the ‘recovery’ since 2009.

change-in-investment

As investment has been so poor, growth in productivity has been low (as in many other capitalist economies).

labour-productivity

French productivity levels (GDP per hour worked) seem higher than the G7 and the UK.  But this is partly an illusion because the unemployment rate is close to 10% or double that of the UK and Germany.  When you account for that, French productivity is not much higher than the UK.

levels

So this upcoming election is important.  French capital wants a president elected who will introduce policies designed to reverse the long-term secular decline in the profitability of capital and put French labour in its place.  For this, they look to Fillon or Macron – either will do.  But votes do not always work out as the strategists want or expect – as we have seen in the UK with Brexit and Trump in the US.

It is still unlikely that Le Pen will enter the Elysee Palace or that Hamon or Melenchon will combine to enable a leftist candidate to get into the second round and defeat Le Pen.  But it’s possible.  But whatever the outcome, the next French president will face major challenges with an economy that has sluggish growth and investment, high unemployment and growing ethnic divisions.  And that is not even considering the probability that there will be a new global slump during the next presidency.

Abenomics: an update

January 27, 2017

Back in 2012 when Japanese PM Abe came to power, he launched a new economic policy that was supposed to get Japan out of its seemingly permanent deflationary stagnation.  The ‘three arrows’ of this policy were 1) to print money and take interest rates down to zero and beyond to stimulate consumer spending – so-called ‘unconventional monetary policy’; 2) to increase government spending and run sizeable budget deficits to ‘pump-prime’ the economy in traditional Keynesian-style; and 3) to introduce ‘structural reforms’ i.e. labour and market deregulation in the neo-liberal approach. Warning – graph alert!

Former Fed chair Ben Bernanke, the architect of unconventional monetary policy, was flown to Abe’s Cabinet meetings to advise on the first arrow.

Japan monetary base

Paul Krugman, the great guru of Keynesian stimulus policies, was also flown in to advise on the second arrow; while Abe himself tried to implement the third arrow with sharp cuts in corporate taxes and weakening of labour laws.

japan-fiscal

In previous posts, I pointed out that Abenomics was really the ultimate policy of mainstream economics in all its wings that would supposedly end Japan’s depression – but it would not work unless profitability of capital was revived and business investment took off.

One of the key targets of Abenomics was to get inflation of prices in the shops rising at 2% a year. This supposedly would force Japanese citizens to spend more and stop saving too much, which had been the result of the deflation of previous years. The combined policies of monetarism and Keynesianism would do the trick.

japan-inflation

Well, the latest data from Japan show the miserable failure of these policies.  Annual consumer prices are now falling not rising.  Core consumer prices, which include oil products but exclude volatile fresh food, fell 0.3% in 2016 from a year earlier, a 10th straight monthly decline.

japan-core-inflation

And as for economic growth, Abenomics has failed spectacularly.  Real GDP growth is struggling to reach 1% this year, way below levels achieved when Abe came into office at the time of ‘recovery’ from the Great Recession.

japan-gdp

It is just as well that Japan’s ageing population continues to shrink because that has meant that GDP per person has risen more.

japan-per-cap

But even this meagre rise in GDP hides the deeper failure of Keynesian style policies.  Fiscal stimulus and monetary easing has not led to increased household spending.  On the contrary, Japanese households are consistently spending less.

japan-household-spend

Why is that?  Well, the answer lies in the partial success of the third arrow – the real drive of Abenomics – namely trying to raise the profitability of capital and the productivity of labour to get Japanese capitalism going. Under Abenomics, profitability has been turned around.  Japanese profitability was in long-term decline during the 1990s and that was only reversed by  the previous neo-liberal policies of PM Koizumi and the global credit boom of the 2000s.  But the Great Recession saw a 25% collapse in profitability.  Abenomics set out to restore profitability of capital.

japan-profitability

And Abe did it in two ways.  The first was a sharp cut in corporate taxes.

japan-corporate-taxes

And while corporate profits taxes were reduced, a special sales tax was imposed on the Japanese public and social security contributions were hiked.

japan-social-security

The outcome was a big shift in the share of labour in national income towards profit share.  Real wages per employee fell and with it, household spending.

japan-real-comp

However, it seems that Japanese corporations, despite improved profitability, are still not prepared to step up business investment by any decisive amount.  That’s because the actual generation of profitable investment is still weak and cuts in corporate taxes are not enough to counteract that. Capital formation remains nearly 20% below where it was in the late 1990s and still below the peak of 2007.

japan-cap-form

As a result, Japan’s productivity per worker has not increased at all under Abenomics.

japan-productivity

So, after four years of Abenomics, employing all the weapons of mainstream economics, and paying their leading advisers to help, Japanese capitalism remains stagnant and worker’s real incomes are falling.

 

 

Beware the zombies

January 23, 2017

Mainstream economics has been seriously puzzled by the failure of the major economies to restore the previous growth rate in the productivity of labour since the end of the Great Recession.  There has been an intense debate over the issue. 

Some argue that productivity growth has been restored but is just not being measured properly, now that much new productivity comes from data, intellectual ideas, software etc and not from the production of things.  But recent research has thrown cold water on this explanation. 

Others argue that productivity growth may be lower, but that is simply the result of the aftermath of the Great Recession, leaving companies unwilling to invest in capital equipment and preferring to speculate in financial markets or just hold cash.  There is some truth in this argument, as I shall explain below.  After all, after a major slump, capitalist companies are going to hoard cash rather than possibly waste it on investment and extra production that may not find a buyer. And a past OECD study found support for what it called the ‘pro-cyclical’ element in post global crash productivity.  “Firms may respond to short-run fluctuations in demand by varying the rates at which their existing capital and labour are utilized, for example by hoarding labour at the time of a crisis waiting for the recovery or underutilising the existing capital stock without shedding it

Others reckon productivity growth had already slowed down before the Great Recession and would not recover because we are now in an era of low growth as all the hi-tech innovations have been exhausted and robots and AI will have little impact on the wider economy.  This view has been strongly contended by mainstream economist, Robert J Gordon, and by more radical observers. It suggests that capitalism may have passed its use-by date.  Again, this argument has some merit but, as I have explained in previous posts, it still does not identify the reason for the investment and productivity growth slowdowns since the end of the Great Recession.

Now some new research brings stronger light onto the debate.   The European Central Bank, the Bank of England and the OECD have recently produced reports that hone in one key feature of the ‘productivity puzzle’.  It seems that productivity growth is not stuttering everywhere in capitalist economies.  In the major economies, the so-called ‘frontier’ companies are increasing their productivity as fast as before the financial crisis.  The disappointing economy-wide productivity figures are to be blamed on the companies that are ‘behind the frontier’.

The OECD finds that the ‘diffusion’ of innovation and productivity growth from leading to lagging companies has slowed down.  The ECB also finds the same thing in its study of Eurozone productivity (where it is worse for services than for manufacturing) and the Bank of England finds the same for the UK and that its effect is substantial.  What is most significant is that the new OECD study found that the cause was the large number of ‘zombie’ companies (companies whose regular revenues at most cover their interest expenses (if that) — companies that, to paraphrase BoE governor Carney, “depend on the kindness of their creditors”.  

The OECD researchers find that such zombies take up a frighteningly large part of the economy. Across the nine European countries they studied, the share of the total private capital stock ‘sunk’ in zombie companies ranges from 5 to 20 per cent. The suggestion is that such businesses hog capital and crowd the market for newcomers, make it harder for more promising companies to expand and hold back the reallocation of labour and capital to more productive and faster-growing companies.   The paper concludes that “the prevalence of, and resources sunk in, zombie firms have risen since the mid-2000s, which is significant given that recessions typically provide opportunities for restructuring and productivity-enhancing allocation” and that “a higher share of industry capital sunk in zombie firms tends to crowd out the growth—measured in terms of investment and employment—of the typical non-zombie firm.” All in all “a 3.5% rise in the share of zombie firms—roughly equivalent to that observed between 2005 and 2013 on average across the nine OECD countries in the sample—is associated with a 1.2% decline in the level of labour productivity across industries.” 

This confirms what I argued in a recent debate on the role of profitability.  The huge profits gained since the end of the Great Recession have been mostly confined to the large companies: just a few mega companies hold most of the cash while thousands of small and medium enterprises (SMEs) hold little cash and much more debt.  Indeed, a minority are really ‘zombie’ firms just raising enough profit to service their debt.”

It is easy to see why there are so many zombies.  Despite the relative recovery of headline profitability in many economies in the credit-fuelled boom from 2002 to 2006, many small to medium-sized companies did not see an improvement in profitability.  Instead they racked up higher debt through bank loans.  The Great Recession caused a collapse in profits and even after 2009, profitability improved little for these companies while debt remained high. But the zombie companies have struggled on because interest rates were so low and banks would not foreclose.  This scenario has been found in the extreme in Italy where ‘non-performing’ bank loans have reached 20% of GDP.

As the ECB explains in its report (ecb-zombie-credit-acharya-et-al-whatever-it-takes ),While banks that benefited from the announcement increased their overall loan supply, this supply was mostly targeted towards low-quality firms with pre-existing lending relationships with these banks. As a result, there was no positive impact on real economic activity like employment or investment. Instead, these firms mainly used the newly acquired funds to build up cash reserves. Finally, we document that creditworthy firms in industries with a prevalence of zombie firms suffered significantly from the credit misallocation, which slowed down the economic recovery.”

According to research by the ‘free market’ Adam Smith Institute, 108,000 so-called zombie businesses in the UK are only able to service the interest on their debt, preventing them from restructuring. In other words, they slow the ‘creative destruction’ of capital by the liquidation of the weak for the strong.

This confirms previous studies such as that in the Journal of Finance (2009), Why firms have so much cash, which found that in order to compete, companies increasingly must invest in new and untried technology rather than just increase investment in existing equipment.  That’s riskier: “the greater importance of R&D relative to capital expenditures also has a permanent effect on the cash ratio. Because of lower asset tangibility, R&D investment opportunities are costlier to finance than capital using external capital expenditures. Consequently, greater R&D intensity relative to capital expenditures requires firms to hold a greater cash buffer against future shocks to internally generated cash flow.”  So companies have to build up cash reserves as sinking fund to cover likely losses on research and development.

Similarly, in a recent paper, Ben Broadbent from the Bank of England noted that UK companies were now setting very high hurdles for profitability before they would invest as they perceived that new investment was too risky. “Even if the crisis originated in the banking system there is now a higher hurdle for risky investment –  a rise in the perceived probability of an extremely bad economic outcome….In reality, many investments  involve sunk costs. Big FDI projects, in-firm training, R&D, the adoption of new technologies, even simple managerial reorganisations – these are all things that can improve productivity but have risky returns and cannot be easily reversed after the event.”  So the profitability of capital has got to be high enough both to justify riskier hi-tech investment and to cover a much higher debt burden (even if current servicing costs are low).  Firms are not going to borrow more to invest even if banks are willing to lend.

Marx’s theory of crisis rests on the idea that after a slump capital will only start to invest to raise the productivity of labour if profitability is rising and at a sufficient level.  Indeed, slumps in production should provide the basis for a recovery in profitability and a reduction in the debt burden (credit) built up to the point of the crisis. But right now there are thousands of heavily indebted SMEs which are barely keeping their heads above water despite low interest rates.  They are keeping profitability too low and debt too high.  They are clogging up the system.

Profitability in the major economies did recover from the trough reached at the depth of the Great Recession in 2009.  According the European Commission’s AMECO database, the net return on capital stock is up between 8-30% since 2009 in the major economies.  But even that recovery has not meant that profitability has returned to its previous peak (2005-7) before the great crash, varying from flat to down near 14%.  And in the UK and the US profitability is now falling, according to AMECO.

nrr-ameco

At the same time, corporate debt levels are still high and rising.

us-corporate-debt

The most extreme strategists of capital recognise the ‘proper’ solution.  Back at the beginning of the Great Depression of the 1930s, the then US Treasury Secretary, Andrew Mellon, warned against keeping ‘dead’ capital going ‘zombie like’ as a ‘moral hazard’.  “Liquidate labour, liquidate stocks, liquidate farmers, liquidate real estate … it will purge the rottenness out of the system. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less enterprising people”.

The ‘solution’ for capital of ‘creative destruction’ in a slump or depression has not altered.  “The fundamental tenet of capitalism, which holds that some bad companies need to fail to make way for new and better ones, is being rewritten,” says Alan Bloom, global head of ‘restructuring’ at Ernst & Young management consultants. “Many European companies are just declining slowly and have an urgent need for new management, a revised capital structure or at worst to be allowed to fail,” he adds.

With corporate debt levels higher than before the global crash and profitability in most economies lower than before and now peaking again, ‘zombie’ companies are going to have to be removed in a new deluge before improved profitability and productivity can be achieved.

 

ASSA 2017 part 2 – Economists and the state of economics

January 11, 2017

Part one of my report on ASSA 2017 covered the debate among mainstream economists and others on the scale and impact of rising inequality and the role of automation on labour and the capitalist economy.

Talking of inequality brings me to consider the state of economics now, as expressed in ASSA 2017.  The failure of mainstream economics to forecast the Great Recession or to explain it; and the subsequent failure to explain how to get out of the Long Depression that ensued raised questions about the methods and polices of the mainstream at this year’s ASSA.

Nobel prize winner Angus Deaton at ASSA had serious questions.  Economic data were faulty, the models used by economists were unreal and the inequality we see in the world was mirrored in the economics ‘profession’ itself.  Deaton sounded upset that most economists could not get their stuff into the top journals, leaving the gravy train of pay and fame to a small elite of Nobel prize winners.  A few top economists got high pay, good jobs and tenure and the same people got their papers in the top five journals and often not on merit.

Of the 537 people who have held American Economic Association office since 1950, for example, 51.1 percent got their doctorates at the University of Chicago, Columbia, Harvard and the Massachusetts Institute of Technology. One-third of the members of the Council of Economic Advisers have had doctorates from MIT. Elite-level economics has become a quite exclusive club.

But economists in general are not really hard done by in the wider scheme of things.  They generally get paid better than most other academics and other ‘professions’ – at least in America.  Indeed, the latest data at ASSA show that newly appointed economists in American academia could expect way more than in most jobs and even most ‘professions’ – starting salaries in the US ate $80-120k.  And even more is paid to economists who go into banking and the world of Goldman Sachs.

salaries

And it is not hard to see why.  The aim of mainstream economics is not to analyse society objectively but to defend and promote capitalism and markets as the only viable system of human organisation.  Modern economics is an apologia not a science. For this wasteful and unproductive exercise, economists are paid relatively well compared to occupations that provide things and services that most people actually need.

But the price of apologetics is to fail to see crises coming in the capitalist mode of production.  Mainstream economics failed to forecast the Great Recession and then to explain it.  And it has failed to explain the subsequent Long Depression and how to get out of it.

Indeed, as the ASSA elite bemoaned these failures in Chicago, the Bank of England’s chief economist also warned of the dangers of placing too much faith in economic forecasts. Andy Haldane admitted economic forecasting was “in crisis” and failed to warn adequately about the financial crisis. And he said of economics: “It’s a fair cop to say the profession is to some degree in crisis”. His intention was to highlight the problems inherent in placing too much reliance on large models of the economy which assume people always behave rationally. Mr Haldane said he hoped the lessons learnt after the financial crisis would help economics move away from “narrow and fragile” models to a broader analysis which encompasses insights from other disciplines.

In the Richard Ely ASSA lecture, Esther Duflo reckoned economists should give up on the big ideas and instead just solve problems like plumbers “lay the pipes and fix the leaks”.  Elsewher, at ASSA, it was also suggested that economists were more like engineers than physicists.

This sounded like Keynes’ famous remark that economists should be like dentists – sorting out troublesome teething problems so that capitalism can then run smoothly. Apparently, Duflo reckons the analogy of plumbers means that pure scientific method of cause and effect was less important than practical fixes. So economists should be more like doctors than medical researchers.  Plumbers, dentists, engineers, doctors – but not, it seems, social scientists, let alone scientific socialists.

The failure of economics does not auger well that the mainstream will know what to do about the rise of ‘the Donald’.  At ASSA, a pack of Nobel Prize-winning economists gave Donald Trump and his policy plans the thumbs-down.  “There is a broad consensus that the kind of policies that our president-elect has proposed are among the polices that will not work,” said Joseph Stiglitz, summing up the views of the panel that included his fellow Columbia University professor Edmund Phelps and Yale University’s Robert Shiller.

Phelps was particularly critical of Trump’s singling out of individual companies for abuse and praise, saying such interference could end up discouraging newcomers from entering markets and bringing with them much-needed innovation. “The Trump government is threatening to drive a silver spike into the heart of the innovation process,” he said. Phelps also voiced concern about Trump’s plans for big tax cuts and spending increases. “Such a policy runs the risk it could lead to an explosion of public debt and ultimately cause a serious loss of confidence and a deep recession,” he said.  Shiller was the only Nobel Prize winner on the panel discussion who didn’t take a shot at Trump. “I’m a natural optimist and I would not like to speculate on how bad it could get,” he said.

Much of this moaning appeared to be sour grapes.  So far, Trump has appointed only one economist to his administration, the rest are mostly billionaires.  Apparently, he does not like ‘experts’.  But as Glenn Hubbard, former Bush adviser and now head of Columbia Business School, said: “I think the president will get any economist, he asks”.  Indeed there was another ASSA panel, chaired by Harvard’s top professor Greg Mankiw who were positive about Trumponomics.  John Taylor and Alan Kreuger expected good results from Trump’s proposed infrastructure plans.

Of course, the economists who are really excluded are those on the radical wing of the ‘profession’ who are not engaged in apologia.  They were not looking to join Trump and they were not going to be invited. In the URPE sessions, Esther Jeffers of the University of Paris reckoned that capitalism is on the verge of a new crisis, due to “the misuse of monetary policy, and the fragility of emerging economies”.  Ilene Grabel of the University of Denver also focused the locus of crises in the so-called emerging economies, because they are being challenged by the pursuit of negative interest rates by some of the world’s central banks and the move away from monetary expansion by the US Fed.

As readers of my blog will know, while rising debt costs threaten many corporations in emerging economies, I still think the locus of the next recession will be found in the advanced capitalist economies, particularly the US.  Minqi Li at the University of Utah presented a new paper that looked at the fall in the profit rate in the US, Japan and China during the 1970s.  He reckoned the revival of profitability up to the Great Recession was now over and the locus of capitalism’s demise could be found in any further decline.

However, mainstream economics does not look at profitability of capital as an indicator of the health of capitalism.  That is why it failed to see the Great Recession coming and will not see the next one.  Since the end of the Great Recession, financial asset prices have rocketed while prices and profitability in the ‘real’ economy have not.

 

asset-prices

But, as we go into 2017, optimism reigns about the capitalist economy, if not with President Trump. It’s going to take a year or so to see if the current optimism expressed in financial markets and among some mainstream economists at ASSA about an economic recovery under Trump is based on good analysis or just on apologia.

ASSA 2017 – part one: productivity and inequality

January 9, 2017

One of the main themes of this year’s annual conference of the American Economics Association, ASSA 2017, was whether capitalism was slowing down.  Was the productivity of labour (output per ASSAworker or per hours worked) no longer growing at previous trend rates and indeed capitalism was entering some level of permanent stagnation?

If capitalism could no longer develop the productive forces effectively, then its historical raison d’etre disappears. Of course, the ASSA assembly of 13,000 economics professors and graduate students, mainly from American universities, to hear hundreds of economics papers did not see the ‘productivity puzzle’, as it has been called, like that.

In the largest hall, the leading mainstream economists of our time debated the issue of slowing productivity growth, confirmed by all the measures, and what this meant.  Olivier Blanchard, former chief economist at the IMF, doubted that productivity was being measured properly at all.  Barry Eichengreen from Berkeley University was more confident of measurement, but argued that there was nothing particularly strange about the current slowdown, as such “decelerations” are “ubiquitous” in many countries at different times.  Productivity slowdowns are usually the result of too little investment in the skills of the workforce and wasteful investment in means of production; or caused by special ‘shocks’ like a sharp oil price rise.  Eventually, the slowdowns end.

Kenneth Rogoff of Harvard University (infamous for the past juggling of his debt data) was even more optimistic.  The productivity growth slowdown now being experienced was temporary. Karl Marx claimed that capitalism would grind to a halt “as the first industrial revolution was fading” but it didn’t.  Keynesian Alvin Hansen (father of the ‘secular stagnation’ thesis) reckoned something similar “at the Great Depression” and he was wrong too.  Rogoff reckoned the current slowdown was caused by a huge ‘debt crisis’ that remains after 2007, but that will subside and the productivity slowdown will “eventually come to an end”.  Marty Feldstein, former economics adviser to the Bush presidency, was very buoyant.  The US economy may have slower productivity growth than before but it was doing better than anywhere else because of its wonderful “entrepreneurial culture and financial system” (!) and a labour market not encumbered with “barriers created by large labor unions, state-owned enterprises and very high tax rates.”

Amid this paean of praise for capitalism in its ‘temporary’ moment of slowdown, the data provided by Dale Jorgensen from Harvard offered a more realistic picture.  Jorgensen reckoned that there were clear signs that, while recovery from the current crisis was likely, a longer-term trend toward slower economic growth will be re-established.”  Jorgensen broke down the composition of economic growth globally and found that the real driver of growth was not ‘innovation’ or even investment in new technology (as measured in neoclassical terms as total factor productivity – TFP), but mainly more and more investment in existing technology and materials.

jorgensen

This conclusion had also been reached by John Ross in his study of Jorgensen’s work before“What is crucial is that the role of different forms of capital, i.e. intermediate products/circulating capital and fixed investment/fixed capital, is the overwhelming force driving US economic growth. Taking the two together 76% of US sectoral output growth is due to fixed and circulating capital, 15% due to labour, and only 9% due TFP.” (Ross).

ross

It means that capitalism mainly grows by relatively more investment in means of production, namely fixed capital with existing technology and material inputs (what Marx called constant capital) relative to investment in labour hours (or variable capital).  The impact of ‘innovation’ and new technology is small.  And Jorgensen reckons that the contribution of the latter will get smaller in the next decade.

In a way, this is another confirmation of Marx’s law of capital accumulation, a long-term tendency for the organic composition of capital to rise.  Marx’s law of the tendency of the rate of profit to fall is the other side of the coin.  To some extent, this tendency will be counteracted by an increase in the exploitation of labour through more people entering the workforce globally and by increased hours of work – but not decisively over the long term.

The other big issue relevant both to future productivity and inequality is the advent of robots and AI.  The ASSA conference collected the main mainstream researchers on this subject.  Daron Acemoglu from MIT argued that automation would actually create as many jobs as it would lose for human beings and the economy would be “self-correcting” in terms of employment and inequality.  William Nordhaus of Yale University presented six reasons why robots and AI would not lead to ‘singularity’ (exponential replacement of humans in production) in this century.  And so all is well with the advent of robotic automation in 21st century capitalism.  Fear of extreme inequality and mass unemployment can be dismissed.

At the same time as the big hitters in mainstream economics debated global productivity and stagnation, in a much smaller room, radical economists, under the auspices of the Union of Radical Political Economics (URPE), were having a similar discussion.  Interestingly, nobody on the panel there though that capitalism was in some ‘secular stagnation’, as formulated by Keynesians like Larry Summers, Paul Krugman or Robert J Gordon, at previous ASSAs. 

Bill Lazonick reckoned that productivity growth had slumped because capital had switched from productive investment into rentier activities of financial speculation.  Companies don’t use the stock market to raise money, they support the stock market”.  Anwar Shaikh reckoned that the Keynesian idea of secular stagnation was silly and that the core of the capitalist problem lay with profitability, not productivity as such.  The key to investment was the profitability of enterprise (the profit rate after deducting interest, rent etc going to the capital of finance and circulation) and that was low.  Until that rose, productivity and economic growth would remain low.

In another room, the ‘centrist’ wing of ASSA met.  These are the more radical Keynesians who reckon that capitalism is failing because of wrong policies and regulations (or lack of them).  If the politicians and rich elite adopted the right ones, then all would be well – or at least fairer and more productive.  You see the problem is that the ‘rules of the game’ have been altered, as Nobel Prize winner and adviser to the leftist British Labour leadership, Joseph Stiglitz, puts it.  The rules have been altered in favour of the rich, corrupt and in favour of finance over productive; in favour of monopoly over competition; in favour of rent over productive profit (see his book).

The panel here were convinced that if the rules in the labour market were changed to help unions organise, then inequality and poverty could be reduced.  Lawrence Mishel reckoned that the “main driver of inequality was the lack of worker power and the globalisation which has led to trade agreements that hurt the incomes of the majority –something mainstream economists lie about”.  Mishel listed the “staggering” number of “poor economic decisions” made in recent decades like austerity, deregulating financial markets, supply-side tax cuts, inadequate efforts to address climate change, the fight against the Affordable Care Act in many states and in Congress, etc.

Dean Baker at the Center for Economic and Policy Research, who also has a book out aptly called “Rigged”, highlighted the need to reverse rising inequality from excessive CEO pay, a bloated financial sector, patent and copyright protections and protections for highly paid professionals.  He calculated that the “efficiency gains” from “reducing or eliminating these rents” would be worth over $3trn, to be used in other productive ways.

What was needed was to “restructure the market” to produce different outcomes because simple tax changes would not do the trick.  Baker said this policy ‘rigging’ of the economy shows that the ‘free market’ does not operate.  Here he seems to be implying that, if it did, then all would be well and fair.  Because the market is ‘rigged’, not because a market economy exists, we need government to intervene to correct inequalities, injustices and apply policies for the majority not for the few.

Baker fails to explain how the market got ‘rigged’.  Did this just happen? Why was the policy choice for the rich not the majority?  Was it not ever thus?  Baker is looking at the symptoms not the causes. Marxists like me would say the policies that led to rising inequality and the growth of finance capital came about because the Golden Age of capitalism, with its decent pensions, public services and benefits and full employment, could no longer be afforded by market capitalism as the profitability of capital plunged through the 1970s.  So the ‘rigging of the rules’ was necessary for the saving of the capitalist market system.

In a later ASSA session, the mainstream, the radical and the liberal met to discuss “the future of growth” (in effect, the future of capitalism). The IMF’s Jonathan Ostrey (naturally) remained optimistic about the future.  In contrast, Robert Gordon was there to tell us the story of his recent book: that capitalism was in for slow growth because the new technologies would have only limited impact.  Anwar Shaikh presented the (Marxist?) argument that capitalism was subject to regular crises and was past it use-by date.  And James Galbraith and Gerald Friedman presented the liberal Keynesian view as above.

There is no doubt that inequality of incomes and wealth has reached levels in some countries like the US or the UK not seen since the start of modern capitalism.  In another session, Daniel Zucman, presented a paper from himself, Emmanuel Saez, Thomas Piketty (the former rock star economist) and the recently deceased Tony Atkinson, that offered the latest data on inequality of incomes in the major economies.  It showed inequality of incomes was highest and still rising in the US; has risen sharply in China (although now tapering off) and was still relatively low (but still higher) in France.

zucman

But is high or rising inequality the fault-line of modern capitalism; is it the cause of low productivity growth and recurring crises of capitalist production?  The left Keynesians think so.  But I have argued that inequality is inherent in a class society including capitalism and that is a symptom rather than a cause of capitalist crises or stagnation.  One paper at ASSA gave some support to that.  The paper found that the empirical evidence does not support the argument that inequality is a major drag on demand growth, except when offset by borrowing by lower income households. There does not appear to be a clear link between the rise in income inequality in recent decades, the financial crisis, or the slow recovery since then.”

In part 2 on ASSA 2017, I’ll discuss the state of modern mainstream economics as ASSA participants see it and the likely efficacy of economic policy in the new era of Trumponomics.

Forecast for 2017

December 28, 2016

It has now been eight years of what I have called a Long Depression, since the Great Recession started in January 2008 (see Recessions,depressions and recoveries 071215).  So, in looking ahead to 2017, I thought it might be necessary to check what my forecasts or predictions were in previous years.

I have been accused of calling a new slump every year on the basis that eventually I’ll be right. That’s a bit like claiming that the time is midnight when it is not, but knowing that it eventually will be.  So were my previous annual forecasts just parroting the view that a slump is just around the corner?  Well, at the end of 2011, I said that “2012 is likely to be another year of very weak economic growth in the major capitalist economies.  But it is not likely to see a return of a big slump in capitalism.”  At the end of 2012, I said “In 2013, economic growth in the major economies is likely to be much the same as in 2012 – pretty weak and below long-term averages. But 2013 is not likely to see a return of a big slump in capitalism.”  At the beginning of 2014, I said that “the change in profitability of capital in the US does not suggest a new recession in 2014. ”At the beginning of 2015, I reckoned that “The global economy remains in a crawl and will do so in 2015 for one good reason: the failure of business investment to leap forward. “And at the beginning of this year (2016), I said As for 2016, I expect much the same as 2015, but with a much higher risk of new global recession appearing….Even if a new global slump is avoided this year, that could be the last year that it is.”

That brings me to 2017.  When I made my 2016 forecast, the world economy seemed to be slowing down fast.  The US economy was nearly at a standstill, Europe’s ‘recovery’ remained weak and Japan appeared to have entered a new recession.  The US economy grew far less than expected in the second quarter of 2016.  Real GDP (that’s the value of national production after inflation is removed) increased at only a 1.2% yoy rate. And US business investment fell at a 9.7% annual rate, the third straight quarterly fall. Japan failed to grow at all in Q2 2016, a sharp slowdown from 2% growth in Q1.  And business investment there also collapsed.  Eurozone growth was still stuttering.  Above all, the talk was for a collapse in China’s economy because of excessive debt, bringing about an end to its miracle growth story.  As Gavyn Davies, former chief economist at Goldman Sachs and now a columnist for the FT, recently described the economic mood at the beginning of 2016: “At the turn of the year, there were forecasts of global recession in 2016. ….It was a bleak period.”

But as the year went on, the imminent collapse of the Chinese economy proved to be wrong – something I did predict.  Indeed, by the second half of the year, there were signs of a modest pick-up in growth as the Chinese authorities pumped more credit into the state banks and corporations and directed a modest expansion in fiscal spending.

Now I have argued ad nauseam that it is the profitability of the capitalist sector of economies that is the driver of investment and thus employment and incomes.  A sustained fall in profitability and in the mass of profits will eventually lead to a fall in investment after a year or so and then deliver a slump in the productive sectors of a capitalist economy, triggering in turn, a financial (credit) crisis.  That appeared to be increasingly likely in the first half of 2016 as corporate profits and investment fell.

But in Q3, corporate profits in the major economies staged somewhat of a recovery back into positive territory and the major capitalist economies appeared to avoid a further slide down in growth towards zero. Corporate investment remains weak but if profits were to continue rise, then investment too could pick up.  JP Morgan seems to think so.  In the past, the investment bank’s economists, like me, have highlighted the strong role profits played in driving the capital expenditure (capex) cycle. So “the recent stabilisation in global profit growth bodes well for capex, in this regard.” (JPM).

global-corporate-profits

Financial markets in the last month or so have been buoyed by the possibility of a sustained economic recovery and also by the prospect of huge corporate tax cuts and infrastructure spending to be initiated by the new American oligarch president, Donald Trump, in 2017.  And America’s households also seem more optimistic about 2017.  The University of Michigan’s consumer sentiment index reached 98.2 in December 2016, the highest reading since January 2004.

consumer-confidence

This renewed optimism encouraged the US Federal Reserve in December to bite the bullet and risk raising its policy interest rate with aim of controlling credit and inflation, supposedly likely to rise next year.  So everywhere, mainstream economists are now forecasting an acceleration in economic growth.

Gavyn Davies summed this up: “there has been a marked rebound in global activity, and in recent weeks this has become surprisingly strong, at least by the modest standards seen hitherto in the post-shock economic recovery….. the first time that all of the major economies have been growing at above trend rates for several years”  So, says Davies, Overall, we can perhaps be hopeful, though certainly not yet confident, that the global economy will begin to overcome the powerful forces of secular stagnation next year.”

But is this optimism for 2017 justified?  After all, every year since the end of the Great Recession in 2009, the main international economic agencies, the IMF, the OECD etc, have forecast a rise in GDP growth, trade and investment.  And every year they have had to eat their words and revise their forecasts down.  Investment in the major economies is now some 20% below where the IMF forecast it would be back in 2007.

investment-slowdown

But perhaps the agencies and economists are right this time and perhaps my forecast of a new slump (predicted by 2018 or so) is going to be proven wrong. Well, perhaps.  But consider this.  First, the so-called pick up in US economic growth is minimal.  If the current forecasts of the final quarter of 2016 are realised, then the overall growth rate for 2016 in the US will be just 1.5%, the slowest annual growth rate since 2012.  And growth in real GDP per person in 2016 will be the slowest since the Great Recession ended in 2009.

Second, much of this very modest growth has come from an expansion of household consumption and corporate borrowing (fuelled by very low interest rates and massive injections of credit).  US mortgage rates are at an all-time low and the housing market is booming again.  In Q3, personal consumption contributed two-thirds of the 3.5% (annualised) growth rate achieved by the US economy with trade and a build-up of stocks delivering the rest. Business investment contributed nothing.

us-business-investment-growth

Global debt sales (half by corporations) reached a record in 2016, matching levels not seen since before the global financial crash.  The money raised has gone into financial speculation, buying back company shares and in higher dividends to shareholders, thus boosting the stock and bond markets rather than productive investment.

But household consumption, although the largest part of national spending, does not drive growth.  And if the cost of borrowing on credit cards and mortgages is now set to rise as the Fed continues to hikes its floor rate during 2017, as planned, then consumption growth could begin to fall back.  The recovery in corporate profits is based on keeping productive investment and wages low (thus weakening productivity growth) and not on an expansion of investment, sales and revenues.  Moreover global growth is mainly coming from emerging economies like China (half of total growth).  Only one-quarter is coming from the major capitalist economies, with the US, Europe and Japan making negligible contributions.

Globally, corporate debt levels continue to rise faster than productive investment.  As the world’s leading bond investment company, PIMCO commented: “The low cost of financing with record-low interest rates simply made building up leverage tempting…This happens every economic cycle, but what makes this one special is the added incentive to issue debt at very low interest rates. (But) it sows the seeds of the next downturn or the next credit event.”

global-debt-and-investment

And there is now the prospect of more reductions in global trade as various international trade agreements bite the dust or flounder – while ‘the Donald’ talks of higher trade tariffs and walls.

world-trade-growth

One of the most graphic illustrations that the days of globalisation are over, making it more difficult for capitalism to get higher profits from the export of capital as profits fall at home, is the sharp fall in global capital flows – from over 25% of world GDP in 2007 to near zero now.  Banks have stopped lending to other banks and taken their money back, while investors are increasingly reluctant to buy the corporate bonds of other countries.

global-capital-flows

Rising interest rates, along with still high corporate debt, sluggish world trade and poor business investment, do not look like a recipe for economic recovery in 2017.  So 2017 will not deliver faster growth, contrary to the expectations of the optimists.  Indeed, by the second half of next year, we can probably expect a sharp downturn in the major economies.  Depending on whether this generates a new credit squeeze on weaker corporations and more pressure on banks. similar to that now being experienced in Italy, is difficult to judge.  But far from a new boom for capitalism, the risk of a new slump will increase in 2017.

 

Top ten posts of 2016

December 23, 2016

As has become customary at the end of the calendar year, here are the top ten most popular posts from my blog for this year.  Topping the list was my review post of Anwar Shaikh’s magnum opus, Capitalism: competition, conflict and crises.  The fact that this was the most popular post is a credit to Shaikh’s magisterial book and also to the serious attitude that my blog readers take to Marxist economics.

As I said in the post, Shaikh’s book is a product of 15 years work.  A theory of ‘real competition’ is developed and applied to explain empirical relative prices, profit margins and profit rates, interest rates, bond and stock prices, exchange rates and trade balances.  Demand and supply are both shown to depend on profitability and interact in a way that is neither Say’s Law nor Keynesian, but based on Marx’s theory of value.  A classical theory of inflation is developed and applied to various countries.  A theory of crises is developed and integrated into macrodynamics.

In the post, I concentrated on Shaikh’s view on the causes of crises under capitalism and highlighted that he had a position is similar to my own on the causes of capitalist crises, the nature and existence of depressions, and the role of Kondratiev and profit cycles.  In a later post, however, I raised criticisms of his position on Marx’s theory of value,, particularly his attempt to reconcile Ricardo with Marx on value.  In my view, there is no reconciliation possible between Marx’s value theory and that of Ricardo and Sraffa.  There is also no unification possible between Marx’s law of profitability as the underlying cause of recurrent crises and slumps and the post Keynesian/Kalecki view of a ‘profit-wage share’ economy.  And there is no meeting between Marx’s view of profitability and credit in modern capitalism and those who hold that finance creates value and that ‘financial speculation’ lies at the centre of capitalist crises.  Shaikh stands for Marx on most of these issues but seems want to build a bridge to other side too.

The second most popular post was also a book review – of John Smith’s Imperialism in the 21st century, in many ways ground-breaking in its analysis of modern imperialism.  Smith shows that capital in the North restored much of the fall in its profitability in the 1970s on the back of the exploitation of the South in the 1980s onwards: “surplus-value extracted from these new legions of poorly paid workers helped to dig the capitalism system out of its hole in the 1970s”.

Smith firmly dismisses the idea that is prominent among mainstream and heterodox economics alike that the global financial crisis and the Great Recession were financial in origin. Smith reckons that gross domestic product (GDP) as a measure of value hides the fact that much of the US GDP is not value created by American workers but is captured through multinational exploitation and transfer pricing from profits created from the exploitation of the workers of the South.

Smith argues that the exploitation of the workers of the South is less through an expansion of absolute and relative surplus value and more through driving wages below the value of labour power (super-exploitation).There was a vigorous debate on my blog over whether Smith was right about this as the dominant characteristic of modern imperialism. That debate continues.

Smith’s view of imperialist exploitation is complemented by Tony Norfield’s book showing how the imperialist financial centres capture the value expropriated from the periphery.  My post on Norfield’s also made the top ten. A key part of Norfield’s book is to weave in facts like that about modern imperialism with a Marxist analysis of the role of finance capital.  And Norfield is incisive in illuminating the nature of the modern British economy.  I have described Britain in the past as the world’s largest ‘rentier’ economy.  That’s an old-fashioned French word for an economy based on sucking up ‘rents’ through the monopoly ownership of capital (or land) from the profits of the productive sectors.  Both the sectors exploit labour but the rentier economy relies on its financial and legal monopoly to take a share of the surplus value of productive capitalist sectors appropriated from labour. This gives British capital its important role in modern imperialism, but also its Achilles heel in any global financial crash or in the shock of Brexit.

The third most popular post in 2016 was on whether Marxist economic theory better explains what had happened in the last ten years than Keynesian economics, which remains the dominant thinking among leftist organisations. Leading Keynesian Brad Delong told us Marxist economists at the annual American Economics Association Conference in San Francisco last January that we are like pessimists just ‘waiting for Godot’, when capitalism can be made to work with the ‘concrete economics’ of Keynesian social democracy (the title of DeLong’s new book this year). Well, the last ten years cast doubt on that view and the next few years will see who is right.

In the post I argued that the cause of the Great Recession and the subsequent Long Depression is not the product of a ‘lack of demand’ as such or ‘pro-cyclical’ government spending policies (austerity) but is caused by a collapse of the capitalist sector, in particular, capitalist investment.  And that investment collapsed because profitability in the capitalist sector fell, then the mass of profits fell, leading to investment, employment and incomes to fall, in that order.  Then it’s the change in profits that leads to changes in investment and demand (consumption), not vice versa, as the Keynesians argue.

At the beginning of 2016, the world economy was looking pretty weak and there was much talk that a growing debt crisis in China was likely to lead to a major crash there, which would then spread globally.  But in a post that proved popular, I questioned the doom-mongering about China and also the size of the impact that China would have on the major capitalist economies. I argued that the US remains the pivotal economy for a global capitalist crisis, particularly as it dominates in financial and technology sectors.  In 1998, the emerging economies had a major economic and financial crisis but it did not lead to a global slump.  In 2008, the US had a biggest slump in its economic post-war history and it led to the Great Recession.  In my view, this weighting still applies.  That proved right, at least for 2016.

One of the big politico-economic events of 2016 was the referendum vote in Britain to leave the European Union.  My post on the day after Brexit got a lot of hits. I got it wrong, having expected a vote to remain in the EU. I had got two previous predictions right: that Scotland would vote to stay in the UK and that the Conservatives would win the 2015 UK general election, but I did not get a hat trick in 2016,  as former Conservative PM David Cameron’s wild political gamble did not come off.  In the post, I analysed the reasons why there was a vote for Brexit and looked at the possible economic impact. That impact has still to be felt both for the UK and for world trade.

The other major political event of 2016, of course, was the surprise victory of Donald Trump for the US presidency, despite polling more than 2m votes less than his Democratic opponent Hillary Clinton.  In a post directly after the result, I again analysed the reasons for Trump’s victory.  I said that, like the vote of the Brits for Brexit, against all expectations, a sufficient number of voters in America (mainly white, older and in small businesses or working in failing industries in smaller central US states) overcame the vote of the youth, the more educated and better-off in the big cities along the coasts.

But it was not so much a working class vote for Trump because hardly more than 50% or so of eligible voters turned out to vote.  A huge swathe of people never vote in American elections and they constitute a sizeable part of the working class.  The most significant issue (52%) for voters, when asked at the booths, was the state of the US economy, with terrorism next (but well down at 18%) and immigration (the Trump card) even lower.  So Trump won because he claimed he could improve the conditions of those ‘who have been left behind’ by globalisation, failing domestic industries and crushed small businesses.

Stock markets are now riding high on expectations that Trump can boost the US economy.  But in the post, I argued that Trump had been handed a poisoned chalice and the US economy would not recover.  Trump would not be able to deliver and his big business cabinet would do in the opposite of what those ‘left behind’ want.  We shall see in 2017.

One of the features of Brexit and Trump events is that it heralds the end of the great neo-liberal era of globalisation and ‘free trade’.  My post on the end of globalisation made the top ten.  It critiqued the views of Keynes in the 1930s and his modern epigone Brad Delong (again!) in claiming that capitalism has been the most successful mode of production in human history and it would be again. Instead, I argued that capitalism is really past its use-by date.  One indicator is that ‘globalisation’ (the spread of capitalism’s tentacles across the world) has ground to a halt.  And growth in the productivity of labour, the measure of future ‘progress’, has also more or less ceased in the major economies.

More short term, a key question for me and it seems my readers, was whether the world economy is heading for another slump.  In a post written early in the year, Can we avoid the coming recession?, I presented the facts as I saw them and offered a cautious forecast that a new economic recession was “due and will take place in the next one to three years at most.” I said that maybe there won’t be one in 2016 (as it has proved)… “But the factors for a new recession are increasingly in place: falling profitability and profits in the major economies and a rising debt burden for corporations in both mature and emerging economies.”

And finally there is my post on how unequal the world is, according to annual study by Credit Suisse, which makes the top ten every year.  This year was no exception, with the finding that the top 1% of the adult wealth holders in the world own 51% of all global personal wealth, while the bottom half of adults own only 1%.  Indeed, the top 10% of adults own 89% of all the world’s personal wealth!  This is a record.

In the past 12 months, global wealth has risen by 1.4% and so it has barely kept pace with population growth. As a result, in 2016, the mean average wealth per adult was unchanged for the first time since 2008, at approximately $52,800.  This mean average tells you that the vast majority of the world’s adults have way less wealth than that.  On average, wealth did not rise, while inequality between rich and poor rose again.

That’s the message of 2016 from my posts: continued depression for the majority and more for the tiny elite.