Archive for the ‘Profitability’ Category

Picking up?

August 17, 2017

The latest economic data are showing that economic growth in the major capitalist countries has been picking up in the first half of 2017.

Japan’s economy expanded at the fastest pace for more than two years in the three months to June, with domestic spending accelerating as the country prepares for the 2020 Tokyo Olympics.

In the Eurozone, real GDP growth rose at annualised rate of 2.5%, with the Visegrad countries of Czech, Poland, Hungary and Slovakia rising at 5.8% in the second quarter of this year.

With the US economy continuing to trundle along at just over a 2% a year growth, the major economies are looking a little brighter in growth terms, it seems – at least compared to the falling growth rates of 2015-6.

What has been the key reason for this slight improvement?  In my view, it is the relative recovery in the Chinese economy, considered by most observers and the evidence as the driver of world economic growth (at the margin) since 2007. As the IMF put it in its latest survey of the Chinese economy, “With many of the advanced economies of the west struggling in the years since the financial crisis of 2007-09, China has acted as the growth engine of the global economy, accounting for more than half the increase in world GDP in recent years.”

Manufacturing output in China increased 6.7% yoy in July, continuing a slight recovery in 2017 after reaching a low in 2016 from a peak of over 11% a year in 2013.  As a result, Eurozone manufacturing output has picked up, particularly in Germany, the Netherlands and Italy as they export more to China.  The US manufacturing sector has also reversed its actual decline in 2016.  Japan’s manufacturing sector leaped up 6.7% compared to 2016, led by construction demand for the Olympics.

This all looks much better.  But remember most of these major economies are still growing at only around 2% a year, still well below pre-2007 rates or even the average in the post-1945 period.  The ‘developed’ capitalist economies are growing at their slowest rate in decades.  Ruchir Sharma, chief global strategist and head of emerging markets at Morgan Stanley Investment Management, noted in a recent essay in the magazine Foreign Affairs that “no region of the world is currently growing as fast as it was before 2008, and none should expect to. In 2007, at the peak of the pre-crisis boom, the economies of 65 countries – including a number of large ones, such as Argentina, China, India, Nigeria, Russia and Vietnam – grew at annual rates of 7% or more. Today, just six economies are growing at that rate, and most of those are in small countries such as Côte d’Ivoire and Laos.”

Nevertheless, all the purchasing managers indexes (PMIs) that provide the best ‘high frequency’ guide to the attitude and confidence of the capitalist sector in each country all show expansion is still taking place – if not at the pace of 2013-14.  Again the key seems to be a recovery in China’s PMI.

 

What does all this tell us about the likelihood of a new global economic recession in the next year or two?  That is something that I have been forecasting or expecting.  The latest data would seem to point away from that.

The mainstream forecasters remain optimistic about growth with the only proviso being that it is China that might collapse.  The IMF survey makes the familiar argument of the mainstream that overall debt is so high that it will eventualy collapse in bankruptcies and defaults, causing a slump and weakening the world economy.  Total debt has quadrupled since the financial crisis to stand at $28tn (£22tn) at the end of last year.

I disagree: for two reasons.  First, when China’s growth slowed sharply at the beginning of 2016, the mainstream observers argued that China could bring the world economy down.  My view was that, important as the Chinese economy was, it was not large enough to take the US and Europe down.  Those advanced economies remained the key to whether there would be a world slump.  And so it has proved.

Second, the size of China’s debt is large but the Chinese economy is different from the advanced capitalist economies.  Most of that debt is owed by the Chinese state banks and state enterprises.  The Chinese government can bail these entities out using its reserves and forced savings of Chinese households.  The state has the economic power to ensure that, unlike governments in the US and Europe during the credit crunch of 2007.  Governments then were beholden to the capitalist banks and companies, not vice versa.  So any credit crisis in China will be dealt with without producing a major collapse in the economy, in my view.

So does this mean that a new world slump is off the agenda?  No, in short.  One of my key indicators of the health of capitalist economies, as the readers of this blog well know, is the movement of profits in the capitalist sector.  Global corporate profits (a weighted average of the major economies) have also made a significant recovery from their collapse at the end of 2015. Indeed corporate profits overall seem to rising at the fastest rate since the immediate bounce-back after the end of the Great Recession.

But this overall figure is driven by the Chinese recovery and the pickup in Japan (due to the Olympics construction?).  Corporate profit growth in the US, Germany and the UK is slowing again after a brief pick-up in late 2016.

For me, the key remains the state of US economy and in particular, profits and investment levels there.  The booming US stock market is now way out of line with corporate earnings levels.  The S&P 500 cyclically adjusted price-to-earnings (CAPE) valuation has only been higher on one occasion, in the late 1990s. It is currently on par with levels preceding the Great Depression.

US corporate profits have recovered in the last few quarters after declining (although now slowing again) and, along with that, business investment has picked up.  Watch this space over the rest of 2017 to see if this is sustained.

Total domestic corporate profits have grown at an annualized rate of just 0.97% over the last five years. Prior to this period five-year annualized profit growth was 7.95%. At $8.6 trillion, corporate debt levels are 30% higher today than at their prior peak in September 2008.  At 45.3%, the ratio of corporate debt to GDP is at historic highs, having recently surpassed levels preceding the last two recessions.  If there is an issue with the level of debt, it is in the US, not in China.

Ten years on

August 8, 2017

It’s ten years on to the day since the global financial crash began with the news that the French bank, BNP had suspended its sub-prime mortgage funds because of “an evaporation of liquidity”.

Within six months, credit tightened and inter-bank interest rates rocketed (see graph above).  Banks across the globe began to experience huge losses on the derivative funds that they had set up to profit from the housing boom that had taken off in the US, but had started to falter.  And the US and the world entered what was later called The Great Recession, the worst slump in world production and trade since the 1930s.

Ten years later, it is worth reminding ourselves of some of the lessons and implications of that economic earthquake.

First, the official institutions and mainstream economists never saw it coming.  In 2002, the head of the Federal Reserve Bank, Alan Greenspan, then dubbed as the great maestro for apparently engineering a substantial economic boom, announced that ‘financial innovations’ i.e. derivatives of mortgage funds etc, had ‘diversified risk’ so that “shocks to overall economic will be better absorbed and less likely to create cascading failures that could threaten financial stability”.  Ben Bernanke, who eventually presided at the Fed over the global financial crash, remarked in 2004 that “the past two decades had seen a marked reduction in economic volatility” that he dubbed as the Great Moderation. And as late as October 2007, the IMF concluded that “in advanced economies, economic recessions had virtually disappeared in the post-war period”.

Once the depth of the crisis was revealed in 2008, Greenspan told the US Congress, “I am in a state of shocked disbelief”.  He was questioned “in other words, you found that your view of the world , your ideology, was not right, it was not working” (House Oversight Committee Chair, Henry Waxman). “Absolutely, precisely, you know that’s precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well”.

The great mainstream economists were no better.  When asked what caused the Great Recession if it was not a credit bubble that burst, Nobel Prize winner and top Chicago neoclassical economist Eugene Fama responded: “We don’t know what causes recessions. I’m not a macroeconomist, so I don’t feel bad about that. We’ve never known. Debates go on to this day about what caused the Great Depression. Economics is not very good at explaining swings in economic activity… If I could have predicted the crisis, I would have. I don’t see it.  I’d love to know more what causes business cycles.”

Soon to be IMF chief economist, Olivier Blanchard, commented in hindsight that “The financial crisis raises a potentially existential crisis for macroeconomics.” … some fundamental [neoclassical] assumptions are being challenged, for example the clean separation between cycles and trends” or “econometric tools, based on a vision of the world as being stationary around a trend, are being challenged.”

But then most of the so-called heterodox economists, including Marxists, did not see the crash and the ensuing Great Recession coming either.  There were a few exceptions:  Steve Keen, the Australian economist forecast a credit crash based on his theory that “the essential element giving rise to Depression is the accumulation of private debt” and that had never been higher in 2007 in the major economies.  In 2003, Anwar Shaikh reckoned the downturn in the profitability of capital and the downwave in investment was leading to a new depression. And yours truly in 2005  said: “There has not been such a coincidence of cycles since 1991. And this time (unlike 1991), it will be accompanied by the downwave in profitability within the downwave in Kondratiev prices cycle. It is all at the bottom of the hill in 2009-2010! That suggests we can expect a very severe economic slump of a degree not seen since 1980-2 or more”  (The Great Recession).

As for the causes of the global financial crash and the ensuing Great Recession, they have been analysed ad nauseam since.  Mainstream economics did not see the crash coming and were totally perplexed to explain it afterwards. The crash was clearly financial in form: with collapse of banks and other financial institutions and the weapons of mass financial destruction, to use the now famous phrase of Warren Buffett, the world’s most successful stock market investor.  But many fell back on the theory of chance, an event that was one in a billion; ‘a black swan’ as Nassim Taleb claimed.

Alternatively, capitalism was inherently unstable and occasional slumps were unavoidable.  Greenspan took this view: “I know of no form of economic organisation based on the division of labour (he refers to the Smithian view of a capitalist economy), from unfettered laisser-faire to oppressive central planning that has succeeded in achieving both maximum sustainable economic growth and permanent stability.  Central planning certainly failed and I strongly doubt that stability is achievable in capitalist economies, given the always turbulent competitive markets continuously being drawn toward but never quite achieving equilibrium”.  He went on, “unless there is a societal choice to abandon dynamic markets and leverage for some form of central planning, I fear that preventing bubbles will in the end turn out to be infeasible.  Assuaging the aftermath is all we can hope for.”

Most official economic leaders like Blanchard and Bernanke saw only the surface phenomena of the financial crash and concluded that the Great Recession was the result of financial recklessness by unregulated banks or a ‘financial panic’.  This coincided with some heterodox views based on the theories of Hyman Minsky, radical Keynesian economist of the 1980s, that the finance sector was inherently unstable because “the financial system necessary for capitalist vitality and vigour, which translates entrepreneurial animal spirits into effective demand investment, contains the potential for runaway expansion, powered by an investment boom.  Steve Keen, a follower of Minsky put it thus: “capitalism is inherently flawed, being prone to booms, crises and depressions.  This instability, in my view, is due to characteristics that the financial system must possess if it is to be consistent with full-blown capitalism.”   Most Marxists accepted something similar to the Minskyite view, seeing the Great Recession as a result of ‘financialisation’ creating a new form of fragility in capitalism.

Of the mainstream Keynesians, Paul Krugman railed against the neoclassical school’s failings but offered no explanation himself except that it was a ‘technical malfunction’ that needed and could be corrected by restoring ‘effective demand’.  

Very few Marxist economists looked to the original view of Marx on the causes of commercial and financial crashes and ensuing slumps in production.  One such was G Carchedi, who summed that view up in his excellent, but often ignored Behind the Crisis with: ““The basic point is that financial crises are caused by the shrinking productive base of the economy. A point is thus reached at which there has to be a sudden and massive deflation in the financial and speculative sectors. Even though it looks as though the crisis has been generated in these sectors, the ultimate cause resides in the productive sphere and the attendant falling rate of profit in this sphere.”  Agreeing with that explanation, the best book on the crash remains that by Paul Mattick Jnr, Business as usual. 

And indeed, profitability in the productive sectors of the capitalist major economies was low historically in 2007, as several studies have shown.  In the US, profitability peaked in 1997 and the rise in profitability in the credit boom of 2002-6 was overwhelmingly in the financial and property sectors.  This encouraged a huge rise in fictitious capital (stocks and debt) that could not be justifies by sufficient improvement in profits from productive investment.

The mass of profit began to fall in the US in 2006, more than a year before the credit crunch struck in August 2007.  Falling profits meant over-accumulation of capital and thus a sharp cutback in investment.  A slump in production, employment and incomes followed i.e. The Great Recession.

Since the end of that recession in mid-2009, most capitalist economies have experienced a very weak recovery, much weaker than after previous post-war recessions and in some ways even weaker than in the 1930s.  A recent Roosevelt Institute report by JW Mason found that “there is no precedent for the weakness of investment in the current cycle. Nearly ten years later, real investment spending remains less than 10 percent above its 2007 peak. This is slow even relative to the anemic pace of GDP growth, and extremely low by historical standards.”

So the Great Recession became the Long Depression, as I described it, a term also adopted by many others, including Keynesian economists like Paul Krugman and Simon Wren-Lewis.  Why did the Great Recession not lead to a ‘normal’ economic recovery to previous investment and production rates?  The mainstream economists of the monetarist school argue that governments and central banks were slow in cutting interest rates and adopting ‘unconventional’ monetary tools like quantitative easing.  But when they did, such policies appeared to have failed in reviving the economy and merely fuelled a new stock market and debt boom.

The neoclassical school reckons that debt should be cut back as it weighs on the ability of companies to invest while governments ‘crowd out’ credit because of their high levels of borrowing.  This ignored the reason for high government debt, namely the huge cost of bailing out banks globally and the slump in tax revenues from the recession.  In opposition, the Keynesians say the Long Depression was all due to ‘austerity’ ie governments trying to reduce government spending and balance budgets.  But the evidence for that conclusion is not compelling.

What the neoclassical, Keynesian and heterodox views have in common is a denial for any role for profit and profitability in booms and slumps in capitalism!  As a result, none look for an explanation for low investment in low profitability.  And yet the correlation between profit and investment is high and continually confirmed and profitability in most capitalist economies is still lower than in 2007.  

After ten years and a decidedly long, if very weak, economic recovery phase in the ‘business cycle’, are we due for another slump soon?  History would suggest so.  It won’t be triggered by another property slump, in my view.  Real estate prices in most countries have still not recovered to 2007 levels and even though interest rates are low, housing transaction levels are modest.

The new trigger is likely to be in the corporate sector itself.  Corporate debt has continued to rise globally, especially in the so-called emerging economies.  Despite low interest rates, a significant section of weaker companies are barely able to service their debts.  S&P Capital IQ noted that a record stash of $1.84trn in cash held by US non-financial companies masked a $6.6trn debt burden. The concentration of cash of the top 25 holders, representing 1% of companies, now accounts for over half the overall cash pile. That is up from 38% five years ago.  The big talk about the hegemoths like Apple, Microsoft, Amazon having mega cash reserves hides the real picture for most companies. 

Profit margins overall are slipping and in the US non-financial corporate profits have been falling.

And now central banks, starting with the US Federal Reserve, have started to reverse ‘quantitative easing’ and hike policy interest rates.  The cost of borrowing and existing debt servicing will rise, just at a time when profitability is flagging.

That’s a recipe for a new slump – ten years after the last one in 2008?

Profitability and investment again – the AMECO data

July 26, 2017

Recently, Larry Elliott, the economics correspondent of the British liberal newspaper, The Guardian raised again the puzzle of the gap between rising corporate profits and stagnant corporate investment in the major capitalist economies. Elliott put it “The multinational companies that bankroll the WEF’s annual meeting in Davos are awash with cash. Profits are strong. The return on capital is the best it has been for the best part of two decades. Yet investment is weak. Companies would rather save their cash or hand it back to shareholders than put it to work.”

Why was this?  Elliott posed some possibilities: “corporate caution is that businesses think bad times are just around the corner”, but as Elliott pointed out the hoarding of corporate cash was “going on well before Brexit became an issue and it affects all western capitalist countries, not just Britain.”

So he considered other reasons that have been raised before: “cutting-edge companies need less physical capital than they did in the past and more money in the bank unless somebody comes along with a takeover bid” or that “the people running companies are dominated by short-term performance targets and the need to keep shareholders sweet”.

So company managers use the cash to buy back their shares or pay out large dividends rather than invest in new technology. “Shareholder value maximisation has certainly delivered for the top 1%. They own 40% of the US stock market and benefit from the dividend payouts, and the share buybacks that drive prices higher on Wall Street. Those running companies, also members of the 1%, have remuneration packages loaded up with stock options, so they too get richer as the company share price goes up.”

There is some element of truth in all these possible explanations for ‘the gap’ between corporate earnings and investment that opened up in the early 2000s.  But I don’t think that corporate investment is abnormally low relative to cash flow or profits.  The reason for low business investment is simpler: lower profitability relative to the existing capital invested and the perceived likely returns for the majority of corporations.

I have dealt with this issue before in previous posts and in debate with other Marxist economists who deny the role of profitability in directing the level of corporate investment and, ultimately growth in production in the major capitalist economies.

The point is that the mass of profits is not the same as profitability and in most major economies, profitability (as measured against the stock of capital invested) has not returned to the levels seen before the Great Recession or at the end of neoliberal period with the dot.com crash in 2000.

And the high leveraging of debt by corporations before the crisis started is acting as a disincentive to invest and/or borrow more to invest, even for companies with sizeable amounts of cash. Corporations have used their cash to pay down debt, buy back their shares and boost share prices, or increase dividends and continue to pay large bonuses (in the financial sector) rather than invest in productive equipment, structures or innovations.

For example, look at the UK’s corporate sector.  Sure the mass of profits in non-financial corporations has jumped from $40bn a quarter in 2000 to £85bn now.  And it may be true that “the return on capital is the best it has been for the best part of two decades”, as Elliott claims.  But it is all relative.  The rate of return on UK capital invested has dropped from a peak of 14% in 1997 to 11.5% now.  Profitability recovered after the Great Recession trough of 9.5% in 2009 but it is still below the peak prior to the crash of 12.3% in 2006.  And UK profitability has stagnated since 2014, prior to Brexit.

Thus it should be no surprise that UK businesses have stopped investing in productive capital.

It’s the same story in the US, where not only is the average profitability of US corporations falling, but so are total profits in the non-financial sector.  Profit margins (profits as a share of non-financial corporate sales) measure the profit gained for each increase in output and these have been falling for some quarters.

And more recently, total profits in non-financial corporations have been contracting.

So again, it is no surprise that business investment is also contracting among US corporations.

I have dealt before with the argument that Elliott offers again that companies are “awash with cash”.

First, it is only a small minority of very large companies like Apple, Amazon, Microsoft etc that have large cash hoards.  The majority of companies do not have such hoards and indeed have increased levels of corporate debt.  And there is a sizeable and growing minority that have profits only sufficient to service their debt interest with none left for expansion and productive investment.  According to the Bank for International Settlements, the share of these ‘zombie’ companies has climbed to over 10%: “the share of zombie firms – whose interest expenses exceed earnings before interest and taxes – has increased significantly despite unusually low levels of interest rates”.

But perhaps the most compelling support for my argument that weak business investment in the major capitalist economies is the result of low profitability is some new evidence that I have gleaned from the EU’s AMECO statistical database. http://ec.europa.eu/economy_ finance/ameco/user/serie/ SelectSerie.cfm

Based on the simple Marxist formula for the rate of profit of capital s/c+v, where s= surplus value and c= constant capital and v= variable capital, I used the following AMECO categories.  s = Net national income (UVNN) less employee compensation (UWCD); c = Net capital stock (OKND) inflated to current prices by (PVGD); v = employee compensation (UWCD).  From these data series, I calculated the rate of profit for each of the major capitalist economies.

Of course, the AMECO categories do not match proper Marxist categories for many reasons.  But they do give cross-comparisons, unlike national statistics.  And my results seem reasonably robust when compared with national data calculations.  For example, when I compared the net rate of return on capital for the US using the AMECO data and Anwar Shaikh’s more ‘Marxist’ measure for the rate of profit in US corporations for 1997-2011, I found similar peaks and troughs and turning points.

The results for profitability in the major capitalist economies, using the AMECO data, confirm that the rate of profit is lower than in 1999 in all economies, except Germany and Japan.  Japan, by the way, still has the lowest rate of profit of all the major economies.  Indeed, the level of the rate of profit is highest in the UK, Italy and an enlarged EU (which includes Sweden and Eastern Europe), while the lowest rate of profit is in the US and Japan.

All countries suffered a severe slump in profitability during the Great Recession, as you might expect.  Then profitability recovered somewhat after 2009. But, with the exception of Japan, all economies have lower rates of profit in 2016 than in 2007, and by some considerable margins.  And in the last two years, profitability has fallen in nearly all economies, including Japan.

The table below shows the percentage change in the level of the rate of profit for different periods.

So the AMECO data show that profitability is still historically low and is now falling. No wonder business investment in productive capital has remained weak since the end of the neo-liberal period (graph below for the US) and now is even falling in some economies.

Will reversing austerity end the depression?

July 13, 2017

Were the policies of so-called austerity the cause of the Great Recession?  If there had been no austerity would there have been no ensuing depression or stagnation in the major capitalist economies?  If so, does that mean the policies of ‘Austerian’ governments were just madness, entirely based on ideology and bad economics?

For Keynesians, the answer is ‘yes’ to all these questions.  And it is the Keynesians who dominate the thinking of the left and the labour movement as the alternative to pro-capitalist policies.  If the Keynesians are right, then the Great Recession and the ensuing Long Depression could have been avoided with sufficient ‘fiscal stimulus’ to the capitalist economy through more government spending and running budget deficits (i.e. not balancing the government books and not worrying about rising public debt levels).

That is certainly the conclusion of yet another article in the British centre-left paper, the Guardian.  The author Phil McDuff argues that holding down wages and cutting government spending as adopted by the US and UK governments, among others, was ‘zombie economics’ “ideas that are constantly discredited but insist on shambling back to life and lurching their way through our public discourse.”  Austerity was absurd economically and the article reels off a list of prominent Keynesians (Simon Wren-Lewis, Paul Krugman, Joseph Stigltiz, John Quiggin) who argue that ‘austerity economics’ was wrong (bad economics) and was really just ideology. In contrast, the Keynesians reckon that “the government does everyone a service by running deficits and giving frustrated savers a chance to put their money to work … deficit spending that expands the economy is, if anything, likely to lead to higher private investment than would otherwise materialise” (Paul Krugman).

But is it right that austerity economics is just absurd and ideological?  Would Keynesian-style fiscal stimulus have avoided the Long Depression experienced by most capitalist economies since 2009?

Sure, ideology is involved.  Government spending in most capitalist economies is spent not on meeting the needs of the people through healthcare, education and pensions.  Much is devoted towards the needs of big business: defence and security spending; grants and credits to businesses; corporate tax reductions (while raising direct taxes on households); road building and other subsidies.  So when ‘austerity’ becomes necessary, the cuts in government spending are aimed at public services (and jobs), welfare benefits etc – as these are ‘unnecessary’ costs for the capitalist sector.  And yes, keeping the state sector small and reducing government intervention to the minimum is the ideology of capital.  But even all this has an economic rationale.

It is an ideology that makes sense from the point of view of capital.  The Keynesian analysis denies or ignores the class nature of the capitalist economy and the law of value under which it operates by creating profits from the exploitation of labour.  If government spending goes into social transfers and welfare, that will cut profitability as it is a cost to the capitalist sector and adds no new value to the economy.  If it goes into public services like education and health (human capital), it may help to raise the productivity of labour over time, but it won’t help profitability.  If it goes into government investment in infrastructure that may boost profitability for those capitalist sectors getting the contracts, but if it is paid for by higher taxes on profits, there is no gain overall.  If it is financed by borrowing, profitability will be constrained eventually by a rising cost of capital and higher debt.

Was austerity the cause of the Great Recession?  Clearly not.  Prior to the global financial crash in 2008 and the subsequent global economic slump, wages and household consumption were rising, not falling.  And government spending growth was accelerating up to 2007 in many countries.  As I have shown on many occasions on this blog, it was business investment that slumped.

To be fair, the Keynesians have not really argued that the Great Recession was a product of austerity policies.  That’s because Keynesian economics never came up with a prediction before or explanation afterwards for the Great Recession.  As Krugman put it in his book End the Depression Now! in 2012, there was no point in trying to analyse why the slump happened, except to say that “we are suffering from a severe lack of overall demand” – thus the slump in demand was ‘caused’ a slump in demand….  For Krugman, there was nothing really wrong with the capitalist “economic engine, which is as powerful as ever.  Instead we are talking about what is basically a technical problem, a problem of organisation and coordination – a ‘colossal muddle’ as Keynes described it.  Solve this technical problem and the economy will roar back into life”.  If the problem is “muddled thinking” and a lack of demand, create more demand.

This gets to the crux of the Keynesian argument on ‘austerity’.  If economies are suffering from a lack of demand, then cutting government spending and balancing government books when capitalists are not investing and households cannot spend is madness.  Even if the Great Recession cannot be explained by Keynesian economics, it can explain the Long Depression that has followed – it’s been caused by austerity.

Now there is clearly something in the argument that when capitalist production and investment has collapsed, driving up unemployment and reducing consumer incomes, then cutting back on government spending will make things worse.  And there is a growing body of empirical evidence that austerity policies in various (but not all major economies) made things worse.  One paper, for example, shows that had countries not experienced ‘austerity shocks’, aggregate output in the EU10 would have been roughly equal to its pre-crisis level, rather than showing a 3% loss. For the depressed and weaker Eurozone economies of Ireland, Greece, Portugal etc, instead of experiencing an output reduction of nearly 18% below trend, the output losses would have been limited to 1%.

British Keynesian economist Simon Wren-Lewis has recently argued that the Great Recession, combined with austerity fiscal policies in the US and the UK, has had a permanent effect on output“A long period of deficient demand can discourage workers. It can also hold back investment: a new project may be profitable but if there is no demand it will not get financed… The basic idea is that in a recession innovation is less profitable, so firms do less of it, which leads to less growth in productivity and hence supply”  This is called hysteresis by mainstream economics.

But is it this lack of demand that has affected productivity growth, innovation and profitability in the Long Depression a result of austerity, or just the failure of the capitalist sector to restore profitability and investment?  The usual way of trying to answer that question is to look at the multiplier effect in economics; namely the likely rise or fall in economic growth achieved from a rise or fall in fiscal spending?  The trouble is that the size of this multiplier has been widely disputed.  For example, the EU Commission find that the Keynesian multiplier was well below 1 in the post-Great Recession period. The average output cost of a fiscal adjustment equal to 1% of GDP is 0.5% of GDP for the EU as a whole, in line with the size of multipliers assumed before the crisis, despite the fact that approximately three-quarters of the consolidation episodes that considered occurred after 2009.  So it is hardly decisive as an explanation for the continuation of the Long Depression after 2009.

So Wren-Lewis has tried to get away from the multiplier argument.  Wren-Lewis defines austerity as “all about the negative aggregate impact on output that a fiscal consolidation can have. As a result, the appropriate measure of austerity is a measure of that impact. So it is not the level of government spending or taxes that matter, but how they change.”  That seems a reasonable definition and yardstick to judge.

Looking at the US economy, Wren-Lewis relies on the Hutchins Center Fiscal Impact Model, which purports to show the impact of government fiscal policy on real GDP growth.  He admits that the measurement is difficult, but at least the model compares changes in net government spending to growth. It shows that there was a switch to austerity from 2011 up to 2015 and this, it is argued, explains why the US economy had such slow growth and ‘recovery’ after the end of the Great Recession.  If austerity had not been followed, the US economy would have made a full recovery by 2013.

Well, what strikes me first about this graph is that, according to the Hutchins Center, fiscal austerity in the US ended in 2015.  But there has been no pick-up in US real GDP growth since.  Indeed, US real GDP growth in 2016, at 1.6%, was the lowest annual rate since the end of the Great Recession.  But maybe, Wren-Lewis would argue, is that hysteresis is now operating to keep productivity and output growth permanently low.  But even if that is right, fiscal stimulus is likely to have little effect from here in getting these capitalist economies going.

Moreover, there is plenty of evidence that fiscal stimulus will have little effect on ending the depression.  Like Wren-Lewis, I have compared changes in government spending to GDP against the average rate of real GDP growth since 2009 for the OECD economies.  I found that there was a very weak positive correlation and none if the outlier Greece is removed.

Another case study is Japan since 1998. I compared the average budget deficit to GDP for Japan, the US and the Euro area against real GDP growth since 1998. 1998 is the date that most economists argue was the point when the Japanese authorities went for broke with Keynesian-type government spending policies designed to restore economic growth. Did it work?

Between 1998 and 2007, Japan’s average budget deficit was 6.1% of GDP, while real GDP growth averaged just 1%. In the same period, the US budget deficit was just 2% of GDP, less than one-third of that of Japan, but real GDP growth was 3% a year, or three times as fast as Japan. In the Euro area, the budget deficit was even lower at 1.9% of GDP, but real GDP growth still averaged 2.3% a year, or more than twice that of Japan. So the Keynesian multiplier did not seem to do its job in Japan over a ten-year period. Again, in the credit boom period of 2002-07, Japan’s average real GDP growth was the lowest even though its budget deficit was way higher than the US or the Eurozone.

Now specially for this post, I have compared government spending (as defined by Wren-Lewis as government consumption plus investment, thus excluding transfers) growth with real GDP growth in the major economies.  From 2010 to 2016, the average real GDP growth rate in Germany, the UK and the US was virtually the same, at about 2% a year, but government spending growth varied considerably, from 3.4% a year in (‘non-austerity’) Germany to just 1.4% a year in austerity US.  The UK applied as much austerity as France but grew faster.  Now it’s true that both Italy and Spain cut government spending over the period and also suffered non-existent growth, but I would venture to argue that this is more due to the failure of Eurozone fiscal integration.  The core Eurozone countries have refused to help out the weaker capitalist ‘regions’ of the Euro area.

Even more convincing is the work done by Jose Tapia in comparing government spending in the US economy since 1929 against business investment and profits growth.  His sophisticated regression analysis found no significant causal connection or correlation between government spending and private investment and profits.  Indeed, Tapia found that “The Keynesian view that government expenditure may pump-prime the economy by stimulating private investment is also inconsistent with the finding that the net effect of lagged government expending on private investment is rather null or even significantly negative in recent decades.”

So, at the very best, the jury is out on whether Keynesian-style stimulus would get capitalist economies out of this depression.  At worst, it could delay recovery in a capitalist economy.

There is a much more convincing driver of investment and growth in a capitalist-dominated economy, namely the profitability of capital, something completely ignored by Keynesian theory. I have shown in the past that real GDP growth is strongly correlated with changes in the profitability of capital (the Marxist multiplier, if you like). The Marxist multiplier was considerably higher than the Keynesian government spending multiplier in three out of the five decades, and particularly in the current post Great Recession period. And in the other two decades, the Keynesian multiplier was only slightly higher and failed to go above 1. Thus there was stronger evidence that the Marxist multiplier is more relevant to economic recovery under capitalism than the Keynesian multiplier.

Indeed, is the low productivity growth in this Long Depression caused by a permanent lack of demand or hysteresis or to low profitability?  The recent annual report of the Bank for International Settlements (the research agency for global central banks) found that productivity growth had slowed down because of “a persistent misallocation of capital and labour, as reflected by the growing share of unprofitable firms. Indeed, the share of zombie firms – whose interest expenses exceed earnings before interest and taxes – has increased significantly despite unusually low levels of interest rates”.

The BIS economists come from the Austrian school that blames ‘excessive credit’ and ‘loose central bank monetary policy’ for credit-crunch slumps.  But they do recognise, from the point of view of capital, that profitability is a factor behind investment, innovation and growth, rather than a ‘lack of demand’.

The policies of austerity do have an ideological motive: to weaken the state and reduce its ‘interference’ with capital.  But the economic foundation of austerity was not mad or bad economics, from the point of view of capital.  It aimed to reduce costs of pubic services, interest rates and corporate taxes in order to raise profitability.  The Keynesian view ignores the movement of profitability as a cause of crises.  And by relying on ‘demand’ as the measure of the health of a capitalist economy, Keynesian policies of fiscal stimulus fall short of solving the “technical problem” of getting the economy to “roar back into life”.

A zombie world

July 8, 2017

The zombies arrived at the G20 meeting in Hamburg this weekend – and I don’t mean the G20 leaders but a group called Gestalten, who dressed as zombies and walked through the streets.  The group said they wanted the G20 to stand for a more open, egalitarian society, rather than power in the hands of the few; and wanted to send a symbol of solidarity and political participation out to the world.

There was little sign of solidarity among the leaders of the capitalist world in Hamburg.  US President Donald Trump, after flying in to see the right-wing president of Poland (as a snub to Putin?), made it clear, in his own peculiar way, that the US would not return to the Paris Accord on climate change and would resist any G20 statement that committed the US to open and free trade.  Indeed, Trump is considering imposing tariffs on EU steel products.

Globalisation, as the leaders of capitalism and big business have come to expect and enjoy, is now under threat from nationalism and protectionism. Then there is the growing political crisis hot spots of North Korea and the Middle East on which the G20 leaders have no clear policy or solution.

But maybe there is one bright spot for capitalism – a seeming improvement in the world economy at last, after six to seven years of depressed economic growth, investment and incomes since the end of the Great Recession in 2009.

As the IMF put it in its last update on the global economy: “The good news is that the world economy is gaining momentum as a cyclical recovery holds out the promise of more jobs, higher incomes, and greater prosperity going forward.”  However, there were caveats: “the world economy may be gaining momentum, but we cannot be sure that we are out of the woods….there are clear downside risks: political uncertainty, including in Europe; the sword of protectionism hanging over global trade; and tighter global financial conditions that could trigger disruptive capital outflows from emerging and developing economies.”

Nevertheless, there appears to be economic recovery in most parts of Europe.  Average real GDP growth in the Eurozone is now heading for 1.5% a year, with Scandinavia and Eastern Europe growing even faster.  The US economy is showing signs of wear and tear, but still manages about 2% a year.  Japan trundles along at about 1.5% a year.  China too, after the mainstream doommongers predicted collapse, continues to expand at about 6.5-7% a year.  Even the some of the major so-called emerging economies like Brazil and Russia appear to be coming out of the slumps they have suffered in the last 18 months.

Global profits seemed to have picked up in recent months after heading into negative territory.  This recovery is driven by improvement mainly in China and Japan.

This has made some mainstream economists (JP Morgan) more confident that the Long Depression may be over.  Recovery and sustained faster growth may be coming soon, led by improved business investment.

Only the UK, of the major economies, seems to be heading downwards.  After the decision to leave the European Union (Brexit), companies have stopped investing and capital flows through the City of London have dropped off.  The latest real GDP data for the first quarter of 2017 showed that the UK economy grew only 0.2%, the lowest rate of growth in the whole of Europe, including Greece!  Industrial output is falling outright and business investment is flat.

The average UK family faces the tightest squeeze on real incomes for five years, as real disposable income per head fell 2% in the first quarter of 2017. Indeed, according to a new report by the Joseph Rowntree Foundation, a family of four (two working adults and two children) requires “at least” £40,800 a year to manage and on average, and such a family in the UK is falling short of that by about £3000.

And all is not entirely rosy in the US too.  The latest monthly jobs data for June showed a further rise in employment, but also a turn up in the unemployment rate for the first time in years.  That suggests employment has peaked.  Wage growth remains subdued at just 2.5% a year and, after inflation, average incomes are crawling. Above all, profits in the productive sectors of the US economy are falling.

The return on equity in the US stock market is at an all-time low – that’s a sign that stock prices are way out of line with earnings (profits) being made by US companies.

And US bond yield curve is flattening (ie gap between the long-term yield and the short-term interest rate in credit markets). That is usually a sign of an economy slowing. When the curve inverts (the long -term yield is lower than the short-term rate), then that is a sign of an upcoming slump.

The bond yield curve is flattening because the US Federal Reserve seems committed to increasing its policy rate that sets the floor for all interest rates for borrowing in the US and often overseas.  This means the cost of borrowing to spend in the shops or to invest in business expansion will rise.  In the minutes of its last meeting, the Fed members are ready to hike rates further even though inflation is not rising, on the contrary, and wages are hardly rising.

As one American hedge fund manager put it: “I don’t see anything different from what the Fed has been saying already. The economy continues to be okay. It’s not overheating  or under-heating. The implicit message is that we are on track to raise interest rates and to shrink the balance sheet, not because the economy is overheating but we want to normalise monetary policy.” But if the Fed continues with this policy, it could well increase downward pressure on corporate profits and investment.  There are already signs that borrowing costs have risen in Asian economies.

Moreover, the underlying reasons for doubting the optimism of the G20 leaders and hedge fund bosses on the world economy are that none of the key causes of low productivity growth and investment have been dealt with.  In its latest report on the US economy, the IMF cut its growth forecasts to 2.1 percent in 2017 and 2018, dropping its assumption that the Trump administration’s tax cut and fiscal spending plans would boost growth. Far from accelerating, the US economy continues its sluggish crawl – at best. While the Trump administration built-in growth projections of 3 per cent by 2021, the IMF sees US growth subsiding to an underlying potential rate of 1.8 per cent by 2020.

Productivity growth in all the major economies continues at historic lows.

While real GDP per head is still well below levels before the Great Recession, inequality of incomes and wealth within the major economies remains at record highs – indeed still rising.

And world trade volumes remain some 25% below peaks before the global financial crash.

The world economy still seems to be zombie-like, even if there is some optimism that the walking dead may be coming to life.

The profitability of Marxian economics

July 1, 2017

I was recently interviewed on my book, The Long Depression, and on other economic ideas, by José Carlos Díaz Silva from the Economics Department of the National University of Mexico (UNAM) where I have been invited next March 2018 to deliver a series of lectures.  In the first part of this interview, posted over a week ago, Jose questions me on the basic themes of my book.

In this second part of an interview, we discuss the importance of profitability in understanding the state of capitalist economies and whether Marxist economics can be attractive to economics students.

JCD: Is the falling profit rate a general explanation of the crisis, which is expressed in different ways in each country?

MR: Yes, that is a good way of putting it.  We do not have a proper world rate of profit because there are national boundaries to trade and capital flows and national states with different laws and taxes etc that affect the flow and holdings of capital.  More dominant capitalist states will thus have different rates of profit and different triggers of crises than weaker and smaller capitalist economies.

JCD: Is it possible to think about calculating a world profit rate? What is the meaning of that?

MR: Well, theoretically, in my view, the concept of a world rate of profit based on a global amount of fixed and circulating capital moving from sector to sector globally is becoming more realistic.  Compared to 150 years ago, capitalism now stretches to every corner of the world.  National barriers to trade, employment and capital flows remain.  So it is not possible to justify entirely such a world rate and measuring it is equally difficult.  However, we can start to make some measurement and several scholars, including myself, have attempted to do so, using an aggregate of national rates of profit.  The results have been encouraging because they show broadly similar trends and generally validate Marx’s law.

JCD: There are big differences of the profit rate among countries? Those differences could explain the international movement of capital? How this can be linked with the international movement of financial capital and, more specifically, with money capital? 

MR: Yes, there are big differences in the level of the rate of profit in different countries.  Theoretically, Marx’s law would suggest a higher rate of profit in so-called emerging economies where the organic composition of capital should be lower (more use of human labour).  And we would expect that, as these countries industrialise, the organic composition of capital would rise and the rate of profit would fall.  And the empirical work that has been done shows just that!

Theoretically too, we would expect capital flows to be towards those economies with higher rates of profit.  There is some evidence to suggest this is the case – in the period of globalization, capital flows to the emerging economies rose sharply. But it is also the case that flows among the more advanced economies (Europe, US, Japan) are still larger.  That is perhaps due to trade and investment pacts and the huge stock of capital already in these areas.  Finance capital flows more efficiently and effectively there.  Also in the recent period of ‘financialisation’ and with falling profitability in productive capital, capital has flowed into fictitious capital markets (portfolio capital) and not into the more productive sectors.

JCD: From the point of view of the falling profit rate thesis: how can you explain so-called financialization? For the neoliberal period what do you think about the explanation in Anwar Shaikh’s latest book?

MR: Although profitability in the major economies stopped falling from the early 1980s up to the end of the 20th century due to counteracting factors, one of those counteracting factors was the switch from productive capital, where profitability did not recover, to financial and unproductive sectors like property.  Financial profits boomed and investment was into fictitious sectors.  Financialisation could be the word to describe this development.  In my view, it does not mean that finance capital is now the decisive factor in crises or slumps.  Nor does it mean the Great Recession was just a financial crisis or a ‘Minsky moment’ (to refer to Hyman Minsky’s thesis that crises are a result of ‘financial instability’ alone). Crises always appear as monetary panics or financial collapses, because capitalism is a monetary economy.  But that is only a symptom of the underlying cause of crises, namely the failure to make enough money!  Anwar Shaikh’s explanation of crises in his latest book seems fairly close to mine, except that he seems to have more faith in Keynesian policies of government spending and the multiplier to enable capitalism to avoid or at least delay a slump.

JCD: According to the data, the line of causation of the crisis goes from falling profitability to an eventual reduction of the gross level of profits. This leads to a fall in the level of investment, and later to production and consumption. So the fall in the consumption is the expression of the crisis, but not its cause? This thesis invalidates the Kalecki-Minsky theory in two ways: a) the determinants of profit, and b) the role of financial instability?

MR: Yes, that pretty much sums up my view of the causation process in cycles of boom and slump.  And the empirical evidence supports this line of causation.  Unlike the Keynesians, the movement of personal consumption is not the driver of slumps, it coincides with them, and so is part of the description of a slump.  Indeed, personal consumption does not fall much in recessions (even in the Great Recession).  What does fall heavily is capitalist investment and this drops before the slump or fall in consumption or employment.  So business investment is the driver not consumption.  Investment is part of ‘aggregate demand’ to use the Keynesian category, but it is led by profits and profitability – contrary to the theoretical view of Keynes-Kalecki who see investment as creating profit.  Their view is partly because Keynes and Kalecki accepted marginalism and rejected Marx’ value theory of profit as coming from the exploitation of labour.  Indeed, for Kalecki, profit is only ‘rent’ that comes from monopoly power replacing competition.  Thus we have loads of heterodox explanations of modern capitalism as one of ‘rent extraction’, monopoly capital, finance capital – but not plain capitalism making profit from the exploitation of labour.

JCD: Can we assert, as the Duménil and Levy do, that there are two kinds of crisis: the classic one of profitability and other of the crisis in finance capitalism?

MR: Well, we can assert it, but is it right?  D-L argue that the depression of the 1880s was a classic profitability crisis; that the crash of 1929 and the depression of the 1930s was not.  Instead it was one of rising inequality and debt, sparking a speculative slump.  The 1970s was another classic profitability crisis, but the global financial crash of 2008 and the Great Recession was similar to 1929 and the 1930s – a result of rising inequality and debt.

If D-L are right, then we Marxists do not have viable general theory of crisis as each major crisis under capitalism appears to have a different cause.  So we may then have to fall back on the theories of the post-Keynesian/neo-Ricardians who look to a distribution theory, namely that some crises are ‘wage-led’ like the current one due to falling wage share resulting in a lack of wage demand; or ‘profit-led’, like the 1970s when wages squeezed profits.

Fortunately, the evidence, in my view, does not show that D-L or the post-Keynesians are right.  When wage share is adjusted for social benefits, overall workers’ incomes as a share of net national incomes did not fall in the neoliberal period.  Wage share fell in the capitalist sector, as the rate of surplus value rose, but not in the overall measure of the economy.  Rising inequality was the result of an increased rate of surplus value and capital gains in financial speculation, but it was not the cause of crises.  All the major crises came after a fall in profitability (particularly in productive sectors) and then a collapse in profits (industrial profits in the 1870s and 1930s and financial profits at first in the Great Recession).  Wages did not collapse in any of these slumps until they started.

JCD: Is there a possibility of solution for the current crisis? Can we talk about the tendency of the world capitalism towards its decomposition? Is a broad war scenario a real possibility? In such case, could it be a solution for world capitalism as it was with World War II?

MR: There is no permanent crisis.  If human political action is absent in changing the capitalist mode of production, then capitalism will revive as the profitability of capital is restored – for a while.  In my view, to restore profitability will require another major slump before this decade is out – and the current ‘recovery’ since the end of the Great Recession in mid-2009 is now eight years old.  If a new slump eventually restores profitability, capitalism could have a new lease of life that might last 15 years, as it did after the second world war.  That war was very effective in raising profitability in the major economies to high levels not seen since the 1890s.  That laid the basis for capitalist expansion in Europe, Japan, the US and eventually industrial Asia.

In my view, another world war is most unlikely as this time such a war could threaten to annihilate capitalism itself and us with it.  Only if lunatic fascist or military dictators came to power in the major imperialist countries could this happen.  A war between the US and China or Russia is thus ruled out unless this happens.  More likely, profitability will be restored by economic slump and the failure of the working class to replace capitalism, as happened in the 1890s.  There is a mountain of new technology to be employed (robots, AI, genetics) that can shed labour and raise productivity.  But only for a while.  As Marx’s law shows, the organic composition of capital will rise and the rate of profit will eventually resume its downward trend.  And each time, it is getting more difficult for capitalism to develop the productive forces and be profitable.  That is its nemesis, along with the further growth of a world working class, which has never been larger.

JCD: By defending the falling profit rate it is assumed that the Marxist labor theory of value is valid. In the context of fiduciary money and the administered exchange rates (not in all cases) by the central banks, how can the link be explained between those two phenomena and the labor theory of value?

MR: Yes, Marx’s law of profitability is intimately connected with Marx’s value theory as it rests on two assumptions, both realistic in Marx’s view.  The first is that all value is created by labour alone (in conjunction with natural resources) and that the capitalist mode of production and competition leads to a rising organic composition as a trend.  But capitalism is a monetary economy.  Capitalists start with money as the crystallised form of previously accumulated value, and then advance money to buy means of production and employ a labour force, which in turn produces a new commodity or service (new value) which is sold on the market for money.  Money leads to more money through the exploitation of labour.

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 mainstream and some heterodox economists seem 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, 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.  The gap between the prices of fictitious capital and money value of productive capital has widened again – presaging a stock market collapse ahead.

JCD. How can we advance towards a serious Marxist theory of international commerce? Which works can be thought as the path to follow?

MR: Now that capital has become global and dominant, Marx’s value theory can be applied more realistically to international trade and investment.  The basic principles of Marxist theory apply: capital will flow to those areas where individual sector or national profit rates are higher, subject to trade and investment barriers.  National economies with lower average production costs ie more efficient capitals, will generate trade surpluses with those national economies that have higher average costs – subject to trade barriers and protectionism.  Which Marxist authors can help in developing the theory of international trade?  Henryk Grossman provided some important insights (Henryk_Grossman_on_imperialism).  Guglielmo Carchedi, in his book, Frontiers of Political Economy, (218328342-Carchedi-Frontiers-of-Political-Economyhas the most comprehensive analysis.  And Anwar Shaikh’s contribution in his latest book, Capitalism, is important.

JCD: What should be taught about Marxism to students of economics?

MR: Well, Marxism is a big subject.  In my view, Marxism is a scientific analysis of human social relations both historically and conceptually.  It explains how human social organization works, how it got like this and offers a view of where it could go.  Above all, it is fundamentally based on the view that the history of human social organization up to now has been one of class division (and struggle).  Since ‘civilisation’ began, there have been rulers who live off the labour of the ruled and dominate and oppress the many to preserve their wealth and rule.  But this social structure is the result of scarcity and the  ability of elites to gain control of scarce resources.  But now, with technology, a world of abundance and the reduction of toil and labour to the minimum is possible globally.  That creates the objective conditions for a different form of social organization based on planning and democracy for all.

What Marxism also argues is that current mode of production and social relations called capitalism cannot deliver on this world of abundance and the end of toil.  It is a mode still based on scarcity and class division.  And it is a promoter of crises, inequality and wars. But it is not eternal and the best we can do. Capitalism has not always existed and all modes of production come to an end.  And indeed it can be dispensed with as the ‘economic problem’ can now be resolved.

Within this view, students of economics need to learn Marx’s theory of value to understand the different forms of class society and the special nature of the capitalist form.  Against that, they need to understand the theories of mainstream economics and its heterodox critics so that they can follow the differences with Marxian political economy.

JCD: One of the main concerns of students is the utility of the knowledge they acquire in the class rooms to get a job. In that perspective, how do we motivate them to study Marxism?

MR: Well, this is understandable.  Everybody needs to make a living and if they are not to become capitalists themselves (and nearly all will not), they need a job.  The world of jobs is hard even for those with a good education and skills.  I have worked in the financial sector for decades and it pays better than nearly any other sector – so it is popular especially among economics students.  Obviously it is easier to do a white-collar ‘professional’ occupation in terms of physical effort and working conditions etc.  But even then, the stress can be high – long hours, deadlines, lack of job security, dependence on bonuses etc.  Alienation, as Marx called it, applies there too. So students should know that ‘making a living’ is only one part of life and it is mainly toil.

Moreover, if they want things to be better for them and their children, they need a better economy, a better world without war, poverty and nature etc with less hours of toil and more hours for real creative development.  Marxism can explain how things are and why, what can happen next and also how things could and should be better.

Europe’s crisis: the Cluj debate with Mark Blyth

June 23, 2017

I’ve just returned from Cluj, Romania’s second largest city, where I discussed the Euro crisis and the future of Europe with Mark Blyth of Brown University.  Mark Blyth has published a number of books, including Austerity: a dangerous idea, which covers the history of the austerity doctrine as he sees it and its impact on the global financial crisis and on Europe’s economies.

The intellectual think-tank Tranzit.ro/Cluj (Tranzit), organised the event brilliantly and it was very well attended.  The discussion was billed as a debate between a Keynesian and Marxist analysis of Europe’s economic crisis.  But, of course, there were many areas of agreement between Mark and myself on the events leading up to the global financial crash and subsequent slumps particularly in the periphery of the Eurozone and on the impact of the policies adopted by the European leaders and the Troika with the distressed states of Ireland, Portugal, Spain and Greece.

In my presentation, I argued that the great European project that started after the second world war had two aims: first, it was to ensure that there were never any more wars between European nations; and second, to make Europe as an economic and political entity to rival America and Japan in global capital.  This would be led by Franco-German capital.

The move to a common market, customs union and eventually the political and economic structures of the European Union was a relative success.  The EU-12-15 from the 1980s to 1999 managed to achieve a degree of harmonisation and convergence: the weaker capitalist economies growing faster than the stronger.

But the move towards further integration with a single currency and the enlargement of the EU to now 28 (soon 27) countries was not so successful.  Now it was divergence, not convergence that was the result: the weaker capitalist economies (in southern Europe) within the euro area lost ground to the stronger (in the north).

Franco-German capital expanded into the south and east to take advantage of cheap labour there, while exporting outside the euro area with a relatively competitive currency.  But the weaker states built up trade deficits with the northern states and were flooded with northern credit and capital that created property and financial booms out of line with growth in the productive sectors of the south.

This divergence was exposed in the global financial crash and the ensuing Great Recession.  The banking system of the southern states was driven to bankruptcy as property prices collapsed and companies and households were unable to meet their debt servicing costs.  This also put French and German banks at risk.  The weaker governments could not bail out their own banks without help and that meant agreeing to drastic austerity measures from the EU’s stability funds and the IMF.

At debate in Cluj, in my view, were two things: why did the period of success for the EU project turn into failure with the global financial crash?  And was the imposition of austerity programmes the main cause of the depression after the collapse in Portugal, Greece etc; or at least, would a reversal of those Troika-style measures have got Greece etc out of trouble?

My view was that the cause of the change from fast growth and convergence from the 1970s to slow growth and divergence from the 1990s can be found in the sharp decline in the profitability of capital in the major EU states (as elsewhere) after the end of the Golden Age of post-war expansion.

This led to fall in investment growth, productivity and trade divergence.  European capital, following the model of the Anglo-Saxon economies, adopted neo-liberal policies: anti trade union laws, deregulation of labour and product markets, free movement of capital and privatisations.  The aim was to boost profitability. This succeeded at least for the more advanced EU states of the north but less so for the south.

The introduction of the euro added another limitation on growth in the south and convergence with the north.  The euro was not an ‘optimal currency union’ (to use the mainstream economics term) because of this.  A strong euro was bad for exports in the south and gave investment power to the north.  The debts being built up by the south with the north were exposed in the crash and sparked the ‘euro crisis’, but only after the global financial crash.

The EU leaders had set criteria for joining the euro, but these criteria were all monetary (interest rates and inflation) and fiscal (budget deficits and debt).  They were not convergence criteria for productivity levels, GDP growth, investment or employment.  Why? Because those were areas for the free movement of capital (and labour) and capitalist production for the market; and not the province of interference or direction by the state.  After all, the EU project is a capitalist one.  Thus some countries clearly unable to converge were still incorporated into the euro area (Greece, Italy).

The imposition of austerity measures by the Franco-German EU leadership on the distressed countries during the crisis was the result of this ‘halfway house’ of euro criteria.  There was no full fiscal union (automatic transfer of revenues to those national economies with deficits) and there was no automatic injection of credit to cover capital flight and trade deficits – as there is in full federal unions like the United States or the United Kingdom.  Everything had to be agreed by tortuous negotiation among the Euro states.

Why? Because Franco-German capital was not prepared to pay for the ‘excesses’, or the problems of the weaker capitalist states.  Thus the bailout programmes were combined with ‘austerity’ to make the people of the distressed states pay with cuts in welfare, pensions and real wages, to repay (virtually in full) their creditors, the banks of France and Germany and the UK.  Eventually, this debt was transferred to the EU state institutions and the IMF – in the case of Greece, probably in perpetuity.

But would a reversal of austerity on its own have turned these economies around without the pain of huge cuts in living standards?  In the debate, I argued that it would not.  The evidence shows that there is little correlation between faster growth and more government spending or bigger budget deficits.  Indeed, during the Great Recession and subsequently, many countries with faster economic growth also had low government spending and budget deficits (see the graph below – if austerity causes poor growth, the line should be sharply from bottom left to top right, but it is nearly flat).  It seemed that faster economic growth was more dependent on other factors – in particular, more investment and in turn higher profitability.

The evidence shows that those EU states that got quicker recovery in profitability of capital were able to withstand and recover from the euro crisis (Germany, Netherlands etc), while those that did not improve profitability stayed deep in depression (Greece).

Reversing austerity or leaving the euro and devaluing would not do the trick.  I used the example of tiny Iceland that did renegotiate its debts and devalued its currency, but it made little difference to the hit that the Icelandic people took in living standards, because, in this case, inflation rocketed to eat into real wages.  In contrast, Estonia and Ireland adopted austerity measures.  But what enabled these economies to turn round and raise profitability was mass emigration of their workforces, which drove down the costs of capital (internal devaluation).

But so weak and corrupt was Greek capital that even drastic austerity and mass emigration have not raised up the economy on a capitalist basis.

Thus my argument was that we can look for the main cause of the crisis in the euro in the falling profitability of capital in Europe prior to the crisis, which was then triggered by the global financial crash and Great Recession.

Now Mark had a different analysis.  First, he pointed out that profits as a share of GDP in the US are near record highs, so how could the crisis be caused by low profitability or profits?  The American multi-nationals are rolling in money and cash; and tax havens are bulging with hidden profits.

Sure, we could agree that the undeniable drop in profitability in the 1970s played a role in the growing difficulties for the EU project and the introduction of neo-liberal policies.  But, in his view, as I understand it, it was these neo-liberal policies attacking real wages that caused the crisis of 2008-9, not falling profitability.  Real wages were held down and so the rising gap between production and consumption had to be filled by a huge expansion of credit (financialisation).  This eventually came tumbling down and kicked off the financial crash.

This analysis is basically the ‘post-Keynesian’ one in economic parlance and Mark mentioned several times the leading post-Keynesian Michal Kalecki in this context.  In this theory, crises are the product of the change in the distribution of product between profits and wages.  The crisis and stagflation of the 1970s was ‘profit-led’, when strong and confident labour forces forced up wages and squeezed profits and full employment led to inflation (Phillips curve style).  But the crisis of 2008 was ‘wage-led’, as wage share in the economy had plummeted and excess (household) credit designed to sustain consumption led to financial instability and collapse (Minsky-style).  Marx’s law of profitability of capital based on a rising organic composition of capital (not the distribution between profits and wages) was irrelevant to this narrative.

The 1970s was an era of profits squeeze and inflation.  According to Mark, this period of ‘stagflation’ (low growth and inflation) was ‘abnormal’; it did not fit into the post-Keynesian analysis that argues that only a full employment economy would generate inflation – as measured by the so-called Phillips curve that shows a trade-off between full employment and inflation.  But by the end of the 1990s, inflation had returned to ‘normal’ levels and now the problem was the post-Keynesian one of ‘wage squeeze’ and ‘underconsumption’.  In this period of ‘secular stagnation’ huge injections of credit did not drive up inflation as the monetarist economists expected but merely fuelled financial speculation and instability.

Now, in my view, this post-Keynesian analysis fails theoretically and empirically.  Was the 1970s collapse in profitability caused by wages rising too high and squeezing profits?  The empirical evidence shows that profitability was falling by the mid-1960s, well before any perceived rise in ‘wage share’ in the major economies.  And this coincided with a rise in the organic composition of capital, as in Marx’s law of profitability.  Profits squeeze only came later in the early 1970s. As Marx said in Capital Volume 3 (p239): “The tendency of the rate of profit to fall is bound up with a tendency of the rate of surplus-value to rise, hence with a tendency for the rate of labour exploitation to rise. Nothing is more absurd, for this reason, than to explain the fall in the rate of profit by a rise in the rate of wages, although this may be the case by way of an exception.”

If profits are the result of the exploitation of labour power and not merely the result of the distribution of production between wages and profits, then it is profits that matters for capital, not wages.  Keeping wages down and profits up is good for capital accumulation.  The contradiction does not lie in the wage-profit nexus but in the limitation in the increase in the productivity of labour as a counteracting factor to the tendency of the rate of profit on overall capital to fall.

Profit share in GDP may be at highs (at least in the US) – although its has been falling back recently.  But this only measures profit per output or profit margins, not profits against the stock of capital accumulated and invested in an economy.  Rising profit margins show capital is making bigger profits; but that can still mean overall profitability is falling.  Yes, many large multinationals are ‘awash with cash’, but there are also many more companies making only enough profit to service their debts (zombie companies) and corporate debt to GDP in most economies is at record high levels too.

Yes, corporations squeezed the share of value added going to wages from the 1980s to boost the rate of surplus value and reverse falling profitability.  But it only had limited success.  By the early 2000s as the euro area started, profitability was falling across the major economies.  Indeed, far from wages and consumption collapsing prior to the Great Recession, as the post-Keynesian thesis would suggest, it was profits and investment that did so, as the Marxist thesis would argue (graph shows inv in green and cons in blue).

Actually, over the period from the 1980s, wage share in most economies did not decline that much.  And when adjusted for social benefits, the share of total value going to labour was pretty stable.  In the graph below, the wage share for the US is measured against GDP and against national income.  Following the blue line, we can see that the ‘profits squeeze’ only began in the early 1970s (well after profitability fell).  Following the average black line, we can see that employee compensation to national income was pretty stable, if not rising in the post war period.

US personal consumption to GDP rose, not so much because of rising household debt filling the gap between output and wages, but because wages from work were supplemented by health and social benefits (so the green line below more than matches the blue line of personal consumption share).

Finally, there are policy implications from these rival theses.  If the euro crisis and the Great Recession were the product of wage compression and too much credit, then the solution for the EU project may just be better taxation of profits, more wage increases and public spending.   In other words, we need a return to the social democratic consensus of the Golden Age, when apparently the right balance between profits and wages was achieved.

Indeed, this scenario is exactly the view and policy objective of post-Keynesian analysis.  Two leading post-Keynesians summed thus up in a recent paper, when they said: “in contrast to other heterodox economists, especially from the Marxian tradition, Post-Keynesians believe that it is possible even within a capitalist economy to counteract effectively these destabilizing tendencies through appropriate macroeconomic policy actions of the state, as long as the political conditions are in place, as it happened to some extent during the early post-World War II “Golden Age”, especially as implemented by certain social democratic regimes, which had held power on the European continent and who were committed to full employment.” I assume this was at least one reason why Mark Blyth, when asked in Cluj, said that “je ne suis pas Marxist”.

However, if the cause of the euro crisis is be found in the main contradiction within capitalist production for profit, namely the law of the tendency of the rate of profit to fall (which brings about recurring and regular slumps in production whatever the ratio of distribution between profits and wages), then a managed solution within capitalism is not possible.  Crises would still re-occur.  And indeed, austerity then has a certain rationality in the very irrationality of capitalism, as it aims to raise profitability, not production or wages.

It is a vain hope that we could return to the golden age where wages and profits were ‘balanced’ (apparently) to avoid crises.  Modern capitalist economies are not generating high levels of profitability, full employment and investment as in the 1950 and 60s – on the contrary, they are depressed.  And they are depressed not by the lack of consumption (US personal consumption to GDP is at its height), but by the lack of sufficient profitability, notwithstanding Apple or Amazon’s huge cash piles.

If there was an abnormal period, it was not the ‘stagflation decade’ of the 1970s where the Phillips curve did not operate, as Mark argued.  It was the Golden age of the 1950s and 196os, when profitability was high after the war and capital could make concessions to labour (under pressure) for higher wages and a welfare state.  Indeed, the Phillips curve is still not operating as Keynesians and post-Keynesians expect.  Where is that curve?; it should be from the top left to the bottom right, but it was nearly flat in the 1970s and it is even flatter now.

Japan, the US and the UK now have record low unemployment rates and yet wages stay low and inflation is virtually non-existent (speech984). Instead of stagflation, economies have stagnation.  Now capitalism is in a new ‘abnormality’, if you like, a long depression, where it can concede nothing to labour, certainly not a social democratic consensus to balance profits and wages.

The profitability of crises

June 19, 2017

I was recently interviewed on my book, The Long Depression, and on other economic ideas, by José Carlos Díaz Silva from the Economics Department of the National University of Mexico (UNAM) where I have been invited next March 2018 to deliver a series of lectures.

In the first part of this interview, Jose questions me on the basic themes of my book.

JCD: In general terms, how could you explain the recent crisis? Can we link the United States crash in 2008 with the problems that followed in Spain, Greece and Ireland, and the latter with the recent scenario as a unique process of crisis?

MR: In my book, The Great Recession and my subsequent book, The Long Depression, I argue that the global financial crash of 2008 and the ensuing deep global slump in capitalist production were caused by a combination of the falling profitability of productive capital (Marx’s law) and excessive borrowing to speculate in fictitious capital (stocks, bonds and property).  At a certain point, bank lending and mortgages and their ‘diversification’ into mortgage-backed derivatives (bought worldwide) could no longer be funded as profit in productive sectors dropped and incomes fell back.  The great Ponzi scheme of financial speculation then collapsed and revealed the underlying failure of capitalist production.  Investment plunged and took employment, incomes and consumption down with it.

This is the ‘normal’ process of capitalist crisis: profitability falls to a point where profits in total stop rising, then investment collapses and the costs of capital (means of production and labour) are reduced violently.  This particular slump was worse because it was combined with the destruction of fictitious capital that had reached unprecedented levels; and because it was global.  Every major economy and financial sector was affected.  The banking crash and the massive credit squeeze spread to Europe.  The credit crunch hit the property markets of Spain and Ireland; and the excessive over-leveraged property and corporate sectors in Greece.  Greece was brought to its knees because of the previously wild borrowing at cheap rates by Greek corporations especially in property; and the tax evasion and capital flight of those corporates and the rich meant that the Greek government had insufficient revenues to handle a collapse in the economy and meet the demands of its creditors, the French and German banks.

So the Euro crisis was really a crisis of global capitalism.  But it had special features in that the weakest parts of the Euro area were hit hardest because they were dependent on investment from the core (Germany, France etc).  And the Euro leaders were unwilling to subsidise the weaker economies.

JCD: Why is important to build a general theory of capitalist crisis?

MR: If we do not develop general theories then we remain in ignorance at the level of surface appearance.  In the case of crises, every slump in capitalist production may appear to have a different cause.  The 1929 crash was caused by a stock market collapse; the 1974-5 global slump by oil price hikes; the 2008-9 Great Recession by a property crash.  And yet, crises under capitalism occur regularly and repeatedly.  That suggests that there are underlying general causes of crises to be discovered.  Capitalist slumps are not just random events or shocks.

The scientific method is an attempt to draw out laws that explain why things happen and thus be able to understand how, why and when they may happen again.  I reckon that the scientific method applies to economics and political economy just as much as it does to what are called the ‘natural sciences’.  Of course, it is difficult to get accurate scientific results when human behaviour is involved and laboratory experiments are ruled out.  But the power of the aggregate and the multiplicity of data points help.  Trends can be ascertained and even points of reversal.

If we can develop a general theory of crises, then we can test against the evidence to see if it is valid – and even more, we can try and predict the likelihood and timing of the next slump.  Weather forecasting used to be unscientific and just based on the experience of farmers over centuries (not without some validity).  But scientists, applying theory and using more data have improved forecasting so that it is pretty accurate three days ahead and very accurate hours ahead.

Finally, a general theory of crises also reveals that capitalism is a flawed mode of production that can never deliver a harmonious and stable development of the productive forces to meet people’s needs across the globe.  Only its replacement by planned production in common ownership offers that.

JCD: When talking about the pertinence of the falling profit rate as a determinant of the crisis, it is commonly underlined in Marx’s works as the strongest explanation. This is, if Marx himself considered the falling profit rate as the foundation of the main explanation of the crisis, then we should think of it as correct, but if we find some textual evidence, in the Marx’s writings, that shows he abandoned this thesis In his last years of work, then it will be incorrect thinking on the falling rate of profit as the main explanation of the crisis. How fruitful is this way of doing research? Is it possible that waiting for the “Marx approval” is a noxious one for the possibility of constructing a theory of crisis?

MR: Interpreting Marx’s voluminous writings to ascertain what his theory of crises is useful, but only to some extent.  Marx’s contribution must be the foundation of any effective and relevant theory of crises under capitalism, in my view.  But as you say, there can be many interpretations and Marx’s unfinished works lead to ambiguities that can exercise academics and scholars for a lifetime!  So there are severe limits on this type of research.  Even if we were to agree on what Marx’s theory of crises is (or even that he had one – because that is disputed), what if he were just wrong?

Moreover, it is 150 years since Marx developed his analysis of capitalism based on the main example of British capital in the mid-19th century.  The world and capitalism has moved on since then – in particular, it is the US that is now the dominant hegemonic capital, capitalism is now global and controlled even more than before by finance capital.  Thus a theory of crises must take into account these new developments.  Also, we have much more data and information to work on compared to Marx’s limited access.  The task now is not to keep analyzing and re-interpreting Marx, but to stand on his shoulders and raise our understanding.

JCD: If we define the organic composition of capital as the level of the value of the means of production to the value of labor power, does this variable depend on distributional factors or the profit rate? Do you think it is important to take into account the materialized composition of capital and the organic composition of capital?

MR: The organic composition of capital is an important Marxian economic category.  It shows the social relation between human labour and machines as the means of production.  Under capitalism, individual capitalists compete to extract the maximum amount of value (and surplus value after paying for the wages of labour power) from their workforces.  That competitive drive for profit (getting the greater share of the total value produced) pushes capitalists to increase their use of machinery in order to raise the productivity of labour by shedding labour (costs).  So Marx reckoned that a rising organic composition of capital was the long-term tendency of the capitalist mode of production.  Indeed, it was the basis of the law of the tendency of the rate of profit to fall (the law as such).  The organic composition of capital is measured in money but Marx says its mirrors the technical composition of capital (machines measured in hours of labour against the amount of hours worked).  However, the increase in machinery by capitalists to replace labour will raise the productivity of labour and reduce the value of labour power if the costs of reproduction of labour fall.  And it can also reduce the costs of machinery.  So the value composition of capital can fall.  But Marx said that, as a rule, this would only slow the rise in the organic composition of capital, not cause it to fall over the long term.

All the empirical evidence shows that Marx was right.  So the basic assumption of Marx’s law of profitability, that there will be a rising organic composition of capital over time, is realistic and proven.  If there is no change in the rate of exploitation or surplus value of the workforce, then a rising organic composition will lead to a fall in the rate of profit.  However, increased mechanization will usually lead to a rise in the productivity of labour and the rate of surplus value.  This acts a counter-tendency to the rising organic composition of capital and the tendency of the rate of profit to fall.  But the tendency will override the countertendencies over time.

JCD: Is the dynamic between the falling profit rate and its counter tendencies the explanation of the economic cycles? Why is so? Which are the differences with the ideas of the Kondratiev’s long waves and the one of Schumpeter about the cycle?

Yes, in Marx’s theory, it is the dynamic between the rising organic composition of capital and the counter-tendencies of a rising rate of surplus value and a falling value composition of capital.  Marx’s law of profitability means that eventually a fall in the profit rate leads to a fall in the mass of profit or at least a fall in new value created.  This leads to a slump in new investment. Capitalists then look to reduce their costs of capital (labour power and assets). So capital values are devalued (after the bankruptcy and merger of capitals and a large increase in the reserve army of labour) to the point where the mass and rate of profit begins to rise again for the surviving capitalists and then investment resumes, and with it employment and incomes. The whole cycle commences again.

In my view, this profit (ability) cycle, as I call it, is the basis of the so-called business cycle.  But it is not the same as the business cycle.  That is affected by the turnover of capital in productive sectors and in unproductive sectors like housing, also by international trade etc.  The profit cycle from trough to trough can last 30-36 years, while the modern business cycle (Juglar) appears to be 8-10 years.  So, for example, in the period 1946-82, there were several business cycles or slumps (1958, 1970, 1974-5, 1980-2).

The Kondratiev cycle, if it exists, and I am inclined to think so, is much longer term, over 54-72 years (I think it has been getting longer).  The K-cycle is driven by the swings in world commodity prices and probably by the cluster of innovation cycles delineated by Schumpeter – but also by the direction of the profit cycle.  The K-cycle has been getting longer because people are living longer (at least in the major economies), so the generational effect is now four times 18 years, not four times 14 years, if you like.  This affects the length of the innovation cycle of discovery, development, explosion, maturity and stagnation – possibly.  In many ways, these are all hypotheses to be proven. Data points are few.  But I argue in my book, The Long Depression, that the conjunction of the downward phase of the K-cycle, the profit cycle and Juglar cycle only happens once every 60-70 years.  When it does, capitalism has a depression rather than just a ‘normal’ slump.  This was the case in the 1880s, the 1930s and now.

JCD: What are the main difficulties for calculating the profit rate? Is there some way of calculating the circulating capital turnover? If it would be possible to calculate the capital turn over, how different the calculation of the profit rate could be? This can explain the constancy of the materialized composition of capital that some have shown?

MR: The difficulties of measuring the rate of profit from the view of Marxian categories are manifold!  First, we must use official statistics that are not accumulated in the best way to measure Marxian categories.  Indeed, some Marxist economists reckon that trying to measure the rate of profit using official statistics in money is impossible and pointless.  Others reckon that the data are so poor we cannot do it practically.  I do not agree.  It is the job of any scientific analysis to overcome these theoretical and practical difficulties in measurement.  And many Marxist economists are doing just that.

On categories, should we measure the rate of profit of the whole economy, or just the capitalist sector, or just the corporate sector, or just the non-financial corporate sector, or just the ‘productive’ sector?  Should or can we include variable capital and circulating capital in the denominator?  Should we measure gross profit or net profit after depreciation?  Can we measure depreciation correctly?

All these various measures are useful and possible.  The data are available for many major economies and many Marxist scholars have now made such measurements.  And yes, variable capital should and can be included empirically.  And there has been work on measuring the impact of the turnover of capital too.  What increases confidence in this work is that, by and large, whatever measure is used, it shows, for most countries, over time that the rate of profit has been falling.  Of course, not in a straight line because there are periods when the counteracting factors dominate, if only for a while.  And each major slump produces a temporary recovery in profitability.  But these turning points are also broadly at the same time.  All this increases confidence that Marx’s law of profitability is valid and relevant to an explanation of recurrent crises under capitalism and also its eventual demise as a mode of production.

JCD: Which is the correct way of calculating the profit rate: historical cost or current cost? Why is so?

MR: Theoretically, capital accumulation should be seen as temporal.  By that I mean, a capitalist must pay a certain money amount for machinery and raw materials to start production.  Then the workforce is employed to produce a new commodity for sale.  It does not matter if the cost of replacing that machinery in the next production cycle has changed.  The profit for the capitalist should be based on the original (historic) cost of the machinery etc not on its current (replacement) cost.  So the rate of profit properly measured should use historic cost measures.  However, this is a matter of theoretical debate, with some scholars arguing for replacement costs and some arguing for something in between!  What is interesting is that the difference this makes to the measurement of the rate profit is greater or lesser according to the change in prices of the means of production over time.  So in the recent period where inflation has been low, particularly for capital goods, over time, the difference between the rate of profit measured on historic costs versus current costs has narrowed.

JCD: Why is the profit rate not in the core of the recent discussion about the crisis, both in the academic and journalistic field? Is it not paradoxical speaking about capital without underlining the profitability determinants?

MR: The reason that profitability is not considered in any discussion of crises is both ideological and theoretical.  Mainstream economics has no real theory of crises anyway: crises are just chance, random events or shocks to harmonious growth under capitalism; or they are the result of the interference in competition and markets by governments, or central banks; or they are result of monopoly or financial recklessness or greed.  Mainstream economics also denies any role or concept of profit in its marginalist theories of production and demand.  This is deliberate: there is no place for a theory of profit based on the exploitation of labour power (Marx’s value theory).  Diminishing returns on utility and productivity lead to no profit at the point of equilibrium.  Also heterodox/Keynesian theories also deny the role of profit, as they are also based on marginalism and (im)perfect competition.  Crises are therefore the result of a ‘lack of effective demand’ caused by an ‘irrational’ change in expectations (‘animal spirits’).  It has nothing to do with the profitability of capital, apparently – or more precisely the exploitation of labour.  And yet capitalism is a system of production for profit in competition.  So why is profit not a determinant in investment and production?  It is an ideological refusal to accept that.  Instead apparently, everybody gets their fair share according to their (marginal) contribution.  The mainstream finds no explanation of crises as a result; and the Keynesians look to ‘demand’ not profit as the driver of crises.

Taking a risk

June 15, 2017

The US Federal Reserve is taking a risk.  Yesterday the Fed’s Monetary Policy Committee raised its so-called ‘policy’ interest rate that sets the floor for all interest rates for borrowing in the US and often overseas.  This means the cost of borrowing to spend in the shops or to invest in business expansion will rise.

Sure the increase was only 25bp (0.25%), from 1% to 1.25% but the Fed clearly intends to continue with further hikes (up to a target of 3% eventually). It has already stopped its quantitative easing programme (boosting bank reserves).

and now it is raising the price of money as well as reducing the quantity available.  Money is getting ‘tighter’ to get.

The Fed is doing this because it believes (or hopes) that the US economy is now set on a sustained acceleration of real GDP growth back to the trend levels of 3%-plus seen before the Great Recession.  The Long Depression, at least in the US, is over, according to the Fed.

But there are indicators in the US economy that the Fed has got it wrong.  First, the Fed thinks that price inflation in the shops and for household services will eventually average 2%-plus a year and so it needs to raise rates to control rising inflation.  And yet the very latest figures for inflation released this week show that it is slowing down, not accelerating.  In April, US personal consumer inflation dropped back to 1.7% a year (core inflation is just 1.5%), with three months of little or no rise.  Although the labour market is ‘tight’ with the unemployment rate very low, there is little or no acceleration in wage rises and consumer spending is weak.

This is very much against the traditional Keynesian economic thinking that tight labour markets lead to rising wages and inflation, in the so-called Phillips curve. The trade-off between low unemployment and rising inflation was exposed as wrong in the 1970s when capitalist economies had both high unemployment and inflation: stagflation. Now the Fed faces low unemployment and low inflation: ’secular stagnation’The Phillips curve is not operating.

The Fed committee is ignoring the low inflation data and instead is emphasising the proposed pick-up in US economic growth that is to come.  Yet the latest real GDP data do not justify that optimism.  In the first quarter of 2017, annual real GDP growth was just 1.2%.  Most forecasts for the current quarter (April-June) suggest a annualised growth rate of 2.5%.  That means in the first half of the year, the US economy would be growing at around 1.8% a year, actually slower than in 2016.

The Fed is forecasting 2.2% for the whole of 2017 – hardly matching pre-crash growth rates.  But even reaching that would require an annual growth rate of 2.6% for the second half of 2017.  Indeed, the Fed expects a growth rate of only 2.1% next year and 1.9% in 2019, with a long-term growth rate of only 1.8%.  This is hardly Trump-type projections of 3-4% a year that Trump claims he can achieve. Indeed, as John Ross shows in an excellent post, US capitalism has consistently shown a declining trend in growth rates, particularly in the 21st century. And that is due to the slowdown in business investment.

All this assumes no new recession before 2020.  And that is the risk. Hiking the cost of borrowing when the economy is only growing moderately and inflation is low will put pressure on corporate debtors, causing a new reduction in investment and even bankruptcies. US corporate debt has never been higher as companies have piled up bonds and loans at very low rates of interest.  Rising costs of borrowing could begin to turn the boom into bust.

Some Keynesians reckon the Fed should change its target for inflation to 4% so its policy rate would not be hiked until inflation reaches that level.  Others say that letting inflation rise to that level and keeping interest rates low for much longer would create a huge financial credit bubble that could be uncontrollable as the economy accelerates.  In other words, mainstream economics is flying blind, unsure what to do.

When the Fed started its hiking plan last December, I warned that the Fed was taking a risk that, given weak business investment, hiking interest rates might push a layer of US companies into difficulty and trigger a new recession or slump.  Indeed, that was why the Fed held off further hikes for a while.  But now it is taking a further leap into the unknown.

It’s true that, after falling in most of 2016, US corporate profits recovered a little towards the end of 2017.  But corporate profits fell back again in Q1 2017, although they were up 3.7% from a year ago. But only including financial sector gains: non-financial sector profits were down on the year.

Globally, corporate profits have also picked up.  Investment bank JP Morgan now follows closely the connection between global corporate profits and business investment (at least one set of mainstream economists who recognise the importance of profit in capitalist economies!).  Readers of this blog will know that there is a close connection between profits, investment and growth in capitalist economies.  JPM finds that global profits are now rising at 5% a year and thus project a similar rise in investment and growth.  So maybe the improvement in profits, investment and growth in Japan and Europe will compensate for the continued weakness in the US.  We shall see.

Moreover, the interest rate set in the US also drives interest rates globally, given the powerful role of US capital.  There has been no real reduction in the build-up of private-sector debt in the major economies that took place in the early 2000s and culminated in the global credit crunch of 2007. That accumulated debt took place against a backdrop of favourable borrowing conditions—low interest rates and easy credit. Between 2000 and 2007, the ratio of global private-sector debt to GDP surged from about 140% to 163%, according to the IMF.

In the emerging economies, after the Great Recession the increase in private sector debt has been massive. Most of this extra debt is the result of corporations in these countries borrowing more to increase investment, but often in unproductive areas like property and finance.  And much of this extra borrowing was done in dollars.  So the Fed’s move to raise the cost of borrowing dollars will feed through to these corporate debts.   The relative recovery in global corporate profits and economic activity in the last part of 2016 may not last through 2017.

Investment, profit and growth

June 13, 2017

I’m always banging on about the close connection between the movement of investment (expenditure on the means of production) and economic growth.  In my view, the evidence is overwhelming (The profits-investment nexus) that it is investment that is the main swing factor in booms and slumps, not personal consumption as many Keynesians focus on.  And it is also a key factor in the long-term growth of labour productivity.

A new analysis by the Levy Forecasting Center, an institute that follows closely the views of Keynes, Kalecki and Hyman Minsky, also confirms this view.  The report comments that “unsurprisingly, net fixed investment is strongly related to growth.”  

The slowdown in real GDP growth since the end of the Great Recession is clearly connected to the slowdown in business investment growth

 

Business investment in the US has ground to a halt and the age of the existing means of production has risen as ageing equipment and technology is not replaced.

As Levy puts it: “In 2009, net investment as a share of the capital stock fell to its lowest level in the post-World War II era and the nominal capital stock even declined. Although net investment has rebounded somewhat in the recovery, its level as a share of the capital stock remains well below the historical average and it declined slightly in 2015.”

Levy points out that investment growth contributes to labour productivity growth most directly through capital deepening—the increase in capital services per hour worked.  “That had added nearly 1 percentage point a year to labor productivity growth in the post-war period to 2010. But since 2010, capital deepening has subtracted from productivity growth and contributed slightly more to the slowdown from 1948-2010 to 2010-15 than did the slowdown in total factor productivity growth.”  In other words, it was just the slowdown or cutback in the sheer amount of investment that did the damage, even more than any slowdown in the use of new techniques.

However, the Levy Institute then fails to explain this investment slowdown. It argues that “this broad-based investment slowdown is largely associated with the low rate of output growth both in the United States and globally”.  This is a circular argument. The slowdown in economic growth is due to the slowdown in business investment, and that in turn is due to the slowdown in growth!

This is close to the argument of the Keynes-Kalecki thesis (espoused by the Levy Institute) that it is investment that creates profit, not vice versa. This nonsensical view should be countered with the realistic one that is the movement in profitability and profits that moves business investment.  And as I and others have shown empirically, this is what happens in a capitalist economy.

For example, Andrew Kliman and Shannon Williams have shown that the fall in US corporations’ rate of profit (rate of return on investment in fixed assets) fully accounts for the fall in their rate of capital accumulation.  And they conclude that “Since a long-term slump in profitability, not diversion, is what led to the trend towards dis-accumulation, it is unlikely that the trend can be reversed in the absence of a sustained rebound of profitability”.

Indeed, if we delineate the rate of profit in the non-financial productive sectors of the economy, we find that profitability has struggled to rise since the 1980s and so along with it, business investment growth has slowed.  Anwar Shaikh, in his latest book, Capitalism, adjusts the official data for measuring the US rate of profit and shows that profitability has stagnated at best since the early 1980s, rising to a modest peak in 1997 before slipping back to a post-war low by 2008.

Similarly, Australian Marxist economist Peter Jones has shown that if the ‘fictitious’ components of profitability are removed from the calculation of the US corporate rate of profit, then the ‘underlying’ rate of profit has never been lower (http://gesd.free.fr/jonesp13.pdf).  Profitability of productive capital consolidated during the 1990s but then dived to post-war lows just before the Great Recession, with little recovery since.

The US rate of profit (excluding ‘fictitious profits’) %

The Levy analysis also makes the valid argument that high corporate debt is impeding new investment.  Non-financial corporate sector debt relative to ‘value-added’ (i.e. sales revenue) is at a historically high level and this is weighing on capital spending.

US business investment in the first quarter of 2017 had a slight uptick after falling for four quarters. That followed a return to positive territory for corporate profits in the second half of 2016 after going negative in early 2016.

 

Does this mean that investment and economic growth is set to pick up finally?  Not according to Levy.  Levy interestingly (in opposition to its own Kalecki thesis) note that “looking back, the capex decline in 2015-16 and the subsequent rebound lagged the profits decline and recovery.”  But Levy reckons that the “corporate profits recovery is likely to stall by mid-year and capital spending will follow with a lag”.  If that happens, the US economy will be heading down, not up, by the end of the year.