Getting a level playing field

March 6, 2017

Financial markets may be booming in the expectation that the US economy will grow faster under President Trump.  But they forget that the main emphasis of Trump’s programme, in so far as it is coherent, is to make America great again by imposing tariffs and other controls on imports and forcing US companies to produce at home – in other words, trade protectionism.  This is to be enforced by new laws.

That brings me to discuss the role of law in trying to make the capitalist economy work better for the interests of capital.  It’s an area that has been badly neglected.  How is the law used to protect the interests of capital against labour; national capital interests against foreign rivals; and the capitalist sector as a whole against monopoly interests?

Last year, there were a number of books that came out that helped to enlighten us both theoretically and empirically on the laws of motion of capitalism. But I think I missed one.  It’s The Great Leveller by Brett Christophers.  Christophers is a Professor in Human Geography at Uppsala University, Sweden.  His book takes a refreshingly new angle on the nature of crises under capitalism.  He says that we need to look at how capitalism is continually facing a dynamic tension between the underlying forces of competition and monopoly.  Christopher argues that in this dynamic, law and legal measures have an underappreciated role in trying to preserve a “delicate balance between competition and monopoly”, which is needed to “regulate the rhythms of capitalist accumulation”.

Christophers reckons this monopoly/competition imbalance is an important contradiction of capitalism that has been neglected or not developed enough.  It may not be the only contradiction but it is an important one that the law (imperfectly) works on.  Indeed, uneven and combined development is an inherent feature of capitalism.

Christophers argues that corporate laws swing from one aim to another, depending on the needs of capital in any particular period.  Thus, in certain periods, anti-trust legislation (breaking up monopolies) dominates legal economic thinking; at others, it is patenting and protecting ‘intellectual property’ (monopoly rights).  The law is a “great leveller”, aiming to keep a balance between too much competition and too much monopoly.

I’m reminded of the recent period prior to the global financial crash and the Great Recession.  The tone of the day was to ‘deregulate’, particularly in the financial sector, to allow new financial products (derivatives) to expand ‘financial diversification’ (competition).  The dangers of this ‘excessive risk-taking’ and uncontrolled ‘competition’ were brought to the attention of the ‘powers that be’ at the annual Federal Reserve Jackson Hole central bankers symposium of 2005 by Raghuram Rajam, then a professor at Harvard and later head of the Reserve Bank of India.  He presented a paper that questioned the reduced banking controls introduced by Clinton’s advisers, Robert Rubin and Larry Summers in the late 1990s.  Immediately he was attacked by Summers as a ‘Luddite’, holding back progress and competition.  Of course, after the Great Recession, Summers became a leading supporter of banking regulation and of the Dodd-Frank banking regulation laws.

The balance between competition and monopoly is the main theme of Christophers’ book.  In my view, contrary to the view of the Monthly Review school, who follow Paul Sweezy’s characterisation of modern capital as ‘monopoly capitalism’, monopoly is not the dominant order of capitalism: competition is – at least what Shaikh calls ‘real competition’, in his huge Capitalism.  The continual battle to increase profit and the share of the market means monopolies are continually under threat from new rivals, new technologies and international competitors. The history of capitalism is one where the concentration and centralisation of capital increases but competition continues to bring about the movement of surplus value between capitals (within a national economy and globally).

Brett Christophers understands well this dialectical dynamic in capitalism.  In his excellent theoretical chapter 1 on Competition, he rejects the monopoly capital theory.  “Monopoly produces competition, competition produces monopoly” (Marx).  The law plays a key role in trying to achieve a balance between the inherently unstable and precarious forces of centralisation and decentralisation that Marx prognosticated.

However, Christopher seems a little ambiguous or ‘soft’ on the theoretical explanations offered for the inherently unstable nature of capitalism.  He appears to accept the view that (underlying) causes of capitalist instability cannot be found in the capitalist mode of production but, as Marxist David Harvey has argued, must really be found in the full circuit of capital (production, distribution and circulation).  To emphasise, as Marx did himself, the production of surplus value at the core of crises and imbalances is to be “productivist” (Jim Kincaid) and to exclude the “chaotic singularities of consumption” (Harvey).  The “anarchy of capitalism” is to be found in competition and exchange, not in the exploitation of labour in production (Bob Jessop).

Well maybe, but this leaves Christophers open to the massaging of Marx’s value theory so that no marks are left.  First, he appears to accept Harvey’s view that value can be created in exchange or even consumption (p74).  Second, he appears to follow the view of post-Keynesian Michal Kalecki that profits are the result of the degree of monopoly or ‘rent-seeking’, thus dismissing Marx’s clear view that new value only comes from the exploitation of labour, not from monopolistic power.   Then there is the reference to the work of mainstream economist Edward Chamberlin’s theory imperfect competition, an extension of neoclassical marginal equilibrium theory.  Marx’s value theory as the basis of the laws of accumulation of capital and competition among capitals has been ignored or chipped away by these authors.

But this is perhaps another debate.  The theme that Christophers highlights is the role of the law in evening out the anarchic swings between excessive monopoly and ruinous competition in different periods of capitalism.  This is a new insight.  As Christophers says, this is a “work of levelling not plugging” to achieve “ongoing growth – in a relatively stable fashion”.  Even that seems a generous concession to the efficacy of competition law between capitals in maintaining stable expansion and accumulation under capitalism.  Do we not note over 50 slumps or recessions in the last 200 years and three huge depressions under the capitalist mode of production, where legislation on banking, corporate monopolies, patents and intellectual property did not work in preserving ‘harmony’?

In a series of well-researched chapters, Christophers outlines the detail in the swings between monopoly and competition according to the conditions of capitalist development. He makes a convincing case for arguing that the first case of ‘legal leveling’ began at the outset of 20th century after a period of excessive competition threatened to drive capitalism into a deflationary spiral.  Legal support for monopoly powers to protect profits dominated between the world wars.  After the second world war, competition came to the fore in order to help innovation and new industries.  In turn, the neo-liberal period from the 1980s, the laws of patent and intellectual property increasingly superseded the anti-trust legislation of Golden Age of the 1960s and 1970s.

This is a powerful narrative but it is also raises questions of causation.  Should we not see company and competition laws as reactions to changes in the health of capital accumulation, rather than something that (successfully?) evens out the upswings and downswings of capitalist expansion? Christophers reckons that the profitability of capital has been “remarkably consistent” since 1945, with an average of corporate profits to GDP of 10% in the last 70 years, which “rarely strayed far from this mean” (p2).  But profits to GDP are not the measure of the profitability of capital (at least in Marxist terms) and even so there has been a wide divergence (6-14%).  All the proper measures of US profitability show a secular decline since 1945, not stability; and in particular, a fall from the 1960s to the 1980s followed by a rise during the neo-liberal period 1980-00 – and a small decline, subsequently to date (see my book, The Long Depression).

This suggests to me that corporate and competition law is more like another counteracting factor designed to react to the health and profitability of capital in the same way as globalisation, attacks on the trade unions and privatisations that we saw from the 1980s – in an attempt (partially successful) to raise profitability of capital as a whole.  After all, it is the level of profitability for capital as a whole which is key to the degree and frequency of crises rather than the sharing out of profit among capitals.

Marx argued that, as capital accumulates, it will experience regular and recurring crises of production and exchange, slumps we call them.  They occur because accumulation leads, over time, to a fall in profitability and profits, forcing capitalists into an investment ‘strike’.  However, Marx also outlined several counteracting factors to this law of the tendency of the rate of profit to fall:  greater exploitation, cheaper technology, expanding foreign trade; speculation in financial assets.  Law could be seen as another counteracting factor, introduced to curb either the excesses of ‘ruinous competition’ in driving down prices and profitability (i.e. helping to protect super profits from innovation or monopoly power); or to break down too much ‘monopoly control’ that could hamper profitability for more efficient smaller capitals or from new technology.

Indeed, one area of law that is missing from Christophers’ otherwise comprehensive analysis is labour law.  One big area of capitalist law is designed to ensure the dominance of capital in the workplace and over the production and control of surplus value.  These are even more important to capital than the laws designed to level the playing field between capitalists.

As we approach the 150th anniversary of the publication of Volume One of Marx’s Capital, we can remember that Marx spent much time recounting the role of law and regulation (inspector reports) in the struggle to protect and improve the conditions and hours of workers in Victorian factories and work places.  The battle for the 10-hour day and getting children out of dark satanic mills and mines etc.

It is no accident that the Trump administration is looking to deregulate banking and reduce environmental regulations, not to help small businesses against monopolies, but instead business in general against labour and the cost of people’s health.  Take the right to work laws of the last 30 years or more.  Following decades of declining membership, unions face an existential crisis as right-to-work laws being pushed at state and federal levels would ban their ability to collect mandatory fees from the workers they represent, a key source of revenue for organized labour.  In their first weeks in office, the new Republican governors of Kentucky and Missouri have already signed right-to-work laws, making them the 27th and 28th states, respectively, to ban mandatory union fees.

On the first page of his book, Christophers rightly highlights the comments that Keynesian guru Paul Krugman made on his blog back in 2012.  Inequality of incomes had risen sharply in the neoliberal period and the average wages of non-supervisory workers had stagnated.  The share of value going to capital had risen.  “So the story has totally shifted; if you want to understand what’s happening to income distribution in the 21st century economy, you need to stop talking so much about skills, and start talking much more about profits and who owns the capital. Mea culpa: I myself didn’t grasp this until recently. But it’s really crucial.” (Krugman)  The amiseration of the working class, as Marx called this relative poverty, appeared to be borne out.  As Krugman said, “isn’t that an old fashioned sort of Marxist discussion?”

As Christophers explains, Krugman offered two possible reasons for this amiseration: either growing monopoly profits of ‘robber barons’ (the Kalecki argument) or technology displacing labour with the means of production (the Marxist argument of labour-saving and ‘capital bias’).  The latest research on the causes of the long-term fall in US manufacturing employment alongside rising output shows that the Marxist explanation is more convincing than the Kalecki ‘monopoly rents’ one.

It’s not monopoly power or rising rents going to the ‘robber barons’ of the monopolies that forced down labour’s share, it’s just (‘real competition’) capitalism.  Labour’s share in the capitalist sector in the US and other major capitalist economies is down because of increased technology and ‘capital bias’, from globalisation and cheap labour abroad; from the destruction of trade unions; from the creation of a larger reserve army of labour (unemployed and underemployed); and from ending of work benefits and secured tenure contracts etc (labour laws).  Companies that are not monopolies in their markets probably did more of this than the big firms.

Christophers only deals with international trade law in passing, as his perceptive analysis concentrates on concentration and centralisation within national economies.  But “The Donald” is concentrating his enviable skills and focus on international law to revoke trade agreements; control the movement of labour across borders and impose tariffs and restrictions on rival powers’ exports etc.  The irony is that this will do nothing to restore manufacturing jobs and incomes in the US – quite the contrary.  No great levelling there.

Perhaps the real great leveller under capitalism is not so much laws designed to level the playing field among competing capitals –important as Christophers has shown that it is.  The real leveller is capitalist crises themselves.  In another new book, also coincidentally called The Great Leveller, Walter Scheidel, a Stanford University historian, argues that what really reduces inequality is catastrophe – either epidemics, wars or massive economic depressions.  It is a simple and perhaps crude idea.  But it is certainly true that the Great Depression of the 1930s cleansed capitalism of its unproductive and inefficient capitals and massively weakened labour to create conditions for new levels of profitability.  And the world war itself destroyed capital values (and physical capital) and introduced new military-induced technologies to exploit new layers of the global working class in the post-war boom.  That was a great leveller of the capitalist landscape (in a different sense) – to lay the basis for renewal of the profit making machine from the 1940s through the Golden Age of the 1960s.

So far the current Long Depression has not managed a similar ‘levelling’.  As Christophers says, it is unclear whether the law will be applied to reduce monopoly power as it was after 1945.  While the depression is unresolved, I doubt it.  Indeed, as Christophers confirms, the balance between competition and monopoly has moved to the international plane, with the likelihood of a new imperialist struggle that we saw at the beginning of the 20th century.

 

Trump’s 100 days

March 2, 2017

After Donald Trump delivered his first presidential address to the US Congress, the American stock market hit yet again a record high.  Since he was elected, the stock market is up over 11%.

The buoyant mood in the market for financial assets is also being mirrored in the views of the top financial analysts.  “There’s no question that animal spirits have been unleashed a bit post the election,” remarked New York Federal Reserve President William Dudley, echoing the terms of Keynesian economic thinking that economies take off when entrepreneurs feel optimistic about future sales.

And the main economic indicators in the US and global economy have been picking up.  The purchasing managers’ indexes (PMI) are surveys of companies in various countries on their likely spending, sales and investments.  And the PMIs everywhere are well above 50, meaning that more than 50% of the respondents are seeing improvement.  The global PMI now stands at its highest level (54) for three years and, according to JP Morgan economists, it suggests that global manufacturing output is now rising at a 4% pace compared to just 1% this time last year.

global-pmi

US manufacturing PMI hit its highest level for two years.

us-pmi

European economies manufacturing sectors also have seemed to turned the corner.

eurozone-pmi

Things are also looking better in the so-called emerging economies.  China has not crashed as many expected this time last year.  On the contrary, the Chinese economy has picked up and, as a result, there has been increased demand for raw materials.

china-pmi

Iron ore prices have rocketed back up, enabling the Australian economy to avoid a recession.  In the last quarter of 2016, the Aussie real GDP grew by 1.1 per cent, the strongest rate of quarterly growth over the past five years (although annual growth in 2016 was 2.4%, better than most other advanced economies, but lower than average).  India too recorded a pick-up in GDP growth to over 7%.

So good are things looking that Gavyn Davies in the FT sarcastically attacked those economists who have been talking about ‘secular stagnation’ in the major economies.  “Whatever happened to that?”, says Davies, pointing out that “Global activity growth has rebounded sharply, and recession risks have plummeted. Growth in real output is now running at higher levels than anything seen since the temporary rebound from the financial crash in 2009/10. Importantly, recent data suggest that the growth rate of fixed investment is beginning to recover, which is a body blow to one of the central tenets of the secular stagnation school.”

fulcrum-forecast

According to the Institute of International Finance, an industry association, growth in GDP across emerging markets surged to an average of 6.4 per cent in January, its fastest monthly rate since June 2011. If confirmed, this will show emerging economies reversing a downward trend in growth that has been in place since the global financial crisis.

em-prospects

Behind this apparent recovery is a small recovery in corporate profits, which up to the middle of 2016 had been slowing fast.  Since then, corporate profits have recovered somewhat around the world and,.according to JP Morgan, business investment has reversed its decline of the last year.

global-capex-jpm

Investors have responded.  Flows to emerging market equity and bond funds have begun the year positively for the first time since 2013. Foreign investors withdrew more than $38bn from EM stocks and bonds in the last three months of 2016 but sent more than $12bn back to those markets in January, the IIF estimates.

debt-flows

Even world trade growth, which has been abysmal and stopping rising altogether at the beginning of 2016, rose 2% at the end of last year (but still way below 3-4% rate in 2015).

So it would seem that the ‘Trump rally’ in stock markets is being accompanied by stronger economic growth and an end to the risk of deflation and stagnation.  Indeed, it is now expected that the US Federal Reserve Bank may well be confident enough to decide to raise its policy interest rate again this month, having stalled on its planned hikes after December.

But as I have argued before in previous posts, financial markets and mainstream economists may be getting ahead of themselves.

Is the US economy really going to leap forward from its sluggish pace of 2% or less that it has achieved since 2009?  Indeed, revised data for US real GDP growth in the last quarter was just 1.9% year over year, actually below the average growth rate since the end of the Great Recession.

us-real-gdp

It is no accident that the wild claims by Trump that his policies would lead to the US economy soon growing at a 4% rate have already been watered down.  Barely a month into Trump’s presidency, his advisers have already downgraded that rather elevated forecast. Steve Mnuchin, Trump’s recently confirmed Treasury secretary who is a former banker at Goldman Sachs, substantially downgraded the Trump’s goal for economic growth to just 3%.  And the Federal Reserve has proved to be wrong repeatedly in its forecast of faster economic growth.

Moreover, business investment growth slowed to a trickle. Investment badly needs a boost if the US economy is to sustain any significant growth rate, let alone the claimed 3-4% target of the Trump administration.  With business investment so weak, US economic growth is not going to accelerate unless corporate profits leap forward and government investment steps up to the plate.

us-investment

Business investment contributed just 0.17 percentage point to GDP growth in the last quarter of 2016, while government investment has collapsed.

us-government-investment

That, of course, is the Trump plan (such as he can explain it), namely to cut corporate taxes to raise after-tax profits and to introduce an infrastructure investment programme.  We shall see.  But corporate profit margins (profit per unit of sales) are not rising but narrowing and the fiscal multiplier effect of any Trump government investment stimulus is likely to be small.

There has been little sign of a recovery in real GDP per person in the US since the Great Recession – on the contrary – and that is the real indicator of (average) economic success.

real-gdp-per-capita

And what happens in the US has a profound influence on the rest of the capitalist world.  There is a close synchronisation of growth rates between the US and the rest of the world economy. Recent research indicates that the US appears to influence the timing and duration of recessions in many major economies.  Estimates indicate that a percentage-point increase in US growth could boost growth in advanced economies by 0.8 of a percentage point, and in emerging market and developing economies by 0.6 of a percentage point after one year.

correlations

Sources: Haver Analytics; World Bank; Kose and Terrones (2015); IMF.
Notes: Contemporaneous correlations between cyclical component of US real GDP and cyclical component of real GDP of advanced economies and emerging economies.

But it also works the other way.  A fall in US economic growth will weaken growth rates elsewhere and any crash in the US stock market will quickly spread abroad.  Estimates suggest that a sustained 10% increase in US stock market volatility could, after one year, reduce investment growth in the US by about 0.6 of a percentage point, in other advanced economies by around 0.5 of a percentage point, and in emerging market and developing economies by 0.6 of a percentage point.

As I have pointed out before, the US stock market is looking ‘overvalued’ and liable to a crash.

sp-500 sp-500-to-sales

The stock market price compared to sales by the companies in the stock market is back at levels not seen since the last crash in 2000.

As I have argued before, the key indicators to tell you if the US and world economy is starting to grow faster or is slipping back are the movement of profits and investment.  In the last half of 2016, corporate profits moved back into positive territory.  To finish off the batch of graphs in this post, here is my measure of global corporate profit growth up to end-2016.

global-profits-updated

Where this graph goes in 2017 is crucial to an analysis of the future.

Kenneth’s three arrows

February 25, 2017

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Endogenous theory recognised what any fool could see: that supply was affected by demand but also demand was affected by supply.  Innovation did not come out of the sky but from the drive of companies to grow (or in the case of Marxist theory, to make more profit and reduce labour costs). Of course, the neoclassical version of growth theory did not consider profitability relevant to innovation but instead looked at aggregate output.  This theory became popular with many reformist economists and politicians – apparently, former adviser and minister in the British Gordon Brown Labour government, Ed Balls, was a keen promoter.

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

ADDENDUM

 

I omitted to mention that, despite being an apparent standard bearer of neoclassical general equilibrium theory, Arrow was by no means a supporter of capitalism. Indeed, he wrote an article in fall 1978 in Dissent magazine making a ‘cautious case for socialism’.

https://www.dissentmagazine.org/…/a-cautious-case-for-socia…

It’s not a Marxist view (“It was in this area of political-economic interactions that Marxist doctrine was most appealing. I was never a Marxist in any literal sense”) but Arrow still exposed many faultlines in capitalism: “as I observed, read, and reflected, the capitalist drive for profits seemed to become a major source of evil”.

“The absorption of the economy by a small elite implied that the formal democracy and freedom was increasingly a sham; the major decisions on which human welfare depended were being made by a few, in their own interests.”

“To sum up, the basic values that motivated my preference for socialism over capitalism were (1) efficiency in making sure that all resources were used, (2) the avoidance of war and other political corruptions of the pursuit of profits, (3) the achievement of freedom from control by a small elite, (4) equality of income and power, and (5) encouragement of cooperative as opposed to competitive motives in the operation of society.”

“There can be no complete conviction on this score until we can observe a viable democratic socialist society. But we certainly need not fear that gradual moves toward increasing government intervention or other forms of social experimentation will lead to an irreversible slide to “serfdom.”
It would be a pleasure to end this lecture with a rousing affirmation one way or the other. But as T. S. Eliot told us, that is not “how the world will end.” Experiment is perilous, but it is not given to us to refrain from the attempt.”

Inequality after 150 years of Capital

February 19, 2017

I have written many posts on the level and changes in inequality of wealth and incomes, both globally and within countries.  There has been a ‘wealth’ of empirical studies showing rising inequality in incomes and wealth in most capitalist economies in the last century.

There have been various theoretical explanations provided for this change.  The most famous is by Thomas Piketty in his magisterial book, Capital in the 21st Century.  This book won the award for the most bought, least read book in 2014, surpassing A brief history of time by scientist Stephen Hawking.

I and others have discussed the merits and faults of Piketty’s work in many places.  Please read these to get a picture.  Suffice it to say that, although Piketty repeats the title of Marx’s book, published exactly 150 years ago, he dismisses Marx’s analysis of capitalism based on the law of value and the tendency of the rate of profit to fall and adopts the mainstream theories of marginal productivity and/or market ‘imperfections’ like ‘rent-seeking’.  This leads to the view that capitalism could be ‘reformed’ and inequality reduced by such measures as a global financial tax or progressive inheritance taxes or more recently a universal basic income (Piketty is now advising French socialist presidential candidate Hamon on this now).

Inequality remains the buzz word of liberal and leftist debate and analysis, not crisis and slump.  Widening inequality has been called “one of the key challenges of our time” by the World Economic Forum, the think-tank of the elite. The ratings agency S&P Global Ratings has cited the income gap as a long-term trend that threatens America’s economic growth. Even the major international agencies like the IMF or the OECD continually analyse movements in inequality to see if more equality would be better for growth and a more stable capitalism.

Post-Keynesian economists like Engelbert Stockhammer or more radical mainstreamers like Joseph Stiglitz reckon rising inequality is the main cause of crises, not falling profitability or the inherent instability of capital as a money-making machine. Again I have discussed these arguments here.

But whatever the causes and processes concerned with inequality of incomes and wealth in the major economies, there is no doubt that it has reached levels not seen since Marx published Capital.  Indeed, here is an interesting chart that tries to gauge the level of inequality reached in the UK back in 1867.  The gini coefficient is the most common measure of inequality of income or wealth.  And in this graph, provided by the global inequality expert, Branco Milanovic, the gini ratio reached over 55 in 1867.

uk-per-cap

According to the graph, that was the peak of inequality and it fell back over the next 100 years, thus appearing to refute Marx’s view that the working class would suffer ‘amiseration’ as capital took a growing share of value produced by labour.  Instead, it would appear to confirm the mainstream view of Simon Kuznets written in the 1960s that once capitalism got going and started delivering economic growth, the forces of market, if not interfered with, would steadily bring forth a more equal society.  The irony is that just as Kuznets reached this conclusion, most major capitalist economies began to generate an increase in inequality in both income and wealth – as the graph shows.

But don’t be fooled by the graph that it seems to show a huge jump in GDP per capita in dollars from 1867 to now.  It’s misleading.  It does not show whether the jump is due to faster economic growth or just slowing population growth in the UK (actually it is the latter).  And of course, it does not show the huge downturns in GDP caused by recurring and regular crises under capitalism in Britain and elsewhere.

The graph does reveal, however, that inequality has been worsening in England to levels not seen since the 1920s.  Indeed, in a new analysis of the World Income Database Piketty and colleagues from the Paris School of Economics and UC Berkeley, describe a “collapse” of the share of US national wealth claimed by the bottom 50% of the country — down to 12% from 20% in 1978 — along with an (unsurprising) drop in income for the poorest half of America. About 117 million American adults are living on income that has stagnated at about $16,200 per year before taxes and transfer payments, Piketty, Saez and Zucman found in research published last year.

And that makes an important point.  The top 1 percent of earners in America now take home about 20 percent of the country’s pretax national income, compared with less than 12 percent in 1978, according to the research the economists published at the National Bureau of Economic Research. Over the same time in China, the top 1 percent doubled their share of income, rising from about 6 percent to 12 percent. America has experienced “a complete collapse of the bottom 50 percent income share in the U.S. between 1978 to 2015,” the authors wrote. “In contrast, and in spite of a similar qualitative trend, the bottom 50 percent share remains higher than the top 1 percent share in 2015 in China.”

Meanwhile, economic growth in China has been so strong that — despite widening inequality — the incomes of the bottom 50 percent have also “grown markedly”, the economists wrote. Their analysis found that the poorest half of Chinese workers saw their average income grow more than 400 percent from 1978 to 20015. For their American counterparts, income decreased 1 percent.“This is likely to make rising inequality much more acceptable” in China, they noted. “In contrast, in the U.S. there was no growth left at all for the bottom 50 percent (-1 percent).”

The IMF and other agencies like the World Bank like to argue that economic growth has picked up so much under capitalism that millions have been taken out of poverty. But economic experts in the field of poverty and global inequality reveal from their figures that official ‘poverty’ has declined for just two reasons.  The first is that the definition of poverty of those living on less than$1 a day is out of date; and second because nearly all the decline has been in China due to its unprecedented economic growth under a state-controlled and directed economy, still far from market capitalism seen in 19th and 20th century capitalism that Piketty and others have analysed.  In most low income countries inequality has hardly changed from very high levels.

growth-and-poverty

And the main reason is the control of wealth.  A very small elite owns the means of production and finance and that is how they usurp the lion’s share and more of the wealth and income.  The US Economic Policy Institute found that the top one percent of society derives an increasing portion of income gains from existing capital and wealth.  It is not because they are smarter or better educated.  It is because they are lucky (like Donald Trump) and inherited their wealth from the parents or relatives.

concentration-of-wealth

A recent study by two economists at the Bank of Italy found that the wealthiest families in Florence today are descended from the wealthiest families of Florence nearly 600 years ago!  So the rise of merchant capitalism in the city states of Italy and then the expansion of industrial capitalism and now finance capital made little or no difference to who owned the wealth. And the work of Emmanuel Saez and Gabriel Zucman has shown that in the US, wealth has become increasingly concentrated in the hands of the super-rich.

extremely-wealthy

So Marx’s prediction 150 years ago that capitalism would lead to greater concentration and centralisation of wealth, in particular in the means of production and finance, has been borne out.  Contrary to the optimism and apologia of the mainstream economists, poverty for billions around the world remains the norm with little sign of improvement, while inequality within the major capitalist economies increases as capital is accumulated and concentrated in ever smaller groups.

The global paradox

February 14, 2017

Most people missed it but America’s intelligence services also looked recently at developments in the world economy.  The Office of the Director of National Intelligence (DNI)  published its latest assessment, called Global Trends: The Paradox of Progress, which “explores trends and scenarios over the next 20 years”.

The DNI concludes that the world is “living in paradox – industrial and information age achievements are shaping a world both more dangerous and richer with opportunity. Human choices will determine whether promise or peril prevails.”  The DNI praises capitalism over the last few decades for “connecting people, empowering individuals, groups, and states and lifting a billion people out of poverty in the process.”

But American capital’s eyes and ears are worried about the future.  There have been worrying “shocks like the Arab Spring, the 2008 Global Financial Crisis, and the global rise of populist, anti-establishment politics. These shocks reveal how fragile the achievements have been, underscoring deep shifts in the global landscape that portend a dark and difficult near future.”  All these developments are bad things for global capital and American supremacy, it seems.  And the DNI reckons that things are not going to get better.  The next five years will see rising tensions within and between countries. Global growth will slow, just as increasingly complex global challenges impend.”

What is the answer?  Well, this comment from the DNI report is unvarnished: It will be tempting to impose order on this apparent chaos, but that ultimately would be too costly in the short run and would fail in the long. Dominating empowered, proliferating actors in multiple domains would require unacceptable resources in an era of slow growth, fiscal limits, and debt burdens. Doing so domestically would be the end of democracy, resulting in authoritarianism or instability or both. Although material strength will remain essential to geopolitical and state power, the most powerful actors of the future will draw on networks, relationships, and information to compete and cooperate. This is the lesson of great power politics in the 1900s, even if those powers had to learn and relearn it.”

In other words, while it would be better to just crush opposition and “impose order” in America’s interests, this is probably not possible with a weak world economy and lack of funds.  Better to try “draw on networks, relationships and information” (ie spy and manipulate) to get “cooperation”.

But it is not going to be easy to sustain America’s dominance and the rule of capital, the DNI report concludes, as globalisation “hollowed out Western middle classes  (read working classes) and stoked a pushback against globalization.”  Moreover, “migrant flows are greater now than in the past 70 years, raising the specter of drained welfare coffers and increased competition for jobs, and reinforcing nativist, anti-elite impulses.” And “slow growth plus technology-induced disruptions in job markets will threaten poverty reduction and drive tensions within countries in the years to come, fueling the very nationalism that contributes to tensions between countries.”

You see, the problem is that the population of America and its capitalist allies are getting older and the new powers have younger, more productive populations.  Yet capitalism cannot deliver for these growing populations in the so-called ‘developing countries’.  Meanwhile, “automation and artificial intelligence threaten to change industries faster than economies can adjust, potentially displacing workers and limiting the usual route for poor countries to develop.”  And then there is climate change and environmental disasters that will entail. This is all going to “make governing and cooperation harder and to change the nature of power—fundamentally altering the global landscape.”

So it is not a pretty picture beneath all the optimistic talk and fanfare we heard from the rich elite at Davos only last month.  Instead, the DNI reckons “challenges will be significant, with public trust in leaders and institutions sagging, politics highly polarized, and government revenue constrained by modest growth and rising entitlement outlays. Moreover, advances in robotics and artificial intelligence are likely to further disrupt labor markets.”  The DNI tries to sound hopeful at the end of this litany of dangers to global capitalism but they are not convincing.

I have posted before about the clear signs that the age of globalisation and capital’s expansion at the expense of labour everywhere appears over.  Another indicator of this was a report from the US-based Global Financial Integrity (GFI) and the Centre for Applied Research at the Norwegian School of Economics.  The report found that trade misinvoicing and tax havens mean the world’s givers are more like takers.  The GFI tallied up all of the financial resources that get transferred between rich countries and poor countries each year: not just aid, foreign investment and trade flows but also non-financial transfers such as debt cancellation, unrequited transfers like workers’ remittances, and unrecorded capital flight (more of this later).  What they discovered is that the flow of money from rich countries to poor countries pales in comparison to the flow that runs in the other direction.

In 2012, the last year of recorded data, developing countries received a total of $1.3tn, including all aid, investment, and income from abroad. But that same year some $3.3tn flowed out of them. In other words, developing countries sent $2tn more to the rest of the world than they received. If we look at all years since 1980, these net outflows add up to $16.3tn – that’s how much money has been drained out of the global south over the past few decades.

Developing countries have forked out over $4.2tn in interest payments alone since 1980 – a direct cash transfer to big banks in New York and London, on a scale that dwarfs the aid that they received during the same period. Another big contributor is the income that foreigners make on their investments in developing countries and then repatriate back home.  But by far the biggest chunk of outflows has to do with unrecorded – and usually illicit – capital flight. GFI calculates that developing countries have lost a total of $13.4tn through unrecorded capital flight since 1980.

Most of these unrecorded outflows take place through the international trade system. Basically, corporations – foreign and domestic alike – report false prices on their trade invoices in order to spirit money out of developing countries directly into tax havens and secrecy jurisdictions, a practice known as “trade misinvoicing”. Usually the goal is to evade taxes, but sometimes this practice is used to launder money or circumvent capital controls. In 2012, developing countries lost $700bn through trade misinvoicing, which outstripped aid receipts that year by a factor of five.

But now global trade growth has slowed to a trickle and capital flows are also falling back.  It has become just that more difficult for multi-nationals and banks to exploit the global south as a way to boost profitability from its decline in the global north.

capital-flows

The ratio of import growth to real GDP growth in the major economies has fallen back sharply.

import-elasticity

The DNI report suggests that increased rivalry over the spoils of imperialism in the 1900s led to a world war.  The DNI reckons that “Although material strength will remain essential to geopolitical and state power, the most powerful actors of the future will draw on networks, relationships, and information to compete and cooperate”.  Compete and cooperate?  And Trump in the presidency?

Apple and the cash pile story

February 8, 2017

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

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

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

apple-tax-bill

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

apple-cash

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

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

cash-hoard

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

cash-to-asset

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

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

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

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

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

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

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

Share prices, profits and debt

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

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

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

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

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

us-fixed-investment

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

us-manuf-prod

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

ross

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

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

global-corporate-profits

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

casey-1

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

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

casey-2

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

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

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

valuation

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

France: penned in

February 1, 2017

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

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

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

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

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

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

french-gdp

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

french-rop

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

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

change-in-rop

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

change-in-investment

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

labour-productivity

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

levels

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

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

Abenomics: an update

January 27, 2017

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

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

Japan monetary base

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

japan-fiscal

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

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

japan-inflation

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

japan-core-inflation

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

japan-gdp

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

japan-per-cap

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

japan-household-spend

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

japan-profitability

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

japan-corporate-taxes

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

japan-social-security

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

japan-real-comp

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

japan-cap-form

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

japan-productivity

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

 

 

Beware the zombies

January 23, 2017

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

nrr-ameco

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

us-corporate-debt

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

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

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