By Mick Brooks       

There has been a debate in recent years within the IMT as to the cause of capitalist crisis. On one side were those who stressed Marx’s tendential fall in the rate of profit as the underlying cause of crisis. The leadership adopted what we shall call an underconsumptionist position. To some this debate may have seemed a little academic. Its importance is revealed by a recently posted comment on Marxist.com on the world economy by Rob Sewell entitled ‘Another day, another crisis.’       

 

Sewell begins by trawling through the Financial Times for alarmist quotes. Long ago Bing Crosby sang a song. ”You gotta accentuate the positive, eliminate the negative”. Sewell adopts the opposite approach. The economic situation is indeed grievous but he steadfastly ignores any quote that indicates that the end of the capitalist world is not yet nigh (still a majority view at the FT). This is the method he has used in economic ‘perspectives’ for thirty years past. It is not the scientific method of Marxism. Still, a clock that has stopped is still right twice a day.

 

Sewell asserts that, “the bourgeois economists” (which bourgeois economists?) “declared the crisis over in the summer of 2009”. Now this is strange, since he later declares inaccurately that, “the mass of profit slumped in 2009.” He then uses his selective quotes from the FT to rubbish this anonymous prediction of recovery. He concludes that the crisis “has got far worse” (than in 2008, when financial meltdown was widely expected) and that the fiscal contraction in the USA, “could be enough to drag the economy into a double-dip recession”.

 

The reader is led by the whole thrust of the article to believe that this is probable. But there is always a get-out in such predictions by Rob Sewell. This is not the method of Marxism. It is the method of Old Moore’s Almanac. The gullible reader finds that ‘fortune may favour you today’, goes out and bets £50 on a horse and loses the lot. He then remonstrates with the author of the Almanac, who replies, ‘we only said fortune may favour you.’ Sewell’s equivalent to that is that this “could be enough to drag the economy into a double-dip recession”.

 

Predictions get even wilder when Sewell foresees what will happen after the break-up of the Euro, (which after all hasn’t happened yet – though it is very insecure). He compares this to the collapse of the rouble area after 1993, which, “resulted in hyper-inflation and a collapse in living standards. Other parallels can be made with Germany in 1923.” The position of the Euro is indeed critical and its break-up would be a calamity for the entire world economy, but why this would take the form of hyper-inflation (In Germany? In Holland? In Finland?) is unexplained. Likewise the assertion that we face “decades of austerity” shows a degree of foresight verging on the divine.

 

Sewell then goes on to explain that Marx, “explained the contradiction of a system based upon the drive for profit”. He then adduces the usual quote used by the IMT leadership that, “The ultimate reason for all real crises always remains the poverty and restricted consumption of the masses, in the face of the drive of capitalist production to develop the productive forces as if only the absolute consumption of society set a limit to them.” The idea is that the workers can’t buy back the commodities they produce.

 

Unusually, Sewell actually gives a citation, so the reader can check. (It’s the Penguin edition of Capital Volume III, by the way.) This quote is a mere aside in one of three chapters on ‘Money Capital and Real Capital’. Marx did not have the opportunity to edit this volume of Capital in his lifetime. Volume III was compiled by Engels from Marx’s notebooks.

 

More to the point, this is the only quote ever used in Socialist Appeal on crisis theory. We wonder why Marx bothered to write anything else on the subject, and he actually wrote quite a lot. This quote is the classic foundation statement of the underconsumptionist school of Marxism. The trouble with the theory is that the workers can never buy back the commodities that they produce, either in slump or boom. It is an essential condition of capitalism that the workers produce surplus value. “The poverty and restricted consumption of the masses” cannot therefore explain the onset of crisis.

Here is Engels’ view. "But unfortunately the underconsumption of the masses, the restriction of the consumption of the masses to what is necessary for their maintenance and reproduction, is not a new phenomenon. It has existed as long as there have been exploiting and exploited classes. Even in those periods of history when the situation of the masses was particularly favourable, as for example in England in the fifteenth century, they underconsumed. They were very far from having their own annual total product at their disposal to be consumed by them. Therefore, while underconsumptionism has been a constant feature in history for thousands of years, the general shrinkage of the market which breaks out in crises as a result of a surplus of production is a phenomenon only of the last fifty years;" (Anti-Duhring pp.395-6).

 

What actually happened to the consumption of the masses during the course of the Great Recession? It fell in absolute terms on account of the fall in production. But it actually increased as a percentage of GDP because investment fell more. This is the normal course of a capitalist recession, which is characterised above all by an investment slump on account of the fall in profits.

 

Robert Higgs, of the Independent Institute in California says that US consumer spending as a share of GDP actually increased during the Great Recession, going up from 69.2% in the fourth quarter of 2007 to 71% in the second quarter of 2009.  In contrast, private domestic US investment peaked in the first quarter of 2006 when $2.3trn (in 2005 dollars) were spent by firms, worth 17.5% of GDP; it troughed in the second quarter of 2009, having collapsed by 36% to $1.45trn, 11.3% of US GDP.

 

Sewell goes on to deal with nameless people on the left who, “have tried to explain the crisis exclusively by reference to profitability.” In other words these people are taking his earlier assertion that capitalism is “based on the drive for profit” seriously. Tsk, tsk! He seems to be taking aim at Karl Marx in particular as the guilty one, for it was he who declared, “This law, and it is the most important law of political economy, is that the rate of profit has a tendency to fall with the progress of capitalist production” (Marx Engels Collected Works Volume 33, p.104).

 

He goes on to assert that these unnamed people, “attempt to equate the level of profits as an indication of the health of capitalism, but this is very simplistic.” Indeed it is, and we know of no Marxist theorist who does this. Certainly Marx didn’t. But profits matter in a society where production is for profit. Profits tend to rise in an upswing and fall as capitalism enters recession. The rate of profit is the ultimate determinant of the boom-slump cycle. Is that so hard to understand?

 

Sewell points to an ‘enigma’ that profits have since recovered, in 2010 according to his view. He goes on: “However to conclude that US capitalism is relatively healthy is fundamentally wrong, as can be seen from the sluggish growth, continuing high unemployment and declining productivity”. The enigma is one that exists only in Sewell’s mind.

 

Sewell’s critique of those who see the rate of profit as critical is a parody of Marx’s position. Marx discusses the tendential fall in the rate of profit in Chapters 13-15 of Volume III of Capital and deals with its effect as an underlying cause of crisis in a dialectical way. In particular he deals with the destruction of capital that takes place in a slump, that is required to prepare the conditions for a new upturn. These chapters are central in understanding the cause of capitalist crisis today.

 

Sewell’s discussion of the “level of profits” is very frustrating. Is he referring to the mass of profits or the rate? Which country’s profits is he using as his guide? What are his sources?  He must be using secret measures of profitability, as nobody else in the world comes to the same conclusion as he does. We have to ask - is he just making it up?

 

He asserts that, “The mass of profits slumped in 2009 after the collapse of world trade.” He says this to ‘prove’ that profits collapsed after the recession and because of the recession, in particular after the collapse in world trade. Therefore in his view the fall in profits was not the cause of the recession. This is intended to buttress his underconsumptionist theory of the crisis. This is bunkum.

 

We shall quote the profit figures (mass of profits) of the USA from the Bureau of Economic Analysis. These are the official figures and America has the best economics statistics in the world. Unlike Sewell’s assertions, anyone can check the figures on the BEA website. Just Google in BEA and you’re there.

The BEA has pre-tax and post-tax profits and other technical details, and makes small revisions to the statistics as new information comes in, but the broad picture is very clear. The figures below are for pre-tax corporate profits. Of course these figures are not drawn up from a Marxist point of view, but all other profit statistics we have seen show the same trends and turning points as those of the BEA.

 

The US Bureau of Economic Analysis shows that in the 3^rd quarter of 2006 the mass of pre tax profits peaked at $1,865bn (the rate of profit was already falling before that). By the 4^th quarter of 2008 it bottomed out at $868bn. This fall in profits is five quarters before the onset of the Great Recession in August-September 2007and six quarters before US GDP peaked. It is also six quarters before world trade figures peaked, so the idea that the collapse in world trade caused the fall in profits is completely off the wall.

 

This represents a fall of more than one half in the mass of US corporate profits. The collapse in profits that the BEA records from 2006 would have caused a recession in any case, with or without a banking crisis. A halving in the mass of profits is catastrophic for capitalism and explains on its own the severity of the Great Recession. This shows that the fall in the rate and mass of profit was the underlying cause of the crisis.

 

What happened in 2009? Contrary to Sewell’s assertion profits began to recover. In the first quarter they were $1,209bn and by the fourth quarter they were up to $1,723bn. The idea that they fell in consequence of the crisis is therefore false. Sewell can only defend the IMT’s crisis theory by systematically misrepresenting the facts. If he cannot interpret the past correctly, what chance is there of providing a correct perspective for the future?

Finally, there is the statement that “capitalism has reached its limits”. We have heard this before. The official leaders of the Fourth International, Cannon, Healy and the rest of them, all asserted after the Second World War that a post-War boom was utterly impossible because “capitalism has reached its limits”. Who opposed this view? Ted Grant.

 

The logic of the position that capitalism has reached its limits is that we are approaching a final crisis of capitalism. This was part of the ‘theory’ of the German Communist Party in the third period (1929-33) which caused them to refuse any attempt at a united front with the Social Democrats, disarmed them and led directly to the victory of Hitler. Of course Sewell’s ultra-left economic perspectives will have no such disastrous consequences, since the IMT is a much less important force than the German Communist Party.

 

He is in effect offering a perspective of permanent crisis, with “decades of austerity”. This prediction is unexplained and frankly mad. Any upturn would disorientate IMT supporters. Though the economic perspectives for the years ahead are gloomy, capitalism will never just collapse. It must be overthrown. There can be therefore no final crisis of capitalism, (as Sewell is suggesting without actually saying) and eventually capitalism will go through an upturn unless there is a workers’ revolution.

 

Older comrades will recall the Socialist Labour League, later the Workers’ Revolutionary Party, led by Gerry Healy which came out with ultra-left economic perspectives that were constantly falsified. It was a parody of third period Stalinism. Naturally the SLL/WRP had a huge turnover of membership as a result. It is distressing to hear Grant’s supposed heirs coming out with what increasingly sounds like a Healyite rant, and an innumerate one at that.

I have great respect for many rank and file supporters of the IMT. The world economy is indeed in great difficulty, and that should open up opportunities for revolutionaries. I shall return to an analysis of world economic perspectives in a forthcoming book. But the IMT membership deserves better than this.

The attached document is a draft document by Jeppe Druedahl refuting the theory that overproduction is the root of capitalist crisis. 

By Mick Brooks

The purpose of this article is to show the explanatory power of Marxist analysis in looking at the dynamics of capitalism. The laws of motion of the system affect all our daily lives profoundly. Having a basic grasp of these laws of motion helps us to understand how changes in social being produce changes in consciousness and thus to participate in the fight for a better society – socialism.

 

This is not yet another attempt to repeat Marx’s analysis. This has been done thousands of times, including by the present author (See Brooks, Sewell and Woods-What is Marxism?). At best surveys of that kind will take the reader back to Capital which is, of course, the definitive treatment.

Neither is it an attempt to ‘prove’ the labour theory of value, as Marxists have been challenged to do over and over again. It is intended rather to show the dramatic effects that the operation of the law of value has on working people’s lives.

 

Chapter 1: The problem of value

Value

Marx begins his analysis in Capital Volume I with the commodity. The commodity is first a useful thing. That does not mean it has to be a material thing, as Marx makes clear. But use values are incommensurable. How do we compare apples with oranges?

Secondly it is an exchange value, which means it can be compared and exchanged with other commodities. To possess this quality of exchangeability commodities must possess a common property they share with one another – value. What does this common property consist of? Marx concludes that, “If then we leave out of consideration the use value of commodities, they have only one common property left, that of being products of labour” (Capital Volume I, p.128)

This approach to the problem of value is daunting to the first time reader, as Marx himself recognised. We intend to approach the issues in a different way. When his friend Kugelmann raised the difficulty of his approach in 1868, the year after the publication of Capital, Marx replied as follows:

“The chatter about the need to prove the concept of value arises only from complete ignorance both of the subject under discussion and of the method of science. Every child knows that any nation that stopped working, not for a year, but let us say, just for a few weeks, would perish. And every child knows, too, that the amounts of products corresponding to the differing amounts of needs demand differing and quantitatively determined amounts of society’s aggregate labour. It is self-evident that this necessity of the distribution of social labour in specific proportions is certainly not abolished by the specific form of social production; it can only change its form of manifestation. Natural laws cannot be abolished at all. The only thing that can change, under historically differing conditions, is the form in which those laws assert themselves. And the form in which this proportional distribution of labour asserts itself in a state of society in which the interconnection of social labour expresses itself as the private exchange of the individual products of labour, is precisely the exchange value of these products.” (Marx-Engels Selected Correspondence, p.209)

This is our starting point:

• All societies have to work in order to live.
• All societies have to allocate the labour available to them according to their priorities.
• In a market economy this proportional allocation of the products of labour is regulated through the exchange value of commodities.
• The exchange value of commodities is determined on average by the (socially necessary) labour time required to produce them.

 

Socially necessary labour time

Corresponding to the twofold nature of the commodity is the twofold nature of the labour that produces it. Concrete labour produces specific use values, but use values are incommensurable. Marx shows that the substance of value is abstract labour. Abstract labour may be regarded as labour from the general pool of labour power available to any society. The magnitude of value is determined by the amount of labour time necessary to produce the commodity. Equal quantities exchange for one another. Marx goes on to qualify this at once:

“Some people might think that if the value of a commodity is determined by the quantity of labour spent on it, the more idle and unskilful the labourer, the more valuable would his commodity be, because more time would be required in its production. The labour, however, that forms the substance of value, is homogeneous human labour, expenditure of one uniform labour power. The total labour power of society, which is embodied in the sum total of the values of all commodities produced by that society, counts here as one homogeneous mass of human labour power, composed though it be of innumerable individual units. Each of these units is the same as any other, so far as it has the character of the average labour power of society, and takes effect as such; that is, so far as it requires for producing a commodity, no more time than is needed on an average, no more than is socially necessary. The labour time socially necessary is that required to produce an article under the normal conditions of production, and with the average degree of skill and intensity prevalent at the time…

“We see then that that which determines the magnitude of the value of any article is the amount of labour socially necessary, or the labour time socially necessary for its production.” (Capital Volume I, p.129)

• The value of a commodity is determined on average by the socially necessary labour time involved in its production.

 

Market forces

The amount of socially necessary labour time to make the commodity is proportional to its price. We are treating money here as the monetary expression of labour time. Labour is not consciously allotted to different purposes. The division of labour is implemented through private exchanges mediated with money.

Let us look at how the allocation of labour is determined through the exchange process under capitalism which is, after all, an unplanned system. How many commodities of each type shall be produced? How much labour time shall be allocated to the production of each? These matters are decided by the impersonal forces of the market. The exchange of commodities is not just a private matter concerning the owners of the commodities. In fact every individual act of exchange is subject to objective economic laws that go to shape the dynamics of the entire capitalist system.

Exchange is the way that a vast global division of labour is established under capitalism through the world market. Capitalism is an unplanned system. Too many of some sorts of commodities are continually being produced, so prices fall below their value in the glut. Too few are produced of others so prices rise above their value with the shortage. How could it be otherwise, since nobody knows how much is the ‘right’ amount to fulfil demand at any point in time? So the capitalists just go ahead, get the commodities produced, and hope they can sell them. Some make fortunes, others fail.

Commodities are usually sold above or below their value, subject to the forces of supply and demand. Only accidentally or occasionally are they actually sold at their value. But value is the axis around which the day to day movement of prices oscillates. Marxists do not deny the importance of supply and demand. For us these surface forces are the executors of the fundamental laws of motion of capitalism identified by Marx. As John Stuart Mill put it, the palpitations of the waves upon the surface of the sea do not negate the fact that there is a sea level and that it varies according to the pull of the tides.

• The law of value is executed by the forces of supply and demand in an unplanned society where commodity production is universal.

 

What drives capitalism?

The establishment of this average socially necessary labour time is no abstract process outlined in books. In introducing the concept, Marx offers the following example:

“The introduction of power looms into England probably reduced by one half the labour required to weave a given quantity of yarn into cloth. The handloom weavers, as a matter of fact, continued to require the same time as before; but for all that, the product of one hour of their labour represented after the change only half an hour’s social labour, and consequently fell to one-half its former value.” (ibid p.129)

The determination of value by the amount of socially necessary labour time means that the quicker the commodity can be produced, the less it will cost. The speed with which the commodities can be produced depends on the productivity of labour. The power loom wiped out the handloom weavers on account of its greater productivity.

The formation of the socially necessary labour time for weaving cloth predominantly by power looms was a huge and dramatic incident in the early history of the British working class movement. It was an event, stretching over decades, which caused the impoverishment and ruin of hundreds of thousands of handicraft workers and their families. And the determination of socially necessary labour time in this devastating and revolutionary fashion is a continuous process under capitalism, causing upheaval and destroying livelihoods as it goes on.

What are the mechanisms driving this apparently impersonal operation of market forces? They are twofold: the need for the capitalists to exploit the working class more and more effectively; and the impulsion caused by competition between the capitalists themselves. As we shall see these processes are interrelated.

• Capitalism is driven by competition between capitalists and by the need all capitalists feel to exploit their workers more effectively.

 

Chapter 2: Exploitation

Exploitation and class society

All societies, as Marx reminded Kugelmann, have to work for a living. All societies have to allot the products of the total labour among their members. Marx calls the labour required to produce the goods that make up the subsistence of the toilers necessary labour.

When the productivity of labour rises sufficiently to produce a surplus over and above the subsistence needs of the population, the question will be posed: who is to enjoy this surplus? The ruling class in all forms of class society is that section of the population that grabs and appropriates the surplus. Exploitation in all forms of class society is nothing else but the extraction of surplus labour by the ruling class from the toiling and exploited classes. Under capitalism this exploitation is hidden behind a veil, a veil that Marx was committed to pierce:

“Capital has not invented surplus labour. Wherever a part of society possesses the monopoly of the means of production, the labourer, free or not free, must add to the working time necessary for his own maintenance an extra working time in order to produce the means of subsistence for the owners of the means of production, whether this proprietor be the Athenian devotee of the good and the beautiful, Etruscan theocrat, Roman citizen, Norman baron, American slave owner, Wallachian Boyar, modern landlord or capitalist.” (Capital Volume I, pp.344-5)

Marx cites the Reglement organique written by the Boyars (landlord class) of what is now Romania to show that exploitation was central to their class society and to any class society. The Reglement was a kind of rule book specifying how much corvee (an obligation to perform unpaid labour) must be performed by the peasantry. The ‘beauty’ of this document, from Marx’s point of view, is that the principle of exploitation is spelled out and transparent. As he points out in the passage above, the ruling class in all forms of class society legitimises its exploitation through its ownership of the means of production. One difference between capitalism and the rule of the Boyars is that the right to snaffle unpaid labour from the peasantry is written down in a book!

“The comparison of the greed for surplus labour in the Danubian Principalities with the same greed in English factories has a special interest, because surplus labour in the corvée has an independent and palpable form. (ibid p.345)

“The necessary labour which the Wallachian peasant does for his own maintenance is distinctly marked off from his surplus labour on behalf of the Boyar. The one he does on his own field, the other on the seignorial estate. Both parts of the labour time exist, therefore, independently, side by side one with the other. In the corvée the surplus labour is accurately marked off from the necessary labour.” (ibid p.346)

In practice the Reglement allowed for unlimited exploitation. “The 12 corvée days of the Reglement organique cried a Boyar drunk with victory, amount to 365 days in the year.” (ibid p.348)

In all forms of class society the wealth (mass of use values) is produced by the toilers. The product of their labour divides into necessary labour (labour that goes to their subsistence) and surplus labour (the fruits of exploitation enjoyed by the ruling class).

We shall return to the specific form of exploitation of the working class later.

• Exploitation is a common feature of all forms of class society.
• It involves a division in the labour performed by the exploited class into necessary labour for their own maintenance and surplus labour, appropriated by the ruling class.

 

Workers and peasants

There are obvious differences between those who work for a wage under capitalism and the wretched Wallachian peasantry. We can assume that the extraction of a surplus from the peasants by the boyars was closely accompanied by the threat of physical force. Exploitation certainly does take place under capitalism. In contrast to pre-capitalist class societies it is not in principle accompanied by extra-economic compulsion. It classically occurs through what appears to be a contract over wages freely entered in to by both parties, as with other relations under capitalism. It happens through impersonal market forces.

That is the theory. In practice the capitalist class has never hesitated to use force when it suits their interests. Marx explains that the process of primitive accumulation examined below, the creation of the modern working class, “is written in the annals of mankind in letter of blood and fire.” (Capital Volume I, p.875) The dawn of capitalism also saw an obscene florescence of outright slavery as the direct counterpart to the emergence of wage labour. And capitalism created the world market through the colonial exploitation of three continents.

The capitalist state does have has a role in guaranteeing the profits of the capitalist class. “The modern representative state,” according to Engels, “Is an instrument of exploitation of wage labour by capital.” (The Origin of the Family, Private Property and the State, p.168) The state guarantees the rights of private property, which disproportionately benefits the capitalists, who own much more property than the workers. The state may intervene in the wage bargaining process, for instance to enforce a minimum wage or to pass anti-union laws. But the worker is usually exploited through the wages contract, without the direct intervention of the state.

It is actually this asymmetry of ownership that makes the wages contract a one-sided affair. The capitalist class, like every ruling class before it, has a monopoly over the means of production.

How this situation came to pass is a long story. Marx calls this process primitive accumulation, the accumulation of the preconditions for capitalist production. This consists on the one hand of the piling up of fortunes in the form of money. The Wallachian boyars, of course, measured their wealth in land.

Secondly primitive accumulation involves the complete separation of the toilers from independent access to the means of production. In the case of peasants, that means the loss of their own plot of land. The workers then have no option but to labour for a wage for the capitalist class, who have progressively acquired a monopoly in the means of production.

The capitalists own the factories, mines, farms and offices, the means of making a living under capitalism. The wage workers are formally free. Unlike the Wallachian peasants, they don’t have to work for a particular boss. The peasants in Romania were serfs, regarded as being as much an appurtenance of the land as a hedgerow, and their unborn children were regarded in the same light. We ‘free’ wage workers rightly see this as a monstrous form of slavery. But, as we can see from Marx’s description, the peasant household has access to its own field. We can assume that, despite the insatiable exactions of the landlords, in normal times the family can feed and clothe themselves at a modest level. Barring famines, their livelihood is more secure than that of a wage worker. Unemployment is not a threat; the word doesn’t even occur in their lexicon.

The difference between workers and peasants is that the workers are ‘free’ in two senses; they do not have to work for any particular capitalist. And they are free from any share in owning the means of production. They have no choice but to work for a capitalist, since the capitalists between them monopolise the means of production.

• Unlike peasants, workers are free in a twofold sense; first they are not obliged to work for a particular capitalist.
• Secondly, since they have no right of access to the means of production, they have to sell their labour power to a capitalist in order to maintain themselves.

 

Chapter 3: The case of Henry Ford

We shall illustrate the dynamics of capitalism by looking at the history of a man and a firm – Henry Ford. We are fortunate in being able to make use of Upton Sinclair’s book The Flivver King. The Flivver was a popular name for the Model T Ford which, together with the Volkswagen Beetle, was the most iconic and important car of the twentieth century. Sinclair wrote his book in 1937 as part of a drive to unionise Ford Motor Co. Although the characters in the book such as Abner Shutt, his family and neighbours, are fictitious, Sinclair drew his information on Ford-America from the public domain. It is not only accurate but sharply observed, informed as it is by a socialist perspective.

Labour power

Workers are told they are paid for the work they do. After all, they are free agents. If they don’t like the boss, they can collect their cards and go somewhere else. There seems to be no exploitation in the wages contract. If you work overtime, you get paid more for more work. If the firm falls on hard times and has to impose short time working, you will lose money. If you are paid for piece work, the harder you work the more you get paid. What could be fairer than that?

Marx described the standard of living enjoyed by the exploited in class society as their means of subsistence. Does this apply to the wages that workers earn in capitalist society as well? Marx rooted the exploitation of wage labour in the fact that, despite appearances, workers are not actually paid for the labour they perform. They are paid for their labour power, their subsistence:

“We mean by labour power, or labour capacity, the aggregate of those mental and physical capabilities existing in the physical form, the living personality, of a human being, capabilities which he sets in motion whenever he produces a use value of any kind.” (Capital Volume I, p.270)

So the capitalist buys a capacity, not a predefined lump of work. What does he get for his money? He gets labour. Labour is the use value of labour power. How much labour he gets out of that capability is up to him. Like the Wallachian boyar, he is forever thinking up ways to squeeze more out of this labour power. That drive, and the resistance to it, forms the central thread of much of the remainder of this narrative.

Throughout Capital Volume I Marx assumes that workers are paid by the day, though he carefully examines other forms of payment such as piece work in Part Six: Wages. He does so for two reasons. The first is that most British workers in the nineteenth century were paid by the day. The second reason is that, whatever the form of wages such as payment by results, they really represent a subsistence for the workers.

In comparing the British factory workers of his time with the Romanian peasant, Marx uses the following example to show how the identical process of exploitation is going on:

“Suppose the working day consists of 6 hours of necessary labour, and 6 hours of surplus labour. Then the free labourer gives the capitalist every week 6 x 6 or 36 hours of surplus labour. It is the same as if he worked 3 days in the week for himself, and 3 days in the week gratis for the capitalist. But this is not evident on the surface. Surplus labour and necessary labour glide one into the other. I can, therefore, express the same relationship by saying, e.g., that the labourer in every minute works 30 seconds for himself, and 30 for the capitalist, etc.” (ibid pp.345-6)

In Marx’s hypothetical example above the worker works 6 hours ‘for himself’, that is to reproduce values sufficient to be exchanged for money equivalent to his wages. He then works 6 hours in the 12 hour day he works for 6 days a week to produce surplus labour. Under capitalism this surplus labour is called surplus value. The rate of surplus value, the rate of exploitation, in this case is 100%. As we shall find out later on, not all this goes directly to the capitalist who directly employs the workers. It goes to feed the entire class of exploiters.

The process of exploitation is veiled. Henry Ford didn’t wave a copy of the capitalist equivalent of the Reglement Organique at the workers like a Wallachian boyar. All we see in the factory of the Henry Ford Motor Co. is cars coming off an assembly line. In fact some cars are sold so as to pay the workers’ wages and more cars are sold to be turned into surplus value. This is how the workers are paid for their subsistence. For part of their working day, working hour, working minute or for any piece of work they perform they are in effect working for themselves. The rest of the time they produce a surplus for the boss class, surplus value.

• Whatever the form of appearance of the wages contract, workers are not paid for the work that they do but for their labour power.

 

Subsistence and class struggle

What does subsistence mean in this case? The subsistence requirements of an American worker working for Ford are certainly different from those of a Wallachian peasant. The Shutts, at one point in Upton Sinclair’s narrative, are a four car household. In fact this was the only way they could get around Detroit at the time. Cars were a necessity, which is not to say that every working class household could afford one. Sinclair’s book is full of incidents where, in hard times, the car has to be sold or is repossessed.

Marx of all people was least inclined to ignore the class struggle. He knew that workers aspired to share in the greater and greater quantity of wealth they were creating. “In contrast, therefore, with the case of other commodities, the determination of the value of labour power contains a historical and moral element.” (ibid p.275)

Upton Sinclair records the fact that in January 1914 Henry Ford introduced a minimum wage of $5 per day for his workers. Sinclair notes that, so far from being a unilateral act of philanthropy, Ford was grappling with massive problems of absenteeism and labour turnover, caused in large part by the relentless speedup imposed at the Ford plant. Sinclair also tells us of the regime of spies and busybodies that were part of the Ford way of life at Highland Park. The book recounts the daily struggle for a decent existence by the Shutt family and their fellow workers. For instance in 1930 when Henry Ford magnanimously unveiled his plan to raise the basic wage to $7, “There were only a few soreheads to point out that since Henry had established his five-dollar minimum, sixteen years back, the cost of living in the Detroit area had nearly doubled, so that the new seven-dollar wage was far less than the old one had been.” (Sinclair p.73)

American workers at this time were the most prosperous in the world. Yet the workers at Ford were still scrambling to keep up with the cost of living. Savings they built up in good times disappeared during layoffs and recession. Workers in the USA were still being paid a subsistence, though with, “A historical and moral element.” (Capital Volume I, p.275)

Meanwhile Henry Ford, who Abner Shutt had first encountered as an enthusiast trying to build a horseless carriage in his neighbourhood workshop, had become a billionaire, the richest man in the world. And he had done so from their unpaid labour.

• Wages paid for the workers’ labour power do not just provide a bare physical subsistence, but contain a historical and moral element.

 

Ford and socially necessary labour time

The law of value states that the value of a commodity is determined on average by the amount of socially necessary labour time involved in its production. That means that value is inversely related to productivity. The more productive the workers are, the less value the commodities they produce will contain, and the less they will tend to cost. This law is executed by competition between capitalists. It was Henry Ford’s genius that he didn’t see the motor car as a toy for the rich, as so many of his contemporaries and rivals did, but as a tool for the masses. He had to sell cheaper than the competition. The best way to do that was to make his cars cheaper, by means of mass production techniques. Labour saving tools and machinery are so called because they economise on the expenditure of labour time, and therefore allow each commodity to contain a smaller amount of value and to cost less.

“In 1909, before the assembly line method was introduced, just over 12,000 Model T Fords were sold at around $950 each; by 1916 sales had risen to 577,000 while the basic price had fallen to $360. This achievement was partly a result of pronounced economies of scale of speed (the average time for assembling a chassis falling from 12.5 man hours in June 1913 to 1.5 man hours in January 1914). (Schmitz–The Growth of Big Business in the United States and Western Europe, 1850-1939, p.63)

Schmitz talks of ‘economies of scale and speed’ (a term he borrows from Alfred Chandler). What does he mean but the coercive operation of the law of value? Why should the price of the Model T have fallen from $950 to $360 in seven years? Because it took much less labour time, socially necessary labour time, to produce one.

Writing of the panic of 1907, Sinclair observes, “It cut down the Ford sales slightly, but not much, for this new product was more and more wanted, and among the hundred million people of America there are always some who can buy what they want. Henry Ford, planning tirelessly, would find new ways to give it to them more cheaply. In the year after the panic he produced 6,181 cars, a little over three per worker; but within three years he was managing to get thirty-five thousand cars out of six thousand workers. (Sinclair p.21)

Here Sinclair calculates the effect of rising productivity on the price of the cars directly in labour time. One worker in 1910 is now producing nearly six cars in a year. The productivity of labour has doubled in three years.

• Raising the productivity of labour means that workers produce more use values in a given time.
• Since the value of the commodities is determined by the socially necessary labour time involved in their production, they will get cheaper as productivity rises.

 

The division of labour

“The work of assembling the flywheel magneto, a small but complex part, was put on a sliding table, just high enough to be convenient for the workers, who sat on stools, each one performing one operation upon a line of magnetos, which crept slowly by. In the old way, a man doing the work of making a magneto could turn out one every twenty minutes; now the work was cut into twenty-nine operations, performed by twenty-nine different men, and the time per magneto was thirteen minutes and ten seconds. It was a revolution

“They applied it to the making of a motor. Done by one man, it had taken nine hours and fifty four minutes. When the assembling was divided among eighty-four different men, the time for a motor was cut by more than forty percent.” (Sinclair p.26)

No doubt when Upton Sinclair penned this passage he was aware as to how strikingly it resembles the example given at the beginning of Adam Smith’s book, The Wealth of Nations. Smith showed how the division of labour in a pin factory means an enormous increase in the productivity of labour in making pins:

“To take an example, therefore, from a very trifling manufacture; but one in which the division of labour has been very often taken notice of, the trade of the pin-maker; a workman not educated to this business…could scarce, perhaps, with his utmost industry, make one pin in a day, and certainly could not make twenty.”

Then Smith outlined how the division of labour works:

“One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations; to put it on, is a peculiar business, to whiten the pins is another; it is even a trade by itself to put them into the paper; and the important business of making a pin is, in this manner, divided into about eighteen distinct operations.”

Smith observed the effect at first hand in a small pin factory. The improvement in productivity was dramatic:

“Those ten persons, therefore, could make among them upwards of forty-eight thousand pins in a day.”

We would expect the price of pins to fall as a result, since they are composed of so much less socially necessary labour time than before, just as the price of cars fell steadily as productivity improved in the motor industry. The other thing to note is that the workers become more and more productive as a natural result of the division of labour. Yet under capitalism the benefits accrue entirely to the owners of the means of production.

• The division of labour raises the productivity of labour, but the benefits accrue to the capitalist.

 

Rising productivity and the car industry

The effects of enhanced productivity in the car industry were not confined to Henry Ford and his plant. At the dawn of motor production dozens, hundreds of enthusiasts were tinkering with prototype horseless carriages in sheds and workshops. If this reminds the reader of the early days of Silicon Valley, it should do. The transition from craft to mass production methods is a natural and normal part of the innovation process under capitalism.

In the UK alone 221 firms began motor manufacture between 1901 and 1905. S.B. Saul observes that 90% of these had left the industry by 1914. (The motor industry in Britain to 1914) The USA had a much bigger home market for cars and was a more advanced capitalist country by this time. The same process of the concentration of capital advanced there with seven league boots.

Later professionalisation of the trade meant the transition from amateur enthusiasts, such as Henry Ford had been in the beginning, to the production of relatively expensive motors by craft methods, till Ford’s mass production methods began to dominate the industry. What happened to the pioneers of car production? Unless they managed to find a niche as a sports or luxury model (The Model T was a very basic design, which made it easy to mass produce, and it was much ridiculed as a result.) they were bound for extinction. “One capitalist always kills many”, as Marx says (Capital Volume I p.929). Henry Ford’s advances in assembly line production struck down many aspiring motor manufacturers.

The rise in productivity made possible by assembly line techniques inevitably means that smaller and weaker laggard capitals fall by the wayside. They simply can’t keep up with the industry leaders and innovators. The scale of production inevitably rose with the vastly increased output from the new plants.  By the 1930s the US auto industry was completely dominated by three mass production giant firms – Ford, General Motors and Chrysler. But though there were far fewer firms in the industry, the big three in Detroit still saw each other as rivals. Every Ford sold meant an American citizen who would not be buying a Chrysler or a GM car any time soon. Competition remained the driving force of the accumulation of capital.

“Henry Ford might insist, as he continually did, that competition was wrong, and that he did not believe in it; but the fact was that he was competing at every moment in his life, and would continue to do so as long as he made motor-cars. In a hundred different plants scattered over the United States efforts were being made to beat him. In the long run, the successful ones would be those who contrived, by one method or another, to get the most out of a dollar’s worth of labor.” (Sinclair p.27)

So this competition was not just a contest between capitalists as to who could make and sell cars cheapest. It was also at bottom, as Sinclair notes, a contest in squeezing more and more surplus out of the working class.

• Competition between capitalists produced dramatic increases in productivity, the scale of production and falls in the price of cars.

 

Surplus value in practice

Where did Henry Ford’s profits come from? From his workers – where else could they possibly come from? The workers at Ford, like the peasants in Romania, were being exploited. That means that some of the value added in production went to reproduce the elements of their wages. And some of the value they added went to make Henry Ford rich. Surplus value is the unpaid labour of the working class.

Upton Sinclair did not have the information to work out the rate of exploitation at Ford. Business secrecy is protected precisely so such details won’t leak out. But the facts speak for themselves. At the beginning of the tale Henry Ford lives in the same neighbourhood as Abner Shutt. By the 1930s he is the richest man in the world, a billionaire.

In 1909, we are told, Ford was selling 12,000 cars at $950 each. Some money from those cars he sold went straight to pay the workers’ wages. Some went to pay for other expenses – the cost of depreciation on the plant, electricity, tyres upholstery and the rest. And some went into Henry Ford’s pocket. This was a surplus, just like that appropriated by Etruscan theocrats, Norman barons and the rest of them. It was surplus value. It was unpaid labour, the fruits of exploitation.

In the hypothetical example Marx used in comparing the exploitation of factory workers in Britain, he suggested that the workers worked six hours to produce the elements of their own subsistence and six hours in producing surplus value. There are two factors that veil the reality of this exploitative relationship: the first is that the nature of the wages contract suggests that the workers are being paid for their labour; in fact they are being paid for their labour power, for their keep.

The second is that (unlike the Danubian peasant) the wage worker doesn’t actually produce all the commodities that they buy with their wages. In the usual way they will specialise in producing a single commodity all day. Usually they will be a detail worker in the production process. Neither will they normally spend part of their time producing goods their boss will consume. They find themselves part of a vast worldwide division of labour imposed by the market, in which commodities produced by the workers of the world are all exchanged against money and pass from continent to continent.

What is the rate of surplus value in the UK today? From the government ‘Blue Books’ used long ago by Marx we can find data that, though rough and ready, can give us a clear idea of the rate of exploitation. We choose the year 2007 as the last set of statistics likely to be unaffected by the crisis. (Crises usually hit profits harder than wages.) All figures are at current market prices.

Gross Domestic Product                         £1,401.042m

Compensation of employees                    £744.857m

Surplus value                                           £656.185m

The formula for surplus value is S/V, where S is surplus value and V is variable capital, the sum laid out by the capitalist on wages. Surplus value is derived simply by deducting employee compensation (which we identify as the wages bill for the country) from GDP. Everything apart from employee compensation counts as surplus value. In the figure for surplus value I have therefore included the following categories:  Operating surplus, Taxes, Government supply, and a mixed, mysterious category called Mixed income, which is a little less than 6% of GDP for that year.

This gives a rate of surplus value of 88%.

Assuming a working day of 7 hours, the workers work on average about 3 hours 43 minutes for themselves and 3 hours 17 minutes to produce surplus value.

(From United Kingdom National Accounts: Blue Book 2007, Office for National Statistics)

Why include taxes as part of the surplus value? Here is the traditional Marxist justification for the procedure

“‘Taxes!’ A matter that interests the bourgeoisie very much but the worker only very little. What the worker pays in taxes goes in the long run into the cost of production of labour power and must therefore be compensated for by the capitalist.” (Engels, The Housing Question, p.36)

• The working class is exploited by the capitalist class, who extract a surplus from them.
• The form taken by the surplus extracted from the workers is surplus value, the unpaid labour of the working class.
• The worker also spends time on necessary labour, producing commodities that are sold to pay their wages.

 

Chapter 4: ‘Getting the most out of a dollar’s worth of labor’

Raising the rate of surplus value

As we have seen, in the battle to make more profits the capitalists need to compete against their rivals. They sell cheaper by making cheaper, raising the productivity of labour in the process. All the time they are engaged, as Upton Sinclair puts it, in the search “to get the most out of a dollar’s worth of labor.”

The extraction of surplus value gives us the basic anatomy of capitalism as a system of exploitation, as a form of class society. But, since the search for surplus value is never ending, it also provides us with the framework to analyse the dynamics of capitalism.

The rate of surplus value or rate of exploitation is given by the formula S/V, when S is surplus value and V is variable capital. For instance, when Marx gave the example of the British factory worker compared with the Romanian peasant, he suggested the former worked six hours for himself and six for the capitalist. In that case the rate of surplus value (S/V) would be 6/6 or 100%. How can the capitalists raise the rate of exploitation? Marx deals with two main methods: these are raising absolute surplus value and increasing relative surplus value.

“The surplus value produced by prolongation of the working day, I call absolute surplus value. On the other hand, the surplus value arising from the curtailment of the necessary labour time, and from the corresponding alteration in the respective lengths of the two components of the working day, I call relative surplus value.”  (ibid p.432)

• The capitalists are impelled by competition among themselves, and by the need ‘to get the most out of a dollar’s worth of labor’, to increase the rate of surplus value, the rate of exploitation

 

Absolute surplus value

The search for absolute surplus value is dealt with magnificently in Chapter 10 of Capital Volume I, entitled The working day. If workers are paid by the day, as most were in the nineteenth century, then what could be simpler than for the boss to demand that they work more and more hours for their recompense?  In terms of our earlier example, if  the bosses manage to force the workers to work a 14 hour day instead of 12 hours, while still paying them the same daily wage then the rate of surplus value (S/V) rises to 8/6 = 133%.

As is often the case in the early stages of an industrial revolution there were masses of desperate people prepared to work for a pittance. No doubt bourgeois economists would put down the possibility of super-exploiting these workers by extending the working day without limit to the forces of supply and demand. The supply of labour exceeded the demand, so the ‘price’ of the workers fell.

In a sense they are right. Supply and demand is important, specially when it is you who are supplying yourself and being demanded (or not) by the bosses. Marx was very much alive to the opportunities provided by recession for the capitalists to try to drive wages below the value of labour power which, as we know, is a level ultimately decided by class struggle. Upton Sinclair was equally aware of this, as he shows in his book. Both men also knew that periods of boom and relatively full employment provided the working class with the best opportunity to advance the level of real wages.

Upton Sinclair does not deal with the production of absolute surplus value as a way of raising the rate of surplus value in his book. The length of the working day was taken as a given in early twentieth century America by most sections of the working class. Workers were by and large paid by the hour. But the main reason for its unimportance to the likes of Henry Ford comes from the obvious advantages of assembly line production, speedup and other techniques to raise the rate of exploitation.

That does not mean that the extraction of absolute surplus value has ceased in modern capitalism. We can all list the occupations where workers are expected to work all the hours to make up a living wage. The mere payment of wages by the hour does not rule out the setting of an hourly rate at such a low level that vulnerable workers are forced to work far longer than the norm established by the better organised sections of the working class.

The extraction of absolute surplus value does not require much initiative or entrepreneurial skill. All the employer needs is the whip hand over the workers. But it was a very successful means of raising the rate of exploitation in the early years of the British industrial revolution In the end the decisive victory over this process of lengthening the working day was achieved by the British working class itself, pressing for the legal limitation of the working day.

Marx also observes that the capitalist enthusiasm for overworking their employees was in danger of killing the goose that laid the golden eggs. He quotes the Reports of the Inspectors of Factories as advising that, “The Ten Hours’ Act, in the branches of industry subject to it has ‘put an end to the premature decrepitude of the former long hour workers’” (Capital Volume I, p.416)

• The capitalist gains absolute surplus value by making the worker labour longer for the same wages.
• That means the worker spends more time in producing surplus value and a smaller proportion of their labour time on necessary labour.

 

Relative surplus value

If the worker is paid by the day and we regard the working day as fixed for the time being, there is only one other way the capitalist can raise the rate of exploitation. Since the working day is divided into a paid part and an unpaid part, the capitalists must reduce the hours that the workers labour to produce the elements of their own maintenance. This will automatically increase the hours they produce surplus value. And the way to do that is to raise the productivity of labour.

The extraction of relative surplus value is a much more complex process than that of absolute surplus value. It is not a conscious outcome of the calculations of the capitalists. Marx says that in essence it consists in shortening the amount of time the workers labour to produce the elements of their wages. But, as we know, the workers do not spend time in the workplace producing all the things they need to subsist on in their natural form. So how does this process work? The impetus comes from the need for capitalists to compete with one another and thus to raise the level of productivity of their workers.

The outcome of increased productivity means that commodities are produced with less socially necessary labour time. In monetary terms they are cheaper. We now have to consider what the effect of cheapening commodities has on the economy as a whole. One possibility is that they are wage goods, commodities that by and large are bought by workers with their wages. If they are wage goods, what will happen when they get cheaper? Will the workers enjoy a higher and higher standard of living through the falling price of necessaries? Our answer is, ‘not necessarily’. Falling prices do not always afford the workers a rising standard of living. The issue is determined by the balance of forces between worker and employer, by the class struggle.

It is quite obvious that workers in advanced capitalist countries have made big gains in their standard of living compared with 200 years ago. There are many more goods in the notional basket of commodities that make up the elements of their maintenance than was the case in the reign of Queen Victoria. Many of these new wants were not even invented at that time. To be fair to Henry Ford, part of his vision was that ordinary working people, wage workers and small farmers, would be able to afford a car made by the methods of mass production he pioneered. It is also the case that for workers and farmers at that time their Model T Ford was not a luxury for riding out on Sunday. It was a necessity for getting to work or sending their crops to market.

• Relative surplus value is gained by making the worker labour more effectively, more productively, in a given time.
• This means that the worker spends more time producing surplus value and less time on necessary labour.

 

Raising the productivity of labour

Marx’s analysis of the extraction of relative surplus value in Capital remains the core of our analysis here. If productivity doubles throughout the economy then prices will halve. If we assume that workers’ living standards remain the same in real terms then, if they formerly worked four hours to produce the elements of their subsistence and four hours producing surplus, they now only need work two hours to produce the basket of goods they need to subsist upon. That means they can work six hours for the boss in an eight hour day. The rate of exploitation has jumped from 100% (S/V = 4/4) to 300% (S/V = 6/2).

Here is the classic position outlined by Marx:

“The cheapened commodity, of course, causes only a proportionate fall in the value of labour power, a fall proportional to the extent of that commodity’s employment in the reproduction of labour power. Shirts, for instance, are a necessary means of subsistence, but are only one out of many. The totality of the necessaries of life consists, however, of various commodities, each the product of a distinct industry; and the value of each of those commodities enter as a component part into the value of labour power…Whenever an individual capitalist cheapens shirts, for instance, by increasing the productiveness of labour he by no means necessarily aims at reducing the value of labour power and shortening, by as much the necessary labour time. But it is only in so far as he ultimately contributes to this result that he assists in raising the general rate of surplus value. The general and necessary tendencies of capital must be distinguished from their forms of manifestation.” (ibid p.433)

Just to emphasise the last point. The capitalist does not set out to reduce the labour time necessary to reproduce the elements of the workers’ subsistence. All he seeks is to steal a march over his competitors. Yet raising the rate of surplus value is the ultimate outcome of the capitalists’ acts. Marx does not derive the laws of motion of capitalism from the motivations of the capitalists. On the contrary he sees the motivations of the capitalist as a product of their position in capitalist society.

• The production of relative surplus value is an unconscious process, driven by competition between capitalists.
• The overall result of this competition is to raise the productivity of labour and make commodities cheaper.
• This reduces the necessary labour time performed by the worker, and therefore raises the rate of exploitation.

 

Vanishing super-profits

Capitalists compete with one another. The overall result of this competition is that productivity rises and prices fall. Naturally this is a process that takes place unevenly in real time. The first capitalists who introduce a labour saving technique can sell the commodity at a price corresponding to the prevailing socially necessary labour time. This is set at the standard level of productivity then established within the industry. Since the innovators have actually had the commodity produced with less labour time (i.e. in principle cheaper) they can make a super-profit for a period of time by selling their goods above their individual value, at the prevailing industry norm.

As their competitors hasten to retool with the new technique, the value of the commodity (the socially necessary labour time required to produce it) will gradually fall to a new, lower average and the super profit will disappear. Thus the pursuit of a higher rate of profit is like chasing a will o’ the wisp.

Here is an example showing graphically how the value of a commodity is determined by socially necessary labour time in the longer term, and how raising the productivity of labour drastically reduces the value of the commodity and its monetary expression, price.

The first ballpoint pen was produced for sale by the Reynolds International Pen Company in 1945:

“The price was set at $12.50…In the early stages the cost of production was estimated to be around $0.80 per pen…By early 1946 (Reynolds) employed more than 800 people in its factory and was producing 30,000 pens per day”

Rival firms sprang up. So, “Reynolds introduced a new model, but kept the price at $12.50. Costs were estimated at $0.60 per pen.”…“Fortune reported fears of an impending price war in view of the growing number of manufacturers and the low cost of production.”…“By Christmas 1946 approximately 100 manufacturers were in production, some of them selling pens for as little as $2.98.”…

“In mid 1948 ballpoint pens were selling for as little as $0.39 and costing about $0.10 to produce. In 1951 prices of $0.25 were common. Within six years the power of the monopoly was gone for ever.”

This example is taken from Richard G. Lipsey-An introduction to positive economics, p.393, a standard economics textbook. Lipsey is an opponent of the labour theory of value. The whole of his book is intended to provide an alternative explanation of economic phenomena. Yet this example shows graphically how the law of value is the regulator of production under capitalism.

The search for super-profits not only generalises the use of new technology throughout the capitalist system; it also opens up new areas of the globe to capitalism. The conquest of new markets is usually associated with the reaping of super-profits, with a higher rate of profit. For instance when British capitalists began to export machine woven cotton to the rest of the world, local handloom weavers were wiped out because they could not compete on price. Locals in the rest of Europe, Asia, Africa and the Americas would compare the price of the imported cloth with prices associated with the productivity of handloom weaving and find the British products cheap.

This is the usual good fortune of industrial pioneers under capitalism. They can sell for a time at a price above the individual value of their product but below the norm established by the former level of productivity, the prevailing social value. Eventually the level of productivity associated with the new technology will become the norm all over the world and super-profits will disappear. This was a painful process that involved the destruction of the livelihoods of millions of handloom weavers all over the world. Even when the lower prices associated with the productivity of machine woven cloth became the norm, the sheer mass of profits from a market of the whole world made the Lancashire cotton magnates very rich. The result of this search for super-profits in new and distant markets binds the world together within the capitalist market.

• Capitalists compete with one another to make commodities cheaper.
• If they can sell their commodities cheaper as a result, they will make a super-profit for a time.
• Capitalists also try to make a super-profit by invading markets not yet completely subject to the laws of capitalism.
• The outcome of their endeavours is to extend the global reach of the capitalist system.

 

The logic of capitalism

This is how Marx explains the effects of this search for super-profits:

“On the other hand, however, this extra surplus value vanishes, so soon as the new method of production has become general, and has consequently caused the difference between the individual value of the cheapened commodity and its social value to vanish. The law of the determination of value by labour time, a law which brings under its sway the individual capitalist who applies the new method of production, by compelling him to sell his goods under their social value, this same law, acting as a coercive law of competition, forces his competitors to adopt the new method.” (Capital Volume I, p.436)

The net result of this competitive process, unknown to the competitors, is that commodities in general will be produced with progressively less labour time and therefore be represented with a smaller quantity of value. That is surely progress for humanity at least in principle, even if it is an unconscious result of the striving of the capitalists for super-profits.

In the twenty-first century we all take for granted many things that were no part of the Shutts’ subsistence basket in the 1930s. So what? The working class has gained some share in the enormous outpouring of commodities we have contributed to. We are more dependent than ever upon wage labour on account of the ruling class’s grip upon our livelihoods for us to make a living. The shackles of wage slavery have still to be struck off.

The motivation of the capitalists in searching for super-profits is not to raise the rate of relative surplus value but to steal a march on their competitors. The intention of the individual capitalist and the outcome of the working of the law of value are two completely different things. The law of value actually works through continual attempts by capitalists to negate its operation. The analysis of the production of relative surplus value is a classic illustration of the general position taken by Marx, that the laws of capitalism operate behind the backs of the individual economic actors, whether workers or capitalists:

“It is not our intention to consider, here, the way in which the laws, immanent in capitalist production, manifest themselves in the movements of individual masses of capital, where they assert themselves as coercive laws of competition, and are brought home to the mind and consciousness of the individual capitalist as the directing motives of his operations. But this much is clear; a scientific analysis of competition is not possible, before we have a conception of the inner nature of capital, just as the apparent motions of the heavenly bodies are not intelligible to any but him, who is acquainted with their real motions, motions which are not directly perceptible by the senses.” (ibid p.433)

• When the new technology and higher level of productivity associated with it are taken up generally within the industry, the super-profit will disappear.
• The laws of capitalism operate behind the backs of individual capitalists and independently of their will.
• The result of the search for super-profits is to raise the overall level of productivity and the global reach of capitalism.

 

Intensity of labour

The production of more absolute surplus value is achieved by making the worker labour for more hours for the same wages over the working day. The capitalist also strives to make the wage earners work harder in the time they are at work. “Increased intensity of labour means increased expenditure of labour in a given time” (ibid p.660).

To achieve this, the capitalist needs to control the labour process. As we have seen in the case of Ford, this is accomplished by mass production methods that turn the workers into an appendage of the machinery.

The principal ways the capitalists can make the labour of one hour worth more to them than before is by making the workers produce more use values in a given period of time; they do this mainly by making their workers supervise more machines and by speeding up the assembly line. This intensification of labour and the accumulation of capital that raises the productivity of labour through the mechanisation of the labour process are two processes that go hand in hand.

“There was always a clamor from the sales department to get more cars. When the plant was turning out a thousand a day, those who had the job in hand knew that by increasing the speed of the assembly line one minute in an hour, they would get sixteen more cars that day. Why not try it? A couple of weeks later, after the workers on the line had accustomed themselves to the faster motions, why not try it again?

“Never had there been such a device for speeding up labor. You simply moved a switch and a thousand men jumped more quickly. It was an invisible tax, like the tariff, which the consumer pays without being aware of it. The worker cannot hold a stopwatch, and count the number of cars which come to him in an hour. Even if he learns about it from the man who set the speed of the belt – again it is like the tariff in that he can do nothing about it. If he is a weakling, there are a dozen strong men waiting outside to take his place. Shut your mouth and do what you’re told!” (Sinclair p.27)

• The capitalists also strive to increase the intensity of labour, to make the workers perform more labour in a given time.
• Two classic methods of raising the intensity of labour are speeding up the assembly line and making the worker mind more machines.

 

Chapter 5: The dynamics of capitalism

The general formula for capital

Marx contrasted the circulation of capital with that of commodities under petty commodity production. The sellers in petty commodity production aim to exchange a commodity they own (and which they probably produced) for money. For their purposes this is simply an intermediate step. It’s stage one. They don‘t want to hang on to the money but to exchange it for another commodity. In effect they intend to exchange a use value they don’t want for one they do want. Money is just an intermediary. Characteristically they exchange an exchange value they own for a commodity of equal value.

Marx labels this as a C – M –C exchange. He contrasts this with the circulation of capital. Let us assume capitalists start with money. Their intention is to end with money, more money than they started with. There is no point for them in exchanging a commodity worth £100 for another worth £100. But that is what the traders of commodities usually do in the C – M – C circuit. For the capitalists the exchange of commodities, and the production of those commodities, is purely incidental to the production of surplus value. So the circuit of capital is M – C – M’, where M’ is a greater sum of money than M with which the capitalist started.

As Marx often had occasion to point out, capital is not a thing. It is a social relation. Capital goes through different forms of existence in its circulation process. Let us begin our analysis with money capital. Whereas the boyars start with land as the basis of their social power, the capitalists begin with money. The capitalists lay out their money on means of production and labour power. Then production can begin. As we know the surplus value is actually generated in the production process by the labour power of the workers being set to work to produce necessary and surplus labour. It must then be realised, the value created turned back into the money form and the circuit completed.

But the necessary labour has not at the stage of production been translated into wages for the workers; nor has the surplus labour become surplus value jingling in the pockets of the capitalists. The firm will usually specialise in producing one or a narrow line of goods. Whether these be motor cars or ice lollies, they have to be sold in order for the values congealed in the commodities to be realised. The production of surplus value and its realisation are two acts separate in time and in place. There are no guarantees that surplus value that has been produced can be realised. Yet, till the commodities have been realised, the circuit of capital has not been completed and capitalist production cannot continue.

Purchase and sale represent the unity of two processes. Yet these two processes can be ruptured and become independent of one another. The result is crisis. As Marx puts it, “The independence of the two correlated aspects can only show itself forcibly as a destructive process. It is just the crisis in which they assert their unity, the unity of different aspects.” (Theories of Surplus Value Volume II, p.500)

This gives us the possibility of crisis. We shall follow this up in more detail in Part 2: The Marxist theory of crisis.

• Under capitalism the aim of the capitalist is to start with money and end up with more money.
• Capital performs a circuit: from money; to production; to commodities produced; to money once more.
• Surplus value must not just be produced. It also has to be realised through the sale of the commodity so that the capitalist can begin the process of exploitation again.

 

Constant capital, variable capital and surplus value

So far we have dealt with the determination of the value of commodities and the decisive role of the productivity of labour in this process. We have also dealt with the division of the working day (or working time generally) into paid labour and unpaid labour, surplus value. We have seen that the battle over this division is never-ending, the objective basis for the class struggle.

As we know, Upton Sinclair was not allowed to look at Henry Ford’s account books in order to establish the rate of exploitation. After all he was preparing a novel, whose whole purpose was to aid the union drive at Ford which, if successful  (and it was), would curtail Henry Ford’s ability to extract more and more surplus value from his workforce without let or hindrance.

We postulated rates of exploitation such as 100% in the examples we have given. If we could give Henry Ford the right of reply, he would no doubt explode that his rate of profit was nothing like as high as we have suggested. And he would be right.

The division of the working day which gives us the rate of exploitation can be represented by V (variable capital) and S (surplus value). By variable capital we mean the money the capitalist lays out in wages. We work out the rate of exploitation with the formula S/V.

But the capitalist doesn’t just have to purchase the services of working class people before the production of surplus value can commence. Earlier we suggested a random list of other expenses Henry Ford might have to pay: the cost of depreciation on the plant, electricity, tyres, upholstery and so forth. So the overall rate of profit on capital outlaid will generally be lower than the rate of surplus value (rate of exploitation).

All these other costs apart from wages are regarded by Marx as constant capital. They are constant capital because they pass their value unchanged to the final product. Constant capital is dead labour. When we come to consider the value of the commodity, as opposed to the division of the working day, this can be divided into three parts: constant capital(C), variable capital (V) and surplus value (S).

This notion of constant capital is easy enough to grasp in the case of the tyres. Henry Ford pays the tyre manufacturer $50, or whatever they cost, and adds $50 to the price of the car. Theoretically he could sell cars with no tyres, and the customers could go out and buy tyres for $50. The tyres are the object of a past process of exploitation. The workers in the tyre factory performed paid labour and unpaid labour in making the tyres, just like Henry Ford’s car workers. Then the tyres are sold to Henry Ford at their value (on average). He makes no money out of buying tyres.

It might be more difficult to accept that the cost of the plant is also dead labour and does not produce a surplus for Henry Ford. Doesn’t assembly line production make car workers much more productive than engineers working in a shed, as was the case in the early days of the industry? Of course the assembly line workers produce more cars. But the cars are cheaper, because they contain less socially necessary labour time than motors produced under craft conditions. The workers are now producing more use values, not more exchange value. The same amount of labour time expresses itself in a greater mass of use values.

The assembly line was produced by workers who were exploited just like the Ford workforce. Then it was sold at its value to Henry Ford. Only the depreciation on the assembly line goes into the value of a motor car, not its entire value. If the assembly line cost $10 million and assists in the production of a million cars before it gives up the ghost, then we can say it adds $10 to the value of each car.

The Marxist way of looking at value as being composed of living labour (V + S) and dead labour (C) is not confined to ourselves. Living labour is the value added in the production process. Her Majesty’s Revenue and Customs use the same form of calculation when they send out bills for Value Added Tax. In assessing a motor manufacturer’s liability to pay VAT they may, as a first approximation, bill them for tax on the full sales price of the cars sold.

The car company’s accounts department will at once reply that the costs of tyres, glass, upholstery and all the other components they bought in are not value added. They will not use the expression ‘constant capital’, but that is the basis of their counter-claim. So they will supply copies of the invoices they paid for these items to HMRC, in effect arguing that they are items of dead labour that added no value in the production of cars. VAT is only levied on value added, that it on the new labour (value) added in the production process. And that’s official.

• The capitalist lays out money on constant capital, which passes its value unchanged to the final product.
• He also lays out variable capital to pay the workers’ wages.
• The value of a commodity may be broken down into constant capital, variable capital and surplus value.

 

The rate of profit

What is decisive in the considerations of the capitalists is not the rate of exploitation but the rate of profit – how much extra they get out compared with what they put in (invest). This is not just the lodestar of individual capitalists. It is a vital regulator of the capitalist system as a whole.

We have already had occasion to point out that the capitalist system is unplanned. How much capital equipment is needed at any point in time? Nobody knows. Nobody calculates. Still it is important for Henry Ford that, when he decides it would be profitable to increase the production of motors at his plant, he should be able to go to the marketplace and buy tyres, upholstery, wood for dashboards and whatever other components he needs in sufficient quantities and proportions to turn out more cars.

Likewise it was important for the workers who came to Detroit that they could be decently housed, clothed and fed. This didn’t happen automatically. Detroit at this time was a vibrant capitalist metropolis sucking in all manner of skills and resources to back up the fast-growing motor industry. How is this proportionality between the different inputs needed for capitalist firms to grow established? How do the use values needed for capitalism to reproduce itself as a system come into existence?

All these skills and resources were attracted to the Detroit area by the search for profit. Capital must reproduce itself. It must find the means to satisfy all its material needs in the marketplace. A vast division of labour is achieved entirely through people buying and selling. But when they are buying and selling, they are oblivious to the actual needs of society, which are unknown to them. They are all looking to their own advantage. Capitalists measure the advantage to themselves in profit, and naturally they look to their own rate of profit compared with that of other capitalist firms.

As we pointed out earlier, commodities are only sold occasionally and accidentally at their value. Usually they are sold at a price above or below their value. If supply exceeds demand, and as a result commodities are sold at a price below their value, this means the capitalists who sell them will have to take a cut in profit. If low profits persist, this can be taken as a signal that the capitalist is in the wrong line of business. Marginal capitalists in the industry are likely to drop away.

Likewise if demand in an industry is booming and capitalists in an industry are making bumper profits, then two things are likely to happen; first the incumbent capitalists will maximise output to the fullest extent to take advantage of the super-profits to be made. They will work their capacity to the utmost, take on more workers and offer overtime to those already on the books. They may plan to expand their output potential. Secondly other capitalists, particularly those that find themselves trapped in low-profit industries, will begin to think seriously about upping stakes and moving to where the serious money can be made.

So the regulator of the division of labour within an unplanned economy is the rate of profit. Low profits in a sector cause exit while high profits attract new entrants. Capital flows are the way in which proportionality is established in an unplanned economy. Naturally the working of these capital flows is as chaotic on the surface as the day-to-day movement of prices.

• Capitalists are guided in their investment decisions by expectations of profit.
• The rate of profit thus serves as a regulator for the capitalist system as a whole.

 

Chapter 6: How capitalism evolves

The accumulation of capital

Don’t think for a moment that Henry Ford spent all the surplus value extracted from his workers on himself, on fine living. He lived well, as Upton Sinclair testifies. But the majority of that surplus value was accumulated, ploughed back into production. Any capitalist has to decide whether to consume the surplus unproductively or to accumulate it, and in what proportions. This decision is presented here as a choice. But really the individual capitalist and individual firm don’t have much choice. They must accumulate or go under. That is the lesson Henry Ford taught his rivals.

Under capitalism there is no natural limit to the rate of exploitation. Nor is there any limit to the accumulation of capital under the system. There is an impulsion upon the capitalists to accumulate most of the surplus value. Thus they are continually raising the level of productivity and, potentially, making us all richer. This is important. Romania remains a desperately poor country. In part this is the heritage of the rule of the boyars. Feudalism did not develop the productive forces in the way capitalism does. Capitalism has a completely different dynamic from previous forms of class society. It is the dynamics of the system that we are trying to outline here.

We have already seen that, in the hunt for higher productivity, capitalists are forced to accumulate the lion’s share of the surplus value as capital rather than spending it on their personal consumption.

It is obvious to the casual observer that the transition from weaving cloth by handloom weavers to the general use of power looms consists of a progressive replacement of human labour power by machinery in the production process. The transition of the Ford Motor Co. from Henry’s shed to the giant River Rouge plant opened to make the Model A Ford in 1928 is an instance of exactly the same trend.

As a result the scale of production in a firm is likely to expand and the number of firms in an industry to fall over time. Marx calls this the concentration of capital. Rather than the small-scale competitive capitalism that typified nineteenth century capitalism, the system in the twenty-first century is dominated by giant firms. These still compete against one another for market share, but quite often this rivalry may be pursued in different ways from just competing on price. Attempts at product differentiation which can lead to an advertising blitz are just one example of a different form of competition between capitalists.

Alternatively, large corporations can use their financial muscle to buy their rivals out. Big firms that supply one another and become interdependent may also form networks. These in turn can solidify into alliances pitted against other capitalist networks. Informal networks can also turn into friendly mergers or provoke hostile takeovers of rival firms.

Centralisation of capital means the merger of capitalist firms, the concentration of ownership rather than production. Whereas the driving force of the concentration of capital is the ever-increasing scale of production and the rising minimum efficient scale needed to produce and sell competitively in modern business, the centralisation of capital derives from the advantages of joint ownership. Production may be divided into different plants separated geographically, but unified by a common purpose which is drawn up by a common management team.

• Raising the productivity of labour in an industry naturally produces a larger scale of production, bigger units of production and a smaller number of firms. This is called the concentration of capital.
• Capital also becomes centralised through links of ownership rather than production.

 

The organic composition of capital

Henry Ford achieved his victories over his rivals by spending first and most on machinery in order to raise the productivity of labour. So the proportion of his capital laid out on labour power (variable capital) compared with that invested in plant and machinery (constant capital) was falling as production became more capital intensive. The natural accompaniment to the raising of the productivity of labour under capitalism is therefore the increasing capital intensity of production.

Marx explains that this is a general tendency in capitalist production, “Every advance in the use of machinery entails an increase in the constant component, that part which consists of machinery, raw material, etc., and a decrease in its variable component, the part laid out in labour power.”  (Capital Volume I p.578)

Marx calls this process the rising organic composition of capital. Readers may find it intuitively obvious that the proportion of dead labour to living labour tends to rise over the history of capitalism – that twenty first century workers usually have more machinery behind their elbow than nineteenth century workers. But Marx is not just referring to the mass of constant capital compared to the number of workers. He calls this the technical composition of capital. This ratio cannot be computed because, just as use values are incommensurable, we cannot compare a mass of machinery etc. of different types with a number of workers.

The organic composition of capital is expressed by the formula C/V, where C is constant capital and V is variable capital. It is calculated in value terms. Since price is here the monetary expression of labour time the organic composition of capital is the value of constant capital relative to variable capital, or how much the capitalist lays out on them respectively. The increase in capital per worker is known in conventional economics textbooks as capital deepening. Here are the figures given in Angus Maddison’s Contours of the World Economy 1-2030 AD, (p.305) for the UK and the USA. All figures are in 1990 dollars.

Gross Stock of Machinery and Equipment Per Capita

UK                       USA

1820           92                          87

1870         334                        489

1913         878                     2,749

1950      2,122                     6,110

1973      6,203                   10,762

2003    14,291                   32,240

These figures are, as we see, only a first approximation to the organic composition of capital. All the same they represent a triumphant vindication of Marxist analysis.

• The rising proportion of constant capital relative to living labour in the production process is called the increasing organic composition of capital.
• The increasing organic composition of capital is a fundamental trend in capitalist production.

 

The tendency for the rate of profit to fall

As we pointed out earlier the rate of profit is calculated by the capitalist as the surplus gained (S) compared with the costs laid out on constant and variable capital (C + V). So the formula for the rate of profit is S/(C + V). Note that, in contrast to calculating the value of a commodity (C + V + S), in this case the whole of the constant capital outlaid is included as costs, not just the constant capital used up in the production of the commodities.

Now there is a fly in the ointment in the progressive rise in the organic composition of capital over time. For the surplus value on which the whole of the ruling class depends for its livelihood comes from the living labour added in the production process. Yet the proportion of living labour compared with dead labour in the production process will tend to fall as the organic composition of capital rises. This will produce a tendency for the rate of profit to fall.

In Part 2: The Marxist theory of crisis we show that in the Grundrisse Marx stated that the tendency for the rate of profit to fall is “the most important law in political economy”. This is not an isolated thought from an unpublished preparatory manuscript. In his economic manuscripts of 1861-3 he repeated this formulation almost word for word: “This law, and it is the most important law of political economy, is that the rate of profit has a tendency to fall with the progress of capitalist production” (Marx Engels Collected Works Volume 33, p.104).

We consider the working out of this law in much more detail in The Marxist theory of crisis. We discuss throughout the course of this book how to apply this basic principle of Marxist economic analysis to the current crisis.

As we have already established, all ‘laws’ in Marx’s sense are tendencies, that is to say they are forces pulling in a certain direction. They are not predictions that always yield a determinate result.

We know that the drive to raise productivity, and therefore for the worker to spend less time on paid labour and more on unpaid labour can raise the rate of exploitation. This rising rate of exploitation is an important counteracting factor to the tendency for the rate of profit to fall. For the moment, observe that the same force, the drive to raise the productivity of labour, which produces the tendency for the rate of profit to fall also produces its own counter-tendencies.

Secondly the same tendency to raise productivity and reduce the relative price that goes prevails in consumer goods industries such as car production (producing ‘wage goods’, the elements that variable capital is spent on) is also at work in the capital goods sector. Though the mass of constant capital per worker has risen enormously over time, the cost of each unit of constant capital will tend to fall. This fall in the price of constant capital is another important counteracting factor to the tendential fall in the rate of profit.

• The rising organic composition of capital produces a tendency for the rate of profit to fall.
• There are also counteracting factors generated by the accumulation of capital. How this tendency and the countervailing tendencies interact is discussed in Part 2.

 

The tendencies of capitalist production

Ford was progressively employing more and more workers as he grew to be an industrial giant. This is how the accumulation of capital proceeds. Marx deals with it in the long Chapter 25 of Capital Volume I: The general law of capitalist accumulation.

He opens the discussion by asserting that, “A growing demand for labour power accompanies accumulation if the composition of capital remains the same.” (p.762) Of course the accumulation of capital does not usually leave the composition of capital untouched. Theoretically the capitalists could open another wing to their plant or another plant in their firm with an identical organic composition of capital to the others and employing the same technology. Given the continual technical progress under capitalism, that is highly unlikely, except in a ‘mature’ or stagnant industry – and that is not where the biggest profits are to be made.

Though firms are likely to employ more workers as they grow, that leaves out of account the wider picture. Weaving firms employing power looms were no doubt taking on ‘hands’ in the early decades of the development of the new technology, but they were ‘displacing’ vastly greater numbers of handloom weavers. Nor was this process confined to the UK. Traditional handicrafts in India and elsewhere were laid waste by British machine-woven cloths with which the handloom weavers were incapable of competing. Handloom weavers were reduced to penury all over the world. The law of value is no mere theoretical construct. It strikes with the power of a hurricane.

Advances in productivity are an imperative under conditions of capitalist competition. They are expressed in a rise in the relative importance of machinery, in particular in the capital laid out by the magnates of industry. Ford’s early workshops could not possibly have competed with his own mass production plants a generation later. The accumulation of capital therefore is usually accompanied by “a relative diminution of the variable part of capital”, according to Marx (ibid p.772). Whether that leads to an absolute fall in the number of employed workers is uncertain. Marx goes on to explain how capitalism generates a reserve army of labour from its own dynamics.

Capitalism is an unplanned system. In this it resembles a creature with no brain, no central system for thinking and planning. The brontosaurus was such a creature. Unfortunately it is now extinct. In an unplanned system it is always possible that too little or two much might be produced. After all nobody knows how much ‘too little’ or ‘too much’ actually is.

Since the capitalists are actually interdependent, if too little is produced in one industry and too much in another that will cause problems for firms further down the supply chain. This dislocation could set off a more general crisis of the system if profits took a tumble. A crisis of overproduction occurs when capitalists cannot sell their commodities and therefore cannot realise the surplus value that has been produced. Under capitalism trade is not conducted by petty proprietors exchanging products for products for their own satisfaction but by capitalists who are only interested in profit.  It is ultimately because production is not to satisfy human wants but to make profit for capitalists, that a crisis of overproduction is an ever-present possibility.

In a footnote to Capital, Chapter 4 (p.254), Marx highlights this confusion in the outlook of an apologist of capitalism:

“‘The inextinguishable passion for gain, the auri sacra fames,’ (accursed love of gold) ‘will always lead capitalists.’ (MacCulloch: ‘The Principles of Polit. Econ.’ London, 1830, p. 179.) This view, of course, does not prevent the same MacCulloch and others of his kidney, when in theoretical difficulties, such, for example, as the question of overproduction, from transforming the same capitalist into a moral citizen, whose sole concern is for use values, and who even develops an insatiable hunger for boots, hats, eggs, calico, and other extremely familiar sorts of use values.”

Crisis is inherent in capitalism because it is an unplanned system where production is for profit and not human wants. The purpose of this essay is to outline the dynamics of capitalism. We are mainly concerned with the long term trends rather than the fluctuations of boom and slump, which we shall deal with separately. To sum up these trends in a single phrase they are, “the abolition of the capitalist mode of production within the capitalist mode of production itself.” (Capital Volume III, p.569) Capitalism is preparing the material conditions for a higher mode of production – socialism.

• As it accumulates, capitalism naturally tends to generate a reserve army of labour.
• Capitalism naturally produces crises. This is because it is an unplanned system where production is for profit.

 

Tasks of the working class

But socialism will not emerge of its own accord. It must be fought for. Socialism can only come about by the destruction of capitalism, which has to be the conscious act of millions of working class people. What will cause this questioning of capitalism in the minds of the workers?

There was no revolution against the boyars in Romania, though the serfs lived lives that in many ways were incomparably poorer and more wretched than those of twenty-first century wage workers. Conditions were stagnant, and we can assume that consciousness stagnated as a result. How different is the capitalist system and the lives of the mass of workers who live under it! Capitalism is unprecedentedly dynamic and continually shakes up the lives of its wage slaves. That was the story of the Shutts who lived through the Great Depression of the 1930s, and it’s the same today. Capitalism is incapable of offering its workers a secure existence.

Since being determines consciousness, changes in consciousness are likely to be triggered in changed conditions. This essay is being written as the world is dominated by the effects of a gigantic recession.  Coming after a long period of relatively full employment and rising living standards for most workers in Britain and other advanced capitalist countries, this recession is bound to produce a profound questioning and criticism. Capitalism stands revealed as a system that squanders human and material resources and where the ruling class always strives to make the workers bear the burden of the crisis and other flaws of their system. It is hoped that this essay will contribute to an understanding of the alternative and how to achieve it.

We have seen that the law of value acts as a natural force like a tsunami, disrupting and ruining people’s lives over and over again in good times and (specially) in bad. Capitalism has developed the productive forces enormously. It has taken us to the threshold of abundance, and then slammed the door firmly in our face.

Capitalism also develops a mass working class, who can and will act as its gravediggers. Even now, more than ever, millions of peasants, handicraft workers and small traders are being drawn into the maw of wage labour. There are now more than a billion wage workers. They, together with their families, outnumber the peasantry for the first time in the history of the world. They are an absolute majority of the globe’s population.

The working class, unlike the isolated peasantry of Wallachia, are concentrated together by the concentration of capital. The technology of mass communication developed by capitalism keeps them informed of movements elsewhere and helps them to plan their own resistance. They find that the small victories they win against the boss are achieved by unity in action. They are schooled in solidarity. The world’s working class, faced with the failure of capitalism, will increasingly turn to the ideas and programme of socialism.

• Capitalism is an unprecedentedly dynamic form of class society.
• Capitalism developed the productive forces, and so produced the conditions for a higher form of society – socialism.
• Capitalism also created a mass working class, who can and will carry through the socialist transformation of society.

 

The historical tendency of capitalist accumulation

What are the general tendencies of capitalist production in broad historical terms? Where are they taking us? Marx sums up his analysis in Chapter 32 of Capital Volume I, entitled The Historical Tendency of Capitalist Accumulation.  After dealing with the process of primitive accumulation, he continues (ibid pp.928-9):

“As soon as the labourers are turned into proletarians, their means of labour into capital, as soon as the capitalist mode of production stands on its own feet, then the further socialisation of labour and further transformation of the land and other means of production into socially exploited and, therefore, common means of production, as well as the further expropriation of private proprietors, takes a new form. That which is now to be expropriated is no longer the labourer working for himself, but the capitalist exploiting many labourers. This expropriation is accomplished by the action of the immanent laws of capitalistic production itself, by the centralisation of capital. One capitalist always kills many. Hand in hand with this centralisation, or this expropriation of many capitalists by few, develop, on an ever-extending scale, the cooperative form of the labour process, the conscious technical application of science, the methodical cultivation of the soil, the transformation of the instruments of labour into instruments of labour only usable in common, the economising of all means of production by their use as means of production of combined, socialised labour, the entanglement of all peoples in the net of the world market, and with this, the international character of the capitalistic regime. Along with the constantly diminishing number of the magnates of capital, who usurp and monopolize all advantages of this process of transformation, grows the mass of misery, oppression, slavery, degradation, exploitation; but with this too grows the revolt of the working class, a class always increasing in numbers, and disciplined, united, organized by the very mechanism of the process of capitalist production itself. The monopoly of capital becomes a fetter upon the mode of production, which has sprung up and flourished along with, and under it. Centralisation of the means of production and socialisation of labour at last reach a point where they become incompatible with their capitalist integument. This integument is burst asunder. The knell of capitalist private property sounds. The expropriators are expropriated…

“The transformation of scattered private property, arising from individual labour, into capitalist private property is, naturally, a process, incomparably more protracted, violent, and difficult, than the transformation of capitalistic private property, already practically resting on socialised production, into socialised property. In the former case, we had the expropriation of the mass of the people by a few usurpers; in the latter, we have the expropriation of a few usurpers by the mass of the people.”

 by Michael Roberts

 Gerard Dumenil and Dominique Levy have made important contributions to the understanding of Marxist economics over the years.  Now they have a new book out, called The crisis of neoliberalism (http://www.jourdan.ens.fr/~levy/dle2011a.htm).  Gerard Dumenil was in London this week to give a presentation on the main ideas in their book.

Dumenil started by saying modern capitalism, or “contemporary capitalism” as he called it, has different phases and takes different forms.  Neoliberalism is the latest.  It is a new form of capitalism.  One of its features is that it is very violent.  You could say it started in 1979 with Volcker’s rate hikes, or with the coup in Chile along with Milton Friedman or with Argentina in 1976, or with Thatcher in 1979, a friend of Pinochet.  But the US is the locus of neoliberalism because it is where ‘financialisation’ and ‘financial hegemony’ started and went furthest (the UK is like a little sister in this regard).

For Dumenil, capitalist crises can be caused by a variety of reasons.  There is no one cause and it won’t be the same cause each time.  He identified what he called “four structural crises” in “contemporary capitalism” of which the crisis of neoliberalism was the latest.  They were structural, unlike ordinary recessions or crises, because they were crises of the prevailing ‘social order’ of capitalism.

The four crises were the decade of 1890s; the 1930s Great Depression; the 1970s crisis; and now the neoliberal crisis of the early 21^st century.  The 1890s crisis was caused by a lack of profitability; but the 1930s depression was a financial crisis (as profitability had been rising up to 1929).  The 1970s crisis was one of profitability again; but the crisis of neoliberalism was one of a collapse of financial hegemony (again profitability had been rising up to 2006).

Profitability is not always and not even often the cause of these ‘structural crises’, argues Dumenil.  He had “no idea why there were structural crises every 30-40 years”, but each structural crisis laid the basis for a change in the prevailing social order’.  Those who argue that falling profitability is the cause of capitalist crises forget that Marx did not raise this cause in the Communist Manifesto, but on the contrary referred to the cause of crisis in the credit system.  The crisis of neoliberalism was caused when capitalists “lost control“ of the credit system.  Dumenil said you can see that because the profit crisis of the 1970s took the form of a capitalist “collapse” while the financial crisis of 2008-9 took the form of an “explosion”.

Neoliberalism is a social order, a new form of capitalism, that can be explained by recognising, according to Dumenil, that there are now three classes or “social orders” in contemporary capitalism: the capitalists; the “popular class” made up of wage workers and lower-level salaried employees; and in between there is what he called the “managerial class”.  The social order changes when the managerial class sides with one or other of the other two.  Thus in the 1930s and in the post war period, the managerial class sided with the popular class against the capitalist class and we had the welfare state etc.  In the neoliberal era, the managerial class sided with the capitalist financial class and the popular class was on the back foot.  With the crisis of neoliberalism, we could look to a new realignment of this ‘social order’, with the managers swinging back again.

Neoliberalism started in the US because US capitalism was uniquely placed to expand financial hegemony and could rely on globalisation for growth.   This made the US economy imbalanced with a growing trade deficit and relying on capital inflows from the rest of the world.  This generated excessive consumption and inadequate investment.  And debt took over from saving.  That meant slow accumulation of capital in productive sectors and the need for more financialisation to raise profits.

It was this imbalance of financialisation and globalisation that caused the structural crisis of 2008-9.  It was not falling profitability.  Dumenil produced a graphic showing that the rate of profit for the US non-financial corporate sector peaked in 1965, fell back to 1982, then rose to 1997, fell again to 2002 and then rose again to peak in 2006.  For Dumenil, the crisis of 2008-9 could not be caused by falling profitability because it rose from 1982 to 2006.  This was especially the case if you looked at after-tax profitability and not overall profitability.   The trigger, but not the cause, of the crisis was the residential subprime loans market and the securitisation of those loans around the world

Dumenil concluded from his analysis that the crisis of neoliberalism may well force the US to change the social order with the managers moving towards the ‘popular class’ and adopting a policy of joint government/private investment in green technology and infrastructure as Obama has been arguing.  Dumenil did not think this would work in solving the crisis of neoliberalism and so capitalism would have a new crisis some time.

Also at the presentation was Costas Lapavitsas of the School of African and Oriental Studies.  He said that Dumenil’s book had two very strong points.  The first was that it showed irrefutably that profitability was not the cause of Great Recession.  Dumenil’s data prove that and it was just “alchemy” to suggest otherwise using various tricks as some profitability proponents do.  The fall in the rate of profit after 2005 was too short to be the cause of the recession in 2008 or certainly not enough to explain the “systemic crisis” that the Great Recession was.

Anyway, the idea that the tendency of the rate of profit to fall is the cause of capitalist crises is really a fairly new idea, one that has arisen only post-war and mainly comes from Anglo-Saxon sources, says Lapavitsas.  Sure, it might have fitted the facts in the 1970s, but not after.  “Classical Continental European Marxists” of the prewar era never proposed profitability as the cause of crisis.  Luxemburg said it was underconsumption and others said it was disproportionality.   Lapavitsas reckons the causes of capitalist crisis is complex not monocausal.  Each “structural crisis” has a different cause and Dumenil brilliantly shows this.

The second strong point in Dumenil’s thesis, said Lapavitsas, is that he looks at capitalism as changing through various ‘social orders’.  Financialisation was a product of new order of neoliberalism.  Indeed, we now ought to look at the financial sector as a “separate entity” and not just as an “adjunct” to the producer sector in capitalism.  That is why neoliberalism is an epochal change.  We need to return to Hilferding and Lenin to understand financialisation.  The circulation of capital is now key to understanding the structural crisis of capitalism not profitability.

Where do you start with all this?  As those of you who have read my posts regularly would not be surprised to guess, I could not disagree more with so many of the propositions presented by Dumenil and Lapavitsas.  Let’s start with Lapavitsas’ two ‘strong points’ from Dumenil’s book.  They seem to me to be the weakest arguments, not the strongest.  It seems that, for Dumenil, every crisis is different.  That’s surely true in its immediate or proximate causes – in the latest crisis, it was the collapse of the US residential homes markets that spread to bank assets and various ‘financial weapons of mass destruction’, as Dumenil says.  In the 1970s,  it was the oil price spike that triggered the first simultaneous post-war capitalist recession in 1974-5.  In 1929, it was the Wall St stock market crash that set off the Great Depression.

But these proximate causes do not reveal the underlying or ultimate cause of capitalist crisis.  I would argue that Dumenil makes no clear distinction between proximate and ultimate cause, but merely cherry-picks his causal explanation as it seems to fit – the very charge that Lapavitsas makes against the ‘post-war Anglo Saxons’.

Lapavitsas seemed to be arguing that, because the great ‘classical’ European Marxists of the pre-war era never proposed Marx’s law of profitability as the main causal explanation of capitalist crisis, it can’t be right.  But just maybe Luxemburg and Bukharin were wrong, and if they were ‘classical Marxists’, then maybe Marx was not a classical Marxist (as he indeed once said).

To claim that Marx’s theory of crisis is better found in that short but brilliant propaganda pamphlet, The Communist Manifesto,written in 1848, before Marx had fully formulated his economic theories, rather than in his mature works, Capital Vols 2 and 3, Theories of Surplus Value and Grundrisse, is tendentious, to say the least.  And were there no non Anglo-Saxons that saw Marx’s law of profitability as the main cause of crisis?  What about Henryk Grossman or Paul Mattick? But perhaps they were not ‘classical Marxists’.

As Guglielmo Carchedi pointed in his article in International Socialism, issue 125 (http://www.isj.org.uk/index.php4?id=614&issue=125) “some Marxist authors reject what they see as “mono-causal” explanations, especially that of the tendential fall in the rate of profit.  Instead, they argue, there is no single explanation valid for all crises, except that they are all a “property” of capitalism and that crises manifest in different forms in different periods and contexts.  However, if this elusive and mysterious ‘property’ becomes manifest as different causes of different crises, while itself remaining unknowable, if we do not know where all these different causes come from, then we have no crisis theory”.

Carchedi comments “if crises are recurrent and if they have all different causes, these different causes can explain the different crises, but not their recurrence.  If they are recurrent, they must have a common cause that manifests itself recurrently as different causes of different crises. There is no way around the ”monocausality” of crises.”

As for Lapavitsas’ second ‘strong point’, is it really convincing to say that neoliberalism is a new social order, a structural change in the balance of class forces?  Is ‘neoliberalism’ not simply an ideological policy response from the strategists of capital to the profitability crisis of the 1970s?  Dumenil’s analysis of ‘contemporary capitalism’ with its three classes or social orders smacks more of the theory of the sociologist Weber, taken up by some Marxists in the 1930s.  For Marx, there are only two classes defined by their relation to the means of production: one that owns the means of production and appropriates the surplus value created; and one that lives only by selling its labour power.  People may think they are not members of either class but from the point of view of Marxist economic theory, they are defined by these economic categories.  The concept of a managerial class is not part of a ‘classical Marxist’ analysis.

There is a political implication from Dumenil’s theory that an alliance can be struck by the ‘popular class’ with the ‘managerial class’ against the ‘capitalist class’ that would tip the balance of forces towards a better society and defeat neoliberalism, something like the New Deal in America or the Popular Front in France in the 1930s.  President Obama could lead such an alliance in a similar way.  The trouble is that the managerial class is an illusion and there is nothing to ally with!

Can we really identify the major cause of a capitalist crisis by whether the economy collapses (profitability) or explodes (financial)?  I’m not sure I know the difference between a collapsing and an exploding economy.

But perhaps most important of all is Dumenil’s data.  He produced pretty much the same results on the movement of the US rate of profit that I and others in the ‘profitability camp’ do.  Namely, the US rate of profit peaked in 1965, then fell back to a low in 1982, then in the era of so-called neoliberalism, it rose to peak in 1997.  That 1997 peak, according to Dumenil and my own data (see graph) was not surpassed in 2006 at the peak of the credit boom.  And the 1965 peak was also higher than the 1997 peak.

 

That suggests, as I argue in my book, The Great Recession, that Marx’s law of profitability is operating as the ultimate cause of capitalist crisis.  Indeed, based on that view, in early 2006, I predicted the Great Recession would take place in 2009-10.  I was wrong  – it came a year earlier.  Dumenil made no such forecast as far as I am aware.

Profitability will soon resume its downward path (after its current recovery from the recession low of 2009), according to my interpretation of the data.  It will reach a new low with a new recession in four to five years time.  If that’s right, we can then judge better whether capitalist crises are a product of capitalists “losing control of credit” or the result of the inexorable tendency for the rate of profit to fall .

http://www.thenextrecession.wordpress.com

This document was written by Mick Brooks a year ago as part of a debate in the IMT which seems to have ceased following the expulsion and resignation of a number of comrades and Brooks’ own resignation as editor of Socialist Appeal. Hopefully the issues it raises will be explored more fully by Marxists who consider theoretical debates more important than the prestige of ‘leaders’.

RS’s article ‘The unfolding capitalist crisis; a nightmare for workers everywhere,’ published in Socialist Appeal and on the In Defence of Marxism website (1) purports to not only deal with the present crisis but to outline the Marxist explanation of capitalist crises in general.

In doing so, he specifically disagrees with those who emphasise the tendency for the rate of profit to fall as a central part of Marx’s analysis, including my article The Marxist theory of crisis (2).

RS’s article is unsatisfactory in a number of ways. None of the quotes from Marx are referenced, as if it were unimportant for readers who want to be able to study Marxism in more depth to be able to find them and study them in context. Likewise some of the ‘facts’ adduced in favour of RS’s interpretation are not given the source from which they have been derived and so cannot be checked. Some quotes are mangled. This is irritating for the reader and makes it quite difficult to either support or critique the article. In sum it is a lazy, sloppy, inadequate piece of work. It is also wrong in its interpretation of Marx and application of his theory to the present crisis.

RS begins his account with the origins of the past boom that has so definitively come to an end.”The Federal Reserve made three interest rate cuts to boost consumption spending in 1998, to levels not seen since the 1950s.” And that’s it. That’s the entire explanation for the boom so far as RS is concerned. In the first place RS neglects to mention that there was a milder world recession in 2000-2001 associated with the dot.com bust despite low interest rates. More importantly he attributes huge significance in government action’s ability to influence the capitalist economy without making any qualifications. If he were to take this thought seriously, the political consequences would be completely reformist.

All the government has to do to get the economy going, if we are to believe this account, is to cut interest rates. The government is an important actor in the capitalist economy today, much more so than in Marx’s time. But it is necessary for Marxists to stress the limitations of government action upon an unplanned capitalist economy with its own economic laws and with the limitations imposed by other variables, such as the exchange rate and the government budget. Interest rates are unprecedentedly low in all the major capitalist economies, but so far that hasn’t on its own stimulated a recovery.

RS seems to ascribe a magical significance in the ability of credit to overcome the contradictions, at least for a time. “Credit…allows capitalism to go beyond its limits by temporarily expanding the market.” Marx’s analysis of the function of credit is much more nuanced. Much of his work in Capital Volume II deals with the role of credit in accelerating the circulation process of capital, so enabling the capitalists to achieve a higher annual rate of profit. Credit can, for a time, increase the market. But there is consumer credit and also producer credit for the capitalists. Credit can expand the ability of capitalists to satisfy the market too. In orthodox economic terms it allows both an increase in demand and in supply.

RS then goes on to detail the severity of the present recession, comparing it with 1929-33. It is true that the collapse in production and trade in the first year of the present crisis was as severe as in 1929-30. He quotes World Perspectives 1994, “In the coming epoch a new depression on the lines of 1929-31 is inevitable.” In fact Marxists have always emphasized that in general economic events have unique features and history does not repeat itself.

But RS, whose article was published in September 2009, should have made the readers aware of the course of the recession after the shock of the first year. It has become increasingly clear that present events, serious though they are, do not constitute a re-run of the 1929-33 crisis. In failing to do this he misleads his readers on economic perspectives. Here is Paul Krugman, writing in the New York Times August 10th 2009. “For a while, key economic indicators – world trade, world industrial production, even stock prices – were falling as fast or faster than they did in 1929-30. But in the 1930s the trend line kept heading down. This time, the plunge appears to be ending after just one terrible year.”

RS then moves on to his central proposition. “While there are many secondary causes of capitalist crisis inherent in ‘the real movement of capitalist production, competition and credit,’ Marxists have always explained that in the final analysis real capitalist crisis is always a crisis of overproduction.”

(RS does not actually explain that the section within the italicized passage in quotation marks is a quote from Marx, let alone where it actually comes from.) The actual quote is as follows: “But now the further development of the potential crisis has to be traced – the real crisis can only be deduced from the real movement of capitalist production, competition and credit,” (Theories of Surplus Value Volume II p 512 Progress Publishers, 1968). Overproduction is not mentioned at this point in the manuscript, whatever the impression given by RS’s formulation.

Marx does deal with overproduction in this section of Theories of Surplus Value – Chapter XVII ‘Ricardo’s theory of accumulation and a critique of it. (The very nature of capital leads to crises)’. As the bracketed part of the chapter title suggests, this is a critique of Say’s law, which asserts that crises of overproduction are impossible. Marx obviously needs to show that crises are in fact possible since Say’s law is wrong. Say’s law is usually spelled out as ‘every seller brings a buyer to market with him’ or ‘supply creates its own demand.’ This suggests that supply is always equal to demand so that overproduction is impossible and that the economy is always in equilibrium at full employment. The apologetic nature of this ‘law’ is obvious.

Say’s basic error is in assuming that products exchange for products, that economic exchange is conducted by barter. Since monetary exchange is the rule under capitalism there is no reason why the seller should not sit on his money after selling, leaving another potential supplier without a market. Under capitalism, where production is for profit, capitalists will always do this if they can’t see a way of making profit by going on to buy with the money they have acquired by selling.

To outline points we shall explain in more detail later, this section of ‘Theories of Surplus Value’ deals with the possibility of capitalist crisis and that this takes the form of overproduction. To explain why crises periodically break out we need an analysis of movements in the rate of profit, ultimately explainable in terms of Marx’s law for the tendency of the rate of profit to fall and its countervailing tendencies.

Ricardo adopted Say’s law, which asserts that general crises are impossible. Ricardo’s followers tied themselves up in knots, as they realised that capitalist crises do happen. So they asserted that there can be overproduction of capital, though not of commodities. Marx ridiculed this contortion, since overproduction of capital must involve overproduction of commodities.

He shares our perspective. “The overproduction of commodities is denied, but the overproduction of capital is admitted. Capital itself however consists of commodities…What then does overproduction of capital mean?…Defined more closely, this means nothing more than that too much has been produced for the purpose of enrichment, or that too great a part of the product is intended not for consumption as revenue, but for making more money, for accumulation;”(ibid. p. 532) We agree that overproduction is the form of appearance of capitalist crisis. We are striving to explain why crises of overproduction occur when they do.

Marx’s thoughts in this Chapter are interesting. They constitute an important aspect of the Marxist theory of crisis. He starts by explaining the possibility of crisis in consequence of the separation of purchase and sale in consequence of monetary circulation.

He goes on to explain: “The word overproduction in itself leads to error. So long as a large part of the needs of society are not satisfied, or only the most immediate needs are satisfied there can of course be no talk of an overproduction of products, in the sense that the amount of products is excessive in relation to the need for them…The limits to production are set by the profit of the capitalist and in no way by the needs of the producers.” (ibid. p. 527)

So Marx explains that overproduction occurs in relation to profit and on account of the profit system.

RS uses a sentence from another quote to assert that overproduction is the fundamental cause of capitalist crisis. As usual, he does not give references. “The ultimate reason for all real crises always remains the poverty and restricted consumption of the masses as opposed to the drive of capitalist production to develop the productive forces as though only the absolute consuming power of society constituted their limit.”

Here is a fuller version: “(T)he replacement of the capital invested in production depends largely upon the consuming power of the non-producing classes; while the consuming power of the workers is limited partly by the laws of wages, partly by the fact that they are used only as long as they can be profitably employed by the capitalist class. The ultimate reason for all real crises always remains the poverty and restricted consumption of the masses as opposed to the drive of capitalist production to develop the productive forces as though only the absolute consuming power of society constituted their limit.”(Capital Volume III, Penguin, 1981 p. 615)

So why do the masses suffer “poverty and restricted consumption?” It is because they toil under a system where production is for profit. Marx’s comment come as an aside in Capital Volume III in Chapter 30 on ‘Money capital and real capital:1’ (one of three chapters on the subject). Marx wants to remind us of the fundamentals in a section dealing with the intricacies of the financial form of appearance of capitalist crisis – of interest rates, balance of payments problems and many other technicalities.

The quote only speaks of the “ultimate reason” for the crisis, its sine qua non. It does not give us a causal mechanism. It does not explain to us what actually causes the onset of crisis – why there’ll be a crisis. This passage has also been discussed in The Marxist Theory of Crisis (2), so only supplementary points of interpretation are made here.

This quote has been wheeled out so many times one would think it was the only word Marx had to say on capitalist crisis. It is so buried in a technical part of his writing that one might suspect that, rather than laying out his theory in a systematic and logical manner, Marx was engaged in a light minded game of ‘hunt the thimble’ with posterity as to essential aspects of his economic theory. This passage cannot be regarded as a theory on its own. It is a mere aside.

Engels, in his chapter on ‘Production’ in Anti-Duhring (Lawrence & Wishart, 1959), points out that the restricted consumption of the masses is a permanent feature of capitalism: “But unfortunately the underconsumption of the masses, the restriction of the consumption of the masses to what is necessary for their maintenance and reproduction, is not a new phenomenon. It has existed as long as there have been exploiting and exploited classes. Even in those periods of history when the situation of the masses was particularly favourable, as for example in England in the fifteenth century, they underconsumed. They were very far from having their own annual total product at their disposal to be consumed by them. Therefore, while underconsumptionism has been a constant feature in history for thousands of years, the general shrinkage of the market which breaks out in crises as a result of a surplus of production is a phenomenon only of the last fifty years;” (pp. 395-396).

We commented on this passage in ‘The Marxist theory of crisis’:

”If the crisis were really caused by the ‘restricted consumption of the masses’ we would expect it to be manifested by an overproduction of consumer goods relative to capital goods. In fact this is by no means the usual case in actual capitalist crises. Most crises have actually begun in the capital goods sector. If the crisis were caused by under-consumption we would expect the workers to suddenly cease providing an adequate market for the capitalists, so triggering the crisis.

“Actually workers’ consumption usually falls as they are laid off as a result of the crisis, further shrinking markets. Their restricted consumption is thus a symptom of the crisis, not its cause. If capitalists generally accumulate a great part of their surplus, then we can expect the capital goods sector to grow relative to consumer goods in the economy. But the effect of this accumulation of capital is to make the workers more productive and therefore make the problem of over-production potentially more severe in the future.”

But the most severe stricture that the restricted consumption of the masses can be regarded as a cause of crisis comes from Marx himself:

“It is sheer tautology to say that crises are caused by the scarcity of effective consumption, or of effective consumers. The capitalist system does not know any other modes of consumption than effective ones, except that of sub forma pauperis or of the swindler. That commodities are unsaleable means only that no effective purchasers have been found for them, i.e., consumers (since commodities are bought in the final analysis for productive or individual consumption). But if one were to attempt to give this tautology the semblance of a profounder justification by saying that the working-class receives too small a portion of its own product and the evil would be remedied as soon as it receives a larger share of it and its wages increase in consequence, one could only remark that crises are always prepared by precisely a period in which wages rise generally and the working-class actually gets a larger share of that part of the annual product which is intended for consumption. From the point of view of these advocates of sound and ‘simple’ (!) common sense, such a period should rather remove the crisis. It appears, then, that capitalist production comprises conditions independent of good or bad will, conditions which permit the working-class to enjoy that relative prosperity only momentarily, and at that always only as the harbinger of a coming crisis. [Ad notam for possible followers of the Rodbertian theory of crises.— F.E.]” Capital Volume II pp. 486-7, Penguin 1978)

This passage is from Volume II, which deals with the circulation process of capital. Marx is explaining that production generates revenues that are spent by the economic actors. As wages rise because there are more workers or they are paid more, more wage goods are produced. Capitalists gain profits, which they can either spend on themselves or invest. Corresponding quantities of investment goods or luxury items appear on the market. Since capitalism is unplanned, this process is not automatic, but that is how the reproduction of the capitalist system proceeds. “The limits of the market” that RS mentions are evidently quite elastic.
A tautology, let us remind ourselves, is a way of saying the same thing twice in different words. It is not an explanation, but a way of trying to conceal the fact that you have no explanation. How does RS deal with this forceful critique of his ‘crisis theory’ provided in this quote? Why, he ignores it.

As we see, underconsumptionist theories were identified by Marx and Engels with Rodbertus and Duhring and contrasted to their own theory.

RS makes it clear that he regards overproduction as the fundamental cause of capitalist crisis. He provides long quotes from Newsweek and Business Week. “Capitalist economists do not like referring to ‘over-production’, but prefer the term ‘over-capacity’, which is basically the same thing and expresses the limits of the market. “The world is awash with goods…” explained Newsweek. “For economists, over-capacity is a tricky concept. Human wants are unlimited, so how could the world ever produce too much of a good thing? The key is what people can pay: In many goods sectors, prices still aren’t low enough to bring forth enough buyers. There will have to be some combination of falling prices and destruction of productive capacity before supply and demand come back into balance.” (Newsweek, 4/2/09)

“This crisis of over-production has been unfolding on a world scale. As the Newsweek article continues, ‘That’s not to say the Obama Administration is on the wrong track with its nearly $900 billion-plus stimulus plan. But it’s important to have realistic expectations. The stimulus can ameliorate the downturn, but not prevent continued contractions in the sectors of the economy where global over-capacity is the most extreme. The world is able to make 90 million vehicles a year, but at the current rate of production, it’s making only about 66 million, according to estimates from market researcher CSM Worldwide. Global production of semiconductor wafers is running at only about 62% of capacity, estimates market researcher iSuppli.”

“In relation to car production, Business Week makes the following observation: ‘Having indulged in a global orgy of factory-building in recent years, the industry has the capacity to make an astounding 94 million vehicles each year. That’s about 34 million too many based on current sales, according to researcher CSM Worldwide, or the output of about 100 plants.’ The article continues, ‘To become profitable, according to Michelle Hill of consulting firm Oliver Wyman, U.S. automakers will need to close at least a dozen of their 53 factories in North America in the next few years’.” (Business Week, 31/12/08)

It is refreshing to find proper citations to be given as to the sources of the evidence, though it is odd for a supposed work of Marxist theory to be culled from airport magazines. But the passages cited do not explain why overproduction occurred when it did. They are purely descriptive as to the state of the world economy

RS then moves on to discuss the role of the tendency for the rate of profit to fall in the current capitalist crisis. The passage seems to be an interpolation in his account, as in RS’s view the rate of profit is unimportant in the present crisis. “Between 1989 and 1997, US corporate profits increased by about 82% and the corporate rate of profit by 27.8%. By 1997 profitability in the corporate had returned to within 15%of its 1960’s high. The non-manufacturing sector had recovered to above its 1969 level to within 15-20% of its heights in the post-war boom.”

This all seems very authoritative. The reader may well wonder where this information comes from. RS does not tell us. It is in fact a quote, or concoction of quotes, from Robert Brenner’s 1998 Verso book ‘The economics of global turbulence.’ The confection of quotes is extraordinary. The first sentence is from page 246 and the next two from page 252, though they are separated by other text. On the same page 252 Brenner opens his discussion on the US profit rate with the words, “In the US, in sharp contrast, profitability has rebounded significantly” in bold type. The USA, in other words, provides an exception to the general processes. So naturally that is the example RS provides. The section beginning on page 251 is titled ‘A new Global boom?’ Brenner’s reply to the question, reiterated in all his writings since 1998, is a firm ‘no.’ He regards the secular fall in the rate of profit as the most important development since the War, one causing what he calls ‘the long downturn.’ This is not the impression the reader would get from RS’s selective quotation from Brenner’s work.

Brenner is a scrupulous and honest commentator. He does not use Marxist categories in working out the rate of profit. For instance he thinks the organic composition of capital is unimportant in movements in the profit rate, citing Okishio’s theorem. But both Brenner, in subsequent writings, and authors attempting to use Marxist analysis such as Andrew Kliman and Michael Roberts have all come to similar conclusions. There was a collapse in profits associated with the 2000-2001 recession (After the 1998 work cited by RS). The rate of profit recovered in the subsequent boom until it collapsed in 2006. Never again did profits reach the high point of 1997 in the meantime. All this is unknown to RS’s readers, since he chooses to use a book written in 1998 to outline the processes that led up to the crash of 2007.

RS goes on, “Despite a dip in profitability during the recession of 2001, profits went on rising until the financial crisis hit in 2007.” No authority is cited for this assertion and I cannot trace one. Clearly it is quite central to his thesis that the rate of profit fell as a result of the recession, which was already in process. “Today, with the world slump, the rate and mass of profit have collapsed. This is directly linked to the collapse of markets and the emergence of overcapacity and overproduction.”

Andrew Kliman explains, “Finally there was a sharp rise in profitability in the middle years of this decade. As we now know, however, it was driven by an asset bubble and was not a sustained recovery. Revised and updated BEA data indicate that the rate of profit fell from a peak of 25% in 2006 to 17.9% in 2008.” (The persistent fall in profitability underlying the current crisis: new temporalist evidence, 2009, pp. 23-24 ) (3)

The trouble for RS is that Kliman and Michael Roberts emphasise that the staggering fall in the rate of profit preceded the onset of recession in 2007. Roberts backs up Kliman’s point. “The rate of profit rose from 2001 to 2005. So does that mean the Great Recession was not caused by declining profitability? The answer is that by 2005, the value rate of profit began to fall again.” (‘The great recession’2009,p. 264.)

Not a single authority that I can find buttresses RS’s assertion that profits fell on account of the crisis and after its onset, Brenner himself in his ‘Afterword’ to the second edition of ‘The economics of global turbulence’ (Verso 2006) emphasises that 1997 was the peak year for profits in the era since the ‘Golden Age’ of capitalism that ended in the recession of 1973-74. Brenner also points out that boom turned into bust in the third quarter of 2006 as profit rates went on the turn. (‘What is good for Goldman Sachs is good for America;’ the May 2009 Prologue to the Spanish edition of the ‘Economics of global turbulence’p.71. (4)) “It is crucial to emphasise that the descent into recession was already well in progress before the outbreak of the financial crisis in July-August 2007. Nonfinancial profits peaked with housing prices in the middle of 2006 and then declined 10 per cent by the third quarter of 2007.”

Fred Moseley too asserts that, “Mid 2006 was the peak of this current profit cycle.” (‘The long trend of profit’ p. 1 (5) ) And Graham Turner (who I think does not regard himself as a Marxist) chips in, “Data published by the Bureau of Economic Analysis strongly supports the argument by those who claim the economic crisis of 2008 was attributable to a declining profit rate” – though his own position is more nuanced. (No way to run an economy, Pluto 2009 pp. 130-131) The official US Bureau of Economic Analysis does indeed indicate that the US rate of profit peaked in the third quarter of 2006 at 17.8% of GDP. By the second quarter of 2007 it was 15.9% and by the first quarter of 2009 it bottomed at 11.1%. This is also the view of a recent paper published by Goldman Sachs and written by Daly and Broadbent, entitled, “The savings glut, the return on capital and the rise in risk aversion”. (6)

It is true that all these authors use different methods to calculate movements in the rate of profit. But they all show the same trend. The evidence suggests quite strongly that the recession was caused by the fall in the rate of profit. This is not a conclusion RS wants to countenance.

RS is guilty not only of playing fast and loose with the facts regarding the rate of profit but also of failing to understand the theory. One of the countervailing factors mentioned by Marx to offset the tendency for the rate of profit to fall is raising the rate of exploitation. RS explains that “The rate of profit began to fall steeply by the mid-1960s. This decline carried on until the 1980s when, after a series of defeats for the working class, the capitalists began an all-out offensive to drive up profitability.” It is quite correct that the working class internationally in the past period has experienced a one-sided civil war on the shop floor to restore the capitalists’ rate of profit. This hardly suggests that the bosses regard the rate of profit as unimportant.

Significant as this is to the class struggle and the life of the workers, one important point is evaded by RS. In the debate between AG and MB and the leadership of our tendency in 1980 it was clearly established that raising the rate of exploitation cannot indefinitely offset the tendency for the rate of profit to fall. Capitalism is inherently crisis-ridden. Crisis is not simply caused by class struggle over the surplus. Even if the workers live on air, as long as the organic composition of capital rises, then eventually the rate of profit must fall. Even AG admitted this at one point in the debate. This view was supported by EG and became the official position of the tendency. RS is in effect putting an opposite view to that defended by AG 30 years ago. He believes that successful class struggle by the bosses has substantially restored the rate of exploitation and therefore the rate of profit.

Likewise the tendency for the rate of profit to fall was an important part of our tendency’s analysis of the crisis of capitalism. “ In all capitalist countries the tendency of the rate of profit to fall has manifested itself in a steep decline. Hence the preoccupation of the ruling classes to increase the rate of profit.” (EG World perspectives 1977 in The Unbroken Thread p. 416)

In a crisis there is a massive destruction of capital, not just physical destruction, but also the destruction of the value of capital. RS mentions this, and quotes Marx approvingly. The role of this destruction is to reduce the organic composition of capital and thus raise the rate of profit to prepare for a new cycle of boom and bust. AG had argued that the reason the rate of profit was threatened in the 1970s was because of rising real wages, which bit into the rate of exploitation. RS is arguing that the rate of profit has been substantially restored (using partial and inaccurate figures) by a bosses’ counter-offensive. Both analyses were and are wrong and contrary to the longstanding tradition of our tendency.

We are not explained why or how the restricted consumption of the masses, which is a permanent condition of capitalism, causes cycles of boom and bust. Then in addition to the cyclical crisis of capitalism, RS introduces us to the organic crisis of capitalism. He never explains or defines this term. We know what organic fertiliser is, but not an organic crisis of capitalism! “This organic crisis, which emerged with a vengeance during the inter-war period, was temporarily overcome by the massive development of world trade following the Second World War.” It seems the organic crisis can come and go as it pleases. It sounds rather like the ‘final crisis of capitalism’, but RS knows that Lenin and Trotsky angrily repudiated the concept at the First Four Congresses of the Communist International. No crisis is final, since the capitalist system will not collapse of its own accord. It must be overthrown. So the organic crisis of capitalism remains a mystery.

(1) http://www.marxist.com/unfolding-capitalist-crisis-nightmare-for-workers.htm

(2) http://www.socialist.net/marxist-theory-crisis.htm

(3) http://akliman.squarespace.com/persistent-fall/

(4) http://escholarship.org/uc/item/0sg0782h

(5) http://www.workersliberty.org/story/2008/03/19/marxists-capitalist-crisis-1-fred-moseley-long-trends-profit

(6) http://www.permanentrevolution.net/files/gs%20savings%20glut%20may%2009.pdf

By Michael Roberts

Abstract

The Great Recession of 2008-9 was the deepest and longest capitalist economic slump since the Great Depression of 1929-32.  Yet, the official strategists of economic policy in all the advanced capitalist economies did not see it coming; then denied it was taking place; and afterwards were unable to explain why it happened.  The vast majority of mainstream economists (both the neoclassical or Keynesian wings) failed to forecast it too.

Afterwards, a bitter dispute has broken out between these two wings on which theoretical model best explained the Great Recession.  This paper argues that neither wing has an adequate explanation because both theoretical models are: obsessed with the actions or motivations of individual economic agents; refuse to provide empirical evidence from history (thus have models lacking in any predictive power); and focus only on flaws in the financial sector for the causes rather than the wider capitalist production process.

These failings also apply to a greater or lesser degree to many heterodox economic explanations, ranging from the behavioural or ‘animal spirits’ versions of the Keynesian model, the Minsky ‘financial instability’ supporters, to the Austrian ‘excessive credit’ school.

This paper argues that the Marxist model of capitalism best explains the Great Recession, rooted as it is in the inherent flaws in the capitalist production process and then its indirect impact on the financial sector.  This reveals how the proximate causes are related to the ultimate.

The methodological lessons for economists from the Great Recession are: 1) turn to the aggregate and away from the individual in forming economic theory; 2) provide empirical evidence that can be tested and retested; and 3) look at the big picture, not one sector of the capitalist economy.

“To understand the Great Depression is the Holy Grail of macroeconomics”. Ben Bernanke, 2002 speech.

The Great Depression was (and in many ways) remains a great puzzle as there were millions of the world’s citizens who wanted to consume more housing, food and clothing; and producers by the hundreds of thousands who wanted to manufacture more housing, food and clothing and yet the two sides could not get together.  Why? What was preventing these economically improving, mutually beneficial exchanges from taking place?  What was it that prevented people from working and producing more?  …At this moment, (the answer) remains largely unknown”.  Randall E Parker, The Economics of the Great Depression, 2009

“There are known knowns.  There are things we know that we know.  There are known unknowns.  That is to say, there are things we know we don’t know.  But there are also unknown unknowns.  These are things we don’t know that we don’t know. Donald Rumsfeld

How great was the Great Recession?

The Great Recession of 2008-9 really was great.  It was the longest and deepest in its contraction of output that the global capitalist economy, as represented by the 30 advanced capitalist nations of the OECD, has experienced since the Great Depression of 1929-32.

From the peak of the previous boom in real GDP growth from 2007 to the trough of the Great Recession in mid-2009, the OECD economies contracted by 6% points of GDP.  If you compare global output in 2009 to where it should have been without a slump, the loss of income was even greater at 8% points (1).

At the trough of the Great Recession, the level of industrial production was 13% below its previous peak, while world trade fell 20% from its previous peak.  World stock markets fell an average 50% from the peak in 2007 (2).

The Great Recession was also the longest since the Great Depression.  Since the Great Depression, the US National Bureau of Economic Research (NBER) has tried to date economic recession with reference to the US economy.  There have been 18 recessions on NBER measures since the Great Depression, now 80 years ago.  The average length of these has been ten months and on average the US economy grows below ‘potential’ for about 19 months during those recessions (measured by rising unemployment).  The Great Recession, still not officially declared as over by the NBER, probably lasted about 20 months, making it more than double the average and the longest by far since 1929-33, which lasted 43 months (3).

The taxonomy of economics

Given its depth and duration, the Great Recession must be one of the most important case studies for explaining the processes of the capitalist economy.  So how robust were the various schools of economic theory in predicting and explaining the nature of the largest and longest slump in capitalism since the Great Depression?

The short answer is that economics as a science has egg on its face over the Great Recession.  Most economists did not predict the oncoming of the slump and in hindsight have struggled to explain what happened and its cause or causes.

We can look at the various explanations or rationalisations of the various schools of economic theory.  We can categorise the economics profession into various schools, with the main division between ‘mainstream’ and ‘heterodox’.  Taxonomy, of course, will have its exceptions, as Darwinians will be the first to proclaim in the field of biology.

In the mainstream, we have two great schools with sub-divisions.  The first is the neoclassical (and by this we should distinguish from the 19^th century classical economists of Smith, Ricardo, Malthus, JS Mill and, of course, Marx).

The neoclassical school is what Marx called the vulgar economics.  This school is ideologically committed to a belief in the ‘free market’ as a starting assumption rather than as a scientifically objective view of economic organisation.

The neoclassical can be sub-divided into the Walrasian general equilibrium analysis; the traditional monetarists (a la Milton Friedman); and the modern ‘Chicago school’ of ‘efficient market’ theorists.

Within the mainstream, there is also the Keynesian school, which rejects the microeconomic categories of the neoclassical school as relevant to macroeconomic forces.  It is divided again.  There are the neo-Keynesians with their synthesis with neoclassical equilibrium theory, namely that slumps are really a product of ‘sticky’ factors of production, particularly wages.  For neo or New Keynesians, slumps are exogenous to the economic model.

And there are Keynesians who concentrate on other aspects of Keynes’ theory; that slumps are the result of the lack of ‘effective demand’, which in turn is induced by ‘liquidity preference’ in the financial sector or is a product of the irrational movements of ‘animal spirits’ among entrepreneurs and the behaviour of consumers (this wing of Keynesianism has now migrated into ‘in-vogue’ so-called behavioural economics).

The divisions between the mainstream Keynesians and the neoclassical school have become very heated in the aftermath of the financial crash and the Great Recession.  But both are still firmly agreed on a market-based system as the only viable form of economy.

Then there are eclectics who sit astride both the major mainstream schools and cherry pick what they want to use.  They particularly include the frontmen and women of the official bodies of monetary and fiscal policy like the central bankers (Alan Greenspan, Ben Bernanke or Mervyn King) and economists within government like Larry Summers.

The heterodox school of economics can also be divided between those who look to the more radical aspects of Keynesian thought: namely the irrational behaviour of markets and the inherent instability of the financial sector (Hyman Minsky et al) as the benchmarks for the economic crisis: and the Marxist school that looks to the inherent instability of capitalism as a whole, namely in its non-financial sector just as much as, if not more than, the financial sector.

The Marxist school can be sub-divided between those who see the cause of capitalist crisis in ‘overproduction’ and/or ‘underconsumption’; or in profitability.  Once again some sit astride these various heterodox schools and cherry pick – so much for accurate taxonomy here.

The official leaders: a complete mess

How did the official leaders of capitalist economic strategy act before, during and after the Great Recession?

Before 2007, no official strategist of economic policy forecast any crisis.  US Fed Chairman Greenspan in 2004 told us that “a national severe price distortion is most unlikely in real estate”.  In 2006, he told us that “the worst may be over for housing”, just the housing bubble burst.  US treasury secretary Hank Paulson said the crisis in the overall economy “appears to be contained”, March 2007.

During the crisis, in October 2008, the great financial maestro 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”.

Greenspan in hindsight tells us that economists cannot predict a bubble and when it happens there is nothing you can do about it.  “You can only break a bubble if you break the underlying basis of the economy”. October 2007.

Greenspan finally summed up what he had learned in a review of the crisis in his paper The Crisis, March 2010.  He told us that what happened was “financial intermediation tried to function with too thin a layer of capital owing to a misreading of the degree of risk embedded in ever-more complex financial products and markets “.  So something as simple as the lack of capital adequacy was the cause.  You’d think he might have noticed that.

Moreover, the bubble that burst in 2008 came about by a conjunction of events that could not be expected.  It was the serendipity of the Fall of the Wall, cheap interest rates and globalisation that came together to create excessive risk taking.  Could the crisis have been avoided?  No, because of these serendipity factors coming together, “I doubt it”, he says.

So for Greenspan, it was chance, a one hundred year event.  “The disasters were the results of massive natural forces and they did constitute a perfect storm”. This idea was echoed by Hank Paulson: this sort of thing happens “only once or twice” in a hundred years.  As economist Daniel Gross commented on the ‘chance explanation’ of the crisis: what’s the difference between once or twice?  “In this instance, several trillion dollars in losses”.

In the aftermath, the official leaders fell back on the argument of Nassim Taleb, that the crisis was a black swan – something that could not have been expected or even known until it was, and then with devastating consequences (4).  As Donald Rumsfeld put it during the Iraq war, it was an ‘unknown unknown’.

Greenspan defined a bubble as “a protracted period of falling risk aversion that translates into falling capital rates that decline measurably below their long-run trendless averages.  Falling capitalisation rates propel one or more asset prices to unsustainable levels.  All bubbles burst when risk aversion reaches its irreducible minimum.”

He notes that several Nobel prize winners in economics were embracing profitable market trading models that were successful only as long as risk aversion ‘moved incrementally’.  But using only 2 to 3 decades of data did not yield a model that could anticipate crisis if risk moved outside that range.

There was nothing wrong with the Black and Scholes option pricing model: “it’s no less valid today than a decade ago”. It is just that the “underlying size, length and impact of the negative tail of the distribution of risk outcomes that was about to be revealed” had not been comprehended.

Greenspan now doubts that stable growth is possible under capitalism (5).  “I know of no form of economic organisation based on the division of labour (he refers to the Smithian view of an 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.”

Of course, these official leaders are the paid proponents of vulgar economics.  You would not expect them to forecast to the public at large that capitalism was about to collapse or could collapse.  The Fed failed to foresee the greatest economic collapse since the Great Depression.  And it is not surprising.  There is a crude pecuniary connection here.  At the Journal of Monetary Economics, a much-published venue of mainstream economics, more than half of the editorial members are currently on the Fed payroll and the rest have been in the past (7).  There were 730 economists, statisticians and others working at the Fed and its regional banks in 1993, according Greenspan.

Over a three-year period, ending October 1994, the Fed awarded 305 contracts to 209 professors worth $3m.  The Fed now employs 220 PhD economists.  In 2008, the Fed spent $389m on research into monetary and economic policy and $433m was budgeted for 2009.  According to the AEA, 487 economists are researching monetary policy and central banking, another 310 on interest rates; 244 on macroeconomic policy.

The NABE reckons that 611 of its 2400 members focus on monetary and banking.  Most of these have worked for or with the Fed.  Many editors of prominent academic journals are on the Fed payroll: 84 out of 190 editorial members in seven top economics journals were affiliated with the Fed.

“Try to publish an article critical of the Fed with an editor who works for the Fed” complained economist James Galbraith.  Even the now extinct Milton Friedman expressed his concerns about this:  “I cannot disagree with you that having something like 500 economists is extremely unhealthy.  As you say, it is not conducive to independent objective research.  There is censorship of material published.”

Asked to be a consultant for the Fed. “It’s a payoff, like money.  I think it’s more being one of part of a club, being respected, invited to conferences, have a hearing with the chairman, having the prestige is as much as a pay check.” Rob Johnson, Senate banking committee economist.

Ben Bernanke is the current Fed chairman and presided over the Great Recession.  Bernanke is an economist who specialised in the Great Depression.  If ever there was an economist who looked at ‘depression economics’, to use Krugman’s phrase, it is Bernanke.

He concluded that depression could be avoided by Fed action.  Following his mentor Milton Friedman, he advocated printing money and even ‘dropping it from helicopters’ to the populace to ensure spending is sustained.  This monetarist theory led him to concentrate on money supply indicators as a guide to the state of the US economy.  “I would like to say to Milton Friedman and Anna Schwartz regarding the Great Depression.  You are right, the US had a Great Depression, but thanks to you, we won’t again”“  Bernanke, 2002 speech.  But “Mr Bernanke, the former head of Princeton University economics department, knows all there is to know about a depression except what causes them” (8).

Like Greenspan, Bernanke did not see the crunch coming.  “We don’t expect significant spillover from the subprime market to the rest of the economy from the financial system”. May 2007.  By June, he was saying the losses would be minimal “between $50-100bn” at most.  So far, the losses in the global financial system have reached just under $2trn.

The head of the Federal Deposit Insurance Corporation, a US government agency responsible for regulating and monitoring the banking system, reported in July 2007 that “the banks in this country are well capitalised and my view is that I would be very, very surprised if any institutions of significant size were to get into serious trouble.” And lo – we have Bear Stearns, Countrywide, Lehmans, Merrill Lynch etc.

The efficacy of the economics of the world’s financial leaders in the Great Recession has been neatly summed up.  “Central banks have shed the conventional wisdom of typical macroeconomics.  But in its place is a “pot pourri of factoids, partial theories, empirical regularities without formal theoretical foundations, hunches, intuitions and half-developed insights.”

Is this the beginning of wisdom or total bankruptcy (9)?

The bankruptcy of mainstream economics

That mainstream economics was equally nonplussed by the financial crash of 2007-8 and the subsequent Great Recession of 2008-9.  The doyen of the neoclassical school, Robert Lucas, confidently claimed back in 2003, that “the central problem of depression-prevention has been solved”.  And leading Keynesian, Oliver Blanchard, now chief economist at the IMF, told us as late as in 2008 that “the state of macro is good”!

But then economic forecasting has not been the strong suit of the mainstream.  In March 2001, just as the mild global economic recession of that year began, according to the Economist, 95% of US economists ruled out such a recession.  Economists surveyed by the Philadelphia Reserve Bank in November 2007 forecast that the US economy would grow 2.5% in 2008 and employment would rise.

How has mainstream economics rationalised this failure to predict and what explanations has it come up with since for the causes of the Great Recession?  Modern vulgar neoclassical economics starts with the assumption (given and not proven) that the market is a perfect reflection of the underlying fundamentals.  Asset prices may change often dramatically, but merely as a rational and automatic response to the arrival of new information.

The price of any given asset at any time is completely correct.  It cannot be over or undervalued.  It is the right price, nothing more nor less.  If all public information is available immediately, it is incorporated into the price.  So any movement cannot be predicted because it depends on information that is not yet known.  You cannot beat the market.

Thus there is the famous (infamous) efficient market hypothesis (EMH).  Financial markets always get prices right given the available information.  Eugene Fama from University of Chicago first promulgated the EMT.  According to Fama, there was no bubble in housing markets because consumers had all the information they needed to buy, so the price was right.

The usual economic joke about EMH is that an economist and his friend come across a hundred dollar bill lying on the ground.  The friend goes to pick it up, but the economist says don’t, it’s not necessary.  If it were a real bill, someone would have already picked it up!

Eugene Fama dismissed criticism of EMH as useless in predicting or explaining the Great Recession (A).  He denied that there was any credit bubble that burst.  “I don’t even know what that means.  People who get credit have to get it from somewhere.  Does a credit bubble mean that people save too much during that period?  I don’t know what a credit bubble means”.

When asked what caused the Great Recession if it was not a credit bubble that burst, 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”.

What would be the legacy of the financial crisis for mainstream neoclassical economics? “I don’t see any. Which way is it going to go?  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.”

But can the market economy be considered efficient after this crisis? “Yes.  And if it isn’t, then it’s going to be impossible to tell.” Thus the great guru of neoclassical economics sums up his school’s contribution to the issue.

Paul Krugman, the leading US Keynesian economist and columnist of the New York Times, delivered a blistering attack on the failure of neoclassical economics to offer any explanation of the Great Recession (10).  Krugman pronounced: “admit that financial markets fall short of perfection; admit that Keynesian economics is the best framework we have making sense of recessions and depressions.  Incorporate the realities of finance into macroeconomics.”

The Chicago School responded equally sharply.  John Cochrane defended the EMT.  “The central prediction of the EMT is precisely that nobody can tell where markets are going – neither benevolent government bureaucrats nor crafty hedge fund managers, nor ivory tower academics.  This is the best tested proposition in all the social sciences”. Thus Cochrane tells us that the main thesis of neoclassical economics can tell us nothing about the financial crash!  Alternatively, the EMT tells us the bleeding obvious: namely, that if someone makes money doing an investment or activity, then other people will copy him/her and whittle away his/her returns over time (11).

For the neoclassical school, asset prices can move out of line with any reasonable expectation of future cash flows (underlying value).  This might be because people are prey to bursts of irrational optimism and pessimism.  But it might also be because people’s willingness to take on risk varies over time and is lower in bad economic times.  We just don’t know, apparently.

Cochrane criticises those who reckon economics needs some theoretical power in predicting crises.  “Crying bubble is empty unless you have an operational procedure for identifying bubbles, distinguishing them from rational low risk premiums and not crying wolf too many years in a row”. In effect, Cochrane says that economists don’t know anything about bubbles.  Unless you can predict when a bubble will burst, stop complaining about the EMT predicting bubbles are impossible!

Cochrane argues that neoclassical economics and the EMT has not been found wanting.  “People say that nobody foresaw the market crash.  Well, that’s exactly what an efficient market is – it’s one in which nobody can tell where it’s going to be.  The efficient markets thesis doesn’t say markets will never crash. It certainly doesn’t say markets are clairvoyant.  It just says that, at that moment, there are as many people saying it’s undervalued as overvalued.” In other words, the EMT tells you nothing!

Keynesian and behavioural economic theory is no better than neoclassical theory in gauging economic crises, according to Cochrane.  “Are markets irrationally exuberant or irrationally depressed today?  It’s hard to tell”.  As Cochrane says, “Let’s see a measure of the psychological state of the market that could come out wrong.  That’s hard to do”. Behavioural economics lacks measurable indicators – but then Cochrane has none himself.

Cochrane thus dismisses any attempt to explain market volatility and collapse.  For him, “it is the central prediction of free market economics, as crystallised by Hayek, that no academic, bureaucrat or regulator will ever be ably to fully explain market price movements.  Nobody knows what ‘fundamental’ value is.  If anyone could tell what the price of tomatoes should be, let alone the price of Microsoft stock, communism and central planning would have worked”.

So there we have it.  The only indicator of value is the market price and no underlying value can be ascertained – this is the ultimate in vulgar economics.  But note the disingenuous words “fully explain”. Apparently, we can explain ‘something’ and thus we could even measure perhaps a fundamental value for something (even if we cannot predict market prices at any one time).

For the neoclassical school, “the case for free markets was never that markets are perfect.  The case for free markets is that government control of markets, especially asset markets, has always been much worse”. On this vulgar ideological assumption, Cochrane dismisses the Keynesian attack on the EMT, but also the key Keynesian policy prescription for the slump, namely fiscal stimulus.

But as Nouriel Roubini (see below) points out, “Crisis economics is the study of how and why markets fail.  Much of mainstream economics, by contrast, is obsessed with showing how and why markets work – and work well.”

For Cochrane, fiscal stimulus won’t work.  It can help employment for a while but only at the expense of weakening consumer demand growth eventually.  Cochrane falls back on the neo-Ricardian theorem of Robert Barro.  Here Cochrane and Barro are on stronger ground as current empirical evidence of previous fiscal stimulus packages suggests that fiscal multipliers in the Keynesian sense are very weak and even negative.

Cochrane argues mischievously that if you are a Keynesian you would have to support Bernie Madoff’s Ponzi scam, because it took money from rich savers and gave it to thieving spenders.  It does not matter what it is spent on or how you get it as long as it spend it and not save it, according to Keynes, says Cochrane.

Paul Krugman’s attack on the failures of the neoclassical school exposed the ‘free marketers’ in Chicago who deny that any frictions or flaws exist in free markets.  Krugman tells us that “economics as a field got into trouble because economists were seduced by the vision of a perfect, frictionless market system”. This is why they have nothing to say on the Great Recession.  For Krugman, only Keynesian theory can provide light where there is dark.

Krugman is particularly upset that the neoclassical school has become obsessed with substituting beautiful mathematical models for truth and reality.  They turned a blind eye to human irrationality, to market imperfections.  Economists now have to live with messiness, the importance of irrational behaviour and imperfections in markets.

“Economics as a field got into trouble because economists were seduced by the vision of a perfect frictionless market system.  If the profession is to redeem itself it will have to reconcile itself to a less alluring vision – that a market economy has many virtues but it is also shot through with flaws and frictions”.

Keynesian Barry Eichengreen argues that “the development of mathematical methods designed to quantify and hedge risk encouraged commercial banks, investment banks and hedge funds to use more leverage as if the very use of mathematical models diminished the underlying risk.”

“Mathematical rigor has the inherent tendency to conceal the weakness of models and assumptions to those who have not developed them and do not know the potential weakness of the assumptions”.

Tony Lawson argues that the fundamental failing of modern mainstream economics is, as Krugman says, is not that it could not predict the recent crisis but that its obsession with mathematical modelling and formalistic models will never produce any successful predictions (12).  Mainstream economic is dominated by this failed approach to economic insights.

But are the Keynesians really saying that maths are not useful in economics.  Surely there is not enough maths?  Or to be more exact, there is not enough logical analysis as well as empirical data to check.  Should we abandon the attempt to compare theories quantitatively against data?

The problem is not the maths but that the neoclassical school builds an economic model on the twin assumptions of rational expectations and individual agents.  This is a false behavioural model and a false macro assumption.  Human beings may not act ‘as expected’ and certainly not at an individual level.

The economics profession has a duty to make that clear just as climate scientists do today over their models and assumptions.  But economists did not – on the contrary.  This shows the vulgar ideological nature of mainstream economics.

More important, the power of the aggregate and history is completely ignored.  The aggregate irons out the irrational or the unexpected (even if some wrinkles remain) and history, namely empirical data and evidence, provide a degree of confidence for any theory (the goodness of fit).  With the neoclassical EFM, neither is applied.

Carmen Reinhart and Kenneth Rogoff have taken a statistical approach with much more success in revealing the regularity of capitalist crises (13).  They complain that “Research on the origin of instabilities, overinvestment and subsequent slumps has been considered as an exotic sidetrack from the academic research agenda (and the curriculum of most economics programs).  This was because it was incompatible with the premise of rational representative agents.”

“A deeper question is whether economists have any handle on ferreting out dangerous price bubbles.  There is much literature devoted to asking whether price bubbles are possible in theory…in theory, rational investors should realise that the chain of expectations driving a bubble is illogical and therefore can never happen.  Are you reassured?  Back in my graduate days, I know I was.”

“But it all depend son how market participants coordinate their expectations.  In principle, prices can jump suddenly and randomly from one equilibrium to another as if driven by sunspots”.

Surely, any study of stock markets would show that they are much more volatile than the standard models of empirical research that Cochrane relies on (14)?

But of course, statistical analysis is also inadequate without a relation to theory.  The work of Reinhart and Rogoff lacks that.  As Paul Krugman says, “correlation may not imply causation… high debt is arguably a consequence of slow growth rather than the other way round”. (B)

David Colander sums up the relative success of the neoclassical and Keynesian schools in explaining the crisis (15): “the failure of economics is not a failure of Classical or Keynesian economics.  Instead, it is a systemic failure in the entire economic profession.”

Colander correctly tells us the bankruptcy of mainstream economics is partly because economic models “fail to account for the actual evolution of the real world economy.  Moreover, the current academic agenda has largely crossed out research on the inherent causes of financial crises.  There has also been little exploration of early indicators of systemic crisis and potential ways to prevent this malady from developing.”

Colander goes on: “systemic crisis appears like an other-worldly event that is absent from economic models.  Most models by design offer no immediate handle on how to think about or deal with this recurring phenomenon.  In our hour of greatest need, societies around the world are left to grope in the dark without a theory.”

“What we need are models capable of envisaging such ‘exceptional circumstances’. Instead, macroeconomics is confined to models of stable states that are perturbed by limited external shocks and that neglect the intrinsic boom and bust dynamics of our economic system”.

But Colander wants us economists to retreat to the idea that economics is not a really a science, but an art.  “It’s not the lack of maths or too much.  It is that an economy is a complex system and we don’t know how to analyse it.  We must start to rely on ‘common sense”.  God help us!

For Colander, the way out, is to admit bankruptcy of mainstream theory and give up on science.  “Economists have had no choice but to abandon their standard models and to produce hand-waving common sense remedies.  But common sense advice, although useful, is a poor substitute for an underlying model that can provide much-needed guidance for developing policy”.

Animal spirits school

The Keynesian school seems to have deserted the old ‘liquidity preference’ element of Keynesian theory for an explanation of this crisis, namely that money gets stuck in the financial sector as individuals hoard cash and banks do not lend it onto the real economy because real interest rates are too high.  Krugman prefers to draw on the causes of the crisis in Keynes perception of the animal spirits of capitalism (namely the changes in the confidence of economic agents, consumers and business leaders, to buy, borrow, invest, or speculate.

The ‘New Keynesians’ who reconciled the more radical aspects of Keynes’ theory with the neoclassical model argue that a cut in the interest rate might help raise ‘effective demand’ or consumption now, but lower planned consumption in the future.  That won’t end economic recession.  So how does a capitalist economy get out of recession?  Through pixie dust!  New Keynesians must assume that some time in the future full employment will be established.  So the old Keynesian cause of recession (an unemployment equilibrium), namely a high real interest rate, is not right.  The problem is the lack of a Tinkerbell effect, the magic of confidence (E).  Recession is the result of confidence falling and the answer is to restore confidence.  It’s as simple as that.

The Keynesians have also deserted their standard ‘effective demand’ theory based on the lack of consumption.  Robert Farmer is a leading Keynesian economist and adviser to various US governments.  For him, the key element of a Keynesian explanation is in animal spirits.  Demand depends on ‘confidence’ and that is best indicated by the movement in stock prices.  Farmer does not tell us why confidence is subject to such sudden and sharp changes.  It just is.

A fall in confidence leads to a fall in stock prices and then to employment, consumption and investment.  And the spiral continues until ‘confidence returns.  Then stock prices rise and the whole process reverses.  Thus the crisis is caused not by a lack of effective demand leading to a collapse in wages and employment, but the lack of speculation in stock markets!

Stock markets could stay permanently in a ‘bear market’.  The answer is not so much to provide fiscal stimulus but for the government and the central bank to intervene through the purchase of stock market indexes to pump prime the investors and restore their animal spirits.

The behaviouralist cul-de-sac

The Keynesians have also looked to behavioural school of economists for better explanations of economic crisis.  For some time, this micro motivation approach to economics has been popular with young economists who have turned away from questions like poverty, inequality or unemployment to study behaviour on television game shows.

For example, the young economists at the Bank of England wish to tell us that such is the role of ‘uncertainty’ in economics (16) (as it is in climate change or the weather) that we must accept “sharp changes in expectations, which is exactly what happened in autumn 2008, with the sudden and synchronous collapse in business confidence around the world”.

For them, the way forward is to look much more closely at the behaviour of economic agents.  There are four key aspects:  1) consumer or business behaviour can be influenced by recent or personal experience (a depression for example).  2) economic behaviour can depend on how the issues are presented to economic agents (like whether their pensions are assured or not)  3) people tend to follow the action of others (the herd instinct, the wisdom in crowds etc) and 4) people have excessive faith in their own judgements and wishful thinking.  Economists are thus faced with a conundrum: they need to provide guidance on the direction of an economy but such is the role of people’s expectations and uncertainty, they cannot with any degree of accuracy.  Oh woe is me.

Apparently “people do not often make decisions in the rational front of brain way assumed in neoclassical economics, but make decisions that are rooted in the instinctive part of the brain and thus produce herd effects and irrational momentum swings.”

According to one source (17), in crises, people know the risks but irrationally decide to ignore them.  This view of ‘irrational behaviour’ is the key element of Keynes’ General Theory and thus the crisis was more a Keynes moment than a Minsky one!

We even have behaviourists developing computer models where the idea is “to populate virtual markets with artificially intelligent agents who trade and interact and compete with each other much like real people” (18).  Apparently, these computerised ‘agent based’ models let “market behaviour emerge naturally from the actions of interacting participants.  What comes out may be a quiet equilibrium (neoclassical) or it may be something else.” Well, that’s helpful!  Apparently, when a model of increased leverage is developed with ‘economic agents’ like computerised hedge funds, we find that instability grows, but not gradually but suddenly.  There is a tipping point, a qualitative change a la Marxist dialectics.  Thus the behaviour of market agents can lead to financial crises by the very nature of markets.  This is nothing new, but chaos or complexity theory practised in a virtual world economy.

The heterodox schools

Austrian school

The Austrian school of economics is outside the mainstream (at least according to ‘the Whig interpretation of the history of economics’) (19).

The Austrians start from micro assumptions.  This is not the neoclassical view of rational fully informed human agents, maximising their utility and profits.  On the contrary, human action are speculative and there is no guarantee of success in investment.

Indeed, according to Carl Menger, the founder of the school, the further out the results of any investment are, the more difficult it is to be sure of success.  Thus investment in goods that are for immediate consumption are easier to estimate the returns on than investment in goods needed for capital goods.  Saving rather than consumption is a speculative decision in order to gain extra returns down the road.

Austrians reckon that the cost of this saving can be measured by the market interest rate which prices the time involved in delivering future output from savings now.  Economic crisis would not happen if it were not for interference in setting that market rate of interest by central banks and governments.

The boom phase in the business cycle takes place because the central bank supplies more money than the public wishes to hold at the current rate of interest and thus the latter starts to fall.  Loanable funds exceed demand and then start to be used in non-productive areas, in the case of the boom 2002-07 in the housing market.  These mistakes during the boom are only revealed by the market in the bust.

Thus “the Great Recession is not a product of the greed of laisser-faire capitalism, it is the unintended consequence of very significant interventions in the operation of the market process: the Fed’s expansionary monetary policy and a set of policies that artificially reduced the costs and risks of home ownership enabling the creation of highly risky loans which themselves then lead to even riskier innovations in the financial industry.”

From an Austrian perspective, the eventual collapse of the house of cards built on inflation (of credit) represents not a failure of capitalism, but a largely predictable failure of central banking and other forms of government intervention.

The Great Recession was a product of the excessive money creation and artificially low interest rates caused by central banks that on this occasion went into housing.  The recession was necessary to correct the mistakes and malinvestment caused by interference with the market pricing of interest rates.  As the Austrians correctly point out, “the recession is the economy attempting to shed capital and labour from where it is no longer profitable”. And no amount of government spending and interference will help to avoid that correction.

Within the Austrian school, there is general agreement that business cycles are primarily caused by periodic credit expansion and contraction of central banks.  Business cycles would not be a feature of a ‘truly free market’ economy.  As long as capitalists were free to make their own forecasts and investment allocations based on market prices rather than by bureaucrats, there would be no business cycles!

Cycles are due to the manipulation of credit by state institutions.  This differs from neoclassical/monetarist school which sees recessions as minor interruptions from growth caused by imperfections in market information or markets not busts caused by artificial credit booms.

On that basis, putting more credit into the economy to solve the recession is like giving more alcohol to a drunken man.  As Krugman says about the Austrian school, they reckon that a recession is like a hangover after a heavy night of boozing.

But if the market was left to set the interest rate and allow capitalists to make investment decisions unfettered or misguided by the state, would that end the cycle of boom and slump?

The Austrians are perceptive in their highlighting that a credit bubble can appear that artificially extends any boom beyond any growth based on real values.  That credit boom can be created by government and central banks desperate to sustain growth when profits appear to be waning (Ricardo) or consumption and investment weakening (Keynes).

In Marxist terms, it means fictitious capital is dramatically expanded to compensate for a slowing of the accumulation in real capital.  The result is that ‘excess capital’ is even greater at the height of the boom and, in the subsequent bust, the reduction in overinvestment, malinvestment or excess capital must be even greater (20).  This produces a Great Recession as opposed to any recession.

For the Austrians, the answer to boom and slump is to do away with central banks and state stimulus and let markets decide the rate of interest (21).  “the rate of interest is one of the most important signs of price signals in any economy.  Anything which acts to distort that signal will produce unintended real economy effects that will eventually have to be corrected by downturn and recession.  In the short term, these effects can be ameliorated or offset by faster growth in credit, but eventually these will lose traction.  Malinvested capital is then exposed and economic activity turns down as a result.”

But is the rate of interest the driving force of capitalist investment and the price signal that capitalists look for to make investment decisions?  As Marx explained, interest is just one part of surplus value and it is the latter that is key to investment.  Value and surplus-value are created in the production process, in particular in the exchange of money for labour and through the productivity of labour using capital goods.

What the Austrian school do not explain is why ‘excess credit’ eventually does not work.  Apparently, there is a point when credit loses its traction on economic growth and asset prices and then, for no apparent cause, growth collapses.

The Austrians ignore the fundamental flaw in the capitalist process identified by Marx in his law of profitability.  For the Austrians, as for the mainstream economic schools, there is no problem with capitalist production for profit – the problem lies in imperfect information and imperfect markets (neoclassical); the periodic lack of effective demand due to mercantilist hoarding and/or the volatility of animal spirits (Keynesianism) or excessive credit created by the state (Austrian).  None of these schools has anything to say about the flawed nature of the social organisation of production.

Left Keynesian school and Minsky

Also outside the mainstream is a subdivision of the Keynesian school, namely those who look to an inherent instability in capitalism to be found in the financial sector.  In the 1980s, Hyman Minsky argued that Keynes had been misunderstood by the revisionists of Keynes, who had incorporated his ideas into the mainstream.

In contrast, Minsky reckoned that Keynes had shown capitalism to be inherently unstable and prone to collapse: “instability is an inherent and inescapable flaw of capitalism”.

This instability is to be found in the financial sector. “The flaw exists 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.”

For Minsky, there is no flaw in the capitalist production process – the real economy – but only in the ‘veil of money’ and financial intermediation between production and consumption.  As debt accumulates, it brings uncertainty and instability into the process.  There are three sorts of borrowers: hedge borrowers, speculative borrowers and Ponzi borrowers.  The first borrows and pays back the principal and interest; the second services the interest only and rely on asset prices to rise to pay the principal.  The third group pays the interest only by borrowing more.

In a boom, the first group declines in proportion and the latter rises as a share, opening up the risk of instability when the pyramid of debt starts to crumble.  The actual trigger for this debt crisis could be in the property market as in 2007 or in equities as in 2000.   The greater the reliance is on leverage and debt to finance investment, the greater is the likelihood of collapse.  Once house prices stop rising enough to cover the servicing of debt, there can be a sudden aversion to risk and a desire to deleverage – this is what has now been described as a ‘Minsky moment’, as in 2007.

Minsky supporters will accept that the Great Recession did not follow his depiction of a financial crisis but argue that the Minsky’s way of looking at an economy would best reveal the cause of the Great Recession, namely in a pro-cyclical burst of credit in financial sector-dominated economy.  Systemic risk in the financial sector eventually collapses into debt deflation (22).

Steve Keen has won the award from the Real Economics Review as the economist who best forecast the financial collapse on 2008 (see below).  Keen draws on Minsky for his theory of endogenous money and also on Marx.  For Keen, Marx has a Minskyan view of the role of money in capitalist cycles and in the power of the credit system to disrupt production (23).

“For Marx, as with Fischer and Minsky before him, the essential element giving rise to Depression is the accumulation of private debt” says Keen, referring to Fischer’s comment that deleveraging can be spiral into debt deflation as the nominal value of debt is outstripped by a fall in prices.  For Keen “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.” Minsky Journal of Finance, Vol 24 1969

For Keen, it is Marx’s distinctive contribution that the cost of borrowing, the market rate of interest, will generally be governed “by the average expectations of the profit of the capitalist class”. That differs from the Austrian school’s view that the market rate is determined by the duration of the investment.  However, Keen denies any role for profitability in the crisis: the crisis is the product of insufficient demand when capitalist expectations of realising profits are not met.

The cherry pickers

Nouriel Roubini is the darling of the financial press, apparently for being alone in predicting the credit crunch and the subsequent crisis.  He dismisses the Taleb view greedily endorsed by Wall Street bankers and Alan Greenspan that the financial crisis was a fat tail event that could not possibly be foreseen in a hundred years.

This idea of the media fostered by Roubini even on the cover of his latest book is good spin (24).  But there were several others who warned of an oncoming asset price crisis or financial crisis.  According to Real World Economic Review, the Revere ward for economics voted on by 2500 people for the three economists who warned the world went to Steve Keen, the Australian economist, with twice as many votes as Roubini who finished second, while Dean Baker from the CEPR came third.

Others who could claim to be prescient include some from the animal spirits school, like Robert Shiller who talked of the housing bust as early as 2006.  From the Austrians, William White was warning of excessive credit back in 2004.  Even your humble self proposed as early as 2005 of the dangers of a housing bust and in 2006 reckoned on the basis of Marxist theory and empirical evidence that a deep recession was due in 2009-10.  It came a year earlier.  Of course, we don’t carry the media clout of Roubini.

Roubini correctly argues that financial crises are more like a succession of white swans, known unknowns; in the sense that the crisis follows a pattern that has happened before with financial crises (see Reinhart and Rogoff).  “Crises are neither freak events that modern economics has made them seem nor the rare black swans that others have made them out to be.  Rather, they are commonplace and relatively easy to foresee and to comprehend.  Call them white swans”.

“Most crises begin with a bubble in which the price of particular asset rises far above its underlying fundamental value.  Crises are not black swans but white swans: the elements of boom and bust are remarkably predictable.”

Roubini, an eclectic, follows the Austrian school in looking at excessive credit as the indicator of future crises (see White and Borio).  But he follows Minsky for his instability idea.

Roubini ridicules the EMH of the neoclassical school.  But for him “as always, pragmatism informs our choices”.  Keynes is here, as is his most radical interpreter, Hyman Minsky, but so are the economists of other camps: Robert Shiller, one of the most visible proponents of behavioural economics; Joseph Schumpeter, the grand theorist of capitalist creative destruction and economists of historical bent, from Charles Kindleberger to Carmen Reinhart and Ken Rogoff.  Their disparate strands inform our idiosyncratic approach”.

“In the history of modern capitalism, crises are the norm, not the exception.  That’s not to say all crises are the same.  Far from it, the particulars can change from disaster to disaster and crises can trace their origins to different problems in different sectors of the economy.”

Roubini tells us that crises cannot be avoided under capitalism.  But they can be prepared for and then mitigated by regulation and reform.  For him, that means controls on derivatives markets, better rating agencies, capitalisation of the banks, with no bank too big to fail, and international economic governance through the likes of the IMF.

But he quotes Hyman Minsky: “There is no possibility that we can ever set this right once and for all.  Instability will be having tested one set of reforms, will after time, emerge in a new guise”… nothing last forever and crises will always return”. However, Roubini is optimistic: at least severe instability only comes along infrequently every 80 years – from Great Depression to Great Recession.  “If we strengthen the levees that surround our financial system, we can weather crises in the coming years.”

Less known to the financial media, but perhaps more discerning in his analysis of crises is William R White, formerly at the Bank of International Settlements, but now chair of the OECD’s economic review committee (25).  For White, mainstream economists have missed the key ingredient that leads to systemic crisis, the build-up of debt.  Drawing on the arguments of the Austrians and Minsky, White criticises the traditional Keynesian view of the economy as a series of flows and wants economists to concentrate on the economic balance sheet and debt stocks in particular.

For White, it is significant that in Krugman’s attack on mainstream economics, he mentions debt only twice in 6000 words and then only to about sovereign debt.  But “debt is the central problem.  When debt to income or debt to GDP doubles, triples or quadruples, you have doubled, tripled or quadrupled the amount of future earnings you are using today.  That necessarily means you will have less to spend in the future.  It’s not rocket science.”

White is not relying on assertion or theory.  Indeed, as early as 2002, BIS economist Claudio Borio made empirical estimates of the correlation between credit to GDP ratios and subsequent banking or financial crises (see below).

For White, the theory of rational expectations from the neoclassical school is shown to be flawed when asset prices can move so far out of step with underlying values.  If the market is so efficient, why is unemployment or the prices of many key commodities like energy unable to adjust?

White is no more enamoured with Keynesian thought – at least in its mainstream (26).  “They have never been good at forecasting turning points in the business cycle”. The animal spirits idea has more validity in explaining volatility.  But “the Keynesian framework has all its fuzziness and uncertainties implicit in the principal functional forms being subject to animal spirits.  No wonder, no empirical forecasting by the mainstream economic bodies can show so much shortcomings.”

For White, the crisis is both financial and real.  “The associated concern that weakness in the financial system could feed back into the real economy through tighter credit conditions also feeds the perception that it is only a financial crisis”.

For him, a credit crisis only becomes a crisis if it feeds back into the real economy – from the credit crunch to the Great Recession. “One tendency that must be resisted is to see this work on imbalances as related solely to ‘financial stability’.  In part, this tendency is related to the misconception that our current problems are limited to those of a financial crisis.”

That is surely right: not all financial crises lead to economic contractions or slumps.  But he offers no explanation of how this process from the financial to the real might work.

The need for testing

“Prediction can be very difficult, especially if it is about the future”. Niels Bohr.

There are some methodological lessons from all the above, whether from the mainstream or the heterodox.  If economists want to understand the causes of financial and economic crisis, they need to look away from individual behaviour or models based on ‘representative agents’ and instead\look to the aggregate: from the particular to the general.

And they need to turn back from deductive a priori reasoning alone towards history, the evidence of the past.  The history may not be a guide to the future, but speculation without history is even less based in reality.  Economists need theories that can be tested by the evidence.

Mainstream economics does not seem to have any predictive power. “I’ve been forecasting for 50 years and I had not seen any improvement in our capability of forecasting”, says the great maestro, Alan Greenspan (27).  Christine Romer, key economic adviser to Obama argues that: “economists cannot predict recessions and economic discontinuities because they are inherently unpredictable”.  It is impossible to see the shocks coming”.  But is that really so?  “Predictions involve modelling.  The difference is that for many people the models are poorly specified, based on little information and cannot be tested.  Those who rail against models and the ‘folly of forecasting’, while still making predictions, are still doing modelling but doing it very poorly”. (28).

If we desert data, economists will head into a virtual world.  Some have already done so (29).  “Many macroeconomists abandoned traditional empirical work entirely, focusing instead on computational experiments.  Researchers choose a question, build a theoretical model economy, calibrate the model so it mimics the real economy along some key statistical dimensions and then run a computational experiment by changing model parameters to address the original question.  The last two decades have seen countless studies in this mould, often in a dynamic stochastic general equilibrium framework.  Whatever might be said in defence of this framework as a tool for clarifying the implications of economic models, it produces no direct evidence on the magnitude or existence of causal affects.  An effort to put reasonable numbers on theoretical relations is harmless and may even be helpful.  But it’s still theory.”

Macroeconomics has taken a turn to theory in the last 10-15 years.  “Many young economists are more comfortable with proving theorems than with getting their hands on any data or speculating on current events” (30).

Sure, every situation is different but “anyone who makes a living out of data analysis probably believes that heterogeneity is limited enough that the well-understood past can be informative about the future.  The process of accumulating empirical evidence is rarely sexy in the unfolding but accumulation is the necessary road along which results become more general.”

Claudio Borio was among the few economists in a major financial institution to look empirically for indicators of oncoming crises.  He found as early as 2002, that unusually strong increases in credit and asset prices have tended to precede banking crises (31).  This work is testable and thus has significant predictive power.  Borio and Lowe looked at the long term relationship between credit growth in the G10 economies and the movement of asset prices.  They found that there were 38 crisis episodes between 1970 and 1990, spread over 26 countries.  When credit as a share of GDP grew to 4-5% pts above trend, it was followed by a some form of financial crisis on nearly 80% of occasions within one year.

Similarly, Carmen Reinhart and Kenneth Rogoff did empirical work for over 60 counties since 1820 and found that debt crises come in waves like earthquakes.  And we appear to be in another wave right now (32).

Marxist school

For the Keynesians, whether of the animal spirits school, the financial instability school (Minsky), the flaws of capitalism lie in the financial sector only.  Modern Keynesian economists usually ignore Keynes’ other hint at the cause of capitalist crisis, namely a falling ‘marginal efficiency of capital’, the closest Keynes comes in his neoclassical model of ‘diminishing returns’ to Marx’s analysis of declining profitability in the capital production process.

Keynes wrote:  “A more typical, and often the predominant, explanation of the crisis is, not primarily a rise in the rate of interest, but a sudden collapse in the marginal efficiency of capital”. (33).  The marginal efficiency of capital, stressed Keynes, depended upon “animal spirits” as much as real factors such as the causes of actual profits.  However, this suggests that Keynes, like Marx, saw crises as originating in the real economy – and in attitudes thereto – more than the financial system, which means it’s not clear that our current crisis is especially ‘Keynesian’.  As we know, Keynes never read any Marx and Keynes did not provide any explanation of this approach and how it would work in a long term unemployment equilibrium that Keynes also posits (34).

Marx posits the ultimate cause of capitalist crises in the capitalist production process, specifically in production for profit.  This is an aggregate theory, not a microeconomic one.  “If it is said that over-production is only relative, this is quite correct; but the entire capitalist mode of production is only a relative one, whose barriers are not absolute. They are absolute only for this mode, i.e., on its basis. How could there otherwise be a shortage of demand for the very commodities which the mass of the people lack, and how would it be possible for this demand to be sought abroad, in foreign markets, to pay the labourers at home the average amount of necessities of life? This is possible only because in this specific capitalist interrelation the surplus-product assumes a form in which its owner cannot offer it for consumption, unless it first reconverts itself into capital for him. If it is finally said that the capitalists have only to exchange and consume their commodities among themselves, then the entire nature of the capitalist mode of production is lost sight of; and also forgotten is the fact that it is a matter of expanding the value of the capital, not consuming it. In short, all these objections to the obvious phenomena of over-production (phenomena which pay no heed to these objections) amount to the contention that the barriers of capitalist production are not barriers of production generally, and therefore not barriers of this specific, capitalist mode of production. The contradiction of the capitalist mode of production, however, lies precisely in its tendency towards an absolute development of the productive forces, which continually come into conflict with the specific conditions of production in which capital moves, and alone can move.” (Capital, vol. III, p. 366)7.

In short this law goes: as capitalism develops the amount of constant capital rises in relation to variable capital. Because labour power purchased with variable capital is the only part of capital which produce surplus value, the amount of surplus value falls in relation to the cost of the capitalists, this depresses the rate of profit unless there is an accelerating increase in the rate of surplus value. The law has many counteracting features (cheapening of the means of production is one of the most important ones) which we will not discuss here, but Marx proves in chapter 13 and 14 that it will assert itself sooner a later as concrete reality.

Marx links this directly with the idea of overproduction: “The so-called plethora of capital always applies essentially to a plethora of the capital for which

the fall in the rate of profit is not compensated through the mass of profit — this is always true of newly developing fresh offshoots of capital — or to a plethora which places capitals incapable of action on their own at the disposal of the managers of large enterprises in the form of credit. This plethora of capital arises from the same causes as those which call forth relative over-population, and is, therefore, a phenomenon supplementing the latter, although they stand at opposite poles — unemployed capital at one pole, and unemployed worker population at the other.  Over-production of capital, not of individual commodities — although over-production of capital always includes over-production of commodities — is therefore simply over-accumulation of capital.”“(Capital, vol. III, p.359)

That does not mean the financial sector and in particular, the size and movement of credit does not play any role in capitalist crisis.  On the contrary, the growth of credit and fictitious capital (as Marx called speculative investment in stocks, bonds and other forms of money assets) picks up precisely in order to compensate for the downward pressure on profitability in the accumulation of real capital.

A fall in the rate of profit promotes speculation.  If the capitalists cannot make enough profit producing commodities they will try making money betting on the stock exchange or buying various other financial instruments.  The capitalists all experience the falling rate of profit almost simultaneously so they all start to buy these stocks and assets at the same time driving prices up. But when stocks and assets prices are rising everybody wants to buy them – this is the beginning of bubble on exactly the lines which we have seen them again and again since the Tulip Crisis of 1637.

If, for example, the speculation takes place in housing this creates an option for workers to loan and spend more than they earn (more than the capitalists have lain out as variable capital) and in this way the realization problem is solved.  But sooner or later bubbles burst when investors realize that the assets are not worth what they are paying for them.  The realization problem reoccurs in an expanded form compared with before the bubble: now the workers have to pay back their loans and this with interest, they have to spend less than they earn.  The result is even greater overproduction than was avoided temporarily in the first place.  While consumer credit only increases demand, producer credit also increases supply.

The basic problem is still the fallen rate of profit which depresses investment demand.  If the underlying economy were healthy an imploding bubble needs not cause a crisis, or at least only a short one.  When workers and capitalists pay interests on their loans, this money does not just disappear, some finance capitalists collect them.  If the total economy is healthy and the rate of profit is high then the revenue generated from interest payments will in one way or another be reinvested in production.

The crisis is necessary to correct and reverse the falling rate and mass of profit.  “The periodical depreciation of existing capital — one of the means immanent in capitalist production to check the fall of the rate of profit and hasten accumulation of capital — value through formation of new capital — disturbs the given conditions, within which the process of circulation and reproduction of capital takes place, and is therefore accompanied by sudden stoppages and crises in the production process.” (Capital, vol. III, p. 358).  In this sense, the cause of crisis for Marx is not just in the anarchy of the market but in the anarchy of production (35).

Joseph Choonara has provided a very useful account of the various Marxist explanations of the Great Recession and, in particular, the debate about whether the crisis is a product of the financial sector alone, or the real economy or a dialectical relationship between the two (36).

Carchedi attacks the financial sector-only argument and doing so gives the underconsumption thesis of crisis another working over (37).  For Carchedi, the flight of money to the financial and speculative sectors of the economy is really a ‘countertendency’ response to the falling rate of profit in the productive sectors.  A higher rate of profit can be generated for a while in these unproductive sectors, helped by the monetary authorities keeping the basic rate of interest low and stimulating credit.

An artificial and temporary inflation of profits in the unproductive sectors helps sustain the capitalist economy and resist the impact of a falling rate of profit in the productive sectors.  The increasing share of debtors who cannot finance their debt (Minsky’s debtors) eventually causes default and the crisis erupts in the financial sector.  “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”

Some Marxists have argued that the credit crunch of 2007 and the ensuing Great Recession is not a classical Marxist crisis of profitability (38).  Marx would have also seen the crisis as financial in cause.  It’s true that Marx distinguished between different sorts of monetary crisis “The monetary crisis defined as a particular phase of every general industrial and commercial crisis, must clearly be distinguished from the special sort of crisis, also called a monetary crisis, which may appear independently of the rest and only affects industry and commerce by its backwash.  The pivot of these crises is to be fond in money capital and their immediate sphere of impact is therefore banking, the stock exchange and finance”.

Going further, some argue that the crisis was the product of a brand new development in capitalism: the globalisation of finance capital and its now overwhelming dominance of the capitalist economy.  Crises can now take place in that sector alone and cause economic recession.  Marx’s law of profitability is no longer relevant.

But financial globalisation is nothing new:  In 1875, banker Karl von Rothschild assigned the banking collapse then to “the whole word becoming a city”. The interdependence of stock markets and credit to the ‘real’ economy is not new.

It’s true that the share of US gross domestic income accruing to finance and insurance rose dramatically from 2.3% in 1947 to 7.9% in 2006.  But as Greenspan said, can we say that the growth of the financial sector was the cause of the Great Recession if it had been expanding for six decades without a crisis of proportions of 2008?

As Mick Brooks puts it: “Movements in the rate of profit have their effect on the financial sector.  This is particularly the case in the modern era when the very predominance of finance capital and the sheer scale of fictitious capital mean that bubbles are constantly being blown.  Bubbles tend to begin as profits revive after a downturn.  They wax fat in the good years.  As crisis impends, capital panics and takes flight.  The bursting of the bubbles seems an accidental affair, but accident is the manifestation of necessity.  In other words, financialisation adds another complicating factor in our analysis, but does not fundamentally change the overall picture (39).”

A cyclical view

In my book, The Great Recession, I approached the question from a different angle that can reconcile Marx’s law of profitability with the growth of the financial sector, the credit bubble and its eventual bursting.  I started with the data.  I generated a series of data based on the US economy to measure the Marxist rate of profit to see if it can provide a causal explanation of the Great Recession and previous slumps in capitalism.  In the graph below, VROP stands for the value rate of profit and OCC stands for the organic composition of capital.  The methodology and sources for the data can be found in my book, The Great Recession, pp305-10.

For the period since 1948, the data confirm Marx’s law of profitability, namely that the profitability of the US capitalist economy moved inversely with the organic composition of capital.  As early as late 2005, this approach yielded a forecast that US capitalism was now in a cycle of downturn for profitability which would eventually lead to series of deeper and longer economic recessions.  In addition, I argued that other economic cycles (housing, employment, investment and inventories) were coinciding at their troughs which would produce a significantly large economic slump around 2009-10.  This proved to be out by one year as the Great Recession started in 2008.

The thesis (drawn from the data) was that the underlying causal drive of economic cycles under capitalism was the movement of the rate of profit.  But there are other laws of motion under capitalism; like the domestic construction or the housing cycle, the employment business cycle and the shorter ‘business inventory’ cycle along with the even longer prices of production cycle (Kondratiev).  They were all combining to reach troughs around this time, as they had done in the Great Depression period.

According to my data, the US rate of profit moves in cycles of about 32-36 years (with more or less equal up and down phases) from trough to trough.  In the post war period, that is from 1946-64 (up phase), 1964-82 (down phase), 1982-97 (up phase) and in the current down phase that should end by 2014-16.  I also found that the stock market cycle follows a similar cycle with a lag of about one to two years behind the profit cycle.  If right, this suggests that we are in what the investment houses call a secular ‘bear market’ that won’t end until about 2018, a couple of years after the trough in profitability, having peaked in 2000 in the last bull market phase.

If Marx’s law of profitability is cyclical in this way, it can significantly help in the debate about whether it is relevant to the Great Recession or whether that was just a financial crisis.  On my data, profitability peaked in 1997, fell back to a low in 2001; then rose again to 2006, before starting to fall again.

If the cyclical approach is correct, it would suggest that after the Great Recession, profitability will recover until about 2013 before it heads down to a new cyclical low by 2015 or so.  At no time, will profitability exceed the peak of 1997, although there have been shorter duration rallies after each economic recession (2001) and now (2008).

First, we are still in a down phase for profitability that began in 1997and won’t end until 2015 or so.  That means another recession is in the offing before capital is sufficiently devalued (and in the case of labour weakened) to create the environment for rising profitability.  On my data, the rate of profit did rise from 1982, suggesting support for the ‘financialisation’ supporters of the causes of crisis.  But it has been falling since then (the 1997 peak has not been surpassed).  Despite a short rally between 2002 and 2006, the rate of profit in the US economy was lower in 2006 than in 1997 – and for that matter way lower than in 1964.

As Marx puts it: “The main damage, and that of the most acute nature, would occur in respect to capital, and in so far as the latter possesses the characteristic of value it would occur in respect to the values of capitals. That portion of the value of a capital which exists only in the form of claims on prospective shares of surplus-value, i.e., profit, in fact in the form of promissory notes on production in various forms, is immediately depreciated by the reduction of the receipts on which it is calculated. Part of the commodities on the market can complete their process of circulation and reproduction only through an immense contraction of their prices, hence through a depreciation of the capital which they represent. The elements of fixed capital are depreciated to a greater or lesser degree in just the same way.” (Capital, vol. III, p. 362-3)

If we extend the data back to 1929, there is a significant rise in profitability from 1938 to 1944.  After that profitability falls to 1964, which does not match my argument that this was an up phase for profitability!  Of course, this period covers the second world war.  The mechanism of the cycle is a rise in the organic composition of capital and a fall in profitability eventually leading to a slump or recession.  That crisis drives down the cost of capital leading to a rise in profitability.  After every slump since the second world war there has been a recovery in profitability for at least a few years.

But war adds a new dimension to ‘creative destruction’.  Physical destruction of the stock of capital accompanies value destruction.  This produces a dramatic fall in the cost of capital.  War is an exogenous event that can sharply interfere in the endogenous law of profitability.

Marx considered the impact of physical destruction on values.  “This is most clearly seen in the physical destruction of commodities. This can even happen indirectly in the form of stoppages: Although, in this respect, time attacks and worsens all means of production (except land), the stoppage would in reality cause far greater damage to the means of production. However, the main effect in this case would be that these means of production would cease to function as such, that their function as means of production would be disturbed for a shorter or longer period.” (Capital, vol. III, p. 362)

What would have happened to profitability without the world war of 1939-45?  The rate of profit was turning down in 1938.  Without war it may have dropped to a cyclical low by, say 1946, before entering an upward phase up to 1964.  If that is right, then the 1946-64 period is an upward phase.  The graph below suggests how that might look using two different measures for constant capital (historic and replacement cost).

The correct measurement of the rate of profit is obviously key.  Before going further in this empirically based explanation of the relation between the rate of profit, the mass of profit, the role of credit and the Great Recession, it is necessary to refer to an important debate about how to measure the rate of profit.

Andrew Kliman has produced a powerful piece of empirical work that shows that the rate of profit never rose between 1982 and 2005 (40).  Thus Kliman concludes that the argument that Marx’s law was irrelevant to the crisis is misplaced.  He also makes a compelling theoretical argument that the Marxist rate of profit should be measured against the historic fixed costs of constant capital and not the replacement or current costs.  If that is not done, then it does look as though profitability rose right up to the start of the crisis in 2007 and it would seem to prove that the Marxist law of profitability is irrelevant after all.

If you accept that Kliman is theoretically correct about historic costs, and there are compelling reasons to do so, then it is essential that you use historic costs in measuring the value of fixed capital.  So I have revised my data to use historic costs.  My data do not significantly differ from Kliman’s if I do this, although there are other differences in the way we measure post-war profitability in the US.

So using the historic cost measure does not invalidate the cyclical view.  There is still a discernable rise in profitability between 1982 and 1997 and a subsequent decline.  The cyclical nature of Marx’s law is still visible if you use historic costs (HC) and not replacement costs (RC).

Marx never argued that the rate of profit was the direct cause of economic crisis and slump.  Instead, it provided the underlying pressure, up or down, in the economic cycle of capitalism.  If the rate of profit was in its down phase, then at a certain point, the falling rate can turn into a falling mass of profit.  It is this that sets the trigger point for economic collapse.

Again, the data for the US economy show that connection.  The US rate of profit peaked in 2006 and began to fall from there.  As we know, the US economy continued to grow well into 2007, just as the falling profit from 1997 did not immediately deliver an economic recession until 2001, after a stock market crash.

We can use strict ‘Marxist’ data to show the mass of profits, but we lack quarterly data to do so.  If we use the official pretax profit figures against GDP, we can see how the mass of profit starts to fall before the US economy went into recession.  The mass of profit started to contract at the end of 2006.  Real GDP growth started to slow a year later and then contracted from the beginning of 2008.  Profits recovered from the end of 2008, but GDP did not expand until a year later.

What about credit?  An acceleration of credit growth is the response of capitalists to a falling rate of profit.  From 1990 to 1997, as the US rate of profit reached a peak, global credit growth generally slowed and even fell below zero.  From 1997 in the downward phase for the rate of profit, credit growth accelerated into double-digit growth before the credit crunch of mid-2007 and the ensuing economic slump (41).

Costas Lapavitsas argues that there is no causal connection between Marx’s law of over-accumulation (as he calls it) and the financial crisis of 2007-9 (C).  One of his main arguments is that there is no evidence that the rate of profit fell before the crisis: “no significant decline in profit rates occurred on the approach to the crisis.  Profitability among manufacturing and other firms appears to have held even in the depths of the recession of 2009.” So, he argues that “the crisis of 2007-9 has little in common with a crisis of profitability as in 1973-5, as is apparent from the extraordinary role of credit and the indebtedness of poor workers” (p18).

Lapavitsas cities Dumenil and Levy (D) as his reference for this, saying that “Dumenil has stated categorically at two RMF conferences (May 2008 and November 2009) that the crisis of 2007-9 is not due to falling profitability.”

I don’t know where D-L get their evidence for this assertion or how Lapavitsas reaches his conclusion about profits holding up.  My evidence is clearly to the contrary.  My measure shows that the rate of profit in the US economy began to fall well before the financial crisis began in summer 2007.  On an historic cost basis, the Marxist rate of profit actually peaked in 2005 at 24.84% and fell by 3% to trough in 2008-9.

These are annual figures, so they don’t reveal the story as well as quarterly ones would.  If you use the BEA official figures for corporate profit that are quarterly, you get a clearer picture.  The mass of corporate profit (pretax adjusted) peaked in Q3’06 at $1655bn, falling 32% to a trough in Q4’08 of $1124bn, before recovering.  That seems pretty significant to me.

You get the same result if you break down the profits figure by non-financial and financial.  On that basis, financial sector domestic profits peaked at $447bn in Q206 and dropped 73% to a trough of $122bn in Q4’08!   But non-financial sector domestic profits also plummeted, peaking in Q3’06 at $988bn and then falling to $629bn in Q1’09, a drop of 36%.  Only profits from the rest of the world held up, at least to the beginning of the crisis (Q4’07), before slipping 30% to a trough in Q2’09.

We can use a rough measure of the rate of profit by looking at the profit to GDP ratio.  It’s the same story here.  The overall profit to GDP ratio peaked in Q3’06 at 12.3% before dropping to 7.8% in Q4’08.  The domestic financial sector profit to gross product ratio peaked as early as Q1’05 at 43.4%, before collapsing to 11.7% in Q4’08.  The non-financial domestic profit to gross product ratio peaked later in Q3’06 at 14.5% and then fell to 9.4% in Q1’09.

Anyway you want to measure it, profitability and/or the mass of profits fell well before the financial crisis began, which at least suggests the direction of the causality is the opposite of what Dumenil claimed and also puts in doubt Lapavitsas’ argument that there is no causal relation one way or the other.

‘Excessive credit’, stock market speculation and the expansion of fictitious capital in all its new and exotic forms was a response to falling profitability in the productive sectors of the economy.  It delayed the inevitable but eventually made the crisis deeper and longer as a result.

In this way, the tools provided by financial engineering used as instrument to hedge risk are turned into weapons of financial mass destruction; as Warren Buffet pointed out.

Conclusion

In sum, the dominant mainstream neoclassical school of economics and the official economists of the finance capital were non-plussed and noncommittal about the financial crisis and the Great Recession.  They did not predict it and they could not explain it – it just was not a good fit.  In hindsight, they fell back on the aphorisms of Donald Rumsfeld, black swans and serendipity.

The mainstream Keynesians were little better.  They did not see it coming and could not explain it, apart from some fuzzy stuff about the volatility of animal spirits.  The trouble with this effective demand theory is that it is only effective in hindsight.  In hindsight, the Keynesians only cry was that Keynes was right.  But they remain devoid of explanation of the cause of the Great Recession and the right policy prescriptions for avoiding another.

Only some pragmatic cherry pickers sitting astride the Austrian theory of excess credit and the Minsky instability thesis were able to forecast a financial crisis, or a ‘Minsky moment’.  And some empirical researchers did provide some indicators of a likely crash in advance (although their work was published after the event).

Within the Marxist school few predicted a crisis except that to say that crisis is always inherent in capitalism as the underconsumption theory supporters would say.  The financialisation explanation is very much one of hindsight.  The more orthodox Marxist profitability explanation remains the most powerful in predictive value.

Three lessons for economists emerge.  First, mainstream obsession with the behaviour or motivation of individual economic agents should give way to power of the aggregate; from the subjective to the objective.

Second, economists’ obsession with theoretical models should be rebalanced with the need for empirical data.  Let us use history, preferably with some predictive power.

Finally, both the mainstream and heterodox have focused too much on the financial sector, dismissing the contradictions in the capitalist production process on which Marx focused as an explanation of capitalist crisis.  That is not to deny the importance of the credit system and inherent speculative nature of the financial sector.

By Michael Roberts

www.thenextrecession.wordpress.com

References

1. M Roberts, The Great Recession, November 2009

2. Barry Eichengreen and Kevin H Rourke, The Great Recession versus the Great Depression, September 2009

3. Allan von Mehren, Danske Bank, Lessons from the Great Depression, March 2010.

4.  Nassim Taleb, The Black Swan

5.  Alan Greenspan, The Crisis, March 2010

6.  op cit, p46

7. Ryan Grim, Huffington Post, 12 March 2010-05-04

8.  Bill Bonner, Gloom, Boom and Doom report, March 2010.

9.  The unfortunate uselessness of most of state of the art academic monetary economics, FT 3 March 2020

A.  Eugene Fama interview with John Cassidy in New Yorker, 21 January 2010.

10.  Paul Krugman: How did economists get it so wrong?, NYT.  And The Great Recession op cit, Chap 44.

11. Robert P Murphy, Cochrane threatens Austrians more than Krugman ever did, September 2009

12.  Tony Lawson, Contemporary economics and the crisis, real-world economics review, no 50, September 2009.

13. Kenneth Rogoff: Bubbles lurk in government debt April 2010 FT.

14. David Colander, How economists got it wrong: a nuanced account, September 2009.

B. Paul Krugman, Our giant banking crisis, what to expect, 15 April 2010

15. David Colander etc “The financial crisis and the systemic failure of academic economics”.  February 2009.

E. Nick Rowe, Tinkerbell in New Keynesian models, 6 June 2010

16. D Aikman et al “Uncertainty in macroeconomic policy making: art of science? March 2010.

17. T Koutsobina, A Keynes moment in the global financial collapse, RWE Issue no 52

18.  Mark Buchanan, The social atom, why rich people get richer get caught and the your neighbour looks like you

19.  Steven Horowitz, The microeconomic foundations of macroeconomic disorder: An Austrian perspective on the Great Recession of 2008., June 2009.

20.  Ben Best, An Austrian theory of business cycles, DATE

21.  Jim Walker, Expo Asia, tu ne ceed malis, March 2010

22. K Erturk and G Ozgur, What is Minsky all about anyway?, Realworld economic review, Sep 09.

23. Steve Keen, The Minsky Thesis: Keynesian or Marxian?

24. Nouriel Roubini and Stephen Mihm, Crisis Economics, May 2010-05-10

25. W White, The Origins of the present crisis, speech to Inaugural Institute of New economic Thinking (NET).

26.  William White, Modern macroeconomic is on the wrong track. OECD Finance and Development December 2009

27. Greenspan to Gross (Dumb Money) p 75).

28. Jeff Miller, A Dash of Insight

29.  Joshua Angrist ad Jorn-Steffen Pische, The credibility revolution in empirical economics; how better research design is taking the con our of econometrics, DATE

30. Ricardo Reis, Columbia University.  From Freakonomics by Justin Wolfers.

31. Borio and Lowe, Asset prices, financial and monetary stability, exploring the nexus, BIS July 2002; Borio and Lowe, Assessing the risk of banking crises, BIS December 2002.

32.  Carmen Reinhart and Kenneth Rogoff, This time is different, 2009.

33. JM Keynes, General Theory etc, chap 32.

34. But see, J Tanaka, Keynes business cycle theory, a new formulation, University of Kitakyusyu, March 2008

35.  Jeppe Druedahl., What is overproduction?, unpublished draft.  March 2010

36.  J Choonara, Marxist accounts of the current crisis, June 2009

37. G Carchedi, The return from the grave: or Marx and the present crisis, April 2010.  And see M Robert, The Great Recession, op cit chap 42.

38.  Husson, Moseley, Marx, Minsky and Crotty on crises in capitalism, October 2007

39.  Mick Brooks, What is financialisation?, 2009

40.  A Kliman, The persistent fall in the rate of profit underlying the current crisis, October 2009

41. David Roche and Bob McKee, Sovereign DisCredit!, April 2010

C.  Costas Lapatvitsas, Financialisation and capitalist accumulation, Research on Money and Finance, February 2010.

Development of the law’s internal contradictions

by Mick Brooks

The three chapters on the Law of the tendential fall in the rate of profit, and particularly Chapter 15 (The development of the law’s internal contradictions), provide the only complete explanation provided by Marx of boom and slump as part of a cycle and not, as over-production theorists would have it, as a crash coming out of a clear blue sky. Bearing in mind Rosdolsky’s outline of Marx’s 1865-66 economic ‘project’ referred to earlier, we find it exactly where we would expect it to be in his writings. After dealing with the production and circulation of capital he turns in Capital Volume III to The process of capitalist production as a whole. Crisis theory deals with all the contradictions of capitalist society.

Marx appears to raise the realisation problem in Chapter 15. “The conditions for the immediate exploitation and for the realisation of that exploitation are not identical. Not only are they separate in time and space, they are also separate in theory. The former is restricted only by society’s productive forces, the latter by the proportionality between the different branches of production and by society’s power of consumption.” (Capital Volume III, p. 352)

It is precisely at this stage in his analysis that Marx introduces the concept of over-accumulation. “Over-production of capital and not of individual commodities – though this over-production of capital always involves over-production of commodities – is nothing more than over-accumulation of capital.” (ibid. p. 359)

He goes on, “There would be an absolute over-production of capital as soon as no further additional capital could be employed for the purpose of capitalist production. But the purpose of capitalist production is the valorisation of capital, i.e. appropriation of surplus labour, production of surplus value, of profit.” (ibid. p. 360)

So over-accumulation is over-production of capital, which manifests itself as over-production of commodities. But too much capital is produced only in relation to profit-making potential. And this tendency produces an unseemly scramble among the capitalists for their chance to grab what profit there is.

“Concentration grows…since beyond certain limits a large capital with a lower rate of profit accumulates more quickly than a small capital with a higher rate of profit. This growing concentration leads in turn, at a certain point, to a new fall in the rate of profit. The mass of small fragmented capitals are thereby forced onto adventurous paths: speculation, credit swindles, share swindles, crises. The so-called plethora of capital is always basically reducible to a plethora of that capital for which the fall in the rate of profit is not outweighed by its mass.” (ibid. p. 359)

So Marx sees no contradiction in raising the so-called realisation problem in the middle of a chapter dealing with the falling rate of profit as the fundamental cause of capitalist crisis. It is precisely the fall in the profit rate that produces the crisis, and over-production (over-accumulation) is its form of appearance. To put it another way, the fact of over-producing firms may be regarded as the trigger, while the fall in the rate of profit is the cause of the crisis.

Moreover viewing the crisis as a crisis of profitability enables us to understand how the downturn prepares the basis for a later upswing. The essential mechanism is through the destruction of capital in a recession.

“The periodic devaluation of existing capital, which is a means immanent to the capitalist mode of production for delaying the fall in the profit rate and accelerating the accumulation of capital value by the formation of new capital, disturbs the given conditions in which the circulation and reproduction process of capital takes place, and is therefore accompanied by sudden stoppages and crises in the production process” (ibid. p. 262).

This destruction of capital is not mainly physical destruction and obsolescence. The destruction of capital values in a crisis actually prepares the way for a reduction in the organic composition of capital, and a revival in the rate of profit. In this way we can explain the entire boom-slump cycle.

In a slump unwanted stocks and unused machinery are sold in fire sales of the assets of bankrupt firms. “Secondly, however, the destruction of capital through crises means the depreciation of values which prevents them from later renewing their reproduction process as capital on the same scale. This is the ruinous effect of the fall in the prices of commodities. It does not cause the destruction of any use values…A large part of the nominal capital of the society i.e. of the exchange value of the existing capital is once for all destroyed, although this destruction, since it does not affect the use value, may very much expedite the new reproduction.” (Theories of surplus value Volume II p. 496)

The crisis therefore prepares the way for a new upturn in the same way as naturalists explain that forest fires can actually prepare the woodland for a new period of growth.

Once Marx has explained how the movement in the rate of profit is the mainspring of economic crisis, he can introduce the ancillary factors that play their role in preparing for the individuality and complexity of any particular capitalist crisis.

Ancillary factors

Now we introduce those economic factors that give each specific historic period its own colour and character. They interact with the general movement of the capitalist economy, based as it is on movements in the rate of profit, accelerating its upswings and deepening its downward drops. The items below are just an indicative list of these epiphenomena.

Wages: One important economic effect of the crisis, of course, is that, by creating mass unemployment, the boss class has the whip hand in trying to drive down the wages of the employed workers. “Stagnation in production makes part of the working class idle and hence places the employed workers in conditions where they have to accept a fall in wages, even beneath the average; an operation that has exactly the same effect for capital as if relative or absolute surplus value had been increased while wages remained at the average.” (Capital Volume III p. 363) The point is that movements in wage levels are based on the bargaining power of the contending classes, which is determined by the level of unemployment – itself dependent on the stage reached in the economic cycle.

Competition: Marx is also aware of the competitive struggle between individual capitalists, and its deleterious effect on their system as a whole, in the teeth of a crisis. Unlike Adam Smith, he does not see competition as the driving force of the falling rate of profit. “Competition, generally this essential locomotive force of the bourgeois economy, does not establish its laws, but is rather their executor. Unlimited competition is therefore not the presupposition for the truth of the economic laws but rather the consequence – the form of appearance in which their necessity reveals itself.” (Grundrisse p. 552)

For Marx the fall in the rate of profit intensifies the pressure on individual capitalists to compete with one another. “(T)he fall in the profit rate that is bound up with accumulation necessarily gives rise to a competitive struggle. Compensation for the fall in the profit rate by an increase in the mass of profit is possible only for the total social capital and for big capitalists who are already established. New and independently operating additional capital finds no compensatory conditions of this kind ready made; it must first acquire them, and so it is the fall in the profit rate that provokes the competitive struggle between capitals and not the reverse”(Capital Volume III p. 365)

Raw material prices: Typically a prolonged upswing will produce a boom in the price of raw materials. We suppose in theory that an increase in the demand for an industrial product is likely to call forth an instant increase in its supply as its price goes up and capitalists, mindful of the profit motive, respond by boosting production. But there are biological and geological limits in the responsiveness of organic and mineral materials’ production to demand conditions. As a result commodity prices are likely to respond spasmodically to changes in demand, with soaring peaks and dizzying drops.

This was most noticeable in the case of oil, which was actually the major basic cheap resource that fuelled capitalism in the ‘golden years’ after the Second World War. Our ‘rigorous’ neoclassical economists descend to the most casual empiricism when they characterise the 1974 crisis as an ‘oil crisis.’ They are incapable of noticing that oil prices generally are determined by the demand for oil, given the supply constraints, and that the demand is provided by capital accumulation in the industrial countries.

Of course, since oil is an important resource for capitalism, if the price of oil rises towards the end of an upswing, that is going to cut into manufacturing costs and therefore profits. And because the rate of profit is likely to be falling by this stage, it is theoretically possible that the oil price hike could help push them over the edge. The important point is to see how commodity prices are located in the cycle of accumulation.

Stocks (Inventories): In a boom the capitalists exude confidence. They develop the belief that ‘this time it’s different’ – this time the boom will last forever. As a result they build up stocks of raw materials, confident in the good times to come. In doing so, of course, they act as excellent customers to the capitalists responsible for producing raw materials. They may also allow stocks of finished goods to accumulate in the warehouses, sure that they will be sold in the fullness of time.

It’s a different story in a slump. Unsold stocks of finished goods are a millstone around their necks. They may well reduce output below what is actually required so as to realise the values of their unsold stocks first. They may be forced to do this because their profits have disappeared and that is the only way to escape bankruptcy. The niggardly approach they develop in the slump to husbanding raw materials hits the capitalists producing these raw materials, for whom this market is the only way they have of making a living.

Expectations: Capitalists have no way of knowing what the future will hold for them. Yet they have to develop a view as to how markets are likely to evolve. Under these conditions capitalists’ expectations can acquire the power of a material force in the economy. Marx gleefully chronicles the swindles carried out by capitalists upon one another. Yet these swindles were indicative of a certain mentality – the belief that anyone with money could make more money. This outlook becomes dominant after a long period of boom because it reflects a certain reality.

On the other hand a crash caused by failed capitalist projects can drag quite reputable and viable capitalist firms and individuals down with it. That is the price capitalists pay for their system. Really the market division of labour makes them all interdependent upon each other and dependent upon the operation of the law of value. But they do not realise this. “(I)n the midst of accidental and ever-fluctuating exchange relations between the products, the labour time socially necessary to produce them asserts itself as a regulative law of nature. In the same way the law of gravity asserts itself when a person’s house collapses on top of him.” (Capital Volume I p.168) After the crash, caution becomes the dominant mood. And of course that caution makes recovery slower.

Finance: When we discussed the tendency for the rate of profit to fall, we made it clear that by ‘profit’ we meant surplus value as a whole and that the rate of profit is calculated as total surplus value divided by total capital invested. Yet surplus value is usually divided into rent, interest and profit (actually there are others who share in this surplus). All three factors can vary against one another.

Traditionally, the share of surplus value going to finance capital is called interest. Interest rates are connected to the boom-slump cycle in a complex way, analysed by Marx in Capital Volume III. We cannot treat the subject fully here.

“If we consider the turnover cycles in which modern industry moves – inactivity, growing animation, prosperity, over-production, crash, stagnation, inactivity, etc.,.. – we find that a low level of interest generally corresponds to periods of prosperity or especially high profit, a rise in interest comes between prosperity and its collapse, while maximum interest up to extreme usury corresponds to a period of crisis.” (Capital Volume III p. 482)

After a recession, interest rates are generally low. Manufacturing capitalists are not making much profit, so they cannot afford to pay the banks much interest. They are not investing in new plant. They are certainly not investing with borrowed money, but gradually trying to cover their losses and restart production on a modest scale with the resources available to them. As production picks up, the demand for loan-capital from manufacturing capitalists rises.

When a crash is looming, “In times of pressure, the demand for loan capital is a demand for means of payment and nothing more than this; in no way is it a demand for money as means of purchase. The interest rate can then rise very high”…just when the industrial capitalists can least afford it. (Capital Volume III p. 647) In a crash everybody needs hard cash. The whole crazy process is about to begin again.

Trade: We would expect that, as profit-making opportunities re-emerge, capitalists would exploit the division of labour to introduce more economies of scale and divide the world ‘rationally’ into areas that can produce goods at the lowest possible cost. This division of labour between capitalist firms is not organised but governed by market forces. We would therefore expect to see trade, including international trade, advance during the upswing and contribute to the strength of that upswing. We would also expect to see trade shrink in the downturn as each capitalist, and each capitalist nation-state, turns on the others, determined to load the burdens of the crisis on anyone but themselves.

As Armstrong (Capitalism since 1945) shows, trade liberalisation did not kick-start

the revival of the European and Japanese economies in the years right after the Second World War. The reason for this was the enormous imbalances in the world economy – in particular the complete dominance of the USA over the capitalist world. All the other advanced countries had massive deficits with America.

“Nor was continued European expansion based on massive import growth from the United States or elsewhere…Indeed, imports fell in 1948 and only regained 1947 levels in 1951. Meanwhile exports steamed ahead and by 1950 had regained prewar levels, with imports still some 10% below.” (pp. 82-3) In other words the increased exports were not a sign of reviving economic health, but served just to repay accumulated debts.

When the road was clear, trade interacted dialectically with profit-making potential in production to push the upswing higher. “The years of the boom saw a phenomenal explosion of trade. Between 1951-3 and 1969-71 the volume of world trade in manufactures grew by 349% whereas the volume of output grew by 194%” (ibid. p. 153).

The slowdown hit trade as well as production. The slowdown in trade made the slowdown in production worse. “The growth of world trade slowed down sharply after 1973, growing at an average 3.8% a year over the period 1973-88, compared to 8.7% per year during the previous decade” (ibid. p. 296). As we shall see later, world trade actually fell in volume terms in the wake of the 1974 crash.

The crash of 1974

The 1974 recession was the first generalised recession of global capitalism since the Second World War. It marked the end of the ‘golden years’. We look briefly at this event as an example of the processes we have been analysing.

In the first instance bourgeois economists, desperate to show that crisis is not inherent in their system, assert that the 1974 crash was ‘all about inflation.’ Certainly inflation was very high in 1974. In the US it was 11%, in Japan 21%, in Britain, 16%, in Germany 7%, and in Italy 19%.

World capitalism had actually thrived on the more moderate inflation, which had become a feature of the whole post-War era, gradually and insidiously increasing over the years. The causes of inflation are complex and cannot be dealt with here. But in Britain, for instance, the government budget deficit was 10% of GDP in 1975. Such deficits have to be paid for, and can contribute to the inflationary spiral.

The main point is that in 1974 inflation ceased to be a stimulant and started to become a major obstacle to economic growth, reflecting imbalances that were making the recession worse. Before 1974 Keynesian economists had perceived inflation as a sign that the economy was growing too fast, while unemployment was evidence that it was going too slow. Now the economy was simultaneously sending out messages that it was running too fast and too slow! The alternative, of course, was that Keynesianism had failed as an explanatory tool and as a remedy for economic problems. Economists started to mutter about ‘stagflation’ and ‘slumpflation’ and to develop alternative theories.

The second illusion spread about 1974 was that it was an ‘oil crisis’. It is true that the price of oil, the basic feedstock of post-War capitalism, quadrupled in less than a year. The oil price hike was not a result of sober economic calculation. After the 1973 Arab-Israeli War, oil producing Arab nations boycotted western countries because of their perceived pro-Israeli bias. Both they and their customers were then astonished at the economic power they had accumulated.

Itoh and Lapavitsas (Political economy of money and finance) put the oil shock in context. “The world market prices of primary products such as corn, wood, cotton, wool and minerals also began to rise rapidly in the later 1960s, reflecting the relative shortage of these products. The quadrupling of the price of crude oil within a few months in 1973-4 owed much to the fourth Arab-Israeli War, but was also integral to the general shortage of primary products due to the over-accumulation of capital in the advanced countries. The terms of trade relative to manufactures were raised by more than 10 per cent in 1970-3 and by nearly 70 per cent in 1970-4. The price of raw materials for manufacturing nearly doubled within the year prior to the first oil shock.” (p. 193)

All the other epiphenomena mentioned in the abstract in the section above (Ancillary factors) came into play in a concrete and painful manner. At the end of the boom speculation and swindling were rife. More and more resources were devoted to the acquisition of raw materials and of land, the price of which was soaring. This feverish speculation was a product of the mentality that the good times would never end.

Banks had been lending more and more to speculators to buy land, thus creating the perfect bubble. The bubble duly burst at the end of 1974, threatening to take the banks with it.

In Britain a dodgy bunch called secondary banks (really property speculators) had to be saved by a rescue operation launched by the Bank of England. The alternative was that, as they sank beneath the waves, they would take large chunks of the financial establishment with them.

The overheated stock exchanges all over the world had the opportunity to chill out. In London share prices went from a high of 339 to a low of 150 in 1974.

Commodity prices, with the exception of oil, also collapsed. By December 1974 copper had lost 60% of its value, posted in April of the same year. Other commodities recorded similar losses. These dry statistics are actually a trail of tears for the poor people totally dependent on their sale on the world market.

World trade, which had actually grown faster than the national economies throughout the post-War period and was regarded as an ‘engine of growth’ took a hit and fell in absolute terms in 1975. It fell because of a recession located in production and the profit-making engine of the capitalist economy.

The crash actually started in the car industry, and spread and spread.  Production fell sharply. From peak to trough over two years industrial production fell 14.4% in the USA, 19.8% in Japan, 11.8% in Germany, 10.1% in Britain, and 15.5% in Italy.

Naturally unemployment soared. By the trough it was 7.9 million in the US, 1.1 million in Japan, 1.1 million in Germany, 1.3 million in Britain and 1.1 million in Italy. The ‘full employment’ era was over.

Capacity utilisation fell in the US from 83% in 1973 to 65% (less than two thirds) in 1975. 1973 was a peak year. But in the 1966 peak 92% of manufacturing capacity was in use. In 1969 it was 86.5%. Measured from peak to peak or from trough to trough capacity utilisation had been falling over the whole post-War period.

Why? Capacity utilisation, investment, output and employment were all falling in line with the rate of profit. Capitalists use manufacturing capacity to the maximum if they think they can make profits. They invest if they think they can make profits. They produce if they think they can make profits. They employ workers if they think they can make profits.

In the USA industrial (pre-tax) profits were 16.2% in the years 1948-50, 12.9% in 1966-70, and 10.5% in 1973. Then they crashed, and so did the economy.

In Britain our figures are taken from Glyn and Sutcliffe - British capitalism, workers and the profits squeeze. In 1950-54 the rate of pre-tax profit was 16.5%, in 1955-59 14.7%, in 1960-64 13%, in 1965-69 11.7% in 1968 11.6%, in 1969 11.1%, and in 1970 9.7%. As we have seen from Capitalism since 1945 quoted earlier, profits then recovered after the 1974-75 recession, but never regained the levels they achieved in the ‘golden years’.

Brenner’s works confirm that, since the 1974 crash, the good times have gone for good. The rate of profit has been consistently lower in the 1970-1990 (or 1993) period than it was from 1950 to 1970. Within the later period, the rate of profit rose in times of boom and fell as the economy entered a recession, as it did in the 1950 – 1970 period.

More recently Andrew Glyn’s most recent book Capitalism unleashed is mainly concerned with other matters. On page 136 he does briefly suggest that the American capitalist class has achieved a clawback of the rate of profit up to the level of the early 1970s. But for Europe (pp. 145-6) and Japan (p. 141) the picture we have painted remains the same. Likewise Brenner’s 2006 book The economics of global turbulence (an update of his previous work) is subtitled The advanced capitalist economies from long boom to long downturn. It does not challenge the link between movements in the rate of profit and the health of the capitalist economy. The fit is almost perfect.

We conclude that the tendency for the rate of profit to fall as explained by Marx is the key to understanding the cycle of boom and slump in the capitalist economy.

Appendix

Countervailing tendencies to the tendency for the rate of profit to fall. Cheapening the elements of constant capital.

The same process of rising productivity that cheapens wage goods can also cheapen capital goods and so reduce the organic composition of capital. Certainly this can happen in practice. But those who have argued that this process can indefinitely offset the tendency for the rate of profit to fall have all too often adopted a false method. The following quotes are taken from a historic debate (The tendency for the rate of profit to fall and post-war capitalism - AG and MB)

“The typical figures used to back up the LTRPF (law for the tendency of the rate of profit to fall) are the huge increase of fixed capital per worker, such as these shown in columns 1-3 below.” (AG)

The author’s Table 1 covers industry for the years 1953-72 and deals in percentage growth rates per year. Column 3 details Capital/Worker and shows the ratio rising by 8.8% (per year over the twenty year period) in the case of Japan, 4.8% for France, 6.0% for Germany, 4.8% for Italy, 4.2% for the UK and 2.2% for the USA.

This would appear fairly clear evidence to most people that the organic composition of capital did indeed rise over that period. But AG goes on to argue that, “These statistics for the capital stock at constant prices are attempts to measure the volume of the capital stock (i.e. number of machines before taking account of their cheapening due to productivity growth). They do not simply get rid of the effect of inflation, but they also ignore productivity growth – the devaluation of capital, which cheapens machines. We want to get at the value composition, i.e. what is relevant for the rate of profit which is calculated on the value of capital – not its physical volume – we have to account for this devaluation of capital. This I have done in a simple way by subtracting the growth of productivity (Column 4) from the growth of the volume of capital per worker to give the growth in the value of capital per worker.” He is introducing the method pioneered by neoclassical equilibrium theorists in treating Marx’s economic system as a set of simultaneous equations.
So AG introduces a Column 4, which measures Productivity (Devaluation of Capital), again measured as an annual rate. The figures for Japan are 8.9%, 5.4% for France, 5.0% for Germany, 5.0% for Italy, 3.0% for the UK and 2.7% for the USA.

He then proceeds to subtract the results of the percentage figures of Column 4 from the results in Column 3. A quick glance at the figures for Capital Growth per Worker in Column 3 will show that they show very similar national trends to the Productivity increase in Column 4.

In fact, using this technique, Column 5 (which AG asserts shows the Ratio of Dead to Living Labour) records, in what AG regards as the ‘proper’ measure of the organic composition of capital, that it actually falls over the period in Japan, France, Italy and the USA. Rises in Germany and the UK are insignificant and it seems from Column 5 that overall movements in the organic composition of capital are indeterminate. AG is treating the increase in productivity as causing an instant and equivalent fall in the price of capital goods.

To many readers who have followed this discussion so far, it is probably not surprising to find that productivity rises as capital per worker increases – as the reason for increasing the organic composition of capital is usually to raise the productivity of labour. But do input prices fall instantly and at the same rate?

AG’s method in ‘depreciating’ the rise in capital per worker by using productivity increases was criticised at the time in the course of the debate. AG is a scrupulous economic statistician. But this method is one that generations of conventional economists have used to try to assimilate Marx into neoclassical economic theory.

They in effect regard the economy as a set of simultaneous equations and Marx as an equilibrium theorist like them.

Marx on the other hand regarded accumulation as a process that takes place in real time. Marx was well aware that rises in productivity in the industries producing the elements of constant capital could lead to a fall in their unit price. But he regarded this adjustment of relative prices to be a messy and protracted result of competition between individual capitalists, not as an instantaneous outcome.

Marx also knew that what are outputs for one capitalist are inputs for another. He raised precisely that issue in his reproduction tables in Capital Volume II. The fall in the prices of these inputs through rising productivity will eventually be reflected throughout the economic system. But these commodity prices are devalorised (depreciated) in real time. This is not the same as the way a mathematician ‘solves’ a set of simultaneous equations, a method applied by neoclassical economists to their ‘model’ of the economy.

More recently, Andrew Kliman has trenchantly denounced this tendency to turn Marx into an equilibrium theorist (Reclaiming Marx’s Capital). Neoclassical economists have for a century accused Marx of ‘inconsistency’, beginning with von Bohm Bawerk’s Karl Marx and the close of his system in 1896. In Capital Volume I, they say, Marx deals in values. In Volume III he introduces prices of production as modified values. Von Bohm Bawerk regarded this as a ‘contradiction.’

As we have indicated earlier Marx uses this procedure because after dealing with the production of capital in Volume I and its circulation in Volume II, he comes to The process of capitalist production as a whole in Volume III. This is where the formation of a general rate of profit is properly dealt with. Until he has derived the general rate of profit, Marx cannot move on to the formation of prices of production from values, so this too belongs in Volume III.

Following von Bortkiewicz’s 1906-07 papers, neoclassical economists have dealt with what they call the contradiction in Marx by using simultaneous equations to transform an economic ‘system’ made up of values into a system of prices. Not surprisingly, they arrive at different results from Marx in the process.

Kliman is an advocate of what is called the temporal single system interpretation (TSSI) of Marx’s economics. By ‘temporal,’ TSSI theorists mean that economic processes take place in real time, unlike the simultaneous equations that instantly devalue output prices as input prices for other capitalists.

The ‘single system’ is contrasted to a dual system, where values have to be transformed into prices in the manner suggested by von Bortkiewicz. In fact prices and values are interdependent. As Kliman explains (p. 33), “First, prices of production and average depend on the general (value) rate of profit s/C, so there is no distinct price system. Second, prices influence value magnitudes, so there is no distinct value system either. The constant capital advanced and the value transferred depend upon the prices, not the values, of means of production.”

When capitalists consider the costs of inputs in calculating their profits, there are three possibilities. (Kliman Chapter 6):

• They can use historical cost – costs they incurred at the time of purchasing the elements of production in the marketplace.
• They can use pre-production reproduction cost – costs of the commodities at the time of production
• They can use post-production replacement costs – costs of the constant capital at the time of sale and after production.

The example Kliman uses is that of apples used to make apple sauce – costing $0.60 when the apple is picked, falling to $0.50 when the apple sauce is made and $0.45 when the apple sauce is cooked and available for sale. It is unfortunate for the capitalist that the price of his input is continually falling in this way, but he can’t buy apples as the cost of an input at 2pm ($0.45) when he actually starts making the sauce at 1pm – when apples cost $0.50. Yet that is the miracle that simultaneous equations perform when they turn output prices instantaneously into input prices!

Is it not obvious that the relevant cost of inputs is this pre-production reproduction cost? This remains the case even if the value of that constant capital later depreciates, and replacement costs therefore fall, as a result of technical progress in the production of means of production.

AG is therefore entirely wrong when he uses increases in productivity to instantaneously depreciate capital values, and thus produce a corresponding fall in the organic composition of capital and increase in the rate of profit, in his Column 5. Yet this procedure is at the heart of his ‘rebuttal’ of Marx’s tendency for the rate of profit to fall, as it has been for generations of neoclassically trained economists.

Bibliography

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November 2007