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Davos dilemna

posted 27 Jan 2012, 13:10 by Admin uk   [ updated 27 Jan 2012, 13:10 ]

  By Michael Roberts, January 26, 2012

 The strategists of capital are attending their annual jamboree in the snow playground of the super-rich in Davos, Switzerland for the World Economic Forum.  Many of the top 0.1% of income earners are there.  And this year the main theme is whether capitalism works and is fair. Capitalism is in crisis – and this time the word ‘crisis’ is not hyperbole.  Even the 2600 attendees at Davos recognise that.  According to a survey by the financial broadcaster, Bloomberg, almost 70% of those asked believed that the capitalist system is in trouble, with 32% saying it needs “radical reworking”.  Less than 20% reckoned ‘free enterprise’ is working.   Most Davos 0.1 percenters are really worried that this failure of capitalism to work could lead to ‘social instability’ in one form or another.

And more than half who were asked at Davos thought that inequality of income and wealth under capitalism was damaging economic growth.  But only one in five wanted any urgent action on the issue!  It seems that greed triumphs over economic logic – or should we say, class interest rules   According to a new study by the OECD, the top 10% of income earners in the world have on average nine times as much income as the bottom 10%.   You can imagine the ratio between the top 0.1% and the bottom 10%.  One of those top 0.1%, Mitt Romney, the main contender for the Republican nomination for the US presidency,was obliged to reveal how much he earned each year and what tax he paid out.  Romney is head of one of the biggest private equity companies (Bain Capital) and one of the highest earners in the US, making over $20m a year.  But he paid only 13.9% of his declared income in tax, way less than the average earner pays as a proportion.  It’s another example of how class rules under ‘free enterprise’.

Take income inequality in the UK.  It has been growing faster than in any other rich country, according to the OECD.  And is this based on reward for successful profit-making?  No.  As Andrew Haldane of the Bank of England has pointed out, when referring to the US, if bankers’ pay were linked to return on assets (ROA) a figure based on profits, it would be much closer to median household incomes than if based on return on equity (ROE), a figure based on the stock market.  Haldane calculated that, if the CEOs of the seven largest US banks had in 1989 agreed to index their salaries not to ROE, but to ROA, by 2007, their compensation would not have grown tenfold.  Instead, it would have risen (only) from $2.8 million to $3.4 million.  Rather than rising to 500 times median US household income, it would have fallen to (only) around 68 times.

Nevertheless, the world’s second richest man in wealth (a Mexican telecoms tycoon is the richest), Bill Gates of Microsoft told the Davos faithful that capitalism was a “phenomenal system” because there is no other system that has improved humanity.  He left aside the question of whether all humanity has benefited from capitalism or the role of capitalism in wars, pollution, global warming, unemployment etc.  Despite these things, Gates supported capitalism because “it has generated so much innovation – it gave me the chance I had as a young boy to start Microsoft and hire my friends.  Other systems don’t allow that to happen”.

Thus Gates promotes the myth that innovation is only possible through the incentive of profit.  Marx too recognised that the capitalist system was a mode of production that drove technology and raised the productivity of labour more than any previous mode of human organisation.  But he reckoned that a socialist, collective mode of production that melded cooperative labour to social need would be even more productive and would not generate the huge inequalities and economic destruction.

Indeed, many, if not most, key innovations that have benefited humanity in the last hundred years were more the result of the incentive of public funding for research in genetics, satellites, health and the environment, much of it done in publicly-owned institutions where profit played no role.  The internet, after all, was invented in the military sector as a form of communication.  And many other innovations like radar came through military funding by the state.    The software basics of Microsoft were already developed in academic circles.   Gates was an entrepreneur who came up with a model to capture those innovations in a profit-making operation.  Indeed, there is much better software available free as ‘open source’ material.  But Microsoft’s monopoly in marketing and links with hardware have kept such free alternatives from being used globally.  Publicly-funded research would just as well have developed such software innovations without the need for a mega corporation that has made a few people super rich by charging for what could be free to all.

Francis Fukuyama once wrote a famous book in the 1990s called The end of history, in which he argued that Western capitalist democracy was the conclusion of all human development.   Now after the Great Recession and the revelations about the extreme inequalities that exist under ‘liberal democracy’, Fukuyama obviously  thought he should do something more.  This week he wrote another article called “The Future of History” in the current issue of Foreign Affairs.  He mused that if some “obscure scribbler … in a garret somewhere (is this him?)” would “outline an ideology of the future that could provide a realistic path toward a world with healthy middle-class societies and robust democracies“… he “could not begin with a denunciation of capitalism as such, as if old-fashioned socialism were still a viable alternative. It is more the variety of capitalism that is at stake and the degree to which governments should help societies adjust to change.  The new ideology would not see markets as an end in themselves; instead, it would value them to the extent that they contributed to a flourishing middle class, not just to greater aggregate national wealth.”   

Fukuyama uses the word ‘middle-class’ as all apologists for capital now use it, as a euphemism for ‘working-class’, a word that no longer exists to describe the majority of people.  There are either the rich, the middle-class or the poor (see my post, The working  poor, 7 June 2011).  But whatever word you use, the 99% are not flourishing under modern capitalism.   Both the IMF and the World Bank have now presented reports that show that the major capitalist economies are struggling to sustain any recovery out of the Great Recession (see my post, The world economy – where are we now?, 18 January 2012). The IMF reckons the Eurozone will contract by 0.5% in 2012, with southern Europe dropping by around 2% or more.  Emerging capitalist economies will grow at a slower pace (5.4%) than the IMF thought back last September.  American capitalism looks a little better, but only with growth at 1.8% in 2012, hardly a rate that can get unemployment down or raise real incomes.  Indeed, Christian Lagarde, the head of the IMF, commented that “It is not about saving any one country or any one region. It is about saving the world from a downward economic spiral. It is about avoiding a 1930s moment … in which a combination of inaction, insularity and rigid ideology could cause a collapse of global demand.’

The figures for the UK economy were released this week.  In the last quarter of 2011, the UK economy contracted by 0.2% qoq after growing 0.6% in Q3’2011.  For the whole of 2011, real GDP rose just 0.9%, half the already paltry rise achieved in 2010.  Another quarter of contraction and the UK economy will be back in a ‘technical recession’, two consecutive quarters of decline.  This is still way short of the slump during the Great Recession of 2008-9, when British capitalism contracted 7.1%.  But it ain’t good.  While the government sector managed a small rise in Q4 of o.4%, the private sector declined, with manufacturing down 0.9%, the biggest drop in over two years.  The recovery from the trough of the Great Recession is stuttering, with only 45% of the output lost in the slump recouped so far.

The chief economist at the IMF, Oliver Blanchard, commented that the global economy is driving “with the brakes on”.  What are those brakes?  Well, one is the draconian measures of fiscal austerity being imposed on households and the public sector across Europe, but soon in the US and Japan.  This is squeezing back the only areas of growth in the economy since the Great Recession, the public sector.  But the other brake is the size and level of debt, both private and public, that capital is burdened with.  A recent report by the McKinsey Institute shows that debt relative to GDP in the major capitalist economies rocketed prior to the credit crunch in 2007.  But since then, ‘deleveraging’ that debt has made only limited progress in the major economies (MGI_Debt_and_deleveraging_Uneven_progress_to_growth_Report).

Now there are those who argue that debt does not matter and the burden of servicing it will fall when economic growth is restored to a sufficient level or, alternatively the real burden can be reduced by higher inflation.  Well, neither of these options is happening.  So the real burden of debt servicing is high.  The other argument is that one man’s debt is another’s credit.  So the size of debt does not matter because it just means that assets are up too.  But that assumes that debts are honoured and there is no default.  If there are defaults, then the reckoning comes.  We have already seen the impact of that when the housing market in the US collapsed and defaults on mortgages rocketed.  The banks found that their assets were worth way less than they thought.  Similarly, there is every possibility that the Greek government will default on its debt to the banks in Europe.  Indeed, it is currently negotiating a 60% ‘voluntary haircut’ on the value of its bonds held by those banks.  That entails huge losses to the banks.

Debt does matter and this form of deleveraging is a severely damaging to the real economy.  In effect, as debt or credit rises, the value it represents gets out of line with real value.  Its value becomes the buyer or seller’s expectation of its real value.  The value is thus fictitious, as Marx called it, which at a certain point will be exposed as such and forced to its real value through deleverage, ie liquidation, bankruptcy and, of course, job losses.

It is not debt as such that is the issue; it is what credit is used for.  Government borrowing used to invest in new industries and employment could pay for itself.  But borrowing to bail out banks that have taken losses on fictitious capital is clearly not productive, but a deduction of resources available for productive investment.  In the 13th century,at the beginning of capitalism, it was bankers bankrupting banks. In the 21st century, in modern mature capitalism, bankers are still bankrupting banks. But it is no longer just banks. In the UK, over half a million individuals and nearly 100,000 businesses have found themselves in insolvency since 2007.

What is clear is that the UK economy, along with other major capitalist economies, is suffering from a long depression similar to that experienced by Japanese capitalism after the collapse of its credit bubble in the late 1980s.  During the decade of the 1990s, Japan’s economy could only grow in real terms by 0.8% a year.  The huge private sector debt mountain was only written down very slowly to avoid a major slump.  The banks were bailed out by the taxpayer and Japanese households had to take the pain in a stagnation of real living standards.  Public sector debt rocketed to over 200% of GDP and household savings fell.

Japanese capitalism did not adopt the policies of fiscal austerity that are advocated by mainstream economics and implemented now.  So Japan avoided a significant rise in unemployment, but the economy stagnated and profitability remained in the doldrums.  Japan’s example shows that the option of fiscal austerity can be avoided, but without deleveraging to cleanse the corporate books of ‘dead capital’ and restore profitability, economic recovery will be weak.  Without profitability restored, capitalism stays in depression.

According to a new report by the International Labour Organisation (ILO), the world faces a challenge of creating 600 million jobs over the next decade.  Global unemployment is now 200 million – an increase of 27 million since the start of the crisis.  In addition, more than 400 million new jobs will be needed over the next decade to avoid a further increase in unemployment.  Even if those jobs were created, it would still leave 900 million workers living with their families below the US$2 a day poverty line, largely in developing countries. Young people are nearly three times as likely as adults to be unemployed.  Even those young people who are employed are increasingly likely to find themselves in part-time employment and often on temporary contracts.

Falling labour force participation masks an even worse global unemployment situation. In the world as a whole, there were nearly 29 million fewer people in the labour force in 2011 than expected based on pre-crisis trends, with 6.4 million fewer youth and 22.3 million fewer adults. This is equal to nearly 1 per cent of the actual global labour force in 2011, and nearly 15 per cent of the total number of unemployed in the world. If all of these potential workers were available to work and sought work, the number of unemployed would swell to over 225 million, or to a rate of 6.9 per cent, versus the actual rate of 6 per cent.  Globally, the employment-to-population ratio declined sharply during the crisis, from 61.2 per cent in 2007 to 60.2 per cent in 2010. This represents the largest such decline on record (since 1991).

Those meeting at Davos who defend capitalism as the only or best system of human social organisation have no answer to this appalling mess.

Michael Roberts blogs at