Looking for a cause is scientific. But dialectically there can be causes at different levels, from the ultimate (essence) to the proximate (appearance). The ultimate provides an explanation for the proximate [Roberts 2014]. The Great Recession of 2008-9, like other capitalist economic crises, had an underlying cause based on the contradiction under capitalism between the rising accumulation of capital (investment and production) and a tendency for the rate of profit on that accumulation to fall. That contradiction arises because the capitalist mode of production is production for value not for use. Profit is the aim, not production or consumption. Value is created only by the exertion of labour (by brain and brawn). Profit comes from the unpaid value created by labour and appropriated by private owners of the means of production.
The underlying contradiction between the accumulation of capital and falling rate of profit (and then a falling mass of profit) can only be resolved by crisis, which takes the form of a collapse in value. Marx reckoned that crises under capitalism recurred at regular intervals because production for profit not need is interrupted regularly and often with increasing intensity by a tendency for the profitability of capital to fall over time [Marx 1970]. That tendency is driven by the nature of capitalist accumulation, namely that individual capitalists compete to increase their profits and their share of total profit exploited from the workers they employ. They do so by introducing technology that raises the productivity of the labour force and reduces the relative amount of workers needed. As capitalists compete, the overall cost of means of production rises faster than the cost of labour (what Marx called a rise in the organic composition of capital). As only labour can create value and profit (if workers don’t work, nothing gets done), there is a tendency for profitability (not total profits) to fall. At regular intervals, this can turn into a drop in total profits and then a reduction in investment and production – a slump.
This law applied to the US economy just as much as any other capitalist economy. In the US, there has been the secular rise in the organic composition of capital (OCC) of 21%, while the main ‘counteracting factor’ in Marx’s law, the rate of surplus value or exploitation (ROSV), fell 4% [Carchedi and Roberts 2018].
Even more compelling, each economic recession in the US has been preceded by a fall in the rate of profit and then by a recovery in the rate after the slump [Kotz 2007]. This is what you would expect cyclically from Marx’s law of profitability.
Clearly a significant fall in the rate of profit is an indicator for an upcoming slump in investment and production in a capitalist economy. Marx argued that a falling rate of profit would, for a while, be compensated for by an expansion of capital investment, so that the mass of profits would continue to rise. But that could not last and eventually the fall in the rate of profit would lead to a fall in the mass of profits, which would engender ‘absolute overproduction’ of capital and a slump in production.
Marx’s theory of crises is confirmed by the evidence for the US in the post 1945 period. Jose Tapia [Tapia 2018] found that “data from 251 quarters of the US economy show that recessions are preceded by declines in profits. Profits stop growing and start falling four or five quarters before a recession. They strongly recover immediately after the recession. Since investment is to a large extent determined by profitability and investment is a major component of demand, the fall in profits leading to a fall in investment, in turn leading to a fall in demand, seems to be a basic mechanism in the causation of recessions.” Sergio Camara and Aberlardo Marina [Camara and Marina 2018] also find that “a significant cyclical decline of the profit rate has substantially preceded the last two recessions… the cyclical slump in the rate of profit must be seen as an important precipitating factor in the deepest economic downturn since the 1930s”
Each crisis can have its own trigger: the 1974-5 slump was triggered by high oil prices; the 1980-2 slump triggered again by high energy prices; the 1991 by a property slump; the 2001 by stock market hi-tech crash; and 2008-9 was preceded by a credit-fuelled bonanza in property, diversified through financial instruments of mass destruction (collateral debt obligations).
Fictitious profits are another counteracting factor to the law of profitability described by Marx. 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 a financial bubble.
An expansion of credit to buy bonds, stocks and other financial assets, Marx called ‘fictitious capital’. But the value of such financial assets is, in the last analysis, supported by the profits of productive assets. In a slump, much of the value of financial assets turns out to be fictitious. Much of the rise in corporate profits was fictitious and proved to be so when financial crash began in 2007.
The boom in credit went into residential property in the United States and other economies. By mid-2006, the residential property boom in the United States had reached mega proportions. Household debt expanded rapidly during the so-called neoliberal era as a result of falling interest rates that reduced the cost of borrowing and created the ensuing property boom in many advanced capitalist economies in the past fifteen years. The creditors were the banks and other money lenders. The assets (home values) eventually collapsed, placing a severe burden of deleveraging on the financial sector.
But all bad things must come to an end and the Great Recession gave way to what I call a Long Depression. The US economy remains the largest and most important capitalist economy in the world. It has performed the best of the top seven largest economies since the end of the Great Recession in 2009. But even US real GDP growth since 2009 has been poor by pre-crisis standards. And if we look at the average real GDP growth per person (per capita), US economy has had average growth of only 1.4% a year over the last ten years, compared to near 3% a year before 2007.
The story of the US economic giant since the Great Recession is one not just of stagnation but of disappearing economic growth in the weakest economic recovery after a slump since the 1930s [Roberts 2016].
After a short burst of acceleration in 2017, after a fall in oil prices and cuts in corporate taxes by President Trump, US economic growth is slowing fast again with business investment decelerating. Most important, non-financial corporate profits remain below 2014 levels and the rate of profit on capital in the US is still well below the level of 2014. In 2017, the US rate of profit was still 6-10% below the peak of 2006 and well below the 2014 peak.
In 2017, US President Trump was boasting that the US economy was booming, with record highs for the US stock market. But by mid-2018 US and world growth had peaked and began to slip back. At the end of 2018, stock markets suffered the deepest fall since the global financial crash in 2008.
Marx said that what drives stock market prices is the difference between interest rates and the overall rate of profit [Marx 1970]. What has kept stock market prices rising since 2009 has been the very low level of long-term interest rates, mainly because there is little demand for bank loans to invest but also partly engendered by central banks like the Federal Reserve around the world, with zero short-term rates and quantitative easing (buying financial assets with credit injections). The gap between returns on investing in the stock market and the cost of borrowing to do so has been high, unlike that for productive investment.
But in 2018 interest rates began to rise (driven by the US Fed) and there are signs that the recovery in the rate of return on capital in the major economies has peaked and is reversing. In Europe, hopes of a synchronised expansion matching that of the US have been dashed, as the leading European economies, France and Germany, have slowed, while the weaker ones like Italy have slipped back into recession. UK real GDP growth is also dropping fast as companies apply an investment strike due to uncertainty over Brexit. The Eurozone economy is now growing at only 1.6% compared to nearly double that rate this time last year. In Asia too, there has been a slowdown in the second half of 2018. Japan’s real GDP was static in Q3 2018. The world’s largest manufacturing economy, China, has also slowed to its lowest since the end of the Great Recession. All the official growth forecasts (from the IMF, the OECD, World Bank etc) are for a lower rate in 2019 compared to 2018. [IMF 2019]
As growth slows, the opposite is happening with the level of debt held by companies. There has been a sharp rise in unbacked corporate debt, called leveraged loans, with issuance hitting record highs in 2018. So the scene is set for a new credit crunch in 2019 if profits stop growing and the cost of servicing the accumulated corporate debt goes on rising. The Bank for International Settlements (BIS), the international research agency for central banks, warned that what it calls the ‘financial cycle’ implies that a new credit crunch is coming [BIS 2018].
“Financial cycle booms can end in crises and, even if they do not, they tend to weaken growth. Once financial cycles peak, the real economy typically suffers. This is most evident around financial crises, which tend to follow exuberant credit and asset price growth, ie financial cycle booms. Crises in turn tend to usher in deep recessions, as falling asset prices, high debt burdens and balance sheet repair drag down growth.” And most important “the debt service ratio is particularly effective in this aspect”.
The US corporate sector ended 2018 with record levels of profits/earnings, rising some 20%, the highest rate since 2010, when the US economy rebounded from the Great Recession. But this profit jump was a one-off. It was driven by huge corporate tax cuts and exemptions from tax in repatriating cash reserves from abroad that the major US companies held. And US corporate revenues have been boosted by a very sharp fall in input costs, namely the fall in the oil price during 2018.
US non-financial corporate debt hit a post-crisis high of 72% of GDP. At around $14.5 trillion in 2017, non-financial corporate sector debt was $810 billion higher than it was a year ago, with 60% of the rise stemming from new bank loan creation. At present, bond financing accounts for 43% of outstanding debt with an average maturity of 15 years vs. the average maturity of 2.1 years for US business loans. This implies roughly around $3.8 trillion of loan repayment per year. “Against this backdrop, rising interest rates will add pressure on corporates with large refinancing needs.” [IIF 2018]
Aside from higher interest rates, the companies that need credit (as opposed to high-rated ones that borrow only because they can do it cheaply) tend to be riskier. A recent Moody’s report found that 37% of US nonfinancial corporate debt is below investment grade. That’s about $2.4trn. [Moody’s 2018]. A lot of that debt is rated BBB, the lowest investment grade rating. That means they are just one step above ‘junk’. The number of BBB-rated companies is up 50% since 2009.
Furthermore, all corporations, both investment grade and speculative, have added significantly more debt since the Great Recession. Some companies borrowed to fund share buybacks and have vast cash flow and reserves. They can easily deleverage if necessary. But smaller, less profitable companies have no such choice. The average non-financial business is roughly 20% more leveraged than at the time of global financial crash in 2007-8.
The usual response of mainstream economics to the risk of a slump in production and as means to achieve recovery after a slump is to advocate easing monetary policy and lowering interest rates. And if that does not work, then they want to apply fiscal easing ie boosting government spending and running deficits on annual budgets to ‘pump prime’ the economy.
The monetarist solution was the main policy adopted after the Great Recession. It failed to stimulate productive investment and output and incomes for the 99%. Instead all cheap money and credit went into speculation in financial assets, stocks and bonds, to the benefit of the top 1%. Interest rates are now very low and can hardly be lowered much more – indeed the US Federal Reserve has been raising its interest rate. So Keynesian economists argue that what is needed is a major fiscal stimulus policy. But would it work?
The Keynesian view is that investment drives GDP, employment and profits through the mechanism of ‘effective demand’. But Marxist theory says that it is profit that ‘calls the tune’, not investment. Profit is part of surplus value, or the unpaid labour in production. It is the result of the exploitation of labour – something ignored or denied by Keynesian theory, where profit is the result of ‘capital’ as a factor of production [Tapia 2018].
The Keynesian view is ‘back to front’: investment does not ‘cause’ profit; but profit ‘causes’ investment. Moreover there is little empirical evidence that investment drives profits as the Keynesian model would suggest. And there is little evidence that government spending or budget deficits (net borrowing) restore economic growth or end slumps. These end only when the profitability of business capital is revived. If the Marxist analysis is right, then government spending and tax increases or cuts must be viewed from whether they boost or reduce profitability. If they do not raise profitability or even reduce it, then any short-term boost to GDP from more government spending will only be at the expense of a lengthier period of low growth and an eventual return to recession.
There is a simple macro accounting identity for Marxists that is the opposite of the Keynesian. It’s Profits + Government surpluses = Investment and the Current Account. So if profits are set to fall while Trump runs huge government deficits (6% of GDP), then investment must fall and the current account deficit (3% of GDP) must narrow. That means a collapse in production and imports – a slump probably within the next 18 months.
That’s for the shorter term. Longer term, the greatest capitalist economy in the world faces a major challenge from a new economic rival, much more serious than the relatively backward Soviet Union post-1945, namely China.
Capitalist economic power can be measured simply by the overall level of productivity, as measured by output per hour worked. On this broad measure of the productivity of labour, the US remains ahead, even compared to other advanced economies in Europe and Japan. China’s labour productivity level is just 20% of the US. But China’s productivity has quadrupled since 2000 alone [Roberts 2015].
The US share of global R&D has declined, in part due to a rapid increase in China’s share, even though the US remains the global R&D leader, accounting for nearly 30% of the world total, about 1.5-2 times the US share of world GDP.
China’s share of total patents granted has risen very rapidly over the last decade to over 20%, but most patents granted to Chinese innovators have come from its own domestic patent office, with far fewer granted abroad. The US share of the world total of royalties on intellectual property has declined somewhat as the EU’s has grown, but it remains very large. China’s share remains negligible. That means US capital is still taking the lion’s share of global profits in technology.
The modern 21st century US economy relies increasingly on advanced knowledge and technology sectors for its growth. The share of US GDP for these sectors is now 38%, the highest of any major economy. But China is not far behind with 35% of its GDP in these sectors, amazingly high for a ‘developing’ economy.
While the US is still the largest producer of high-tech goods, its share of world exports has shrunk considerably while China’s share has grown. The US still remains the largest global producer of commercial knowledge-intensive services and second only to the EU in exports. China’s share remains quite small.
But these hi-tech sectors are highly concentrated in just a few firms. There are wide swathes of American industry, including tech, which benefits little from this US superiority. Just five firms have over 60% of sales in biotechnology, pharma, software, internet and comms equipment. The top five in each sector are taking the lion’s share of profits too.
China now ranks second only below the US in terms of outward investment. Its stock of direct investment assets has been growing 25% annually hitting a value of $1.3trn. China is also pushing aggressively into ‘the belt’ countries of its ‘one road’ project. That’s reflected in its exports, with sales to these states double those to the US.
Foreign trade now contributes relatively little to US corporate profits. Back in the 1940s, foreign subsidiaries of US-based corporations accounted for only 7% of all US profits – the same proportion as exports. Globalisation of US corporate operations and capital investment has changed that in the last 35 years. In 2016, the share of domestic profits has shrunk to 48% of total profits, while the shares of foreign operations and exports have grown to 40% and 12%, respectively.
But since the Great Recession, ‘globalisation’ seems to have paused or even stopped. World trade ‘openness’ (the share of world trade and finance capital compared to global GDP) has been declining since the end of the Great Recession.
It is this decline in globalisation as world economic growth stays low and the profitability of capital remains squeezed that lies behind this new trade war.
Trump’s blundering blows on trade have an objective reason: to preserve US profits and capital in the key growing tech sectors of the world economy from the rising force of Chinese industry. So far, the US is still holding a strong lead in hi-tech and intellectual property sectors, while China’s growth has been mainly in taking market share at home from American companies, not yet globally. But China is gaining.
This will be the game changer for American capital in the 21st century.
References:
Marx, K. (1970) Capital Volume 3, Chapters 13-15, London Lawrence and Wishart.
Roberts M, The Long Depression (2016), Haymarket Books, Chicago.
David Kotz, (2007) Economic Crises and Institutional Structures: A Comparison of Regulated and Neoliberal Capitalism in the U.S. PERI paper.
Carchedi G and Roberts M, The Long Roots of the Present crisis in The World in Crisis, (2018) Haymarket Books, Chicago. pp 13-36
Tapia J, Investment, profit and crisis; theories and evidence, in The World in Crisis, 2018, Haymarket Books, Chicago, pp78-129.
Camara S and Marina A, The neoliberal financialisation of the US economy, in The World in Crisis. Pp318-329
Carchedi G and Roberts M (2018) The World in Crisis: a global analysis of Marx’s law of profitability , Haymarket Books, Chicago.
Roberts M, Tendencies, triggers and tulips – the causes of the crisis: the rate of profit, overaccumulation and indebtedness, Presentation to the Third Economics seminar of the IIRE, 14 February 2014, Amsterdam.
Moody’s
https://www.marketwatch.com/story/us-investment-grade-corporate-bonds-now-riskier-than-before-each-recession-since-1981-moodys-2018-11-16
IMF, World economic outlook update, https://www.imf.org/en/Publications/WEO/Issues/2019/01/11/weo-update-january-2019
IIF, https://www.forbes.com/sites/johnmauldin/2018/06/13/yet-another-debt-crisis-is-brewing/#9bf785eff579
BIS Quarterly Review, Borio C, The financial cycle and recession risk https://www.bis.org/publ/qtrpdf/r_qt1812g.htm