Tuesday, August 16, 2011

Marx was right

The spectre of Karl Marx haunting economics

Nouriel Roubini is a mainstream economist who teaches at New York University. He is no Marxist. In an interview with the Wall Street Journal, Roubini admitted that Marx was right about Capitalism and raised the possibility that Capitalism is destroying itself in the way Marx outlined more than a century and a half ago.

"Karl Marx had it right. At some point, Capitalism can destroy itself. You cannot keep on shifting income from labor to Capital without having an excess capacity and a lack of aggregate demand. That's what has happened. We thought that markets worked. They're not working. The individual can be rational. The firm, to survive and thrive, can push labor costs more and more down, but labor costs are someone else's income and consumption. That's why it's a self-destructive process."

Alas, Roubini is presenting a view on the cause of crises are caused by underconsumption. In this theory, a crisis is precipitated when the production of consumer goods increases faster than consumer demand, which is mainly that of wage and salary workers. It has been put in a various forms by a variety of people. It is the one with the longest pedigree, and the one which probably most non-Marxists would recognise as the Marxist theory of crisis. Indeed, for about half the life of the Socialist Party, it’s the theory that you would have found in the pages of the Socialist Standard. The details of the different underconsumption theories differ, but all understand the cause of crisis as being an insufficiency of monetary demand in the market to realise profits. They point to a contradiction in the cycle. On the one hand, there is a tendency under capitalism for Mr Moneybags to cut costs and keep wages to a minimum, in order to maximise profits. On the other hand, the main market for his goods consists of those very same workers. And if workers have had their wages suppressed, they cannot also at the same time constitute a vibrant consumer market. Marx himself at one point says that it is the impoverishment of the masses, their underconsumption, that is the ultimate cause of all crises.

However, Marx also pointed out, elsewhere, that to say so is a pure tautology: it is a defining characteristic of crisis that vast amounts of unsold wealth sit side by side with great poverty. The main problem facing underconsumption theory, as Marx also pointed out, is that, on the dawn of a crisis, wages tend to have reached a peak over the cycle. If underconsumptionism is true, why should a period of high wages precipitate a crisis and a period of low wages lay the basis for a new round of capitalist prosperity, as actually occurs? The Socialist Party therefore – on these and other grounds – abandoned underconsumptionist theory in the late 1950s. The Socialist Party now adhere to what is called the "disproportionality theory" which says that capitalism’s cyclical crises are due to the so-called ‘anarchy of production’, in other words, a consequence of the fact that wealth production is not consciously designed for social ends, but the result of individual businesses and entrepreneurs seeking profit, guided only by their expectation of profit and regulated by the invisible hand of the market via competition. This planless anarchy inevitably leads one sector of the economy, in its drive for profits, to expand disproportionately faster than the other sectors. This initial sectoral overproduction then leads to falling profits and prices, falling demand for inputs, and so on, and hence transmits trouble to other sectors of the economy, potentially leading to the appearance of a more general crisis. This theory seems to fit the facts pretty well, and serves as a good first-cut explanation for what has actually happened in the present crisis.

In the terms of this theory of one sector of the economy expanding disproportionately faster than the other sectors and this initial sectoral overproduction, through its knock-on effects, transmitted to other sectors of the market economy leading to the appearance of a more general crisis can be identified in the run up to the start of the current crisis, the American retail property market, in its drive for profits, produced more houses than could be profitably sold. This led to the appearance of ‘subprime’ mortgages, where people who could not afford the houses were nevertheless loaned the money in the belief that wages could cover the low cost of servicing the loan, with never-ending house price rises at some point picking up the slack. When interest rates began to rise, those wages were no longer sufficient to meet obligations, and people began defaulting on their loans in 2006. Mortgages then became more expensive, houses were harder to sell, and hence prices stalled or fell. By December 2007, nearly a million US households were in foreclosure. House prices then began to collapse more rapidly, taking with them the whole structure of financial products built on them, which by this time made up a massive part of the financial structure of the US and the rest of the world, for reasons we will consider later. This swiftly led to the bankruptcy or near-bankruptcy of major banks and insurance houses, and flows of credit dried up. But businesses rely on credit to meet everyday running costs. So a disproportionate expansion of the US housing market soon threatened to bring down all those businesses that rely on credit, ie, practically all of them, not to mention all those businesses that relied on the housing market for its custom. It turned out that the number of businesses relying on the housing market was simply staggering – homeowners had taken out loans against the rising value of their property to fund consumption, and to make up for their stagnant wages, and this consumption accounted for a huge proportion (70%) not just of the US economy, but those of whole countries around the world, particularly China. Falling house prices in America therefore threatened to stall the whole global economy.

In an attempt to keep things moving and to guarantee social peace, the state stepped in to rescue some of the banks and encourage them to lend. But this just moved the problem around, spreading the initial sectoral disproportion into the state finances. This then led states to try to impose the losses on their populations, with austerity programmes and cuts in the social wage – which threatened to deepen the crisis and choke off effective demand – or to wriggle their way out of it by printing money – which threatened a crisis of stagflation.

Disproportionality theory, then, seems a good fit as a general explanation for the current recession.

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