The Failure of Capitalist Production docx

co nd itio ns th at set the stage fo r the crisis and recession, and less on the pro xim a te causes o f these events.. To take one key example, the recent financial crisis is often a tt

A N D R E W K L I M A N

T h e F a i l u r e o f

C a p i t a l i s t P r o d u c t i o n

U n d e r l y i n g Caus es o f t he G r e a t Re c e s s i o n

THE FAILURE OF CAPITALIST

In m emory o f Ted Kliman (1929-2009) and Chris Harman (1942-2009)

For Jesse

For Anne

List of Tables

2.1 N on -L in e a r Effect o f Falling P ro fita b ility on Business

4.2 Sovereign D ebt Defaults and Restructurings,

5.1 Rates o f P rofit, U.S C orpo ratio ns, Selected Trough

6.1 Rates o f P ro fit and E q uity-m arket Rates o f Return 117

‘>.1 Pay, Exports, and Economic G ro w th in the U.S

List of Figures

3.1 M ortgage B o rro w in g and Real H om e Prices, U.S 293.2 Relative Increases in L ia bilities and Assets, U.S

3.3 N et Lending o r B o rro w in g by U.S H ouseholds 31

3.8 Federal Funds Rate and H om e M ortgage B o rro w in g 43

4.2 Im pact o f C hina on G ro w th o f GDP Per C apita 53

4.7 Change in Debt, A ll U.S Dom estic N on fina ncia l

4.10 U.S Treasury D ebt as Percentage o f GDP, Actual vs

4.11 Gap between A ctual and Potential Labor Force, U.S 67

4.14 Changes in Income Inequality am ong U.S Households 70

5.2 U.S M u ltin a tio n a ls ’ Rate o f Profit on Foreign D irect

5.4 Inflatio n-A d juste d Properry-Income Rates o f P ro fit 83

5.7 Effect o f A lternative Adjustm ents on Rates o f Profit 87

5.8 The Rate o f P ro fit and the Rate o f A ccu m ulatio n 915.9 N et Investment as Percentage o f Profit, U.S.

5.10 N et Investment as Percentage o f A fter-Tax Profit,

6.2 C urre n t-C o st “ Rates o f P ro fit,” U.S C orpo ratio ns 111

6.4 R elationship between C urrent-C ost and

6.5 C urre n t-C o st and “ Real” Rates o f Profit, U.S

6.6 C urrent-C ost, “ R eal,” and In flatio n-A d juste d Rates

7.2 P ro fit Share o f U.S C o rp o ra tio n s ’ N et Value Added 125

7.6 Gap Between N o m in a l and M E LT-A djusted Rates

7.7 A lte rna tive D ecom position o f the N o m in a l Rate

7.9 Rate o f N o n -IP E & S D epreciation, U.S Business

7.10 Losses Due to A d d itio n a l M o r a l D epreciation,

8.1 W orkers’ Share o f U.S N a tio n a l Income, 1 9 6 0 -2 0 0 9 1548.2 Real H o u rly C om pensation, Private-Industry

List of Abbreviations

CPI-U-RS CPI Research Series Using C urre n t M ethods

clerical w orkers

LTFRP law o f the tendential fall in the rate o f p ro fit

Development

S & Ls savings and loan associations

I thank everyone w h o provided expert advice on technical matters and everyone w h o offered comments on the papers, book reviews, talks, interviews, and d ra ft m anuscript that eventually turned in to this book I have benefited enorm ously fro m th eir feedback It not only im proved the book significantly but guided the direction o f my research in crucial ways I w o u ld like to thank each one by name, but unfortunately I cannot Even were they not too numerous to list, they include many audience members and reviewers whose names I

do not know I f you are among them, please k n o w that the difference between w h a t you o rig in a lly read o r heard and the ideas as they appear in the final text is a sign o f m y debt and g ratitude to you

I thank my departm ental colleagues at Pace University, w h o have been very supportive o f my research I also th an k the u niversity’s

D yson College o f A rts and Sciences, w h ic h granted me released tim e to pursue my research on p ro fita b ility trends and provided a research grant th at enabled me to purchase a supersized com puter

m onitor The m o n ito r has made the w o rk o f data analysis much less onerous and more productive

None o f the book is a republication o f previously published w orks

o f mine, but I have dra w n freely on those listed below I thank the

fo llo w in g publishers fo r a llo w in g me to do so:

• The Com m une, w hich published “ The Econom ic Crisis: A n interview w ith Andrew K lim a n ” as pam phlet no 4, November 2008

• The In s titu te fo r Social Sciences o f G yeongsang N a tio n a l University, w hich published “ Masters o f Words: A reply to

M ichel Husson on the character o f the latest economic crisis,”

in M a rx is m 2 1 , vol 7, no 2, Summer 2010.

• In te rn a tio n a l Socialism, w h ic h published “ A Crisis fo r the

C entre o f the S ystem ,” in issue no 120, O c to b e r 2 0 0 8 , and “ Pinning the Blame on the System,” a review o f C hris

H a rm a n ’s Z o m b ie C a p ita lis m , in issue no 124, September

2009

• L e x in g to n B o oks, w h ic h p u b lis h e d R e c la im in g M a r x 's

“ C a p ita l” : A refutation o f the m yth o f inconsistency in 2007.

xii

• M a rx is t-H u m a n is t Initiative, w hich published “ The Persistent

F all in P r o fita b ility U n d e rly in g the C u rre n t C risis: N e w

te rn po ralist evidence” in M a rc h 2 01 0 and, in W ith Sober

Senses, its online p ub lica tion : “ O n the Roots o f the C urre n t

E conom ic Crisis and Some Proposed S o lu tio n s,” A p r il 17, 2009; “ H o w (N o t) to Respond to the Economic C risis,” M ay

5 ,2 0 0 9 ; “ Cherry Picking Peaks and Troughs,” M a y 13, 2009;

“ Appearance and Essence: Neoliberalism, financialization, and the underlying crisis o f capitalist p ro d u c tio n ,” M ay 17, 2010, and “ Lies, Damned Lies, and Underconsum ptionist Statistics,” September 16, 2010

• M egafoni, an online jo u rn a l, w hich published Joel K a itila ,

Lauri Lahikainen, and Jukka Peltokoski’s interview, ‘“ Kukaan

ei tiedá, o nko kriisi o h i’— Andrew K lim a n in haastattelu,” on

K lim a n ,” in E l A ro m o no 50, July 2009.

• T a y lo r &c Francis, w h ic h p ublished ‘“ The D e s tru c tio n o f

C a p ita l’ and the C u rre n t Econom ic C risis,” in Socialism &

Democracy, vol 23, no 2, July 2009.

• The W o rk e rs ’ L ib e rty w eb site, w h ic h p u b lis h e d M a r t in

T h o m a s’ interview , “ A n d re w K lim a n — The level o f debt is

a stro no m ica l,” on January 12, 2009

Special thanks go to Anne fo r her invaluable e dito rial advice and

ca reful c o p y -e d itin g , and fo r her in te lle c tu a l, professional, and personal su pp ort, w ith o u t w hich neither this n o r my p rio r book could have been w ritte n

N ew York C ity June 2011

co nd itio ns th at set the stage fo r the crisis and recession, and less

on the pro xim a te causes o f these events

N ow , explanations o f crises and slumps that appeal to underlying

c o n d itio ns are frequently less than illu m in a tin g To take one key example, the recent financial crisis is often a ttrib u te d to greed.1 Yet

as a p opular saying goes, blam ing the crisis on greed is like blam ing

an airplane crash on gravity G ra vity is always there, but airplanes

do not always crash The underlying co nd itio ns th at we w an t to

k n o w about are not permanent conditions like gravity, b ut specific, contingent conditions that made a crash more likely than otherwise,

o r more like ly than usual

I w ill therefore not say much abo ut greed, either in general o r

as it has been shaped by ca pita lism N o r w ill I say m uch abo ut capitalism as such I do not believe that capitalism is here to stay

in the w ay th a t g ra v ity is, but it has been a ro un d fo r hundreds

o f years, so blam ing the crisis on capitalism as such does little to illu m in a te w hy a m ajor crisis erupted a few years ago rather than

in the 1960s It is n o t incorrect to blame the recent crisis on the nature o f capitalism — just as it is not incorrect to blame the crisis

on greed The problem is sim ply th at these explanations are not satisfying; they do not tell us w hat we w a n t to know

The “ fa ilu re o f c a p ita lis t p ro d u c tio n ” in th is b o o k ’s title is therefore a reference, not to capitalism in general, but to specific and unresolved p roblem s w it h in the c a p ita lis t system o f value

p ro d u c tio n since the 1970s I w ill argue th a t the economy never

fu lly recovered fro m the recessions o f the m id -1 9 7 0 s and early 1980s I w ill put fo rw a rd an explanation o f w h y it did not I w ill argue th at the persistently fra il co nd itio n o f capitalist pro du ction

1

was among the causes o f the financial crisis A nd, most im portantly,

I w ill argue th at it set the stage fo r the G reat Recession and “ the new n o rm a l,” the state o f not-quite-recession that we n ow endure

In lig h t o f the fra ilty o f capitalist p ro du ction , the recession and its consequences were w a itin g to happen

Just as m ore lay behind the G reat Depression than the stock

m arket crash and the bubble that preceded it, more lies behind the Great Recession and “ the new n o rm a l” than the financial crisis and home-price bubble o f the 2000s As Paul Krugm an and R obin Wells(2010) noted in an essay published 15 m onths after the recession

o ffic ia lly ended in the U.S.:

[there] hasn’t been m uch o f a recovery I f the fundam ental pro blem lay w ith a crisis o f confidence in the banking system,

w h y hasn’t a restoration o f banking confidence b ro ug ht a return

to strong economic growth? The likely answer is that banks were

o nly part o f the problem

There is also reason to doubt that the financial crisis by itself— in the absence o f longer-term conditions that reduced the economy’s a bility

to w ithstan d shocks— w o u ld have triggered such a severe recession The actual declines in p ro d u ctio n , em ploym ent, and income that

to o k place, large as they were, are not true measures o f the U.S econom y’s in a b ility to absorb the shock o f the financial crisis The true measures are the declines th at w o u ld have taken place i f the Treasury had n o t b o rro w e d m ad ly to p ro p up the economy In the first tw o years th at fo llo w e d the collapse o f Lehman Brothers,

it b o rro w e d an a d d itio n a l $3.9 t r illio n , w h ic h caused its to ta l indebtedness to rise by more than 40 percent The a dd itio n a l debt was equal to 13.5 percent o f the $28.6 tr illio n o f Gross Dom estic

P roduct (G D P) th a t was produced d u rin g these tw o years Yet despite the enorm ous increase in debt and the a d d itio n a l spending and tax cuts financed by means o f it, real GDP at the end o f the tw o years remained less than at the pre-recession peak In contrast, the

Treasury’s debt declined in the tw o years between m id -1929 and

m id -1 9 3 1 , and by m id -1 9 3 2 it was s till o n ly 15 percent greater than in m id -1929 It is like ly th a t the latest recession w o u ld have been alm ost as bad as the G reat Depression, maybe even worse,

if the governm ent had refrained fro m run n in g up the public debt

T his book focuses on the United States, p a rtly because much o f

it consists o f a detailed analysis o f data The data th at are available

fo r o ther countries’ economies are n ot as complete and often not as

reliable as data fo r the U.S economy The other reason w hy 1 focus

on the U.S is that it was the epicenter o f the latest crisis It cannot

be a uto m a tically assumed th at the analysis o f the U.S case applies

to o ther countries But since the U.S was the epicenter— since, in other w ords, the crisis erupted elsewhere because it first erupted in the U.S and then spread— the relative lack o f discussion o f other economies does n o t reduce the adequacy o f this b o o k ’s analysis o f the long-term economic d ifficulties underlying the crisis and slump

MAIN THESIS

The rate o f p ro fit— that is, p ro fit as a percentage o f the a m ount o f money invested— has a persistent tendency to fall However, this tendency is reversed by w ha t John Fullarton, K arl M a rx , and others have called the “ destruction o f c a p ita l” — losses caused by declining values o f financial and physical capital assets o r the destruction o f the physical assets themselves Paradoxically, these processes also restore p ro fita b ility and thereby set the stage fo r a new boom , such

as the boom th at fo llo w ed the Great Depression and W o rld W ar II

D u rin g the global economic slumps o f the m id-1970s and early

1 980s, however, much less capital value was destroyed than had been destroyed during the Depression and the fo llo w in g W o rld War The difference is largely a consequence o f econom ic policy The

am ount o f capital value that was destroyed d u rin g the Depression was far greater than advocates o f laissez-faire policies had expected, and the persistence o f severely depressed conditions led to significant rad ica liza tion o f w o rk in g people Policymakers have not wanted this to happen again, so they n o w intervene w ith m onetary and fiscal policies in order to prevent the full-scale destruction o f capital value T his explains w h y subsequent d o w n tu rn s in the economy have not been nearly as severe as the Depression But since so much less capital value was destroyed durin g the 1970s and early 1980s than was destroyed in the 1930s and early 1940s, the decline in the rate o f p ro fit was not reversed A nd because it was not reversed,

p ro fita b ility remained at too lo w a level to sustain a new boom

The chain o f causation is easy to understand The generation

o f p ro fit is w h a t makes possible the investment o f p ro fit So, not

surprisingly, the relative lack o f p ro fit led to a persistent decline in the rate o f capital accum ulation (new investment in productive assets as

a percentage o f the existing volume o f capital) Sluggish investment has, in tu rn , resulted in sluggish g ro w th o f o u tp u t and income

A ll this led to ever more serious debt problems Sluggish income

g ro w th made it more d iffic u lt fo r people to repay their debts The decline in the rate o f p ro fit, together w ith reductions in corporate income ta x rates th a t served to p ro p up c o rp o ra tio n s ’ a fte r-ta x rate o f p ro fit, led to greatly reduced ta x revenue and m o u n tin g gove rn m e nt budget deficits and debt A n d the g ove rn m e nt has repeatedly a tte m p te d to manage the re la tive s ta gn atio n o f the economy by pursuing policies th a t encourage excessive expansion

o f d ebt These p olicies have a r t if ic ia lly boosted p r o f it a b ilit y and econom ic g ro w th , b u t in an unsustainable m anner th a t has repeatedly led to burst bubbles and debt crises The latest crisis was the most serious and acute o f these

Although the financial crisis is over, and the recession officially ended

tw o years ago, the debt problem s persist— w ith in the European

U nion, they are now critica l— as do massive unem ploym ent and the severe slum p in home prices These problem s seem to be the main factors th at have kept the U.S economy fro m g ro w in g rap id ly since the end o f the recession For a long tim e, Am ericans were w illin g to increase their b o rro w in g and reduce their saving, since they believed that increases in the prices o f their houses and shares o f stock were

an adequate substitute fo r real cash savings But those increases have vanished, and m any people are w o rrie d a b o u t w he th er they w ill hold on to th e ir jobs and homes, so they have begun to b o rro w less and save more And because o f continuing debt, unemployment, and housing-sector problem s— and p ro ba bly because o f concerns that they w ill suffer a dd itio n a l losses on existing assets and ultim ately have to report losses th at they have not yet “ recognized” — lenders are less w illin g to lend The lo w level o f b o rro w in g /le n d in g has caused spending and economic g ro w th to be sluggish

I c e rta in ly do n o t advocate fu ll-sca le d e s tru c tio n o f c a p ita l value— o r any o th e r policies intended to m ake c a p ita lis m w o rk

b elte r; it is n o t a system I favor Yet the d e s tru c tio n o f ca pita l value w o u ld indeed be a so lu tion to the systemic problem s I have out lined— unless it led to revolution or the collapse o f the system A massive wave o f business and personal bankruptcies, bank failures, uni w rite -d o w n s o f losses w o u ld solve the debt overhang N e w

n w n ris i o uld take over businesses w it h o u t assuming th e ir debts 111<I p m i h.tse them at fire-sale prices T his w o u ld raise the potential

i m ill p i<t l i i , and it w ou ld therefore set the stage fo r a new boom

If this does not happen, I believe that the economy w ill continue to

be relatively stagnant and prone to crisis

THE C ON VENTION AL LEFT ACCOUNT

This is not a book th a t I set o u t to w rite A t the start o f 2009, I began the em pirical research that eventually became the core o f the book, but at the tim e I had a d ifferent, and very lim ite d , objective

in m ind However, I soon discovered things th a t im pelled me to dig deeper and w iden the scope o f my research

To understand the significance o f w ha t I gradually learned, one needs to be fa m ilia r w ith the co n v e n tio n a l w is d o m on the left regarding recent LJ.S economic history and its relationship to the recent crisis and recession W h a t fo llo w s is a b rie f sum m ary o f the conventional account (Later in the book, I w ill quote various authors and provide citations.)

A ccording to conventional w isdom , the rate o f p ro fit fell from the start o f the post-W o rld W ar II boom thro ug h the d o w nturns

o f the 1970s and early 1980s But by that tim e, economic policy had become “ neo lib eral” (free-m arket), and this led to increased

e x p lo ita tio n o f w orkers Consequently, U.S w orkers are not being paid more, in real (inflation-adjusted) terms, than they were paid decades ago, and th e ir share o f income has fallen The increase

in e x p lo ita tio n led to a significant rebound in the rate o f p ro fit

N o rm a lly , this w o u ld have caused the rate o f accum ulation to rise

as w ell, but this tim e it did not

The conventional account blames the “ fin a n c ia liz a tio n ” o f the economy fo r the failure o f the rate o f accum ulation to rebound It holds that financialization, another component o f neoliberalism, has induced companies to invest a larger share o f their profits in financial instrum ents, and a smaller share in the p ro ductive capital assets (factories, m achinery, and so on) th a t make the “ real” economy grow As a result, economic g ro w th has been weaker d u rin g the last several decades than it was in the first few decades that follow ed

W o rld W ar II, and this factor, along w ith a d d itio n a l b o rro w in g that enabled w o rk in g people to m aintain th eir standard o f liv in g despite the d ro p in th e ir share o f income, has led to long-term debt problem s These debt problem s, and o ther phenomena that also stem fro m financialization, are said to be the underlying causes o f the latest econom ic crisis and slump

This was not an interpretation o f recent economic history that

I found p a rtic u la rly appealing, and I knew that proponents o f the

conventional w isdom mis-measure the rate o f p ro fit But I had no

reason to believe th at their measures were overstating the rise in

p ro fita b ility instead o f understating it N o r d id I d ou bt that their other em pirical claims were based on fact Yet in the course o f my research, I found that:

• U.S co rp oratio ns’ rate o f p ro fit d id not recover in a sustained manner after the early 1980s T h e ir before-tax rate o f p ro fit has been trendless since the early 1980s and a rate o f p ro fit based on a broader concept o f p ro fit, more akin to w hat M a rx meant by “ surplus-value,” continued to decline

• N e o lib e ra lis m and fin a n c ia liz a tio n have n o t caused U.S

c o rp o ra tio n s to invest a s m aller share o f th e ir p r o f it in pro du ction Between 1981 and 2001, they devoted a larger share o f th eir p ro fit to productive investment than they did between 1947 and 1980 (and the post-2001 d ro p in this share

is a statistical fluke) W h a t accounts fo r the decline in the rate

o f accum ulation is instead the decline in the rate o f p ro fit

• U.S w orkers are not being paid less in real terms than they were paid decades ago T h e ir real pay has risen A n d th eir share o f the n a tio n ’s income has not fallen It is higher n ow than it was in 1960, and it has been stable since 1970.These findings do no damage to the claim th at a long-term b uildu p

o f debt is an underlying cause o f the recent crisis and subsequent problems However, all o f the other causal claims in the conventional leftist account fall to the ground

The c o n v e n tio n a l w is d o m im p lie s th a t the latest econ om ic

crisis was an irred u c ib ly financial one O f course, a financial crisis

triggered the recession, and phenomena specific to the financial sector (excessive leverage, ris k y m ortgage len din g, and so on) were among its im p o rta n t causes But w hat I mean by “ irreducibly fin a n c ia l” is th a t conventional w isd o m on the left holds th a t the recent crisis and slump are u ltim ately rooted in the financialization

o f capitalism and macroeconom ic difficulties resulting from finan­

cialization The persistent fra ilty o f capitalist pro du ction supposedly

has n oth ing to do w ith these m acroeconom ic difficulties Indeed,

on this view, the capitalist system o f p ro d u ctio n has not been frail

at all, since the rate o f p ro fit, the key measure o f its perform ance, recovered substantially after the early 1980s

The p o litic a l im plications o f this controversy are profou nd I f the long-term causes o f the crisis and recession are irreducibly financial,

we can prevent the recurrence o f such crises by doing away w ith neoliberalism and “ financialized capitalism ” It is unnecessary to do away w ith the capitalist system o f p ro d u c tio n — th at is, pro du ction driven by the aim o f ceaselessly expanding “ value,” o r abstract wealth Thus, w ha t the crisis has put on the agenda is the need for policies such as financial regulation, activist (“ Keynesian” ) fiscal and monetary policies, and perhaps financial-sector nationalization, rather than a change in the character o f the socioeconomic system.2

If, on the o ther hand, a persistent fall in the rate o f p ro fit is an

im p o rta n t (albeit indirect) cause o f the crisis and recession, as this book argues, then these policy proposals are not solutions A t best, they w ill delay the next crisis A n d a rtificia l governm ent stim ulus that produces unsustainable g ro w th threatens to make the next crisis worse when it comes The economy w ill remain sluggish unless and

u n til p ro fita b ility is restored, o r the character o f the socioeconomic system changes

H O W T H IS BOOK DIFFERS

Q uite a few books have put fo rw a rd different leftist perspectives on the recent crisis and recession M a n y o f them focus, as have most other books on these topics, on the proxim ate causes o f these events

T his book differs fro m them , as I noted above, in th a t it focuses

on the long-term , underlying conditions that enabled the financial crisis to trigger an especially deep and long recession, and one w ith persistent after-effects

Yet a fa ir num ber o f other books from the left also focus on the

u n d e rly in g causes Some o f them — such as Foster and M a g d o ff (2009), H arvey (2010), D um én il and Lévy (2011), and M c N a lly(2011)— put fo rw ard some version o f the conventional leftist account discussed above And some, like the w orks by F oster-M agdoff and Harvey, also stress the supposed facts that w o rk e rs ’ share o f to ta l income declined and th a t this led to a lack o f demand th at was covered over by rising debt From such a perspective, the crisis appears not to be a crisis o f capitalism , but a crisis o f a specifically

neoliberal and financialized fo rm o f capitalism I do not th in k the

facts are consonant w ith these views, and I trust that disinterested readers w ill find, at m in im u m , th at this b o o k ’s em pirical analyses call such views in to question

On the other hand, some other books from the left have appeared that regard the crisis as a crisis o f capitalism , and that take issue

w ith the conventional account o r parts o f it— inclu d in g H arm an

(2009), Roberts (2009), Carchedi (2011), and M a ttic k (2011) To these can be added articles such as Desai and Freeman (2011),

O nishi (2011), and Potts (2011) I do not agree w ith a ll o f these

w orks in all respects, b u t I am p ro ud th a t this book can n o w be counted among them

Except fo r the b ook by D um e n il and Levy, this b oo k contains the m ost in -d e p th and com prehensive data analyses o f any o f the w o rk s I have cited above, as w ell as most other books on the topic A nd among the w o rk s that take issue w ith the conventional leftist account, its treatm ent o f the underlying causes o f the Great Recession is arguably the most comprehensive

To some degree, this b o o k ’s differences w ith the conventional account reflect methodological and theoretical differences Like most

o f its other critics cited above, I am a p ro ponent o f the tem poral single-system in terpretatio n (TSSI) o f M a r x ’s value theory It has long been alleged that the value theory and the most im p o rta n t law based upon it— the la w o f the tendential fall in the rate o f p ro fit (LTFRP), the core o f M a r x ’s theory o f capitalist economic crisis— are interna lly inconsistent and m ust therefore be corrected o r rejected However, TSSI research has demonstrated that the inconsistencies are n o t present in the o rig in a l texts; they result fro m p a rtic u la r interpretations W hen M a r x is interpreted as the TSSI interprets him , the inconsistencies disappear (see, fo r example, K lim a n 2007)

As Chapter 6 w ill discuss in more detail, the TSSI’s a bility to reclaim

M a r x ’s C apital fro m the m yth o f inconsistency impinges upon the

controversy over the underlying causes o f the Great Recession in the

fo llo w in g way In their supposed proofs that the LTFRP is internally

inconsistent, his critics replace the te m p ora lly determ ined rate o f

p ro fit to w hich his theory refers w ith an atem poral “ rate o f p r o fit” (the current-cost o r replacement-cost rate), and they then fin d that

M a r x ’s la w does n o t survive this process o f su b s titu tio n Those

w h o have accepted these proofs have also accepted the manner in

w hich the proofs mis-measure the rate o f p ro fit Thus, when they found that the atem poral “ rate o f p r o fit” trended upw ard after the early 1980s, they to o k this as conclusive evidence th at ca pita list

p ro du ction has been sound, and that the true underlying causes o f the Great Recession are therefore neoliberalism , fin an cia liza tion , and heightened e x p lo ita tio n Analysis o f actual rates o f p ro fit leads

to quite d ifferent conclusions

However, I do n ot w a n t to overstate the role o f m ethodological and theoretical differences P rior to analyzing the data, I had no

p rio r belief that actual rates o f p ro fit had failed to rebound since the

t-arly 1980s, and I even w ro te th at “ p ro fita b ility has been propped

up by means o f a decline in real wages fo r most [U.S.J w o rk e rs ” (k lim a n 2009: 51), w hich I believed to be an unam biguous fact

M eth od olo gy and theory greatly influence the kinds o f questions one asks and the data one regards as significant, but they have no influence over the data themselves

In other words, this book is an empirical analysis, not a theoretical

w o rk Even my claim that the atem poral “ rate o f p ro fit” is not a rate o f p ro fit in any norm al sense o f the term is an em pirical claim

If it, and this b o o k ’s other claims and findings, are “ true fo r ” those

w ho find its conclusions appealing, they are no less “ true fo r ” those

w ho do not N o t everything is a m atter o f perspective I f I can now say that a persistent decline in U.S co rp o ra tio n s ’ p ro fita b ility is a significant underlying cause o f the Great Recession, and that M a r x ’s

e xplanation o f w h y the rate o f p ro fit tends to decline fits the facts rem arkably w ell, it is because 1 have crunched and analyzed the numbers I could not have said these things a few years ago.The re la tio n s h ip between Brenner’s (1998) analysis and mine

is com plex We both conclude that ca pita lism ’s recovery fro m the slumps o f the 1970s and early 1980s was far fro m robust, though

I find his expression “ long d o w n tu rn ” misleading and instead refer

to “ relative stagnation.” A nd we both conclude that p ro fita b ility problems were a source o f the malaise However, Brenner arrived

at this conclusion p artly by analyzing movements in the atem poral current-cost “ rate o f p ro fit,” w hile I do not Since proponents o f

the conventional leftist account looked at the very same rate, and

pointed to its upw ard trend as crucial evidence that neoliberalism had put capitalism back on an expansionary path, Brenner in effect argued th at the glass was half-em pty in order to counter the claim

th at it was h a lf-fu ll (I argue th a t it is n o t a glass in any n orm al sense o f the term.)

O n a th e o re tica l plane, Brenner roots fa llin g p r o fita b ility in technical change, but in o th e r respects his fa llin g -ra te -o f-p ro fit

th eo ry has little in co m m on w ith M a r x ’s Indeed, he embraces the supposed p ro o fs th a t M a r x was w ro n g to co nclud e th a t cost-reducing technical change can cause the rate o f p ro fit to fall (see Brenner 1998: 1 1 -1 2 , n l and K lim a n 2007: 6 -7 , 8 2 -3 , 113)

To e xplain fa llin g p ro fita b ility , Brenner (1998: 2 4 -5 ) appeals to

a d d itio n a l factors: “ reduced prices in the face o f d o w n w a rd ly

inflexible costs,” insufficient demand, and o v erprod uctio n due to

im perfect in fo rm a tio n He argues th a t the c o m b in a tio n o f these

factors and cost-reducing technical change can cause the rate o f

p ro fit to fall

The reason w h y Brenner appeals to infle xible costs is th a t his theory is atem poral, and it is therefore unable to explain h ow cost­and price-reducing technical change can cause the rate o f p ro fit to fall when costs are flexible (In an atem poral theory, i f costs fall

by the same percentage th at prices fa ll, the rate o f p ro fit remains unchanged.) But M a r x ’s LTFRP has no need fo r this hypothesis, o r

fo r Brenner’s other a dd itio na l factors Even when costs are flexible,

costs incurred in the past do not fall when prices fall today Because

it recognizes this te m p o ra l d is tin c tio n , M a r x ’s la w can e xplain

h ow technical change itself— in the absence o f special a d d itio n a l factors— can cause the rate o f p ro fit to fa ll.3

Let me fin a lly note a nother difference between this b o o k and some others on the topic: it discusses and quotes others’ arguments

at some length, especially those w ith w hich it takes issue It does

so p a rtly because the dialectical intellectual tra d itio n to w h ic h I belong strongly emphasizes debate and critique, h oldin g th a t these are the p rin c ip a l means by w h ic h know ledge develops I regard the re fu ta tio n o f in c o rre c t claim s and argum ents as one o f this

b o o k ’s p rim a ry tasks I am not try in g to tell a story a bout w h a t has gone w ro ng , fo r readers to accept i f they fin d it appealing or

reject if they do not I am try in g to separate w h a t has gone w ro ng

fr o m w h a t has not I also discuss and quote o th e rs ’ argum ents

at some length because I consider it intellectually irresponsible to ignore contrasting views o r characterize them w ith o u t supplying the evidence and arguments needed to support the characteriza­tions— comm on practices to w hich my w o rk is frequently subjected.One a uth or I quote frequently is M a rx I do not do so in order to support m y arguments, but in order to help establish w h a t his ideas actually were, to help explicate these ideas, to avoid plagiarism, and,

in a few cases, to express something th at I cannot express equally well in my o w n words

SYNOPSIS OF SUBSEQUENT CHAPTERS

The next chapter sets o u t the theoretical fra m e w o rk that underlies the em pirical analyses th a t fo llo w It discusses key components o f

M a r x ’s theory o f crisis— the tendential fall in the rate o f p ro fit, the operation o f cred it m arkets, and the destruction o f capital value through crises— and h o w they can help account fo r the latest crisis and Great Recession

C ha pter 3 co nta ins a b rie f discussion o f the fo rm a tio n and bursting o f the hom e-price bubble in the U.S., and the Panic o f

2008 th at resulted I then discuss h ow Federal Reserve (Fed) policy

co n trib u te d to the fo rm a tio n o f the bubble I argue that the Fed wanted to prevent the United States fro m going the w ay o f Japan After Japan’s real-estate and stock-m arket bubbles burst at the start

o f the 1990s, it suffered a “ lost decade,” and the Fed wanted to make sure th a t the b ursting o f the U.S s to ck-m a rke t bubble o f the 1990s did not have sim ilar consequences The latest crisis was

therefore not caused o nly by problem s in the financial and housing

sectors As far back as 2001, underlying weaknesses had brought the U.S economy to the p o in t where a stock-m arket crash could have led to long-term stagnation

C hapter 4 examines a variety o f global and U.S economic data and argues that they indicate that the economy never fu lly recovered from the recession o f the 1970s Because the slow dow n in economic

g ro w th , sluggishness in the lab or m arket, increase in b o rro w in g relative to incom e, and o th e r p roblem s began in the 1970s o r earlier, p rio r to the rise o f neoliberalism, they are not a ttributable

it adjusts fo r in fla tio n , I argue th at it mis-measures the effect o f

in fla tio n and th at this mis-measurement is the predom inant reason

w hy it rose

C ha pter 7 loo ks at w h y the rate o f p ro fit fe ll It shows th a t changes in the d is trib u tio n o f corp oratio ns’ o u tp u t between labor and non-labor income were minor, and it decomposes movements in

the rate o f p ro fit in the standard manner o f the M arxian-econom ics literature 1 then show that an alternative decom position analysis reveals th a t the rate o f p ro fit fe ll m a in ly because e m p lo ym en t increased too slo w ly in relationship to the accum ulation o f capital

T his result implies th at M a r x ’s fa llin g -ra te -o f-p ro fit theory fits the facts rem arkab ly w ell The chapter concludes w ith a discussion

o f d e p re cia tion due to obsolescence ( “ m o ra l d e p re c ia tio n ” ) I show th at the in form a tion -tech no log y revo lu tion has caused such depreciation to increase substantially and th at this has significantly affected the measured rate o f p ro fit The rates o f p ro fit discussed in Chapter 5 and p rio r sections o f Chapter 7 w o u ld have fallen even

m ore if I had employed M a r x ’s concept o f depreciation instead o f the U.S governm ent’s concept

C ha pter 8 exam ines u n d e rc o n s u m p tio n is t theory, w h ic h has become increasingly p op u la r since the recent crisis T his chapter shows that, contrary to w hat underconsum ptionist authors contend, U.S w o rk e rs are p a id m ore now , in in fla tio n -a d ju s te d term s, than they were paid a few decades ago, and th e ir share o f the

n a tio n ’s income has n o t fallen The rest o f this chapter criticizes the underconsum ptionist theory o f crisis In particular, I argue that the underconsum ptionist theory presented in Baran and Sweezy’s

influential M o n o p o ly C ap ital rests on an elemental logical error.

C hapter 9, w h ic h concludes the b oo k, discusses w h a t is to be undone I argue th a t the U.S governm ent’s response to the crisis constitutes a new m anifestation o f state-capitalism , and I c ritic a lly exam ine p o lic y proposals based on the b elief th a t greater state reg ulatio n, c o n tro l, o r o w nership can put capitalism on a stable path I then discuss the p o litic a l im p lic a tio n s o f underconsum p- tionism and critiq u e its view th at re d is trib u tio n o f income w o u ld stabilize c a p ita lis m F ina lly, I take up the d if fic u lt question o f whether a socialist alternative to capitalism is possible A lth o u g h I

do not believe I have “ the answer,” I address the question because

I believe th at the collapse o f the U.S.S.R and the latest crisis have made the search fo r an answer o u r most im p o rta n t task

Profitability, the Credit System,

and the "Destruction of Capital"

2

T his chapter sets o u t the theoretical fra m e w o rk th a t guided the

em pirical analyses o f later chapters It briefly outlines the lynchpins

o f M a r x ’s theory o f capitalist economic crisis— the tendential fall

in the rate o f p ro fit (LTFRP); the operation o f credit markets, and the destruction o f capital value through crises— and discusses their

a p p lic a b ility to the latest crisis and the Great Recession

The first section discusses M a r x ’s LTFRP and h ow it can help account fo r econom ic crises and slumps— even if the rate o f p ro fit rises in the period im m ediately preceding the crisis, as it did in the

m id-2000s I argue th a t M a r x ’s theory regards a fa ll in the rate

o f p ro fit as an in d ire c t cause o f crises, it leads to crises o n ly in

co njun ction w ith financial m arket in sta b ility and in sta b ility caused

by lo w (as distinct fro m falling) p ro fita b ility

The second section examines w ha t M a rx and others have called the “ destruction o f c a p ita l” — losses due to p lum m eting values o f financial and physical capital assets as well as destruction o f the physical assets themselves— that occurs d u rin g crises and slumps Later in this b oo k, I w ill argue th at the economy failed to recover

fu lly from the slumps o f the 1970s and early 1980s, and th at the incomplete recovery problem and policym akers’ response to it set the stage fo r the latest crisis In this chapter, I o ffe r an explanation

o f w hy the recovery was incomplete: the a m ount o f capital value destroyed durin g the m id -1970s and early 1980s was not enough to restore the rate o f p ro fit and thereby a llo w productive investment

to proceed at a healthy pace M y discussion o f the destructio n

o f capital w ill also help c la rify w hy the LTFRP predicts recurrent crises, not a long-term decline in the rate o f p ro fit th ro u g h o u t the history o f capitalism

THE FALLING RATE OF PROFIT AS AN INDIRECT CAUSE OF CRISES

As C hapter 5 w ill show, some measures o f U.S co rp o ra tio n s ’ rate

o f p ro fit ind icate th a t it was basically trendless between 1982

13

and 2007, and p ro fita b ility rose sharply in the years im m ediately preceding the latest crisis I t may therefore be th o u g h t th at a fa llin g rate o f p ro fit cannot have been a cause o f the latest crisis and slump

It certainly was n ot a p ro x im a te cause, but I shall argue th a t it was

a key indirect cause The rate o f p ro fit was lo w at the start o f the

1980s and it never recovered in a sustained fashion This led to a

m arked decline in the rates o f capital accum ulation and economic

g ro w th 1 G overnm ent policies kept this problem fro m getting out

o f hand, b u t also pro lo ng ed and exacerbated it T he Treasury borrow ed more and more in order to pro p up after-tax profits and paper over the econom y’s sluggishness Interest rate reductions, governm ent loan guarantees, the e lim in a tio n o f the capital gains tax on m ost sales o f homes, and other measures fueled a massive

b uild-up o f mortgage debt A nd the governm ent repeatedly bailed

o u t domestic and foreign creditors

Such policies succeeded in p ro pp in g up demand, keeping it from

fa llin g back to levels consistent w ith the p ro d u c tio n o f new value and the rate o f p ro fit But in between, there were increasingly severe debt crises and b urst bubbles— the T h ir d W o rld debt crisis, the stock-m arket crash o f 1987, the U.S savings and loan crisis, the East Asian crisis, the burst dot-com bubble, and finally, the biggest debt crisis and burst bubble since the Great Depression The more sophisticated and widespread credit markets are, the greater is the degree to w hich such “ forced expansion” (M a rx 1991a: 621) can take place— but also the greater the degree o f ultim ate co ntractio n when the law o f value eventually makes its presence felt It is like

a rubber band stretching and snapping back

MARX'S LAW OF THE TENDENTIAL FALL IN THE RATE OF PROFIT

M a rx held th at as capitalist p ro du ction develops, capitalists tend to adopt more productive, labor-saving techniques; th at is, they tu rn increasingly to methods o f p ro d u c tio n that replace w orkers w ith machines O n the basis o f this tendency and his theory that value is

de termined by labor-time, he deduced the LTFRP (M a rx 1991a, part 3) The law is that p ro d u c tiv ity increases under capitalism produce

a tendency fo r the general rate o f p ro fit to fall: “ The progressive

tendency fo r the rate o f p ro fit to fall is thus sim ply the expression,

peculiar to the capitalist mode o f p ro d u c tio n , o f the progressive

developm ent o f the social p ro d u c tiv ity o f la b o u r” (M a rx 1991a:

\ I S>, emphasis in origin al).

W h y do p ro d u c tiv ity increases re s u ltin g fro m la b o r-s a v in g

technical change tend to lo w e r the rate o f profit? This idea seems

preposterous to many people For instance, Brenner (1 9 9 8 :1 1 -1 2 ,

n l ) argues that the LTFRP “ flies in the face o f com m on sense” and that its falsity is “ in tu itiv e ly o bviou s.” So what? A lm ost all modern physics also flies in the face o f com m on sense, but its conclusions are not less correct on th at account.2

The LTFRP “ flies in the face o f com m on sense” because it seems intuitively obvious to many people that a more productive capitalism

is a more p rofitable capitalism This in tu itio n is reinforced by the fact th at technologically advanced companies are more profitable than backw ard ones— an in d iv id u a l com pany does raise its rate o f

p ro fit by adopting techniques o f production that are more advanced than those o f its com petitors However, to assume that this implies that the econom y-wide rate o f p ro fit w ill also rise when p ro du ctivity rises th ro u g h o u t the w hole economy is a logical error, the fallacy

o f com position Here are a couple o f analogous cases: if you are

in a stadium and you stand up, you can see better; but i f everyone stands up at once, you w ill not all see better I f you get a master’s degree, you w ill get a better jo b and make m ore money; but i f everyone has a master’s degree, you w ill n o t all get better jobs and make more money

So let us set in tu itio n s aside and exam ine the actual logic o f the situation When labor-saving technical changes are introduced,

m ore o f each d o lla r o f advanced ca pita l is invested in means o f

p ro d u c tio n , w h ile less is used to hire w orkers But according to

M a r x ’s theory that value is determined by labor-tim e, it is w o rk e rs ’ liv in g labor that adds all new value M oreover, an average hour o f

labor “ always yields the same a m o un t o f value, independently o f

any variations in p ro d u c tiv ity ” (M a rx 1990a: 137, emphasis added)

Technical inn ova tion therefore causes a fall in the am ount o f new value created per d o lla r o f advanced capital And if surplus-value (profit) is a constant share o f new value, the am ount o f surplus-value created per d o lla r o f advanced ca pita l— in other w ords, the rate o f

p ro fit— necessarily falls as w ell

O f course, capitalist businesses do not k n o w about o r care about value o r surplus-value as measured in terms o f labor-tim e They

k n o w about and care about money prices and money profits So it may help to restate M a r x ’s law in terms o f price and p ro fit When

p ro d u c tiv ity increases, more physical things and physical effects (services) are produced per labor-hour A ccording to M a r x ’s theory, however, the increase in p ro du ctivity does not cause more new value

to be created The same a m o un t o f value is “ spread o u t” among

m ore items, so the increase in p ro d u c tiv ity causes the values o f

in d iv id u a l items to decline In o ther w ords, things can be produced

more cheaply A n d because they can be produced more cheaply, their

prices tend to fa ll? In a com petitive environm ent, companies must

low er the prices they charge when their costs o f p ro d u ctio n decline

I f they fail to do so, they risk a significant loss o f m arket share or even ban kru ptcy when com petitors cut th eir prices in response to reduced p ro du ction costs.4 Yet even monopolies th at enjoy low er costs w ill generally tend to reduce their prices, because the reduction

in costs allow s the p ro fit on each item to increase even i f its price

is lower, and the reduction in price allow s them to sell more items.The tendency fo r prices to fall as a result o f technical inn ova tion

is recognized even by n o n -M a rx is ts like A lan Greenspan (2000):[F]aster p ro d u c tiv ity g ro w th keeps a lid on u n it costs and prices Firms hesitate to raise prices fo r fear that th eir com petitors w ill

be able, w ith low er costs fro m new investments, to wrest m arket share fro m them

Indeed, the increased a v a ila b ility o f labor-displacing equipm ent and softw are, at declining prices and im p ro v in g delivery times,

is arguably at the ro o t o f the loss o f business p ricing pow er in recent years

But the “ loss o f business p ricing p o w e r” due to “ labor-displacing equipm ent and softw are” is the c ru x o f the LTFRP; M a r x presented the law n o t o n ly in term o f value and surplus-value, but also in terms o f price and p ro fit (see esp M a r x 1991a: 3 3 2 -8 ) Assume

th at the rate o f surplus-value (rate o f e x p lo ita tio n ) is constant, and

th a t physical o u tp u t and physical capital g ro w at the same rate These are fa irly reasonable assumptions U nder these conditions, technical in n o v a tio n w ill n o t produce a tendency fo r the rate o f

p ro fit to fall i f it does n o t also tend to depress prices; but if it does tend to depress prices, the rate o f p ro fit w ill indeed tend to fa ll.5

As I stressed above, M a rx regarded a fall in the rate o f p ro fit as an

indirect cause o f crises To be legitimate, an explanation in terms o f

indirect causes m ust give an account o f h ow they operate, through intermediate links, to produce the phenomenon in question In the rem ainder o f this section, I focus on tw o interm ediate links— lo w

p ro fita b ility and the credit system— that connect the fall in the rate

o f p ro fit durin g the post-W orld W ar II period to the latest economic crisis and slump.

LOW PROFITABILITY

A fall in the rate o f p ro fit can have persistent effects Even if the rate

o f p ro fit does not continue to fall up to the m om ent o f economic crisis, a p rio r fall can set the stage fo r such a crisis by producing

a lo w average rate o f p ro fit This is so even i f the rate o f p ro fit is

constant o r rising in the period im m ediately preceding the crisis

As Farjoun and M achover (1983: 163 -6 ) pointed out, relatively few businesses w ill encounter serious trouble when the average rate

o f p ro fit is relatively high Even businesses whose rates o f p ro fit are well below average w ill be able to survive However, i f a fall

in the rate o f p ro fit has led to an average rate o f p ro fit th a t is relatively low, many more o f the lo w -p ro fita b ility businesses w ill find themselves in serious trouble, because their rates o f p ro fit are now less than the m in im u m needed in order to survive T his is just

as much the case when the average rate o f p ro fit has stabilized as when it continues to decline

If relatively few businesses’ rates o f p ro fit are far below average,

w hile a greater percentage are only somewhat below average, then the percentage o f unviable businesses increases at a rising rate as the average rate o f p ro fit declines Assume, fo r instance, th at rates

o f p ro fit are n o rm a lly distributed (as in a bell curve), that 6 percent

is the m in im u m rate o f p ro fit a firm needs in o rd e r to survive, and that the average rate o f p ro fit falls by three percentage points

As Table 2.1 and Figure 2.1 show, this fall results in many more business failures when the average rate is in itia lly lo w (15 percent) than when it is in itia lly high (30 percent) I f the relative dispersion

o f rates o f p ro fit is the same in the tw o cases, as the table and figure assume, then only 0.5 percent more businesses fail when the average rate falls fro m 30 percent to 27 percent But 4.4 percent more businesses— eight-and-a-half times as m any— fail when the average rate o f p ro fit falls fro m 15 percent to 12 percent

Table 2.1 Non-Linear Effect o f Falling Profitability on Business Failures

Average (mean) rate of profit 30.0% 27 0 % 15.0% 12.0%

Relative dispersion (coefficient of variation) 0.5 0.5 0.5 0.5Unviable businesses (rates of profit < 6% ) 5.5% 6 0% 11.5% 15.9%

rate of profit

Figure 2.1 Distributions of Rates of Profit

Thus, s h o rt-te rm decline in p ro fita b ility o f s im ila r a m p litu d e have m uch more serious and widespread consequences when the average rate o f p ro fit is lo w than when it is high L o w p ro fita b ility

as such makes the economy less stable, m ore prone to crises and serious slumps A fall in the average rate o f p ro fit w ill therefore have destabilizing effects that persist even i f it stopped falling a long time ago

M o re o v e r, m any phenomena th a t are sometimes regarded as

effects o f a decline in the rate o f p ro fit are a c tu a lly effects o f a

lo w rate F or instance, when the rate o f p ro fit falls, the rate o f

a ccum ulatio n o f ca pita l (p rod uctive investm ent) tends to fall as

w ell But this implies th at i f the rate o f p ro fit is lo w and fails to rebound, the rate o f accum ulation w ill also tend to be lo w and fail

to rebound (In Chapter 5 , 1 w ill show that the rate o f accum ulation

o f U.S c o rp oratio ns has tracked their rate o f p ro fit very closely.)

A lo w rate o f capital a ccum ulation w ill in tu rn tend to result in

lo w g ro w th rates o f em ploym ent, o u tp u t, income, and demand fo r consumer goods and services A nd when g ro w th o f income (profits, wages, tax income, and so on) is sluggish, it is m ore d iffic u lt fo r businesses, households, and governments to pay back their debts

T h is sets the stage fo r debt and fin an cia l crises d o w n the road

Another factor th at can co n trib u te to the problem is lo w interest rates When the rate o f capital accum ulation is low, interest rates

w ill tend to be lo w as w ell (all else being equal, the less businesses wish to b o rro w in order to fund productive investment, the more lenders have to reduce the interest rates they charge in o rd er to induce them to b o rro w ) But lo w interest rates make b o rro w in g more attractive and cause bond, stock, and real-estate prices to rise,

w hich encourages speculation in these asset m arkets and makes them more vulnerable to crisis.6

THE CREDIT SYSTEM

A n o th e r key interm ediate lin k between fa llin g p ro fita b ility and economic crisis is finance The credit m arket plays a crucial role in

M a r x ’s crisis theory, especially in C hapter 15 o f C apital, Volume

3, w hich sketches o u t the relationship between the fa llin g tendency

o f the rate o f p ro fit and economic crisis M a rx argues:

If the credit system appears as the principal lever o f overproduction and excessive speculation in commerce, this is sim ply because the reproduction process, w hich is elastic by nature, is now forced [once the credit system has developed] to its extreme lim its; and this is because a great part o f the social capital is applied by those

w h o are not its owners, and w ho therefore proceed quite unlike owners w ho, when they function themselves, anxiously weigh the lim its o f their private capital (M a rx 1991 a: 572)

A lo t o f ideas are packed in to this sentence The first h a lf suggests

th a t the c re d it system fa cilita te s the fo rm a tio n o f bubbles and thereby accentuates both booms and busts It allows the economy to

g ro w more rap id ly fo r some time than is w arranted by fundamental econom ic co n d itio n s such as p ro fita b ility and the p ro d u c tio n o f new value But fo r this very reason, the eventual co ntraction is also more severe than it w o u ld otherwise be M a r x ’s use o f the w o rd

“ elastic” is apt

The second h a lf o f the sentence deals w ith w ha t is n ow called

m o ra l hazard— th at is, failure to “ anxiously w eig h ” whether your

investment behavior is to o risky, because you are not the one w ho

w ill suffer the losses th at result from excessive risk-taking M o ra l hazard is frequently cited as a key factor th a t co n trib u te d to the latest crisis Financial institutio ns th at originated mortgage loans did not anxiously weigh the risks involved because they sold o ff the

loans Those w h o bought the loans in the fo rm o f mortgage-related securities bore the risks O r they to o failed to a n x io u s ly w eigh the risks because the risks were borne by those w h o insured these securities And those w ho lent to large financial institutio ns failed

to anxiously weigh the risks because they suspected, correctly, that the governm ent w o u ld regard the institutio ns as “ too big to fa il” and bail them o u t.7

I dou bt th at any o f this w o u ld have surprised M a rx Indeed, he

argues that moral hazard is the problem that makes the credit system

“ the princip al lever o f overprod uctio n and excessive speculation.”

H e also suggests th a t m o ra l hazard is n o t a defect created by any p a rtic u la r fin a n cia l system b u t an ine vitab le b y -p ro d u c t o f credit as such, since debtors ine vita b ly take risks w ith cre d ito rs’ funds, even when they do business directly, instead o f through the interm ediation o f financial institutions This suggests that regulation and the breaking up o f to o -b ig -to -fa il institutio ns w ill not do away

w ith m oral hazard

In any case, M a r x ’s focus on the credit system makes clear that his crisis theory is not one in w hich a fall in the rate o f p ro fit causes

a fall in the rate o f accum ulation, w hich then causes an economic crisis, in the m anner o f one b illia rd ball h ittin g a second one and the second one h ittin g a th ird He does argue th at “ the rate o f accum ulation falls together w ith the rate o f p r o fit” (M a rx 1991a: 349), but he does not hold that the fall in the rate o f accum ulation

is a direct cause o f an economic crisis This is largely because he

distinguishes between crisis (a rupture in the rep roduction process

o f capital) and stagnation (slumps, recessions, depressions) The

business cycle consists o f “ periods o f moderate activity, prosperity,

o v e r-p ro d u c tio n , crisis and s ta g n a tio n ,” o r “ periods o f average activity, p ro du ction at high pressure, crisis, and stagnation” (M a rx 1990a: 580, 785) A fall in the rate o f accum ulation can directly cause a fall in the rate o f g ro w th o f o u tp u t, b u t the fall in the rate

o f a c c u m u la tio n m ust be m ediated by o th e r factors in o rd e r to result in a crisis

M a rx argued that a decline in the rate o f p ro fit leads ind ire ctly

to a crisis by encouraging speculation and o v e rp ro d u c tio n A nd because the fa ll in the rate o f p ro fit leads to a crisis o nly indirectly,

it does n o t do so im m ediately:

in view o f the fact th at the rate at w h ic h the to ta l capital isvalorized, i.e the rate o f p ro fit, is the spur to capitalist production(in the same way as the valorization o f capital is its sole purpose),

a fall in this rate slows d ow n the fo rm a tio n o f new independent

ca pitals and thus appears as a th re a t to the developm ent o f the ca pitalist p ro d u c tio n process; it prom otes o v e rp ro d u c tio n , speculation and crises (M a rx 1991a: 3 4 9 -5 0 8)

I f the rate o f p r o f it falls we have s w in d lin g and general

p ro m o tio n o f sw in d lin g, th rough desperate attempts in the way

o f new methods o f p ro du ction , new capital investments and new adventures, to secure some k in d o f extra p ro fit, w hich w ill he independent o f the general average [p ro fit determ ined by the average rate o f p ro fit] and superior to it (Ibid.: 3679)

It is o nly when debts fin ally cannot be repaid th at a crisis erupts, and the crisis then leads to stagnation:

The m a jo r ity o f these b ills |o f exchange] represent actual purchases and sales,10 the ultim ate basis o f the entire crisis being the expansion o f these far beyond the social need O n top o f this, however, a trem endous num ber o f these b ills represent purely fraudulent deals, w hich n o w come to lig h t and explode; as well

as unsuccessful speculations conducted w ith b orro w ed capital; and fin ally c o m m o d ity capitals [th a t is, businesses’ inventories

o f finished productsj th at are either devalued or unsaleable, or returns th at are never going to come in (Ibid.: 621)

The chain o f paym ent o b lig a tio n s at specific dates is broken

in a hundred places, and this is s till fu rth e r intensified by an

a c c o m p a n y in g b re a k d o w n o f the c re d it system, w h ic h had developed alongside capital A ll this therefore leads to violent and acute crises, sudden fo rcib le devaluations, an actual stagnation and disruption in the reproduction process, and hence to an actual decline in reproduction (Ibid.: 363)

This account has a very modern ring C apitalism has changed far less than many people— its critics as well as its supporters— w an t

to th in k

Several facts about the current crisis may at first glance seem to suggest th at it did not result from the fall in the rate o f p ro fit The crisis erupted w ell after much o r all o f the fall had occurred Its main im m ediate cause was the bursting o f an asset-price bubble And it was im m ediately preceded by speculative frenzy and a huge rise in asset prices that led to a sharp (but tem porary) increase in the rate o f p ro fit.11

As we have seen, however, M a r x ’s theory holds precisely that a fall in the rate o f p ro fit leads to crises only indirectly and in a delayed manner The fall leads first to increased speculation and the build-up

o f debt th at cannot be repaid, and these are the imm ediate causes

o f crises Thus, the tim in g o f the cu rren t crisis and the sequence

o f events leading to it do n ot c o n tra d ic t the theory, but are fu lly consonant w ith it and lend support to it N o th in g anomalous has occurred th at requires us to lo o k elsewhere fo r explanations

THE DESTRUCTION OF CAPITAL (VALUE)

The LTFR P im p lie s th a t there is an ever-present tendency in capitalism fo r labor-saving technical inn ova tion to low e r the rate

o f p ro fit Yet M a r x also argued th at this tendency is interru pted and counteracted fro m tim e to tim e by “ the destruction o f capital thro ug h crises” (M a rx 1989b: 127, emphasis om itted)

Part o f w h a t he was referring to is the destruction o f physical capital assets In an economic slump, physical capital is destroyed as machines and buildings lay idle, rust, and deteriorate A tremendous

a m o un t o f physical capital was also destroyed in W o rld W ar II But insofar as the theory o f crisis is concerned, w h a t matters is the

destruction o f capital in terms o f value— the decline in the value o f

physical capital assets as well as the decline in the (fictitious) value o f financial assets O f course, when physical assets are destroyed, their value is destroyed as w ell, but the predom inant factor that causes capital value to be destroyed is fa llin g prices As debts go unpaid, the prices o f financial assets such as mortgage loans and mortgage- backed securities fall Prices o f equities also ty p ic a lly fall d u rin g recessions and depressions, and prices o f produced com m odities— both physical capital assets and consumer goods and services— have frequently fallen as well

I’he decline in prices that to o k place during the Great Depression caused a massive a m o u n t o f ca pita l value to be destroyed As measured by the G D P price index, prices o f goods and services

m i lit* U.S fell by 25 percent between 1929 and 1933 The prices

ol ilie lixed assets owned by U.S corp oratio ns fell by 23 percent between the end o f 1928 and the end o f 1932 A ccording to Irv in g

I c.liei ( I 354, C hart V), the national w ealth o f the United States plummeted by 59 percent over the same period, m ostly because o f

I i II i mj' pines And the D o w Jones Industrial Average fell by more ili.in pen cm between September 1929 and July 1932

Yet the destruction o f capital is not only a consequence o f serious economic crises and the slumps they trigger It is also a m ain cause

o f the booms that fo llo w , because it is a crucial factor that helps to restore p ro fita b ility 12 Capitalists invest in equipment, hire w orkers, and produce only in order to make a p ro fit I f the expected rate o f

p ro fit isn’t high enough, there w o n ’t be sufficient investment and hiring , so there w o n ’t be a boom But by restoring p ro fita b ility , the destruction o f capital sets the stage fo r a new b o o m 13

Imagine, fo r instance, a business that can generate $3 m illio n in

p ro fit annually I f the value o f the capital invested in the business

is $100 m illio n , the owners’ rate o f p ro fit is a mere 3 percent Yet

if, as a result o f the destruction o f capital value, new owners can acquire the business fo r only $10 m illio n instead o f $100 m illio n ,

their rate o f p ro fit— the return they receive on their investment— is

a healthy 30 percent A trem endous incentive to invest, expand

p ro d u c tio n , and em ploy more w orkers has been created N otice

that this is the case even in the absence o f new markets o r rising

demand th at w o u ld lead investors to expect greater pro fit

Thus, the massive destruction o f capital value th at to o k place

d u rin g the Great Depression and W o rld W ar II set the stage fo r the boom that follow ed A t the start o f the Depression, it is alleged, the destruction o f ca pita l— w hich was called “ liq u id a tio n is m ” — was actually advocated by Andrew M ellon , President H oo ver’s Treasury Secretary In his memoirs, H oo ver (1952: 30) w rote:

M e llo n felt that governm ent must keep its hands o f f and let the slum p liq u id a te itself M r M e llo n had o n ly one fo rm u la :

“ Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” He held that even panic [in the financial system] was not altogether a bad thing He said: “ It w ill purge the rottenness

o u t o f the system enterprising people w ill pick up the wrecks from less competent people.”

Some conservative economists gave s im ila r advice A cco rding to

M ilto n Friedman (1999):

If you go back to the 1930s, w hich is a key p oint, here you had the A ustrians sittin g in L on do n, [F rie d rich] H ayek and Lionel

R obbins, and saying you just have to let the b o tto m d ro p o u t

o f the w o rld Y o u ’ ve just got to let it cure itself You can’t do

a nyth ing about it You w ill o n ly make it worse

However, it seems that the am ount o f capital value that needed to be destroyed in order to restore healthy rates o f capital accum ulation and economic g ro w th was substantially more than liq u id atio nists had expected Both H ayek and R obbins later expressed regret at having recommended that activist policies not be used to counteract the deflation o f the early 1930s (see W h ite 2010: 1 12 -1 3).

P o lic y m a k e rs in m o re rece nt tim es have u n d e rs ta n d a b ly been a fra id o f ano the r G reat D epression, and ano the r wave o f radicalization o f w o rk in g people like th at w hich the Depression o f the 1930s triggered T his legacy o f class struggle has helped shaped economic p olicy and perform ance d u rin g the last several decades

To prevent a repeat o f the 1930s, policym akers have successfully used debt financing and debt guarantees to retard and head o ff the destruction o f capital The d o w nturns o f the m id-1970s and early 1980s, and even the latest d o w n tu rn , were therefore noth ing like the Great Depression But since the destruction o f capital restores

p ro fita b ility and thereby lays the foun da tion fo r the n ext boom, we have also not experienced anything like the boom th at fo llo w ed the

G reat Depression and W o rld W ar II O n the contrary, the economy

never fu lly recovered fro m the slump o f the 1970s (I w ill document

this in detail in Chapter 4.)

Policymakers responded to the latest crisis and slum p by once again papering over bad debt w ith more debt, and by using debt

to s tim u la te the e conom y a r t if ic ia lly — this tim e on a massive, unprecedented scale In the first tw o years fo llo w in g the collapse o f Lehman Brothers in mid-September 2008, the to ta l debt o f the U.S Treasury increased by 40 percent, from $9.6 trillio n to $13.5 trillio n The a dd itio n a l b o rro w in g amounts to alm ost $12,500 per person

A ccording to projections fro m the Obam a a d m in is tra tio n — w hich are far more o ptim istic than those contained in a 2010 International

M o n e ta ry Fund w o r k in g paper (Celasun and K e im 2 0 1 0 )— the Treasury’s debt w ill rise to $19.8 t r illio n by the end o f fiscal year

2015, w hich means that it w ill have more than doubled in just seven years The $10.1 t r illio n increase in the debt is equal to 9.0 percent

of projected G DP th ro u g h o u t the 7-year period (and, to repeat, the

a d m in is tra tio n ’s G DP projections are very o ptim istic)

II these measures succeed in e xtrica tin g the economy fro m the

r I In i s o l the Great Recession and the prospect o f deflation, full-scale tlr-.tnu lio n of capital w ill once again have been averted But fo r the

li mi iblc h itu re , the U.S w ill c o n fro n t a debt burden th at w ill be ilillu till in manage, at best, and p ro ba bly slower econom ic g ro w th i mu n i i.m s use in response to the g ro w in g debt M oreover,

the huge increase in indebtedness suggests that the next debt crisis could be much worse than the latest one I f th a t proves to be the case, the next wave o f panic to strike the financial markets w ill be even more severe and have more serious consequences.

DESTRUCTION OF CAPITAL VALUE A N D THE LTFRP

The d e s tru c tio n o f c a p ita l value th ro u g h crises is a re c u rre n t phenomenon The restoration o f p ro fita b ility th at this destruction brings about is therefore a recurrent phenomenon as w ell Because

o f this, the rate o f p ro fit does not have a determinate secular trend

th ro u g h o u t the entire history o f capitalism , and efforts to deduce

o r predict such a trend are futile

For instance, arg um en ts th a t the rate o f p r o f it m ust tre n d

d o w n w a rd in the lon g run , because technical progress leads to

fa lling p ro fit, overlo ok the fact that p ro fit is only one determ inant

o f the rate o f profit An equally im p orta nt determinant o f the rate o f

p ro fit is the capital value that is advanced, the magnitude o f w hich depends largely upon h o w much capital value has been destroyed

th ro u g h crisis I f capital value has been destroyed on a massive

scale, the peak rate o f p ro fit in the boom that fo llo w s is like ly to be

higher than the p rio r peak And if m ajor slumps become increasingly

frequent, the tendency fo r the rate o f p ro fit to fall between slumps has less and less tim e in w hich to operate, so it is like ly that trough

rates o f p ro fit rise over time.

The LTFRP therefore does not and cannot predict th at the rate

o f p ro fit w ill actually display a falling trend th ro u g h o u t the history

o f capitalism And despite a com m on belief to the contrary, there seems to be no evidence th a t M a rx predicted such a secular fall

O n the contrary, he held th a t “ |c]ounteracting influences (are] at

w o rk , checking and cancelling the effect o f the general law ,” and

that the LTFRP “ has constantly to be overcome by way o f crises”(M a rx 1 9 9 la : 339, 367, emphasis added) Thus w ha t M a rx meant

by the “ tendency” o f the rate o f p ro fit to fall was not an em pirical trend, b ut w h a t w o u ld occur if there were no destruction o f capital value o r other “ counteracting influences” such as the tendency o f the rate o f surplus-value to rise

The most like ly source o f the belief that M a rx predicted a secular decline in the rate o f p ro fit is the fact th at the classical economists

to w ho m he was responding did indeed make this prediction It is thus assumed that he and they were discussing the exact same issue However, M a r x e x p lic itly repudiated this notion:

W hen A d am S m ith explains the fa ll in the rate o f p ro fit [as stemming] fro m a superabundance o f capital he is speaking

o f a perm a ne nt effect and this is w ro n g As against this, the

tra n sito ry superabundance o f capital, overprod uctio n and crises are som ething differen t Permanent crises do n o t exist (M a rx 1989b: 128, starred note, emphasis in o rigin al)

T h a t M a r x regarded c a p ita lis m ’s econom ic crises as tra n s ito ry , though unavoidable and recurrent, is also im p o rta n t to stress The com m on belief th at he predicted the collapse o f capitalism , as a result o f the LTFRP alone o r in conjunction w ith other causes, is yet another belief fo r w hich evidence is lacking M an de l, a p ro m inent advocate o f the view that M a r x predicted a collapse o f the system, acknowledged th at no textual support fo r this claim can be found

in his presentation o f the LTFRP o r elsewhere in Volum e III o f

C a p ita l H ow ever, a ccording to M a n d e l, “ a num ber o f passages

fro m Volum e 1 ” support the theory o f collapse (1991: 79) Yet

he cited o nly one such passage, the end o f the penultim ate chapter, and this passage says n o th in g a bo ut the system’s collapse M a rx (1990a: 9 2 9 -3 0 ) projects that the system’s tendencies w ill result in social revo lu tion (“ The exprop ria tors are e x p ro p ria te d ” ), and not because o f any collapse, but because o f the centralization o f capital and g ro w in g revolt o f the w o rk in g class.14

The p o litic a l im p lic a tio n s o f the LTFR P are th e re fo re n o t

fa ta lis tic ones But they are re v o lu tio n a ry T heories th a t trace crises to lo w p ro d u c tiv ity , sluggish dem and, the anarchy o f the

m arket, state in te rv e n tio n , high wages, lo w wages, and so on, suggest th a t c a p ita lis m ’s crisis tendencies can in p rin c ip le be substantially lessened o r elim inated by fix in g the specific problem that is m aking the system perform poorly But the LTFRP suggests that economic crises are inevitable under capitalism , because they are not caused by factors th a t are external to it, th at is, factors that can be elim inated w hile keeping the system intact As M a r x (1973: 7 4 9 -5 0 , emphasis added) p u t it: “ The viole nt destruction

o f capital n ot by relations external to it, but rather as a co n d itio n

o f its self-preservation, is advice to be gone and to give room

to a higher state o f social p ro d u c tio n ”

A c c o rd in g to his th eo ry, the tendency o f the rate o f p r o f it

to fa ll and econom ic crises are instead roo ted in a re la tio n s h ip

th at is “ in te rn a l” to ca pita l, the in te rn a l c o n tra d ic tio n between physical p ro d u ctio n and the p ro d u c tio n o f value th at is b u ilt in to the very fu n c tio n in g o f capitalism : as physical p ro d u c tiv ity rises,

co m m od ities’ values fall As a result, th e ir prices tend to fa ll, as does the rate o f p ro fit, and this leads u ltim ately to economic crises and the destruction o f capital value.

N ow , this co ntrad iction and the crises to w hich it leads obviously exist only because products are com m odities— that is, things that

have value as w ell as having uses But capital is n oth ing other than

value that is invested in order to end up w ith more value, so the fact (hat products have value is part and parcel o f capitalism as such, no matter w hat its form s o f pro pe rty and in s titu tio n a l structures may be.1 s Thus the c o ntrad iction w ith in capitalism and the effects o f the

co n tra d ictio n do not stem fro m any p a rtic u la r fo rm o f capitalism , and they cannot be overcome by replacing one p a rtic u la r fo rm o f the system w ith a d ifferent one To overcome them, it is necessary

to do away w ith capital, w hich requires, as we see, doing away w ith com m odities and the p ro d u ctio n o f com m odities— in other w ords,

w ith value and the p ro du ction o f value.16

Double, Double, Toil and Trouble:

Dot-com Boom and Home-price

Bubble

3

A t firs t, the recent fin a n cia l crisis was w id e ly characterized as

a “ subprim e m ortgage c ris is ” 1 I t is n o w generally recognized, however, th a t the increased rate o f defaults on subprim e loans was just one facet o f a m ore general p ro blem , the b u rs tin g o f a home-price bubble in the U.S., and th at this burst bubble was the

m ain factor th at triggered the crisis and G reat Recession

The first tw o sections o f this chapter b rie fly discuss w h y the bubble form ed and w h y it burst,2 and h o w this eventually led to the Panic o f 2008 The final section then looks more closely at the role o f Fed policy as a factor th at co ntribu ted to the fo rm a tio n and persistence o f the bubble

The so-called “ d o t-c o m ” b oom — the rapid rise in stock prices

d u rin g the latter h a lf o f the 1990s th at was fueled in p art by the

g ro w th o f the Internet and in fo rm a tio n technology— turned in to

a burst bubble in 2000 I shall argue that the Fed became gravely concerned th at the U.S m ig h t suffer a deflationary slum p like the one th a t had recently led to Japan’s “ lost decade,” 3 and th a t it responded to this threat w ith an exceptionally “ easy-money” policy that helped fuel yet another bubble T his shows th at the latest crisis was n o t m erely a consequence o f financial-sector problem s th a t developed later in the decade It was also a consequence o f economic weakness in the U.S that extends back much further

THE HOME-PRICE BUBBLE

A steep rise in home mortgage b o rro w in g , w hich led to a steep rise

in home prices, began in the latter half o f the 1990s (see Figure 3.1 ).4 One reason b o rro w in g may have begun to skyrocket was th at the latter h a lf o f the 1990s was the period o f the dot-com bubble A

lo t o f m oney was being made in the stock m arket, some o f w hich was then invested in residential and comm ercial real estate A nother

2 8

factor th at may have stim ulated mortgage b o rro w in g was a change

m incom e-tax law P rio r to 1997, people w ho sold their homes at a price greater than the price at w hich they bought it were required

lo pay tax on the difference But in th at year Congress elim inated

i he tax on most o f these capital gains; fo r a m arried couple filin g a

jo in t tax return, the first $500,000 is exempt In 1999, the volum e

of mortgage b o rro w in g was already 146 percent greater than in

I 995 and 75 percent greater than in 1997 (Factors th at caused the rise to continue w ill be discussed in the next section.)

- hom e prices, deflated by P C E price index (left-hand axis) hom e prices, deflated by C P I-U (left-hand axis)

— — m ortgage borrowing (right-hand axis)

Figure 3.1 Mortgage Borrowing and Real Home Prices, U.S.

(mortgage borrowing as percentage of after-tax income; 1997 prices = 100)

The h o m e -p ric e b u b b le was n o t an is o la te d p he no m e no n

C o m m e rc ia l real-estate prices increased by ro u g h ly the same percentage, between the start o f 2001 and late 2007, th a t home prices increased between the start o f 2000 and m id-2006 And stock prices recovered q u ic k ly after crashing at the start o f the decade The S&tP 500 index rose by 95 percent between early 2003 and late

2007, an average annual increase o f over 20 percent

A lth o u g h households’ demand fo r assets, both financial assets and ta ng ible ones, increased ra p id ly , th e ir lia b ilitie s increased

rap id ly as w ell O n average, increases in lia b ilities funded o nly 44 percent o f households’ n ew ly acquired financial and tangible assets between 1952 and 1992— the rest were purchased o u t o f people’s actual incomes— and deviatio ns fro m the average were modest (see Figure 3.2) But then came the dot-com “ b o o m ” o f the 1990s

and the “ b o o m ” o f the 2000s, both o f w hich were inflated by an

ever-growing m ountain o f debt By 1999, the ra tio o f new liabilities

to newly acquired assets stood at 96 percent, w hich means th at all but 4 percent o f the a d d itio n a l assets were bought w ith borrow ed money And this situation persisted u n til the latest crisis erupted; fro m 1999 th ro u g h 2 00 6, the average ra tio o f new lia b ilitie s to newly acquired assets was 94 percent Thus, w h ile households in

1992 lent o u t (via deposits in banks, and so on) m ore than they borrow ed by an a m ount equal to 2.9 percent o f the n a tio n ’s GDP, they increasingly turned in to borrow ers (see Figure 3.3) By 2005, their b o rro w in g exceeded th eir lending by an a m o un t equal to 2.9 percent o f GDP.5

Figure 3.2 Relative Increases in Liabilities and Assets, U.S Households

(increase in liabilities as percentage of newly-acquired assets)

B ut between 1995 and 2 0 0 5 , h ou seh olds’ a fte r-ta x incom e increased o n ly o n e -fo u rth as q u ic k ly as m ortgage b o rro w in g

T his made it increasingly d iffic u lt fo r home purchasers to meet

th eir mortgage payments Income also grew far more slow ly than