Artwork by Julie Cockburn
Is it to the wrong ideas of economists or to the interests of the power-holders that we should turn to explain the “Great Contraction” of 2008-2009? John Maynard Keynes believed that the Great Depression of 1929-32 was caused by the wrong theory of how the economy worked in the minds of policymakers – the remedy for which was to equip them with the right theory. But this ignored one thing: that the reigning ideas are, more often than not, the product of the dominant power structures.
Economics, therefore, needs to be supplemented by political economy – the study of how power affects the choice of ideas and policies and the distribution of income; in short, Keynes plus J A Hobson and Karl Marx.
Keynes explained that it was uncertainty that causes economies to crash. Hobson explained how unequal income distribution makes crises more likely and recoveries more difficult. Marx explained that this inequality is inherent in the power structure of the capitalist system. All have their part to play in explaining the crisis and collapse of 2008.
Let’s consider first of all the case of the “closed” economy – what happens in an economy without foreign trade.
The closed economy
The strong message of Keynes’s General Theory is that investment is the unruly element in a decentralised market economy, because of the existence of irreducible uncertainty. For one reason or another, businessmen lose confidence in the future and stop investing at the same rate as before. This is how recessions or depressions start.
In Keynes’s theory there is no automatic recovery mechanism, so that, in the absence of an external stimulus, a collapsed economy might get stuck in a situation of “underemployment equilibrium”.
The present crisis exhibits the truth of both parts of this analysis: there was a collapse of “animal spirits” in 2007-2008 and the developed world has since been in semi-slump.
Hobson, Keynes’s near-contemporary, argued that because of the unequal distribution of wealth and income too much of the national income is saved and too little consumed. This leads to more investment producing more goods than the remaining income of the community can buy at prices profitable to the producers. Periodic crises of “realisation” are the result. Today China is a classic case of an oversaving, underconsuming economy.
This has some affinity with Marx’s theory of capitalist crisis, but the mechanism is different. For Marx, crises were the result of a fall in the profit rate. In the Marxist scheme, the surplus value extracted from labour – paying workers less value than they produced – was the source of profit. With the substitution of machinery for labour, surplus value became increasingly difficult to obtain. So, like Hobson’s economy, Marx’s suffers from periodic crises. In Hobson’s economy these are crises of surplus production. In Marx’s economy these are crises of profitability or surplus value.
Keynes, Hobson and Marx all suggest permanent remedies for the tendencies towards crisis. Keynes called on the state to maintain enough effective demand in the economy to offset the ravages of uncertainty. Hobson wanted the state to redistribute income in order to reduce the share of saving in national income. Marx’s more radical cure, as we know, was to abolish surplus value – the profit-seeking system we call capitalism – altogether.
Keynes never engaged properly with Marx, but he saw some similarity between his views and Hobson’s because Hobson, as Keynes did, challenged the core classical belief that saving is always good.
Where Hobson went wrong, Keynes suggested, was in identifying overproduction as the worst consequence of excess saving. For Keynes this was only a “secondary evil”; the primary evil was a propensity to save, which was not realised in investment and production.
According to Keynes, Hobson’s theory was incomplete because he had no “independent theory of the rate of interest”. In Keynes’s theory, the rate of interest (the rate that banks charge for loans) is determined not by the volume of saving, as Hobson, following the classical economists, believed, but by “liquidity preference” – the desire, in situations of great uncertainty, to hold savings in liquid form, chiefly cash. Thus the interest rate cannot be the price that keeps the desire to save in equilibrium with the desire to invest: far from falling when people decided to save more, the rate of interest might easily go up, as people decided to hoard cash. Situations could thus arise when the expected rate of profit fell below the minimum rate at which banks were willing to lend. “Oversaving” thus went with “underinvestment”, not with “overinvestment”. This speaks to the present situation where, despite huge injections of liquidity by central banks, commercial banks refuse to lend to customers, preferring to sit on piles of cash.
What, then, eliminates the excess saving and brings the economy back into balance? Keynes suggested it was the fall in income. As economies get poorer, the amount of saving falls to the level of the reduced investment. Thus economies regain “equilibrium”, but it is an inferior equilibrium to the previous one. This is a good approximation to the current state of Britain, with no clear tendency for a shrunken economy either to grow or to contract.
Keynes was aware that a grossly unequal income distribution made it harder to maintain full employment. The rich save more than the poor, so the more unequal the distribution of income, the larger the gap to be filled by investment if the economy is to reach full employment. At the same time, the richer that societies are as a whole, the fewer new investment opportunities there will be. Hence the problem of unemployment would get worse over time from both ends. Underinvestment becomes a structural problem as wealth increases, because bona fide investment opportunities decline while the ratio of saving to income rises.
So, what should governments do to maintain full employment? Keynes suggested that in the short and medium term a government should provide sufficient public investment from loans, but in the longer run it should redistribute wealth and income in favour of those with a higher propensity to consume. This latter was in line with Hobson’s remedy for slumps, reached by a different theoretical route.
Keynes’s ultimate policy aim was to absorb some of the unwanted surplus of saving in increased leisure. This would mark entry to the “golden age” of capital abundance – the theme of his futuristic essay “Economic Possibilities for Our Grandchildren”, published in 1930. A hundred years hence, Keynes thought, both capital accumulation and consumption would approach saturation.
Marx, too, looked forward to this kind of utopia but he denied that it could ever be achieved by capitalism. The capitalist class (and the political apparatus it controlled) would never allow the scale of public investment Keynes wanted – which it would deem inefficient and wasteful; nor the measures of redistribution advocated by both Hobson and Keynes – which it would condemn as weakening the incentive to save and work. As machines increased the productivity of labour, and thus the possibility of shorter hours of work, capitalists would force down real wages by raising unemployment, and more generally by pauperising the mass of the population. Sooner or later this would cause a revolution. It was socialism, not capitalism, that would inherit the era of abundance.
The ideas of the three thinkers all play out differently when we introduce a foreign sector. Let us call this “globalisation”.
The open economy
In a closed economy – one without a foreign sector – it is excess saving, according to Hobson, that causes periodic slumps. But an open economy provides an alternative: the domestic saver can lend his savings abroad to develop new markets. Hobson called the need to find a foreign vent for saving the “economic taproot of imperialism”. This was taken up by Lenin to explain why capitalism hadn’t collapsed on schedule. Faced with a falling rate of profit, capitalists could restore their profits by opening up sources of exploitation abroad.
Unfortunately, this remedy – which both Hobson and Lenin called imperialism – only postponed the evil day. The competitive drive to capture new markets and open up new sources of exploitation would lead to wars between the leading powers for the “division and redivision of the world”. Hobson thought the Boer war was a precursor of a new type of capitalist war. Lenin interpreted the First World War in the same terms. Keynes drew a similar conclusion to Hobson and Marx. “If nations can learn to provide themselves with full employment by their domestic policy,” he wrote in 1936, “there would be no longer a pressing motive why one country need force its wares on another or repulse the offering of its neighbour.”
The contemporary value of the analysis of all three thinkers is that it forces us to look more critically at the phenomenon of globalisation. Is globalisation the consequence of a benign and normal search for higher returns? Or is it an attempt to solve problems of underconsumption and declining profitability in the capital-exporting countries which would otherwise bring their economies crashing down?
All three analyses are relevant to this problem. Keynes was the least interventionist of the three. He thought moderate globalisation was potentially beneficial but it needed to be underpinned by monetary “rules of the game” which would prevent surplus countries from “hoarding” their surpluses and thus impose austerity on the debtor countries. In his International Clearing Union, which he proposed in 1941, the reserves of persistent creditor countries would be taxed and the proceeds redistributed to the debtor countries. But no such mechanism was established by the Bretton Woods Agreement of 1944, and the problem of adjustment of trade balances between creditor and debtor countries plagues not just the eurozone but US-China relations, threatening a descent into currency wars and protectionism.
The intuitions of Hobson and Lenin also speak to our present situation. Hobson’s notion of a structural imbalance between production and consumption, leading to “excess saving” that requires a foreign vent, surely applies to China. Lenin’s idea that the export of capital is required to overcome periodic crises of profitability in the advanced capitalist nations helps explain the “offshoring” of manufacturing (and service) jobs to China and east Asia.
Today’s “crisis of capitalism”
We have gone in the opposite direction to Keynes’s, Hobson’s and Marx’s hopes, pushing into a distant future the golden age of capital abundance. We are still fixated on economic growth and have abandoned any attempt to control the level or kind of investment. In order to make growth happen, we encourage more and more consumption through advertising, while actively promoting inequality.
And instead of the state embarking on wasteful and unnecessary investment programmes to keep people in jobs, we leave it to the financial sector to do this, wasting the money of investors in order to enrich a tiny minority, while most people fall ever deeper into debt.
A structural analysis of how we got to where we are should start with an account of how Keynesian ideas, which saw off the Marxist challenge after the Second World War, were in turn dethroned by neoliberalism in the 1970s, opening the way for the dominance of finance capitalism.
The political economies of the capitalist world between 1950 and the 1970s brought about a balance of forces between capital, labour and government. Economic policy was designed to achieve full employment, wages grew with productivity, incomes were equalised through progressive taxation, and international exchange was restricted. This configuration created a virtuous circle of growth.
This was the Keynesian age. Keynes believed that the power of ideas – his ideas – would be enough to kill off Marx permanently, but he never considered the possibility that his own ideas might be at the mercy of changes in the power structures of western societies. After 1980, the state proved unable to protect the Keynesian revolution from the consequences of the continuing full employment it guaranteed. Over time, full employment strengthened trade union power; unions used their position to push wages ahead of productivity; wages started to encroach on profits; inflation took hold as governments tried to stay ahead of trade union demands. To end what had become a vicious spiral of “stagflation”, the business class demanded lower taxes, freedom to export capital, free trade and an end to the full employment commitment. Two of the countervailing powers, the unions and the state, were humbled, leaving capital in control. This brought back the power system of the 19th century, brilliantly aaalysed by Marx.
The economics profession justified the shift back to an older form of capitalism. The technical ammunition for the monetarist counter-revolution was provided by Milton Friedman’s restatement of the quantity theory of money, coupled with his assertion that in each economy there existed a “natural” rate of unemployment, which could not be lowered, except temporarily, by printing money.
Friedrich Hayek’s slow-burning Road to Serfdom, published in 1944, offered a powerful political economy argument against state intervention in economic life. There was also a revival of the Schumpeterian idea that the dynamism of capitalism depended on bouts of creative destruction. “Free-market” think tanks and journalists, funded by business, provided the simplifications and slogans needed for politicians to understand and mouth the new verities.
In this way, after 1980, a new economic paradigm established itself, based on widening income inequality, repression of real wage growth, an accelerated transfer of manufacturing jobs to east Asia and a resulting high level of structural unemployment and underemployment. A rickety economy was rescued from collapse in the 1990s by the dotcom boom, and in the 2000s by asset-price inflation, financed by exploding private debt-to-income ratios. A banking collapse was inevitable.
Globalisation was business’s “open” economy answer to the problem of domestic underconsumption identified by Hobson and the declining rate of profit predicted by Marx. Hobson’s oversaving analysis best explains China’s reliance on export-led growth, but it also sheds light on western countries’ reliance on access to cheap credit to maintain the stagnating purchasing power of what is now called “the squeezed middle class”. Analysis in terms of the declining rate of profit is good at explaining the accelerated transfer of productive capacity to east Asia. And by completing the destruction of the Keynesian state, globalisation has handed our future to finance, which Keynes identified as the most uncertain, least stable element in the economic structure.
According to the Harvard economist Dani Rodrik, we face a “political trilemma”: press on with globalisation and restrict democracy to improve economic efficiency, limit globalisation in the name of democracy, or globalise democracy.
The first option will be politically intolerable for large democracies of the west and the third is pie in the sky, which leaves the second. It is time to call a halt to the rush towards globalisation and take stock.
At the minimum, there needs to be a global bargain between the US and China and a regional bargain between Germany and its partners in the eurozone on their respective “rules of the road”, which should aim to prevent the continuing current account imbalances. This is the problem that Keynes’s clearing union was designed to overcome but which the Bretton Woods system failed to solve.
Yet Rodrik’s “trilemma” does not dig deep enough. It assumes that globalisation would be best if it could be made to work equitably. But global economic integration, in the absence of domestic policies to maintain full employment, create a broad base for consumption in all countries and reduce hours of work in the rich countries, is bound to be destructive for the reasons Keynes gave in 1936: it forces countries into export-led solutions to domestic problems which deny democratic control and are bound to bring them into conflict. Closed economy problems identified by Keynes, Hobson and Marx must be overcome if the open economy is to work harmoniously.
What hope is there of this? Given that the Marxist physic of abolishing capitalism is worse than the disease, the question is whether it is any longer in business’s interest to go along with a system that crashes every few years, with increasingly harmful economic and social consequences. Keynes repeatedly said he had come not to destroy capitalism, but to make the world safe for capitalism – and make capitalism safe for the world. It may be that business interests are now sufficiently aligned with the needed domestic reforms to enable further global economic integration to proceed peacefully, if less hectically. If a change in the configuration of “vested interests” allows better “ideas” to succeed, the recent crisis will not have been in vain.
Robert Skidelsky’s most recent book, co-written with Edward Skidelsky, is “How Much Is Enough? The Love of Money and the Case for the Good Life” (Allen Lane, £20)