What’s the cause of the Great Recession: debt or a fall of profit?

I like the economist Steve Keen, and others like the ‘Georgist’ economist Michael Hudson, and have little knowledge of contemporary Marxist economics, but this critique of Keen by Michael Roberts convinces me they still bring useful insights to the table.

(context: British marxist economist Michael Roberts attented a conference featuring the views of Steve Keen on the origins of the current crisis)

Michael Roberts:

” This was entitled The deluded discipline of economics and organised by Prime Economics (www.primeeconomics.org), which is a left Keynesian policy research group based in London. The main speaker was Steve Keen, the Australian economist who was promoting the second edition of his book, Debunking Economics – (http://www.amazon.co.uk/Debunking-Economics-Revised-Expanded-Dethroned/dp/1848139926/ref=sr_1_1?ie=UTF8&qid=1317987820&sr=8-1). This is a brilliant destruction of the unrealistic and contradictory assumptions and conclusions of modern mainstream economics, particularly neoclassical theory. Don’t miss it. Steve Keen was also the winner of the Real Economics Review prize for predicting the global financial crisis of 2008-9, which he won over the competition of greater media luminaries like Nouriel Roubini (see my paper op cit).

Keen argued that mainstream economics could not have predicted the crisis because it is wedded to a fetish that economics is really a process of supply meeting demand at the intersection of two curves to achieve equilibrium. Dynamic, unstable processes in the real world are ignored or denied. Neoclassical economics is a neat and plausible theory, but wrong. It makes some psychological assumptions about individual needs and tastes and ignores income inequality, different savings patterns and social classes. It assumes that an individual demand curve can just be aggregated to the macro level of the whole economy. Indeed, for the neoclassical model, there is only one demand curve, not even an aggregation of lots of individual ones. But the world of the individual cannot be just multiplied to the aggregate – this is a fallacy of composition. There is not a straight path from the micro to the macro. This was the mistake of all those previous theorists like Say or Walras that assumed that because an individual seller must have a buyer, so total supply in an economy must be matched by total demand. This was fallacy first debunked by Marx and later by Keynes (who never read Marx).

Keen made fun with the various statements of mainstream economists prior to the crisis. And he quoted Nobel prize winning neoclassical economist Robert Solow who attacked the fetishism of the mainstream. I have another quote from Solow, when the octogenarian gave evidence to the US Congress on the state of mainstream economics in July 2010: “The macroeconomics that dominates serious thinking, certainly in our elite universities and in many central banks and other influential policy circles seems to have absolutely nothing to say about the problem. One single combination worker-owner-consumer-everything else simplified economy has nothing useful to say about anti-recession policy because it has built into its essentially implausible assumptions the conclusion that there is nothing for macroeconomic policy to do”. That’s why mainstream economics got things so wrong and remains in denial.

Uncertainty, change and, above all, the intervention of money and credit disprove the neoclassical assumptions. And that is where Keen makes his key point that, in a modern capitalist economy credit is necessary to ensure investment and growth. But once credit is in the economic process, there is nothing to stop it mismatching demand and supply. Indeed, to really measure the level of demand, credit must be added to income. And Keen discovered that in the major capitalist economies leading up to the crisis of 2007, private sector credit outstripped the growth of national income. It reached record levels, over 300% of GDP in the US. That credit bubble was bound to burst and thus caused the Great Recession.

Undoubtedly the rise of excessive credit in the major capitalist economies was a feature of the period before the crisis. And its very size meant that the crunch would be correspondingly more severe as capitalist sector saw the value of this fictitious capital destroyed. But is it really right to say that excessive credit is the cause of capitalist crisis? Marx argued that credit gets out of hand because capitalists find that profitability is falling and they look to boost the mass of profits by extending credit. Uncontrollable credit is a product of falling profitability. In my book, The Great Recession, I provide evidence for this point and in my paper (op cit, p30).

But there appears to be no role for profit and profitability in Keen’s crisis model. Indeed, in his book, he starts his model with capital (or money if you prefer), which leads to investment, then income and, within income, to profits and wages. As I have argued in a previous post, this is back to front (see Double dips, deficits and debt, 24 August 2011). I think it is a delusion or a fetish to look at credit as the main or only cause of crisis. In a capitalist economy, profit rules. If you deny that, you are denying that capitalism is the right term to describe the modern economy. Maybe it would be better to talk about a credit economy, and credit providers or creators and not capitalists. We must start with profit,which leads to money, investment and capital accumulation and then to employment and incomes. The Keynesian/Keen model assumes that capital (or credit) is already in place with or without profits. The issue for Keen is that you can have too much of a ‘good thing’.

This leads to some interesting policy conclusions. If excessive credit is to blame for capitalist crises and not any flaws in the profit mode of production, then the answer is the control of credit. Indeed, in the meeting Keen argued that the best policy prescription was to keep private sector credit at about 50% of GDP in capitalist economies (it is way over 100% in most). Then financial crises could be avoided. Even if that were true, how could it be done without public ownership and control of the banking sector? No doubt, Keen would support that measure.

Ann Pettifor from Prime Economics also spoke at the meeting and promoted the idea that we need more credit expansion to get the economy out of the depression it is in. For her, credit creates activity and income (in contrast to Marx who reckoned that activity by labour created income). And yet we had just heard from Keen that too much credit causes crises! This becomes almost semantic: debt is bad, but credit is good. Of course, Pettifor was arguing that banks need to provide credit for productive purposes to households and small businesses and not speculate in stocks and bonds. But that means converting the banks into public service entities. Doing so, poses the question of control over the whole private sector and its ability to make profits. It can’t stop at controlling credit: ‘socialised investment’ in credit would not be enough.”

1 Comment What’s the cause of the Great Recession: debt or a fall of profit?

  1. AvatarJames Edwards

    “Marx argued that credit gets out of hand because capitalists find that profitability is falling and they look to boost the mass of profits by extending credit.”

    To me, such a strategy would appear self-destructive and hence irrational. Why would capitalists extend further credit, when they’re already faced with falling profits?

    On the contrary its the very nature of profit that ensures an excessive buildup of underutized capital and thence a decline in the rate of interest. Financial intermediaries to whom capitalists loan their idle capital are forced to seek higher risk and therefore more profitable avenues of investment in order to retain their accustomed rates of interest.

    This is precisely the point at which the capitalist demands the State to intervene in order to forestall the continued decline in profitability through making investments in capital intensive infrastructure developments, or formenting wars, which are just as effective at dissapating material abundance which is the chief cause of the decline of profitability.

    “In a capitalist economy, profit rules. If you deny that, you are denying that capitalism is the right term to describe the modern economy.”

    On the face of it, this proposition is illogical, because profit is the product, not the source of capital. Something Marx called surplus value. And today the distinction between worker and capitalism is far more foggy than in Marx’s days since many Western workers have considerable savings, most especially in their pension funds. One could question who is most robbed by capitalist profit, the worker or the consumer. And there is possibly far more surplus value extracted between countries as between social classes. Does one really believe that the sharply diverged incomes of American and Chinese workers relate solely to productivity?

    No infact the sequence begins with a phenomonen that Marx called primitive accumulation, where the capitalists create institutional arrangements that have and continue to decisively swing social power in favour of the wealthy relative to the workers. John Bates Clarke, the founder of American neoclassical economics referred to wealth creation as, “the mere appropriation of limited natural gifts ..” and that repelling intruders “is almost the only form of labor which exists in the most primitive social state” (p.10). Those who appropriate them create wealth by so doing.
    The essential attribute of wealth is “appropriability,” to create which “the
    rights of property must be recognized and enforced Whoever makes, interprets, or enforces law produces wealth” J.B. Clarke, 1886 The Philosophy of Wealth

    http://www.masongaffney.org/publications/K1Neo-classical_Stratagem.CV.pdf

    Speaking purely in terms of disinterested observation he is right, because it is the power provided by prior legally enforced appropriation, that allows capitalists to demand others produce for them. Money and profit are merely the numeral representation of legal claims over and title to own the former commonwealth (land, water rights, fishing quotas, electromagnetic spectrum, rights-of-way) that have become increasingly expropriated and enclosed over time.

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