Economic Crisis - what causes it?

If you read any of the usual pundits in the business columns, economic crises are almost as mysterious as acts of God. One minute the economy is booming and everyone is happy, and then almost without warning it seems, everything is turning sour, the economy is contracting and people are talking about crisis, austerity, belt-tightening, hard times, and recession.

Given the frequency with which economies boom and bust, you would have thought that by now someone, somewhere, would have identified what was going on and what we need to do to avoid it. Many economists have analysed what's going on and there are very many explanations in terms of money supply, productivity, inflation, overseas competition, global energy prices, lack of entrepreneurial skill, and so on, but they all seem to fail in some respect: they just don't explain why it keeps happening.

Of course, given any of these factors, we can create a case that if other people don't work in our interests, then we suffer the consequences. In many ways, that's the nub of the problem. Capitalism is a competitive system based on the accumulation of capital. It is a compulsive system in that capitalists have very little choice: if they don't try to expand, they risk either going bust or being taken over.

Equally, the working person has no choice but to work. Marx famously, and accurately, described the working class as that class which has no direct control over the means of production and they are therefore forced to work for others. Deprived of the means of subsistence, such as land of their own on which to grow sufficient food for their families, they have to work for someone else. That's precisely how the transition from feudalism to capitalism occurred.

So how does the economic cycle go?

Production continues with increased competition between capitals, each trying to increase their productivity and reduce their costs in order to increase profits. As competitors do the same, the prices fall and so does profitability. It is no longer possible to sell at a profitable price and so production is cut back. People are laid off, plants are closed and the drop in spending power results in lower sales which exacerbates the decline. We get a slump brought on by overproduction.

This is a fairly superficial account though because all sorts of factors affect demand and the state frequently takes action to moderate the trends. But Marx identified a much more insidious consequence of capitalism: the falling rate of profit. To understand that, we need to look first at the labour theory of value

The labour theory of value

In traditional economics, we are told about factors of production, about land, labour, capital, and about how each attracts its rewards. Labour gets its wages, land gets its rent, and capital gets its profit. As the market wheels turn and capital circulates, all the factors of production get their just rewards. If demand increases, then so do prices until demand drops again. If labour is scarce then wages tend to rise increasing the costs of production until the price rises enough to depress demand causing a reduction in the demand for labour and wages fall again.

All these processes, we are told, tend to equilibrium. Since everyone is free to shop around, workers move between employers and labour rates equilibrate. Since consumers can shop around demand evens out with supply. But in fact, this model ignores the element of compulsion, the force of accumulation pressure. Not only do these equilibrium forces operate, but they do so in a system which is fundamentally unequal. Rather than equilibrating, they are dominated by the process of capital accumulation.  Prices do not equilibrate, they fluctuate.

Marx realised that the source of value was labour power, and labour power alone. Capital and land do not create value and therefore do not get what is due to them. The value which is returned to capital and land is actually value produced by working people. The source of rent and profit is therefore labour. It is compulsion which allows the capitalist to appropriate that unpaid-for value.

Once this is understood, the whole notion of equilibrium is replaced by a dynamic model in which profit is realised as surplus value, the value produced by working people which is in fact not paid for in equal value. By virtue of owning the means of production, and the fact that the worker has no choice but to work, the capitalist is enabled to take value from working people without compensating them with equal value.

The inequality of capitalism is therefore endemic. It is an essential consequence of the extraction of surplus value and follows inevitably from the ownership of the means of production by a small ruling class. Capitalism can therefore never preside over a fair society.

The fall in the rate of profit

But economically the consequences are more far-reaching. Because capitalism draws in more and more productive resources to fuel competition, the scale of production rises and more and more capital is tied up in the process. Small handicraft is superceded by factory production which then gets consolidated into massive plants. As companies are bought up and consolidated, the capital intensity of the operations rise.

As more and more capital is employed with proportionately less and less people, the source of surplus value, the labour itself, is relatively reduced. For that reason, it becomes more and more difficult to realise higher profit rates. As the capital intensity of production rises, the rate of profit tends to fall because to realise the same amount of profit requires a greater circulation of capital. And since everyone else is completing, that becomes less and less possible.

If capitalism continues to accumulate to compete, the rate of profit tends to fall. Capital becomes more and more concentrated and in order to remain profitable, exploitation has to increase. Labour needs to be more productive and cheaper so there is a pressure to increase productivity and reduce staffing levels. Unless new markets and production processes absorb the slack, unemployment rises. Unfortunately, the process is self-limiting as foreign markets experience the same pressures.

What governments tend to do

To alleviate the fall in the rate of profit, a number of things are possible. We mentioned one, the increase in productivity and consequent reduction of unit cost. Sweatshops in the third world exploited by the likes of Nike, DisneyWorld, and others, are one source of cheap labour. Using desperate immigrant labour, and even prison labour, is another way.

Another way again is to actually destroy some of the value embodied in products. For that to take place the market has to be compelled by political necessity. Military spending is perfectly adapted to this form of capital siphoning. Highly capital intensive goods are made obsolete periodically if they are not physically destroyed by warfare. Since governments are able to allocate the necessary capital extracted through taxes, they do not need to establish any kinds of market equilibrium or demand. Their own policies manufacture the necessary demand. They create the demand and destroy the appropriate amount of capital.

Such an analysis may sound strange at first but we should remember that it is the accumulation of capital in the production process which causes the rate of profit to fall. If that capital can be reduced, then overall the rate of profit can increase. There is an economic need to destroy capital and that is exactly what happens in a depression, in a recession, in every economic crisis. Military spending serves the same purpose but without the far-reaching knock-on reduction in economic activity. Indeed, in the case of post-WWII USA, it actually provided around 20% of the economic activity, stimulating growth in other economic sectors giving rise to the post-war boom (though it couldn't last).

That is a far cry from claiming that governments deliberately use military spending to increase the rate of profit: most conventional economists are actually mystified about how the economy functions, why it has periodic crises. We only have to look at the comments from Ben Bernanke who said that "understanding the Great Depression is the Holy Grail of macroeconomics." He simply didn't understand how it could have happened.

Governments, believing as they do that competition and a free market is the guarantor of economic stability, have nothing to offer to prevent further crises. All they can do is provide increasing forms of taxation to bail out beleagured capital. The recent banking crisis demonstrates that all social democratic governments, both left and right, will simply take capital from working people to make good the deficit.

As people lose their homes and jobs, and as investments collapse in value, the finance industry is heavily compensated by government funds, obtained from higher taxation. Cuts in social spending push the burden of the crisis onto working people, the only real source of value.

But for anyone interested in actually understanding what is going on, a more far-sighted analysis is needed than is offered by conventional economics. Those pundits have failed miserably to predict the recent crisis, or even to explain it. In contrast, left-wing and particularly Marxist economists have provided comprehensive and detailed analyses using OECD published data. They have explained in detail how the crisis developed, how the commoditisation of re-sold mortgages exacerbated the pressure to crisis already present, and how the bubble was always going to burst.

In addition, they have explained how international politics has been shaped by these crisis and how for example the opening of the capital markets in Eastern Europe has dovetailed into the spread of crises throughout the world. Once we drop the manifest nonsense of conventional economics based on an equilibrium model and a devout belief in competition, we can analyse what is really going on, who benefits and who loses.

One of the most useful of these analyses is to be found in Chris Harman's book, Zombie Capitalism, which discusses these ideas much more fully, and is highly recommended.

It's available on Amazon.