Part 4

Part 4: Capitalism and finance

The previous Part dealt mainly with the production of surplus value, the accumulation of capital and the tendency for the capitalist system to go into crisis. The counterparts to these processes in the ‘real’ economy are    developments on the monetary side. These were shown to have their own importance in the course of the Great Recession. The ‘financialisation thesis’, discussed in this Part, contributes to an important debate within Marxism triggered by an analysis of the recent crisis.

Chapter 4.1: The financial edifice


We have encountered money in the form of a means of circulation in Chapter 3.5, where it is used as an intermediary in the C – M – C (commodity – money – commodity) circuit. The owner sells a commodity they don’t want in order to buy a use value they do want. Money also functions in the circuit of capital, where the capitalist starts with money and intends to end up with more money (M – C – M’).

Money can also act as a means of deferred payment. It is paid up front for receipt of commodities in the future. This is the foundation of the credit system.

It is in the nature of the capitalist system that the turnover of capital generates piles of idle money capital at various points in the system, for instance as part of a fund for replacing fixed constant capital. The credit system syphons up this money capital and mobilises it for further accumulation.

At an early stage of capitalist development companies were offering commercial credit to one another. Bills of exchange were issued by textile firms in the expectation of selling their goods overseas so that they could keep production going at home. These bills of exchange were discounted (so they effectively earned interest for the buyer) and usually ended up in a bank.

This commercial credit binds the chains of production together and reinforces the mutual interdependence of the capitalists. It also means that, if any link in the chain is broken, they will all suffer.

Credit has since received a huge extension. Consumer credit has boomed, as we saw in Part 1. Credit may be used to encourage investment. Credit also magnifies the possibilities of speculation enormously, and the evil consequences if it all goes wrong.

“In a system of production where the entire interconnection of the reproduction process rests on credit, a crisis must evidently break out if credit is suddenly withdrawn and only cash payment is accepted, in the form of a violent scramble for means of payment.” (Capital Volume III, p.621)

  • Modern capitalism is completely dependent on      the credit system.

Fictitious Capital

So credit feeds speculation. Speculation occurs in what Marx called fictitious capital. The new millennium boom was characterised by the creation of enormous quantities of fictitious capital. The Great Recession saw an immense destruction of this fictitious capital. What is it?

Marx explained that capital is at the outset a sum of values such as a car plant in the possession of the capitalists. This real capital is put to work to produce surplus value. The whole capitalist edifice is based upon the unpaid labour of the working class. But, as capitalism evolves, the capitalists become split up into different fractions, all of whom come to share the illusion that money begets money. After all for them this is not pure illusion, but the reality of their experience. So capitalism generates what Marx called fictitious capital. This is how the situation presents itself to the capitalists:

“The matter is simple. Let the average rate of interest be 5% annually. A sum of £500 would then yield £25 annually if converted into interest-bearing capital. Every fixed annual income of £25 may then be considered as interest on a capital of £500. This, however, is and remains a purely illusory conception, except in the case where the source of the £25, whether it be a mere title of ownership or claim, or an actual element of production such as real estate, is directly transferable or assumes a form in which it becomes transferable (p.595)… The formation of a fictitious capital is called capitalisation. Every periodic income is capitalised by calculating it on the basis of the average rate of interest, as an income which would be realised by a capital loaned at this rate of interest. For example, if the annual income is £100 and the rate of interest 5%, then the £100 would represent the annual interest on £2,000, and the £2,000 is regarded as the capital-value of the legal title of ownership on the £100 annually.” (Capital Volume III, p.597)

Whereas we started our analysis of capitalism with capital as real values producing a certain amount of surplus value, with fictitious capital the calculation is conducted the other way round – from revenue to the assumed capital sum. The ownership of money as a means of owning the means of production is a social power. It entitles the owner to share in the surplus value, and the value of the piece of paper which the owner of money capital buys is assessed against the return. That is why the capital is fictitious, or illusory. It represents an entitlement to a stream of surplus value that has not yet been produced.

So we enter a world turned upside down:

“The independent movement of the value of these titles of ownership, not only of government bonds but also of stocks, adds weight to the illusion that they constitute real capital alongside of the capital or claim to which they may have title. For they become commodities, whose price has its own characteristic movements and is established in its own way.” (ibid p.598) This is why share prices (‘stocks’ as Marx calls them) can oscillate wildly and deviate for long periods from the economic fundamentals.

“All this paper actually represents nothing more than accumulated claims, or legal titles, to future production whose money or capital value represents either no capital at all, as in the case of state debts, or is regulated independently of the value of real capital which it represents.” (ibid p.599)

  • Capitalism      generates huge quantities of fictitious capital, titles to ownership of      the share of future surplus value.

Share capital

Share prices are a form of fictitious capital. To understand the apparently mysterious movements of the stock exchange, we must go back to basics. The foundation of the capitalist system is the pumping of surplus value (unpaid labour) from the working class in the production process. The capitalists own the means of production mainly in the form of shares. A share in a company is simply a piece of paper entitling its owner to a regular dividend. A share dividend is that part of the firm’s profits that is paid out to the shareholders. That dividend in its turn can only be a part of the unpaid labour of the working class.

Once a company has been floated on the stock exchange, its shares pass from hand to hand. The company in question gets no part of the share’s selling price. If I buy a second hand Ford share, Ford no more benefits than if I buy a second hand Ford car. Of course new shares can be issued to finance new investment. But since the Second World War this has been an insignificant source of investment finance, specially in the Anglo-Saxon countries.

So shares are just pieces of coloured paper traded on the exchanges. How do speculators assess their value? A share price reflects expected future profitability. One point of holding a share is to collect the dividend. But if profits are expected to rise, then the price of the piece of paper will rise as speculators pile into shares. So as the bubble blows itself up, speculators gain both ways – from dividends and from the rising price of their paper asset. The herd instinct of the traders can produce rushes and panics for all manner of reasons. At root though the health of the stock exchange is a reflection of the expected profitability of the real economy – even though there can be time lags and overshooting before trends in the real economy eventually make themselves felt on the floors of the exchanges.

Shares are a form of fictitious capital but share price movements have real effects on the economy. The collapse in share prices in 2008 was a distorted reflection of the collapse in profits that had already taken place, as it was in 1929. It made the crash worse since it made millions of shareholders dramatically poorer, as it did in 1929. The share price collapse was an important secondary factor in the development of recession in 1929 and 2008. The share price boom in the ‘emerging’ economies such as India and Brazil since the middle of 2009 reflects the fact that their economies have once again been booming. This also sucks in money from outside areas to fuel the boom.

  • Share      prices are a form of fictitious capital, and as such are subject to bouts      of speculation.
  • Ultimately      share prices are based on expected future profitability.
  • Movements      in share prices reflect movements in the economy and have their effect on      the rest of the economy.


The story of the credit crunch is the story of derivatives. Derivatives are so called because they are financial instruments (pieces of paper) derived from other transactions (represented by other pieces of paper). In short they are forms of fictitious capital. Marx’s analysis of fictitious capital is important to us because the derivatives bearing the bundles of sub-prime mortgages that caused the Great Recession were, of course, the most tremendous example of the creation of fictitious capital in the history of the world. How the whole house of cards collapsed is dealt with in Part 1: What happened in the Great Recession. Though we need some understanding of the complexities of the financial system that apparently brought the world economy to the brink of ruin, it is also necessary for Marxists to take a deeper look at modern capitalism and the underlying cause of the crisis.

The most basic form of a transaction on the market is when money changes hands in one direction while a commodity (including a financial instrument) changes hands in the opposite direction at the same time. Money is used here simply as a means of circulation. This is called a spot transaction.

Apart from spot markets there are futures markets. A future is a form of derivative. The usual homely example given in economics textbooks is of a farmer who is anxious to eliminate uncertainty about next year’s harvest. It could be a bumper crop (which may not be good news for the farmer) or it could be a bad year. (If it’s a dearth all round, farmers could actually make more money). Our farmer can’t be bothered. He just wants to know where he stands. He needs money up front for seed corn for next year. So he sells his next year’s harvest (a crop he hasn’t harvested yet) for an average price and lets someone else have a little flutter on what next year’s crop will bring. By using a future contract derived from a spot transaction due to take place next year, the farmer is trying to unload uncertainty on to someone else.

Another type of derivative is an option. By taking up an option the speculator can take a decision later as to whether to exercise it or not. This means that the owner of the option can gamble on what the product will be worth at some point in the future, and whether it will be worth their while exercising the option.

A swap is yet another form of derivative. Though the roots of the concept are ancient, they mainly enter the present tale in the form of complex credit default swaps (CDSs). Swaps are said to be a form of insurance held against someone else’s default – including that of a sovereign nation. In fact they are a way of gambling.

Whereas most derivatives were comprehensible deals in the past, the recent explosion in their use comes with a related phenomenon called securitisation. This consists of wrapping up financial assets such as mortgages together and selling them on as a security. The purpose of this is said to be the elimination of risk. The risk from the financial instrument is indeed transferred from the desk of the financial institution that issues the security. But it doesn’t disappear. It is just transferred to the current owner of the security. Some of these securities might involve slicing and dicing the income from mortgages in the state of Florida or California, for instance. In the euphoric atmosphere of the bubble, the buyer did not question whether these mortgages would keep paying out. This was despite the fact that they hadn’t the foggiest idea what was happening in the local housing market where the mortgages had been issued. Some of these instruments were in any case so complex as to be incomprehensible.

It is all a long way from the old yarn about farmers. It is not the intention of this survey to go in detail into the intricacies of these financial instruments. And they are intricate. Andrew Haldane gives the example of a CDO squared (Collateralised Debt Obligation squared. It’s a CDO of a CDO. Don’t ask!). The documentation for this instrument ran to 1,125,000,300 pages. He comments, “But an investor in a CDO squared would need to read in excess of 1 billion pages to understand fully the ingredients. With a PhD in mathematics under one arm and a diploma in speed-reading under the other, this task would have tried the patience of even the most diligent investor” (Rethinking the Financial Network).


No wonder not a soul understood how these things really worked!


  • Derivatives      are so called because they are derived from another transaction.
  • Over the      past decade, the world economy has been awash with derivatives and other      forms of fictitious capital.


People unacquainted with capitalist realities may be under the impression that banks only lend out money that they actually have, that they operate in effect as large piggy banks. This is far from the case. The goldsmiths and silversmiths in the seventeenth century were the antecedents of the English banking system. They held rich people’s valuables for safekeeping, and noticed that most of these people did not want to withdraw their money most of the time. So they could lend out most of the borrowed money they held on deposit. They just kept enough cash in their vaults to cover the normal level of withdrawals.

This process is called leverage. In the past governments have set prudential limits as to what multiple of loans that banks could make compared with their holdings of backing assets. (These limits are imposed in part globally by the Basel Accords.) The principles of neoliberalism held that free market capitalism could not fail and that regulation just slowed the dynamism of the system down. For this reason national regulations imposing limits on potential leverage were progressively scrapped as part of the deregulatory drive of the ‘neoliberal era’ over the last two decades or so. (The expression ‘neoliberal era’ is in quite common use. We shall discuss whether it is appropriate in the section on Financialisation.)

Gordon Brown as British Chancellor bragged of his ‘light touch’ regulation of the City of London and Canary Wharf.  Really this was ‘soft touch’ regulation by the government. Just before the credit crunch UK banks were reported as trading with leverage ratios of between 25:1 and 35:1. The big five US banks at one time were working with a capital adequacy ratio of 50:1. This means that the latter held only one dollar in reserve for every fifty dollars of loans out in the wild. With gearing like this, failure was not an option. If more than one loan in fifty went sour for any reason, the bank would be unable to pay the depositors and would become insolvent. And we now know how many bad loans were out there.

All this is not unprecedented. The share price bubble in the 1920s was fed by trading ‘on the margin’. This meant that a speculator only needed to put down a small percentage (such as 10%) of the share price to acquire the share. As long as share prices continued to rise the speculator would be able to stump up the rest by selling the share on to the ‘greater fool’. This leverage actually fed the speculation and the psychology of euphoria that inflated the share price bubble before 1929.

The level of leverage attained by the financial system by 2007 sounds scary; and so it proved. But leverage does not cause capitalist crisis, though it no doubt amplifies it; nor does consumer credit cause crisis. Leverage makes it possible for the system to mobilise all its resources to take advantage of profitable markets. Capitalism will continue to grow as long as profitable markets exist, but when they dry up leverage makes the crisis dramatically worse.

  • Leverage      means that financial institutions can lend out much more than they hold as      reserves.
  • Leverage      amplifies the fluctuations that naturally take place in a capitalist      economy.

The bubble

It is now generally agreed that the huge increase in house prices across large swathes of the advanced capitalist world constituted a speculative bubble – now that it has burst. That was very much a minority view five years ago. All manner of argument was put forward by so-called experts to justify the continued rise in the price of housing as sustainable and rational.

Charles Kindleberger’s book Manias, panics and crashes defines bubbles as follows: “In this book a bubble is an upward price movement over an extended range that then implodes.” (p.13) Kindelberger bases much of his analysis on the work of the heterodox economist Hyman Minsky. (See Part 1: What happened in the Great Recession for more on Minsky.)

Bubbles are widely seen by orthodox economists as irrational. In fact many, those of the ‘efficient markets hypothesis’ school, deny that they can exist.

Kenneth Rogoff explains in the Financial Times (07.04.10 Bubbles lurk in government debt):

“In the classic bubble, an asset (say a house) can have a price far above its ‘fundamentals’ (say the present value of imputed rents) as long as it is expected to rise even higher in the future. But as prices soar ever higher above fundamentals, investors have to expect they will rise at ever faster rates to make sense of ever crazier prices. In theory, ‘rational’ investors should realise that no matter how many suckers are born every minute, it will be game over when house prices exceed world income. Working backwards from the inevitable collapse, investors should realise that the chain of expectations driving the bubble is illogical and therefore it can never happen. Are you reassured? Back in my days as a graduate student, I know I was.”

The pro-capitalist apologists among the economists know about the South Sea bubble and the Mississippi bubble. But for years the vast majority of economists and business commentators denied that house prices were in a bubble. They seemed to be saying to us, in the words of Groucho Marx, “Who do you believe – me, or the evidence of your own eyes?”

At least Rogoff now knows better. He adds:

“In my work on the history of financial crises with Carmen Reinhart, we find that debt-fuelled real estate price explosions are a frequent precursor to financial crises. A prolonged explosion of government debt is, in turn, an exceedingly common characteristic of the aftermath of crises”. As for the long process of recovery, “Of course, huge volatility and corrections along the way are normal.”

We shall return to this prognostication later in our analysis.

Irrational they may be, but bubbles certainly do exist. In the early years of the twenty-first century large areas of the capitalist world were in the grip of a vast house price bubble. A bubble is a situation where people are buying because the price is going up, and prices are going up because people are buying. In Britain the speculative frenzy meant that house prices peaked at 5.5 times average annual earnings before the crash. These prices were completely unaffordable to first time buyers and those without a foot on the housing ladder. The only people who could really afford to buy a house at these prices were those who already had one, trading on the inflated price of one piece of property for another.

Rising house prices make people feel richer and enable them to borrow more on the equity of their home. All this prosperity has to be paid for. Eventually it becomes clear that the production of wealth cannot keep pace with the expansion of credit. The word bubble is used because such a development is ultimately unsustainable and the bubble is bound to burst. This duly came to pass in 2005 and 2006, at about the same time as the profit rate tanked. When house prices fell, the euphoria created by the bubble also popped and consumer borrowing, based on the apparently never-ending rise in prices, was bound to implode.

Why did house prices fall? Why did the bubble burst? As we have explained, the bubble continued to inflate and unscrupulous agents began to offer mortgages to people who could not possibly afford to keep up the payments. They were called sub-prime mortgages and millions were issued. In the end the housing bubble was pricked when house prices began to fall. More and more sub-prime mortgage holders defaulted, causing further drops in house prices.

  • The rise in      house prices over the past decade was a classic speculative bubble. It was      bound to burst.
  • Bubbles      have become a common feature of recent capitalist booms

Efficient markets?

When we denounce the buying and selling of derivatives as gambling, this may summon up to the reader the picture of a raffish fellow in a loud checked suit and two-tone shoes on a racecourse taking bets. Nothing could be further from the truth.

The biggest gamblers in the capitalist system wear sober suits to work in their offices at hedge funds in places like Mayfair in London, and regard themselves as respected pillars of the financial sector. Indeed mathematics has been called in aid to exploit the derivatives market. Some of the most brilliant minds on the planet, including Nobel Prize winners in maths, have been enrolled in the cause of making money out of derivatives trading in these financial centres.

Maths is, or should be, a neutral aid to study and analysis. Unfortunately, not only has scarce brain power been diverted away from any purpose genuinely useful to humanity towards derivatives trading by the pull of fat salaries; maths has also been squandered in the service of the false and self-seeking ideology called the efficient markets hypothesis. The mathematicians, using dozens of computers all linked together to concentrate their intelligence, proved beyond a peradventure that making money by gambling on derivatives was a certainty. It was impossible, utterly impossible, for there to be a collapse on the scale on the one that actually happened. Will Hutton explains (Them and us, p.192):

“Part of the problem was the ideological belief that financial markets were efficient. The likes of Myron Scholes were on a mission to prove the superiority of free markets and to make their own fortunes.”

What they actually proved was that free markets can be enormously damaging and destabilising to millions of ordinary people’s lives. The fate of Long Term Capital Management (LTCM), the hedge fund that crashed amid much fraud in 2000, should have alerted the unwary to the fallacy of the efficient markets hypothesis. LTCM was piloted by the Nobel Prize winners in economics Myron Scholes and Robert C. Merton to its destruction.

True believers in the efficient markets hypothesis and smug optimism as to the future of capitalism still existed after the collapse of LTCM. Unfortunately these deluded optimists were running the system. Alan Greenspan, then Chair of the Fed, was one. He opined in a speech in January 2004:

“Recent regulatory reform coupled with innovative technologies has spawned rapidly growing markets for, among many other products, asset-backed securities, collateral obligations and credit default swaps…These increasingly complex financial instruments have contributed, especially over the recent stressful period, to development of a far more flexible, efficient and hence resilient financial system than existed just a quarter century ago.” (Quoted in Cassidy-How markets fail, pp.226-7)

There have been dozens of accounts of the crisis that emphasise the headline financial scandals and the nemesis that came upon the heads of financiers who regarded themselves as ‘masters of the universe.’ Though a fascinating and entertaining story, we think an undue emphasis on this side of things can serve to downplay the reality of the events – which is that the Great Recession was and is a pure crisis of capitalism.

All the same, the amount of derivatives traded was staggering – at the peak of the boom about $800 trillion were floating around. This was roughly twelve times the size of the world’s annual product at the time. And the week before its collapse in October 2008 the British bank RBS was handling £500 billion in derivatives – one bank dealing with sums equivalent to a third of Britain’s GDP. The lesson is – the bigger they come, the harder they fall.

In the new millennium the world became awash with paper transactions and speculation about pieces of paper. It seems that the capitalist class had all gone mad and wanted to make money without going to the trouble of getting anything produced. The sheer scale of global transactions was astronomical. And, as we now know, it was money out of control.

In extracts from his book Beyond the Crash (published in the Guardian 07.12.10) Gordon Brown outlines the enormity of the rise in total global financial flows:

“If I had said in 1990 that global flows of money, which were then around $0.6trn a day, would double as the world economy grew, people might have believed me, but if I had said these flows would rise by more than 2,000%, few would have thought it possible. In fact something much bigger happened: a 6,600% increase in global financial flows, so that by April 2010 these were flows of $4trn a day.”

  • Markets are      not necessarily ‘efficient’. They can be massively destructive and wreak      havoc on working people’s livelihoods in the process when they fail.

Shadow Banking

So the derivatives were actually structured and issued by the big banks in Wall Street and the City of London. Money without limit seemed to be there for the making from the derivatives trade. Where did these financial instruments end up? They were snapped up by the shadow banking system, a murky network of financial institutions.

The best known of these shadow banking institutions are the hedge funds. In 2007 they held $2trn in investments. They are able to make huge sums of money but have proved very risky. Some have disappeared off the face of the earth since the crisis. The reason they are so risky is because they hold no assets whatsoever against a rainy day. In effect they are betting on credit with no financial backing. This means you have to win your bet every time because you can’t pay up if you lose.

An even more secretive and speculative part of the shadow banking system were the conduits and Structured Investment Vehicles (SIVs). Citigroup spun off an SIV called Centauri that had had lent out $21bn by the time the credit crunch struck. This is an example of the way the ‘legitimate’ Wall Street banks were enlisting the shadow banking system as an accomplice in these lucrative trades. Yet Centauri was not mentioned at all in the Citigroup 2006 annual report.

Then there are money market funds and other institutions that most of us have never heard of and have no idea what they do. But money market funds dispose of $3,000bn. In her article Road map that opens up shadow banking (Financial Times 18.11.10) Gillian Tett describes a diagram of the shadow banking sector as resembling the circuit board of a complex piece of electronic equipment.

We know that the Basel Accords imposed some standards of capital adequacy upon the mainstream international banks. We have seen that national regulations were being progressively torn up and the banks were successfully evading these backing requirements as leverage soared during the boom. But the shadow banking system was completely unregulated and unpoliced. Its activities were below the radar of the authorities. It introduced a new element of instability into the system. It helped spread the poison wider and faster.

The first part of the capitalist system to register the enormity of the shock that was coming was the shadow banking system. These murky institutions were making huge sums of money till 2007. They took a heavy hit by the end of the year. After all this sector was the stinking sump where most of the toxic securities ended up. Most of us never knew shadow banking existed in the first place. Much of this sector melted away as silently as it had been built up.

Naturally there are still financial institutions in the shadow banking sector making money. These firms are opportunist to their marrow. Their survival depends on their ability to duck and weave with the financial climate. But the sector was struggling by the end of 2007, and that anticipated the difficulties coming the way of the whole capitalist system.

In reality the death of shadow banking, like that of Mark Twain, has been much exaggerated. As we discover in Part 1: What happened in the Great Recession the Fed, the US central bank, as part of its desperate attempt to rescue capitalism, doled out $3.3trn to such deserving causes as hedge funds in the wake of the financial meltdown of 2008.

Gillian Tett (ibid) reports that the shadow banking sector handled $20trn in early 2008, compared with $11trn held in the mainstream banking sector. By the end of 2010 shadow banking assets had shrunk, but only to $16trn, while Wall Street holdings were up $13trn. The shadow banks were the buffers for the rest of the financial sector in 2008, but they have survived to do mischief another day. In reality they were umbilically linked to Wall Street (like Citigroup and Centauri). That is why the establishment moved heaven and earth to make sure the sector survived.

“The implosion of the U.S. financial system during 2007-2008 came about precisely because many financial firms outside the traditional and regulated banking sector financed their illiquid investments using short-term borrowing.” (Reinhart and Rogoff-This Time is Different, p.145)

Truly this sector was the wild west of international finance.

  • An      unregulated shadow banking system with unsound practices was allowed to      develop as part of the speculative frenzy of recent years.

Chapter 4.2: The financialisation debate

What is financialisation?

The majority of academic Marxists are unwilling to accept that the Great Recession is a classic crisis of capitalism of the type analysed by Marx. Many use the concept of financialisation to analyse the modern capitalist economy. They then move on to see the crisis as caused by financialisation. One example of this thinking is Costas Lapavitsas (Financialisation and capitalist accumulation: structural accounts of the crisis of 2007-9, p.3) where the author declares, “Financialisation represents systemic transformation of capitalist production and ultimately accounts for the crisis of 2007-9.”

There has indeed been a significant trend towards what has been called financialisation over the last three decades. The phenomenon of financialisation exists and needs to be examined. What does it mean? Martin Wolf identifies the key facts:

  • finance is      much more transactions oriented
  • there has      been a proliferation of new financial instruments
  • workers      have also increasingly been drawn into the maw of the credit system
  • financial      firms have become relatively more important in the functioning of the      capitalist system as a whole
  • non-financial      firms have more and more set up financial subsidiaries and resorted to      financial calculation in their objectives.

“Finance has become far more transactions-oriented. In 1980, bank deposits made up 42 per cent of all financial securities. By 2005, this had fallen to 27 per cent. The capital markets increasingly perform the intermediation functions of the banking system. The latter, in turn, has shifted from commercial banking, with its long-term lending to clients and durable relations with customers, towards investment banking….A host of complex new financial products have been derived from traditional bonds, equities, commodities and foreign exchange. Thus were born ‘derivatives’, of which options, futures and swaps are the best known. According to the International Swaps and Derivatives Association, by the end of 2006 the outstanding value of interest rate swaps, currency swaps and interest rate options had reached $286,000bn (about six times global gross product), up from a mere $3,450bn in 1990.” (Martin Wolf-The new capitalism: how unfettered finance is fast reshaping the global economy. Financial Times 19.06.07)

Here is Lapavitsas’ definition of the financialisation process. “Financialisation…has three main features. First less reliance of large corporations on banks; second, banks shifting their objectives towards mediating in open markets and transacting with individuals; third, increasing implication of individuals in the operations of finance.” (ibid)

This is not a definition. It is a list of practices. It is a list of features that are more common nowadays than in former times. How common do they have to be for financialisation to become an accomplished fact? We are not told. Still, at least Lapavitsas gives us a useful list of techniques associated with the concept.

Here is Epstein’s stab at a definition. “Financialization means the increased role of financial motives, financial markets, financial actors and financial institutions in the operations of the domestic and international economies.”  (Financialization and the World Economy, Introduction by Gerald A. Epstein, p.3)

This will not do!  This is not really a definition either. We cannot use Epstein’s form of words to analyse whether a particular capitalist economy can be regarded as an example of financialisation. The phrase just gives us quantitative trends, rather than describing a qualitative change. Again we ask: how much of an “increased role” in financial motives etc. do we have to have in order to be at the stage of financialised capitalism?

There are important differences between those who discuss financialisation and what it means for capitalism. Here is John Bellamy Foster (The financialization of accumulation, p.2):

“Financialization can be defined as the long-run shift in the center of gravity of the capitalist economy from production to finance. This change has been reflected in every aspect of the economy, including (1) increasing financial profits as a share of total profits; (2) rising debt relative to GDP; (3) the growth of FIRE (finance, insurance and real estate) as a share of national income; (4) the proliferation of exotic and opaque financial instruments and (5) the expanding role of financial bubbles.” In a footnote Foster makes it clear that he regards financialization as “a secular trend in today’s economy”, not as a stage in capitalist development.

We agree with John Bellamy Foster and Fred Magdoff, who assert: “We will argue that, although the system has changed as a result of financialization, this falls short of a whole new stage of capitalism, since the basic problem of accumulation within production remains the same.” (The great financial crisis, p.77)

We too regard financialisation as a long term trend in modern capitalism, but not as a “systemic transformation of capitalist production,” to use Lapavitsas’ phrase. It is because financialisation is a trend rather than an accomplished fact or stage which capitalism has attained that those who strive to analyse it constantly stumble over comparative terms such as “increased role” in their attempts to define the concept.

  • Financialisation      is an important long term trend in modern capitalism.

The financialisation thesis

We believe that some commentators, including some who regard themselves  as Marxists, have put more weight on the concept of financialisation than it can really bear. Advocates of financialisation in this latter sense suggest that it is central to a whole new phase of capitalist development. Many argue that finance is now dominant in some sense in modern capitalism (a view that we shall contest shortly). They contend that the Great Recession is purely financial in origin. We shall for convenience call this the ‘financialisation thesis’ in the rest of this discussion.

Costas Lapavitsas is concerned that “traditional explanations fare poorly in relation to this crisis” (Lapavistsas, p.4), and that there, “is an exceptional role of finance in causing the crisis” (ibid). In the first place, as we have explained earlier, capitalist crises all have unique as well as common features. This latest crisis is no different in that regard. If there is “an exceptional role of finance in causing the crisis”, that does not make it a new kind of crisis. He and those who think like him should take the title of Reinhart and Rogoff’s book This Time is Different seriously. It refers to the euphoric phase of any speculation-fuelled boom where the gamblers claim ‘this time is different’, just before boom topples over to bust – showing that this time is really just the same as last time.

Secondly Lapavitsas does not seem concerned about analysing the levels of causation involved in a multi-layered crisis such as that of 2007-9 (Though he was able to do this about the 1974-5 crisis. See Chapter 2.3 The crash of 1973-4.). His analysis of the current crisis suggests that finance has become over-mighty within capitalism, that it is inherently unstable and that is why we have a crisis. That’s it. We regard that view as superficial.

Lapavitsas’ position puts him close to Fred Moseley who, for instance, declares the present crisis to be “a Minsky moment” (The long trend of profit). He argues that Hyman Minsky’s Keynesian views on financial instability offer more guidance to understand the present than Marx’s theory of crisis. We dealt with Minsky’s views in more detail in Part 1: What happened in the Great Recession. Our basic answer to Moseley and to Minsky is that capitalism has always been crisis-prone, and it always will be, with or without financial panics and crashes.

The implications of the financialisation thesis seem to be reformist, though this is seldom spelt out. ‘Reformist’ is used here as an analytical term, not as an insult. Its advocates claim that the origins of the present crisis lie in the financial arena, and capitalism in its current phase is dominated by financialisation. If therefore we could attain a form of capitalism unburdened by financialisation, presumably such crises would disappear. Husson (In his paper Financial crisis or crisis of capitalism, p.1) sets himself the task in the opening paragraph of enquiring “how to reverse financialization,” not how to overthrow capitalism.

If we take this argument seriously, financialisation seems to be a negative feature for capitalism itself. We have every sympathy with those who see modern capitalism as a wasteful, destructive and parasitic social formation. We do not think we can hark back to a ‘nice’ capitalism as against the ‘nasty’ capitalism we are faced with at present. Capitalism has always been nasty! Nor can we do away with financialisation and leave capitalism intact.

Two questions immediately arise. Is a non-financialised form of capitalism in prospect? If it is, what strata of the capitalist class are prepared to fight for it? Should we set up a popular front with these people to march together to a crisis-free future? Alas, we see no section of the capitalist class eager to fight against financialisation. There is a reason for this.

It would be a profound mistake to see different forms of capitalism as options that can just be selected and picked off the shelf. Capitalism evolves; but the specific way it evolves in a specific country or region is the result of deep historical causes. These cannot simply be reversed by an act of will. Firms and capitalists that exist in a specific form or stage of capitalist development are conditioned in ways to survive and prosper within it. They are creatures and victims of the system. That perception is central to Marx’s analysis. He says of the capitalist, “His actions are a mere function of capital – endowed as capital is, in his person, with a consciousness and a will.” (Capital Volume I, p.739)

A closer look at the role of finance within the system might explain why a non-financialised capitalism is not on the cards. Surplus value is not generated in the financial sector. The profits declared by financial firms are a transfer from surplus value generated by productive capital. But functioning capitalists need a financial sector in order to realise their surplus value and to oil the wheels of commerce generally. The financial system is a necessary part of the capitalist system, though its upkeep is just a cost to the rest of the capitalist class.

In addition, the new practices and profit-making possibilities brought to the fore by financialisation affect the activities of all sections of the capitalist class, not just the banks and financial institutions. Lapavitsas states (ibid p.24), “Large corporations have acquired independent financial skills – they have become financialised.” He is right to deny that finance capital is dominant under financialisation. It would be a mistake to try to divide the capitalist class into ‘useful’ capitalists, whose firms produce surplus value, and the financial parasites who batten on their backs. There are no antagonisms between the two groups.

It is precisely because non-financial corporations use financial instruments and respond to financial parameters so much more than they did in the past that the Great Recession, starting in the banking sector, spread so quickly to the rest of the economy.

  • Modern capitalism      cannot separate itself from the tendency to financialisation.
  • The      ‘financialisation thesis’, that financialisation represents a new stage of      capitalism, is a misdiagnosis of the situation.

Finance and the capitalist system

The relationship between finance and the rest of the system has changed constantly over the course of the history of capitalism. Hilferding (in Finance Capital) already saw the domination of finance over industry as one of the key new features of capitalism at the dawn of the twentieth century.

What relation does his analysis bear to the modern advocates of the financialisation thesis? We mean those such as Epstein and many of the other contributors in the compilation Financialization and the World Economy, who see financial dominance as a new feature of capitalism one hundred years later.

Hilferding’s model was the German capitalism of his time. The specific phenomena incorporated into Hilferding’s theory are often seen as significant because they were part of the launching of German capitalism as a major competitor nation on the world economy. Whereas British capitalism evolved ‘organically’ from petty artisan production, and external finance therefore paid a subordinate role in accumulation, German capitalism could only compete on the world market at the time it emerged as big business. Big business required large amounts of fixed capital. This in turn meant that industrial capital could not be financed by private capitalists themselves alone from retained profits, as was generally the case with early British capitalism. Firms had to have recourse to borrowing. This gave the banks a key role.

Hilferding was one of the theorists who were trying to grapple with the complex of new features that made up the imperialist phase of capitalism a hundred years ago. Lenin was another.  The changing role of finance capital was one characteristic of imperialism. Imperialism definitely represented a new phase compared with the competitive capitalism analysed by Marx in Capital (based on nineteenth century Britain). It should be noted that Lenin (in Imperialism, the highest stage of capitalism) gave a broader sociological definition of finance capital than Hilferding’s strict reliance on the practices of German banks. This was because in part Lenin used and adapted the Liberal-radical Hobson’s analysis in his treatment of British imperialism. Likewise Lenin tended to speak of the ‘fusion of financial and productive capital’ in preference to Hilferding’s formulation of the ‘domination of finance capital.’

Both Lenin and Hilferding were grappling with the fact that capitalism in the early twentieth century was different in important respects from the capitalism described by Marx. It had evolved. It was of overwhelming importance for Marxists of the time to analyse the phenomenon of imperialism and the World War that had issued out of imperialism. Lenin analysed the cluster of features that made up imperialism: monopoly capitalism, the merger of finance and industrial capital, the export of capital, division of the world among capitalist associations and its division among the imperialist powers. This did indeed constitute a new era of capitalist development. The fundamental feature of imperialism was rooted in production. It was the transition from competitive capitalism to monopoly (what we would today call oligopoly).

It is obvious that the features of financialisation mentioned by Lapavitsas are not as important  “Less reliance of large corporations on banks; second, banks shifting their objectives towards mediating in open markets and transacting with individuals; third, increasing implication of individuals in the operations of finance” – all these, significant as they are, do not signify a new epoch of capitalism.

The fact that imperialism was indeed a new phase of capitalism did not in any case negate the basic features of the system. The cause, form and magnitude of capitalist crisis were unaffected. Imperialism was a structural feature of capitalism. We still live in the imperialist phase of capitalism, though direct colonies are no longer the rule as they were in Lenin’s time. So where does financialisation fit into the picture? Is it supposed to be opposed to or imposed on top of imperialism? New features and practices of modern capitalism of course, are constantly being thrown up, but financialisation does not change the basic nature of the system.

In reality financialisation does not represent the domination of productive capital by finance, but rather their interpenetration and the domination of both by financial calculation. Lapavitsas agrees with this approach. He states (ibid p.24), “Large corporations have acquired independent financial skills – they have become financialised.”

For instance every major car firm now has its own hire purchase company, such as the General Motors Acceptance Corporation and the Ford Motor Credit Company. Before these were set up, a car buyer would have had to save up, or try for a bank loan. These credit institutions are more than just a convenience to these car companies. They illustrate the way that production has been almost erased as a separate activity in a welter of financial calculation at the top of a big corporation. The crisis of these hire purchase companies was an important part of the present acute crisis inside the world motor industry.

We see that modern capitalists take a purely financial view of their firm’s operations. Not only that, they are increasingly intertwined with and dominated by financial institutions, financial instruments and financial considerations. Their ambition, mad as it may seem, is to move from the classical M – C – M’ (Money – Commodity – Money) circuit of capital to M – M’, to make money directly from money.

British and American firms have never been dependent on the banks for the provision of long term finance, and financialisation represents a loosening of the ties with the banks compared with the German version of capitalism analysed by Hilferding. Nowadays, instead of borrowing directly from a bank, firms issue a security for sale on the market which is handled by the bank for a fee.

  • The role of finance within capitalism has      changed throughout its history.
  • Theorists such as Lenin developed a completely      adequate explanation of the changing role of finance in the era of      imperialism.
  • Advocates of the ‘financialisation thesis’ do      not properly theorise where financialisation stands in relation to the      earlier analysis of imperialism.

A neoliberal age?

The financialisation thesis is often linked with the notion of neoliberalism. Michel Husson, for instance, refers to the ‘neoliberal age’. Alfred Saad-Filho, another advocate of the financialisation thesis, (Crisis in neoliberalism or crisis of neoliberalism? in Socialist Register 2011, p.242) declares, “Neoliberalism is the mode of existence of modern capitalism.” Phil Hearse speaks of the present period as a “neoliberal ‘regime of accumulation’”. (Socialists and the capitalist recession, p.8). And Dumenil and Levy’s latest book is called The crisis of neoliberalism, a title that shows they agree with the others.

It is quite true that there are distinct periods of capitalist development, each with its own features. We have characterised the period of the post-War boom (1948-73) as a unique golden age in this book. Many others have taken the same view. Now there certainly are huge differences between the era of the post-War boom, in which economic policy making was dominated by the economic theories of Keynes however bowdlerised, and the more recent period, dominated by the neoliberal ideology that has been adopted by decisive sections of the ruling class.

It is pointless just to argue over words. David McNally in Global Slump also refers to the neoliberal era. He means by this no more than that the last thirty years, in contrast to the golden age of the post-War boom, have been a period of ruling class onslaught on the working class internationally, and of capitalist restructuring. This is true and very important (though restructuring is a permanent feature of the accumulation of capital). But if we use the concept of a neoliberal era to represent a whole new stage in the development of capitalism, as other authors suggest, then a different analysis of the nature of the system is being proposed. If they are right, what are this period’s new features? How is capitalism likely to evolve? How much of our traditional analysis of capitalism will remain valid?

In our view it would be quite wrong to refer to the 1948-73 period as the age of Keynesianism. Keynes’ ideas did not determine the nature of the period. His ideas clicked and were widely adopted because they reflected the economic upsurge of the time. Keynesianism anticipated a trend towards class collaboration, of workers and capitalists both cutting themselves bigger slices of an expanding cake, as a possibility.

Likewise it would be wrong to characterise the subsequent age as one dominated by neoliberalism. Neoliberalism, like Keynesianism, is an ideology. The ruling ideas of the more recent period were the ideas of, and reflected the interests of, the ruling class of that period. Afflicted by crisis in their system, they needed to go on the offensive against workers’ living standards. Neoliberalism was and is their ideological assault weapon.

Some theorists such as Husson have not only associated financialisation with neoliberalism but also with increasing inequality between the classes in modern capitalism. It is quite true that the ascendancy of neoliberal ideas has inspired a wholesale onslaught on working class living standards and that the gap between rich and poor has grown over the past thirty years.

Husson argues that all these features together (financialisation, neoliberalism and increasing inequality) make up the conditions required to produce the Great Recession. The causal links are not obvious. In the first place neoliberalism is a political phenomenon, a ruling class response to changing conditions of capitalist development. Secondly capitalism has existed with very different levels of inequality in different times and in different countries. Inequality is a permanent, structural feature of capitalism. Inequality does not cause crisis, which is endemic to capitalism. Finally crises of overproduction have been features of capitalism throughout its evolution and are unique to capitalism – not just its financialised stage.

Husson argues not only that capitalism has become more unequal, but also that wages in the advanced capitalist countries have stagnated over this period. He does not actually prove this. He asserts:

“Financialisation is not an independent factor and it appears as the logical counterpart of the decline in wages and the scarcity of investment opportunities which are profitable enough. Therefore the rise of social inequalities…is a constitutive feature of the functioning of contemporary capitalism.” (Financial crisis or crisis of capitalism? p.2)

The link Husson has created between financialisation and inequality is not obvious. It is true that workers are more dependent on consumer credit than ever before. Does that mean that relative stagnation of wages has caused workers to try to maintain their living standards by borrowing – that inequality leads to financialisation? Or does financialisation impoverish workers and, if so, how? We are not told. In the latter case financialisation would cause the rise in inequality.  Husson himself is unclear as to the direction of causation between financialisation and the increased inequality that he asserts.

Wages have not actually declined in the advanced capitalist countries over recent decades, as the reader might think from reading Husson. Andrew Kliman has argued forcefully that the level of workers’ pay in the USA should correctly be measured by employee compensation, not just the money wage, because that is what bosses pay to employ workers. (This is pointed out in his forthcoming This sucker could go down.) Employee compensation has not stagnated even in the States.  Nobody seriously argues that wages have flatlined in real terms in the other advanced capitalist countries over recent decades.

Kliman also makes the case (in A crisis of capitalism) that the share of wages in US output has remained broadly stable. Wages have, it is true, grown more slowly than before.  Surely this is because the accumulation of capital, and with it the rate of growth, has slowed down since the golden age of the post-War boom.

It seems to be true that financial firms are taking a bigger proportion of total profits; Martin Wolf mentions a ratio of 40% of financial to non-financial profits in recent years (Financial Times 28.01.09, quoted in Harman-Zombie capitalism, p.383). It is elementary that financial firms do not directly exploit workers and thus do not produce surplus value from them. The financialisation thesis sees finance as battening first onto productive capital, and only secondarily on the working class by way of consumer credit.

This increasing share of profits accruing to finance must therefore come at the expense of ‘productive’ capital (that sector that generates surplus value). How does this affect the dynamics of the system? Some have tried to argue that financialisation has slowed the rate of accumulation. It is true that, since finance capital does not generate surplus value but just appropriates it, these increasing exactions will shrink the funds available for capital accumulation in the productive sector.

We have written previously on the growth of unproductive labour (unproductive of surplus value) relative to productive labour in the modern capitalist economy. (Brooks-Productive and unproductive labour) It is a vital issue in the long term development of capitalism. It has important implications for the rate of profit. Since the issues are complex, and the trend to unproductive activities has evolved over decades, we shall ignore it here as we are mainly analysing the boom-slump cycle.

We discuss Husson’s attempted explanation as to how this might occur in the section on Measuring the rate of profit. Investment is generally lower than in the era of the post-War boom. But the main reason for this is because the rate of profit has been generally lower, as we shall see.

  • Neoliberalism is the      ideology of capitalism on the offensive against the working class, not a      new age of capitalism.
  • The main reason for the      slowdown in accumulation over recent decades is not because of      neoliberalism or financialisation. It is because the rate of profit has      been secularly lower.

Financialisation and the Crisis

There are indeed new practices associated with financialisation. Finance capital has been endlessly innovative, though all this novelty does not produce an atom of surplus value. Paul Volcker, former Chair of the Federal Reserve has tartly observed that, of all the fiendishly complex financial instruments that have been invented in recent decades, the only innovation that has really benefited the consumer is the ATM (which our financial geniuses were quite unable to come up with). In any case new financial practices and techniques cannot be regarded in themselves as ushering in a new era of capitalist development.

We quoted Martin Wolf earlier as he explained how some of the specific practices associated with financialisation have changed the working of capitalism. Though he was very gung-ho about the future of capitalism at the time he was writing, it is clear now that many of the changes he outlined served to help trigger the credit crunch. He sums up the effects of these changes as follows:

“These derivatives have transformed the opportunities for managing risk.” (The new capitalism: how unfettered finance is fast reshaping the global economy. Financial Times 19.06.07)

This strikes us as a joke in view of the economic and financial ruins we see all around us now. The immediate reason for the credit crunch was that banks no longer hang on to mortgages and other assets, and just count the money from them as it comes in. As we now know they bundled these assets up and sold them on, including the toxic sub-prime mortgages, and passed these exotic securities on all round the world.  In other words they generalised risk rather than managing it.

The other side of this game of passing the risk parcel is that innumerable financial intermediaries have sprung up taking a cut – agency fees – for every transaction. This is what Wolf calls financial intermediation – turning loans into securities. But none of this was the root cause of the crisis. For this we have to turn to the driving force of capitalism –the rate of profit.

  • The trend to securitise assets as part of      financialisation has universalised risk, not eliminated it.

Financialisation and the rate of profit

It is a puzzle that so many academic Marxists should be reluctant to claim this crisis as proof of the correctness of Marx’s ideas. In part they have been misled by the financialisation thesis, which has caused them to misunderstand the nature of modern capitalism and the nature of the crisis as a result. They seem mesmerised by the extent of fraud and swindling during the boom. An ancillary reason why they have got it wrong is that some perceive the rate of profit in the twenty-first century to be higher than it really was and is, and therefore downplay it as the root cause of crisis. Lapavitsas, for instance, asserts (ibid p.18):

“The crisis of 2007-9 has little in common with a crisis of profitability, such as 1973-5, as is apparent from the extraordinary role of credit and the indebtedness of poor workers.” To buttress his arguments he makes a footnoted reference to Dumenil and Levy: “Dumenil has stated categorically at two RMF (Research on Money and Finance) Conferences that the crisis of 2007-9 is not due to falling profitability.”

This is not good enough. There is a serious debate on the rate of profit, and there are many well-grounded research papers that categorically deny Dumenil’s verbal assurances that he is right and almost everyone else wrong.

In addition, Lapavitsas’ remarks about “the extraordinary role of credit and the indebtedness of poor workers” are just beside the point. In the book (Political economy of money and finance, by Itoh and Lapavitsas, Macmillan 1999) Lapavitsas correctly identified the 1973-4 crisis as at bottom one of profit. This was despite ‘the extraordinary role of oil prices’ that many at the time concluded made it unique rather than a classical capitalist crisis of capitalism. Lapavitsas knew better then. In Political economy of money and finance p.193-4 he explains the fundamental cause of the 1973 crisis, “In short the underlying overaccumulation of capital worsened the conditions for the production of surplus value in the major capitalist countries and resulted in a fall in the profit rate.” What’s the difference now?

The financialisation thesis has been used in part by Husson as an ad hoc justification to account for the apparent paradox between the alleged rise in profits and the slow rate of accumulation. He suggests that financialisation syphons off much of the surplus value from productive capitals. It slows the system down:

“The growing mass of profits not invested was mainly distributed in the form of financial revenue, and here lies the source of the process of financialization. The difference between the profit rate and investment rate is also a good indicator of the degree of financialization.” (Financial crisis or crisis of capitalism? p.2)

Husson asserts, “The share of wages has fallen”. (ibid p.2) Husson here seems to assume that the neoliberal offensive has swept all before it everywhere. The distribution of income in modern capitalism is actually a complex question which needs to be argued and proved, not just asserted. Kliman has looked at the evidence for the USA and contradicts him (A crisis of capitalism).

There seems little doubt that the rich have got richer in most capitalist countries but that does not prove Husson’s point about the share of wages in national income. Even if this trend to a falling wages share and therefore a rising share of profits has been in operation, it has presumably proceeded at different tempos in different countries. The argument that there is a trend towards a bigger share of profits is linked to, but separate from, Husson’s argument that the rate of profit has risen over recent decades.  We examine the evidence in a later section, but we find his case is unsubstantiated.

After asserting that the wages share has fallen, Husson goes on, “And (the share) of investment stagnated: in these conditions who will buy production that continues to grow? The solution to this problem relies on the recycling of profits not invested, which is carried through by the redistribution operated by finance.” (ibid p.2)

Husson takes us back to a simple underconsumptionist view of the Great Recession which, as we argue at length later on, cannot explain the reasons for the crisis. He appears to argue that this syphoning off of surplus value should have the same ‘beneficial’ effect as Malthus ascribed to the unproductive consumption of the aristocracy in offsetting the tendency of capitalism to overproduction and crisis. If so, Husson’s thesis has been definitively disproved by the reality of the Great Recession.

Husson’s explanation for the alleged discrepancy between investment and profits is very ingenious, but our explanation is more straightforward. It is that Husson’s calculations are wrong and that the rate of profit is still much lower than it was in the 1960s, as we show later. In addition the fact that profits collapsed in 2006 before the Great Recession (as Husson admits), is by now almost universally accepted. This fall in the rate of profit can therefore be taken as the underlying cause of the crisis.

It should be emphasised that Husson is almost alone with Dumenil and Levy in asserting the complete recovery of profit rates in the new millennium. His calculations have been subjected to a severe criticism by Andrew Kliman in Master of Words.  We examine the problems of measuring the rate of profit for the new millennium in more detail in a separate section.

  • Though there are always      accidental factors involved in capitalist crisis, the fall in the rate of      profit has consistently been an underlying cause of crisis.
  • Those who argue that the      rate of profit has recovered over recent decades need to explain why the      rate of accumulation has remained depressed.
























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Part 3

Part 3: The accumulation of capital

The purpose of this Part is to show the explanatory power of Marxist analysis in looking at the dynamics of capitalism, including Marx’s theory of crisis. Then we can investigate how far Marx’s crisis theory illuminates our understanding of the great Recession.

The laws of motion of the system affect all our daily lives profoundly. Having a basic grasp of these laws of motion helps us to understand how changes in social being produce changes in consciousness and thus to participate in the fight for a better society – socialism.

This is not an attempt to ‘prove’ the labour theory of value, as Marxists have been challenged to do over and over again. It is intended rather to show the dramatic effects that the operation of the law of value has on working people’s lives.

The economics profession as a whole has shown itself to be clueless and in denial in the face of the Great Recession, an event  which could well serve to ruin the livelihoods of millions of working people all over the world. Marxism offers an explanation for the crisis, and a way forward from the chaos of capitalism.

This is in sharp contrast to economic orthodoxy which, at best, regards crisis as an accidental disturbance of production under capitalism. In the worst case, as we saw in the Introduction, official economists are prepared to swear blind that crisis is impossible, even after it has happened! By contrast Marx saw capitalism as a system which inevitably produces crisis. To understand why the system ‘breaks down’ from time to time, we need to know how it works the rest of the time.

Chapter 3.1: The problem of value


Marx begins his analysis in Capital Volume I with the commodity. The commodity is first of all a useful thing. That does not mean it has to be a material thing, as Marx makes clear. But use values are incommensurable. How do we compare apples with oranges?

Secondly it is an exchange value, which means it can be compared and exchanged with other commodities. To possess this quality of exchangeability commodities must possess a common property they share with one another – value. What does this common property consist of? Marx concludes that, “If then we leave out of consideration the use value of commodities, they have only one common property left, that of being products of labour” (Capital Volume I, p.128)

This approach to the problem of value is daunting to the first time reader, as Marx himself recognised. We intend to approach the issues in a different way. When his friend Kugelmann raised the difficulty of his approach in 1868, the year after the publication of Capital, Marx replied as follows:

“The chatter about the need to prove the concept of value arises only from complete ignorance both of the subject under discussion and of the method of science. Every child knows that any nation that stopped working, not for a year, but let us say, just for a few weeks, would perish. And every child knows, too, that the amounts of products corresponding to the differing amounts of needs demand differing and quantitatively determined amounts of society’s aggregate labour. It is self-evident that this necessity of the distribution of social labour in specific proportions is certainly not abolished by the specific form of social production; it can only change its form of manifestation. Natural laws cannot be abolished at all. The only thing that can change, under historically differing conditions, is the form in which those laws assert themselves. And the form in which this proportional distribution of labour asserts itself in a state of society in which the interconnection of social labour expresses itself as the private exchange of the individual products of labour, is precisely the exchange value of these products.” (Marx-Engels Selected Correspondence, p.209)

This is our starting point:

  • All      societies have to work in order to live.
  • All      societies have to allocate the labour available to them according to their      priorities.
  • In      a market economy this proportional allocation of labour and the products      of labour are regulated through the exchange value of commodities.
  • The      exchange value of commodities is determined on average by the labour time      required to produce them.

Socially necessary labour time

Corresponding to the twofold nature of the commodity is the twofold nature of the labour that produces it. Concrete labour produces specific use values, but use values are incommensurable. Marx shows that the substance of value is abstract labour. Abstract labour may be regarded as labour from the general pool of labour power available to any society. The magnitude of value is determined by the amount of labour time necessary to produce the commodity. Equal quantities exchange for one another. Marx goes on to qualify this at once:

“Some people might think that if the value of a commodity is determined by the quantity of labour spent on it, the more idle and unskilful the labourer, the more valuable would his commodity be, because more time would be required in its production. The labour, however, that forms the substance of value, is homogeneous human labour, expenditure of one uniform labour power. The total labour power of society, which is embodied in the sum total of the values of all commodities produced by that society, counts here as one homogeneous mass of human labour power, composed though it be of innumerable individual units. Each of these units is the same as any other, so far as it has the character of the average labour power of society, and takes effect as such; that is, so far as it requires for producing a commodity, no more time than is needed on an average, no more than is socially necessary. The labour time socially necessary is that required to produce an article under the normal conditions of production, and with the average degree of skill and intensity prevalent at the time…

“We see then that that which determines the magnitude of the value of any article is the amount of labour socially necessary, or the labour time socially necessary for its production.” (Capital Volume I, p.129)

  • To      qualify our previous conclusion, the value of a commodity is determined on      average by the socially necessary labour time involved in its production.

Market forces

The amount of socially necessary labour time to make the commodity is proportional to its price. We are treating money here as the monetary expression of labour time. Labour is not consciously allotted to different purposes. The division of labour is implemented through private exchanges mediated with money.

Let us look at how the allocation of labour is determined through the exchange process under capitalism which is, after all, an unplanned system. How many commodities of each type shall be produced? How much labour time shall be allocated to the production of each? These matters are decided by the impersonal forces of the market. The exchange of commodities is not just a private matter concerning the owners of the commodities. In fact every individual act of exchange is subject to objective economic laws that go to shape the dynamics of the entire capitalist system.

Exchange is the way that a vast global division of labour is established under capitalism through the world market. Since capitalism is an unplanned system, too many of some sorts of commodities are continually being produced, so prices fall below their value in the glut. Too few are produced of others, so prices rise above their value with the shortage. How could it be otherwise, since nobody knows how much is the ‘right’ amount to fulfil demand at any point in time? So the capitalists just go ahead, get the commodities produced, and hope they can sell them. Some make fortunes, others fail.

Commodities are usually sold above or below their value, subject to the forces of supply and demand. Only accidentally or occasionally are they actually sold at their value. But value is the axis around which the day to day movement of prices oscillates. Marxists do not deny the importance of supply and demand. For us these surface forces are the executors of the fundamental laws of motion of capitalism identified by Marx. As John Stuart Mill put it, the palpitations of the waves upon the surface of the sea do not negate the fact that there is a sea level and that it varies according to the pull of the tides.

  • The      law of value is executed by the forces of supply and demand in an      unplanned society where commodity production is universal.

What drives capitalism?

The establishment of this average socially necessary labour time is no abstract process outlined in books. In introducing the concept, Marx offers the following example:

“The introduction of power looms into England probably reduced by one half the labour required to weave a given quantity of yarn into cloth. The handloom weavers, as a matter of fact, continued to require the same time as before; but for all that, the product of one hour of their labour represented after the change only half an hour’s social labour, and consequently fell to one-half its former value.” (ibid p.129)

The determination of value by the amount of socially necessary labour time means that the quicker the commodity can be produced, the less it will cost. The speed with which the commodities can be produced depends on the productivity of labour. The power loom wiped out the handloom weavers on account of its greater productivity.

The formation of the socially necessary labour time for weaving cloth predominantly by power looms was a huge and dramatic incident in the early history of the British working class movement. It was an event, stretching over decades, which caused the impoverishment and ruin of hundreds of thousands of handicraft workers and their families. And the determination of socially necessary labour time in this devastating and revolutionary fashion is a continuous process under capitalism, causing upheaval and destroying livelihoods as it goes on.

What are the mechanisms driving this apparently impersonal operation of market forces? They are twofold: the need for the capitalists to exploit the working class more and more effectively; and the impulsion caused by competition between the capitalists themselves. As we shall see these processes are interrelated.

  • Capitalism      is driven by competition between capitalists and by the need all      capitalists feel to exploit their workers more effectively.

Chapter 3.2: Exploitation

Exploitation and class society

All societies, as Marx reminded Kugelmann, have to work for a living. All societies have to allot the products of the total labour among their members. Marx calls the labour required to produce the goods that make up the subsistence of the toilers necessary labour.

When the productivity of labour rises sufficiently to produce a surplus over and above the subsistence needs of the population, the question will be posed: who is to enjoy this surplus? The ruling class in all forms of class society is that section of the population that grabs and appropriates the surplus. Exploitation in all forms of class society is nothing else but the extraction of surplus labour by the ruling class from the toiling and exploited classes. Under capitalism this exploitation is hidden behind a veil, a veil that Marx was committed to pierce:

“Capital has not invented surplus labour. Wherever a part of society possesses the monopoly of the means of production, the labourer, free or not free, must add to the working time necessary for his own maintenance an extra working time in order to produce the means of subsistence for the owners of the means of production, whether this proprietor be the Athenian devotee of the good and the beautiful, Etruscan theocrat, Roman citizen, Norman baron, American slave owner, Wallachian boyar, modern landlord or capitalist.” (Capital Volume I, pp.344-5)

Marx cites the Reglement organique written by the boyars (landlord class) of what is now Romania to show that exploitation was central to their class society and to any class society. The Reglement was a kind of rule book specifying how much corvée (an obligation to perform unpaid labour) must be performed by the peasantry. The ‘beauty’ of this document, from Marx’s point of view, is that the principle of exploitation is spelled out and transparent. As he points out in the passage above, the ruling class in all forms of class society legitimises its exploitation through its ownership of the means of production. One difference between capitalism and the rule of the boyars is that in the latter case the right to snaffle unpaid labour from the peasantry is written down in a book!

“The comparison of the greed for surplus labour in the Danubian Principalities with the same greed in English factories has a special interest, because surplus labour in the corvée has an independent and palpable form.” (ibid p.345)

“The necessary labour which the Wallachian peasant does for his own maintenance is distinctly marked off from his surplus labour on behalf of the boyar. The one he does on his own field, the other on the seignorial estate. Both parts of the labour time exist, therefore, independently, side by side one with the other. In the corvée the surplus labour is accurately marked off from the necessary labour.” (ibid p.346)

In practice the Reglement allowed for unlimited exploitation. “The 12 corvée days of the Reglement organique cried a boyar drunk with victory, amount to 365 days in the year.” (ibid p.348)

In all forms of class society the wealth (mass of use values) is produced by the toilers. The product of their labour divides into necessary labour (labour that goes to their subsistence) and surplus labour (the fruits of exploitation enjoyed by the ruling class).

We shall return to the specific form of exploitation of the working class later.

  • Exploitation      is a common feature of all forms of class society.
  • It      involves a division in the labour performed by the exploited class into      necessary labour for their own maintenance and surplus labour,      appropriated by the ruling class.

Workers and peasants

There are obvious differences between those who work for a wage under capitalism and the wretched Wallachian peasantry. We can assume that the extraction of a surplus from the peasants by the boyars was closely accompanied by the threat of physical force. Exploitation certainly does take place under c   apitalism. In contrast to pre-capitalist class societies it need not in principle be accompanied by extra-economic compulsion. It classically occurs through what appears to be a contract over wages freely entered in to by both parties, as with other relations under capitalism. Exploitation happens through impersonal market forces.

That is the theory. In practice the capitalist class has never hesitated to use force when it suits their interests. Marx explains that the process of primitive accumulation examined below, the creation of the modern working class, “is written in the annals of mankind in letter of blood and fire.” (Capital Volume I, p.875) The dawn of capitalism also saw an obscene florescence of outright slavery as the direct counterpart to the emergence of wage labour. And capitalism created the world market through the colonial exploitation of three continents.

The capitalist state does have has a role in guaranteeing the profits of the capitalist class. “The modern representative state,” according to Engels, “Is an instrument of exploitation of wage labour by capital.” (The origin of the family, private property and the state, p.168) The state guarantees the rights of private property, which disproportionately benefits the capitalists, who own much more property than the workers. The state may intervene in the wage bargaining process, for instance to enforce a minimum wage or to pass anti-union laws. But the worker is usually exploited through the wages contract, without the direct intervention of the state.

It is actually this asymmetry of ownership that makes the wages contract a one-sided affair. The capitalist class, like every ruling class before it, has a monopoly over the means of production.

How this situation came to pass is a long story. Marx calls this process primitive accumulation, the accumulation of the preconditions for capitalist production. This consists on the one hand of the piling up of fortunes in the form of money. The Wallachian boyars, of course, measured their wealth in land.

Secondly primitive accumulation involves the complete separation of the toilers from independent access to the means of production. In the case of peasants, that means the loss of their own plot of land. The workers then have no option but to labour for a wage for the capitalist class, who have progressively acquired a monopoly in the means of production.

The capitalists own the factories, mines, farms and offices, the means of making a living under capitalism. The wage workers are formally free. Unlike the Wallachian peasants, they don’t have to work for a particular boss. The peasants in Romania were serfs, regarded as being as much an appurtenance of the land as a hedgerow, and their unborn children were regarded in the same light. We ‘free’ wage workers rightly see this as a monstrous form of slavery. But, as we can see from Marx’s description, the peasant household has access to its own field. We can assume that, despite the insatiable exactions of the landlords, in normal times the family can feed and clothe themselves at a modest level. Barring famines, their livelihood is more secure than that of a wage worker. Unemployment is not a threat; the word doesn’t even occur in their lexicon.

The difference between workers and peasants is that the workers are ‘free’ in two senses; they do not have to work for any particular capitalist. And they are free from any share in owning the means of production. They have no choice but to work for a capitalist, since the capitalists between them monopolise the means of production.

  • Unlike      peasants, workers are free in a twofold sense; first they are not obliged      to work for a particular capitalist.
  •  Secondly, since they have no right of      access to the means of production, they have to sell their labour power to      a capitalist in order to maintain themselves.

Chapter 3.3: The case of Henry Ford

We shall illustrate the dynamics of capitalism by looking at the history of a man and a firm – Henry Ford. We are fortunate in being able to make use of Upton Sinclair’s book The Flivver King. The Flivver was a popular name for the Model T Ford which, together with the Volkswagen Beetle, was the most iconic and important car of the twentieth century. Sinclair wrote his book in 1937 as part of a drive to unionise Ford Motor Co. Although the characters in the book such as Abner Shutt, his family and neighbours, are fictitious, Sinclair drew his information on Ford-America from the public domain. It is not only accurate but sharply observed, informed as it is by a socialist perspective.

Labour power

Workers are told they are paid for the work they do. After all, they are free agents. If they don’t like the boss, they can collect their cards and go somewhere else. There seems to be no exploitation in the wages contract. If you work overtime, you get paid more for more work. If the firm falls on hard times and has to impose short time working, you will lose money. If you are paid for piece work, the harder you work the more you get paid. What could be fairer than that?

Marx described the standard of living enjoyed by the exploited in class society as their means of subsistence. Does this apply to the wages that workers earn in capitalist society as well? Marx rooted the exploitation of wage labour in the fact that, despite appearances, workers are not actually paid for the labour they perform. They are paid for their labour power, their subsistence:

“We mean by labour power, or labour capacity, the aggregate of those mental and physical capabilities existing in the physical form, the living personality, of a human being, capabilities which he sets in motion whenever he produces a use value of any kind.” (Capital Volume I, p.270)

So the capitalist buys a capacity, not a predefined lump of work. What does he get for his money? He gets labour. Labour is the use value of labour power. How much labour he gets out of that capability is up to him. Like the Wallachian boyar, he is forever thinking up ways to squeeze more out of this labour power. That drive, and the resistance to it, forms the central thread of much of the remainder of this narrative.

Through most of Capital Volume I Marx assumes that workers are paid by the day, though he carefully examines other forms of payment such as piece work in Part Six: Wages. He does so for two reasons. The first is that most British workers in the nineteenth century were paid by the day. The second reason is that, whatever the form of wages such as payment by results, they really represent a subsistence for the workers.

In comparing the British factory workers of his time with the Romanian peasant, Marx uses the following example to show how the identical process of exploitation is going on:

 “Suppose the working day consists of 6 hours of necessary labour, and 6 hours of surplus labour. Then the free labourer gives the capitalist every week 6 x 6 or 36 hours of surplus labour. It is the same as if he worked 3 days in the week for himself, and 3 days in the week gratis for the capitalist. But this is not evident on the surface. Surplus labour and necessary labour glide one into the other. I can, therefore, express the same relationship by saying, e.g., that the labourer in every minute works 30 seconds for himself, and 30 for the capitalist, etc.” (ibid pp.345-6)

In Marx’s hypothetical example above the worker works 6 hours ‘for himself’, that is to reproduce values sufficient to be exchanged for money equivalent to his wages. He then works 6 hours in the 12 hour day he works for 6 days a week to produce surplus labour. Under capitalism this surplus labour is called surplus value. The rate of surplus value, the rate of exploitation, in this case is 100%. As we shall find out later on, not all this goes directly to the capitalist who directly employs the workers. It goes to feed the entire class of exploiters.

The process of exploitation is veiled. Henry Ford didn’t wave a copy of the capitalist equivalent of the Reglement Organique at the workers like a Wallachian boyar. All we see in the factory of the Henry Ford Motor Co. is cars coming off an assembly line. In fact some cars are sold so as to pay the workers’ wages and more cars are sold to be turned into surplus value. This is how the workers are paid for their subsistence. For part of their working day, working hour, working minute or for any piece of work they perform they are in effect working for themselves. The rest of the time they produce a surplus for the boss class, surplus value.

  • Whatever      the form of appearance of the wages contract, workers are not paid for the      work that they do but for their labour power.

Subsistence and class struggle

What does subsistence mean in this case? The subsistence requirements of an American worker working for Ford are certainly different from those of a Wallachian peasant. The Shutts, at one point in Upton Sinclair’s narrative, are a four car household. In fact this was the only way they could get around Detroit at the time. Cars were a necessity, which is not to say that every working class household could afford one. Sinclair’s book is full of incidents where, in hard times, the car has to be sold or is repossessed.

Marx of all people was least inclined to ignore the class struggle. He knew that workers aspired to share in the greater and greater quantity of wealth they were creating. “In contrast, therefore, with the case of other commodities, the determination of the value of labour power contains a historical and moral element.” (ibid p.275)

Upton Sinclair records the fact that in January 1914 Henry Ford introduced a minimum wage of $5 per day for his workers. Sinclair notes that, so far from being a unilateral act of philanthropy, Ford was grappling with massive problems of absenteeism and labour turnover, caused in large part by the relentless speedup imposed at the Ford plant. Sinclair also tells us of the regime of spies and busybodies that were part of the Ford way of life at Highland Park. The book recounts the daily struggle for a decent existence by the Shutt family and their fellow workers. For instance in 1930 when Henry Ford magnanimously unveiled his plan to raise the basic wage to $7, “There were only a few soreheads to point out that since Henry had established his five-dollar minimum, sixteen years back, the cost of living in the Detroit area had nearly doubled, so that the new seven-dollar wage was far less than the old one had been.” (Sinclair p.73)

American workers at this time were the most prosperous in the world. Yet the workers at Ford were still scrambling to keep up with the cost of living. Savings they built up in good times disappeared during layoffs and recession. Workers in the USA were still being paid a subsistence, though with “a historical and moral element.” (Capital Volume I, p.275)

Meanwhile Henry Ford, who Abner Shutt had first encountered as an enthusiast trying to build a horseless carriage in his neighbourhood workshop, had become a billionaire, the richest man in the world. And he had done so from his workers’ unpaid labour.

  • Wages      paid for the workers’ labour power do not just provide a bare physical      subsistence, but contain a historical and moral element.

Ford and socially necessary labour time

The law of value states that the value of a commodity is determined on average by the amount of socially necessary labour time involved in its production. That means that value is inversely related to productivity. The more productive the workers are, the less value the commodities they produce will contain, and the less they will tend to cost. This law is executed by competition between capitalists. It was Henry Ford’s genius that he didn’t see the motor car as a toy for the rich, as so many of his contemporaries and rivals did, but as a tool for the masses. He had to sell cheaper than the competition. The best way to do that was to make his cars cheaper, by means of mass production techniques. Labour saving tools and machinery are so called because they economise on the expenditure of labour time, and therefore allow each commodity to contain a smaller amount of value and to cost less.

“In 1909, before the assembly line method was introduced, just over 12,000 Model T Fords were sold at around $950 each; by 1916 sales had risen to 577,000 while the basic price had fallen to $360. This achievement was partly a result of pronounced economies of scale of speed (the average time for assembling a chassis falling from 12.5 man hours in June 1913 to 1.5 man hours in January 1914). (Schmitz–The Growth of Big Business in the United States and Western Europe, 1850-1939, p.63)

Schmitz talks of ‘economies of scale and speed’ (a term he borrows from Alfred Chandler). What does he mean but the coercive operation of the law of value? Why should the price of the Model T have fallen from $950 to $360 in seven years? Because it took much less labour time, socially necessary labour time, to produce one.

Writing of the panic of 1907, Sinclair observes, “It cut down the Ford sales slightly, but not much, for this new product was more and more wanted, and among the hundred million people of America there are always some who can buy what they want. Henry Ford, planning tirelessly, would find new ways to give it to them more cheaply. In the year after the panic he produced 6,181 cars, a little over three per worker; but within three years he was managing to get thirty-five thousand cars out of six thousand workers. (Sinclair p.21)

Here Sinclair calculates the effect of rising productivity on the price of the cars directly in labour time. One worker in 1910 is now producing nearly six cars in a year. The productivity of labour has doubled in three years.

  • Raising      the productivity of labour means that workers produce more use values in a      given time.
  • Since      the value of the commodities is determined by the socially necessary      labour time involved in their production, they will get cheaper as      productivity rises.

The division of labour

“The work of assembling the flywheel magneto, a small but complex part, was put on a sliding table, just high enough to be convenient for the workers, who sat on stools, each one performing one operation upon a line of magnetos, which crept slowly by. In the old way, a man doing the work of making a magneto could turn out one every twenty minutes; now the work was cut into twenty-nine operations, performed by twenty-nine different men, and the time per magneto was thirteen minutes and ten seconds. It was a revolution

“They applied it to the making of a motor. Done by one man, it had taken nine hours and fifty four minutes. When the assembling was divided among eighty-four different men, the time for a motor was cut by more than forty percent.” (Sinclair p.26)

No doubt when Upton Sinclair penned this passage he was aware as to how strikingly it resembles the example given at the beginning of Adam Smith’s book, The Wealth of Nations. Smith showed how the division of labour in a pin factory means an enormous increase in the productivity of labour in making pins:

“To take an example, therefore, from a very trifling manufacture; but one in which the division of labour has been very often taken notice of, the trade of the pin-maker; a workman not educated to this business…could scarce, perhaps, with his utmost industry, make one pin in a day, and certainly could not make twenty.”

Then Smith outlined how the division of labour works:

“One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations; to put it on, is a peculiar business, to whiten the pins is another; it is even a trade by itself to put them into the paper; and the important business of making a pin is, in this manner, divided into about eighteen distinct operations.”

Smith observed the effect at first hand in a small pin factory. The improvement in productivity was dramatic:

“Those ten persons, therefore, could make among them upwards of forty-eight thousand pins in a day.”

We would expect the price of pins to fall as a result, since they are composed of so much less socially necessary labour time than before, just as the price of cars fell steadily as productivity improved in the motor industry. The other thing to note is that the workers become more and more productive as a natural result of the division of labour. Yet under capitalism the benefits accrue to the owners of the means of production.

  • The      division of labour raises the productivity of labour, but the benefits      accrue to the capitalist.

Rising productivity and the car industry

The effects of enhanced productivity in the car industry were not confined to Henry Ford and his plant. At the dawn of motor production dozens, hundreds of enthusiasts were tinkering with prototype horseless carriages in sheds and workshops. If this reminds the reader of the early days of Silicon Valley, it should do. The transition from craft to mass production methods is a natural and normal part of the innovation process under capitalism.

In the UK alone 221 firms began motor manufacture between 1901 and 1905. S.B. Saul observes that 90% of these had left the industry by 1914. (The motor industry in Britain to 1914) The USA had a much bigger home market for cars and was a more advanced capitalist country by this time. The same process of the concentration of capital advanced there with seven league boots.

Later professionalisation of the trade meant the transition from amateur enthusiasts, such as Henry Ford had been in the beginning, to the production of relatively expensive motors by craft methods, till Ford’s mass production methods began to dominate the industry. What happened to the pioneers of car production? Unless they managed to find a niche as a sports or luxury model (The Model T was a very basic design, which made it easy to mass produce, and it was much ridiculed as a result.) they were bound for extinction. “One capitalist always strikes down many others”, as Marx says (Capital Volume I, p.929). Henry Ford’s advances in assembly line production struck down many aspiring motor manufacturers.

The rise in productivity made possible by assembly line techniques inevitably means that smaller and weaker laggard capitals fall by the wayside. They simply can’t keep up with the industry leaders and innovators. The scale of production inevitably rose with the vastly increased output from the new plants.  By the 1930s the US auto industry was completely dominated by three mass production giant firms – Ford, General Motors and Chrysler. But though there were far fewer firms in the industry, the big three in Detroit still saw each other as rivals. Every Ford sold meant an American citizen who would not be buying a Chrysler or a GM car any time soon. Competition remained the driving force of the accumulation of capital.

“Henry Ford might insist, as he continually did, that competition was wrong, and that he did not believe in it; but the fact was that he was competing at every moment in his life, and would continue to do so as long as he made motor-cars. In a hundred different plants scattered over the United States efforts were being made to beat him. In the long run, the successful ones would be those who contrived, by one method or another, to get the most out of a dollar’s worth of labor.” (Sinclair p.27)

So this competition was not just a contest between capitalists as to who could make and sell cars cheapest. It was also at bottom, as Sinclair notes, a contest in squeezing more and more surplus out of the working class.

  • Competition      between capitalists produced dramatic increases in productivityand the      scale of production, and falls in the price of cars.

Surplus value in practice

Where did Henry Ford’s profits come from? From his workers – where else could they possibly come from? The workers at Ford, like the peasants in Romania, were being exploited. That means that some of the value added in production went to reproduce the elements of their wages. And some of the value they added went to make Henry Ford rich. Surplus value is the unpaid labour of the working class.

Upton Sinclair did not have the information to work out the rate of exploitation at Ford. Business secrecy is protected precisely so such details won’t leak out. But the facts speak for themselves. At the beginning of the tale Henry Ford lives in the same neighbourhood as Abner Shutt. By the 1930s he is the richest man in the world, a billionaire.

In 1909, we are told, Ford was selling 12,000 cars at $950 each. Some money from those cars he sold went straight to pay the workers’ wages. Some went to pay for other expenses – the cost of depreciation on the plant, electricity, tyres upholstery and the rest. And some went into Henry Ford’s pocket. This was a surplus, just like that appropriated by Etruscan theocrats, Norman barons and the rest of them. It was surplus value. It was unpaid labour, the fruits of exploitation.

In the hypothetical example Marx used in comparing the exploitation of factory workers in Britain, he suggested that the workers worked six hours to produce the elements of their own subsistence and six hours in producing surplus value. There are two factors that veil the reality of this exploitative relationship: the first is that the nature of the wages contract suggests that the workers are being paid for their labour; in fact they are being paid for their labour power, for their keep.

The second is that (unlike the Danubian peasant) the wage worker doesn’t actually produce all the commodities that they buy with their wages. In the usual way they will specialise in producing a single commodity all day. Usually they will be a detail worker in the production process. Neither will they normally spend part of their time producing goods their boss will consume. They find themselves part of a vast worldwide division of labour imposed by the market, in which commodities produced by the workers of the world are all exchanged against money and pass from continent to continent.

What is the rate of surplus value in the UK today? From the government ‘Blue Books’ used long ago by Marx we can find data that, though rough and ready, can give us a clear idea of the rate of exploitation. We choose the year 2007 as the last set of statistics likely to be unaffected by the crisis. (Crises usually hit profits harder than wages.) All figures are at current market prices.

Gross Domestic Product                         £1,401.042m

Compensation of employees                    £744.857m

Surplus value                                           £656.185m

The formula for surplus value is S/V, where S is surplus value and V is variable capital, the sum laid out by the capitalist on wages. Surplus value is derived simply by deducting employee compensation (which we identify as the wages bill for the country) from GDP. Everything apart from employee compensation counts as surplus value. In the figure for surplus value we have therefore included the following categories:  Operating surplus, Taxes, Government supply, and a mixed, mysterious category called Mixed income, which is a little less than 6% of GDP for that year.

This gives a rate of surplus value of about 87%.

Assuming a working day of 7 hours, the workers work on average about 3 hours 45 minutes for themselves and 3 hours 15 minutes to produce surplus value.

(From United Kingdom National Accounts: Blue Book 2007, Office for National Statistics)

[Why include taxes as part of the surplus value? Here is the traditional Marxist justification for the procedure:

“‘Taxes!’ A matter that interests the bourgeoisie very much but the worker only very little. What the worker pays in taxes goes in the long run into the cost of production of labour power and must therefore be compensated for by the capitalist.” (Engels, The Housing Question, p.36)]

  • The      working class is exploited by the capitalist class, who extract a surplus      from them.
  • The      form taken by the surplus extracted from the workers is surplus value, the      unpaid labour of the working class.
  • The      worker also spends time on necessary labour, producing commodities that      are sold to pay their wages.

Chapter 3.4: ‘Getting the most out of a dollar’s worth of labor’

Raising the rate of surplus value

As we have seen, in the battle to make more profits the capitalists need to compete against their rivals. They sell cheaper by making cheaper, raising the productivity of labour in the process. All the time they are engaged, as Upton Sinclair puts it, in the search “to get the most out of a dollar’s worth of labor.”

The extraction of surplus value gives us the basic anatomy of capitalism as a system of exploitation, as a form of class society. But, since the search for surplus value is never ending, it also provides us with the framework to analyse the dynamics of capitalism.

The rate of surplus value or rate of exploitation is given by the formula S/V, when S is surplus value and V is variable capital. For instance, when Marx gave the example of the British factory worker compared with the Romanian peasant, he suggested the former worked six hours for himself and six for the capitalist. In that case the rate of surplus value (S/V) would be 6/6 or 100%. How can the capitalists raise the rate of exploitation? Marx deals with two main methods: these are raising absolute surplus value and increasing relative surplus value.

“The surplus value produced by prolongation of the working day, I call absolute surplus value. On the other hand, the surplus value arising from the curtailment of the necessary labour time, and from the corresponding alteration in the respective lengths of the two components of the working day, I call relative surplus value.”  (ibid p.432)

  • The      capitalists are impelled by competition among themselves, and by the need      ‘to get the most out of a dollar’s worth of labor’, to increase the rate      of surplus value, the rate of exploitation

Absolute surplus value

The search for absolute surplus value is dealt with magnificently in Chapter 10 of Capital Volume I, entitled The working day. If workers are paid by the day, as most were in the nineteenth century, then what could be simpler than for the boss to demand that they work more and more hours for their recompense?  In terms of our earlier example, if  the bosses manage to force the workers to work a 14 hour day instead of 12 hours, while still paying them the same daily wage then the rate of surplus value (S/V) rises to 8/6 = 133%.

As is often the case in the early stages of an industrial revolution there were masses of desperate people prepared to work for a pittance. No doubt bourgeois economists would put down the possibility of super-exploiting these workers by extending the working day without limit to the forces of supply and demand. The supply of labour exceeded the demand, so the ‘price’ of the workers fell.

In a sense they are right. Supply and demand is important, specially when it is you who are supplying yourself and being demanded (or not) by the bosses. Marx was very much alive to the opportunities provided by recession for the capitalists to try to drive wages below the value of labour power which, as we know, is a level ultimately decided by class struggle. Upton Sinclair was equally aware of this, as he shows in his book. Both men also knew that periods of boom and relatively full employment provided the working class with the best opportunity to advance the level of real wages.

Upton Sinclair does not deal with the production of absolute surplus value as a way of raising the rate of surplus value in his book. The length of the working day was taken as a given in early twentieth century America by most sections of the working class. Workers were by and large paid by the hour. But the main reason for its unimportance to the likes of Henry Ford comes from the obvious advantages of assembly line production, speedup and other techniques to raise the rate of exploitation.

That does not mean that the extraction of absolute surplus value has ceased in modern capitalism. We can all list the occupations where workers are expected to work all the hours to make up a living wage. The mere payment of wages by the hour does not rule out the setting of an hourly rate at such a low level that vulnerable workers are forced to work far longer than the norm established by the better organised sections of the working class.

The extraction of absolute surplus value does not require much initiative or entrepreneurial skill. All the employer needs is the whip hand over the workers. But it was a very successful means of raising the rate of exploitation in the early years of the British industrial revolution. In the end the decisive victory over this process of lengthening the working day was achieved by the British working class itself, pressing for the legal limitation of the working day.

Marx also observes that the capitalist enthusiasm for overworking their employees was in danger of killing the goose that laid the golden eggs. He quotes the  Inspectors of Factories as advising that, “The Ten Hours’ Act, in the branches of industry subject to it has ‘put an end to the premature decrepitude of the former long hour workers’” (Capital Volume I, p.416)

  • The      capitalist gains absolute surplus value by making the worker labour longer      for the same wages.
  • That      means the worker spends more time in producing surplus value and a smaller      proportion of their labour time on necessary labour.

Relative surplus value

If the worker is paid by the day and we regard the working day as fixed for the time being, there is only one other way the capitalist can raise the rate of exploitation. Since the working day is divided into a paid part and an unpaid part, the capitalists must reduce the hours that the workers labour to produce the elements of their own maintenance. This will automatically increase the hours they produce surplus value. And the way to do that is to raise the productivity of labour.

The extraction of relative surplus value is a much more complex process than that of absolute surplus value. It is not a conscious outcome of the calculations of the capitalists. Marx says that in essence it consists in shortening the amount of time the workers labour to produce the elements of their wages. But, as we know, the workers do not spend time in the workplace producing all the things they need to subsist on in their natural form. So how does this process work? The impetus comes from the need for capitalists to compete with one another and thus to raise the level of productivity of their workers.

The outcome of increased productivity means that commodities are produced with less socially necessary labour time. In monetary terms they are cheaper. We now have to consider what the effect of cheapening commodities has on the economy as a whole. One possibility is that they are wage goods, commodities that by and large are bought by workers with their wages. If they are wage goods, what will happen when they get cheaper? Will the workers enjoy a higher and higher standard of living through the falling price of necessaries? Our answer is, ‘not necessarily’. Falling prices do not always afford the workers a rising standard of living. The issue is determined by the balance of forces between worker and employer, by the class struggle.

It is quite obvious that workers in advanced capitalist countries have made big gains in their standard of living compared with 200 years ago. There are many more goods in the notional basket of commodities that make up the elements of their maintenance than was the case in the reign of Queen Victoria. Many of these new wants were not even invented at that time. To be fair to Henry Ford, part of his vision was that ordinary working people, wage workers and small farmers, would be able to afford a car made by the methods of mass production he pioneered. It is also the case that for workers and farmers at that time their Model T Ford was not a luxury for riding out on Sunday. It was a necessity for getting to work or sending their crops to market.

  • Relative      surplus value is gained by making the worker labour more effectively, more      productively, in a given time.
  • This      means that the worker spends more time producing surplus value and less time      on necessary labour.

Raising the productivity of labour

Marx’s analysis of the extraction of relative surplus value in Capital remains the core of our analysis here. If productivity doubles throughout the economy then prices will halve. If we assume that workers’ living standards remain the same in real terms then, if they formerly worked four hours to produce the elements of their subsistence and four hours producing surplus, they now only need work two hours to produce the basket of goods they need to subsist upon. That means they can work six hours for the boss in an eight hour day. The rate of exploitation has jumped from 100% (S/V = 4/4) to 300% (S/V = 6/2).

Here is the classic position outlined by Marx:

 “The cheapened commodity, of course, causes only a proportionate fall in the value of labour power, a fall proportional to the extent of that commodity’s employment in the reproduction of labour power. Shirts, for instance, are a necessary means of subsistence, but are only one out of many. The totality of the necessaries of life consists, however, of various commodities, each the product of a distinct industry; and the value of each of those commodities enter as a component part into the value of labour power…Whenever an individual capitalist cheapens shirts, for instance, by increasing the productiveness of labour he by no means necessarily aims at reducing the value of labour power and shortening, by as much the necessary labour time. But it is only in so far as he ultimately contributes to this result that he assists in raising the general rate of surplus value. The general and necessary tendencies of capital must be distinguished from their forms of manifestation.” (ibid p.433)

Just to emphasise the last point. The capitalist does not set out to reduce the labour time necessary to reproduce the elements of the workers’ subsistence. All he seeks is to steal a march over his competitors. Yet raising the rate of surplus value is the ultimate outcome of the capitalists’ acts. Marx does not derive the laws of motion of capitalism from the motivations of the capitalists. On the contrary he sees the motivations of the capitalist as a product of their position in bourgeois society.

  • The      production of relative surplus value is an unconscious process, driven by      competition between capitalists.
  • The      overall result of this competition is to raise the productivity of labour      and make commodities cheaper.
  • This      reduces the necessary labour time performed by the worker, and therefore      raises the rate of exploitation.

Vanishing super-profits

Capitalists compete with one another. The overall result of this competition is that productivity rises and prices fall. Naturally this is a process that takes place unevenly in real time. The first capitalists who introduce a labour saving technique can sell the commodity at a price corresponding to the prevailing socially necessary labour time. This is set at the standard level of productivity then established within the industry. Since the innovators have actually had the commodity produced with less labour time (i.e. in principle cheaper) they can make a super-profit for a period of time by selling their goods above their individual value, at the prevailing industry norm.

As their competitors hasten to retool with the new technique, the value of the commodity (the socially necessary labour time required to produce it) will gradually fall to a new, lower average and the super profit will disappear. Thus the pursuit of a higher rate of profit is like chasing a will o’ the wisp.

Here is an example showing graphically how the value of a commodity is determined by socially necessary labour time in the longer term, and how raising the productivity of labour drastically reduces the value of the commodity and its monetary expression, price.

The first ballpoint pen was produced for sale by the Reynolds International Pen Company in 1945:

“The price was set at $12.50…In the early stages the cost of production was estimated to be around $0.80 per pen…By early 1946 (Reynolds) employed more than 800 people in its factory and was producing 30,000 pens per day”

Rival firms sprang up. So, “Reynolds introduced a new model, but kept the price at $12.50. Costs were estimated at $0.60 per pen.”…“Fortune reported fears of an impending price war in view of the growing number of manufacturers and the low cost of production.”…“By Christmas 1946 approximately 100 manufacturers were in production, some of them selling pens for as little as $2.98.”…

“In mid 1948 ballpoint pens were selling for as little as $0.39 and costing about $0.10 to produce. In 1951 prices of $0.25 were common. Within six years the power of the monopoly was gone for ever.”

This example is taken from Richard G. Lipsey-An introduction to positive economics, p.393, a standard economics textbook. Lipsey is an opponent of the labour theory of value. The whole of his book is intended to provide an alternative explanation of economic phenomena. Yet this example shows graphically how the law of value is the regulator of output and price under capitalism.

The search for super-profits not only generalises the use of new technology throughout the capitalist system; it also opens up new areas of the globe to capitalism. The conquest of new markets is usually associated with the reaping of super-profits, with a higher rate of profit. For instance when British capitalists began to export machine woven cotton to the rest of the world, local handloom weavers were wiped out because they could not compete on price. Locals in the rest of Europe, Asia, Africa and the Americas would compare the price of the imported cloth with prices associated with the productivity of handloom weaving and find the British products cheap.

This is the usual good fortune of industrial pioneers under capitalism. They can sell for a time at a price above the individual value of their product but below the norm established by the former level of productivity, the prevailing social value. Eventually the level of productivity associated with the new technology will become the norm all over the world and super-profits will disappear. This was a painful process that involved the destruction of the livelihoods of millions of handloom weavers all over the world. Even when the lower prices associated with the productivity of machine woven cloth became the norm, the sheer mass of profits from a market of the whole world made the Lancashire cotton magnates very rich. The result of this search for super-profits in new and distant markets binds the world together within the capitalist market.

  • Capitalists      compete with one another to make commodities cheaper.
  • If      they can sell their commodities cheaper as a result, they will make a      super-profit for a time.
  • Capitalists      also try to make a super-profit by invading markets not yet completely      subject to the laws of capitalism.
  • The      outcome of their endeavours is to extend the global reach of the capitalist      system.

The logic of capitalism

This is how Marx explains the effects of this search for super-profits:

“On the other hand, however, this extra surplus value vanishes, so soon as the new method of production has become general, and has consequently caused the difference between the individual value of the cheapened commodity and its social value to vanish. The law of the determination of value by labour time, a law which brings under its sway the individual capitalist who applies the new method of production, by compelling him to sell his goods under their social value, this same law, acting as a coercive law of competition, forces his competitors to adopt the new method.” (Capital Volume I, p.436)

The net result of this competitive process, unknown to the competitors, is that commodities in general will be produced with progressively less labour time and therefore be represented with a smaller quantity of value. That is surely progress for humanity at least in principle, even if it is an unconscious result of the striving of the capitalists for super-profits.

In the twenty-first century we all take for granted many things that were no part of the Shutts’ subsistence basket in the 1930s. So what? The working class has gained some share in the enormous outpouring of commodities we have contributed to. We are more dependent than ever upon wage labour on account of the ruling class’s grip upon our livelihoods for us to make a living. The shackles of wage slavery have still to be struck off.

The motivation of the capitalists in searching for super-profits is not to raise the rate of relative surplus value but to steal a march on their competitors. The intention of the individual capitalist and the outcome of the working of the law of value are two completely different things. The law of value actually works through continual attempts by capitalists to negate its operation. The analysis of the production of relative surplus value is a classic illustration of the general position taken by Marx, that the laws of capitalism operate behind the backs of the individual economic actors, whether workers or capitalists:

“It is not our intention to consider, here, the way in which the laws, immanent in capitalist production, manifest themselves in the movements of individual masses of capital, where they assert themselves as coercive laws of competition, and are brought home to the mind and consciousness of the individual capitalist as the directing motives of his operations. But this much is clear; a scientific analysis of competition is not possible, before we have a conception of the inner nature of capital, just as the apparent motions of the heavenly bodies are not intelligible to any but him, who is acquainted with their real motions, motions which are not directly perceptible by the senses.” (ibid p.433)

  • When      the new technology and higher level of productivity associated with it are      taken up generally within the industry, the super-profit will disappear.
  • The      laws of capitalism operate behind the backs of individual capitalists and      independently of their will.
  • The      result of the search for super-profits is to raise the overall level of      productivity and the global reach of capitalism.

Intensity of labour

The production of more absolute surplus value is achieved by making the worker labour for more hours for the same wages over the working day. The capitalist also strives to make the wage earners work harder in the time they are at work. “Increased intensity of labour means increased expenditure of labour in a given time” (ibid p.660).

To achieve this, the capitalist needs to control the labour process. As we have seen in the case of Ford, this is accomplished by mass production methods that turn the workers into an appendage of the machinery.

The principal ways the capitalists can make the labour of one hour worth more to them than before is by making the workers produce more use values in a given period of time; they do this mainly by making their workers supervise more machines and by speeding up the assembly line. This intensification of labour and the accumulation of capital that raises the productivity of labour through the mechanisation of the labour process are two processes that go hand in hand.

“There was always a clamor from the sales department to get more cars. When the plant was turning out a thousand a day, those who had the job in hand knew that by increasing the speed of the assembly line one minute in an hour, they would get sixteen more cars that day. Why not try it? A couple of weeks later, after the workers on the line had accustomed themselves to the faster motions, why not try it again?

“Never had there been such a device for speeding up labor. You simply moved a switch and a thousand men jumped more quickly. It was an invisible tax, like the tariff, which the consumer pays without being aware of it. The worker cannot hold a stopwatch, and count the number of cars which come to him in an hour. Even if he learns about it from the man who set the speed of the belt – again it is like the tariff in that he can do nothing about it. If he is a weakling, there are a dozen strong men waiting outside to take his place. Shut your mouth and do what you’re told!” (Sinclair p.27)

  • The      capitalists also strive to increase the intensity of labour, to make the      workers perform more labour in a given time.
  • Two      classic methods of raising the intensity of labour are speeding up the      assembly line and making the worker mind more machines.

Chapter 3.5: The dynamics of capitalism

The general formula for capital

Marx contrasted the circulation of capital with that of commodities under petty commodity production. The sellers in petty commodity production aim to exchange a commodity they own (and which they probably produced) for money. For their purposes this is simply an intermediate step. It’s stage one. They don‘t want to hang on to the money but to exchange it for another commodity. In effect they intend to exchange a use value they don’t want for one they do want. Money is just an intermediary. Characteristically they end up exchanging an exchange value they own for a commodity of equal value.

Marx labels this as a C – M –C exchange. He contrasts this with the circulation of capital. Let us assume capitalists start with money. Their intention is to end with money, more money than they started with. There is no point for them in exchanging a commodity worth £100 for another worth £100. But that is what the traders of commodities usually do in the C – M – C circuit. For the capitalists the exchange of commodities, and the production of those commodities, is purely incidental to the production of surplus value. So the circuit of capital is M – C – M’, where M’ is a greater sum of money than M with which the capitalist started.

As Marx often had occasion to point out, capital is not a thing. It is a social relation. Capital goes through different forms of existence in its circulation process. Let us begin our analysis with money capital. Whereas the boyars start with land as the basis of their social power, the capitalists begin with money. The capitalists lay out their money on means of production and labour power. Then production can begin. As we know the surplus value is actually generated in the production process by the labour power of the workers being set to work to produce necessary and surplus labour. It must then be realised, the value created turned back into the money form and the circuit completed.

But the necessary labour has not at the stage of production been translated into wages for the workers; nor has the surplus labour become surplus value jingling in the pockets of the capitalists. The firm will usually specialise in producing one or a narrow line of goods. Whether these be motor cars or ice lollies, they have to be sold in order for the values congealed in the commodities to be realised. The production of surplus value and its realisation are two acts separate in time and in place. There are no guarantees that surplus value that has been produced can be realised. Yet, till the commodities have been realised, the circuit of capital has not been completed and capitalist production cannot continue.

Purchase and sale represent the unity of two processes. Yet these two processes can be ruptured and become independent of one another. The result is crisis. As Marx puts it, “The independence of the two correlated aspects can only show itself forcibly as a destructive process. It is just the crisis in which they assert their unity, the unity of different aspects.” (Theories of Surplus Value Volume II, p.500)

This gives us the possibility of crisis. We shall follow this up in more detail in Chapter 1.7 Marx’s theory of crisis.

  • Under      capitalism the aim of the capitalist is to start with money and end up      with more money.
  • Capital      performs a circuit: from money; to production; to commodities produced; to      money once more.
  • Surplus      value must not just be produced. It also has to be realised through the      sale of the commodity so that the capitalist can begin the process of      exploitation again.

Constant capital, variable capital and surplus value

So far we have dealt with the determination of the value of commodities and the decisive role of the productivity of labour in this process. We have also dealt with the division of the working day (or working time generally) into paid labour and unpaid labour, surplus value. We have seen that the battle over this division is never-ending, the objective basis for the class struggle.

As we know, Upton Sinclair was not allowed to look at Henry Ford’s account books in order to establish the rate of exploitation. After all he was preparing a novel, whose whole purpose was to aid the union drive at Ford which, if successful  (and it was), would curtail Henry Ford’s ability to extract more and more surplus value from his workforce without let or hindrance.

We postulated rates of exploitation such as 100% in the examples we have given. If we could give Henry Ford the right of reply, he would no doubt explode that his rate of profit was nothing like as high as we have suggested. And he would be right.

The division of the working day which gives us the rate of exploitation can be represented by V (variable capital) and S (surplus value). By variable capital we mean the money the capitalist lays out in wages. We work out the rate of exploitation with the formula S/V.

But the capitalist doesn’t just have to purchase the services of working class people before the production of surplus value can commence. Earlier we suggested a random list of other expenses Henry Ford might have to pay: the cost of depreciation on the plant, electricity, tyres, upholstery and so forth. So the overall rate of profit on capital outlaid will generally be lower than the rate of surplus value (rate of exploitation).

All these other costs apart from wages are regarded by Marx as constant capital. They are constant capital because they pass their value unchanged to the final product. Constant capital is dead labour. When we come to consider the value of the commodity, as opposed to the division of the working day, this can be divided into three parts: constant capital (C), variable capital (V) and surplus value (S).

This notion of constant capital is easy enough to grasp in the case of the tyres. Henry Ford pays the tyre manufacturer $50, or whatever they cost, and adds $50 to the price of the car. Theoretically he could sell cars with no tyres, and the customers could go out and buy tyres for $50. The tyres are the object of a past process of exploitation. The workers in the tyre factory performed paid labour and unpaid labour in making the tyres, just like Henry Ford’s car workers. Then the tyres are sold to Henry Ford at their value (on average). He makes no money out of buying tyres.

It might be more difficult for the reader to accept that the cost of the plant is also dead labour and does not produce a surplus for Henry Ford. Doesn’t assembly line production make car workers much more productive than engineers working in a shed, as was the case in the early days of the industry? Of course the assembly line workers produce more cars. But the cars are cheaper, because they contain less socially necessary labour time than motors produced under craft conditions. The workers are now producing more use values, not more exchange value. The same amount of labour time expresses itself in a greater mass of use values.

The assembly line was produced by workers who were exploited just like the Ford workforce. Then it was sold at its value to Henry Ford. Only the depreciation on the assembly line goes into the value of a motor car, not its entire value. If the assembly line cost $10 million and assists in the production of a million cars before it gives up the ghost, then we can say it adds $10 to the value of each car.

The Marxist way of looking at value as being composed of living labour (V + S) and dead labour (C) is not confined to ourselves. Living labour is the value added in the production process. Her Majesty’s Revenue and Customs use the same form of calculation when they send out bills for Value Added Tax in the UK. In assessing a motor manufacturer’s liability to pay VAT they may, as a first approximation, bill them for tax on the full sales price of the cars sold.

The car company’s accounts department will at once reply that the costs of tyres, glass, upholstery and all the other components they bought in are not value added. They will not use the expression ‘constant capital’, but that is the basis of their counter-claim. So they will supply copies of the invoices they paid for these items to HMRC, in effect arguing that they are items of dead labour that added no value in the production of cars. VAT is only levied on value added, that it on the new labour (value) added in the production process. And that’s official.

  • The      capitalist lays out money on constant capital, which passes its value      unchanged to the final product.
  • He      also lays out variable capital to pay the workers’ wages.
  • The      value of a commodity may be broken down into constant capital, variable      capital and surplus value.

The rate of profit

What is decisive in the considerations of the capitalists is not the rate of exploitation but the rate of profit – how much extra they get out compared with what they put in (invest). This is not just the lodestar of individual capitalists. It is a vital regulator of the capitalist system as a whole.

We have already had occasion to point out that the capitalist system is unplanned. How much capital equipment is needed at any point in time? Nobody knows. Nobody calculates. Still it is important for Henry Ford that, when he decides it would be profitable to increase the production of motors at his plant, he should be able to go to the marketplace and buy tyres, upholstery, wood for dashboards and whatever other components he needs in sufficient quantities and proportions to turn out more cars.

Likewise it was important for the workers who came to Detroit that they could be decently housed, clothed and fed. This didn’t happen automatically. Detroit at this time was a vibrant capitalist metropolis sucking in all manner of skills and resources to back up the fast-growing motor industry. How is this proportionality between the different inputs needed for capitalist firms to grow established? How do the use values needed for capitalism to reproduce itself as a system come into existence?

All these skills and resources were attracted to the Detroit area by the search for profit. Capital must reproduce itself. It must find the means to satisfy all its material needs in the marketplace. A vast division of labour is achieved entirely through people buying and selling. But when they are buying and selling, they are oblivious to the actual needs of society, which are unknown to them. They are all looking to their own advantage. Capitalists measure the advantage to themselves in profit, and naturally they look to their own rate of profit compared with that of other capitalist firms.

As we pointed out earlier, commodities are only sold occasionally and accidentally at their value. Usually they are sold at a price above or below their value. If supply exceeds demand, and as a result commodities are sold at a price below their value, this means the capitalists who sell them will have to take a cut in profit. If low profits persist, this can be taken as a signal that the capitalist is in the wrong line of business. Marginal capitalists in the industry are likely to drop away.

Likewise if demand in an industry is booming and capitalists in an industry are making bumper profits, then two things are likely to happen; first the incumbent capitalists will maximise output to the fullest extent to take advantage of the super-profits to be made. They will work their capacity to the utmost, take on more workers and offer overtime to those already on the books. They may plan to expand their output potential. Secondly other capitalists, particularly those that find themselves trapped in low-profit industries, will begin to think seriously about upping stakes and moving to where the serious money can be made.

So the regulator of the division of labour within an unplanned economy is the rate of profit. Low profits in a sector cause exit while high profits attract new entrants. Capital flows are the way in which proportionality is established in an unplanned economy. Naturally the working of these capital flows is as chaotic on the surface as the day-to-day movement of prices.

  • Capitalists      are guided in their investment decisions by expectations of profit.
  • The      rate of profit thus serves as a regulator for the capitalist system as a      whole.

Chapter 3.6: How capitalism evolves

The accumulation of capital

Don’t think for a moment that Henry Ford spent all the surplus value extracted from his workers on himself, on fine living. He lived well, as Upton Sinclair testifies. But the majority of that surplus value was accumulated, ploughed back into production. Any capitalist has to decide whether to consume the surplus unproductively or to accumulate it, and in what proportions. This decision is presented here as a choice. But really the individual capitalist and individual firm don’t have much choice. They must accumulate or go under. That is the lesson Henry Ford taught his rivals.

Under capitalism there is no natural limit to the rate of exploitation. Nor is there any limit to the accumulation of capital under the system. There is an impulsion upon the capitalists to accumulate most of the surplus value. Thus they are continually raising the level of productivity and, potentially, making us all richer. This is important. Romania remains a desperately poor country. In part this is the heritage of the rule of the boyars. Feudalism did not develop the productive forces in the way capitalism does. Capitalism has a completely different dynamic from previous forms of class society. It is the dynamics of the system that we are trying to outline here.

We have already seen that, in the hunt for higher productivity, capitalists are forced to accumulate the lion’s share of the surplus value as capital rather than spending it on their personal consumption.

It is obvious to the casual observer that the transition from weaving cloth by handloom weavers to the general use of power looms consists of a progressive replacement of human labour power by machinery in the production process. The transition of the Ford Motor Co. from Henry’s shed to the giant River Rouge plant opened to make the Model A Ford in 1928 is an instance of exactly the same trend.

As a result the scale of production in a firm is likely to expand and the number of firms in an industry to fall over time. Marx calls this the concentration of capital. Rather than the small-scale competitive capitalism that typified nineteenth century capitalism, the system in the twenty-first century is dominated by giant firms. These still compete against one another for market share, but quite often this rivalry may be pursued in different ways from just competing on price. Attempts at product differentiation which can lead to an advertising blitz are just one example of a different form of competition between capitalists.

Alternatively, large corporations can use their financial muscle to buy their rivals out. Big firms that supply one another and become interdependent may also form networks. These in turn can solidify into alliances pitted against other capitalist networks. Informal networks can also turn into friendly mergers or provoke hostile takeovers of rival firms.

Centralisation of capital means the merger of capitalist firms, the concentration of ownership rather than production. Whereas the driving force of the concentration of capital is the ever-increasing scale of production and the rising minimum efficient scale needed to produce and sell competitively in modern business, the centralisation of capital derives from the advantages of joint ownership. Production may be divided into different plants separated geographically, but unified by a common purpose which is drawn up by a common management team.

  • Raising      the productivity of labour in an industry naturally produces a larger      scale of production, bigger units of production and a smaller number of      firms. This is called the concentration of capital.
  • Capital      also becomes centralised through links of ownership rather than      production.

The organic composition of capital

Henry Ford achieved his victories over his rivals by spending first and most on machinery in order to raise the productivity of labour. So the proportion of his capital laid out on labour power (variable capital) compared with that invested in plant and machinery (constant capital) was falling as production became more capital intensive. The natural accompaniment to the raising of the productivity of labour under capitalism is therefore the increasing capital intensity of production.

Marx explains that this is a general tendency in capitalist production, “Every advance in the use of machinery entails an increase in the constant component, that part which consists of machinery, raw material, etc., and a decrease in its variable component, the part laid out in labour power.”  (Capital Volume I, p.578)

Marx calls this process the rising organic composition of capital. Readers may find it intuitively obvious that the proportion of dead labour to living labour tends to rise over the history of capitalism – that twenty first century workers usually have more machinery behind their elbow than nineteenth century workers. But Marx is not just referring to the mass of constant capital compared to the number of workers. He calls this ratio the technical composition of capital. It cannot be computed because, just as use values are incommensurable, we cannot compare a mass of machinery etc. of different types with a number of workers.

The organic composition of capital is expressed by the formula C/V, where C is constant capital and V is variable capital. It is calculated in value terms. Since price is here the monetary expression of labour time the organic composition of capital is the value of constant capital relative to variable capital, or how much the capitalist lays out on them respectively. The increase in capital per worker is known in conventional economics textbooks as capital deepening. Here are the figures given in Angus Maddison’s Contours of the World Economy 1-2030 AD, (p.305) for the UK and the USA. All figures are in 1990 dollars.

Gross Stock of Machinery and Equipment Per Capita

                    UK                       USA

1820           92                          87

1870         334                        489

1913         878                     2,749

1950      2,122                     6,110

1973      6,203                   10,762

2003    14,291                   32,240

These figures are, as we see, only a first approximation to the organic composition of capital. All the same they represent a triumphant vindication of Marxist analysis.

  • The      rising proportion of constant capital relative to living labour in the      production process is called the increasing organic composition of      capital.
  • The      increasing organic composition of capital is a fundamental trend in      capitalist production.

The tendencies of capitalist production

Ford was progressively employing more and more workers as he grew to be an industrial giant. This is how the accumulation of capital proceeds. Marx deals with it in the long Chapter 25 of Capital Volume I: The general law of capitalist accumulation.

He opens the discussion by asserting that, “A growing demand for labour power accompanies accumulation if the composition of capital remains the same.” (p.762) Of course the accumulation of capital does not usually leave the composition of capital untouched. Theoretically the capitalists could open another wing to their plant or another plant in their firm with an identical organic composition of capital to the others and employing the same technology. Given the continual technical progress under capitalism, that is highly unlikely, except in a ‘mature’ or stagnant industry – and that is not where the biggest profits are to be made.

Though firms are likely to employ more workers as they grow, that leaves out of account the wider picture. Weaving firms employing power looms were no doubt taking on ‘hands’ in the early decades of the development of the new technology, but they were ‘displacing’ vastly greater numbers of handloom weavers. Nor was this process confined to the UK. Traditional handicrafts in India and elsewhere were laid waste by British machine-woven cloths with which the handloom weavers were incapable of competing. Handloom weavers were reduced to penury all over the world. The law of value is no mere theoretical construct. It strikes with the power of a hurricane.

Advances in productivity are an imperative under conditions of capitalist competition. They are expressed in a rise in the relative importance of machinery, in particular in the capital laid out by the magnates of industry. Ford’s early workshops could not possibly have competed with his own mass production plants a generation later. The accumulation of capital therefore is usually accompanied by “a relative diminution of the variable part of capital”, according to Marx (ibid p.772). Whether that leads to an absolute fall in the number of employed workers is uncertain. Marx goes on to explain how capitalism generates a reserve army of labour from its own dynamics.

Capitalism is an unplanned system. In this it resembles a creature with no brain, no central system for thinking and planning. The brontosaurus was such a creature. Unfortunately it is now extinct. In an unplanned system it is always possible that too little or two much might be produced. After all nobody knows how much ‘too little’ or ‘too much’ actually is.

Since the capitalists are actually interdependent, if too little is produced in one industry and too much in another that will cause problems for firms further down the supply chain. This dislocation could set off a more general crisis of the system if profits took a tumble. A crisis of overproduction occurs when capitalists cannot sell their commodities and therefore cannot realise the surplus value that has been produced. Under capitalism trade is not conducted by petty proprietors exchanging products for products for their own satisfaction but by capitalists who are only interested in profit.  It is ultimately because production is not to satisfy human wants but to make profit for capitalists, that a crisis of overproduction is an ever-present possibility.

In a footnote to Capital, Chapter 4 (p.254), Marx highlights this confusion in the outlook of an apologist of capitalism:

“‘The inextinguishable passion for gain, the auri sacra fames,’ (accursed love of gold) ‘will always lead capitalists.’ (MacCulloch: ‘The Principles of Polit. Econ.’ London, 1830, p. 179.) This view, of course, does not prevent the same MacCulloch and others of his kidney, when in theoretical difficulties, such, for example, as the question of overproduction, from transforming the same capitalist into a moral citizen, whose sole concern is for use values, and who even develops an insatiable hunger for boots, hats, eggs, calico, and other extremely familiar sorts of use values.”

Crisis is inherent in capitalism because it is an unplanned system where production is for profit and not human wants. The purpose of this Chapter is to outline the dynamics of capitalism. We are mainly concerned with the long term trends rather than the fluctuations of boom and slump, which we shall deal with separately. To sum up these trends in a single phrase they are, “the abolition of the capitalist mode of production within the capitalist mode of production itself.” (Capital Volume III, p.569) Capitalism is preparing the material conditions for a higher mode of production – socialism.

  • As      it accumulates, capitalism naturally tends to generate a reserve army of      labour.
  • Capitalism      naturally produces crises. This is because it is an unplanned system where      production is for profit.

Tasks of the working class

But socialism will not emerge of its own accord. It must be fought for. Socialism can only come about by the destruction of capitalism, which has to be the conscious act of millions of working class people. What will cause this questioning of capitalism in the minds of the workers?

There was no revolution against the boyars in Romania, though the serfs lived lives that in many ways were incomparably poorer and more wretched than those of twenty-first century wage workers. Conditions were stagnant, and we can assume that consciousness stagnated as a result. How different is the capitalist system and the lives of the mass of workers who live under it! Capitalism is unprecedentedly dynamic and continually shakes up the lives of its wage slaves. That was the story of the Shutts who lived through the Great Depression of the 1930s, and it’s the same today. Capitalism is incapable of offering its workers a secure existence.

Since being determines consciousness, changes in consciousness are likely to be triggered in changed conditions. This book is being written as the world is dominated by the effects of a gigantic recession.  Coming after a long period of relatively full employment and rising living standards for most workers in Britain and other advanced capitalist countries, this recession is bound to produce a profound questioning and criticism. Capitalism stands revealed as a system that squanders human and material resources and where the ruling class always strives to make the workers bear the burden of the crisis and other flaws of their system. It is hoped that this book will contribute to an understanding of the alternative and how to achieve it.

We have seen that the law of value acts as a natural force like a tsunami, disrupting and ruining people’s lives over and over again in good times and (specially) in bad. Capitalism has developed the productive forces enormously. It has taken us to the threshold of abundance, and then slammed the door firmly in our face.

Capitalism also develops a mass working class, who can and will act as its gravediggers. Even now, more than ever, millions of peasants, handicraft workers and small traders are being drawn into the maw of wage labour. There are now more than a billion wage workers. They, together with their families, outnumber the peasantry for the first time in the history of the world. They are an absolute majority of the globe’s population.

The working class, unlike the isolated peasantry of Wallachia, are concentrated together by the concentration of capital. The technology of mass communication developed by capitalism keeps them informed of movements elsewhere and helps them to plan their own resistance. They find that the small victories they win against the boss are achieved by unity in action. They are schooled in solidarity. The world’s working class, faced with the failure of capitalism, will increasingly turn to the ideas and programme of socialism.

  • Capitalism      is an unprecedentedly dynamic form of class society.
  • Capitalism      developed the productive forces, and so produced the conditions for a      higher form of society – socialism.
  • Capitalism      also created a mass working class, who can and will carry through the      socialist transformation of society.

The historical tendency of capitalist accumulation

What are the general tendencies of capitalist production in broad historical terms? Where are they taking us? Marx sums up his analysis in Chapter 32 of Capital Volume I, entitled The Historical Tendency of Capitalist Accumulation.  After dealing with the process of primitive accumulation, he continues (ibid pp.928-9):

“As soon as the labourers are turned into proletarians, their means of labour into capital, as soon as the capitalist mode of production stands on its own feet, then the further socialisation of labour and further transformation of the land and other means of production into socially exploited and, therefore, common means of production, as well as the further expropriation of private proprietors, takes a new form. That which is now to be expropriated is no longer the labourer working for himself, but the capitalist exploiting many labourers. This expropriation is accomplished by the action of the immanent laws of capitalistic production itself, by the centralisation of capital. One capitalist always kills many. Hand in hand with this centralisation, or this expropriation of many capitalists by few, develop, on an ever-extending scale, the cooperative form of the labour process, the conscious technical application of science, the methodical cultivation of the soil, the transformation of the instruments of labour into instruments of labour only usable in common, the economising of all means of production by their use as means of production of combined, socialised labour, the entanglement of all peoples in the net of the world market, and with this, the international character of the capitalistic regime. Along with the constantly diminishing number of the magnates of capital, who usurp and monopolize all advantages of this process of transformation, grows the mass of misery, oppression, slavery, degradation, exploitation; but with this too grows the revolt of the working class, a class always increasing in numbers, and disciplined, united, organized by the very mechanism of the process of capitalist production itself. The monopoly of capital becomes a fetter upon the mode of production, which has sprung up and flourished along with, and under it. Centralisation of the means of production and socialisation of labour at last reach a point where they become incompatible with their capitalist integument. This integument is burst asunder. The knell of capitalist private property sounds. The expropriators are expropriated…

“The transformation of scattered private property, arising from individual labour, into capitalist private property is, naturally, a process, incomparably more protracted, violent, and difficult, than the transformation of capitalistic private property, already practically resting on socialised production, into socialised property. In the former case, we had the expropriation of the mass of the people by a few usurpers; in the latter, we have the expropriation of a few usurpers by the mass of the people.”

Chapter 3.7: Marx’s theory of crisis

The purpose of this Chapter is to look at Marx’s scattered writings on crisis and to try to find out what he actually said on the subject. Secondly we spend much of the rest of this book trying to test Marx’s interpretation of how capitalism accumulates, and how it stumbles into crisis, against the reality of the capitalist economy. We look in detail at the recent world economic crisis that began in 2007 and which we call the Great Recession.

As David Harvey remarks (The enigma of capital p.116), “There has been a tendency within the history of crisis theorising to look for one dominant explanation for the crisis-prone character of capitalism. The three big traditional camps of thought are the profits squeeze (profits fall because real wages rise), the falling rate of profit (labour-saving technological changes backfire and ‘ruinous’ competition pulls prices down), the underconsumptionist traditions (lack of effective demand and the tendency towards stagnation associated with excessive monopolisation).”

Harvey has omitted the disproportionality school of crisis theory associated with Hilferding, among others. Harvey responds to these controversies by retreating into eclecticism. To be fair, his book is not centrally concerned with the causes of the Great Recession and mainly pursues his own themes.

What is the ‘cause’ of capitalist crisis? We believe a consistent thread can be found in Marx’s writings. And the attempt to develop a coherent Marxist theory of crisis must be made. We cannot change the world unless we understand it. The reason we put ‘cause’ of capitalist crisis in inverted commas here is because much of the confusion as to the reasons for the boom-slump cycle comes from the different levels of causation that are at work.

  • The cause of the crisis is neither an      institutional tendency to produce too many consumer goods relative to      capital goods or any other disproportionality inherent in the capitalist      system.
  • Notions of overproduction and underconsumption      cannot explain the boom-slump cycle. They cannot tell us why the crisis      breaks out when it does.
  • Both the profits squeeze theorists and those      who argue that the underlying cause of the crisis lies in the tendency for      the rate of profit to fall agree that a decline in the rate of profit is      fundamental to the onset of recession. They disagree as to why it has      fallen. We investigate what has happened to the rate of profit later.
  • We try to show that the      underlying cause of crisis and the basic explanation for the cycle are movements in the rate of profit.      These movements in turn can be analysed using Marx’s law of the tendency      for the rate of profit to fall which manifests itself as a periodic      overaccumulation of capital. Overaccumulation is the overproduction of      capital.

Overproduction as the form of appearance of capitalist crisis

As is well known, the Communist Manifesto refers to a capitalist crisis of overproduction. Sometimes overproduction is referred to as the realisation problem. This means that the crisis manifests itself as capitalists being unable to sell goods that have already been produced. Overproduction, in other words, is not absolute but relative to the purchasing power of the population.

Now it is true that the Manifesto is not a major economic work of the mature Marx. In 1848 he had not yet developed the notion of labour power, for instance. But there is absolutely nothing wrong with the formulation of the Manifesto, as long as we understand that overproduction is the form of appearance of capitalist crisis. We can and do point to the paradox of idle workers confronting idle machines as the cause of want. This is a distinctive feature of capitalism, an ‘achievement’ no other social system can show.

“It is enough to mention the commercial crises that by their periodical return put on trial, each time more threateningly, the existence of the entire bourgeois society…In these crises there breaks out an epidemic that in all earlier epochs would have seemed an absurdity – the epidemic of overproduction. Society suddenly finds itself put back into a state of momentary barbarism; it appears as if a famine, a universal war of devastation had cut off the supply of every means of subsistence; industry and commerce seem to be destroyed; why? Because there is too much civilisation, too much means of subsistence, too much industry, too much commerce.” (Communist manifesto, pp.7-8)

This is all very clear. But it is description, not explanation. It tells us what happened, not why it happened.

Engels has a very similar approach to crisis in Anti-Duhring. (This passage is reproduced in Socialism utopian and scientific.) “As a matter of fact since 1825, when the first general crisis broke out, the whole industrial and commercial world, production and exchange among all the civilised peoples and their more or less barbaric hangers-on, are thrown out of joint about once every ten years. Commerce is at a standstill, markets are glutted, products accumulate as multitudinous as they are unsaleable, hard cash disappears, credit vanishes, factories are closed, the mass of workers are in want of means of subsistence because they have produced too much of means of subsistence.” (pp.379-80)

  • We argue that the crisis takes the form of      appearance of a realisation crisis, of a crisis of overproduction. That      means goods produced cannot be sold.

Underconsumptionist theories of crisis

What could be more obvious than to argue that, since the commodities cannot be sold, the root of the problem lies in the fact that the workers who produce them cannot afford to buy them? The working class is exploited in the scientific sense that they produce more values than they are paid in the form of wages. This is the logic of the underconsumptionist view.

Engels, in his chapter on ‘Production’ in Anti-Duhring, is a stern critic of Duhring’s underconsumptionist interpretation of capitalist crisis. He points out that the restricted consumption of the masses is a permanent feature of capitalism:

“But unfortunately the underconsumption of the masses, the restriction of the consumption of the masses to what is necessary for their maintenance and reproduction, is not a new phenomenon. It has existed as long as there have been exploiting and exploited classes. Even in those periods of history when the situation of the masses was particularly favourable, as for example in England in the fifteenth century, they underconsumed. They were very far from having their own annual total product at their disposal to be consumed by them. Therefore, while underconsumptionism has been a constant feature in history for thousands of years, the general shrinkage of the market which breaks out in crises as a result of a surplus of production is a phenomenon only of the last fifty years;” (pp.395-6).

Exploitation is a feature of all class societies. So is underconsumption. By contrast to capitalism, all previous economic crises have taken the form of famines, of physical shortages of the means of subsistence. Only capitalism produces periodic crises of overproduction. Why is capitalism different?

It is quite true that workers can’t buy all the value they produce. Surplus value ends up, of course, in the hands of the capitalist class. This is just another way of saying capitalism is a system where production is for profit.

If the crisis were really caused by the ‘restricted consumption of the masses’ we would expect it to be manifested by an overproduction of consumer goods relative to capital goods. In fact this is by no means the usual case in actual capitalist crises. Most crises have actually begun in the capital goods sector. If the crisis were caused by underconsumption we would expect the workers to suddenly cease providing an adequate market for the capitalists, so triggering the crisis.

Actually workers’ living standards usually rise in the boom phase that precedes the onset of crisis. Their consumption falls as they are laid off as a result of the crisis, further shrinking markets. Their restricted consumption is thus a symptom of the crisis, not its cause.

  • Underconsumption is a permanent condition of      capitalism.
  • It cannot therefore explain capitalist crisis.

Theories of crisis based on disproportionality

Capitalism is an unplanned system. Another theory of crisis is that the slump is caused by capitalist anarchy. Capitalist firms are dependent on one another. How much they produce depends on how much other firms produce. This is true of their inputs (of raw materials etc.) and for the sale of their finished products. But capitalist firms are unaware of their interdependence and regard themselves as independent, free spirited buccaneering outfits. Even if they became aware of their mutual interdependence, they would not be able to communicate this to other firms.

So capitalists can produce commodities in the wrong proportions. Marx investigated the problem of the reproduction of the material elements of production in Capital Volume II. Each capitalist is producing outputs that are inputs for other capitalists. National income consists of a circular flow of commodities, and every capitalist has to find the material components of production available in the marketplace. Definite proportions between the different sectors of production have to be established for this to happen. But of course the individual capitalist just takes it for granted that this will always occur.

How are these proportions established in practice? It is a central feature of capitalism that the system is unplanned. It is actually a permanent feature of capitalism that there is localised overproduction of some commodities and underproduction of others at the same time. Corrections are made after the fact, through falling prices and profits in the case of overproduction, and rising prices and profits in the case of scarcity. This in turn will cause capital flows into and out of those sectors. The question is – why should this continuous process lead to a generalised crisis?

It is true that in a horse race, if one horse trips that can bring the others down. But why should the horse trip in the first place? Surely the molehill (or whatever) is what we would say caused the accident? It is not just that the horses are bunched – competing with one another, yet dependent on the other horses keeping the right distance – that causes the collapse. Yet disproportion between different sectors is often presented a fundamental cause of capitalist crisis.

The problem of reproduction is particularly acute in the case of capital goods. One argument against the underconsumptionist school is that investment is the most volatile component of national income, not consumption. The boom-slump cycle is thus an investment cycle. Booms correspond to periods with high profits leading to high levels of investment, while slump is a period when profits collapse, leading to steep falls in investment.

“Just as the heavenly bodies always repeat a certain movement once they have been flung into it, so also does social production, once it has been thrown into this movement of alternate expansion and contraction. Effects become causes in their turn, and the various vicissitudes of the whole process, which always reproduces its own conditions, takes on the form of periodicity.” (Capital Volume I, p. 786)

Here Marx compared the economic cycle with the movements of heavenly bodies, such as comets. Once put in orbit for any reason they continue to circulate round their orbit with great regularity. Once a great volume of investment comes on stream at the beginning of an upswing, we can expect a mass of this investment to become obsolescent at about the same time later on. This will produce an investment cycle linked to the boom-slump cycle. We have the same problem as the astronomer who wants to find out how Halley’s Comet got into its present orbit. We are still not able to explain why capitalism goes into crisis when it does.

“To the same extent as the value and durability of fixed capital applied develops with the development of the capitalist mode of production, so also does the life of industry and industrial capital in each particular investment develop, extending to several years, say an average of ten years…We can assume that, for the most important branches of large-scale industry, this life cycle is on average ten years. The precise figure is not important here. The result is that the cycle of related turnovers extends over a number of years, within which capital is confined by its fixed component, is the material foundation for the periodic cycle…But crisis is always the starting point of a large volume of new investment. It is also therefore, if we consider the society as a whole, more or less the new material basis for the next turnover cycle.” (Capital Volume II, p.264)

All this is true, but it does not provide a fundamental explanation for the boom-slump cycle. We shall try to show later that the cycle is primarily caused by movements in the rate of profit, and that the profit cycle produces a corresponding investment cycle.

  • Investment is volatile and its fluctuations      are important in analysing capitalist crisis.
  • Fixed capital may tend to be replaced in      cycles related to the boom-slump cycle; but the periodicity and incidence      of this investment cycle must itself be explained.

Marx and the tendential fall in the rate of profit

There is an impulsion on every capitalist to raise the productivity of labour. Though there are other ways he can do this, historically and in practice it has been crucial to put more and more machinery etc. behind the elbow of each worker in order that they can produce faster and cheaper.

To exploit the workers more effectively costs the capitalists more. More and more constant capital (plant and machinery etc.) is deployed for each worker. This will mean than more and more dead labour is used compared to living labour in the production process. But constant capital (dead labour) passes its value unchanged to the final product. Only living labour produces new values.

The proportion of the mass of machinery per worker is what Marx calls the technical composition of capital. What concerns the capitalist is how much dead labour costs compared with living labour.

The organic composition of capital measures the ratio of the value of living to dead labour in the production process. “By the composition of capital we mean…the ratio between its active and passive component, between variable and constant capital.” (Capital Volume III p.244) Marx adds, “The organic composition of capital is the name we give to its value composition, in so far as this is determined by its technical composition and reflects it.” (ibid p.245).

There is a tendency for the organic composition of capital to rise over time in those branches of industry where labour saving equipment can be applied, and therefore in the economy as a whole.  This is the fundamental reason for the tendential fall in the rate of profit.

Here is an illustration of the capital intensity of modern capitalist production, taken from a newspaper article (Mark Milner, Guardian April 17th 2007). The General Motors plant producing Astra cars at Ellesmere Port was to be revamped. The report stated that:

  • The plant will employ 2,200      workers
  • Productivity is likely to      rise by 30%
  • The plant will produce      180,000 cars a year
  • Investment will be 3.1      billion Euros (round about £2 billion at the exchange rate at the time)

So each worker would produce nearly 90 cars a year on average. (Of course no worker produces a car single-handed. It is a team effort.) The machinery behind the elbow of each worker is getting on for £1,000,000!

This is casual and empirical but powerful evidence as to the correctness of Marx’s analysis of the dynamics of capitalism – the connection between rising productivity and a higher level of exploitation, the increasing scale of production and the greater mass of dead labour relative to living labour applied in the production process as the system develops.

Marx goes on to specifically link this rising organic composition with the tendency for the rate of profit to fall. “With the progressive decline in the variable capital in relation to the constant capital, this tendency leads to a rising organic composition of the total capital, and the direct result of this is that the rate of surplus value, with the level of exploitation of labour remaining the same or even rising, is expressed in a steadily falling general rate of profit…The progressive tendency for the general rate of profit to fall is thus simply the expression, peculiar to the capitalist mode of production, of the progressive development of the social productivity of labour.” (ibid pp.318-9)  

The whole point about the investment in fixed constant capital is that it locks away the capitalist’s money for years. So the rate of profit is calculated on the total capital advanced, whether used up or not.

In Capital Volume III Marx wrote three chapters on The law of the tendential fall in the rate of profit. This law is also referred to in the Grundrisse, where Marx describes it as “in every respect the most important law of modern economy and the most essential for understanding the most difficult relations. It is the most important law from the historical standpoint. It is a law which, despite its simplicity, has never before been grasped and, even less, consciously articulated” (p.748). This is not an isolated thought from an unpublished preparatory manuscript. In his economic manuscripts of 1861-3 he repeated this formulation almost word for word: “This law, and it is the most important law of political economy, is that the rate of profit has a tendency to fall with the progress of capitalist production” (Marx Engels Collected Works Volume 33, p.104).

We shall argue that Marx was right and that crisis in the post-War capitalist economy can be explained in terms of movements in the rate of profit, and ultimately by Marx’s theory.

Marx presents this tendency as a law. Different people use the word ‘law’ in different senses. Some scientific writers quite legitimately use the term to mean a statistical regularity. In this case there would be a law for the rate of profit to fall if we could observe the rate of profit falling continuously. We can’t. And Marx is quite clear that is not how the tendency for the rate of profit to fall operates in practice. For him a tendency is a force operating in a certain direction.

  • The rising organic composition of capital      produces a tendential fall in the rate of profit.

Counteracting factors

This force, in a dialectical way, actually unleashes contradictory forces that may tend to drag the rate of profit up. Marx mentions six counteracting factors to the underlying tendency for the rate of profit to fall.

The most important of these counteracting factors are increasing the rate of exploitation and cheapening the elements of constant capital. This is the case because both of these occur as a result of the tendency in capitalism to make labour more productive and commodities cheaper. Could these counter-tendencies indefinitely offset the tendency for the rate of profit to fall? The operation of these counter-tendencies will be tested in practice later on in this book.

We use the symbols used by Marx:

  • C is constant capital
  • V is variable capital, the      amount laid out on wages by the capitalist
  • S is surplus value, conventionally      divided into rent, interest and profit.
  • The rate of exploitation is      S/V.
  • The organic composition of      capital is C/V.
  • The rate of profit is S/(C +      V).

Increasing the rate of exploitation

Let us assume that the worker works four hours to produce the elements of her own subsistence and four hours producing surplus value. As a result of new techniques, productivity doubles and the worker is now only working two hours for herself and six hours for the bosses. Her standard of living is unaffected – she can still buy the same bundle of wage goods as before. But there are limits to this process in increasing the rate of exploitation.

In mathematical terms the rate of exploitation is bounded by the new value added by the worker (V + S). As productivity continues to rise in the sector producing wage goods, S tends to increase towards (V + S), while V tends to zero. As long as constant capital continues to increase (C tends to infinity), the rate of profit must eventually fall.

Cheapening the elements of constant capital

The same tendency to raise productivity and reduce the relative price that prevails in consumer goods industries is also at work in the capital goods sector. Though the mass of constant capital per worker has risen enormously over time, the cost of each unit of constant capital will tend to fall. This fall in the price of constant capital will reduce the organic composition of capital, expressed in market prices. This is another important counteracting factor to the tendential fall in the rate of profit.

There is more capital at the worker’s elbow, but each unit of capital costs less because of rising productivity. The question is: can this indefinitely offset the tendency for the rate of profit to fall? Marx believed it could not. We later quote Alan Freeman’s work to show that the reason for falling profits in the USA is overwhelmingly because of the rising organic composition of capital.

 Andrew Kliman’s Reclaiming Marx’s ‘Capital’: A refutation of the myth of inconsistency published in 2007 deals correctly with the interpenetration of the tendential fall in the rate of profit and the counteracting factors:

“In short, although the falling tendency of the rate of profit is ‘constantly…overcome’, the tendency is not nullified. It makes its presence felt, since it is only ‘overcome by way of crises.’ Recurrent economic crises, not a declining rate of profit over the long term, are what Marx’s theory actually predicts.” (p.31)

  • Raising the rate of exploitation cannot indefinitely offset the tendency for the rate of profit to fall.
  • If the organic composition of capital continues to rise, then the constant tension between the tendency for the rate of profit to fall and the counter-tendencies must eventually produce crises.

How the tendency manifests itself in practice

Marx’s analysis is actually subtler than many give it credit for.  “There is a possibility for the mass of profit to grow even though the rate of profit may fall at the same time…We have seen how it is that the same reasons that produce a tendential fall in the profit rate also bring about an accelerated accumulation of capital and, hence, a growth in the absolute magnitude or total mass of the surplus labour (surplus value, profit) appropriated by it.” (ibid p.331)  In Capital Volume III, Marx even referred to the law as a “double-edged law of a decline in profit rate coupled with a simultaneous increase in the absolute mass of profit, arising from the same reasons.” (ibid p.326)

So the rate of profit can fall, and usually does fall, while the mass of profit available to the capitalist class rises. In the end though, if the rate of profit continues to fall then the mass of profit must follow suit. This is what happened in 2006 on the eve of the Great Recession.

In addition the mass of profit is expressed in a greater and greater quantity of use-values (‘wealth’), each of which involves less and less labour time to produce, and so each has less value congealed within itself.

Secondly, the reader should bear in mind that, “we are deliberately putting forward this law before depicting the decomposition of profit into various categories, which have become mutually autonomous.” (ibid p.320) Rent, interest and profit, conventionally presented as the components of surplus value, all vary against one another and all follow their own economic laws. This is very important when we consider the actual onset of crisis.

Chapter 15 of Capital Volume III (The development of the law’s internal contradictions), provide the only complete explanation provided by Marx of boom and slump as part of a cycle and not, as underconsumption theorists would have it, as a crash coming out of a clear blue sky. Marx does discuss the realisation problem in Chapter 15. “The conditions for the immediate exploitation and for the realisation of that exploitation are not identical. Not only are they separate in time and space, they are also separate in theory. The former is restricted only by society’s productive forces, the latter by the proportionality between the different branches of production and by society’s power of consumption.” (Capital Volume III, p.352)

It is precisely at this stage in his analysis that Marx introduces the concept of overaccumulation. “Overproduction of capital and not of individual commodities – though this overproduction of capital always involves overproduction of commodities – is nothing more than overaccumulation of capital.” (ibid p.359)

He goes on, “There would be an absolute overproduction of capital as soon as no further additional capital could be employed for the purpose of capitalist production. But the purpose of capitalist production is the valorisation of capital, i.e. appropriation of surplus labour, production of surplus value, of profit.” (ibid p.360)

So overaccumulation is overproduction of capital, which manifests itself as overproduction of commodities. But too much capital is produced only in relation to profit-making potential. And this tendency produces an unseemly scramble among the capitalists for their chance to grab what profit there is.

“Concentration grows…since beyond certain limits a large capital with a lower rate of profit accumulates more quickly than a small capital with a higher rate of profit. This growing concentration leads in turn, at a certain point, to a new fall in the rate of profit. The mass of small fragmented capitals are thereby forced onto adventurous paths: speculation, credit swindles, share swindles, crises. The so-called plethora of capital is always basically reducible to a plethora of that capital for which the fall in the rate of profit is not outweighed by its mass.” (ibid p.359)

So Marx sees no contradiction in raising the so-called realisation problem in the middle of a chapter dealing with the falling rate of profit as the underlying cause of capitalist crisis. It is precisely the fall in the profit rate that produces the crisis, and overproduction (overaccumulation) is its form of appearance.

To put it another way the fact of overproducing firms may be regarded as the trigger of the crisis in Marx’s account, while the fall in the rate of profit is the underlying cause.

  • Marx referred to a double-edged law of a declining rate of profit with an increasing mass of profit.
  • Marx shows how the tendential fall in the rate of profit and the counteracting factors interact with one another to produce the underlying cause of the boom slump cycle.

The destruction of capital

Moreover viewing the crisis as a crisis of profitability enables us to understand how the downturn prepares the basis for a later upswing. The essential mechanism is through the destruction of capital in a recession.

“The periodic devaluation of existing capital, which is a means immanent to the capitalist mode of production for delaying the fall in the profit rate and accelerating the accumulation of capital value by the formation of new capital, disturbs the given conditions in which the circulation and reproduction process of capital takes place, and is therefore accompanied by sudden stoppages and crises in the production process” (ibid p.358).

This destruction of capital is not mainly physical destruction and obsolescence. The destruction of capital values in a crisis actually prepares the way for a reduction in the organic composition of capital, and a revival in the rate of profit. In this way we can explain the entire boom-slump cycle.

In a slump unwanted stocks and unused machinery are sold in fire sales of the assets of bankrupt firms. “Secondly, however, the destruction of capital through crises means the depreciation of values which prevents them from later renewing their reproduction process as capital on the same scale. This is the ruinous effect of the fall in the prices of commodities. It does not cause the destruction of any use values…A large part of the nominal capital of the society i.e. of the exchange value of the existing capital is once for all destroyed, although this destruction, since it does not affect the use value, may very much expedite the new reproduction.” (Theories of surplus value Volume II, p.496)

The crisis therefore prepares the way for a new upturn in the same way as naturalists explain that forest fires can actually prepare the woodland for a new period of growth.

  • The destruction of capital effectively reduces      the organic composition of capital and raises the rate of profit.
  • In doing so, it prepares the conditions for a      new upturn and provides the outlines of an explanation for the boom-slump      cycle.

Chapter 3.8: Ancillary factors in capitalist crisis

We have tried to disentangle the underlying cause of crisis (the fall in the rate of profit) from the various triggers that seem to have begun the movement from boom to slump in this and previous crises. These apparently accidental factors are really the manifestation of economic necessity.  The credit crunch in 2007 and the oil price spike in 1973 were two such triggers. There are also the ancillary factors that affect the course and severity of the downturns and make each one a unique historical event, as we see in Parts 1and 2.

The ancillary factors we shall discuss are:

  • wages
  • competition
  • commodity prices
  • stocks (inventories)
  • expectations
  • interest rates
  • world trade.

We shall check how important these ancillary factors were in the Great Recession.


One important economic effect of the crisis, of course, is that, by creating mass unemployment, the boss class has the whip hand in trying to drive down the wages of the employed workers. “Stagnation in production makes part of the working class idle and hence places the employed workers in conditions where they have to accept a fall in wages, even beneath the average; an operation that has exactly the same effect for capital as if relative or absolute surplus value had been increased while wages remained at the average.” (Capital Volume III, p. 363) The point is that movements in wage levels are based on the bargaining power of the contending classes, which is determined by the level of unemployment – itself dependent on the stage reached in the economic cycle.

It has been mentioned several times that the most favourable situation for the working class is at the crest of a boom when labour power is in heavy demand and may exceed supply for a while. That is when real wages are most likely to go up. In a recession the boot is on the other foot.

We have seen that process unfold dramatically over the past three years. Involuntary part-time working, wage cuts, prolonged wage freezes, ‘give back’ contracts, short time working, layoffs, redundancies, mass unemployment and a complete drying up of job vacancies – this has been the lot of the working class generally. The Great Recession was a signal for an all-out assault on workers’ wages and conditions. Wages are far more than an ‘ancillary’ factor when they represent your living standards!

This onslaught was quite unexpected for a new generation of workers who for the most part had not experienced hard times before. So the assault did not immediately provoke a co-ordinated counter-attack from the working class who, after all, had few weapons to fight back with. All the same it has produced a hardening of attitudes and a widespread recognition of the precariousness of life under capitalism.

We must remind ourselves that unemployment is a lagging indicator of crisis. In the USA, Britain and most continental European countries the jobs situation has hardly improved throughout 2010 and 2011 and, with ferocious cuts in the pipeline, austerity looms for years ahead. This makes it difficult, but all the more important, for workers to fight back. It also gives the labour movement time to mobilise.

Working class determination to resist is growing worldwide, and we have already seen the first lightning bolts of class struggle. The Great Recession will be remembered as the opening of a new period of working class struggle against capitalism.


Marx was also aware of the competitive struggle between individual capitalists, and its deleterious effect on their system as a whole, in the teeth of a crisis. Unlike Adam Smith, he did not see competition as the driving force of the falling rate of profit. “Competition, generally this essential locomotive force of the bourgeois economy, does not establish its laws, but is rather their executor. Unlimited competition is therefore not the presupposition for the truth of the economic laws but rather the consequence – the form of appearance in which their necessity reveals itself.” (Grundrisse, p.552)

For Marx the fall in the rate of profit intensifies the pressure on individual capitalists to compete with one another. “(T)he fall in the profit rate that is bound up with accumulation necessarily gives rise to a competitive struggle. Compensation for the fall in the profit rate by an increase in the mass of profit is possible only for the total social capital and for big capitalists who are already established. New and independently operating additional capital finds no compensatory conditions of this kind ready made; it must first acquire them, and so it is the fall in the profit rate that provokes the competitive struggle between capitals and not the reverse”(Capital Volume III, p.365)

Marx observed that “it is one thing to share out profits and another to share out losses.” Competition under capitalism is not like a ‘fair fight’ between equally matched contestants. It is a process where the weakest, hanging on during the good times, finally go to the wall. Often what remains is looted by the winners, or rather survivors. This is what has happened to Woolworths and MFI. This is what has turned many of our high streets into boarded up ghost towns. This is what very nearly happened to GM and Chrysler in the USA. This is the reality of capitalist competition.

This process is all part of the destruction of capital, the ‘healing’ process of the bust. Capitalism seems to have adopted the anarchist Bakunin’s slogan, “The passion for destruction is a creative passion.” How far must this devastation go? How many working people’s lives have to be shattered before the conditions for a big upturn are prepared? We shall see.

Commodity prices

Typically a prolonged upswing will produce a boom in the price of raw materials. We suppose in theory that an increase in the demand for an industrial product is likely to call forth an instant increase in its supply as its price goes up and capitalists, mindful of the profit motive, respond by boosting production. But there are biological and geological limits in the responsiveness of organic and mineral materials’ production to demand conditions. As a result commodity prices are likely to respond spasmodically to changes in demand, with soaring peaks and dizzying drops.

This was most noticeable in the case of oil, which was actually the major basic cheap resource that fuelled capitalism in the ‘golden years’ after the Second World War. Our ‘rigorous’ neoclassical economists descend to the most casual empiricism when they characterise the 1973-4 crisis as an ‘oil crisis.’ They are incapable of noticing that oil prices generally are determined by the demand for oil, given the supply constraints, and that the demand is provided by capital accumulation, particularly in the advanced countries.

Of course, since oil is an important resource for capitalism, if the price of oil rises towards the end of an upswing then that is going to increase costs and therefore cut into profits. And because the rate of profit is likely to be falling by this stage, it is theoretically possible that the oil price hike could help precipitate a fall in the actual mass of profit and bring about a recession. The important point is to see how commodity prices are located in the cycle of accumulation.

Commodity prices have by and large stayed buoyed up throughout the Great Recession. There are two reasons for this. The first is that there is a speculative element in the trade for commodities. There is still plenty of idle money around with time on its hands to do mischief. Despite the depressed conditions in the world economy early 2011 has seen a spike in food prices. This obviously hits workers in the poor countries hardest.

The second reason raw material prices have stayed high is because of demand from China, a densely populated resource-poor country. Chinese industry is a powerhouse. All its trading partners have been lifted by demand for raw materials and components being sucked in to China.  The recession has demonstrated that permanent feature of historical development, combined and uneven development. China has hardly been touched by the downturn at all. It is true that the Chinese economy is only responsible for about 8% of global output, but the regional impact of its continued growth has been immense, as is the effect it has had on raw materials suppliers as far away as Africa.

Stocks (inventories)

In a boom the capitalists exude confidence. They develop the belief that ‘this time it’s different’ – this time the boom will last forever. As a result they build up stocks of raw materials, confident in the good times to come. In doing so, of course, they act as excellent customers to the capitalists responsible for producing raw materials. They may also allow stocks of finished goods to accumulate in the warehouses, sure that they will be sold in the fullness of time.

It’s a different story in a slump. Unsold stocks of finished goods are a millstone around their necks. They may well reduce output below what is actually required so as to realise the values of their unsold stocks first. They may be forced to do this because their profits have disappeared and that is the only way to escape bankruptcy. The niggardly approach they develop in the slump to husbanding raw materials hits the capitalists producing these raw materials, for whom this market is the only way they have of making a living.

It is widely believed that there is a stock cycle within the overall boom-slump cycle. This is called the Kitchin cycle. Kitchin suggested that the cycle of building up and running down stocks took place over 4-5 years. This theory was developed during what is now called the ‘just in case’ phase of industrialisation, where big manufacturers routinely held big stocks of components, ran large stores holding spare parts in their factories and housed these stocks in warehouses, just in case.

The expectation is that, as output turns down, piles of unused stocks will stand exposed. Firms will then carry on producing by using up their existing stocks of materials and components. Of course that means they will cancel contracts with their suppliers for the time being. That will have a knock-on effect on the economy. When they have used up existing stocks they will re-open supply lines and rebuild their stocks. This creates a mini-cycle within the cycle.

Japanese manufacturing developed the ‘just in time’ (JIT) system, where component suppliers sometimes delivered on the hour, just in time to be incorporated into the production process. Naturally JIT economised on the capital that was invested in stocks that would otherwise have been lying around unused. It cut costs. It has been widely adopted in other countries. Computerisation has in principle allowed much more effective stock control and planning – until an unforeseen event like the credit crunch causes the whole chain of production to seize up like a motorway pile-up.

It is not absolutely clear what has been happening to stocks since the recession bit. There have been contradictory reports in the financial press, but it seems that the feeble recovery beginning in 2009 has not been led by massive investment in capital equipment. There remains far too much excess capacity for that to be widespread. Capitalists, it seems, have rebuilt stocks instead, but reports in the financial press up to the summer of 2011 suggest that phase of recovery is more or less over. We may have to wait to establish exactly what role the running down and building up of stocks has played in the Great Recession.


Capitalists have no way of knowing what the future will hold for them. Yet they have to develop a view as to how markets are likely to evolve. Under these conditions capitalists’ expectations can acquire the power of a material force in the economy. Marx gleefully chronicles the swindles carried out by capitalists upon one another. Yet these swindles were indicative of a certain mentality – the belief that anyone with money could make more money. This outlook becomes dominant after a long period of boom because it reflects a certain reality.

On the other hand a crash caused by failed capitalist projects can drag quite reputable and viable capitalist firms and individuals down with it. That is the price capitalists pay for their system. Really the market division of labour makes them all interdependent upon each other and dependent upon the operation of the law of value. But they do not realise this. “(I)n the midst of accidental and ever-fluctuating exchange relations between the products, the labour time socially necessary to produce them asserts itself as a regulative law of nature. In the same way the law of gravity asserts itself when a person’s house collapses on top of him.” (Capital Volume I, p.168) After the crash, caution becomes the dominant mood. And of course that caution makes recovery slower.

We have seen almost hysterical mood swings between boom and slump, and the effect they had on economic developments. The bubble was sustained for a while entirely by euphoria, by a suspension of disbelief, by a feeling that participant speculators were walking on air.

Then came the crash. The objective conditions for capitalist profit-making were revealed to be horrible. But that had been the case for years previously. It was as if the movers and shakers of the system had suddenly woken up to the fact that they had been living in cloud cuckoo land. The let down was extreme. There is no doubt that the new mood of sobriety, of enduring a hangover after a very entertaining party,  has been important in causing investment to suddenly shut down and for the world to plunge into recession.

Interest rates

When we discuss the tendency for the rate of profit to fall, by ‘profit’ we meant surplus value as a whole. The rate of profit is calculated as total surplus value divided by total capital invested. Yet surplus value is usually divided into rent, interest and profit (actually there are others who share in this surplus). All three factors can vary against one another.

Traditionally, the share of surplus value going to finance capital is called interest. Interest rates are connected to the boom-slump cycle in a complex way, analysed by Marx in Capital Volume III. We cannot treat the subject fully here.

“If we consider the turnover cycles in which modern industry moves – inactivity, growing animation, prosperity, overproduction, crash, stagnation, inactivity, etc.,.. – we find that a low level of interest generally corresponds to periods of prosperity or especially high profit, a rise in interest comes between prosperity and its collapse, while maximum interest up to extreme usury corresponds to a period of crisis.” (Capital Volume III, p.482)

After a recession, interest rates are generally low. Manufacturing capitalists are not making much profit, so they cannot afford to pay the banks much interest. They are not investing in new plant. They are certainly not investing with borrowed money, but gradually trying to cover their losses and restart production on a modest scale with the resources available to them. As production picks up, the demand for loan capital from manufacturing capitalists rises.

When a crash is looming, “In times of pressure, the demand for loan capital is a demand for means of payment and nothing more than this; in no way is it a demand for money as means of purchase. The interest rate can then rise very high”…just when the industrial capitalists can least afford it. (Capital Volume III, p.647) In a crash everybody needs hard cash. The whole crazy process is about to begin again.

The new millennium boom was weak and anaemic. It was fed by artificially low interest rates. Since the conditions for making profits in production were unspectacular, much of this cheap money flowed into speculation. Therefore low interest rates profoundly shaped the course and pattern of the boom.

In a sense the entire crisis began with a change in the conditions for borrowing. The credit crunch was not just a sudden hike in interest rates, which Marx identified as the usual pattern at the onset of crisis. On this occasion loan capital dried up altogether. That had the same effect as Marx had outlined, but even more dramatically.

World trade

We would expect that, as profit-making opportunities re-emerge, capitalists would exploit the division of labour to introduce more economies of scale and divide the world ‘rationally’ into areas that can produce goods at the lowest possible cost. This division of labour between capitalist firms is not organised but governed by market forces. We would therefore expect to see trade, including international trade, advance during the upswing and contribute to the strength of that upswing. We would also expect to see trade shrink in the downturn as each capitalist, and each capitalist nation-state, turns on the others, determined to load the burdens of the crisis on anyone but themselves.

As Armstrong (Capitalism since 1945) shows, trade liberalisation did not kick-start the revival of the European and Japanese economies in the years right after the Second World War. The reason for this was the enormous imbalances in the world economy – in particular the complete dominance of the USA over the capitalist world. All the other advanced countries had massive deficits with America.

“Nor was continued European expansion based on massive import growth from the United States or elsewhere…Indeed, imports fell in 1948 and only regained 1947 levels in 1951. Meanwhile exports steamed ahead and by 1950 had regained prewar levels, with imports still some 10% below.” (pp.82-3) In other words the increased exports were not a sign of reviving economic health, but served just to repay accumulated debts.

When the road was clear, trade interacted dialectically with profit-making potential in production to push the upswing higher. “The years of the boom saw a phenomenal explosion of trade. Between 1951-3 and 1969-71 the volume of world trade in manufactures grew by 349% whereas the volume of output grew by 194%” (ibid p.153).

The slowdown hit trade as well as production. The slowdown in trade made the slowdown in production worse. “The growth of world trade slowed down sharply after 1973, growing at an average 3.8% a year over the period 1973-88, compared to 8.7% per year during the previous decade” (ibid p.296). As we shall see later, world trade actually fell in volume terms in the wake of the 1974 crash.

We quote Kindleberger (in National income and the crisis in Part 6) to show that, for poor and peripheral countries, trade was by far the most important and volatile element of national income during the Great Depression. Their economies went into a tailspin because their export markets in the advanced countries dried up. Trade-led growth has also been a way for capitalist countries such as Japan and Korea to develop.

Of course we should not see trade as a completely independent factor in economic development. Usually world trade develops rapidly when profit-making opportunities abound and accumulation is proceeding fast. And countries develop on the back of world trade because they have developed a competitive advantage in production.

So trade is volatile. Precisely for this reason the Eichengreen O’Rourke index, which tracked the downward path of the Great Recession against 1929-33, showed that for the first year of the recent crash, world trade was actually collapsing faster than it had done after 1929. Then it slowed and reversed after one year. The turnaround can be attributed to the revival in profits, which was noticeable by the beginning of 2009. But world trade can augment the fluctuations in capitalist production.

Movements in the rate of profit are at the heart of the Great Recession and of the partial recovery we have seen since. But boom and slump are complex, multi-layered processes. These ancillary factors have their own importance in the development of the Great Recession.

  • Any real      capitalist crisis involves a complex interaction of factors. The Great      Recession showed that clearly.
  • The tendential fall in the rate of profit is      the underlying cause of capitalist crisis.
  • Many other factors interact with it in the      complexity of capitalist boom and slump.









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Part 2: Previou…

Part 2: Previous capitalist crises

Our contention is that, while every crisis is a unique historical event, there is also a common thread and pattern to all of them. We compare the similarities and differences here.

Chapter 2.1: The Great Depression, 1929-33

Financial panics have not been the only trigger for a full-scale crisis of capitalism, as they were in 2007-8. It is widely believed that the Great Depression of the 1930s was triggered by the New York Stock Exchange crash of October 1929. Actually this is a myth, but the Wall Street crash was a shattering event that made the crisis much worse. Charles Kindleberger shows that the crisis in ‘the real economy’ was well under way before the stock exchange crash. Discussing the deeper causes of the Great Depression, he comments:

“The difficulty with all these lines of reasoning, however, is the speed with which the collapse of production took place, and the fact that it began well before the stock market crash. Industrial production fell from 127 in June to 122 in September, 117 in October, 106 in November, and 99 in December. Specifically, automobile production declined from 660,000 units in March 1929 to 440,000 in August, 416,000 in September, 319,000 in October, 169,500 in November, and 92,500 in December.” (Kindleberger, Manias, Panics and Crashes, p.61)

Here are extracts from 1929 – Can in Happen Again?, written by the present author in 1999. Our intention is to show some of the global interconnections that spread the crisis from USA to the rest of the world at the time; and from the manufacture of cars plus electricity and the associated industries, that were the heart of the 1920s boom, to the economy as a whole.

“But when the car factories started laying workers off, and by December 1929 were only churning out 92,000 cars, that was bad news for tin and rubber workers in Malaysia. The little local difficulty in Detroit became a global crash. That is what credit does – it generalises local problems as well as it generalises local prosperity. It drops us all in the same situation together, whether we know it or not. Credit is one of the ways we are all drawn into the world economy as cogs. It is one way a global division of labour is established behind the backs of the participants.

“We have seen that the economist Thomas Wilson was right when he noted that the market slump ‘reflected in the main the change which was already apparent in the industrial situation’. But the financial collapse in turn reacted back on the fundamentals…This further piece of bad news would be heard soon enough in Malaysia. The lesson of 1929 was – we’re all in this together. The crisis began in the real economy, not on Wall Street. The crash made things worse back there in industrial USA, and all over the world where commodities are produced and exchanged.” (1929 – Can in Happen Again?)

The 1920s boom was no more solidly grounded than the one that ground to a halt in 2007, and crashed the following year. There was a bubble in the roaring twenties – a bubble in share prices. (There was a bubble in land and house prices in Florida too.) There were also massive global imbalances, as there were in the last decade. But even before the share price bubble burst in October 1929 the outlines of the looming slump were clear. Throughout the decade, as Tom Kemp makes clear, “The heavy investment in constant capital especially plant and machinery imposed a continuous struggle against the tendency for the rate of profit to decline.” (The Climax of Capitalism, p.40)

Though not exactly a double dip recession (the misery did not stop coming or even draw breath) the Great Depression, like any complex multi-faceted phenomenon such as a major recession, went through different phases. It first came to general notice spectacularly with the Wall Street crash. It intensified in 1931. The strings of international payments, the global imbalances of the era, were finally severed in 1931.

Briefly the 1920s had been characterised by the declining British and French ‘victors’ of the First World War squeezing Germany for reparations in order to repay the USA for the loans they had borrowed in order to win the War. The whole crazy money-go-round came to an end in 1931 with a banking collapse. This was not just like the steady stream of bankruptcies of banks mainly in farming areas throughout the 1920s. This banking collapse brought to a halt the whole system of international payments and intensified the crisis.

Then countries like the UK effectively devalued – by coming off the gold standard. That ushered in a period of monetary and trade anarchy, a new stage in the downward spiral of despair. Like the recent Great Recession, the Great Depression ground through phases like the Wall Street crash of 1929 and the financial crisis of 1931, all of which were aspects of one capitalist crisis.

Eighty years after it happened, academic economists are still divided as to the causes of the Great Depression. Peter Temin has argued from a Keynesian perspective that it was caused by an autonomous shift in spending. Perhaps. But autonomous shifts in spending have themselves to be explained. Less persuasively Milton Friedman opined that the Depression was the result of a collapse in the money supply. This was supposed to have occurred because of the failure of thousands of banks in the USA over the inter-War period. Farm banks in places like the Dakotas had been going bust one by one throughout the 1920s as part of the post-War agricultural crisis. The main waves of banking collapses however occurred in late 1930 and then in March 1931, when the Great Depression was already well under way. (See Temin – Did Monetary Forces Cause the great Depression? for the detailed argument.)

How far was the crash a direct result of the tendency for the rate of profit to fall? Economic data collection was not nearly as well developed in the 1920s and 1930s as it is today. In many cases comparable figures do not exist at all. In others the statistics are drawn up in a different way, making direct comparison impossible. All the same we know that, “Corporate profits had reached a high of $9,000 million in 1929. Not only did profits fall to about one third of that figure in 1930, but became negative in 1931 and 1932.” (Kemp ibid, p.91) So, as we shall see, the fall in profits closely shadowed the collapse of investment over the period of the Great Depression.

  • The Great      Depression, contrary to myth, was not caused by the Wall Street Stock Exchange      crash in 1929.
  • The      severity of the Great Depression, like the present crisis, was rooted in      the weaknesses and imbalances of the preceding boom.

Chapter 2.2: The rate of profit after the Second World War

The Second World War prepared the conditions for a massive revival in the rate of profit and for a golden age of capital accumulation. The principal reason for this was the destruction of capital during the War. This is discussed in more detail in Part 7.

Let us look first at the evidence from Capitalism since 1945 (Armstrong, Glyn and Harrison). On page 8, Armstrong et al. deal with the increase of investment as a result of the War. “In Japan throughout the period 1939-44 private industrial investment ran at around the rate of the mid-thirties. In Germany between 1936 and 1943 the volume of investment in industry grew continuously to an unprecedented level….In the United States investment grew rapidly during the early years of the war. The peak in 1941, however, still represented a lower level than that achieved in 1929, and it then declined and stayed at a rather low level (less than half the 1929 peak) for the remainder of the war. Investment in plant and machinery in the United Kingdom rose by nearly one-half between 1938 and 1940, but then declined to well below half the previous rate for the last three years of the war.”

So far, then, investment was recovering from the Great Depression as a result of the open-handed arms spending by the warring states. Rates of profit were extremely high throughout the War in the fascist countries, as the authors point out, because of the repression of the labour movement.

Post-War chaos and devastation at first held the economies back. Despite the ‘advantages’ of fascism in Italy, “the low level of capacity utilisation, especially in 1946, substantially increased overheads, such as depreciation. Overall the share of profits in industrial output in 1947 can hardly have been much below that in 1938.” (ibid p.53)

In Japan the profit share rose year on year from 1947-1951 from 8%, to 9%, to 15% to 22%, to 26% (ibid p.91). In Germany “profits were high” (ibid p.97). The authors show industrial production, industrial employment and industrial productivity increasing by leaps and bounds after the War.

The authors sum up the causes of the post-War recovery. “The balance between wages and productivity was extremely favourable to the employers. Profits were comparable to prewar levels even in the countries then under fascism” (p.105). The revival of the possibility of profitable production was a precondition of the great post-War boom.

Throughout what the authors call the ‘golden years’, the rate of profit was in gentle decline. This was not a straight-line movement, of course. The rate of profit went down in years of downturn and revived in the upturn. There continued to be a cycle of boom and slump, but it was much more moderate over this period. The rate of profit did revive after each downswing, but did not generally recover its previous peak. So the graph lines for Europe, the United States, Japan and the advanced capitalist countries as a whole show profit rates dipping as we approach 1974, the year of the first generalised post-War crisis of capitalism. Diagrammatically, the movement in the rate of profit resembles the teeth of a saw that tapers downwards.

At bottom, as we show later, the 1973-4 crisis was not an oil crisis, or an inflation crisis: it was a crisis of profitability. On p. 251 Armstrong et al. shows manufacturing profit rates in Europe, Japan and the USA recovering after 1974, but never returning to the levels seen in the ‘golden years’.

Taking up the record on the rate of profit for the later period in The economics of global turbulence (1998) Brenner begins, “Between 1970 and 1990, the manufacturing rate of profit for the G-7 economies taken together (the biggest capitalist economies) was on average about 40% lower than between 1950 and 1970…the radical decline in the profit rate has been the basic cause of the parallel, major decline in the growth of investment and with it the growth of output, especially in manufacturing over the same period. The sharp decline in the rate of growth of investment – along with that of output itself is – I shall argue, the primary source of the decline in the rate of growth of productivity, as well as the major determinant of the increase of unemployment. The reductions in the rate of profit and of the growth of productivity are at the root of the sharp slowdown in the growth of real wages.” (p.7-8).This is Brenner’s central thesis. And we agree with him. What we need to find out is why this happened.

On page 8 of The boom and the bubble Brenner shows the fall in average profits in the 1970-93 period compared with the golden years of 1950-70 in a diagram. The US sees falls from 24.3% to 14.5%, Germany 23.1% to 10.9%, Japan 40.4% to 20.4% and the G-7 as a whole from 26.2% to 15.7%. Moreover output, net capital stock, gross capital stock, labour productivity and the real wage all follow the trend set by the net profit rate. It is clear that profit determines the whole rhythm of capital accumulation

  • There has been a secular decline in the rate      of profit since the Second World War.
  • There have also been cyclical movements in the      profit rate over the period determining the boom-slump cycle.

Chapter 2.3: The crash of 1973-4

The 1973-4 recession was the first generalised recession of global capitalism since the Second World War. It marked the end of the ‘golden years’. We look briefly at this event as an example of the processes we have been analysing.

In the first instance bourgeois economists, desperate to show that crisis is not inherent in their system, assert that the 1973-4 crash was ‘all about inflation.’ Certainly inflation was very high in 1974. In the US it was 11%, in Japan 21%, in Britain, 16%, in Germany 7%, and in Italy 19%.

World capitalism had actually thrived on the more moderate inflation, which had become a feature of the whole post-War era, gradually and insidiously increasing over the years. The causes of inflation are complex and cannot be dealt with here. But in Britain, for instance, the government budget deficit was 10% of GDP in 1975. Such deficits have to be paid for, and can contribute to the inflationary spiral.

The main point is that in 1973-4 inflation ceased to be a stimulant and started to become a major obstacle to economic growth, reflecting imbalances that were making the recession worse. Before 1974 Keynesian economists had perceived inflation as a sign that the economy was growing too fast, while unemployment was evidence that it was going too slow. Now the economy was simultaneously sending out messages that it was running too fast and too slow! The alternative, of course, was that Keynesianism had failed as an explanatory tool and as a remedy for economic problems. Economists started to mutter about ‘stagflation’ and ‘slumpflation’ and to develop alternative theories.

An oil crisis?

The second illusion spread about 1973-4 was that it was an ‘oil crisis’. It is true that the price of oil, the basic feedstock of post-War capitalism, quadrupled in less than a year. The oil price hike was not a result of sober economic calculation. After the 1973 Arab-Israeli War, oil producing Arab nations boycotted western countries because of their perceived pro-Israeli bias. Both they and their customers were then astonished at the economic power they had accumulated.

Itoh and Lapavitsas (Political economy of money and finance) put the oil shock in context. “The world market prices of primary products such as corn, wood, cotton, wool and minerals also began to rise rapidly in the later 1960s, reflecting the relative shortage of these products. The quadrupling of the price of crude oil within a few months in 1973-4 owed much to the fourth Arab-Israeli War, but was also integral to the general shortage of primary products due to the overaccumulation of capital in the advanced countries. The terms of trade relative to manufactures were raised by more than 10 per cent in 1970-3 and by nearly 70 per cent in 1970-4. The price of raw materials for manufacturing nearly doubled within the year prior to the first oil shock.” (p.193)

All the other ancillary phenomena mentioned in the abstract in the section above (Chapter 3.8 Ancillary factors) came into play in a concrete and painful manner. At the end of the boom speculation and swindling were rife. More and more resources were devoted to the acquisition of raw materials and of land, the price of which was soaring. This feverish speculation was a product of the mentality that the good times would never end.

Banks had been lending more and more to speculators to buy land, thus creating the perfect bubble. The bubble duly burst at the end of 1974, threatening to take the banks with it.

In Britain a dodgy bunch called secondary banks (really property speculators) had to be saved by a rescue operation launched by the Bank of England. The alternative was that, as they sank beneath the waves, they would take large chunks of the financial establishment with them.

The overheated stock exchanges all over the world had the opportunity to chill out. In London share prices went from a high of 339 to a low of 150 in 1974.

Commodity prices, with the exception of oil, also collapsed. By December 1974 copper had lost 60% of its value, posted in April of the same year. Other commodities recorded similar losses. These dry statistics are actually a trail of tears for the poor people totally dependent on their sale on the world market.

World trade, which had actually grown faster than the national economies throughout the post-War period and was widely regarded as an ‘engine of growth’, took a hit and fell in absolute terms in 1975. It fell because of a recession located in production and the profit-making engine of the capitalist economy.

The crash actually started in the car industry, and spread and spread.  Production fell sharply. From peak to trough over two years industrial production fell 14.4% in the USA, 19.8% in Japan, 11.8% in Germany, 10.1% in Britain, and 15.5% in Italy.

Naturally unemployment soared. By the trough it was 7.9 million in the US, 1.1 million in Japan, 1.1 million in Germany, 1.3 million in Britain and 1.1 million in Italy. The ‘full employment’ era was over.

Capacity utilisation fell in the US from 83% in 1973 to 65% (less than two thirds) in 1975. 1973 was a peak year. But in the 1966 peak 92% of manufacturing capacity was in use. In 1969 it was 86.5%. Measured from peak to peak or from trough to trough capacity utilisation had been falling over the whole post-War period.

Why? Capacity utilisation, investment, output and employment were all falling in line with the rate of profit. Capitalists use manufacturing capacity to the maximum if they think they can make profits. They invest if they think they can make profits. They produce if they think they can make profits. They employ workers if they think they can make profits.

The rate of profit

In the USA industrial (pre-tax) profits were 16.2% measured against net capital stock in the years 1948-50, 12.9% in 1966-70, and 10.5% in 1973. Then they crashed, and so did the economy.

In Britain our figures are taken from Glyn and Sutcliffe British capitalism, workers and the profits squeeze. In 1950-54 the rate of pre-tax profit was 16.5%, in 1955-59 14.7%, in 1960-64 13%, in 1965-69 11.7% in 1968 11.6%, in 1969 11.1%, and in 1970 9.7%. As we have seen from Capitalism since 1945 quoted earlier, profits then recovered after the 1974-75 recession, but never regained the levels they achieved in the ‘golden years’.

Brenner’s works confirm that, since the 1974 crash, the good times have gone for good. The rate of profit has been consistently lower in the 1970-1990 period than it was from 1950 to 1970. Within the later period, the rate of profit rose in times of boom and fell as the economy entered a recession, as it did in the 1950-70 period.

More recently the late Andrew Glyn’s most recent book Capitalism unleashed (published in 2006) is mainly concerned with other matters. On page 136 he does briefly suggest that the American capitalist class has achieved a clawback of the rate of profit up to the level of the early 1970s. He regards that as exceptional. For Europe (pp.145-6) and Japan (p.141) the picture of lower secular profit rates that we have painted remains the same. Likewise Brenner’s 2006 book The economics of global turbulence (an update of his previous work) is subtitled The advanced capitalist economies from long boom to long downturn. It does not challenge the link between movements in the rate of profit and the health of the capitalist economy. The fit is almost perfect.

  • The example of the 1973-4 crash shows in practice the underlying importance of the tendential fall in the rate of profit.
  • It also shows how it interacts with apparently accidental factors to produce a classic crisis of capitalism.

Chapter 2.4: Recessions since 1973-4


1980-2 is the only double dip recession since the Second World War. Once again there was a trigger – and it was oil again. The Iranian Revolution of 1979 disrupted the supply of oil to the capitalist world and sent its price soaring. Inflation, which the authorities believed they had under control after inflicting much pain on the working class, took another jump.

The deeper pattern in the world economy is shown by movements in the rate of profit. The rate of profit never really recovered fully after 1974 and continued to decline. It reached an all time low for the post-War period in 1982. This was why the disruptions of the Iranian Revolution proved deadly. World capitalism was in deep recession again only five years after the previous collapse.

Radical and even semi-revolutionary moods were developing among the working class in several advanced capitalist countries. The boss class fought back. One of Ronald Reagan’s first acts as President of the US in 1981 was to sack the entire unionised cohort of air traffic controllers when they went on strike. Trade union leaders were paraded on television in leg manacles. The union was smashed.

Paul Volcker was nominated as Chair of the Federal Reserve, the US central bank in 1979. Together with the policies of the Thatcher administration in Britain at the same time this represented a turn by decisive sections of the ruling class away from a formal commitment to full employment and Keynesian policies towards no holds barred class struggle. The Fed under Volcker began to hike interest rates, ‘as part of the fight against stagflation’. Stagflation was the term coined for the problematic combination of unemployment and inflation that dominated the economy in the 1970s and early 1980s. Aware that full employment and a return to the conditions of the golden years of the post-War boom were not in prospect in any case, the ruling class showed themselves prepared to create and increase unemployment if necessary through savage contractionary monetarist policies in order to undermine the power of organised labour. Thatcher showed the same resolve in the UK as Reagan in the USA on behalf of her class. Anything to restore the rate of profit!

  • Coming after the 1973-4 crisis, the 1979-82      downturn was particularly severe.
  • Once again an oil price spike was the trigger      and the fall in the rate of profit the underlying cause of the crisis.


The recession of 1990-1, in contrast, was not accompanied by any headline-grabbing trigger. Capitalism will go into crisis from time to time with or without oil crises, inflationary spikes, stock exchange crashes, or banking collapses. The crash was heralded by a cyclical fall in the rate of profit once again. This is shown by Michael Roberts (The great recession p.36) and Robert Brenner (The economics of global turbulence 1998 p.103). In both accounts profits peak in 1989, take a tumble the following year and recover after 1991. Roberts comments, “The rate of profit rose steadily” (after 1982) “apart from the merest of pauses in the recession of 1990-2, up to a new peak in 1997” (ibid p.38). Of course this recession was relatively mild by comparison with those of 1973-4 and 1979-82.

There was a large speculative element in the boom in the UK that preceded the 1990-1 bust. The Thatcher government had undertaken a wholesale deregulation of the banks. The banks then began to lend like crazy. Nigel Lawson, who was Chancellor of the Exchequer at the time, was later asked why he hadn’t made any attempt to choke off the speculation by raising interest rates. “Was the government responsible for the banks taking leave of their senses?” he responded. The short answer to that is surely ‘yes’.

  • 1990-1 was a comparatively mild recession. The      rate of profit dipped, but not as seriously as in the previous recessions.


The crisis of 2001 exhibited a characteristic which seems to be a permanent feature of the modern capitalist economy. There was a bubble and it burst. We shall discuss the reasons for these persistent bubbles later on. The bubble emerged in the price of ‘new technology’ shares. George Soros surmises in his book (The crash of 2008 and what it means, Public Affairs, 2009) that the capitalist world is afflicted by a super-bubble which, once suppressed at one point in the world economy, pops up again somewhere else. This is a plausible hypothesis that we shall take up again when we deal with Economic perspectives in Part 7.

Robert Brenner shows (in What is Good for Goldman Sachs is Good for America) that the mad dash to grab a share of the supposed profits to be made in the ICT ‘revolution’ produced massive overcapacity in that sector. Declining returns in the rest of the economy did not at first stem the speculative inflow of capital into ICT. On the contrary. Capital in search of profit had nowhere else to go. The phenomenon of leading sectors and industries forging ahead is a common feature of a capitalist boom, which invariably grows unevenly and chaotically, with disastrous results later on. This Gadarene stampede resembles a gold rush, where most come away poorer than they started. Marx would have recognised in the boom a direct descendant of the railway mania of the 1840s

Brenner comments:

“Between 1995 and 2000, industrial capacity in information technology quintupled, accounting by itself for roughly half of the quadrupling of the industrial capacity that took place in the manufacturing sector as a whole, which also smashed all records. As a consequence the gain in profitability deriving from the increased productivity growth was counterbalanced by the decline in profitability that resulted from growing over-supply.” (p.31)

From the low of 1982, the secular rate of profit crept up in a jagged fashion, dropping back again with the onset of each recession. By 1997 it had reached a post-1982 high. Most commentators agree that it has never regained the 1997 level since. When the bubble burst ICT profits crashed. The ICT sector’s rate of return, as Brenner records, fell from 22% in 1997 to 4.6% in 2000. The collapse dragged down the rest of the economy with it.

Then came the crash. “As a result, in 2001 alone, the rate of profit in the manufacturing sector as a whole fell by 21.3%, to a level over a third down from its 1997 peak.” (ibid p.34)

This downturn was also comparatively mild. The crash was less severe elsewhere in the world. Britain, Spain and Ireland were technically not in recession at all over this period, though their economies slowed down. The rate of profit revived after the 2001 recession, and, it is generally agreed, had turned down decisively by 2006 before the current slump.

  • The boom that preceded the 2001 bust was      accompanied by a bubble in ICT share prices.
  • We conclude that the tendency for the rate of      profit to fall as explained by Marx is the key to understanding the cycle      of boom and slump in the capitalist economy.




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Part 1 Chapter 8

Chapter 1.8: The Euro crisis

The Great Recession put world currencies in a spin. The stresses and strains of crisis not only cause the bosses to attack ‘their own’ working class all the more strongly; they also bring into the open national antagonisms between the capitalist powers. This took the form of an increasing tendency to protectionism and of the ‘currency wars’ that are discussed later in Part 7 on Economic perspectives. For now we concentrate on the crisis of the Euro.

The Euro is a single currency that has been adopted by seventeen member nations of the European Union (EU) since 1999. Uniquely, the Euro is a currency without a home country. This poses problems when the currency comes under attack. National governments can use economic policy measures to defend their national currency. These measures are fiscal and monetary policy.

The Eurozone is the area of countries that have given up their national currency and adopted the Euro. There are no common EU or Eurozone fiscal (taxing and spending) policy levers. Fiscal policy remains in the hands of the nation states that have joined the Euro. They are supposed to subscribe to severe rules as to how big a deficit and public debt they can run.

The rules, referred to as the Maastricht criteria, are a classic piece of neoliberal gobbledegook. They insist that members of the Eurozone restrict their fiscal deficit to 3% of national income, while the national debt stays below 60% of GDP. These figures seem to have been plucked out of the air.

All fiscal crises are thus seen as instances of deliberate fiscal profligacy by national governments, tendencies to be held in check by the EU authorities. The notion that economic crisis could sweep away these imposed limits in one country after another through forces outside the nation state’s control seems not to have occurred to the founders of the Euro.

The member states have also given up control over monetary policy to the European Central Bank (ECB). In principle there should be a single interest rate across the Eurozone established by the ECB. Since the Eurozone is a mighty actor on the world economy, interest rates for member countries were expected to be generally lower than they were in their own national currency, as speculators faced little risk in holding Euros. The weaker peripheral countries in the Eurozone believed that the might of the countries coming together to adopt the Euro would provide them with a safe haven from economic storms. How wrong they were!

Over the past decade two distinct groups of nations have clearly emerged within the Eurozone. First there are those sometimes known as the PIGS (Portugal, Italy, Greece and Spain) or PIIGS (as above but with Ireland) or the Southern Comfort zone or Club Med. (This categorisation involves a semi-racist stereotype of lazy South Europeans – and Irish – compared with the industrious North Europeans who minted these expressions.)

What these peripheral countries have in common is that they are running deficits with their trading partners in the Eurozone. They are buying more from them than they are selling. The biggest surplus in the zone by far is run by Germany, an industrial giant within the EU. German capitalists pay some of the highest hourly wages within the EU, but they face the lowest relative unit labour costs (RULCs).

These costs are for instance much lower than those of Greece, where workers’ standards of living are much lower. The difference in RULCs is accounted for by German workers’ much higher level of productivity. RULCs are the real measure of a nation’s competitiveness. Clearly lower productivity is not a fault to be laid at the door of Greek workers. It is the result of the longstanding failure of Greek capitalists to invest.

  • For the      peripheral countries in the Eurozone, the sovereign debt crisis also      became a crisis of the Euro.

Greece under attack

The Euro came under threat as a result of the economic crisis. This threatens to overwhelm the single currency. Naturally the weakest countries were first to come under attack. We shall use the case of Greece to illustrate how these processes work.

The attack on the Euro took the form in the first instance of an attack on Greece and its public finances. Governments borrow money by issuing bonds. The Greek PASOK (Pan-Hellenic Socialist Party) government under Papandreou discovered upon sweeping into office that the preceding Nea Dimokratia (ND, right wing) administration had lied about the size of the budget deficit. Told that the deficit was below the Maastricht limit of 3% of GDP, they found that the actual deficit was really an alarming 12%. As the Greek crisis grew, it became clear that Goldman Sachs had been hired by the Greek ND government to cover up the extent of the mess to the rest of the world. Not only that. The ECB authorities had either been negligent in probing into the extent of the budget deficit or had actually connived at its concealment in order to maintain the myth of an unsinkable Euro.

In principle a government bond denominated in Euros and issued by any government in the Eurozone should attract the same rate of interest, set by the ECB. In practice bond dealers began to discriminate against Greece and other countries they regarded as risky. In effect they were factoring in risk, the possibility of a sovereign default, into the price of the security. The ‘spread’, the difference between interest rates on German government bonds, for instance, and those of Greece was a measure of that perceived risk.

During the boom years, the notion that any advanced capitalist country government would default was unthinkable. In 2010 the spread between the interest rate on Greek Euro bonds and German bonds denominated in Euros began to widen. The unthinkable was being thought more and more often. The interest rate spread also meant that governments like that of Greece, which were in the sights of the ‘bond vigilantes’ had to pay higher interest rates just to service their public debt. The bond markets were signalling that they believed a default was a distinct possibility.

The bond market speculators certainly had fun playing cat and mouse with the weaker economies. They were aided in this by the credit rating agencies, private capitalist firms with the power to assess the possibility of a nation state defaulting on its debt. These were the same credit rating agencies that had earlier been paid by the banks to award AAA credit ratings to the toxic sub-prime derivatives they were issuing.

If a country was downgraded by the rating agencies for whatever reason the bond vigilantes would soon be on the warpath. In addition to betting on derivatives generally, speculators found ways to bet on the possibilities of countries defaulting. Another kind of derivative, called a Credit Default Swap (CDS) offered the opportunity to have a little flutter on the fate of whole nations. Greece, for instance, was assessed by the CDS market at one time in 2010 as having a 55% chance of being unable to pay its creditors and defaulting.

  • The bond      markets saw weakness in some Eurozone countries, and began to demand a      risk premium.

The problem with fixed exchange rates

A fixed exchange rate in danger such as the Euro offers speculators a one way bet. This was the case before Britain was bombed out of the European Exchange Rate Mechanism (ERM), the predecessor of the Euro, in 1992. Though separate currencies in the EU still existed at this time, they were fixed against one another through the ERM.

The one way bet is that, if the speculators bet on a devaluation and there is no devaluation then they don’t lose any money. If the currency devalues, they can make a fortune. Here’s how. To keep the arithmetic very simple, imagine that originally $1 = £1 and that sterling is under threat. The speculators buy dollars with their pounds at the fixed exchange rate. They are betting against sterling. After the devaluation occurs $1 = £2 and the speculators cash in their dollars for twice as many pounds as they originally held.

So an unstoppable wall of money builds up, till the devaluation becomes an accomplished fact. George Soros alone is reckoned to have made £1bn by betting that sterling could not survive within the ERM in 1992. This is what has been happening to the weak economies within the Eurozone since 2010. A wall of speculative money builds up and waits for the fall.

  • A fixed exchange rate offers speculators a tempting, risk-free opportunity to make money.

EU ‘rescue’

The spread between German and Greek government bonds was also ringing alarm bells in the capitals of Europe. Their treasured project of monetary union was critically endangered. For months the authorities in the strong countries of the Eurozone dithered, either putting their own national interests first or seemingly unaware that the threat to the Euro was a threat to themselves as well. Finally they woke up to the impending crisis. As the speculation increased they realised they would have to bail out their weaker trading partners.

The Greek government could not possibly pay its debt, as we shall see. Why should the country not default? The French and German governments, hitherto so contemptuous of the Greek people’s plight, suddenly became aware that the principal victims of a Greek government default would be the French and German banks who had incautiously lent Greece the money in the first place.

So, in a hamfisted and dilatory way the ECB, the EU and the International Monetary Fund (IMF) together organised a ‘rescue’ package. Let us be clear. This was a rescue package for French and German banks, not for the Greek people. It did not seem much like rescue to the Greek working class. They were subjected to severe attacks on their living standards. They have been put on rations by world capitalism, but they are fighting back.

It was easy for the bond markets to bully Greece, a country with a population of about 11 million people who are quite poor by North European standards. It has a small economy. When in extremis the main European powers are forced to put all their economic clout together they can just about afford to bail out a country the size of Greece. They have shown that they can afford to do it – just.

As the Greek crisis dominated the headlines the EU ‘rescuers’ mounted a full-scale ‘shock and awe’ plan of pledging 440bn Euros through the newly-devised European Financial Stability Facility (EFSF) to see off the bond markets, with a further 310bn on call. Not one cent of this money was to go to the Greek people.

This rescue felt more like a foreign occupation to the Greeks, as their finance ministry was invaded by pushy officials from the IMF, the EU and the ECB (the troika). Greek workers were being set up to bear the burden of the still escalating government debt. They face the same pressures as British workers or French workers – but in spades.

Greece underwent its first bail out in May 2010. In November 2010 the EU authorities also rescued Ireland. The EU’s fear was that the contagion could spread to Italy or Spain. Then the crisis would be too big to handle. That fear is justified.

Greece had a GDP of about 455bn Euros at the time of the bail out so, in effect, the EFSF could have bailed out Greece with its 750bn Euros fund. Spain had a GDP of more than 2trn Euros at the time of the first Greek rescue. It has 20% unemployment in 2011. House prices have fallen by 40% since 2007. If Spain fell ill, the whole might of the EU would be unable to buttress its place in the Eurozone.

We have discussed the sovereign debt crisis and the Euro crisis separately from the fiscal crisis of the state. They raise separate technical economic issues. But they are all in fact aspects of the same unfolding crisis of capitalism.

  • Greece was      bailed out by a Eurozone rescue package in 2010 – loans were offered to help      service their bloated public debts. But the debts remained.
  • The price      paid by the Greek people for this ‘rescue’ was redoubled austerity.

‘Crowding out’

In the final section of this book we take up and dismiss the British Tory-dominated coalition’s argument that they have to cut back the government deficit and debt because otherwise public spending is likely to ‘crowd out’ private investment which is needed for the recovery. Austerity is the standard response by the capitalist establishment to the effects of the economic crisis upon government finance. It was agreed at the G20 (Group of 20 most important countries) meeting as the correct strategy for the capitalist world in June 2010. Let us remember first that the deficits have been incurred, and the debts have ballooned, in order to bail out the capitalist class – not because of extravagant social spending to benefit the workers. The Tories’ arguments are specious in any case. They want to take a knife to the public sector anyway, and this is just the perfect excuse.

But for those countries worst hit by the fiscal and foreign debt crisis crowding out is more than a theoretical possibility. They are carrying an immense dead weight of debt which will slow down the recovery. Interest rates on a bloated national debt can rise and even choke off a revival of economic activity. Take the case of Greece. Public debt was 141% of GDP at the end of 2010 according to Buiter et al. (The debt of nations). They predict that, “Greece needs to run a (permanent) general government primary surplus of around 6% of GDP just to stabilise its general government gross debt-to-GDP ratio at the level of around 150% of GDP expected at the end of 2012” (p.56).


Giving so much of everything the Greek people produce for the indefinite future to the bond financiers without any return, and without even reducing the national debt, means bleeding the Greek economy to death. The authors go on, “This means that additional tightening equal to 10% of GDP is needed over the next few of years to just stop the gross general government debt-to-GDP ratio from rising in Greece” (ibid)


This is on top of all the sacrifices already demanded. Buiter estimates that interest payments on the national debt will ‘crowd out’ 8% of Greek national income by 2013. This will be seen by the vast majority of Greeks as a huge drain on wealth that they have created. But this crowding out is not created by the insatiable demand for decent public sector services, pensions and benefits from the Greek working class, as capitalist apologists suggest. It is the continued cost that a relatively poor country pays for remaining part of the world capitalist system. The answer to this sort of crowding out is to break with capitalism.


  • The      costs of bailing out capitalism are likely to be visited on the working      class for years to come – unless they fight back.


Bond markets on the rampage

The bond vigilantes for their part will have noted from the Greek experience that there is a great deal of money to be made from other people’s misfortune. That ‘rescue’, as we see, has not ended the threat to Greek living standards from the bond markets, or the threat to the Euro. Trade unionists in Greece reckon the real unemployment rate was 20% at the end of 2010 and still rising. Greek workers face an indefinite period of austerity ahead.

It has to be said that, though the bond markets do have the power to bully and blackmail small nations, they are not composed of uniquely evil people. The bond markets are all part of the normal working of the capitalist system. And the bond vigilantes can be used as an excuse. The coalition government (the ConDems) in Britain longs to trim back the outreach of the state in favour of private capital. It is very useful for Cameron and Osborne to appear in public with crocodile tears in their eyes lamenting that the pressure of the financial markets has left them with no option but to cut, cut, cut the public sector.

The bond markets seem to pick on one weak spot after another for attack. This is called ‘contagion’ in the financial press by analogy with the spread of disease. But the contagious nature of a disease is actually caused by the spread of microbes. We know this to be the case even though we can’t see the blighters. What causes the spread of speculation and instability in capitalist markets? It is a purely psychological phenomenon, spurred on by the expectation of making a killing. And, as we know from experience of the bond and currency markets, these expectations can become self-fulfilling.

  • Bond      markets have the power to bring down governments. So far from financial      markets being ‘efficient’ or ‘rational’, they can be quite hysterical.

The Euro on trial

The economies of the Eurozone are generally on the mend, though very slowly. But we know that the pain inflicted on the Greek economy by severe cuts in government spending and public sector workers’ pay and conditions mean that it will continue to roll backwards in 2011 and after. When an enfeebled economy like that of Greece is linked with the fate of the heartlands of European capitalism by means of a common currency, then the crisis is by no means over.

The temporary resolution of the Greek crisis in 2010 gave the heads of the leading EU countries time to pause for thought. They realised that a Euro crisis still stalks them, that the economic recovery is anaemic and fragile, and that a collapse could bring them all back into recession. The recognition was beginning to dawn that the pressures the capitalist crisis had placed on relatively small weak countries such as Greece were unbearable. They needed a plan B, a way to organise a conciliatory default of one of the peripheral countries if the need arose. It might be the least worst option. The alternative was ruin for all of them.

Greece, in particular, may have to be taken through a default. The problem involved in an orderly restructuring of Greek public debt is that this really means that the French and German banks that lent the money in the first place will have to take a hit. That will be resisted by the Franco-German leaders of the Eurozone unless it is the only alternative to economic collapse. The dilemma, of course, is that the collapse of French and German banks resulting from such losses could actually trigger such a disaster.

Default could partly be forced as a result of class battles. The Greek working class is rightly furious at having to shoulder the debt burdens heaped upon them by their tax-dodging ruling class. They will increasingly demand a repudiation of these debts. No wonder they are in the van of struggle against the effects of the recession.

The problem is the faulty design and architecture of the Euro project. The single currency does not have the resources of a capitalist nation state behind it. Instead monetary affairs are organised by squabbling national cliques. The Eurozone is a powerful economic region. By and large its economies are growing again. But in the longer term the fate of the single currency is by no means certain.

  • The      economies of the Eurozone are mainly on the mend, which should help the      survival of the Euro for the time being.
  • Some      countries remain very weak, and the faulty architecture of the Euro means      the single currency is still under threat. A Euro crisis could plunge the      whole Eurozone back into recession.

2011: the Euro crisis drags on

A year after the 2010 bail outs it has become clear that nothing had changed fundamentally. In 2011 Portugal had to undergo a ‘rescue’ like that of Greece and Ireland, and Spain and Italy felt themselves under siege by the bond markets. The institutional weakness of the Euro, concealed by years of boom, remained. The crisis of the Euro poses problems for the whole of the Eurozone, and for the world economy as a whole. We shall continue to use Greece as an example of these difficulties.

The weakness of the Greek economy is not an accident. Capitalism is a system based on competition that produces losers as well as winners. The system naturally generates imbalances through the uneven development of different capitalist regions. These imbalances within the EU could unsettle the single currency.

The impossible situation that the Greek people find themselves in could bring down the Euro. The ECB and IMF are concerned with the threat of contagion. If Greece is let off the hook only a little bit, then Ireland, Portugal and all the other debtor countries will be queuing up for equal treatment. If Greece collapses, that could be the start of a chain reaction that could drag the world economy right to the brink of meltdown as it was in September 2008. Commentators are starting to whisper about ‘a Lehman moment’ that signalled the near-collapse of world banking.

Despite all the top US bankers and the Treasury Secretary being closeted away for an entire weekend in September 2008, no agreement to save the stricken Lehman Brothers bank could be arrived at. Whatever the reason, this failure is now seen as catastrophic – leading to the collapse of all the subsequent financial dominos. Greece could be the equivalent of Lehman Brothers in the sovereign debt crisis. Its default could bring down the Euro.

The Greek government debt and deficit were higher in 2011 than they had been a year earlier. It was quite clear by now that the Greek economy was in a vicious circle, where cuts fed economic decline and further decline necessitated yet more cuts. The Greek economy was in effect going on a diet by slicing off limbs in order to lose weight.

One reason for the deteriorating economic situation was that much of this enforced austerity didn’t even go to pay off the country’s monster debts. Costas Lapavitsas estimated in the Guardian (21.06.11) that, “Servicing the debt will cost 12% of GDP, vastly more than health and education.” All this money will be syphoned off just to pay interest on the existing debt, not even to reduce the principal. Most of this money is drained out of the country.

Before the bail out in 2011, holders of Greek government securities were making higher returns than they would do even on the stock exchange. At that time the return on two year Greek bonds stands at 28%. The spread (the difference between the rates on German bonds and those of the Greek government), hardly discernable at the beginning of 2010, was in the summer of 2011 a gaping 1,460 basis points (14.6%), further adding to the debt burden.

The justification for these usurious rates is that the excess is payment for the risk that bondholders take by holding Greek government debt. At the time of writing the spreads between Spanish and Italian government bonds and those of Germany are also becoming a chasm. This spells disaster, since the emergency funds available to the EU authorities are insufficient to bail out either Spain or Italy.

Commentators have suggested, quite plausibly, that, had the European authorities borrowed aggressively at low EU rates in January 2010 to prop up the Greek government, they could have seen off the speculators at comparatively little cost. But as L.P. Hartley commented, “The past is a foreign country.”

  • Uneven      development generates imbalances within the Eurozone which could prove      fatal to the single currency.

The prospects of default

There is no doubt that Greece will default eventually – and quite possibly other peripheral countries within the Eurozone too. The only doubt is whether this will be a conciliatory, managed default organised by the EU authorities as the least worst option; or whether default will be a unilateral act of defiance at the continued imposition of intolerable burdens upon the Greek people.

How would a default proceed? We have only historical experience to go on, and every national default is a unique historic event. Having said that, Argentina’s default in 2001 provides some clues.

 Argentina has long gone through alternating periods of hyperinflation (from printing paper money to pay debts) and austerity. Reinhart and Rogoff lament (This time is different, p.259), “Perhaps Latin America would have done better in terms of economic stability had the printing press never crossed the Atlantic.”

After a period of rapid inflation in the 1980s the Argentine authorities opted for a currency board as a way of pinning the peso to the dollar and fighting rising prices. This meant that Argentina’s Central Bank could not issue another unit of the national currency unless it was backed by a greenback earned as foreign exchange through exports. It was an extreme form of fixed exchange rate system, offering the monetary authorities no room for manoeuvre.

The cure was worse than the disease. Inflation slumped, but so did economic activity. The pain was intolerable. It was made worse by massive capital flight which turned into a run on the banks. The government responded to the run on the banks by effectively freezing bank accounts. Violent protests erupted. A state of emergency was declared but it didn’t save the government. President de la Rua escaped the people’s anger by helicopter in December 2001.

The interim government had no alternative: in the last week in December 2001 it defaulted on the major part of the intolerable burden $132bn of public debt. Much of the debt was foreign owned. It is not possible to default on foreign debt without severe damage to the domestic circulation of money, which was already in turmoil. All the currency, after all, passed through Argentinean banks.

The interim government was forced to suspend convertibility with the dollar. Devaluation followed as a matter of course, together with a period of chaos, where most economic activity was conducted by means of barter. Naturally foreign capital would not touch Argentina with a barge pole after this default.

Argentina is potentially a wealthy country with an export-oriented big business agricultural sector. The world economy was booming at the time and the Chinese seemed to have an insatiable appetite for Argentinean soy. After the default the economy recovered rapidly, assisted by the cheapness of the Argentinean peso in world markets. The country grew by 8.8% in 2003, 9.0% in 2004, 9.2% in 2005, 8.5% in 2006 and 8.7% in 2007. (Greece will not achieve this, as its main exports are to the European Union, still mired in the backwash effects of the Great Recession.)

Argentina began to run a huge trade surplus. It seemed once again a tempting prospect to foreign ‘investors’. A deal was negotiated with foreign creditors by 2005 in which they accepted part-payment of the debt. Bonds were swapped at 25-35% of their former face value.  International capital was prepared to write off previous losses in view of mouth-watering future profits. Once again Argentina was viewed as a fine place to do business and good money was thrown after bad.

The prospects for Greece in the event of a default are not as rosy as they were for Argentina. When Greece first defaulted in 1826, the country was shut out of foreign capital markets for the next 53 years. (Reinhart & Rogoff, ibid pp.12-13) Modern Greece has actually spent half of its existence in default and financial limbo with foreign investors.

  • Argentina      had a strong export sector and ready markets to hand when it defaulted.      Greece doesn’t.
  • Argentina      defaulted in the teeth of a world boom that helped the country’s export      earnings. Greece faces years of austerity in its export markets.
  • International      capital was desperate to get a cut of Argentina’s profits. Nobody wants to      invest in Greece except to buy state-owned assets for a song.
  • Greece will      have to default. The only question is whether this is organised by the EU      authorities or comes about as a unilateral act of defiance

The options for Greece

Default:  The troika is charged with supervising Greece’s debt repayment. It consists of the European Commission, the European Central Bank and the International Monetary Fund. To the Greek people the troika is a foreign agency united in grinding them down with its iron heel, driving them all to penury. Why not default?

A default usually proceeds in the panic-stricken atmosphere of crisis. At the first hint of non-payment a flight of capital and a run on the banks begin. Of course a resolute anti-capitalist government would issue a guarantee on citizens’ bank deposits to avoid this. If a government is determined to go through with the default and sees no alternative, it must impose capital controls. If panic spreads it may have to declare a bank holiday as well, and shut down the ATMs for a short time. The only effective way to carry through a default effectively is therefore to nationalise the banks.

It may be argued that Greece needs the money on offer from the troika. After all the government is still running a primary deficit (a deficit excluding interest payments on the national debt). That means that at least some of the ‘rescue’ package on offer will go to pay for public services, not just drain out of the country as interest payments. So it would be irrational to refuse.

This is a powerful argument. The troika will hand out the payments a tranche at a time. If the Greek parliament were to refuse to pass the package, civil servants and other public service workers would soon find that they were not being paid and public services would pack up as the money ran out.

That is how the troika intends to make the Greeks learn how to sit up and beg!

The price of a bail out is perpetual austerity. The vast majority of Greeks are ruled by a swelling political mood of indignation and a determination to free themselves from the chains of debt.

Deflation: Deflation as a policy option is discussed in more detail in Chapter 6.2: Government economic policy options. In theory deflation means that, after immense hardship, wages and prices fall till the country becomes competitive.  We find in Chapter 6.2 that deflation was an ineffective method of adjusting international competitiveness in the case of Britain in the 1920s. The weakness of deflation as a policy, and its dangers as an economic process that runs out of control, are discussed in Chapter 7.2.

In Greece the prospects for a deflationary return to competitiveness are worse. We already know that deflation is not working in Greece. When wages fall, workers do not just put up with the cut in living standards, as economic theory predicts. Many leave paid employment and return to their ancestral village to help out on the family smallholding and eke out a living there instead. The models used by neoclassical economics, which suggest that wages will smoothly fall till competitiveness is regained, are therefore hopelessly flawed.

Devaluation (by exit from the Euro): What about exit from the Euro? There is no constitutional procedure for this within the European Union, but that is the least of the Greeks’ problems. The new Drachma, if launched, would probably fall to half the value of the Euro. Many experts believe it would fall far further.

The good news is that this would give Greek exports a competitive edge. Their exports would be half the price that they were before on world markets. The bad news is that their creditors would demand that debts denominated in Euros be repaid in Euros. That would mean earning twice as many new Drachmas as before. That is why it is more important to repudiate the debt than to leave the Eurozone, though one might lead to the other in a crisis.

  • Default is      a high-risk option, but everything else seems to be worse.
  • Deflation      is seen to have failed already in Greece. It is part of the problem, not      the solution.
  • Exit from      the Euro may come about as a result of default, but is not a primary      policy objective for the Greek working class.
  • Unless      decisive action such as a unilateral default, the Greek political and      economic crisis will rumble on and on, posing problems for the Eurozone as      a whole. No obvious solution is in sight.

The EU’s dilemma

The troika is divided among itself. The Germans under Merkel had been insisting that speculators who took the risky investment in Greek bonds should share in the losses. They have a point. The alternative, of course, is that European taxpayers (specially German taxpayers) bear the entire burden of the losses for which they are in no way responsible. The fundamental question facing the European authorities is – who will take the hit?

The holders of peripheral country bonds are mainly banks – including German banks. European banks are now teetering on the brink, their vaults stuffed with toxic government bonds. The ECB is opposed to shifting the burden on to bondholders for fear it will provoke an avalanche of bank defaults. Merkel has now abandoned her earlier position for this reason.

The troika realises that it is caught in a dilemma. A dilemma is a choice of two alternatives, both of which are impossible. That is why the authorities are dithering, making the situation worse. We have not only a crisis of the Euro but also a crisis of European-wide decision making. Rather than sorting out a common position behind the scenes and presenting it to the world, the troika engages in public dissent.

There are two reasons for this: the first is the clash of national antagonisms within the EU which makes the formulation of a common European-wide strategy impossible. Merkel and Sarkozy are not concerned with the problems of the Greeks; they are too busy listening to the voices back home. Since that is the case, the call for a new Marshall Plan for Europe is a fantasy.

The second reason for the paralysis the fact that there is no way out of this crisis. Merkel wanted to relieve the pressure on Greece by letting the bondholders share the pain. Then it was explained to her that these bonds are held by German and other banks. European banks are currently up to their necks in assets that they know or strongly suspect are worthless. How many are insolvent? The troika knows that any attempt to tamper with the unstable pile of debt that has built up could trigger the avalanche Merkel wants to avoid.

The ECB has been clandestinely buying up bonds of the weaker Eurozone countries. Some have called for the launch of Eurobonds, backed with the full might of the Eurozone. Then even the weaker countries could borrow at lower rates, since the chance of default would be much smaller. The trouble is this would be seen as a giant step towards complete fiscal union. The ECB would have to have the power to dictate to nation states how many bonds they could issue, how much they could borrow. In effect the level of the national debt and deficit would be taken out of the hands of the nation states. None of the existing Eurozone countries are prepared to go that far along the road to fiscal union at present.

Half-witted British Eurosceptics scoff at the plight of Greece and the Euro. ‘It’s nothing to do with us,’ they rant. The sub-prime mortgage scandal in Florida and California may have seemed to be nothing to do with us. But we’re all part of the capitalist world economy. British banks may have little exposure to Greece, but they are massively committed to Ireland. If Greece went down, Ireland would be next in line to go.

Though British banks have few direct holdings of Greek government debt, they have apparently been having a little flutter on Credit Default Swaps. Described as an insurance policy, CDSs are really a form of gambling on the prospects of sovereign default. US banks also hold $34bn in Greek CDSs. They stand to lose heavily if Greece defaults.

At the time of writing the Greek crisis and the crisis of the Euro look set to run and run.

  • Once again immense hardships are being imposed on working people in order to ‘socialise’ losses and bail out the banks.
  • The troika is paralysed because nothing they do can provide a solution to the problem of probable Greek default and the fate of the Euro. This is the nature of capitalism in crisis.

A new EU constitutional treaty?

All through 2011 one interminable summit meeting after another failed to lance the boil of the Euro crisis. In the financial press ‘kicking the can down the road’ became a wearisome cliché. In fact some palliative action, rather than endless dithering, would have been welcome to other world leaders. It is true that, not only were the national leaders of the Eurozone divided against each other, but also that nothing they could do collectively would solve the fundamental cause of the crisis. These were:

  • The Euro crisis was rooted in a severe crisis of capitalism.
  • This had manifested itself in all the capitalist countries (not just those in the Eurozone) as a huge build up of state debt and deficits. This was because of collapsing government receipts and the expense of bailing out the banks.
  • The crisis in Europe was compounded by the uneven economic performance of the different capitalist countries within the Euro.
  • The faulty architecture of the Euro made a solution difficult, if not impossible.
  • The capitalist crisis that first manifested itself as a banking crisis in 2007 once again took the form of a European banking crisis in 2011.

The German proposal to amend the EU treaties in December 2011 sounded as if, at last, the severity of the crisis had at last penetrated the skulls of the European leaders. Obama’s American administration was in despair, aware that a return to recession in the Eurozone would have catastrophic effects on the entire fragile global economic recovery. American bankers had failed the test by letting Lehman Brothers go to the wall in September 2008. As a result the world economy had been on the brink of meltdown. This was Europe’s ‘Lehman moment’, and onlookers were determined that the world economy should not be again on the point of collapsing into the abyss.

In fact the German proposal was hopelessly inadequate. It suggested that more severe rules on government ‘overspending’ should be written into the EU constitution, and that such institutions as the ECB and the European Court of Justice (ECJ) should be empowered to take recalcitrant nations in hand. How would imposing fines on governments in deep economic difficulties help?

In other words the proposal was based on the half-witted neoliberal proposition that the problem was that some countries (such as Greece) were hapless spendthrifts while others (such as Germany) always cut their coat according to their cloth. It ignored entirely the fact that exploding state debts and the Euro crisis were both the creation of the crisis of capitalism.

In fact Germany has done extraordinarily well out of the Euro regime. It has allowed the country to run export surpluses with most of its Eurozone partners. Rival nations were unable to devalue, in order to give their own economies a ‘quick fix’ of respite against the overwhelming productive advantage of German exports.

Yet the German representatives seem unable to recognise that fact. Instead they urge all their trading partners to follow their lead, cut government spending, and export more as a way out of their difficulties. As economist Paul Krugman sarcastically puts it, “Somehow southern Europe is supposed to deflate its way to prosperity, while everyone runs a trade surplus, presumably against that potentially habitable planet we’ve discovered 600 light years away.”

The immediate reaction from financial markets to the deal was far from favourable. In the first place the exact arrangements will probably take months of backstairs haggling to set out. Secondly the programme for a greater degree of fiscal unity will take months, if not years, to put in place through the minefield of EU decision-making. The proposal is not a true plan for fiscal union within the Eurozone in any case. It was shamefacedly called a fiscal compact.

In essence it allows Germany to impose its will on the other countries. In particular countries under threat will be offered no protection from the rigour of the markets, as they would be in a federal country. There are no plans for the ECB to guarantee national bond issues so that countries such as Greece can borrow at lower rates, rather than the usurious interest charges that are bleeding the country dry. Under German pressure, the plan to issue Eurobonds has been abandoned

Federal countries such as the USA have a central bank (called the Federal Reserve in the US) which acts as a lender of last resort. So, if a bank is in Wyoming is in difficulties, the Fed will act to bail it out. There are no plans for the ECB to do the same for Greek, or Portuguese, or Spanish or Italian banks. It will not act as lender of last resort.

But that is the only thing that could face the bond markets down. What is needed, financial analysts insist, is a ‘big bazooka’, a fund large enough to convince speculators that they would lose any bet against as country in the Eurozone. To protect the position of Italy, or Spain, or even France would require amassing a war chest of trillions of Euros. No such plans are on the table.

In the short term the ECB could print money and buy up Eurozone government securities with the proceeds. This is equivalent to what a central bank does when it goes to the rescue of a bank within its jurisdiction. That could hold back the speculators for a while. The ECB has been forbidden from printing money. The plan represents a conservative straitjacket on the Eurozone area. As a result Europe is likely to languish in the doldrums for the indefinite future.

  • European-wide decision making is still dominated by the conflicting national interests of the member countries.
  • German domination within the EU has come to mean the imposition of forced austerity upon the other members of the Eurozone. That will not solve the crisis of the Euro.



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Part 1 Chapter 7

Chapter 1.7: Fiscal crisis of the state

All over the world the crisis of capitalism has produced a fiscal crisis of the state. Apart from the direct cost of bailing out the banks, the economic downturn means the government has to pay out more in unemployment benefits and other maintenance costs while tax receipts shrivel.

The US total public debt stood at 96.4% of GDP by the end of January 2011. The federal deficit was 10% of national income at the same time. This means that the American government was borrowing almost $1of every $10 it was spending. Interest rates were very low at this time. All the commentators agree they are sure to rise. That will pose a catastrophic increase in the burden of debt servicing upon the American people before even a cent of the debt is repaid. As we see later, Reinhart and Rogoff have done a number of historical surveys of the impact of recessions upon national debts; and of the effects of ballooning national debts in slowing the subsequent recovery. They estimate that, if public debt exceeded 90% of national income in their surveys of past recessions, the growth rate has slowed from 3.7% to 1.7% thereafter.

The USA remains a giant in the world economy. It is difficult to imagine the mighty dollar being tossed about by market forces like the Icelandic Kroner, but it has happened before and could happen again. Likewise though the American government may not be forced to go cap in hand for a bail out like the Irish or the Greeks, the USA remains in deep trouble. The recession may be (technically) over; the crisis is still ongoing.

Unemployment remains stubbornly high in the States, despite the revival of economic activity since 2009.The official U3 measure of joblessness remains above 9%. The main reason it has fallen is because jobseekers have become so discouraged by the daunting prospect before them that they have dropped out of the labour market altogether. Meanwhile the U6 measure of unemployment shows that almost one in six of American workers can’t get a full time job they want. U6 is regarded as a more realistic measure of the problem because it includes those only working part time though they believe they need a full time job to make ends meet.

Obama tried a genuine fiscal boost on coming to office in 2009, not just following the Bush administration’s policy of buying up toxic assets and throwing money at the banks. The package was to be worth $787bn. Why did it have no effect?

Part of the package was to retain the Bush government’s tax cuts, with the intention of leaving spending money in people’s pockets. The problem with this was that the Republican tax cuts were overwhelmingly targeted at the rich. Rich people, as is well known to economists, spend a smaller proportion of their money than the rest of us. (Though, of course, they spend more money in absolute terms.) So the stimulus effect of that part of the package was slight. Secondly Obama maintained unemployment benefits and tried to put a floor under still collapsing house prices, for instance by forcing Fannie Mae and Freddie Mac to keep buying up mortgages. Welcome as this must have been to desperate American workers this was just relief, not a programme for recovery.

The small part of the programme money left was intended to create jobs by increasing government spending. In fact the stimulus effect was blown away by the fiscal crisis of the states, cities and local administrations. As fast as the federal government tried to stimulate the economy, state governments in particular were slashing jobs and spending. This is partly because many of them are committed to running balanced budgets.

Just to take one example Illinois confronted a $15bn budget deficit by the end of 2010, with a huge iceberg of more than $60bn in unfunded pension liabilities to come. The state is stony broke. Public sector workers are being arbitrarily dismissed in state after state. Public services are being shredded. There is a real prospect of a default of municipal bonds somewhere in the USA. The deadlock on the federal budget between Obama and the Republicans in Congress went within an inch of a government shutdown in the summer of 2011. 

Japanese finances are also in the mire. After a spectacular bubble in land prices burst in 1990, the country has suffered severe deflationary pressures for two decades. (See the section on Deflation in Chapter 7.2.) The government responded with several unsuccessful fiscal injections. All this achieved was ratcheting up the national debt to twice the level of GDP. That’s the official figure – public finances in Japan are a murky affair.

At the same time the British coalition government is banging on about the crisis of state finance. They are pressing panic buttons since the national debt has been spiralling from 40% of GDP to a projected 75% as a result of the Great Recession. The British government was predicting a government deficit of 12.5% of GDP in 2010.

They are not alone. Rumours abound of future disasters to come in the form of debt landmines hidden in Spanish cajas (savings banks) or German landesbanken (regional banks). All the major capitalist governments in the world face similar problems with their budgets and with unemployment.

  • The crisis      of capitalism has manifested itself as a crisis of state finances.

The debate on state spending

Though Keynes’s policy prescriptions designed to save capitalism have proved failures in the past whenever they have been tried, his critique of the orthodoxy of his time, as it is of our time, was remarkably prescient. The ‘Treasury view’ in the inter-War period (discussed in more detail in Government economic policy options in Part 6) asserted that there were two sorts of government; those that were fiscally prudent and balanced the budget – and spendthrifts, most likely socialists. Keynes noted that in fact the budgetary stance of the government was dependent upon the state of the economy. During a boom the money rolled in to the state coffers causing a surplus, while in a recession income naturally sagged and a deficit loomed, whatever the political persuasion of the administration. This is precisely what has happened over the past four years.

The effect of these deficits will be to boost the national debt. Britain had a national debt of 40% of Gross Domestic Product (GDP) in 2007, before the crisis struck. Most economists, even those of a conservative persuasion, would regard this as manageable. Three years later, massive deficits are driving the UK national debt up to around 75% of national income. All the main political parties in the UK describe this debt burden as insupportable and claim it is necessary that steps be taken to reduce it at any cost. We discuss in the Afterword whether this is true. (It’s not.) All major capitalist powers have the same attitude to the deficit and the public debt, though the situation is complicated in the USA by the political deadlock between President Obama and the Republican-dominated House of Representatives.

The crisis of capitalism, which first manifested itself as a financial crisis appears later as a fiscal crisis of the state. Governments all over the world find themselves head over heels in debt. Their deficits, the difference between what they receive as tax etc. and the outgoings needed to feed the unemployed and prop up tottering capitalism, are soaring. Soaring deficits mean a rising burden of national debt. Deficits are the difference between two very large flows – money in to the government and money out. They are also both dependent on the growth of the economy, so estimates are subject to constant revision. The deficits and debts are usually measured as a percentage of GDP. The 2009 figures show the scale of the problem. This was the year when the crisis of 2008 really impacted on government finances.

Eurostat reports the budget deficits of the worst hit Eurozone countries in 2009 as follows:

  • Greece 15.4%
  • Ireland 14.4%
  • Spain 11.1%
  • Portugal 9.3%%

The situation is much worse for the weaker economies than for the USA and Britain. In 2007 Ireland was running a government surplus and its national debt was only 13% of national income. By 2010 the country was running a budget deficit of about 14.7%, despite two years of government-imposed austerity after 2008 – or perhaps because of these savage cuts to the living body of the Irish economy. So far from getting the country out of a hole, the austerity programme had produced a 17% fall in the level of economic activity and unemployment running at 14% in Eire by the end of 2010. Property prices had fallen by 34% over the same period, and were still in freefall. This tale should be a lesson and a warning of the dangers in accepting austerity programmes to workers elsewhere in the world.

If national income falls it becomes more and more difficult to pay off the debt. One reason is that more and more tax revenue is going straight out again, not to repay the debt but to pay the soaring bill of interest payments. It is estimated that Ireland’s national debt is now equal to its GDP. The overwhelming reason for this is because the government has absorbed all the bad debts of Irish banks. Now for every five Euros paid in tax in Ireland, one Euro will go straight to interest payments on the debt.

The fiscal crisis of the state means a new round of redundancies, wage restraint and cuts. Whereas private sector workers had borne the brunt of the first wave of attacks when the banks failed, public sector workers and public services are now in the cross hairs. According to the capitalists, the working class is to pay twice for a crisis that was none of their making.

In the Eurozone the fiscal crisis of the state is entangled with the fate of the Euro. In the case of small peripheral countries such as Ireland, where most of the borrowing for the national debt is from abroad, then the state funding crisis will also manifest itself as a sovereign debt crisis.

  • The crisis      of capitalism, manifested as a crisis of state finances, has imposed a      further round of hardships on the mass of the people.

Sovereign debt crisis

Two years ago Gillian Tett was asking the question in the Financial Times (22.11.09), “Will sovereign debt be the new subprime?”  She was definitely on to something.

The crisis of government finance has indeed shown up as a sovereign debt crisis, particularly for small countries such as Greece, Iceland and Ireland. All governments routinely borrow to finance their expenditure. They do so by issuing bonds (sometimes called gilts in the UK) to wealthy individuals. For Greece, Ireland and other small countries most of these bonds were owned by people outside the country, foreign banks in particular. We shall deal in detail with the problems this posed later, as part of the crisis of the Euro. For the time being we want to record the fact that the financial crisis, the crisis of state finance and the sovereign debt crisis are all part of the unfolding of the same capitalist crisis.

  • For the weaker countries, the crisis of government finances was also a sovereign debt crisis.
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Part 1 Chapter 6

Chapter 1.6: Into the abyss?

For one year, from early 2008 to the first quarter of 2009, all the signs pointed to a crisis as severe as that of 1929-33. World trade was falling just as fast as it had done in 1929-30. Kindleberger used a famous ‘spider’s web’ diagram, called The Contracting Spiral of World Trade: Month by Month , January 1929 – June 1933 in his book The World in Depression, 1929-39 (p.170), to show how world trade had contracted by 1933 to one third of its 1929 level.




Could this happen again? It did look for one year as if the world economy was shrinking as fast as it had done in the Great Depression. Here is Martin Wolf in the Financial Times (16.06.09) reflecting the general panic of the time:

“First, global industrial output tracks the decline in industrial output during the Great Depression horrifyingly closely. Within Europe the decline in the industrial output of France and Italy has been worse than at this point in the 1930s. The declines in the US and Canada are also very close to those in the 1930s. But Japan’s industrial collapse has been far worse than in the 1930s, despite a very recent recovery.

“Second, the collapse in the volume of world trade has been far worse than during the first year of the Great Depression. Indeed, the decline in world trade in the first year is equal to that in the first two years of the Great Depression. This is not because of protection, but because of collapsing demand for manufactures.

“Third, despite the recent bounce, the decline in world stock markets is far bigger than in the corresponding period of the Great Depression.”

  • In the      beginning of 2009, all the signs were that the collapse was as rapid and      complete as that of the Great Depression.

Bottoming out

Then, around the early part of 2009, the decline in world trade and output levelled out. Here’s the ‘phew’ from the Financial Times:

“Comparisons between the global financial crisis and the Great Depression in the 1930s have been a staple of the international commentariat ever since financial markets froze last year.

“Such parallels have seemed a little overblown for some measures of output, such as industrial production.

“However, a tracking comparison by Barry Eichengreen at the University of California and Kevin O’Rourke at Trinity College Dublin shows the volume of world trade falling about twice as fast as during the Depression.

“In the 15 months after the peak in the global economy in June 1929, commerce fell by around 10 per cent; in the same period after the recent turning point in April 2008, global trade was down by 20 per cent.

“…And yet in practice, the fall in trade has not only levelled out but actually turned around. “

(World trade: Turnaround in global commerce defies the doomsayers, Alan Beattie Financial Times 05.10.09)

If the world economy had really crashed this time as deep as it had in 1929-33, then we could have been looking at unemployment levels in excess of 30% in the heartlands of world capitalism, and a state of economic ruin that led in the 1930s to fascism in Germany and World War. After about twelve months the indicators stopped pointing so starkly down.

Why? No doubt economists and economic historians will pick this question over for decades to come. Our very preliminary conclusion is that the government bail-out put a floor on the downswing of economic forces. That can only be part of the explanation for the turnaround.

  • The      collapse was stemmed in 2009, partly because of massive government      intervention

Profits turn around

There is no doubt that by the beginning of 2009 the fall in profits had also bottomed out and the rate was starting to rise. We reported earlier that, according to the Bureau of Economic Analysis, US pre tax profits peaked in the 3rd quarter of 2006 at $1,865bn, a year before the credit crunch struck. The mass of profits fell throughout 2008. They hit a trough in the 4th quarter of that year at $861bn. By the first quarter of 2009 pre tax profits had bounced back to $1,130bn., and by the 4th quarter they were up to $1,548bn. By the 3rd quarter of 2010 they had reached $1,845bn.

That seems an almost complete recovery of the mass of profit but, as we discuss in more detail in Rate of profit and crisis in Part 5, it does not mean we are back to business as usual before the Great Recession. This information on movements in the rate of profit may sound like assertion at this stage in our narrative. We discuss the data in great detail and provide sources in Chapter 5.3: Testing the Marxist theory of crisis.

By the end of 2008 firms that had been a feature of every high street in the advanced capitalist world, such as Woolworth and MFI, had collapsed. Dole queues all over the world were getting longer. Unemployment is described as a lagging indicator of the level of economic activity. But most national economies began to turn up again in the early part of 2009 (The UK lagged behind.). The way was led by the revival in the rate of profit.

This revival does not mean, of course, that the way is automatically set fair for complete economic recovery. Overaccumulation means the overproduction of capital. Once a crisis of overaccumulation has broken out, then the excess capital has to be destroyed. Though the rusting and decomposition of plant and machinery may play its part, a slump mainly has this effect by destroying the value of capital. This reduces the organic composition of capital (as explained in Chapter 3.7) and helps the rate of profit to revive. This slow, wasteful process of capital destruction has been going on below the surface, taking workers’ jobs and livelihoods with it, since the recession struck. Unemployment continues to rise even after profit rates recover.

By 2010 the recession was over. By ‘recession over’ we mean here the strictly technical sense in which a recession is defined as a period of falling output. Larry Summers calls the present situation, “A statistical recovery and a human recession.” The good times seem as far off as ever.

  • The      recovery in profits after the end of 2008 prefigured a new upturn.
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Part 1 Chapter 5

Chapter 1.5: Bailing out capitalism

The capitalist monetary and credit system was in danger of disappearing into thin air. The authorities in Britain, the USA and elsewhere had no alternative but to step in to save capitalism from itself. It has often been said that the problem was that the banks were too big to fail. In that case an alternative would be to split them up into smaller units. The fact was that they were too interconnected to fail, and too important for the capitalist system. Capitalism cannot function without banks.
Two years later the banks have recapitalised themselves at the public expense, are making bumper profits and handing out obscene bonuses. They are shrugging off with contempt any suggestion that they should be reformed so that such a crash could never happen again. The whole incident shows that, rather than elected politicians dictating to the banks, the financial interests have dictated to the governments.
In response to the crisis President Bush’s right-wing Treasury Secretary Hank Paulson, a free market ideologue and former chief executive of Goldman Sachs, immediately began to formulate a plan to bail out the capitalist system at the public expense. He produced his first draft plan within a week of the Lehman collapse. The Troubled Asset Recovery Programme (TARP) involved spending the unprecedented sum of $700bn on buying troubled (toxic) assets, which the banks had acquired voluntarily to make money, in order to clean up their balance sheets for them.
• Capitalist governments threw vast sums of taxpayers’ money at the banks to bail them out.
Socialism for the rich
Correctly, the cry went up that this was socialism for the rich, while the rest of us had to subsist on the thin gruel of neoliberal dogmatism. Losses were being socialised (in other words distributed to the common people) while profits continued to be regarded as the reward for private enterprise. The TARP was eventually pushed through Congress, despite huge resistance from ordinary Americans, who saw Wall Street being bailed out while their own local Main Street was being left to sink. The millionaire politicians knew they needed to do the job to preserve the capitalist system but were mindful of the hostile attitude of their constituents. So, with grumbling from Congress, TARP was passed in November in a bipartisan manner in order to rescue capitalism. It was signed off by Bush in one of his last acts as President.
In addition to this fiscal largesse, the Fed and the Bank of England resorted to the extraordinary step of printing money. Every elementary economics textbook denounces this policy as utterly irresponsible. This step was called quantitative easing. The effects of this strategy are discussed in Chapter 6.4 on Monetarism.
Much later, at the end of 2010, we found out how the Fed had doled out at least $3.3trn on top of the TARP from its soup kitchen to millionaires and billionaires, well away from public scrutiny. We only discovered this largesse because Bernie Sanders, the sole member of Congress who regards himself as a socialist, used US banking legislation to ask a few pertinent questions. Finally the truth trickled out. US firms like Harley Davidson, Caterpillar, Verizon and Dell all got handouts. These loans were virtually interest free.
But it was the banks that really coined it. According to Sanders Goldman Sachs trousered $600bn in total doles (more than the GDP of Greece), almost $2trn went to Morgan Stanley, $1.8trn to Citigroup, nearly $1trn to Bear Stearns and $1.5trn to Merrill Lynch. Other beneficiaries were foreign banks, hedge funds and tax dodgers based in the Caymans, Bermuda or the British Virgin Islands. These sums make TARP look like peanuts. (Sanders-A real jaw dropper at the Federal Reserve, Huffington Post)
While the super-rich were scurrying round the back door of the Fed for their handouts with their begging bowls, dole queues lengthened throughout the USA and families whose homes had been repossessed were sleeping in their cars or hostels for the homeless. Sanders reckons that much of this money was used, “not to reinvest in the economy, but rather to lend back to the federal government at a higher rate of interest by purchasing treasury securities.”
What was the TARP for? What was it intended to achieve? To rescue capitalism from itself. For years during the good times we had to endure the complacent drivel from the powers that be about the triumph of free market capitalism. The bail-out certainly represented a complete panic-stricken reversal of policy. It was a matter of socialising losses in order save the skins of the capitalist class.
We have had occasion to point out before that neoliberalism was really an ideological cloak for the interests of capitalism red in tooth and claw. When their decisive interests are threatened the ruling class will not hesitate to resort to state intervention in the economy (and, if necessary, to the most brutal repression) to secure what they want. That is what the capitalist state is for – a weapon of last resort. The legends of non-intervention in the economy and the superiority of free markets which the capitalists retail to the mass of the population are strictly for the birds.
• The authorities abandoned the pretence of laissez faire and intervened massively in order to rescue capitalism.
The British and international experience
Back in Britain the bank HBOS was struggling. Lloyds took it over for a song. Prime Minister Brown brokered the takeover. It must have seemed a good deal to Lloyds’ chief executives at the time, but only a month later the dead weight of HBOS dragged Lloyds itself under the water. At the same time the London stock market was gripped by panic. In the month of September 2008 Gordon Brown found himself with no option but to nationalise failed bank Bradford and Bingley outright. The Bank’s assets were sold off for next to nothing to Santander while Josephine and Joe Public were lumbered with its losses.
In October 2008 RBS, a bank founded in 1727, was on the point of disappearing in a matter of hours, taking the rest of the banking system with it unless the government intervened. Gordon Brown immediately came up with a £400bn standby package to save the banks. £40bn was pumped in as a matter of the utmost urgency. £40bn would have built more than 1,500 schools or 70 new hospitals, but the banks, we were told, are more important than health or education The New Labour government was forced to take a majority stake of 60% in RBS and 40% in Lloyds/HBOS, in all but name nationalising the banks.
At exactly the same time there was a major run on the Allied Irish Bank, while Iceland in effect declared itself bankrupt as a nation. Iceland had built up debts through its banking system equivalent to an astounding 1,200% of the nation’s GDP.
• Wherever the banks were in trouble, governments intervened to bail them out.
Back to Keynes?
Was the intervention in late 2008 a return to Keynesianism? The economic policy prescriptions of Keynes are a pragmatic response to capitalism in crisis. The leading idea of Keynesianism is that output is determined by aggregate demand, and that the government can and should manipulate the level of demand to get the economy out of trouble. Buying toxic assets as if they were nuclear waste and burying them deep in the earth does not stimulate demand. It is not intended to do so. The intention was to bail out the banks – nothing more or less. It was not Keynesianism in action.
It is true that some of the ancillary ideas, such as ‘cash for clunkers’ – paying people to bring in their old cars for scrap and subsidising them to buy new ones – are classic Keynesian measures. They are also important for us because they show that this was not just a banking crisis. It was a crisis afflicting major industrial corporations. Why otherwise did giant firms that had dominated the industrial landscape of the USA for decades confront ruin so quickly after the financial crisis broke? Why did the auto manufacturing firms in the US and Europe need handouts from the state?
Socialists would regard the scrap and build policy as a ridiculously inefficient use of resources in the face of so much human need. We could do better! At least it was intended to stimulate the economy. But bailing out the banks was not intended to provide a market. It was a policy born of desperation. Keynesian policies were strictly subordinate to the main purpose of the package, which was to bail out the banks and save capitalism.
In 2009 the Obama administration did attempt to launch a genuine Keynesian fiscal stimulus for the US economy. He was able to do this because the federal government can run deficits. But the states, cities and local government are in a desperate financial plight. Hammered by the crisis, their tax receipts have collapsed and they are casting around desperately for cuts, in some states such as California summarily sacking thousands of their workers. These local cutbacks completely neutralised any positive effect of Obama’s federal fiscal boost in alleviating the effects of the crisis.
• The intervention was not a turn to Keynesian economics.
• The bail-out was a panic stricken piece of pragmatism.

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Part 1 Chapter 4

Chapter 1.4: A new stage in the capitalist crisis

The authorities who were supposed to run the capitalist system were clearly shocked by the onset of recession and the scale of the catastrophe. These things were not supposed to happen! They didn’t know what to do.

The collapse of Bear Stearns   

In March 2008 Bear Stearns, one of the big five investment banks on Wall Street, went bust. In a matter of months Bear share prices had collapsed from $100 to less than $2. This was of course because of the sharp fall of profits in the financial sector. Clearly the poison ran deep. Bear Stearns, it seemed, was up to its neck in dodgy deals, and the reality could no longer be glossed over.

The Bush government in the USA swiftly organised the bank’s sale to its rival JPMorgan Chase. This was understandably treated with mistrust by financiers in the know. Morgan seemed to be the government’s favoured investment bank. In fact the sale was virtually a give-away. Morgan had to pay just $256m, mainly in its own shares, for Bear Stearns. The Bear’s buildings alone were said to be worth $2bn.

The destruction of capital that takes place in a crisis described by Marx might seem to be a hazy concept to some (see Economic perspectives in Part 7 for an explanation). It does not mainly consist of rusting and decomposition of plant and equipment. More important is the destruction of the value of capital, by a fire sale of assets. The case of Bear Stearns shows how it happens in practice, as one firm eats another in a crisis. This destruction of capital was quite immediate and comprehensible to the Bear’s 25,000 employees as they marched out of the bank with their possessions in boxes to an uncertain future.

So Bear Stearns was salvaged. The bank was not allowed to collapse altogether. This would have had a massive knock-on effect on the already severely damaged financial system. What did this rescue show, apart from what a fraud laissez faire and neoliberalism are? When working people find themselves in economic difficulties they are left to fend for themselves as best they can. When an arm of the establishment is threatened, no effort or expense is spared to bail it out. One part of the establishment sprang into action to save another part. Does this mean that the banks are ‘too big to fail’, as is often said? We shall discuss this question in more detail later.

Quite apart from the financial fireworks the Great Recession was now in unstoppable spate, rampaging through the world wrecking jobs and livelihoods. Profits and share prices of all the bastions of capitalism, not just the banks, were sinking throughout the year.

  • Banking      collapse spread the crisis throughout world capitalism.


But the complete financial meltdown that began in September 2008 still came as a shock. Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) were not regular capitalist firms. They were two state-guaranteed institutions that lent money out for mortgages. Even in normal times they were responsible for 40% of mortgages held in the USA. Over the years immediately before the crisis this had soared to more than 80% of mortgages, as capitalist institutions refused to take the risk on sub-prime property loans. The risky and loss-making activities of the capitalist market were left, as usual when things go pear shaped, for the state to pick up the bill. Fannie and Freddie got themselves in a pickle by playing the sub-prime market recklessly. They were reckoned to be leveraged 50 times over on their fast-disappearing assets. This is equivalent in horse racing to putting all your money on a 50 to 1 outsider. That means defaults on just 2% of their loan portfolio would put them in Queer Street.

 The US government, staffed by neoliberal ideologues, immediately stepped in to nationalise Fannie and Freddie in September. The alternative was that millions of homeless American households would go to the wall, but that was not the Bush government’s concern.  More important, they feared that Fannie and Freddie would drag the banks down with them.

Then Lehman Brothers, an old-established bank and longstanding pillar of Wall Street, collapsed. It was found to be up over its head, even deeper than the other big banks, drowning in toxic securities. It was quite clear by August that Lehman was in serious difficulties. In September 2008 Treasury Secretary Paulson was closeted with the other big banking chiefs all weekend, but in the end no rescue could be agreed. Lehman was allowed to go to the wall. Whether that was a mistake by the financial authorities in the USA or the product of an obscure squabble between different cliques of bankers is not clear. Certainly the ramifications of its collapse for the whole world capitalist system were vast.

Lehman was broke, no doubt about it. Financially it was incapable of standing on its own two feet. Some capitalists can turn a buck in a crisis as easily as they make money in good times. Speculators, like vultures, began to short Lehman shares, that is to bet that they would go down further. Whether the establishment could have stepped in to save Lehman or not, its collapse provoked panic and a financial catastrophe. Next to fall was AIG, the world’s largest insurance company. It was quite clear that AIG was doomed on Monday September 15th after it was announced that Lehman was dead in the water. AIG’s credit rating was slashed. An insurer has to be solvent. It also has to be able to assess risk accurately. AIG had failed on both counts.

All the institutions that fell were links in a chain. Money manager Lewitt warned at the time, “(AIG’s) collapse would be as close to an extinction-level event as the financial markets have seen since the Great Depression. AIG does business with virtually every financial institution in the world” (quoted in Paul Mason – Meltdown, p.13).

AIG had a turnover of $110bn a year and assets of $1trn. AIG had come to grief by insuring these complex financial instruments based on sub-prime mortgage contracts. It was utterly out of its depth. It was bailed out, once again at astronomic public expense. At the same time Merrill Lynch was forcibly taken over by Bank of America.

Meanwhile as share ‘values’ melted away millions of people who held their wealth in the form of shares were suddenly much poorer – $32trn poorer in fact. In October 2007 world stock exchanges were handling shares with a total market capitalisation of $63trn. By November 2008 this had shrunk to $31trn. This showed the capital was fictitious! The share price collapse was just collateral damage in the maelstrom of the meltdown.

All these banks, familiar props of the capitalist system were now bankrupt, laid low by the derivatives generated from sub-prime mortgages, in other words by the corruption and stupidity of their system. Were the bankers guilty? No doubt about it. For years they had strutted the economic stage as ‘wealth creators’. They had awarded themselves obscene bonuses since they plainly regarded themselves as superior in intelligence to the rest of humanity. Now it had become clear that these half-wits were no more in charge of the forces they had summoned up than the sorcerer’s apprentice. Marx and Engels had observed in 1866 that the bankers who brought down Overend, Gurney and Co., and threatened large chunks of the capitalist system in the process, were just as clueless.

Were the bankers the only guilty ones? No – they were just the instruments that triggered a crisis that had been long in preparation below the surface of events.

  • The      collapse of September 2008 confronted the world with the prospect of      financial meltdown.
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Part 1 Chapter 3

Chapter 1.3: The crisis begins

There were early signs of problems to come. The US housing market seems to have peaked in 2005-6, at almost exactly the same time as the rate of profit turned decisively down. As we see later, the actual mass of profits peaked at the third quarter of 2006, according to the US Bureau of Economic Analysis (BEA), and fell like a stone thereafter. This was a full year before the credit crunch exploded. So the credit crunch did not cause the fall in profits (though it made it worse). The fall in profits was the underlying cause of the crisis triggered by the credit crunch.

There was no direct connection between the housing and profits downturn, though they were both signs that the economy was slowing down. They later came together in tandem to produce a humdinger of a crisis. Desperate to keep the market afloat the sub-prime peddlers were issuing more and more dodgy mortgages. Inevitably there began a steady stream of sub-prime mortgage defaults. But, if the defaulters couldn’t keep up their payments any more, the securities their mortgages had been incorporated in were worthless. From early 2007 the stock exchange proved jittery and volatile. In late summer of 2007 the credit crunch struck.

The Credit Crunch

The first form of appearance of crisis was the recognition by financiers that their entire financial system was really a house of cards about to collapse. Wealth holders everywhere realised that they held financial assets that were not really assets at all. There was panic. The derivatives were so complex that nobody knew which ones were good coin and which ones were toxic. They had been rolled together so skilfully that the poison had been spread throughout the system.

Then things started to happen very quickly:

  • There was a      rush to write off assets. Bankers gawped at pieces of paper they would      unthinkingly have accepted a few months before. Nobody could be sure that      bank assets were really worth anything.
  • Bank      profits collapsed. This was important in itself, since financial profits      have been such a big proportion of the declared profits of capitalist      firms over recent years. After the general collapse in the rate of profit the      year previously in 2006, it had calamitous consequences for the system as      a whole.
  • It suddenly      became obvious that the banks were seriously over-extended. They did not      know where they stood. Since the banks could not trust their own assets,      they could not trust those of other banks. Inter-bank lending froze.
  • Since the      banks realised they were overleveraged they sharply reined in outside      loans as well, instead of hurling money at borrowers willy nilly. Lending      to customers almost dried up completely. Even if loans were available,      this lifeline to hard-pressed individuals and firms would suddenly cost      enormously more than before.

Northern Rock

The financial crisis that had gestated in the USA had an impact all over the world. The first victim of this panic in Britain was Northern Rock. Northern Rock began life as the North of England Building Society. It was a genuine mutual institution and, as such, as safe as houses. Building societies were completely safe and transparent. They would wait till somebody came through their door to deposit £100 as savings before they would lend that £100 to another customer who wanted to put money down on the mortgage for a house. Margaret Thatcher decided that the mutuals did not behave in the best traditions of turbo-charged capitalism and legislated for them to be turned into conventional banks.

The management of these ‘newly liberated’ firms eagerly embraced the chance to become buccaneering free-spirited entrepreneurs, and take the financial rewards that came with it. Adam Applegarth, chief executive of the Rock, bought himself a fleet of vintage sports cars. His bank was known as one of the most reckless lenders in Britain, though there was hefty competition for that title at the time. Customers with the Rock could expect 125% mortgages, so they could get a patio built on their home or go off on a holiday to Thailand as well as a house, all with no money down. As a result Northern Rock became seriously overextended. It was borrowing short term on the money markets in order to lend long for people to buy houses.

As lending dried up in the credit crunch, Applegarth and co. were caught with their trousers down. Northern Rock almost certainly didn’t have a single sub-prime mortgage derivative on its books. But the scandal prepared in Florida and California and other places thousands of miles away came home to Newcastle. That’s the magic of world banking! After all sub-prime was only the trigger, not the underlying cause of the crisis.

In August and September of 2007 it dawned on Northern Rock’s depositors that their money was no longer safe. People were queuing up all night desperate to pull their money out. There was a run on a British bank for the first time since Overend, Gurney and Co. went belly up in 1866.

In Britain the New Labour government under Gordon Brown, with Alistair Darling as Chancellor, had an attitude of abject servility to finance capital as magical ‘wealth creators’. It took them ages to work out that firms like Northern Rock had screwed up completely and had shown massive stupidity and recklessness. What were they going to do when the penny finally dropped? They dithered, but in the end the decision was forced upon them. They nationalised Northern Rock.

They did so, it goes without saying, not as a step towards the socialist transformation of society but as an attempt to protect capitalism from itself. This act represented a tearing up of the neoliberal handbook: ‘Nationalisation is bad! Nationalised industries are inefficient!’ In reality neoliberalism has never been more than an apologetic ideology for whatever rampant capitalism wants and needs. And now capitalism needed subsidy, intervention and even nationalisation. Taking over Northern Rock in Britain was the first step in an enormously costly operation to bail out the capitalist system at the public expense. What they carried out in the end, and this was repeated many times in many countries in 2008, was the socialisation of losses which were dumped on the taxpayers, while profits remained in the hands of private capitalists.

  • Panic grew      over the value of bank assets and the safety of deposits.
  • The      financial panic spread to areas without a single toxic sub-prime mortgage.

Into recession

The banks were obviously in big trouble all over the world. Bank profits are often overestimated because the profits from fictitious capital are calculated up front. Normally this doesn’t matter too much if the money arrives eventually. Now record profits were melting away.

Fictitious capital may sound like a pompous, cryptic phrase in the pages of Capital.  Here was the reality. Now the phantom nature of bank assets was clearly shown. They were dissolving, disappearing in a puff of smoke. The derivatives were worthless. The money they were supposed to tap would never arrive.

Since the banks no longer trusted one another the credit crunch also caused inter-bank lending to virtually dry up altogether. All this was bound to have predictable, profoundly adverse effects on the rest of the economy.

Banks and the other financial institutions control the circulation of money and credit. Capitalism cannot go on without the circulation of commodities through the medium of money. The big freeze of bank lending meant that recession was definitely on its way.

The toxins were spread throughout the world by way of the US banking system. Because global finance and world capitalism are all interconnected, the crisis that began in the USA spread all over the world. For the vast majority of countries that went into slump this was not a financial crisis in its origin.

Take the case of Spain. Spanish banks remained relatively heavily regulated. They were not the cause of Spain’s movement into recession. The rest of the world was dragged down by a financial crisis that began in the USA and radiated throughout world capitalism. This shows that the credit crunch was just the trigger for a classic capitalist crisis that had been long in preparation.

  • Bank      lending and inter-bank lending dried up.
  • The crisis      spread to the ‘real economy’.

A crisis of profitability

Underlying all the financial jiggery pokery was the fall in the rate of profit. Eventually this must cause a fall in the actual mass of profit. This is what happened. The US Bureau of Economic Analysis (BEA) shows that in the 3rd quarter of 2006 the mass of pre tax profits peaked at $1,865bn. By the 4th quarter of 2008 it bottomed out at $861bn. This represents a fall of more than one half. The collapse in profits that the BEA records from 2006 would have caused a recession in any case, with or without a banking crisis. A halving in the mass of profits is catastrophic for capitalism and explains on its own the severity of the Great Recession.

The profits of the financial institutions had just evaporated. This was important since banks alone represented more than 20% of the value of the New York Stock Exchange. But other important firms such as Microsoft were making it known that they were also in difficulties. Their profits were down too. This was much more than just a financial crisis.

Most of those in government in all the main capitalist countries saw the capitalist system as not just efficient but the only one possible, and as natural as the sun rising in the morning. The deep shock felt by these administrators of the system at the onset of crisis was palpable.

Though there was shock, and the dawning of an understanding that the preceding boom had been built on a lie, the enormity of what was to come to pass had not yet penetrated. Even without the financial meltdown that came the following year, by the end of 2007 the world economy was clearly moving into recession.

  • Underlying      the financial crisis was a collapse in profits.
  • Not just      the rate, but also the mass of profits, was falling by the 4th      quarter of 2006, almost a year before the credit crunch

House prices and construction

What were the links between the gridlock in finance and the rest of the economy? One important linkage was via the housing market. The unsound boom was based on a vast expansion of consumer credit and a house price bubble. The reason housing may be subject to a speculative element is because it is not just a commodity but, under capitalism, potentially an appreciating asset. Most people who aspire to buy a house do so because capitalism offers them little other opportunity to put a roof over their heads. They correctly say that they are interested in bricks and mortar, not speculation.

Whereas the price of commodities may also be subject to speculation under capitalism, such flurries are usually short-lived. The reason is that higher prices and profits will in the end call forth an increase in supply. It is true that this increase may be a lumpy, uncertain process that takes place over time. Bigger crops will take time to plant. New deposits of oil or natural gas or minerals have to be prospected and extracted.

Usually rising prices cause an increase in supply. But, in the case of a potential asset such as housing, higher house prices can actually generate rising demand. Why rent when, for the same money, you can also acquire an appreciating asset by buying property? That was a real option for many people in the years of the boom. The capitalist system has for centuries proven itself incapable of providing enough affordable housing for the mass of the population. The fact of perpetual housing shortage itself feeds speculation and bubbles.

The housing market had already turned down in the USA before the credit crunch. This revealed the rottenness of the sub-prime mortgage market. Now the logic of the housing bubble was turned on its head. Instead of facing ever-rising house prices, real property prices collapsed. Mortgage holders had up till now had the prospect of in effect subsidising their cost of housing through the illusory rise in the price of their home. Now they were trapped. They had bought a house at (say) $250,000 and it later fetched only $200,000. But they still had to pay the inflated repayment costs. And they couldn’t really afford to sell out without taking a whopping loss. This is called negative equity. It can freeze the entire housing market.

That is exactly what happened. First house prices slumped. Then the level of housing sales collapsed. All over Britain, and the rest of the capitalist world that had shared in the housing bubble, estate agents stared idly out of the plate glass windows of their offices waiting for the next customer.

The banks had caught a cold. They needed money badly and the terms they demanded from customers were suddenly much more onerous. 125% mortgages were a thing of the past.  The banks wanted hard cash in the form of substantial deposits before issuing a mortgage at all. Naturally, despite the fall in house prices from their previous ridiculous levels and a dramatic fall in interest rates, this made it still more difficult for first time buyers to get on the housing ladder. The housing market froze over still harder.

If nobody is buying houses, why build them? If the price of housing is falling, why build a house for sale at £250,000 when it will only fetch £200,000 on completion? Capitalism is production for profit after all. These are the questions capitalists in the building industry were asking themselves. So, in the countries where there had been a house price bubble – the USA, Britain, Ireland, Spain and Hungary among them – the collapse of the construction industry was an important lever transmitting the effects of the financial crash through to the rest of the economy.

The building industry is an important part of the economy. A house price bubble means a bubble in the construction industry. That bubble was bound to burst after house prices went south. All the industries associated with housebuilding went into reverse. Supplies of raw materials, tools and machinery to the construction industry comprise large parts of the capitalist economy. And of course building workers are a substantial section of the working class and customers for a whole range of consumer goods. So when the construction industry goes into a deep slump the misery radiates out throughout the economy.

  • As the      house price bubble collapsed, so did the fortunes of the construction      industry.

Misery radiates out

The drying up of credit from the banks was one factor pushing firms, specially small firms, towards the brink by the beginning of 2008. The case of JCB in Staffordshire may be taken as a typical example. JCB makes earth-moving equipment, mainly for the construction industry. Still a firm owned by the Bamford family, JCB remains a world-class manufacturer. As soon as recession loomed, demand for their diggers dropped dramatically. Building firms were laying off workers and going to the wall.

From the outset management at JCB were calling for sacrifices from their workforce. Voluntary redundancies and short-time working were the order of the day. The workers were cowed for the moment, hoping for better times. The main union at JCB, the GMB, co-operated with management – to no avail. The bad news just kept coming.

A trawl through the archives of the Financial Times as to what has happened to JCB since the Great Recession struck is a depressing experience.  It is a tale of fear and panic over sales and profits, and also of management scaremongering and blackmailing to put pressure on their workers. It is a story of cut after cut in wages and conditions demanded from the workers – in the false hope that, if they kept their heads down, things would get better eventually.

What a review of the evidence really shows us is that capitalist firms are run for profit and that, if profits are not forthcoming in sufficient quantities for the likes of the Bamford family owners, the workers can go hang. The management of JCB showed themselves well aware that their profits were the unpaid labour of the working class. The evidence from the case of JCB also shows that workers are not to blame for the crisis, and that their sacrifice will not restore capitalism to health.

The story so far is summed up in JCB digs deep to restore lost profitability, filed by Jonathan Guthrie in the Financial Times on 14.07.10. JCB had actually avoided losses in 2009, turning in profits of £29m on sales a third lower than in the previous year. The cost to the workers has been grievous. The UK workforce has been progressively cut from 10,000 to 7,000 to 4,000. The short time working and wage freezes demanded from the workers were apparently not enough to save their jobs. That lesson could be repeated a thousand times over by looking at firms in Britain or anywhere else in crisis-stricken world capitalism.

When hard times hit, workers do not immediately abandon buying bread and other necessities. They have to be really on their uppers for that to happen. But they may well defer the decision to replace the old banger with a new car. The market for motors, which have some of the qualities of an investment good for consumers, is therefore likely to take a hit as hard times come around. The car industry was another transmission mechanism for the crisis to bite the rest of the economy, particularly in the USA.

In the States General Motors, Chrysler, and even Ford were all in real difficulties already before the nuclear bomb of financial meltdown exploded in September 2008. This shows again that the Great Recession was not a purely financial crisis. Not only did the Bush administration hasten to bail out the banks. It also threw a $24bn lifeline to GM and Chrysler. It wasn’t enough. GM was back with the begging bowl before new President Obama asking for another $20bn the next year. Effectively the old-established auto giants were virtually bankrupt. Their profits were wilting. It has been obvious for decades that the three big oligopoly mass producers of cars in Detroit had not kept up with the global competition. As with any capitalist crisis, and as we will show in the section on Rate of profit and crisis in Part 5, it is the laggard firms that are shaken out. When the weaklings collapse, they drag others down with them. Similar packages were launched in the European Union and the UK to bail out the car makers, in addition to the worldwide ‘cash for clunkers’ programmes aimed at getting drivers to trade in their old gas guzzlers for new models.

In the first half of 2008 more than two and a half million jobs were at risk, dependent on the fate of the plants of the Detroit big three. There is no doubt that, if the Detroit motor manufacturers had been allowed to go to the wall, the effects on US industry, and the Mid-West in particular, would have been seismic. The effects of unemployment would not just have devastated the livelihoods of car workers, but of all those other millions working on the famously long supply chain that sends components to the car plants. The 2008 government sponsored bail-out of the banks in the USA also (just) saved the bacon of the struggling motor manufacturers.

  • What seemed      on the surface to be a financial crisis became a full scale crisis of      capitalism
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Part 1 Chapter 2

Chapter 1.2: Before the crisis

The unstable, lopsided boom

The 2001 recession was precipitated by a fall in profits, as we show later. As usual the downturn was followed by a recovery. The subsequent boom was however quite anaemic, particularly in the advanced capitalist countries. For instance, in the USA growth in Gross Domestic Product (GDP) has only been about 1.9% p.a. over the past decade, the lowest rate since the 1930s. The new millennium economy grew far slower than in the golden age in the post-War boom (1948-73), which can now be seen as a unique period of capitalist prosperity and relatively full employment.

The rate of profit recovered after 2001 and the world economy grew once again. Optimism grew with the economic boom. Britain’s Chancellor of the Exchequer (finance minister), and later Prime Minister, Gordon Brown assured us there would be “no return to boom and bust”. Likewise Mervyn King, Governor of the Bank of England, in 2008 referred to the preceding decade as NICE (non-inflationary consistent expansion).The right wing economist Robert Lucas went further, as we noted in the Introduction. He asserted that, “Macroeconomics…has succeeded. Its central problem of depression-prevention has been solved for all practical purposes, and has in fact been solved for many decades.”

The rate of profit in the boom

We deal elsewhere, in Part 5, with the rather technical debate on the rate of profit. It is generally agreed that, after the post-War low point of 1982, the rate of profit made a secular recovery without ever reaching the heights of the 1950s and early 1960s. This produced an economic upturn. This secular recovery was jagged, overlain by a series of cyclical ups and downs shadowing the booms and slumps of the period. The rate of profit peaked in this later period in 1997. Although the actual level of profit in the new millennium is controversial, it is agreed that the rate revived after the 2000-1 crash and rose till 2005 or 2006, when it crashed once again.

Is the movement in the profit rate a secular or a cyclical phenomenon? In part it is both. There is no doubt that the rate of profit was generally higher in the period of the post-War boom than it has been subsequently. Generally capitalism in different eras can exist and has existed with different profit rates.

Individual capitalists are concerned with what is likely to happen to profits in the near future. Investment decisions are based on the answer to the question – are profits likely to go up or down? So we are particularly concerned here with movements in the profit rate over the cycle, as the underlying determinant of the movement from boom to slump.

Two observations, which will be developed later, need to be made at this point. The desperate struggle by the ruling class to restore the rate of profit after its 1982 nadir was successful first in so far as it used mass unemployment as a whip to increase the rate of exploitation of the working class on the shop floor. Secondly the mass destruction of capital that accompanied the early 1980s recession also served to raise the rate of profit.

On the rate of exploitation in the UK for instance, Michael Roberts reckons that the lowest rate of surplus value was 55% of GDP or 36% of NNP in 1975. The rate of exploitation peaked in 1997 at 93% of GDP or 71% of NNP according to his calculations (unpublished communication).

 His research was compiled by deducting employee compensation from Gross Domestic Product and Net National Product in the UK for every year since 1955. The main difference between NNP and GDP is that, in the former, depreciation is excluded. When this is stripped out, the rate of exploitation seems lower. The trends are the same in both sets of calculations.

This onslaught on the conditions of the working class was a grievous blow to millions of workers all round the world. Raising the rate of surplus value is a countervailing tendency to Marx’s tendency for the rate of profit to fall. But as long as the organic composition of capital continues to rise, as Marx explained, then an increased rate of exploitation cannot indefinitely offset the fall in the rate of profit. (This is discussed in more detail in Chapter 5.4)

The secular tendency for profit rates to be lower in the recent period than they were in the era of the post-War boom, whether in boom times or bust, poses a question to the capitalist class. Should they invest in the production of surplus value or in speculation? As the rate of profit declines for productive capitals, more and more capitalists will opt to speculate instead. Since speculation does not produce surplus value, and since it is a zero-sum game for capitalism – what one wins the other loses – this speculative flurry will make the situation worse for the capitalist system as a whole.

That is what has happened over recent decades. It is important to explain the exotic features of the past boom, such as the house price bubble and the explosion of consumer credit, as a consequence of the relatively low rate of profit and accumulation in the economy as a whole.

The reason for the controversy about the actual level of the rate of profit in the new millennium (not of its direction of movement) flows from peculiarities of the most recent boom. More than any upturn in history it has been supported by a gigantic bubble, mainly in house prices. A bubble is a situation where people are buying because prices are going up…and prices are going up because people are buying. When the bubble burst in 2006, the price of a home in the USA was 4.6 times the average annual wage. Over the previous two decades property prices averaged 3 times yearly earnings. Home owners could borrow more and more on the soaring paper price of their house, using it as collateral. Other asset prices followed a similar trajectory over the course of the speculative boom. There was a massive generation of fictitious capital, as we discuss later. We will argue that, in such circumstances, profits were inflated as a result of inflated asset prices.

  • Movements      in the profit rate are partly secular and partly cyclical. The rate of      profit in the world economy has been generally lower than before 1974.
  • There is a close      causal connection between swings in the profit rate and the boom-slump      cycle.

Global imbalances

The house price bubble was not the only ‘imbalance’ in the boom. Imperialism, as Lenin pointed out is a stage of capitalist development characterised by the export of capital. During the boom we had the unusual situation that the government of China (a relatively poor country) was exporting capital on the grand scale to prop up consumption in the dominant imperialist power in the world, the USA. Relations between the US and China are a secular phenomenon that will evolve over decades. None the less these international relations are an important part of the background to the Great Recession. Throughout the decade the rising Chinese economy was running a huge bilateral surplus with America, exporting far more than it was importing from the States. The Chinese government then channelled a large part of this money back into the USA by buying Treasury Bonds and other government securities. The Chinese government added the sum of $2,400 billion to its foreign reserves in this way over the decade. This is sometimes called the savings glut. In effect China was lending the US the money it needed to buy Chinese goods. Clearly that was not sustainable in the long term either.

The consequence of this monetary inflow was that the Fed under Alan Greenspan was able to hold interest rates in the USA at an unprecedentedly low level. Whether these low interest rates were an inevitable consequence of the imbalances in the world economy or a positive policy option pursued by Greenspan does not concern us at this point.

These global imbalances are a major concern of neoclassical economists. Martin Wolf, an authoritative journalist with the Financial Times, analyses the background to the Great Recession in terms of imbalances between the net exporting nations, such as Germany and China, and the importers such as Britain and the USA. It is true that the exporting nations were saving over the recent past and the importing countries were borrowing from them. These features are important to the form of the boom and severity of the subsequent bust. We shall see that there were similar global imbalances and a world money-go-round in the 1920s. These also contributed to the severity of the Great Depression in the 1930s.

Paul Krugman follows a similar line of argument, with observations about the ‘savings glut’ and global imbalances more generally in his column in the New York Times and on his blog. This is a staple explanation of the Great Recession from the economics establishment. Really the problems faced by the world economy were not caused by an excess of saving. That was a symptom of the lack of profitable investment opportunities in the boom of the recent past, at least in the traditional capitalist heartlands.

Marxists know that capitalism has followed a business cycle since its inception, with or without global imbalances. Boom and bust are not caused by imbalances. The imbalance between China and the USA is a secular phenomenon of capitalism in the new century.  Imbalances are a permanent feature of capitalism.

Rather than seeing these imbalances as aberrant, Marxists see combined and uneven development as the way capitalism naturally develops. Combined and uneven development is an inevitable characteristic of capitalism and of historical development more generally, and the global imbalances are just an expression of that. The best discussion of this principle in general terms is in Peculiarities of Russia’s development, Chapter 1 of Trotsky’s History of the Russian Revolution, and in the associated Appendix 1 to Volume One of the same book.

  • Global      imbalances, such as those between net exporting and saving countries like      China and net importers and borrowers like the USA, have been an important      contributory factor to the instability of the world economy.
  • Global      imbalances are not the cause of the Great Recession.

Consumer credit and housing bubble

The capital inflow from China and other countries fed a consumer boom in the USA almost entirely based on credit, not on rising working class living standards, which were largely stagnant or rising only slowly in the USA. Indeed as Philip Stevens pointed out in the Financial Times (05.11.10) The US “economy grew by 60 per cent – six times as fast as median earnings – during the 20 years from 1990.” So over those years, “The median earnings of these workers have risen in total by less than 10 per cent after adjustment for inflation.” Meanwhile, “The share of overall incomes of the wealthiest 1 per cent of households stood at about 12 per cent of national income in 1990. By 2007 that had jumped to more than 19 per cent. Measured in 2007 dollars, the incomes of this group more than doubled from a little more than $800,000 a year to $1.8m.”

By 2005 consumer debt was 127% of consumer’s income. Americans were head over heels in debt. This explosion of consumer credit was in part a compensatory mechanism for the slow growth of real wages. Underlying both features was a relatively slow rate of accumulation in the economy compared with the golden years of the post-War boom. The boom and the bubble fed on one another. Inflated house prices provided collateral for more borrowing. More credit drove up property prices further. As long as the bubble kept inflating, all was well.

At one point during the boom the US consumer (‘the consumer of last resort’, about 4% of the world’s population) was reckoned to be responsible for a quarter of the growth in demand in the entire world economy. As we point out while discussing credit in more detail (in Part 4 in The financial edifice), artificially expanding the market can feed growth, as long as the capitalists are faced with profitable investment opportunities. When the rate of profit eventually turns down the apparently miraculous possibilities for expanding output provided by consumer credit will suddenly dry up.

The same process of spiralling indebtedness was at work on this side of the pond. A survey by accountants PwC in late 2010 found that total debt (corporate, household and government) in the UK in 1987 was double GDP. By 2009 total debt was £7.5 trillion, 540% of GDP. PwC commented, “The rise in debt of the financial sector from 46% of GDP in 1987 to 245% in 2009 is particularly striking as banks lend large amounts to the shadow banking sector and most financial institutions geared up in search of higher returns on equity.”

The movement of the household sector into the red as a result of the speculative boom is also noteworthy. Households have historically always been net savers. The slow and painful unwinding of this excessive indebtedness during and after the crisis has impoverished millions who had been living beyond the means granted to them by capitalism. The way they were suddenly forced to draw in their spending made things worse for everybody else as well.

The housing bubble was ultimately unsustainable. So was the soaring of consumer debt associated with the bubble. Rising asset prices and borrowing had lost all contact with the ability of the economy to produce more real wealth. No wonder British workers describe credit as buying on the ‘never never’. Eventually the bubble burst, as it was bound to, with dramatic consequences.

  • The new      millennium boom was fuelled in part by an unsustainable boom in consumer      debt.
  • The      explosion in credit was fed by a house price bubble.        

Sub-prime mortgages

The iceberg on which the unsound, unstable boom finally foundered was the development of sub-prime mortgages, particularly in the USA. Agents were targeting so-called NINJAs, people with no income, no job and no assets, and offering them mortgages. These predatory lenders did not care that the people to whom they were offering the mortgages could not possibly keep up the payments. The victims were typically offered a low introductory ‘teaser’ rate of payment for the first year or so, before interest rates were yanked up, once the sucker was hooked. What did the brokers think would happen? They did not care. They were working on commission. They would move on before the victim’s home was repossessed.

In the years before the 1929 New York Stock Exchange crash, share prices tripled. That was a bubble as well. Speculators talked about getting out and taking their profits, passing on the shares at their inflated prices to ‘the greater fool’. The same psychology was at work with sub-prime in recent years. Between 2004 and 2006 we know that more than $1.7trn in sub-prime mortgages were issued. As long as house prices kept going up, very few people fell behind in their payments and had their homes foreclosed on. They could always sell up for a capital gain or borrow money based on their rising property price.

How many sub-prime mortgages were actually issued over all in these years? Four years after the crisis broke, nobody has the faintest idea. It will take decades before the mess is finally sorted out – if ever. In a sense the question is irrelevant. Financiers boast of leverage – of the way they can multiply the effect of their money. The financial innovations of the new millennium made it possible to multiply the toxic effect of the sub-prime mortgages so they poisoned the whole world’s supply of credit.

Over the period of the housing bubble Wall Street sliced and diced these sub-prime mortgages up into $1.3trn of financial instruments and passed them on. The process of wrapping up mortgages and the like into financial instruments is called securitisation. It is dealt with in more detail in the section on The financial edifice in Part 4.

Over this period almost all the mortgages were securitised and sold on. The justification for this procedure was the elimination of risk. Passing on these financial instruments did indeed take any risk off the issuing bank’s balance sheet. As far as it was concerned, if there was a problem it was somebody else’s. In fact this was just a game of pass the parcel. Risk had not been eliminated; it had been generalised.

So the problem of the borderline fraud involved in the sub-prime mortgage racket was generalised when the mortgages were wrapped up in incredibly complex pieces of paper and sold on to other financial institutions. They in turn could then be used as assets in order to increase lending out still further. This is called increasing leverage. The securities passed all round the earth. These financial instruments became part of the circulation and payments system of world capitalism as a whole.

  • The house      price bubble was pricked by the plethora of sub-prime mortgages issued.
  • Since these      mortgages were securitised, their risk was spread all round the world

Derivatives explode

These securities (pieces of paper) are called derivatives because they are derived from another financial instrument (piece of paper), in this case from a bundle of mortgages. They are regarded as assets because, as long as the mortgagee keeps paying up, they offer a steady stream of income from other people’s labour (see The financial edifice for more on derivatives).

Starting with the 1990s creation of derivatives exploded. While production advanced at an average rate of 3% p.a., derivatives were growing at 25% a year. This was a classic pyramid of paper claims. The edifice would survive as long as the production of surplus value went ahead. But at the first stumble, the pyramid was bound to collapse. Warren Buffet, the investment guru, correctly called derivatives “financial weapons of mass destruction”.

As far as we know the scandal of sub-prime mortgages was mainly prevalent in a few states of the USA. But the credit crunch reverberated throughout the world. This is because money and finance are the bloodstream of a capitalism. The banks operate as the beating heart of the system. Injecting these toxic derivatives into the banking system was the direct equivalent of poisoning the system’s bloodstream.

Derivatives have been around for a long time in the financial system. But they’ve got much more complicated. Most of them are speculation pure and simple.

All these derivatives are forms of what Marx called fictitious capital (see The financial edifice for a fuller explanation). They are pieces of paper that do not themselves represent value in the way that a car plant incorporates value. The car plant is real capital. None the less fictitious capital enables the owner to tap into a stream of income, in other words to appropriate unpaid labour, just like the owner of a car plant. Another difference with real capital is that the income that the owner of fictitious capital hopes to enjoy does not actually exist yet. It is just a potential share of surplus value in the future. The future is always uncertain, as the banks discovered when their fictitious profits melted away in the course of the credit crunch.

  • Derivatives      are derived from spot transactions.
  • Derivatives      are a form of fictitious capital.
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