Profits lead the way

From Michael Robert Blog

By michael roberts
It’s been a long time since my last post.  I’ve been snowed under trying to get some papers and articles done.  But anyway, back to the moment!
Are the mature capitalist economies on the road to sustained economic recovery?  It depends on what you mean by sustained and recovery, of course.  The major capitalist economies (i.e what is called the G7) are experiencing some economic growth since the end of Great Recession in mid-2009.  Real gross domestic product (GDP) is rising at about 1-3% a year.  Can this growth be sustained or will these capitalist economies slip back into recession (i.e. a contraction of national output) or at best just crawl along?

The debate between the Keynesians and the Austerians continues.  The Keynesians claim that consumption and employment growth is weak so any reduction in government spending and any reversal of easy money policies (low interest rates and the printing of money) would push the capitalist economy back into slump.   The Austerians claim that the size of the budget deficits and the level of public debt being run up by governments in the major economies are so burdensome that it will restrict economic recovery.  The Keynesians want go on spending; the Austerians want to start cutting.  The strategists of capital in the US have so far adopted the first approach (except for the ‘tea party’ campaigners who wish to reverse it for ideological not economic reasons; while the British have opted for the second strategy.  Who is right?  I would argue that both are right and wrong.  Above all, both approach the question from the wrong angle because they do not recognise the underlying laws of motion of capitalism.

My overall view is that these major capitalist economies are likely to achieve an up phase in growth through to mid-2013 (maybe a bit longer) before entering another economic downturn.  How do I reach that brave forecast, considering that most forecasts by economists turn out to be even worse than weather forecasts?  Well, as I outlined in my book, The Great Recession, I think it is the job of scientists (and economists ought to be social scientists) to analyse empirical data, develop hypotheses and test them against evidence.  And that means making predictions or forecasts that can be tested for the validity of any theory (physical or economic).

So what are the best indicators for how the major capitalist economies are going to go?  GDP is one indicator of recovery but it is backward looking.  GDP rises when consumption and investment rise.  Consumption is driven by employment and wage increases.  In turn, wages are driven by the willingness of employers to invest in more production capacity and take on more staff.  So investment leads consumption into a recession and it leads consumption in the recovery.  That was the case in the Great Recession, which was really a collapse of investment not of consumption – at least initially.  This is something that the Keynesians do not recognise.

But what drives investment?  For Marx and for me it is profitability.  Profits lead the way.  In a capitalist economy, where production is for profit and accumulation of capital depends on its profitability, profits are the best leading indicator of an upcoming slump and/or a recovery.  If profits keep rising , there is more probability that any recovery is sustainable.  From these basic assumptions, we can make a judgement about where the top capitalist economies are heading over the next few years.  The fault of both the Keynesian and Austerian approaches is that both do not look at the key variable for the health of a capitalist economy: profitability and profits.

Before the Great Recession, the rate of profit in the US peaked and began to fall from 2005-6.  We can see the process more closely if we use capitalist categories because they can be measured for each quarter of a year while the data for Marxist categories are only annual.  Using profits to GDP (or profit margins),  US profitability began falling well before the credit crunch started to bite and the Great Recession ensued.  Once the mass of profits began to fall, then the collapse in investment followed.  This reveals the connection between the rate of profit, the mass of profit and capitalist crisis.

If we use the same indicators for looking at the recovery, US profitability and the mass of profits troughed in mid-2009 and began a staggering revival.  Indeed, the profits recovery has never been so quick and large after a recession.  That’s because in this Great Recession, capital values have been reduced more than usual.  Variable capital (to use the Marxist term) or the wage bill has been cut through job losses and the capping of wage rates.  So real incomes for the majority of working households have fallen.  The share of profits in national output has jumped accordingly, or in Marxist terms, the rate of exploitation or surplus value has leapt.  Also with investment slumping, the value of constant capital (the accumulated stock of fixed assets) has dropped.  And fictitious capital in the form of the value of stock plummeted.  So the bottom line in the Marxist equation for profitability, s/c+v, has fallen while the top line has risen.

This is the key to the recovery: not Keynesian boosts to consumption or Austerian cuts to public and private debt levels.  Indeed, during the Great Recession consumption fell only a little, while debt rose even more.  In this recovery, consumption is hardly rising compared to GDP and debt is still high (this applies to the US, the UK, Japan and most of Europe).  In the leading capitalist economies, debt held by households in the form of mortgages, credit cards and loans has fallen only slightly.  Deleveraging, as it is called, still has a long way to go.  In the capitalist corporate sector, there has been no deleveraging at all.  Nevertheless, the recovery is under way because profitability and profits have recovered.

And that is beginning to drive up investment.  Those capitalist corporations that survived the Great Recession (that is most) are now flush with cash that they have accumulated by laying off labour and stopping investment.  They have held back from investing (a ‘strike of capital’) while allowing the taxpayer to hand over large lumps of free cash through zero interest rate loans and cuts in corporate taxes.  But now they are beginning to reinvest.  If profits continue to grow, investment will gather pace.  Then employment will start to rise.  We see that now in the US and the UK.  In both, public sector employment in falling and private sector employment is rising.

As long as profits keep rising and profitability stays up, investment will rise and drive up employment, which will eventually provide  a rise in household incomes that will allow more consumption and the recovery becomes ‘sustainable’ .  There will be no slip back into what we used to call a ‘double-dip recession’  (see my previous post on this, No double-dip, 29 October 2010).
But this ‘sustainable’ recovery is likely to be shorter and weaker than in previous ones, in my view. 

That’s because there is a cycle of profitability that I have identified for the US as lasting about 32-36 years.  Currently, this cycle is in its downward phase and has been since 1997.  The 1997 level of profitability has not been surpassed even after the credit-fuelled boom leading up to 2006-7.  Profitability has recovered from its recession trough in 2009, but it won’t get back to 1997 levels or even that of 2006.  So investment growth will be weaker and slower.  In the graph below, VROP means the Marxist or value rate of profit and OCC means the organic composition of capital, Marx’s measure of capital accumulation.  When capital accumulates, it eventually drives down the rate of profit.  This is a cyclical process that takes 16-18 years in each direction.


One reason that profitability won’t get back to 1997 levels is that capitalism still has a huge layer of ‘dead capital’ that it needs to clear.  This is machinery and plant that is old and unproductive; this is labour that does not have the right skills; and it is also fictitious capital (debt) that needs to be paid down to restore profitability. So US capitalism (and the other G7 economies to varying degrees) need to have the ‘cleansing ‘ experience of another slump before too long, in order to start afresh with companies unburdened with debt and unproductive assets.  That means another recession will be on the horizon, probably from about 2014 onwards.  In the meantime, the recovery from 2009 could continue for another few years.