Double dips, deficits and debt

by michael roberts

I recently did a post that argued the US economy was not yet in recession (see US heading into recession again?, 15 August 2011).  I was criticised in this blog for being too optimistic and not recognising that the US economy had already slipped into a ‘double-dip’ recession.  And there has been a chorus of mainstream economists who have now come out with various indicators to show that the major capitalist economies are already in recession, or teetering on the brink.   For example, look at this graphic generated by David Rosenburg, one of the investment banking ‘bears’.  It combines the index of US business activity from the Philadelphia Federal Reserve Bank,  a good guide to sentiment in ‘smokestack America’  and the index of consumer confidence produced by the University of Michigan, supposedly the best indicator of consumer sentiment.  The graph shows that we are on the edge of recession territory for the US economy.

The concept of a double-dip recession comes from the recession of the early 1980s, when the major economies contracted in national output in 1980, recovered in 1981 and then contracted again in 1982.  So it was a double dip within two years.  The Great Recession began in early 2008 and troughed in mid-2009.  If the recovery of the last two years is now over and the major economies are now turning into another recession three years from the last turn, to call it double-dip is stretching it somewhat.  Indeed, if we look at the graphic of year-on-year real GDP growth for the US, we are not quite there yet.

The usual length of the economic cycle of post-war capitalism of trough to trough is about 9-10 years. i.e. 1982, then 1991.  But this was in a period of up-phase in profitability (see my book, The Great Recession).  In the down-phase of the profits cycle (1929-46; 1965-82 and now 1997-2014),  recessions come thicker and faster.  Take the Great Depression.  The crash of 1929 led to a slump that reached its bottom in mid-1932.  Then there was a recovery (weak as it was) that lasted for over four years until early 1937.  Then the US economy slipped into another recession that troughed in mid-1938, six years after the previous trough.  After that, a global arms race and eventual war restructured the capitalist economies into state-directed economic expansion.

Another more modern scenario was during the down-phase of 1965-82.  It started with a mild slump in 1969-70 (similar to 2001) followed by a worldwide collapse in 1974-5 (similar to the Great Recession of 2008-9).  Then came a recovery that lasted for over four years until 1979-80 and then the double-dip recession.  If this current down-phase in profitability follows a similar path, then it would suggest the trough of the recession in 2009 will be repeated no earlier than late 2013.  But that’s the trough.  The major economies would begin  to turn down around late 2012 in that scenario, if history is any guide, given the average length of each capitalist contraction of 18-24 months.  So that’s still about 15 months away at least.

But maybe I’m wrong and we are already in a new recession, implying a double-dip.   The graphs above suggest the US economy is teetering on the brink.   But there is still evidence that we are not there yet – after all,  US industrial output and the capacity utilisation rate rose last month. Also, the ECRI leading indicators measure of the US economy does show a slowdown, but is not yet indicating a recession.

And another mainstream measure of the ‘likelihood of recession’ is rising but not yet at a 50% probability.

To make a judgement on the likelihood of a recession, I look at profits, which are key to the health of a capitalist economy.  Profits in the major economies have risen dramatically since mid-2009. As I have shown in various posts, US profits are now above their previous peak in 2007-8.  Indeed, US corporate profits are up 130% from  their trough in mid-2009 and, as a share of GDP, they are at their highest since 1950.  Even on a proper Marxist measure of profitability, which is  a better guide than these ‘mainstream’ measures based on investment or the share of GDP, the rate of profit is up sharply from lows in 2009.  It is probably only just beginning to peak and fall back.   As it usually takes about two to three years before the fall in profitability feeds through to a drop in the mass of profits that could kick off another crisis,this would suggest any recession is unlikely before 2013.

However, it is true that much of this rise in profits has been due to huge tax handouts by governments to corporations, particularly financial ones.  Also, corporations in the major capitalist economies have benefited from their production locations and exports to developing capitalist economies, where economic growth has been stronger.  Profits from overseas now constitute 30% of total net earnings of the top 500 US companies.   Both these factors that have helped drive up profits until now are likely to be less visible from here, as governments try to reduce spending and raise taxes and even developing economies experience some slowdown.  Indeed, recent forecasts put global growth to slip from 5% a year in 2010 to under 4% this year and next, with the US growing at just 2% a year and Japan and Europe at little more than 1% a year.   It’s not a contraction, but it might suggest a ‘stall speed’.
I remain convinced that profits are the best guide to the future, rather than the indicators of ‘effective demand’,  such as consumer spending or investment, as the Keynesians believe.  The Keynesians look at ‘effective demand’ because they have a cockeyed view of the capitalist economy.   Keynesians do not start with a theory of value (i.e. where income comes from in an economy).  For them, the only value is money.  Money must be spent to provide ‘effective demand’ in an economy.  Thus, investment and consumption demand delivers incomes (profits and wages) not vice versa, as Marxist (and classical) economics argues.

Take the famous Kalecki identity.  Michal Kalecki was a Polish born radical Keynesian who recognised that capitalism suffered booms and slumps.  Using Keynes’ view of a capitalist economy as a series of incomes and expenditure flows, Kalecki came up with the following identity:  Total profits after tax = private investment + government deficits + net exports + capitalist consumption – workers saving.    If we exclude the external demand (net exports) and government demand (deficits), we are left with a view of the economy that says profits = capitalist investment + capitalist consumption – any saving by workers (this reduces income going to profit).  If we take out workers saving, we find that gross profits (namely before tax and workers savings) is equal to capitalist investment and capitalist consumption.  That makes it simple and obvious: profits go to capitalists to spend.

But here is the cockeyed part.  For the Keynesians, it is the right hand side of the equation that causes the left hand side;  namely, that it is capitalist investment and consumption that creates profit.  As my esteemed  Marxist colleague, Andrew Kliman (http://akliman.squarespace.com/writings/) put it in an email to me, this is “ass-backwards”.  “Effective demand” cannot precede production.  There is always demand in society for human needs.  But it can only be satisfied when human beings do work to produce things and services out of nature.  Production precedes demand in that sense and labour time determines the value of that production.  Profits are created by the exploitation of labour and then those profits are either invested or consumed by capitalists.  Thus, demand is only ‘effective’ because of the income that has been created, not vice versa.  Because the Keynesians have no theory of value, they read their own identity the wrong way round.

The reason I raise this at length is that the Keynesians draw from their analysis the conclusion that any decline in capitalist investment can be counteracted by government investment (spending) and this will compensate for any decline in profits and perhaps even raise profits.  So a capitalist crisis can be avoided by government spending, which will not damage profits or come into conflict with the creation of profits.   For more (favourable) comments on this cockeyed Keynesian view, see  Philip Pilkington’s recent piece, (http://www.nakedcapitalism.com/2011/08/philip-pilkington-profits-in-a-capitalist-economy-%E2%80%93-where-do-they-come-from-where-do-they-go.htmlf)

But look again at the Kalecki identity: profits =  investment + capitalist consumption + government deficit (we are excluding overseas profits and workers savings here).  From a Marxist view, profits are the causal variable.  So if profits fall, then either investment, capitalist consumption or the government deficit must fall, or all three.  Government competes with the capitalist sector to maintain its share of the profit.  If the government deficit is maintained or increased, it eats into the profit available for capitalist accumulation and capitalist luxury spending; it does not increase profit, only income.  That is why capitalists oppose bigger government deficits to avoid a slump.

If Keynes and Kalecki are right, then all that we need to do to keep a capitalist economy going is to have more government budget deficits.  Moreover, it does not matter whether these deficits (of spending over taxes) are financed by printing money or issuing government bonds for banks to buy.  Either way, as long as governments spend more, then an economy can create profits and grow (because spending creates income and profits, not vice versa!).  But if governments run deficits and run up debt, this debt must be serviced through interest payments to banks and other financial institutions.  Debt servicing costs (interest and repayments) must either be met through taxes on capitalists and/or workers, or through increased inflation reducing real incomes for creditors.  Payment can be delayed by raising even more debt to repay old debt, Ponzi-style.  But there is no free lunch (eventually): debts must be paid or written off.  Either debtors or creditors must meet the bill.  This eats into profits available for capitalist investment one way or the other.

Of course, under the Kalecki equation, workers could run down their savings to pay off debt or taxes on workers could be increased to reduce any fall in profits.  And that is what has started to happen in the aftermath of the Great Recession.  Despite higher profits, since the trough of the Great Recession, new investment has stayed low and employment has not revived much in the major economies.  Now fiscal retrenchment and higher taxes will make it even more difficult for  the wider economy to grow.  In this sense, the Keynesians are right.

But more printing of money and more government spending not financed by taxation will also eat into the profitability of the capitalist sector and weaken its growth potential.  In this sense, the Austerians are right.

Don’t get me wrong.  I am not opposing an increase in government spending and running deficits to do so.  More government investment is vital for job growth and raising wages.  What I am arguing is that it is not a policy that helps capitalist investment and the overall expansion of the capitalist economy.  It won’t ‘save’ capitalism, as Keynes thought.

Even Paul Krugman, the doyen of mainstream Keynesian economics, has now admitted that the size of debt (or what Marx called fictitious capital ) in a capitalist economy is relevant to economic recovery.  Steve Keen, a promoter of the Minsky view of capitalist crisis (see my paper, The causes of the Great Recession) has recently taken Krugman to task for not recognising the role of debt until now in squeezing the strength out of this recovery (see his Sense from Krugman on private debt at www.debtdeflation.com/blogs).

In a previous post, I have shown how adding in the level of debt (or fictitious capital) to the tangible stock of fixed assets to measure against profits puts a whole new slant on the level of profitability in the US.  Indeed, as the graph below shows (NOS = net operating surplus of US corporations), US profitability (a la Marx) when measured in this way (green line) has not really recovered since the Great Recession ended.  That’s why investment and growth remain weak.
So the issue is not really whether the major capitalist economies are about to enter a double-dip recession or not.  What is clear is that the recovery since 2009 has been one of the weakest on record.  National output has not returned to its pre-crisis peak in any of the major economies.  In that sense, we are in another Great Depression.  Even if there is a mild recovery through to 2013, another recession is on the cards in order to ‘cleanse’ the capitalist economies of the ‘excessive debt’ and ‘dead capital’ that is weighing down on profitability.