Wednesday, January 23, 2013

World Economy: The global crawl

by Michael Roberts

In this post I am returning to my theme that the world capitalist economy is in a Long Depression in which the recovery in output and employment after the end of the Great Recession of 2008-9 is very weak and much less in extent and pace than we have seen in previous recoveries after capitalist slumps like those of 1974-5, 1980-2 or 1990-1.  Be warned, in doing so, there will be an awful lot of graphs!
Global industrial production is crawling along.  The World Bank produces a monthly index of global industrial production, making it a very good measure of how well the productive sector of the world capitalist economy is doing.  This index covers the world and is not confined to the major capitalist economies (G7) or even the advanced economies.  It includes the likes of China, India and emerging Asia and Latin America.
What does the index show?  It shows a real crawl – indeed in the latter half of 2012, global industrial output growth slowed to no more than a 2% year-on-year pace, below the average seen over the last 20 years of about 3% a year.  There was a sharp recovery after the humongous fall in the Great Recession, but that recovery seems to have dissipated and is certainly not nearly as strong as the recovery in the 1990s up to the emerging economy crisis of 1998 or after the slump of 2001.

The weakness is particularly visible in the major capitalist economies of the US, Europe and Japan.  In a recent post, Michael Burke highlighted how just awful the relative decline in UK industrial output has been since the Great Recession (  See his graph below.
13 01 14 Figure 1 Industrial production[4]
As Michael puts it: “The base date for measuring output is 2009 when the IP was set at 100. This means that in each of the last 3 months industrial production has been below the level seen in 2009, which was the deepest recession in Britain since the 1930s….. The British economy has slumped to levels of output last seen 20 years ago”.

Another more recent measure of activity in the global productive sector is the global Purchasing Managers Index (PMI), something I have followed in other posts to establish a more up to date gauge of where the world economy is going.  If the global PMI is above 50 then there is expansion indicated in the world manufacturing sector.  Below 50 means contraction.  After the initial burst of recovery from the Great Recession, expansion turned back into contraction in 2012 until the last few months.  The index is now just over 50, suggesting slow growth.

I’ve argued in this blog many times that the key to sustained growth is investment by the capitalist class in new equipment, plant and buildings (what is called capex).  The Oxford Economics research bureau has constructed a world capex index to see how productive investment is going.  Again it’s the same story.  After the initial recovery from the Great Recession, investment growth worldwide has slipped back and is now rising at no higher than 2% a year compared to an average of over 5% a year before the Great Recession.

Not all economists agree that investment is needed to kick-start or sustain economic growth.  The Keynesians seem to think that ‘effective demand’ is what is needed,  meaning not just or even mainly investment, but a significant rise in spending, mainly consumer spending, or failing that, any spending, namely from government.  This theory leads some Keynesians to argue, as Joseph Stiglitz does, that the reason for the weak recovery is rising inequality, which reduces consumer spending by the masses and so keeps ‘effective demand’ weak ( 

However, other Keynesians like Paul Krugman reject this version of the ‘underconsumption’ thesis based on inequality.  For Krugman (as for Keynes), if capitalists have more to spend on luxury goods that will do for effective demand just as well, even if it is morally repugnant (

The Austrian school deny the role of consumption in sustaining economic growth.  On the contrary, more consumption means less saving and thus less investment.  And it is investment by the capitalist sector that matters.   Marxist economics agrees that investment is the driver of growth and employment.  The question is what will cause investment to rise.  The Austrians say it is plenty of saving, while the Marxists say it is plenty of profit.

Both the Austrians and the Marxists reckon that profit matters.  From profit flows investment and then employment and then consumption – not vice versa as the Keynesians would have it.  But there is one big difference.  The Austrians  reckon that profitability will be fine as long as the market is left to its own devices and there is no interference by trade unions or government or monopolies.  The Marxist view is that there is an inherent contradiction in the capitalist investment process, namely the tendency of the rate of profit to fall with accumulation.  That happens because of the capitalist mode of production for profit and leads to cycles of booms and slumps that interfere with steady investment expansion, whatever the ‘interference’ of government or monopoly.

If Marx’s law is correct, it should mean that rising profitability and especially rising total profits should lead to more investment.  Indeed in many posts (see, I have tried to show that profits lead investment, not vice versa.  And in my book, The Great Recession, and in an academic paper, I have analysed the causal connections more closely (

Even better has been the work of A Tapia Granados, entitled Does investment call the tune?  Empirical evidence and endogenous theories of the business cycle, to be found in Research in Political Economy, May 2012,   Tapia shows that in over 251 quarters of US economic activity from 1947, corporate profits stop growing, stagnate and then start falling a few quarters before a recession.  Using regression analysis, Tapia finds that pre-tax profits can explain 44% of all movement in investment, while there is no evidence that investment can explain any movement in profits.

Dr Jim Walker of the Austrian school has also confirmed that causation process: from profits to investment, not vice versa, in the business cycle.  Using Granger Cause analysis that tests null hypotheses, he tested two data series, US corporate  profits  and corporate investment, and found that the null hypothesis that ‘a change in corporate profits does not cause a change in corporate investment’ was strongly rejected.  In other words, corporate profits do appear to predate and explain movements in investment.

So that brings us to a conundrum.  US profitability has made a significant recovery since the trough of the Great Recession in mid-2009.  And the mass of profit has jumped well ahead of the previous peak in early 2006.  So why has there not been a similar sharp recovery in investment and thus growth?  Well, the first thing to say is that US economic growth has been much better than that in Europe or Japan and so has investment growth.  And that would seem to follow as average profitability has not recovered much at all in Europe and Japan, as I shall show below.

Second, even though profitability in the US has risen, profitability in the productive sector (industry, manufacturing and transport) has not done so well.  The rate of profit in the US financial sector rose significantly from the mid-1990s as the credit boom began while the rate of profit in the non-financial sector remained in the doldrums.
As a result, net investment (after depreciation) remains at very low levels.

It’s true that the mass of profits did rise significantly after the trough of 2009 in the US.  But these profits seem to have been ‘hoarded’ as cash by the large companies in both the US and Europe.

One reason for this conundrum has been offered by a Canadian right-wing think tank, CD Howe Institute.  This institute points out that cash balances in corporations were building up for some years even before the crisis and slump.  It is not a reluctance of companies to invest because of the slump.  Instead they need cash on hand in order to source goods and raw materials in a hurry instead of building up inventories or stocks.  So cash has replaced high inventories in a world of ‘just-in-time’ manufacturing.  This may have some validity but it also suggests that high cash balances are no indicator of low investment.  And yet that is what we have.  So this explanation does not really seem to answer the conundrum.  I reckon there are better reasons.

The first is that even if the US profit share is up, US corporate profitability is still below the levels of previous peaks in 2006 and 1997 respectively.

Second, debt deleveraging still has some way to go, even though debt to income has come down for households (mainly through mortgage defaults).  Public sector debt to GDP is still rising and corporate debt is stable at relatively high levels.  Only low interest rates are keeping many companies from going under.   But Keynesian-monetarist type policies of low interest and ‘quantitative easing’ have done nothing to stimulate investment in the productive sectors,  Instead, they only jack up stock and bond prices for the financial sector and the rich.  And what fiscal stimulus and extra government spending there has been applied has not been to boost government investment.  Indeed, the US government is now preparing fiscal austerity measures for this year that will more than match anything done in Europe.

In some ways, the simplest explanation for this world in a crawl is that profitability has not recovered at all for most capitalist economies.  The US remains the exception.  Using the EU Commission’s AMECO database, I found that the net rate of return on the stock of capital in the major economies in 2012 was still well below the peaks of 2007 everywhere except the US (and on my own measure of the US rate of profit even there it is lower than 2007).

Dr Walker (op cit) looked at the return on equity for companies in Europe and Asia.  This is not such a good measure of corporate profitability, although it does measure profit against the value of a company’s stock price, which perhaps takes into account any fictitious capital.  On this measure, Walker found that only China really had achieved a higher average rate of return since the crisis.  Rates of return on equity in Europe and Japan were down 30-50% compared to before the crisis.

Now some investment bank economists have recently suggested that global manufacturing is set for a revival this year.   And it’s true that there have been some signs of a pick up in capital goods orders and we shall know by the end of this week if the PMIs in the Eurozone and elsewhere are also indicating some expansion – they are deep in contraction territory at the moment.
world cap goods orders

So I’ll return to those measures when we get the data.  But even if there is a pick up from the lows we’ve seen in 2012, the investment cycle will probably remain in the doldrums and so will global growth.

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