By Kumar David –

Prof Kumar David

Are we again staggering towards a global economic bust? The falling rate of profit thesis revisited

A secular decline in the rate of profit is again driving the global economy to crisis just as it did in the decades of the 1990s and 2000s culminating in the 2008 catastrophe. The falling rate of profit (FRP) thesis, one of Marx’s key hypotheses, is unfolding now 150 years after it was enunciated, but interwoven with globalisation. He could not possibly have foreseen the twist due to globalisation. The thesis, in Volume 3 of Kapital, was written before Volume 1 and figuratively speaking, the manuscript was hauled out from under the bed where it had been stuffed. Preparing publication eleven years after Marx died was a nightmare. Scholars accuse Engels of goofing up philosophical nuances but this criticism does not extend to FRP.

FPR goes like this. As capitalism booms, as it did after WW2, there is colossal accumulation of capital, and there comes a stage at which it is not possible to reinvest it all, and to market the output profitably. Profit falls, investment falters, employment declines, markets dry up and systemic collapse ensues. This is the story that culminated in 2008; it is also true of the Great Depression of the 1930s; but the period leading to the New Depression (ND) that commenced in 2008, is classic.

Marx had a closed economy, a single-country model, in mind. What makes the antecedents of the ND more complex and more fascinating is globalisation. Stellar success built a mountain of capital in the post-WW2 period. At the same, time wages were held high to minimise class conflict. As a result, manufacturing in America, UK and many European countries turned uncompetitive in comparison with China, South Korea, Taiwan and Mexico. The FPR thesis hit, and hit with an international flavour. Manufacturing declined in the West and shifted to these destinations; Western capital itself compounded the problem by uprooting and moving to the new locations, often as joint ventures. Markets however stayed in the West because wages and living standards remained high.

Everywhere, market prices of similar goods are similar because of competition. Denote market price by (c+w+s) where c is the portion of cost attributable to capital, w the human resources or wage portion, and s the surplus or profit. Thanks to globalisation, high-tech, high-productivity plant is ubiquitous, that is, c is the same whether in America or China. If (c+w+s) and c are similar, it follows that (w+s) is also much the same. Now, the rate of profit is s divided by the outlay (c+w); that is, the rate of profit is s/(c+w). If c and (w+s) are fixed, the way to enhance the rate of profit is to raise s and reduce w correspondingly. As any mudalali will tell you; if you can’t lower capital or materials costs, or raise prices, to enhance profits just lower wages. Raising productivity is an alternative that I will not discuss because technology has peaked globally; hence it is not a broad option.

This FRP challenge becomes harsher if c rises, intrinsically, due to technological progress or massive capital accumulation as during 1945-75. That is, if c becomes larger, s/(c+w) becomes smaller, other things remaining unchanged. This in a nutshell is the crux of the FRP thesis. Today it tells two stories in one; first the difficulties experienced by Western manufacturing due to FRP, and second the concomitant shift of manufacturing to China and Asia to take advantage of lower wages (w) and hence higher surplus (s); the FRP story and the globalisation story.  Think Foxtrot; Taiwanese entrepreneurship, global capital, hundreds of thousands of workers in dozens of plants in China, all come together, and a global market of tens of millions of digital chips lies at its feet!

The story of the 2008 crisis

This introduction is what conventional economists, their books and their journals, will NOT tell you. They won’t tell you, not only because it is too much Marx, but for another more scary reason. It is an endorsement of the FRP thesis, and to concede that FRP lies at the beating heart of capitalism is to concede that periodic catastrophic collapse is generic to capitalism. The rest of the scholarly storyline in books, journals and websites is well researched and many faceted. Ask not embarrassing questions about the viability of capitalism, and these studies are informative and educative.  Most such work is now very well known and there is no need for me to summarise here. I do so only to the extent that it foreshadows a second edition of the crisis waiting to unfold. Last week’s close shave with US debt default expedites this process by engendering uncertainty.

Excess capital in the West in the 1990s and early 2000s had to devise some way to yield a profit. It did so in two ways; a booming asset price bubble and the birth of a casino financial industry. But before a short paragraph on each of these, let me mention that capital accumulation in the West was aggravated by economic success in the East as well. The mountain of dollars collecting in China, Japan and the Petro-countries due to US trade deficits, did not stay there. It came back to roost as US Treasuries and corporate bonds. Furthermore, folks in China, Japan and Eastern Europe are big savers and banks in these countries bought big into US bank bonds and investment instruments. Why? The US dollar is the world’s reserve currency, the safe haven for global savings. As a result the US was foist with its own petard!

The excess drove an asset price bubble and a speculative financial industry. House prices, stock prices, and company valuations rose above rational values. Last week the Nobel Prize for economics was awarded to Robert Schiller, Eugene Fama and Peter Hansen, whose separate work, underlined the herd instinct and irrational exuberance of stock markets. Money also poured into property in expectation of selling down the line at a madder price. Unscrupulous brokers and lenders induced hapless households into borrowings they would not be able to service when repayments fell due. Households, indebted to inordinate extents, could not repay when prices crashed and ruined their asset values. Mortgages tanked, bank balance sheets shrivelled, bank bondholders and depositors fled; loss of confidence withered bank equity values. Some went to the wall; others were rescued by the state.

Credit card and consumer debt played out the same way; family lives crumbled. Did you know that household and corporate debt together, in the US, UK, France and Germany, is twice as large as government debt?

The finance industry invented magical ways of playing monopoly; making money out of money, without performing any productive activity. New products, collectively known as derivatives, going by individual names like collateralised debt obligations (CDO), hedges, and credit default swaps (CDS) were leveraged into highly risky instruments. Contracts and mortgages were bundled to form bigger pools (securitised), pools were then sliced and sold as separate blocks; traces of origin and visibility of risk was lost. Crucially, they were heavily correlated in a linked financial system; meaning, when one went down, others were prone to do the same. This is the financial domino that collapsed in the fourth quarter of 2008. This financialisation was the stuff of a deadly decoction.

This is not the whole story; there was regulatory failure, secondly central banks held interest rates near zero to encourage investment but which actually fuelled speculation, and thirdly banks failed to hold sufficient reserves. But I must again repeat that the real drivers were the imperatives forced on capitalism by the falling rate of profit, the flight of manufacturing to Asia, and the impact of globalisation and a global financial system.

Retreading the road

Asset prices and the financial industry are retreading this path within five years of the 2008 debacle, not because they are insane but because there is nothing else to do. What else is capitalism to do? There is overproduction in the sense that needy people do not have the means to enter the market and the well off do not need much more to enhance comfortable lifestyles. Sans profitable investment in the production of goods and useful services, an asset price bubble is again absorbing capital. True there are profitable niches such as Apple, Goole and the social networks, but in general equity prices are rising irrationally; that is stock prices are out of kilter with dividends or the true value of firms. Serious analysts warn that the early 2000s is repeating itself; another asset price bubble is forming.

A second rather complex phenomenon is the increasing price of Treasury Bonds; this is the same as saying long-term yields and interest rates are falling. The US Fed, the Bank of Japan, the ECB and the Bank of England are injecting vast amounts of liquidity into the system under names like quantitative easing. They are also holding real interest rates near, at, or below zero in the hope of spurring investment and job creation. There has been some success, but on the whole growth in response to these prodigious efforts has been disappointing. Instead of investing in the real economy investors are buying sovereign bonds, a sign of falling confidence in a recovery. The stock market bubble is compounded by a bond market bubble.

Property prices are also on the rise though the living standards of the poorer half of the United States has fallen in the last decade, inequality risen quite steeply, and the middle class is shrinking. The top 10% of US households control 75% of the country’s wealth. This time round the property bubble is not fuelled by sub-prime mortgages but by widening disparity in purchasing power allowing a small class to invest excess capital in real estate. This bubble is nowhere near as serious as the 2000s, but it is growing. It is unlikely to initiate a collapse as in 2008 by itself, but will nosedive if a downturn is triggered by other factors. Hence there are three bubbles inflating simultaneously – equity, bonds and real estate – because FRP and globalisation rule out a return to “healthy”, normal capitalism. Classical capitalism is RIP!

A blog-post by Daniel Alpert remarks:

“Some may argue that the problems are too complex to be resolved and the best we can do is to wait them out. If we were able to do that, policy makers would be saved from having to make some very tough decisions. But economic, political, and social pressures arising during this age of oversupply are not likely to grant that luxury. It is long past time to sit down and lay out a new economic playing field that is conducive to more evenly shared growth”.

A book from Monthly Review Press, The Endless Crisis by John Bellamy Foster and Robert W. McChesney (October 2012), explores these issues in depth but from a broader perspective than the FRP thesis alone, which has been my point of departure in this essay.