People's Democracy

(Weekly Organ of the Communist Party of India (Marxist)


No. 44

November 09, 2008


Another World Depression?  Finance Capital and Neo-Deflationism

Utsa Patnaik

THE capitalist world is in turmoil, with widespread financial crisis, bankruptcy of the largest investment and insurance corporations, massive injection of state funds to avert banking collapse, stock market declines world wide, capital flight, and the onset of economic recession in the US and the Euro-zone. The US is in recession and the Euro-zone’s expected 2009 growth rate has been revised down from 1.9 to 0.1 percent. There is downturn in employment in countries closely integrated through trade with these industrial regions, especially in China. A number of countries have already seen capital flight and currency depreciation of such severity that they have been forced to turn to the IMF (Iceland, Ukraine, Pakistan ) or enter into emergency financial arrangements (Hungary, South Korea). Many observers call it the severest crisis since the Great Depression. Reportedly world leaders are pouring over the works of not only J M Keynes but also of Karl Marx in a desperate search for a way out.

There are certainly many points of similarity of the present situation with that in the late 1920s. A recession in world agriculture from 1925 preceded manufacturing slowdown and the 1929 stock market crash, similarly there has been agrarian depression in the developing world for a decade before the 2008 crash. However this pervasive agrarian depression has been entirely ignored by economists, who cannot see the connection between increasing poverty in the global South, and the world of high finance. Another point of similarity is the undermining of the position of the world capitalist leader. From the mid-1920s Britain, the then capitalist leader, found it increasingly difficult to maintain external lending to support growth abroad while keeping its own markets open to imports. The US, the present world capitalist leader similarly finds its position severely undermined: it is unable to shore up demand in the world by keeping its own market open and expanding at an adequate rate. Despite borrowing massively from other countries to sustain its import-dependent consumption it is now unable to avoid domestic recession. This is the stuff of serious crisis, when the capitalist leader can no longer lead effectively, and there is no substitute leader or set of institutions in sight.


Above all, the fundamental similarity in both cases, lies in the domination of finance over industry, and the pursuit of economic policies favouring finance capital, at the expense of growth of the real economy particularly the output of basic necessities required by the masses. The dogma of balanced budgets marked the domination of financial interests in the 1920s. The domination of finance in the modern world and its ideology known as ‘neo-liberalism’ has been evident since the 1970s. We might as well call it neo-deflationism, for the ideology of finance capital  always involves policies deflating the level of mass demand.

Today a global food crisis coexists with unprecedented financial collapse and a recession which may well turn into a depression. The roots of this conjuncture of triple crisis lie in the deregulatory market oriented, expenditure-deflating policies of the dominant neo-liberal regime, implemented for over a quarter century. What is the connection between the different crises? The economic dogmas of finance capital, when they shape public policy, always produce highly deleterious effects on the real economy. Faced with agricultural recession and unemployment, finance ministers in every country in 1929, all deflationists to the core, pressed through with repeated rounds of expenditure reduction to achieve balanced budgets, thus raising unemployment further, reducing production and pushing the world into depression. Britain’s ability to maintain long-term external lending to the industrialising world had depended heavily on its appropriating India’s large export earnings, and this ability to lend collapsed as the earnings declined sharply, marking the demise of the Gold Standard. Keynes’s argument that the theory underlying deflationism was wrong since it assumed full employment, and expansionary policies should be followed in the actual situation of unemployment, went unheeded until a great deal of damage had been done.

The ascendancy of finance capital from the 1970s has seen exactly the same misguided expenditure deflating policies with the same incorrect theory being peddled by the Fund and Bank, that public investment ‘crowds out’ private investment, which assumes full employment - with much less excuse for such intellectual infantilism seven decades after the General Theory, than there was in 1929. States have shown an insensate obsession with inflation targeting regardless of unemployment and have undertaken repeated Fund-guided cuts in public spending, thus lowering the level of economic activity in the material output sphere. The destructive impact was strengthened by additional measures taken to practice monetary austerity, reduce the ratio of fiscal deficit to GDP, put caps on wages, retrench labour from enterprises, devalue currencies, and open up developing economies to free trade and capital flows. The GDP growth rate of developing economies halved between the 1970s and 1990s. India saw cutbacks in investment, public spending and credit to small producers after 1991: the textile industry was plunged in crisis, and the food grains output growth rate fell from the pre-reform 2.8 per cent to 1.7 per cent in the 1990s. In the last eight years it has gone below 1 per cent even after factoring in last year’s record harvest. Per capita grain output is declining faster than ever before.


Market oriented policies have been attacking small producers worldwide, leading to shortages of necessities like food and textiles, while promoting consumer credit to the elites for cars, white goods and durables marketed by foreign corporations, as  the service sector boomed. Global annual grain output per head fell from 335 kilogram to 310 kilogram between 1980-85 and 2000-05. Textile spending per head in real terms has been falling from already low levels in the developing world, which has seen the worst form of rising income inequality, an absolute decline in the real income of the masses. Long-term food output decline should have produced inflation long ago, instead the inflation rate was at a historic low until recently. In India, the Consumer Price Index of agricultural labour rose only 11 percent between 2000 and 2005 precisely when per head grain output was falling and large grain exports took place. The answer lies in the sharp compression of aggregate demand. Since the very same expenditure deflating policies which reduce output growth, also reduce aggregate demand through rising unemployment and a severe squeeze on mass incomes, the result was demand adjustment to material shortages. Inflation did not occur because mass purchasing power was falling faster than output was falling and the punishment was being absorbed by millions of peasants and labourers in the global South who were more hungry and had less to wear over time.

In sub-Saharan Africa declining  per head income has so reduced foodgrain demand – below 135 kilogram per head annually with average calorie intake of  1800 per day or less – that populations can tip over into famine any moment with current food price rise. In India and China since per head income has been rising at 6 and 8 percent annually, total grain demand per head taking both direct use as food and indirect use as feed, should have risen sharply. Yet it has fallen drastically – in India from 178 kilogram net in the early 1990s to only 157 kilogram by the triennium ending 2004-5. The food part of cereal demand per head in China fell from 204 kilogram to 166 kilogram comparing three-year averages centred on 1992 and 2002 while the food plus feed demand fell from 263 to 230 kilogram. China has seen diversion of grain growing land to cotton and its abnormally high savings rate reflects the squeeze on rural mass consumption, which it has been trying to reverse in the last two years.

Both the neo-conservative George Bush and the progressive Paul Krugman are thus incorrect in saying that increased total demand for grain from the new-rich in China and India, accounts for the current food price rise. On the contrary, per head cereal demand has fallen in both countries drastically, while the world’s highest grain consumer remains the US with nearly 900 kilogram per head. No doubt with unchanged income distribution demand would have risen sharply. A demand projection for India to 2020 by Bhalla, Hazell and Kerr (published by the International Food Policy Research Institute) assuming 1993 income distribution, gives us a total net cereal demand of 219 million tonne by 2007. But actual demand was a massive 62 million tonne lower owing to loss of mass purchasing power.

The trigger which has made the global grain shortage explicit through sharp inflation from 2006, is the subsidised diversion of grain to ethanol production in the global North. The US will quadruple its maize conversion to ethanol to 110 million tonne by 2009 compared to 27 million tonne in 2003.  Global grain stocks have disappeared. For years the developing countries were urged to divert their land to growing products ranging from gherkins to roses, for filling supermarket shelves in advanced countries in exchange for foodgrain imports. Dozens of countries from Philippines to Botswana were persuaded by the IMF to dismantle their food procurement and distribution systems and rely on the global market. Nearly fourty of these grain import-dependent countries have seen food riots in the last year. The UPA government too was doing its best to run down procurement and undermine the FCI, until the sharp food price rise has forced it to draw back from the brink last year.

The counterpart of increasing hunger and impoverishment in the global South is the repeated credit-financed consumption booms in the global North, created by the artificial stimulus of frenzied speculative financial activity in jacking up asset values and forcing credit far beyond the borrowers’ capacity to repay. The personal debt of US citizens is now reportedly only 2 percent less than that country’s GDP. Two million persons will lose their homes in 2009 owing to foreclosures in the US. The same irresponsible model has been introduced in our country where every blandishment is offered by banks to the middle classes to live beyond their means and low cost credit is easily available for cars and consumption durables, while millions of peasants and artisans are starved of affordable credit for production and driven to ruin and suicide.

Financial institutions in the North have been given total freedom to market ‘innovative financial instruments’ which is an euphemism for unethical practices, unsecured lending and speculation. Grossly tumescent speculative finance has been encouraged in its licentiousness, by the very same central banks in Europe and by the Federal Reserve in the US, which are now scrambling to avert a slide to the abyss once the public has seen the lack of probity of the managers of the system, lost confidence in financial institutions, and are cutting back spending. ‘Injecting liquidity’ into the banks in itself is no solution to the impending depression – they need to reverse deflationary policies. But the IMF while lending to Iceland has once again laid down tight money (18 percent interest rate) and expenditure cuts as conditions and will do the same with Pakistan, Hungary and Ukraine.


The period 1993-4 to 2004-5 has seen sharp rise in unemployment rates in both rural and urban India according to NSS data. With the start of global recession India’s exports of goods and services will reduce, unemployment rise further and incomes decline in all economic sectors – whether it is the coffee grower, the diamond processor or the garments exporter. Hot money outflow has already led to rupee depreciation and rising domestic fertiliser and fuel prices are canceling out any benefit from price rise for peasants. Millions of wage and small salary earners are reeling under food price inflation.

Before the situation deteriorates, further measures to counter the adverse trends need to be introduced. First, we need an urgent Grow-more-Food campaign because our grain output per head has fallen drastically. This is also impacting output of livestock products badly by raising feed cost, so we see sharp inflation in milk and animal products prices.  Second, we need large scale public investment in forms which will add to the supply of basic necessities. The prime minister is off the mark in talking of infrastructure investment at present by which he means wide roads, big bridges and airports. This will have the same effect as producing guns, adding to the burden on the people while not adding to the supply of necessities whose prices are skyrocketing. Third, the FCI and the commodity boards need to go in for effective market intervention to stabilise price both to the producer and consumer. Fourth, genuine implementation of the NREGP with at least Rs 25,000 crores annual allocation and works aimed at assured irrigation, will help to revive mass demand for food and textiles, and substitute a growing internal market for a faltering external one. Fifth, once there is good riddance to hot money further hemorrhage of capital should be stopped by instituting capital controls.

In recessionary times the capitalist world has always needed a leading country which either lends abroad to keep up demand, or keeps its market fully open to the inflow of distress goods. Far from lending, the US is the world’s largest debtor. Some bourgeois economists are wistfully requesting China with its mountainous reserves to help the US. But since China’s external exposure through trade to the industrial world is very large, the recession will affect it badly and eventually may well reduce its capacity to lend. As regards keeping its markets open, the US with its steel tariff and numerous non-tariff barriers has turned protectionist some time ago. The president-elect under the pressure of rising domestic job losses has promised to penalise outsourcing and keep jobs at home. The crisis–ridden world capitalist leader is no longer capable of leading, and there is no new leader to take on its functions: nothing it seems can avert world depression. Nor can the burden of adjustment continually be passed on to the global South whose masses have been pushed down too far already to go down further without famine and civil strife.