People's Democracy

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


No. 21

May 31, 2009


Greed As An Explanation Of Crisis

Prabhat Patnaik


THERE is a very common view that the current financial crisis of the capitalist world, and its fall-out in the form of the most severe slump since the Great Depression of the 1930s, are a consequence of �greed� on the part of the financial sector. This view has even entered the thinking of many progressive intellectuals. To talk of greed as underlying the crisis is certainly not incorrect, but it is not enough. �Greed�, or grabbing the maximum for oneself in any given situation, is not some exceptional trait that financiers in the last few years suddenly displayed. It is central to capitalism; the system functions precisely through the greed of the capitalists. In fact Adam Smith the founder of classical economics drew attention to the paradox that the system as a whole functioned benevolently (so he thought) even though functionaries of the system, the capitalists, were motivated exclusively by their own self-interest (a euphemism for �greed�). His predecessor, Mandeville in his Fable of the Bees, had gone even further, underscoring how �private vice� produced �public virtue�.


But those who explain the crisis in terms of �greed� often do not emphasise that �greed� is what activates capitalism in its entirety, that it is not some abhorrent trait exhibited by a few people in some exceptional circumstances, but what drives the system all the time. Now, since this is not said, and since the totality of speech consists of both what is said and what is not said, the �greed� explanation, by being incomplete, is also wrong and misleading.  


It suggests as if it was possible for capitalism to have escaped this crisis if only the greed of some financiers could have been controlled, as if the crisis had nothing to do with the structural aspects of capitalism but only with the avoidable excesses committed by some financiers. It suggests an implicit distinction between capitalism marked by excessive greed and capitalism sans such greed, between, as it were, �good� capitalism and �bad� capitalism, and attributes crises to �bad� capitalism. The crisis then becomes the result of an aberration of capitalism, not of its basic character: if only such �greed� were eschewed, capitalism would be crisis-free.





This suggested explanation is fundamentally wrong. Those accused of excessive �greed� were doing nothing more than simply maximising their gains which is what all capitalists are supposed to do. In fact maximising gains is supposed, in economic theory, to constitute �rational� behaviour on the part of capitalists. So, what is called �greed� is not, as we have seen, an aberration; it is the essence of the behaviour of the capitalists. All capitalism is like this; there is no �good capitalism�.


Karl Marx had in fact gone further in this matter. In his view, �greed� or so-called �rational behaviour� was not merely a general feature of capitalism; it was actually forced on the capitalists. The capitalists did not have a choice in the matter, since any capitalist who is �non-greedy� would fall by the wayside. Capitalists maximised gains not out of individual volition but as a matter of necessity. In the Darwinian struggle in which all capitalists, competing against one another, were involved, any one who did not maximise gains, and hence fell behind in the race of accumulation, would go under. The process of centralisation of capital, whereby, as Marx put it, �one capitalist kills many�, necessarily meant that large capital displaced small capital; there was intense pressure on every capital therefore not to remain small but to grow large instead, for which it had to accumulate capital. For accumulating capital, surplus value had to be earned to the maximum possible extent, i.e. gains had to be maximised. That was the essence of capitalist behaviour, the pursuit of a �rationality� peculiar to it, whence it followed that a rejection of this �rationality� was possible only with the replacement of capitalism by socialism.


Indeed the same �greed� which is supposed to underlie the slump is what underlay the preceding boom as well. In other words, since �greed� drives the system it causes both booms and slumps. The manner in which it does so is as follows. Booms in capitalism, as is well-known, are supported by bouts of euphoria, or �speculative excitement�. An initial rise in asset prices gives rise to expectations of a further rise, which makes wealth-holders, precisely because they are �greedy�, demand more of the asset and hence causes an actual further increase. And so the process goes on creating a speculative bubble. Of course the decision to demand more of an asset depends not only upon its expected price appreciation, but also upon the evaluation of the risk associated with holding more of it. But the same euphoria that makes wealth-holders expect a continuation of asset price increases, also gives rise to an underestimation of risk. It is this phenomenon of euphoric expectation of capital gains net of risk premium that makes for bubbles, given the �greed� (or the �rationality�) of the wealth-holders.





A rise in asset prices caused by such a bubble, however, has important consequences for the real economy. The rise in asset prices improves the wealth position of the asset holders which increases their consumption expenditure. In the case of financial assets, since it makes raising finance easier, it enlarges investment expenditure. In the case of all producible assets, such as houses for instance, since the rise in asset price makes it exceed the cost of production, there is larger demand for newly-constructed assets and hence larger production of them. Thus the asset price bubble raises aggregate demand, and hence output and employment, well beyond what it would have been in the absence of such a bubble.


If for some reason however the rise in asset prices comes to an end, then speculators start deserting the asset like a sinking ship. The reverse mechanism sets in, with expenditure shrinking for two analytically distinct reasons: the first is simply the operation in the opposite direction of the very forces mentioned earlier that served to accentuate the boom. The second is through the credit system. As asset prices fall, those who have borrowed from banks, find themselves becoming insolvent, which in turn makes the banks insolvent. Credit therefore dries up, and in extreme cases, as during the Great Depression of the 1930s, even depositors become chary of keeping their deposits with an insolvent banking system. The pervasive desire, down the line, is to hold cash rather than private debt, and in extreme cases the preference is for currency and not even bank deposits. This desire too is governed by the need to cut losses, the obverse of maximising gains, i.e. of �greed�.


Hence in contemporary capitalism, with its developed financial markets, speculation which is necessarily rampant, plays as important a role in accentuating the boom as it does in precipitating a crisis. Speculators, like all other capitalists, are driven by �greed�. It is their �greed� which causes pronounced booms just as it is their �greed� which causes severe crises, because of which it is best if we forget the word �greed� and see the cyclical phenomenon as a whole, including the occurrence of severe crises, as being embedded in the system itself.




Some may feel that while the crisis itself has to be located in the modus operandi of the system itself, its severity this time is caused partly by the fact that the development of the enormous �derivatives� market made investment banks feel less exposed to risk. They sold off their risky assets, experienced an �I-am-all-right-Jack� syndrome, and went in for the acquisition of more risky assets which were again sold off, and so on. While they felt less risk, the risk to the system as a whole kept cumulatively increasing. Or, looking at it from the point of view of the system as a whole, there was a systematic understatement of risk because of the development of �derivatives�, so that when the crash came it was all the more severe. And since such behaviour which amounts to duping the system for maximising one�s own gain, goes beyond the normal modus operandi of the system (where the question of duping does not necessarily arise), it can surely be characterised as �greed�.


Even this however would not be scientifically correct for at least three reasons. First, hedonistic maximisation which is the essence of capitalist �rationality� does not concern itself with whether the system is being duped. It does not stop short of duping the system. If as a capitalist I can make more money by duping the system, then it is rational on my part to do so. Hence there is no special �greed� involved in duping the system. Duping the system, if it is possible to do so for gain, is part of �rational behaviour�. Second, it is not even the case that the Wall Street investment banks that were selling off their loans in the �derivatives� market were consciously duping the system. It was more a case of the anarchy of the financial market making everybody unaware of the risks that were piling up rather than any particular group consciously duping some other group. Since all of them would get blown up if the financial system collapsed under the risks being piled up, the fact that the investment bankers behaved as they did was more a reflection of the anarchy of the system than of any special �greed� on their part over above what is commonplace under capitalism. Third, investment banks� behaviour, no matter how we choose to characterise it, was as much responsible for the prolonged boom as it was for the slump.


It is a feature of �bubbles-led growth� that the more the boom is prolonged, the greater is the severity of the crash. The underestimation of risk owing to the introduction of �derivatives� was responsible for the strength of the boom: asset prices kept rising and rising (which they would not have done to the same extent if risk had been accurately assessed), because of which the real economy too benefited in terms of output and employment growth. Precisely because of this very fact however, when the crash came, it was all the more severe.


Thus whichever way we look at it, the �greed explanation� simply will not do. If �greed� is defined as not being co-terminus with capitalist �rationality�, then it is simply wrong to attribute the crisis to �greed�, since that implies that the crisis has nothing to do with the nature of capitalism per se. If �greed� is taken to be co-terminus with capitalists� �rationality�, then there is no point talking about �greed� per se. Whichever way we look at it, the �greed� explanation lacks justification, which is but another way of saying that a scientific analysis of capitalism in crisis must be substituted for sheer moral indignation.