People's Democracy

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


No. 47

November 22, 2009

 On Crises And Great Depressions


Prabhat Patnaik 

A HALLMARK of a capitalist crisis is the sudden collapse of the level of activity, or a sudden and violent replacement of a downward for an upward movement of the economy. This suddenness arises above all because of the nature of the asset markets, which tend to be dominated by speculators, i.e. by buyers and sellers who are interested in the asset in question not because of the yield that it would give over a period of time, but because of the capital gains they would get on it within a short span of time. They have in other words no interest in the asset as such, i.e. in holding on to it for any length of time; their exclusive concern is with comparing its price today with its expected price tomorrow.


In markets dominated by speculators, the actual price today depends upon the price that is expected to prevail tomorrow, and the latter in turn depends upon what the speculators today expect the speculators tomorrow to be doing. Hence in such markets speculative price �bubbles� tend to get built up.


For instance, if for some reason the price of an asset happens to increase, and the speculators on balance expect the price to rise even more, then they would demand more of this asset and the price will actually increase. This would induce a further expectation of price rise and hence a further actual price rise, thus leading to a gradual spreading of euphoric expectations about the movement of the price of the asset in the immediate future. The actual price rise that occurs because of this euphoria constitutes an asset price bubble. In markets dominated by speculators, which typically are those markets where the carrying cost of the commodity being traded is negligible, the formation of such bubbles is a common phenomenon. And the foremost among such markets are those of financial assets where the carrying costs are negligible.


When such bubbles drive up asset prices (and the formation of such a bubble in one market is not necessarily conditioned by the collapse of a similar bubble in some other market, so that bubbles can simultaneously arise in several markets), those holding such assets feel wealthier and hence increase their consumption. Bubbles in financial markets lower the cost of raising finance, and for that reason stimulate real investment. Likewise, when the price of an asset increases that is reproducible, more of that asset is produced, which again raises real investment for its production. In other words, asset price bubbles stimulate aggregate demand in a capitalist economy, and hence have a real impact in terms of output and employment.


If for some reason the price rise comes to an end, whether because the output increase, on account of the real investments undertaken earlier, finally occurs, and dampens expectations of a further price rise, or because it suddenly dawns on the speculators that they are sitting on top of a bubble that might collapse any day, then speculators leave this asset like rats deserting a sinking ship. The asset price collapses, with a corresponding negative impact on real investment and consumption.


Those who had borrowed to purchase the asset when its price was high, suddenly find themselves, when the asset price has collapsed, having debts against which the assets they hold are worthless. They become insolvent; those who had given loans to them, namely the banks, are also threatened with insolvency; and so even are the depositors. And everyone rushes to convert their financial claims upon others into cash; and to hold on to whatever cash they have, instead of giving it out as loans to anyone else or exchanging it against claims on others. Hence credit dries up, and liquidity preference increases dramatically, which both compounds the contraction of real aggregate demand and generalizes the financial crisis that might have originated in one market to the economy as a whole.


It is this which explains the fact that crises in capitalism are sudden and violent, since every boom, no matter how set off, is invariably fed by speculation. All capitalist booms are �bubble�-sustained. Capitalism is not only a system where the real living conditions of millions of people depend upon the whims and caprices of a bunch of speculators; but it is also characterized, precisely for this very reason, by the fact that these millions are often pushed into destitution suddenly, violently, and spontaneously.


If the system was left to itself, then the recovery from such a sudden and violent disruption would take an inordinately long and unpredictable period of time. Every such crisis in other words would become a Great Depression. The fact that this is not so, and that crises, even though precipitated suddenly and violently, have, except on certain well-known and rare historical occasions, soon been followed by new booms, is not because of any spontaneous mechanisms within capitalism, but because of an element that strictly speaking is exogenous to the closed capitalist economy.



Economists have often suggested that �innovations�, in the widest sense of the term, are endemic to the system, and can stimulate a new boom within a closed capitalist economy, and have used this as an argument against the claim that capitalist dynamics requires a stimulus from �outside� of its closed economic system. But innovations are typically adopted in significant measure only when capitalist economies are booming, i.e. they follow the initiation of a boom rather than themselves initiating a boom. In fact, many have argued, notably W. Arthur Lewis, that during the inter-war period a whole lot of innovations remained unutilized in capitalist economies because of the Great Depression. Innovations in short do not prevent Depressions; on the contrary Depressions prevent innovations. What does prevent Depressions is the access of capitalist economies to an �outside� stimulus, �outside� of its closed economic system.


Let me clarify the analytical content of the argument before proceeding further. If there is an underlying upward trend in the economy, then even when the crisis is precipitated in the manner discussed above, it is short-lived. The factors underlying the upward trend pull up the economy soon after it has plunged into a crisis. On the other hand if for some reason the underlying trend is missing then the crisis lasts longer and becomes a Great Depression.


During the recent history of capitalism, spanning say the last century and a half, there have been two such underlying trends, both, as mentioned above, stimulated by factors �outside� of the closed economic system of capitalism. The first underlying trend was founded upon the entire system of colonialism; the second underlying trend was founded upon systematic intervention in demand management by the capitalist state. Both colonialism and State intervention belong to a realm �outside� of the closed capitalist economic system proper. The end of the first of these two great stimuli gave rise to the Great Depression of the 1930s; the end of the second of these two great stimuli has given rise to the current crisis which therefore is going to be far more protracted than is made out by the spokesmen of capitalism, and is indeed likely to be another Great Depression like the 1930s one.



Let me elaborate on these two great phases of capitalist dynamics. The first phase, the phase of British leadership over the capitalist world and of the hegemony of the pound sterling under the Gold Standard, came to an end with the first world war. It was marked by four main features: first, there was a massive migration of labour from Europe to the temperate regions of white settlement, such as the United States, Canada, Australia, and New Zealand, and together with it a migration of capital, especially from Britain, which was the largest capital exporter of the pre-war period.


Second, as the leading capitalist power of the period, interested in keeping the Gold Standard arrangement going, Britain had to accommodate the ambitions of the newly industrializing powers of the time, notably those located in continental Europe, by running a current account deficit with them (and thereby providing them with an open market); this meant that Britain had to obtain a current account surplus visavis countries other than continental Europe, that was large enough both to offset the current account deficit visavis continental Europe, and additionally to finance its capital exports to the �new world�.


Third, this current account surplus did not exist visavis the �new world� itself, since the �new world�, keen on developing its own capacity for producing manufactured goods, did not want British manufactures to any significant extent; on the other hand the �new world� did want a range of primary commodities and mineral resources which were produced in Britain�s tropical colonies like India and Malaya.


Fourthly, and finally, the colonial system, for all these reasons, played a key role, of absorbing British goods, like textiles, that were �unwanted� elsewhere, in continental Europe as well as in the �new world�, and of making an equivalent amount of exports available to the latter regions (even though such absorption of British goods on their part decimated their own domestic pre-capitalist producers); and, additionally, of making available a further amount of exports to the �new world�, for which they were never paid and which therefore constituted a pure colonial tribute, that constituted Britain�s capital exports to the �new world�.


The pre-war capitalist boom therefore was founded upon the colonial system, or more accurately the imperial system (since the bourgeois juruducal term �colonies� is used to cover both �colonies� like the U.S. and �colonies� like India and Malaya). A number of writers like Alvin Hansen of the U.S. and John Maynard Keynes of the U.K. have noted the role played by the �expanding frontier�, i.e. by the migration of labour and capital from what was then the capitalist metropolis into the �new world�, in sustaining the long pre-war boom. But underlying this �expanding frontier� was a whole arrangement involving the tropical colonies, i.e. the imperial system built by capitalism.


This world, as Keynes was to note in his Economic Consequences of the Peace, collapsed with the war. This was not only because the �frontier� closed, but because even before formal decolonization, the old imperial arrangement could not no longer be sustained in its former role. Japan was making incursions into Britain�s Asian markets, to counter which Britain had to make concessions to the newly emerging manufacturing  bourgeoisies in many of these countries; one way or the other it no longer had these markets �on tap� as in the pre-war period. The old stimulus underlying the first great phase of capitalist dynamics thus evaporated with the war; the result was that the crisis that erupted in the late-twenties became the Great Depression. The underlying trend, stimulated by an �outside� element that would have kept the crisis brief, had disappeared. Hence the crisis got protracted and became the Great Depression.


The fascist countries were the first to come out of the Depression through militarism; the liberal capitalist countries came out of it only on the eve of the war when, in response to the fascist threat, they too started arming themselves. It was the second world war in short that ended the Great Depression.



In the post-war period, a new �outside� element came to provide the stimulus for yet another phase of capitalist dynamics, and that was State expenditure. In one sense this was a continuation of the war experience; the United States, which, notwithstanding Roosevelt�s New Deal, had only 10 percent capacity utilization in its producer goods industries, or what Marx had called department I, before war preparations began in the late thirties, continued in the post-war period with a massive military apparatus, the need for which arose because of its assuming the role of the leader of the capitalist world, and hence becoming the gendarme of counter-revolution. At the same time however, under the pressure of the working class and in the face of the socialist �threat�, many capitalist countries in Western Europe, with social democratic governments, undertook substantial welfare state expenditure. Much of it was financed by taxes upon the workers themselves, so that it did not entail a net addition of demand in the economy as large as the magnitude of the expenditure itself would suggest; but it did add significantly to demand. State intervention in demand management, whether through military or welfare state expenditure (apart from the State�s effecting changes in private spending through fiscal and monetary means), became accepted policy.


This provided over a period roughly from the early-1950s until the early 1970s, the biggest boom in the history of capitalism (over a comparable period). But this period of Keynesian �demand management� came to an end in the early-1970s. The reason which is most often cited for the unsustainability of Keynesian �demand management� is the inflation it gave rise to. If capitalist economies function with high levels of employment for long, then class struggle over the distribution of output gets exacerbated, since the principal weapon in the hands of the capitalists for beating down the workers in this struggle, namely the existence of a reserve army of labour, loses its efficacy. Since the wage bargain is in money rather than in real terms, the manifestation of this exacerbation of struggle over distribution is accelerating inflation.


There is however a second and more powerful explanation for the decline of Keynesian �demand management�, and that is the emergence of international finance capital. Centralization of capital is an immanent tendency of capitalism, and even during the years of the post war boom centralization of capital was going on, leading eventually to a process of globalization of finance, and the formation on the basis of such globalization of an international finance capital. When Lenin had written Imperialism, he had talked of German, French or British finance capital, i.e. of finance capital that was nation-based and nation-State aided. But the finance capital that has emerged in the contemporary epoch represents a still higher level of centralization of capital compared to Lenin�s time, and hence differs in many ways from what Lenin had written about.


There are at least three ways in which finance capital in the current period differs from that in Lenin�s time: first, it does not represent a coalescence between industry and finance, and its movements are not dictated by any strategic considerations relating to the promotion of a country�s industry; rather its objective is to obtain speculative gains and it moves around the world in quest of such gains. Secondly, precisely because it is �globalized� and wants to tear down all barriers to its movements, it is international and does not represent a particular nation and does not need the backing of a particular nation-State. Thirdly, its influence is to mute inter-imperialist rivalries, rather than intensify them, since any such rivalry breaking the world into different spheres of influence constitutes a hindrance to its free global flow.


Finance capital is always opposed to any Sate activism, except that which promotes its own exclusive interest, and it invariably favours the principle of �sound finance�, i.e. the tenet that States should eschew fiscal deficits. The reason for this lies less in the realm of economics in the narrow sense than in the realm of political economy in the broader sense. Any State activism that is undertaken because there is a general perception of the need for it, undermines the social legitimacy of capitalism; it suggests ipso facto that capitalism is a flawed system which has to be rectified by the intervention of the State. Hence, capital of all descriptions opposes State activism, typically on the grounds that such activism is counter-productive.


If capital, even when engaged in production, and hence capitalists, even when connected with the production process, feel vulnerable if the need for State intervention gains currency in society, then one can imagine how much more vulnerable finance capital would feel on this score, since the financiers in charge of it constitute what Keynes had aptly called the �functionless investors�. Finance capital, therefore, is particularly in need of promoting the myth that its �state of confidence� holds the key to social progress, and that therefore State activism must be directed, if at all, in promoting its interest; any other form of State activism is supposedly counter-productive.


Even in Keynes� time, therefore, finance capital had stoutly opposed State intervention in demand management through fiscal means; and its opposition was only overcome in the changed context of the post-war years, when the working class had both emerged more powerful, and been insistent that it was not going back to the capitalism of the pre-war years. But State intervention, or State activism, refers only to the nation-State; when finance capital becomes international, while the State remains a nation-State, its opposition to State activism and to deviations from the principles of �sound finance� acquires a spontaneous effectiveness, since any State that ignores its caprices then runs the risk of precipitating a capital flight. State intervention in demand management through fiscal means in such conditions (except perhaps by the leading capitalist State, the U.S.) gets undermined. The second �outside� element that had stimulated capitalist dynamism ceases to be effective, creating conditions where a crisis, again, tends to get converted to a Great Depression.



This defines our present conjuncture. The decline of the stimulus provide by State expenditure was not immediately followed by any Depression, because a series of asset price bubbles, coming one after another, kept the U.S. economy, and hence the economies of the advanced countries as a whole, reasonably dynamic, even though the average growth rate of the OECD between 1973 and 2003 was much lower than between 1951 and 1973. There was first the stock market bubble, followed by the dotcom bubble, followed in turn by the housing bubble. The collapse of these bubbles however has precipitated a crisis that, unless there is a revival of fiscal activism, will become a Great Depression; and the hegemony of finance in today�s globalized world thwarts the prospects of such fiscal activism.


True, there has been, especially in the U.S., fiscal intervention in the immediate context of the crisis, but it is seen as a temporary measure, not as a revival of the Keynesian regime of State intervention in demand management through fiscal means.


Indeed, already there are demands for a withdrawal of the fiscal stimulus provided to overcome the crisis, exactly as there were during the  mid-1930s. And if the stimulus is withdrawn, which it is likely to be unless the hegemony of finance is struggled against and the correlation of social forces changed, the world will be plunged into a new Great Depression.


Looking at the matter differently, the old stimulus provided by the access to colonial markets has run its course, since the relative size of these markets has shrunk so greatly that they cannot play their old role (which does not mean that imperialism has become irrelevant, since access to raw materials continues to be of paramount importance). The alternative stimulus provided by State expenditure is thwarted in the new conjuncture by the hegemony of finance capital in its globalized incarnation. We are once more therefore in a situation where the underlying trend, provided by stimuli �outside� of the closed capitalist system proper, no longer exists. This is why the current crisis has every possibility of turning into another Great Depression.


Of course, there may be another asset price bubble round the corner that may usher in a new boom. But this does not seem imminent. What is more, even if the capitalist system henceforth saw sporadic asset price bubbles giving rise to booms, followed by crises when fiscal intervention by the State prevented the worst from happening, i.e. even if such fiscal intervention became not a part of the system as earlier but an occasional recourse in crises, and got withdrawn whenever new asset price bubbles developed, such a regime would not produce bubbles even of the magnitude of those of the eighties, nineties and this century in the foreseeable future. Hence we may have a Great Depression that is shallower in the presence of such bubbles than it might have been in their absence, but avoiding such a Depression altogether appears to be impossible within the existing class correlations in advanced capitalism. Almost everyone, including even the IMF, is agreed that the unemployment situation in the U.S. itself, will remain grim till 2011. It may in fact remain grim for a lot longer than that.