By Yan Barcelo
Are periodic crises an inherent feature of the economic system or are they just an oddity of our times?
In Ben Bernanke’s book about the economic crisis of 2008, The Courage to Act: A Memoir of a Crisis and its Aftermath, the former chairman of the US Federal Reserve describes a 4 p.m. meeting in the White House on September 16, 2008, to discuss frightening and urgent financial events. The meeting was in the windowless Roosevelt Room, near the Oval Office. At one side of the polished wooden table sat Bernanke and Hank Paulson, secretary of the Treasury at the time, and on the other side of the table sat then president George W. Bush and then vice-president Dick Cheney; various economic advisers, aides and financial head honchos filled the remaining chairs around the table. The president began the meeting with a blunt question: “How did we get to this point?”
Many will be surprised that the leader of the most powerful economic nation in history would ask such a question, and some will no doubt attribute it to the former president’s alleged lack of intelligence (not true, according to all knowledgeable accounts). But there is some evidence that Bernanke himself was at a loss to explain the crisis. In 2007, he had publicly stated, “At this juncture ... the impact on the broader economy of the problems in the subprime market seems likely to be contained.” When asked toward the end of his tenure what surprised him most about the financial crisis, he replied, “The crisis.” And in his book, he writes that while he and his colleagues may have seen pieces of the puzzle, they failed to understand how the pieces fit together.
Bernanke later delves into the minutiae of the economic circumstances that led to the crisis, as have many other commentators. What is not questioned is the economic, political and social organization itself, capitalism, defined very broadly as a system of production where private enterprise is dominant and profit is the driving force. Is capitalism by its very nature dysfunctional and prone to crises?
The evidence from the past 40 years suggests that capitalism is mostly dysfunctional. The number of crises that members of the boomer generation have experienced in their lifetime boggles the mind: stagflation in the 1970s, the interest rate explosion of the early 1980s, the 1987 stock market crash, the 2000 dot-com explosion, and finally, the crisis of 2007-’08 followed by the Great Recession. And let’s not forget all the peripheral bumps and shocks: in the 1990s, the world witnessed the peso and ruble crisis, the East Asian bust, the LTCM failure, followed in the 2000s by the Libor scandal and the Enron, WorldCom and Nortel blowups.
When asked if capitalism has become dysfunctional, Robert J. Shiller, 2013 Nobel laureate in economics and professor of economics at Yale University, says, “Not at all.” Meaning that capitalism is no more dysfunctional than it was in the past. Shiller accurately predicted both the dot-com bubble and the housing bubble. “Acute crises came with modern finance, for example the Mississippi Bubble in European stock markets of 1720. There were major financial crises or crashes beginning in 1792, 1837, 1857, 1873, 1884, 1893, 1907, 1920, 1929, 1973, 1982, 1990, 2000 as well as 2007 and there were often associated severe economic contractions.”
So what the boomer generation has experienced is just “crisis as usual.” But the crises of the past 30 years are not quite the same as those in the past. According to Kevin Harris, director for North America at 4Cast-RGE, in New York, what we mostly had in those days “were inventory and durables cycles. Managers wrongly anticipated demand, then needed to undo the mistake by reducing production, laying off employees, thereby reducing consumption and economic activity. We tend not to have those anymore.”
Today, finance dominates production and Harris says that instead of inventory cycle mistakes, we make asset valuation mistakes. Shocks to the real economy transfer with more impact.
So, we are experiencing the same shock cycles, but they have more intensity. What drives the shock cycle? Is it good old greed? Sure, there’s a lot of that, but Harris thinks there is more to it than greed. Mistakes of overreach in the system crop up modestly at first, then get transferred to other players who, driven by competition, have no choice but to pick them up and repeat them just to stay in the game, increasing the momentum until something pops. For example, leading up to the financial crisis, many people were issuing tons of subprime mortgages. “Were they particularly ‘greedy’?” asks Harris. Not necessarily. They were just doing their job, otherwise they would have been out of a job. According to Harris, the term “greed” misses the inevitability of the buildup of bad or mistaken behaviour. “All players, as long as the music continues, just have to keep on dancing,” he says.
Karl Marx, that great 19th-century critic of capitalism, believed that the inherent contradictions of capitalism (which involves technology throwing workers out of jobs, and overproduction creating gluts on the market and economic depressions) would be its undoing. Is that where we’re headed? The systematic exploitation of labour, Marx thought, would lead to the impoverishment of the working class or proletariat, and the interests of the capitalist class in making ever more profit would conflict with the interests of the economy and society at large. The deadlock that would arise would lead to a proletarian revolution that would bring an end to capitalism. History is still holding its breath.
Offering a new twist on Marx’s prediction, bestselling author Naomi Klein thinks that climate change will bring about the downfall of capitalism. The threat of “ecocide,” she writes in her most recent book, This Changes Everything, will cause people to radically question capitalism’s endless gobbling up of resources for profit and usher in an alternative worldview “embedded in interdependence rather than hyperindividualism, reciprocity rather than dominance, and cooperation rather than hierarchy.”
Another bestselling author, futurologist Jeremy Rifkin, also subscribes to the vision of a “collaborative and sharing” future that will push capitalism to the sidelines. But it’s not the “ecocide” threat that will do the trick; it’s the Internet of Things and the digital economy that are already accelerating productivity and pushing the price of products and services near zero. The ranks of “prosumers” are growing in a “collaborative commons” where they produce nearly free 3-D printed products and share cars and homes, bypassing the reigning capitalist market. (For more on the sharing economy see “The Great Exchange”)
Until its prophesied downfall happens, capitalism remains the only game in town and is still charging ahead, though in different guises. On the good side, you have “managerial capitalism” and “entrepreneurial capitalism,” and on the bad side, you have “state-guided capitalism” and “oligarchical capitalism,” says an article (published on the Project Syndicate website and later as a book) titled “Good Capitalism, Bad Capitalism,” by Robert Litan, William Baumol and Carl Schramm.
The ideal model, according to these authors, includes a combination of the two good forms: big stable firms driven by entrepreneurial innovators. South East Asian countries represent state-guided capitalism, in which state planning ultimately leads to developmental dead ends. Oligarchical capitalism, the worst form, dominates the Arab Middle East and Latin America and Africa, where extreme inequality in income and wealth reigns, and where elites, instead of promoting growth, aim at maximizing personal income and wealth.
However, the stagnation and lethargy that have prevailed since the financial crisis lead many observers to question where capitalism now stands. The engine of capitalism seems to be out of fuel. Is this only circumstantial or is it structural? The jury is still deliberating.
In all developed countries, yearly GDP growth seems stuck below 2%, even though central banks have set interest rates near or below zero and flooded markets with money. “Had you told most economists at the time of the crisis that this would be the outcome, no one would have believed you,” says Jimmy Jean, senior economist at Mouvement Desjardins in Montreal.
Productivity, a fundamental condition of rising prosperity, has been declining significantly since the 1970s in most G7 countries, according to the OECD Compendium of Productivity Indicators 2016. In the US, from a yearly growth of about 2% in the 1970s, it has fallen below 1% since 2009. In all developed economies, Canada included, productivity growth now lingers well below 1%, in some countries flirting with a 0% rate.
That emblematic fixture of capitalism, the stock market-listed corporation, especially the small public stock company, seems to be on a slow path toward extinction. In 1996, small initial public offerings (IPOs) in the US reached a peak of 380 per annum. In 2009, they fell to four, inching up to 96 in 2014, according to data collected by Jay Ritter, professor of finance at the Warrington College of Business at the University of Florida in Gainesville. In Canada, “there were approximately seven IPOs a year of all sizes on the TSX in the last five years,” says Ritter. “In 1986, there were 70.”
If small companies don’t make it to the stock market, too bad. Here’s the key question: is the startup creation engine holding up? Not really. Startup creation is steadily declining, from 550,000 a year in 1978 to 400,000, according to data from the Kauffman Foundation. The bad news, reports The Washington Post in an article commenting on the Kauffman data, is that “young businesses account for nearly all net new jobs created annually in the United States.” Numbers from Statistics Canada show very similar patterns.
Innovation is dying. At the end of his 2013 TED Talk, Robert Gordon, an economist at Northwestern University, invited Alexander Graham Bell, Thomas Edison and the Wright brothers onstage to pick up their “Oscars of innovation.” Of course, they didn’t show up. Then Gordon imagined the legendary threesome asking the audience a key question: “Can you match what we achieved?” As Gordon had just spent the previous 12 minutes arguing, the answer was no, not at all. Capitalism has grown on the back of a huge wave of job- and industry-creating technologies: cars, planes, drugs, electricity. Today’s new technologies, such as artificial intelligence and robotics, says Gordon, simply won’t be able to take up his challenge. They simply don’t have the same job-creating potential as the previous technologies. As a result, economic growth, which has averaged 2% a year for the past 150 years, will slow down to a yearly crawl of 0.2%, where it stood before the Industrial Revolution.
Capitalism is stuck in a classic crisis situation. In a 2011 article called “Is Capitalism Doomed?” Nouriel Roubini, who became famous for predicting the financial crisis, wrote, “Firms are cutting jobs because there is not enough final demand. But cutting jobs reduces labor income, increases inequality and reduces final demand.”
Is capitalism doomed? Marx, Klein and Rifkin would say yes, and that its downfall is imminent. But economists of the two dominant schools of thought, neoliberals and neo-Keynesians, would say no.
Capitalism can bounce back if government stops bleeding it to death, claim the neoliberals.
Big government is suffocating entrepreneurship and productivity. “As more and more professions get regulated, they seize up, making it increasingly difficult for new entries,” says Bill Robson, president and CEO of the C.D. Howe Institute. “The history of the last 20 years tells us that the ‘stiflers’ proliferated and might have had the upper hand most of the time.” Big government is also the main culprit in the subprime blowout of 2008. “It started with the Community Reinvestment Act — a highly intrusive statute that required banks to lend to risky borrowers,” says Andrey Pavlov, professor of finance at the Beedie School of Business at Simon Fraser University in Vancouver.
According to neo-Keynesian economics, the former mainstream school of thought presently making a comeback, the crisis is the result of neoliberal policies that have been blindly applied since the Thatcher/Reagan era: systematic deregulation, huge tax cuts for the rich and for business, austerity programs, and the neglect of unions and the working classes. What’s needed now is for government to get back into the saddle, stop austerity measures, launch big public infrastructure programs, promote energy conservation and reduce inequality, as Columbia University professor Joseph Stiglitz, Economics Nobel laureate and former chief economist at the World Bank, proposed in a 2011 article titled “To Cure the Economy.”
Another school of thought that is gaining a lot of traction, led by the Modern Monetary Theory school, believes that, far from waiting for its death or its revival, capitalism is already dead, or in a near-death state. It drowned in “financialization,” in which profit is driven by leveraged financial assets and not by the material production of goods and services. We have shunned production-focused capitalism to embrace a finance-centred “rentier economy.” The signs of capitalism’s funeral procession abound.
Some would say that capitalism’s death knell first sounded in a famous 1970 essay in The New York Times Magazine by neoliberal economist and 1976 Nobel Prize winner Milton Friedman. He wrote that “the social responsibility of business is to increase profits.” Forget customers, clients, creditors and society; increasing “shareholder value” was the only purpose of enterprise, which soon translated into increasing the price of shares, as presented in a 2013 article titled “The Shareholder Value Myth,” by Lynn Stout, professor at the Cornell Law School. The adoption of this belief in business circles has led to countless egregious practices and conditions.
As a result, manufacturing, the most central component of capitalism as a production-directed economic system, is eroding. In the US in 2013, it accounted for 80% of exports and 90% of patents and innovation; in Canada, it accounted for 70% of exports and 55% of innovation.
There is an inverse correlation and causality between the evolution of manufacturing and finance, says Michael Collins, author of The Rise of Inequality and the Decline of the Middle Class. “At its peak in the mid-twentieth century,” he reports, “manufacturing accounted for 40% of GDP and created 20% of the nation’s jobs. Today finance controls 20% of GDP with 5% of the jobs, while manufacturing has plummeted to 10% of GDP and 9% of jobs.”
Many rentier economy practices lead to the erosion of the jobs, R&D and innovation capacity of manufacturing. Three of these practices are offshoring, activist shareholders and stock buybacks by corporations. For example, from 2006 to 2015, the total of share buybacks amounted to US$3.9 trillion, money “that could have been spent on innovation and job creation in the US, but which mostly contributed to increase the wealth of executives whose revenues are now massively linked to stock options,” says William Lazonick, professor of economics at the University of Massachusetts-Lowell.
Profits in the financial sector — identified in American and Canadian national accounts as FIRE (finance, insurance and real estate) — accounted for about 11% of total corporate profits in the US in 1984. By 2001, they had grown to a whopping 40%. After falling to 10% in 2008, they shot back up to 33% the very next year. In Canada, by 2014, FIRE’s profits absorbed 29.2% of corporate profits. FIRE’s share of GDP in the US was 20% in 2010 and in Canada, it was 6.8% in 2014.
Volatility reigns in such economies. “Our financialized capitalism thrives on volatility,” says Ritu Birla, an historian of empire and capitalism who is also director of the Initiative in Global Governance, Economy and Society at the Munk School of Global Affairs at the University of Toronto. “Your average hedge fund manager profits from the rise and fall of market prices, operating differently than the average investor who is concerned with stable, long-term portfolio growth. The hedge fund manager wins on both sides. Profit is produced through volatility.” Yet, for production-oriented capitalism, stability is a fundamental requirement.
All these economic factors have concentrated more and more wealth in the hands of fewer and fewer people. In 2010, 1% of the world’s population held US$91 trillion, or 45.5% of a total world wealth estimated at US$200 trillion by a Credit Suisse study. In 2016, total wealth had grown to US$260 trillion, of which the top 1% held 50.5%.
The situation in the “Unequal States of America,” as the Allianz Global Wealth Report 2015 calls the US, is particularly distressing. Of the 53 countries analyzed in the study, the US comes out with the highest rate of income distribution inequality at 81, compared to 73 in Brazil and 70 in Mexico, countries that fit Litan, Baumol and Schramm’s oligarchical capitalism model. In Canada, the rate stands at 64, slightly above the global average.
Some proponents of financialization argue that the aftermath of the financial crisis brought on the largest transfer of wealth to the rich in history. Operations with names such as TARP, Large-Scale Asset Purchase Program, Operation Twist and Quantitative Easing resulted in shifting the weight of the crisis from the wealthy to taxpayers. In a landmark 2009 Atlantic article, titled “The Quiet Coup,” former IMF chief economist Simon Johnson likened the whole situation to an oligarchical takeover of government in a Third World country. Practically all holders of toxic “assets” and debt were made whole when, in Johnson’s view, they should have paid for their financial folly.
The received wisdom, perpetuated by most commentators, is that the shock of an orderly bankruptcy procedure put in motion by government would have been unbearably costly to the economy. Those who say that “are either apologists or don’t understand what they’re talking about,” insists Randall Wray, professor of economics at Bard College and senior scholar at its Levy Economics Institute and a foremost proponent of the Modern Monetary Theory school of thought. “We should definitely have shut them all down, investigated, prosecuted for fraud, fired the management. And all those big banks should have been shut down. It would certainly not have been more costly than what we are now stuck with: 10 years and the economy still hasn’t recovered.”
In his Atlantic article, Johnson proposed the same kind of government-managed bankruptcy procedure. “It would allow the government to wipe out bank shareholders, replace failed management, clean up the balance sheets, and then sell the banks back to the private sector. The main advantage is immediate recognition of the problem so that it can be solved before it grows worse.” That is similar to what Franklin Delano Roosevelt did with his famous “bank holiday” upon taking office as president in 1933.
Global debt has increased by US$57 trillion since 2007, according to a 2015 McKinsey Global Institute study, most of it landing in the public sector after the financial crisis, while it has remained flat in the private sector. Total debt now reaches 233% of GDP in the US and 221% in Canada.
Michael Hudson, who teaches economics at the University of Missouri-Kansas City, explains what this implies for economies. “Let’s say that debt is equal to 100% of GDP (it stands well above that in most countries). If a country pays interest at usually 5%, it would have to grow 5% per year just to pay the interest. And if countries are growing at 1%, and the interest rate that everybody pays is about 5% or 6%, then you’re going to have the actual economy shrinking every year as there’s this siphoning off of interest. That’s what debt deflation is.”
At the level of citizens, Hudson goes on to explain, this is what it looks like: “Trying to rise into the middle class these days is a road to debt peonage. It involves taking on mortgage debt to buy a home of one’s own, student loans to get the education needed to get a good job, an automobile loan to drive to work, and credit-card debt just to maintain one’s living standards as the debtor falls deeper and deeper in the hole.”
This is exactly the situation of the millennial generation, the least entrepreneurial of today’s generations, as The Washington Post article points out. Home ownership, the primary source of savings and potential collateral for a loan to launch a business, has steeply declined among millennials since 2010, and the size of their student debt also deters them from starting a business.
The huge debt hanging over citizens, governments and corporations involves interest payments going to the FIRE sector, mostly to banks, whose profits are astronomical. This is not capitalism, according to Hudson and Wray. This is the predatory rentier system the classical economists were fighting against. Maybe the Litan/Baumol/Schramm entrepreneurial capitalism model is the most dynamic, but that is not where the US and the developed economies stand anymore. They increasingly exhibit the features of the oligarchical capitalism model that the authors have assigned to dubious Latin American and Middle Eastern countries. But that is not capitalism, Hudson would object. It is precapitalism, a modern version of feudalism.
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