A way out of depression?

Global capitalism is mired in depression. A Keynesian tract for our times proposes a way out - and is reviewed by LYNN WALSH.

THE US ECONOMY, with feeble growth and persistently high unemployment, is in a state of depression, according to Paul Krugman. It is not as severe as the great depression of the 1930s, but "it’s nonetheless essentially the same kind of situation that John Maynard Keynes described in the 1930s: ‘a chronic condition of subnormal activity for a considerable period without any marked tendency either towards recovery or towards complete collapse’."

Krugman deplores the huge loss of economic output, the permanent undermining of manufacturing capacity, and the social catastrophe of long-term mass unemployment. The rescue of the banks through the TARP (Troubled Asset Relief Programme) after the collapse of Lehman Brothers in 2008 averted a collapse of the financial system, though on extremely favourable terms to the banks and speculators. President Barack Obama’s Keynesian-type stimulus programme averted a catastrophic economic slump, but was too limited (in Krugman’s view) to produce sustained growth.

Political leaders, according to Krugman, have failed to learn the lessons of the 1930s. Through a combination of distorted ideology and economic self-interest they exerted pressure for a return to deficit reduction policies in 2010, undermining the fiscal stimulus policy. Obama lacked the "Rooseveltian resolve" demonstrated by president Franklin D Roosevelt during the great depression. Krugman recognises that Obama faced bitter opposition from the Republican-dominated Congress, but criticises his failure to make the case for a bigger stimulus package. Obama failed to effectively mobilise public opinion behind such an intervention. The result is the current, lamentable state of the US economy.

So Krugman has written a tract for the times. Its title suggests that it is a campaigning pamphlet rather than an academic analysis. It is succinct, polemical, satirical in places, advocating unashamedly Keynesian policies which, in his view, could rapidly end the recession and produce sustained growth.

Krugman is a prominent academic economist in the US, but best known for his informative and polemical columns in the New York Times. He is the most prominent of the Keynesian economists (including people like Joseph Stiglitz) who advocate more state intervention to stimulate recovery, and are severely critical of the voodoo economics of the ultra-free-marketeers, now championed by the Republican presidential candidate Mitt Romney, and especially by his vice-presidential candidate, Paul Ryan.

Much of the book is an analysis of the crisis which hit the US and the world economy from the end of 2007. It is succinct and clear, jargon free, and sound, as far as it goes – but ultimately superficial. It is a well-known story. The massive credit boom after 2001 (both in the US and throughout the capitalist world) led to a housing bubble, especially in those countries which followed the US/Anglo-Saxon model. Finance, particularly the shadow banking system, became even more dominant. The securitisation of debt and the vast expansion of financial derivatives were supposed to minimise or – in some people’s dreams – even rule out risk.

As the financier Warren Buffett (and Socialism Today) predicated, however, derivatives became instruments of mass destruction. With the collapse of the housing bubble they amplified the fallout. Without state intervention in the US and elsewhere to rescue the banks there would have been a worldwide collapse of the financial system.

Krugman’s explanation, however, is limited. He argues that political leaders ‘forgot’ the lessons of the 1930s, cancelling out much of the regulatory limits on financial institutions (starting under Ronald Reagan but much more under Bill Clinton). Undoubtedly, the abolition of the Glass-Steagall Act (1933), which enforced the separation of deposit banks and speculative finance houses, facilitated rather than caused the acceleration of financialisation. Underlying this trend was a turn by the capitalists away from investment in manufacturing and towards ever greater investment in the financial sector. Short-term profits through financial speculation, which tended to concentrate profits increasingly in the hands of the top 1% - or, more accurately, the top 0.01% - became a dominant economic trend. Ultra-free-market ideology was promoted to legitimise the shift.

Financialisation changed the structure of the US economy and other advanced capitalist countries. They concentrated more and more on services, boosted consumer demand through the expansion of cheap credit and the boom in housing and financial assets, and outsourced manufacturing to low-cost economies such as China. Krugman has little or nothing to say about these structural changes in the US and the global economy. This reflects the characteristic weakness of the Keynesian approach. He believes that the current problems could be rapidly overcome by a change in macroeconomic policy.

He sees the current depression as "gratuitous" – "this doesn’t have to be happening". His explanation is that "we’ve suffered a software crash… The point is that the problem isn’t with the economic engine, which is as powerful as ever. Instead, we are talking about what is basically a technical problem, a problem of organisation and coordination – a ‘colossal muddle’, as Keynes put it. Solve this technical problem, and the economy will roar back to life".

This reflects Krugman’s illusion – the Keynesian illusion – that the capitalist economy can be managed, that imbalances can be overcome by government intervention with the right policies, that capitalist leaders and policymakers can be persuaded to adopt the right policies through rational argument. If anything, Krugman is even more naive than Keynes himself, who recognised the difficulty of persuading capitalists to accept state intervention outside a war situation that threatened their existence.

‘It’s all about demand’

KRUGMAN DESCRIBES HIMSELF as "a sorta-kinda New Keynesian" who "often turn[s] to old Keynesian ideas". He follows Keynesian thinking that rejects ‘Say’s law’, the idea that, over time, demand will always match supply. According to the classical political economists of the early period of capitalism this reflected the fact that the market would always achieve equilibrium. This doctrine came to the fore again in the 1990s, when free-market economists (including Alan Greenspan, one time head of the Federal Reserve bank) embraced the absurd idea of the perfectibility of markets. Some enthusiasts even claimed that booms and slumps were phenomena of the past. After the collapse of Lehman Brothers in 2008, even Greenspan had to admit that he was wrong, although he has subsequently reverted to his ultra-free-market notions.

Krugman also follows Keynes in arguing that "it’s all about demand": the main factor in the current depression is the insufficiency of aggregate demand (that is, the total money-backed demand for goods and services, including capital goods). "In 2008 [Krugman writes] we suddenly found ourselves living in a Keynesian world… by that I mean that we found ourselves in a world in which lack of sufficient demand had become the key economic problem…" This situation, he argues, requires activist government policies.

Clearly, the collapse of demand following the financial crisis was the immediate cause of the economic downswing. Households were massively in debt, and were hit by the collapse in house prices and the steep rise in unemployment. Many businesses (especially small and medium) were hit by the credit squeeze and the collapse of consumer demand. Big corporations, with huge cash reserves, were not prepared to invest in new capacity on the basis of shrinking markets. Both the household and the business sector were caught in a classic ‘debt trap’. They desperately struggled to reduce their debts, ‘saving’ more than they invested or spent on goods and services.

The Keynesian argument is that in this situation the state has to step in and stimulate demand. Lowering interest rates (even to zero) is not enough. By borrowing money to finance deficit spending – or by printing money – the state should inject demand into the economy. Increases in the social safety net (for instance, unemployment benefit) and job creation schemes (such as, infrastructure projects) could reduce unemployment and support increased demand.

Krugman approves of the measures taken by the US government and the Federal Reserve in 2008/09. The Fed reduced interest rates to near-zero and pumped credit into the economy through the so-called quantitative easing policy. Krugman also approves the rescue under George W Bush of the banks and the shadow banking institutions through the TARP ($700bn), though he rightly comments that they were bailed out on extremely lenient terms. In contrast, the promised help for ‘under-water’ mortgage holders (home buyers with negative equity) has largely failed to materialise. He particularly supports Obama’s $787 billion stimulus package, but is very critical of its limited character (almost 40% of it taking the form of tax cuts rather than increased spending).

Krugman’s main criticism is that the programme was much too small and has been largely abandoned since 2010. This, he argues, is why the recession has continued and unemployment remains at such a high level. (Krugman’s criticism of Roosevelt’s New Deal stimulus is also that it was too small, giving way to another recession in 1937.)

If Obama had continued the stimulus policy, particularly through public works that created millions of jobs, the US recession might not have been so severe. However, in isolating the factor of ‘demand’ as the crucial factor, Krugman fails to get to the root of the problem. The Keynesian idea is that a spurt of state spending will jump-start the economy, creating jobs, stimulating investment, and so on, "until the private sector is ready to carry the economy forward again". But it is far from certain (leaving aside capitalist hostility to an increase in the economic role of the state) that a short-term stimulus of this type would actually revive investment and production by the big corporations.

Capital investment has been declining as a share of GDP in the US and other advanced capitalist countries since the early 1980s, despite the increased share of profits in national income. The stagnation of capital investment continued in the US in the 1990s and the 2000s despite the high level of demand (which was sustained by credit/debt).

Keynes believed that ‘equilibrium’ of the market would break down at a certain point because of the capitalists’ so-called ‘liquidity preference’. In other words, they would save more than they invested, preferring to hoard their cash rather than invest it productively. Keynes explained this through the factor of ‘confidence’, a subjective explanation. In reality, the lack of confidence is rooted in an estimation of a much more objective factor: the prospects of making adequate profits.

It is the ‘liquidity preference’ of the big corporations which has been behind the turn towards speculative financial activity since the early 1980s. Krugman’s analysis reflects the weakness of Keynesian theory: it focuses on empirical, macroeconomic policy, and fails to come to grips with the underlying forces, especially the trajectory of profitability. Amazingly, Krugman makes no reference to profits or profitability – the word does not even appear in the index (but this is not uncommon in Keynesian textbooks). He graphically illustrates the growing inequality in the US, but makes no attempt to link this to the intensified exploitation of the working class, from whose labour power all profit is derived.

A policy fix?

"BY APPLYING TIME-HONOURED economic principles whose validity has only been reinforced by recent events, we could be back to more or less full employment very fast, probably in less than two years. All that is blocking recovery is a lack of intellectual clarity and political will". This is a point that Krugman repeats several times throughout the book. "Time-honoured principles" refers to Keynesian policies.

Like Keynes before him, Krugman argues that his policies are moderate. He is proposing "measures that would mainly try to boost the economy rather than trying to transform it…" Like Keynes, he makes it clear that he is not challenging the fundamental structure of capitalism. He is warning that a prolonged slump "poses [dangers] to democratic values and institutions" – code for upheavals and class conflict.

Despite his biting criticism of Republican politicians, big-business leaders and academic advocates of ultra-free-market policies, Krugman frequently appears surprised at their posture. He sees it as a failure on their part to understand the issues and come to grips with reality. He hopes that the pressure of enlightened public opinion may change their position. "The sources of our suffering are relatively trivial in the scheme of things, and could be fixed quickly and fairly easily if enough people in positions of power understood the realities".

Yet the author himself repeatedly points to the vested interests – or, as Americans say, ‘special interests’ – of those championing free-market policies. The social weight of big business has been markedly increased in the last 30 years. There has been a huge concentration of wealth into the hands of the top 1%, or even a small fraction of the top 1%. Money, as Krugman says, buys influence, and big business has exerted enormous influence over both the Democratic and Republican parties.

Why do many on the right, for instance, vehemently oppose the monetary policies of the Federal Reserve under Ben Bernanke? In effect, quantitative easing is a form of Keynesianism for bankers. Many of the major financial institutions would have collapsed but for the cheap liquidity provided by the Fed. However, the finance capitalists in particular are obsessed by the spectre of inflation, even though it is not an immediate threat. (Given that there is global overcapacity which depresses price levels and the banks are mostly sitting on the reserves rather than channelling them into circulation.) The financiers support policies that favour creditors rather than debtors. The moneylenders abhor low interest rates and inflation (which depresses real, inflation-adjusted interest rates).

Krugman quotes a comment of Keynes himself. Free-market ideas, Keynes said, "[afford] a measure of justification to the free activities of the individual capitalists, [attracting] to [these ideas] the support of the dominant social force [the capitalists] behind [government] authority". In the US, big-business spokespersons and Republican politicians make no secret of the fact that they see any form of state intervention to overcome the recession as the thin end of the wedge, posing the danger of ‘socialism’.

Krugman provides many of the ingredients required for an analysis of the political-economic situation in the US. But he himself fails to provide such an analysis. As a liberal, he fails to see right-wing ideology, the vested interests of big business, and the rightward moving leaders of the Republican Party as manifestations of class interests, as, in fact, ideology/policy that represents the interests of a powerful section of the capitalist class, especially finance capital.

Krugman’s solution

KRUGMAN HAS LITTLE difficulty in showing that deficit reduction policies, to which capitalist governments turned as soon as there was a limited revival in 2010, have made the situation worse. His comments in the chapter on Europe, ‘Eurodämmerung’ (‘Europe’s twilight’, after Wagner), have been further confirmed by the continuing recession throughout the EU and eurozone. He shows that the policy of ‘expansionary austerity’ – based on the idea that deficit reduction will promote ‘confidence’ in the economy and thereby encourage investment and growth, is so much hocus-pocus. Krugman wittily refers to the ‘Austerians’, the leaders and economists who advocate austerity, strongly influenced by the ultra-free-market economics of the Austrian school like Friedrich Hayek and Ludwig von Mises.

Krugman argues that the additional $5 trillion of debt accumulated by the federal government since 2007 need not be an excessive burden on the economy. This requires about $125 billion in interest payments, around 1% of GDP. Plausibly, US capitalism could sustain a significantly higher level of debt – provided there was GDP growth that allowed it to be steadily reduced over a period (even a long period). The problem politically is that the capitalist class in the US, having enjoyed a steady reduction in its tax liabilities since the 1980s, is intransigently opposed to paying higher taxes in order to finance public investment.

Krugman justifiably criticises Obama’s stimulus (including the very limited second package) as too little, too late. But, given the clarion call of this book’s title, Krugman’s proposals are surprisingly limited and vague. He advocates a big extension of quantitative easing, with the Fed buying up a much wider range of assets (including company bonds and home mortgages) to inject more money into the economy. He argues that the restoration of federal support to states and cities could create three million jobs over the next two or three years. Effective mortgage relief, promised by Obama but never delivered, could stimulate consumer spending. Krugman calls for more public spending and public works (repair and renewal of infrastructure), but is surprisingly vague. He recognises that Obama faced massive political opposition in Congress, even from sections of the Democratic Party, and perhaps Krugman himself wants to avoid giving a hostage to fortune by proposing specific measures.

No historical perspective

KRUGMAN’S ANALYSIS LACKS historical perspective. He recognises that Roosevelt’s New Deal was not entirely successful, giving way to a new recession in 1937. In his view, it was not big enough or sustained long enough. However, he argues that the huge increase of public spending in a response to the opening of the second world war in 1939 pulled the US out of recession. Even before the US entered the war, rearmament and the increased global demand for US goods boosted its economy.

The war was financed by borrowing, but the national debt was paid down quite rapidly during the post-war economic upswing. According to Krugman, this shows that historically high levels of debt need not be a problem, so long as there is sustained GDP growth. "What the threat of war did was to finally silence the voices of fiscal conservatism, opening the door for recovery…" Liberal Keynesians, however, can hardly advocate a war to resolve economic problems!

Jokingly, Krugman suggests that "what we really need right now is a fake threat of alien invasion that leads to massive spending on anti-alien defences". This is revealing. The joke highlights Krugman’s failure to grasp the unique historical character of the second world war and the post-war upswing – or of the current historical conjuncture.

"The fact is that we had almost two generations of more or less adequate employment and tolerable levels of inequality after world war two, and we can do it again". But Keynesian policies cannot recreate the conditions required for a prolonged economic upswing. The structure of capitalism (though not its essential character) has changed, as have global economic relations. The collapse after 1989 of the Soviet Union and the other Stalinist states (planned economies ruled by bureaucratic regimes) removed a counterweight to capitalism. There was a weakening and political disorientation of the trade unions and traditional workers’ organisations. This emboldened the capitalists, led by the US ruling class, to launch an assault on working-class living standards and rights, and to push for the ‘perfection’ of the market. Finance became the dominant force in the advanced capitalist countries. The situation is entirely different from the post-second world war period.

A programme of public works?

ARE KEYNESIAN POLICIES now ruled out? Some people undoubtedly think so. "In the current market environment", says a Deutsche Bank analyst, "there is no room for using a Keynesian-type expansionary fiscal policy to boost demand in countries with low growth – the markets will simply not accept such a strategy". (International Herald Tribune, 10 January) Global financial markets are now far bigger than they were in Keynes’s time, or even before the 1980 neo-liberal ‘revolution’. In 1980 financial assets (in reality, credit/debt securities) were equal to one year’s output of the global economy. By 2006 such assets amounted to four times global output. This scale gives speculators – the so-called ‘bond-market vigilantes’ – the power to speculate against any governments that carry out policies of which they disapprove.

The bond traders, moreover, are reinforced by ultra-free-market ideology, which now dominates the thinking of capitalist governments and international agencies such as the OECD. Despite the deepening of the current world recession, they really believe that unfettered markets will produce growth – and mass unemployment and impoverishment of sections of the working class will not dent this growth.

The kind of policies advocated by Krugman, if effectively implemented, could cushion the downswing in the US and elsewhere. But they would not overcome the underlying problems of capitalist accumulation. In any case, many Keynesians feel that it is already too late. For instance, Keynes’s biographer, Robert Skidelsky, writes: "At last, opinion is starting to shift [in favour of Keynesian policies] – but too slowly and too late to save the world from years of stagnation". (The New Republic, 12 July)

Yet things can change. The capitalist crisis will produce social explosions and eruptions of class conflict. In the US, for instance, in the event of Romney winning the presidency and implementing the policies advocated by Ryan, they are likely to provoke an even worse slump. (It is possible that even a Romney-Ryan presidency would be forced more by pressure from big business to temper its crazy ideas with more pragmatic policies.)

Explosive movements of the working class and deep social crisis will, under certain conditions, push capitalist governments into adopting Keynesian-type measures to avoid a mortal threat to their system. Keynes himself said that his policies were designed to avoid revolution. When it is a question of saving their system, the capitalist class will, at least temporarily, make concessions to the working class. To reduce mass unemployment they may well adopt public works programmes. They will be forced to repair the social safety net. But such policies will be a temporary expedient. They will not be a return to the long-term, sustained Keynesian policies of the post-war upswing, when the state increased its intervention in the economy and developed an extensive social welfare infrastructure. Keynesian policies may buy time for the ruling class but they cannot resolve the crisis of capitalism.

How, as socialists, should we regard a stimulus package or programme of public works? In the face of mass unemployment and the prospect of prolonged economic stagnation, the leaders of workers’ organisations should indeed be calling for a massive programme of public works to provide jobs and stimulate growth.

To be effective, a public works programme would have to be on a much bigger scale than that proposed by Krugman. It would mean the refurbishment and addition of new infrastructure, especially homes, schools, hospitals, community facilities, etc. Workers should be employed on a living wage with full trade union rights.

Effective economic stimulus would require a big increase in social spending, increasing pensions and other benefits. Tax rates for the wealthy and big corporations should be substantially increased, with a levy on the uninvested cash piles of big companies. Effective measures should be taken against tax evasion and avoidance.

It has to be recognised in advance, however, that the capitalists will vehemently resist a bigger role for the state and increased taxation. A programme to provide jobs and stimulate growth would require the mobilisation of the working class. Moreover, increased taxation in itself will not be sufficient to develop the economy. The dramatic raising of the living standards of the majority of the population would require the resources (additional real wealth) created by increased production.

The banks and finance houses would have to be nationalised (not bailed out and propped up at public expense), and run under democratic workers’ control and management. This would ensure the credit required to develop all sectors of the economy. There would also have to be capital controls to prevent any flight of capital. Such measures would undoubtedly meet the entrenched resistance of the capitalist class. State intervention in favour of the working class would unavoidably pose the question of the takeover of the commanding heights of the economy, to form the basis of a democratic plan of production (run by elected representatives of the workers and the wider community).

Any government carrying out such a policy would need an international perspective, collaborating with the workers’ movement in other countries to develop socialist planning at an international level.