Economists may need a crash rethink of the basic tenets of economic orthodoxy, writes Larry Elliot
Another normal week for the global economy. Russia’s on the point of financial meltdown, the Chinese government is battling to stave off devaluation, bankruptcies are up 35% in Japan, stock markets are down almost everywhere, the biggest industrial merger of all time is announced between BP and Amoco, and the Latin American honeymoon is looking more and more like a divorce.
Even for a true believer, what’s going on out there takes some explaining. Certainly some of the normal excuses about self-correcting markets and the beneficial effects of stability are wearing a bit thin.
Perhaps this really is a new paradigm. It may be that, in six months’ time, what is happening now will all seem like a bad dream and we can get on with deciding on how to divide up the bounty from unfettered free markets. That’s one possibility. However, it’s not the only one.
Graham Turner at Tokai Bank certainly has a different way of looking at things. “The world economy is heading for its sharpest downturn since the 1930s,” he says. “While the ramifications of the collapse in asset prices in Asia continue to ricochet across the world, the first signs of the next major deflationary shock likely to hit the global economy have started to emerge.”
What evidence is there for this? Well, apart from the truly grisly data coming out of Asia, Turner points to what is happening in the United States. “The three-and-a-half-year long bull market in US share prices finally appears to be succumbing to the harsh economic reality that, in a low inflation environment, profits can go down as well as up. This revelation is coming as something of a shock to US investors duped into believing the rise in profits of recent years would be sustained indefinitely.”
Recent data bears this out. Helped by a weak dollar, corporate profits in the US picked up steadily following the recession at the time of the Gulf War, and were rising at an annual rate of almost 30% by the end of 1994.
Since then, however, the trend has been downwards, so that by the first quarter of this year they were growing at an annual rate of less than 5%. Profits fell in both the final three months of 1997 and the first quarter of 1998.
Yet the bulls on Wall Street paid little heed. The stock market was recently as high as in 1929, the price-earnings ratio even higher, and the US dividend yield at a record low. Profit figures for the second quarter are out later this month: given the current gloomier mood in New York, it will be interesting to see how they are received.
Turner thinks the fall in profitability and the squeeze on corporate earnings is entirely predictable, citing the hi-tech sector as a classic example of what has been happening. “When the price of computer chips collapsed in early 1996, providing the first indication that export earnings were coming under pressure in South Korea and Thailand, the problem was hardly helped by US companies accelerating production.
“The leading chip manufacturer, Micron, increased output … ferociously during the course of 1997, trying to wrestle market share from ailing Asian producers. The subsequent glut in the production of microchips has seen prices plummet from $21 to below $1.
“While computer chips provide perhaps one of the more dramatic examples of global over-production, numerous other anecdotal examples can be found. Companies must have been accelerating investment to improve productivity. However, across the globe, companies have also been investing heavily with the intention of taking market share from companies within their own industry and in new sectors.”
The intriguing question is whether this decline in profits is cyclical or secular. The recent rash of high- profile mergers suggests that big firms are feeling the pinch and looking for ways of cutting over- capacity in order to defend their earnings.
Robert Brenner, in the latest New Left Review, argues that a study of profits helps explain what is really going on. His thesis goes like this: between 1970 and 1990, the manufacturing rate of profit for the G-7 nations was about 40% lower than between 1950 and 1970, and in 1990 it was 45% below the peak reached in 1965.
“These changes were tell-tale signs of the marked deterioration of the whole economy in the period after the early 1970s.”
Why? Said Brenner: “The decline in the profit rate has been the basic cause of the parallel, major decline in the rate of growth of investment, and with it the growth of output, especially in manufacturing, over the same period.
“The sharp decline in the rate of growth of investment – along with that of output itself – is the primary source of the decline in the rate of growth of productivity, as well as a major determinant of the increase of unemployment. The reductions in the rate of profit and of the growth of productivity are at the root of the sharp slowdown in the growth of real wages.”
But, according to the right, we know what caused the downturn in productivity: the bolshie behaviour of labour, which reduced profits and put money which should have been going to investment into workers’ pockets.
Now that unions have been tamed, the market will be allowed to work freely, and less efficient firms will be driven out of production by lower-cost producers, who in turn will be able to keep up the level of profits.
Not so, says Brenner. He says there is little empirical evidence to support the “workers are to blame” thesis, partly because unions in the West co-operated in keeping up profits during the Golden Age, but also because it is hard to see why, after 25 years of high unemployment and reduced union power, profits are still falling.
Instead, the real explanation is the fault of the “unplanned, uncoordinated and competitive nature of capitalist production and, in particular, individual investors’ unconcern for and inability to take account of the effects of their own profit-seeking on the profitability of other producers and of the economy as a whole”.
Theoretically, the free-market view may have much to commend it. It may be that higher-cost producers should immediately quit the market in the face of lower- cost production, but this is not what happens in practice. The higher-cost firms try to compete by cutting their costs, resulting in aggregate profits being lower.
Brenner argues that the fall in aggregate profitability responsible for the long downturn was not so much the result of a squeeze by labour on capital, as of the over-capacity and over-production which resulted from intensified, horizontal inter-capitalist competition.
“The intensification of inter- capitalist competition was itself the manifestation of the introduction of lower-cost, lower-price goods into the world market, especially in manufacturing, at the expense of existing higher-cost, higher-price producers, their profitability and their productive capacity.
“The long downturn … has persisted largely because the advanced capitalist economies have proved unable to accomplish profitably sufficient reductions and re- allocations of productive power so as to overcome over-capacity and over- production in manufacturing lines, and thereby to restore profitability.”
Does this help us to explain anything? It may well do. BP and Amoco are linking up in a bid to remove excess capacity, as are Daimler Benz and Chrysler. Bill Gates wants to secure monopoly profits for Microsoft, Rupert Murdoch wants to drive newspapers out of business in the United Kingdom by predatory pricing. Above all, it explains why firms say they favour more competition, but in reality desire less of it.
In practical policy terms, it suggests that we may need to have a crash rethink of the basic tenets of economic orthodoxy. The greens may be vindicated in their belief that reckless over- production is putting the environment in jeopardy; the Marxists may be vindicated in their analysis that capitalism faces a crisis of profitability; the die-hard Keynesians may be vindicated in their belief that unregulated markets tend towards instability and disequilibrium.
Orthodox thinking seems to be that, in a period of excess supply, we should be squeezing demand. That is the recipe for turning a recession into a slump.