The rate of profit and economic crisis – the debate

It’s been a while since my last blog – other things to do, I’m afraid.  And I promised to deal with some of the key criticisms of my view of the laws of motion of capitalist crisis that I raised in my  book, The Great Recession (available from Lulu.com http://www.lulu.com/product/paperback/the-great-recession/6079458).

However, that will have to wait because I want to discuss a debate on the economic crisis that has developed among some of the small number of Marxist economists out there.  There seems to be two schools of thought among Marxists about the causes of the Great Recession.  And it depends on measurements of the rate of profit.

One group reckons that the rate of profit rose from about the early 1980s to reach levels that matched or surpassed the level of the rate  of profit of the Golden Age in the 1960s.  So the slump of 2008-9 could not have been caused by Marx’s law of the tendency of the rate of profit to fall.  Instead, a better explanation is that it was the huge growth of financial sector in the capitalist economy that did it.  Profitability rose, but the financial sector got out of hand and lent excessively and eventually this Ponzi-like expansion of credit burst.

This is a theory of crisis more popularly associated with Hyman Minsky, the Keynesian economist of the 1990s, who reckoned that capitalism was subject to booms and slumps because of the inherent instability and volatility of financial markets.  The economic crisis of 2008 was a ‘Minsky moment’ and not due to a crisis of profitability.

The other school of thought is more classically Marxist.  It argues that the Great Recession was the result of falling profitability – indeed figures showing that the rate of profit rose from 1982 are misleading because they mismeasure the rate of profit.  On the contrary, the rate of profit has stayed down, laying the basis for economic slumps.

This is an important debate.  If it is right that the Marxist law of profitability did not cause the recession and it was a result of ‘financialisation’, or too much economic power in the hands of bankers, then the policy solutions will be vastly different.  The crisis could be avoided by reining in the power of the bankers and stimulating the non-financial sector through tax cuts etc – Keynesian policies as such.  Alternatively, if the crisis was due to Marxist law of falling profitability, only a complete replacement of the capitalist system of production would enable such crises to be avoided in the future.

Where do I stand on this?  Well, I think both sides of the argument are right and wrong.  The ‘financial crisis’ boys and girls are right to argue that the rate of profit did rise from its lows in the early 1980s, but they are not right to conclude that the crisis was the result of wicked bankers alone.  The ‘profitability’ boys and girls are right to see that as the ultimate cause of the Great Recession, but wrong to try and prove this by arguing that there has been no rise in the profitability of capitalism since the 1980s.

Let me explain.  Andrew Kliman is a superb and profound Marxist economist (http://akliman.squarespace.com/).  Along with Alan Freeman in the UK, Andrew in the US has ploughed a sometimes lonely furrow in defending Marxist categories as the best explanation of economic forces.  His book, Reclaiming Marx’s Capital (http://www.lexingtonbooks.com/Catalog/SingleBook.shtml?command=Search&db=^DB/CATALOG.db&eqSKUdata=0739118528) wonderfully summed up why Marx’s economic theory was logical and consistent and refuted the bogus criticisms of capitalist (and even so-called Marxist) economists over the last 40 years. You can read my review of his excellent work in Chapter 23 in my book.

Late last year, Andrew published a detailed analysis of the movement of the rate of profit in the US (see http://akliman.squarespace.com/persistent-fall/).   He argued that if you measured the rate of profit properly, you would find hardly any rise in the period 1982-08.  If he is right, then the ‘Minsky guys’ would be in trouble.  But that paper has now been subject to attack by other Marxist economists and Andrew has sought to defend his method of measurement in a new paper released on his website (http://akliman.squarespace.com/storage/Masters%20of%20Words%20pdf%202.20.10.pdf).

The main criticism levelled against Andrew’s measures is rather technical.  Andrew measures the rate of profit using the historic cost of fixed assets.  Others, including myself, use the current or replacement cost measure of fixed assets.  Andrew argues that historic cost is better because it measures what capitalists actually spent on their capital assets, not the price or cost of replacing those assets which can easily be inflated or deflated over time by market prices.  He shows that by removing the impact of falling prices during the 1982-08 period virtually removes all the increase in profitability recorded by using the current cost measure.

You can read about many of these technicalities in Appendix A to my book (Measuring the rate of profit).  I have other criticisms of Andrew’s methods of measurement in that Appendix; in particular, his odd omission of any cost of ‘variable capital’ (employee costs) in his measure.   Suffice it to say that there are good arguments for using the current cost measure and, as Andrew explains in the technical appendix of his latest paper, Marx also followed a current cost measure.

But even if Andrew is right about what is the correct measure for fixed assets, his figures show that the rate of profit did stop falling after 1982, having dropped sharply from 1964-82.  So the period after 1982 up to 1997 was clearly a different phase for profitability, whatever the measure used.

That does not mean that we must accept the view that falling profitability was not the cause of crisis in 2001 or 2008.   My approach is different.  I have shown in my book that the rate of profit moves in a cycle of about 32-36, with an up phase of 16-18 years followed by a down phase of similar length.  Profitability rose from 1982 to 1997 in an up phase and then entered a down phase.  The rate of profit, despite rallying from 2001 to 2005, did not return to the level seen in 1997.  And after 2005, it began to fall, eventually leading to a drop in total profits and the economic crisis of 2008.  If that is right, then the Great Recession came about because of  Marx’s, not Minsky’s, law.

This approach is not ‘catastrophist’, as ‘profitability’ boys and girls have been accused of, namely that they want a permanently falling rate of profit.  On the contrary, it is a ‘two-wheeler cyclist’ view.  And a cyclical view of Marx’s law of profitability and crisis is, I think,  the essence of Marx’s own view of capitalist boom and slump, as I have argued in this blog before (see Profit cycles – do they exist?, 11 February 2010).

No doubt the huge expansion of fictitious capital or credit that took place between 2001 and 2007 contributed to the size of the eventual bust and slump of 2008.  But the seeds of the slump were set by falling profitability (indeed, that is why credit was expanded to try and overcome of delay its impact).  And the bust came when the mass of profits began to fall in 2007.

The current down phase in profitability has some more years to run.  Another big slump will be necessary before the new up phase can begin.