The Political Economy of Post-crisis Global Capitalism

by Duncan K. Foley Department of Economics New School for Social Research 6 East 16th, New York, NY 10003 foleyd@newschool.edu External Professor, Santa Fe Institute

Abstract While the Depression of the eighteen-nineties and the Stagation of the nineteen-seventies appear to be manifestations of Marxs tendency for the rate of prot to fall, the Great Depression of the nineteenthirties and the Great Recession of the two-thousands appear to be the rooted in rising rates of exploitation. Mainstream macro-economics represents the watershed changes in world capitalism in the nineteenseventies as technical improvements in economic theory and policy, thereby obscuring their underlying political economy. Globalized nancial capitalism eliminated upward wage pressures, and created an enormous engine for the appropriation of surplus value, which has led to a chronic stagnation of aggregate demand and unsustainable stress on the world nancial system. The lack a coherent solution to the problem of aggregate demand at the world level threatens to exacerbate conicts among the capitalist nations and challenges U.S. hegemony.
Paper prepared for the Economy and Society Conference at the University of Chicago, December 3-5, 2010. These remarks reect ongoing conversations with Ramaa Vasudevan on the political economy of contemporary world capitalism.

Marxs theories of capitalist crisis

World capitalism from the last decades of the nineteenth century to the rst decades of the twenty-rst century seems to exhibit two major types of crisis, crises of falling protability and crises of rising rates of exploitation, each emphasized by Marx at dierent stages of his work. It appears more clearly in retrospect that the Depression of the eighteen-nineties and the Stagation of the nineteen-seventies were manifestations of a falling rate of prot, while the Great Depression of the nineteen-thirties and the Great Recession of the twenty-oughts had their roots in increasing rates of exploitation.1 In his earlier writings on capitalism, Marx explored the contradictions that arose from combining Ricardos and Malthus theory that capitalism would tend to force wages to a minimal subsistence level with Smiths postulate that capital accumulation would lead to rising labor productivity through the extension of the division of labor. Marxs rate of exploitation is the ratio of non-wage incomes (prots, interest, rent, expenditures on unproductive labor, and taxes, which Marx calls surplus value) to wages, which rises without limit in an economy where wages grow less rapidly than labor productivity (value added per worker). The contradictions of this pattern of capital accumulation (which might be called the Tendency for the Rate of Accumulation to Rise) center on the diculty society has in managing a large and growing surplus value. From a purely economic point of view the main diculty is maintaining what Keynes has taught us to think of as aggregate demand. Wages are spent rapidly and reliably on workers consumption, but capitalist consumption absorbs only a small part of surplus value incomes; the remainder has to nd an outlet in investment, social expenditure, or the employment of unproductive labor to maintain aggregate demand. A rise in the rate of exploitation makes great demands on the nancial system, which must recycle realized surplus value from its highly liquid form as money revenue from the sale of commodities to a highly illiquid form as means of production. If the nancial system fails to accomplish this function, aggregate demand stagnates and capital accumulation is frustrated, not through a lack of potential prot, but through an inability to realize potential prot. A rising rate of exploitation, which fosters increasing inequality in the distribution of incomes, also exacerbates the latent class tensions that shape bourgeois society and politics. The gap between
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See (Foley, 2006, ch 3) for further detail on Marxs theories.

the growing productivity of workers and their diminishing share of the fruits of that growing productivity feeds various forms of critical consciousness, which, in Marxs view, would lead to a revolutionary political crisis. While Marx was developing his analysis of capitalism in the eighteenfties and eighteen-sixties European, and particularly British and North American capitalism began to show a distinctly dierent pattern in the evolution of the rate of exploitation. Wages started to grow, eventually at average rates comparable to the growth of labor productivity, stabilizing the ratio of surplus value to wage incomes. Marx observed this historic change and re-formulated his picture of the long-horizon evolution of capitalism along the lines of a Tendency for the Rate of Prot to Fall. The main mechanism for this dynamic in Marxs analysis was induced technical change, rst systematically analyzed by Ricardo in his Chapter on Machinery. Capitalists, faced with rising real wages (imposed from the point of view of each individual capital by the overall labor market), would seek to avoid the consequent increases in production costs by substituting capital equipment for labor, thereby raising labor productivity. Marx pointed out, however, that in many cases the result of this substitution would be a rise in the value of capital per worker (or in Marxs own terms the organic composition of capital). Since the prot rate is the ratio of surplus value, not to wage incomes, but to the capital invested in production even if capitalists manage to maintain the rate of exploitation, they may experience a fall in the rate of prot. If capitalists willingness to invest depends on the level of the rate of prot, the falling rate of prot may also lead to aggregate demand stagnation, as business investment dries up. While an increasing rate of exploitation and a falling rate of prot can both eventually lead to a crisis of aggregate demand, the two scenarios have dierent implications in other political economic dimensions. The fundamental phenomenon that gives rise to the falling rate of prot scenario is upward pressure on wages, which in non-gold standard monetary systems can be seen as cost-push ination. An increasing rate of exploitation, on the other hand, is rooted in the stagnation of wages, aggressive pursuit of cost reduction, and price deation. As a result the crises stemming from the two dierent scenarios unfold in divergent ways. The falling-rate of prot crisis is often precipitated by central bank action to raise interest rates by reducing the liquidity of the nancial system to restrain capital accumulation

so as to create unemployment in order to reduce upward pressure on wages. (Michal Kalecki analyzed this dynamic in his prescient 1944 article on The political economy of the business cycle Kalecki (1971).) The increasing-rate of exploitation crisis more often occurs in an atmosphere of speculation in nancial assets, and the bursting of nancial asset bubbles, leaving the economy over-leveraged and vulnerable to a long period of debt deation which central bank provision of liquidity is powerless to combat.

From 1977 to 2007

Mainstream economists tend to represent the crisis of the 1970s primarily as a scientic turning-point in economic theory Sargent (2008). According to this view, during the post-World War II decades a wrong theory (the American version of Keynesian aggregate demand management, including the idea of a tradeo between ination and unemployment) had gained consensus acceptance in the academy and decisive inuence over economic policy, particularly monetary policy. The attempt to manage the U.S. economy on the basis of Keynesian principles failed with the emergence of stagation, a combination of stubborn inationary pressures and excess economic capacity. Edmund Phelps and Milton Friedmans demonstration of the existence of a natural rate of unemployment, Thomas Sargents and Robert Lucas development of rational expectations equilibrium macroeconomic theories, and Lucas critique asserting the philosophical necessity of grounding macroeconomics in the microeconomic foundations of Walrasian equilibrium theory overturned discredited Keynesian theories and policies. The key innovation in academic economics was the replacement of structural dynamic macroeconomic models by real business cycle and then dynamic stochastic general equilibrium models in which monetary policy has no or only temporary eects on the real economy. In line with the vision behind these models, which holds that markets reliably and stably enforce a growth path on the real economy determined by tastes, technology and resources, economic policy was re-oriented to the empowering of markets through de-regulation and privatisation. Monetary policy, powerless to aect the real economy according to this view, is appropriately centered on ination targeting. The development policy that follows from this same world view emphasizes liberalization of trade and capital

ows, and the orientation of developing economies to the world market through export-led growth. The mainstream economists argue that the adoption of economic policies consistent with universal economic laws following the New Classical counter-revolution in academic economics overthrowing Keynesian errors resulted in a Great Moderation in macroeconomic stability in the advanced capitalist world and unprecedented gains in incomes in developing countries as a result of globalization. Many aspects of this just-so story are controversial or false (for example, advanced econometric techniques are unable to pin down the elusive natural rate of unemployment, monetary policy has inescapable impacts on the stability and viability of credit markets, speculative assets markets have exhibited recurrent instability). But in my view its greatest weakness is that it leaves the political economic aspects of the 1970s crisis and its aftermath obscured and mystied. The concrete source of inationary pressures in Europe and the United States in the 1970s was upward pressure on wages. (The dramatic increases in the price of oil in this period were a secondary phenomenon that served mostly as a smoke-screen to obscure the class dimension of the inationary pressures of that period.) This wage-push pressure presented central banks with an unwelcome dilemma. They could allow oligopolistic corporations to pass on wage increases to consumers in the form of higher prices, validating the resulting ination by increasing the money supply. Or the central bank could resist ination by restricting the money supply, and creating a crisis of credit availability. The inability of central bankers to resolve this dilemma led to stagation. It is in this political economy context that the full implications of Friedmans slogan that ination is always and everywhere a monetary phenomenon can be appreciated. From the political economy point of view, ination targeting is more aptly understood as suplus value targeting. The resolution of the class struggles of the 1970s involved much more than the re-orientation of mathematical economics, or even the reform of monetary policy. Deeper and more structural changes in world capitalism as a context for U.S. capitalism were necessary.2 The sharp and unprecedented (in the post WWII period) rise in real interest rates that followed the Volcker coup encouraged corporate management to shift focus from growth to protability and cost-reduction.
See Dumnil and Lvy (2004, 2010) for a thorough quantitative examination of the e e process of globalization and nancialization summarized here.
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The business school cult of shareholder value that blossomed in this period had as much impact on rm management as the Lucasian revolution had on macroeconomic policy. The Thatcher and Reagan regimes created political environments hostile to labor and unions. The post-WWII preponderance of U.S. corporations in the world economy was challenged particularly by recovered and energetic German and Japanese competition. The convergence of these developments transformed the political economy of the U.S. and other advanced capitalist economies. Upward pressure on wages eased, and then practically disappeared in the U.S. where real wages stagnated for decades starting in 1975-1980. The pressure on capitalist rms to increase prots by cutting costs was increasingly met not by capital-using innovations, but by the relocation of major parts of the production chain to lower-wage regions of the world. The pattern we associate with Marxs falling rate of prot was replaced by a pattern of increasing rates of exploitation. Globalization emerged as a tremendous engine of surplus value creation and appropriation. Out of the political economic crisis of the 1970s a new global conguration of capitalist accumulation emerged. While these developments were undoubtedly reected in the changing style and rhetoric of academic economics, they were rooted in far more fundamental changes in the structure of production and the sources of protability than market fundamentalism can reveal. With the easing of upward pressures on wages the political lives of central bankers did indeed become easier. In place of the unpleasant task of resisting wage pressures through unaccommodating monetary policy, central banks found themselves more frequently playing the role of heroic rescuers in various catastrophes arising from the instabilities of unregulated speculative nancial markets. The emergence of globalization, however, did not solve all the problems of the capitalist economy. In particular, the problem of regulating world aggregate demand became more acute and problematic. As a result of the U.S. veto of Keynes proposals for a genuinely international central bank which could create world liquidity at Bretton Woods in 1944, the U.S. became de facto the world economys central bank and regulator of world aggregate demand. This system privileged the U.S. as the creator of world money, and exempted the U.S. from the disciplines of trade and investment balance that other countries experience. The growth of world liquidity depended on the emission of dollar liabilities by the U.S. The U.S. current account eectively

became the fulcrum of world aggregate demand regulation. The U.S. ability to create world money complemented the U.S. role as diplomatic and military leader of the free world by releasing any budget constraint on U.S. foreign expenditures for these purposes. This system also placed certain burdens and responsibilities on the U.S., which lost its ability to manage the value of its own currency, and in theory had to balance its domestic economic management against the needs of the world system in shaping its economic policies. In theory the collapse of the xed exchange rate system that also occurred in the 1970s restored control of scal and monetary policies determining aggregate demand to individual nations. Each country could regulate aggregate demand as it pleased, with the exibility of exchange rates taking up the slack and compensating for divergent rates of price ination. But this theoretical freedom proved to be incompatible with the exigencies of globalization. The world capital market tended to over-value emerging market economies currencies, leading to capital inows, de-industrialization, bubbles in nontradable assets like real estate, culminating in nancial crises and currency devaluations. (These crises have become a quasi-regular feature of the world economy.) Thus globalization put a premium, especially for export-oriented economies, on stabilizing their exchange rates through interventions currency markets. As a result the regulation of world aggregate demand returned to the size of the U.S. current account decit. The accounting mirror-image of the balance of payments current account is the capital account. The huge engine of surplus value generation created through globalization required mechanisms to recycle surplus value into aggregate demand on an unprecedented scale. U.S. and other leading nancial institutions were happier to take on this function and collect increasing shares of the surplus value in the process than they proved capable of achieving the necessary intermediation. As Keynes eloquently pointed out, it is no easy trick to persuade wealth holders to part with liquidity by transforming the immediately fungible and liquid form of money surplus value into stubbornly specic and risky concrete investments. It is not surprising that this was an era of an explosion of technical nancial devices such as derivative securities which oered to straddle one or another part of this gap. Of course, no amount of ingenious nancial innovation can actually eliminate the gap; someone has to be left as the residual bearer of risk for specic real investments.

Thus the solution of the political economic problems of the 1970s shaped the environment that produced the nancial-economic crisis of 20078.

3 The political economy of post-crisis global capitalism

The political debacle of the Obama administration in the U.S. reveals the dangers inherent in thinking of macro-economic performance and policy in excessively narrow terms. Obamas economic advisers tended to operate in a discourse in which the economy is the central concept. In this discourse the economy has its own laws and behavior, reected in the movement of a statistical index, real, that is, ination-corrected, Gross Domestic Product. The theories of growth and uctuation dominant in mainstream teaching and research argue that tastes, technology and resources (including labor), typically regarded as slowly changing parameters, give rise to a long-run growth path around which the economy uctuates due to external shocks. Conventional mainstream economic opinion is sharply divided between fresh-water laissez-faire economists who argue that self-stabilizing market processes provide the best possible response to external shocks, and salt-water interventionist economists who allow for some degree of market failure which justies government intervention in the form of monetary or scal policy to achieve a better adaptation of the economy to (especially large) external shocks. There is no disagreement, however, on the basic assumption that the economy tends to return to a long-run growth path after a major macro-economic shock. This view of the economy typically abstracts from political and political economic institutions, and relegates specic discussion of historical factors to the realm of changes in tastes, technology and resources. Thus for example the distinction between productive and unproductive labor characteristic of classical political economists like Smith and Marx, hovers only on the vague edge of conventional economics as the empirical observation of the growing share of the service sector in GDP. The global context in which national economies operate tends to be regarded, at least in rst approximation, as a boundary condition, the rest of the world, which is a source of shocks. Obamas economic advisors not only internalized these views, but made the terrible political error of publicly proclaiming them, assuring

the public that a recovery of the economy was inevitable, and even venturing to quantify its dimensions, for example, in the prophecy that the U.S. unemployment rate would, even in the absence of scal stimulus, peak at 8%. The laissez-faire right of the profession opposed extreme scal and monetary policy responses to the crisis on the ground that they would do more long-run harm than good; the Keynesian left of the profession argued strongly that in the face of an catastrophic collapse of nance even the almost unprecedented monetary and scal measures taken would prove inadequate to hasten the return of the economy to its long-run path. This conventional view of macro-economic dynamics is strongly bolstered by the fact that major departures from a relatively stable long-run growth path (at least for the U.S. economy) have been rare. The main disturbing anomalies to these views up to the current crisis were the Great Depression, which depressed measures of real GDP below their trends for over a decade, and the ongoing stagnation of the Japanese economy following the bursting of its real estate bubble in the late 1980s. Uncannily enough (and contrary to the expectations of the majority of the economics profession) U.S. real GDP did return to a close approximation to its pre-Great Depression trend path after the Second World War. (So far a similar happy dnouement has eluded e the Japanese.) Marxist-based political economic analysis of macro-economic dynamics, though far from having achieved consensus even on major points of interpretation, oers a considerably more articulated institutional and historical picture. The Marxist tradition, following the work of the European rgulation and American social structures e of accumulation schools, understands that national systems of capital accumulation depend on historically specic institutions, policies, and practices that constitute a system of accumulation. Within this political economic paradigm, the question of the eventual recovery of the U.S. economy unpacks into two related questions. First, does the global system of nancialized capitalism guided by largely unregulated speculative asset markets that developed in the decades prior to the crisis of 2007-8 provide a viable framework for world capital accumulation? Second, will the U.S. be able to return to the political and economic hegemony it enjoyed in the 1945-2007 period?

3.1

Global accumulation

One striking feature of post-crisis global capitalism has been the extent to which the peripheral or emerging markets economies have escaped major disruption. Continuing stagnation or renewed contraction of the big advanced capitalist economies could eventually result in major damage to accumulation in the peripheral economies. But from the vantage point of the last months of 2010 it is hard to make a strong case against the viability of the process of surplus-value extraction and realization the peripheral economies have evolved. It is instructive, however, to understand how these economies, particularly, but not only, in East Asia, have managed to insulate themselves from the crisis-produced turmoil in the advanced capitalist world. After the East Asian nancial crisis, shrewd policymakers in peripheral economies realized the immense advantage for their export-led models of development of maintaining low (or, depending on ones point of view, undervalued) exchange rates against the dollar. These countries (particularly China) followed a policy of de facto pegging their exchange rates to the dollar at relatively low values for their national currencies. These countries typically also have eective methods of repressing upward pressure on money wages, and can, as a result, limit the inationary pressures that a low exchange rate policy generates. The main side-eect of this exchange rate policy has been the need for central banks to accumulate very large foreign currency reserves, mostly in dollar-denominated assets. Since central banks can always create the domestic currency required to buy dollars to prevent a rise in their exchange rates, there is no technical limit on this policy stance. In theory the enormous reserves these countries are accumulating could be more protably invested in real capital accumulation in their own economies, but this consideration pales beside the promise of continuing access to world export markets and the (apparent) autonomy for domestic macro-economic policy provided by reserve accumulation. Other emerging markets economies, such as Brazil, face a much tougher policy dilemma. Historically these economies have been prone to ination, even hyper-ination, set o by undervalued exchange rates. In the current world environment, the currencies of countries which do not intervene vigorously to prevent their values from rising are being bid up relative to the dollar, and their economies are threatened by the resulting loss of competitiveness of their exports.

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3.2

The dollar dilemma

One of the pillars of pre-crisis U.S. global hegemony was the role of the dollar as the de facto world money, and the consequent privilege of the U.S. to ignore its current-account decits. But precisely this asymmetric role of the dollar in the world economy has the implication that the U.S. cannot control its own exchange rate; the international value of the dollar is the result of the decisions of other countries as to how to intervene to control their own exchange rates. In the post-crisis environment of slow world economic growth and high unemployment in advanced capitalist countries, a war of competitive devaluation has predictably emerged. U.S. policy makers are helpless to confront the resulting dynamic except by contemplating a major change in world nancial institutions, which up to this time has been kept o-limits to responsible policy debate. The consequences have contributed signicantly to the weakness of the U.S. recovery and its stubbornly high rate of unemployment. The immediate aftermath of the nancial crisis centered on U.S. nancial markets and institutions was a rise in the value of the dollar. The monetary and scal stimulus measures adopted in the hope of engineering a domestic U.S. recovery of vigorous GDP growth were oset by the failure of the dollar to fall. It is interesting to see that international reaction to the Feds adoption of further quantitative easing of U.S. monetary policy has been a chorus of criticism complaining of the possible deleterious eects of this policy in other countries.

3.3

World aggregate demand

The main obstacle to renewed stable capital accumulation on a world scale, then, is chronic insuciency of world aggregate demand. The peripheral economies have avoided the consequences by successfully diverting demand to themselves through maintaining low values of their domestic currencies relative to the dollar and euro. But from a global perspective there is simply not enough demand generation to support continued rapid growth of the emerging markets economies and provide politically acceptable levels of job creation in the advanced capitalist economies. As I discussed above, this dilemma was already salient in the pre-crisis period, and contributed to the constellation of circumstances that precipitated the crisis itself. The possible solutions to aggregate demand insuciency in closed economies (such as the world economy necessarily constitutes) are

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well-known. Eective demand in a closed economy arises from household consumption, business investment, and government expenditure. Thus any resolution of the inadequate aggregate demand problem would have to stem from some combination of increased spending of these sectors. The prospects for a strong increase in demand from the households of the advanced capitalist economies are very weak, due to the enormous overhang of household debt in these economies, particularly the U.S. Increases in household income in these countries are much more likely to be used to de-leverage households by reducing debt than spent. This is the proximate cause for the weak response of the U.S. and European economies to the post-crisis stimulus. The year 2010 has also seen a (panicky and exaggerated) shift of political sentiment in the advanced capitalist countries against government spending, whether funded by taxation or borrowing. The resulting reforms (eectively contractions of the level of government spending) are very likely to contract world demand further. Whether this eect by itself will be enough to trigger another actual world recession, or will simply prolong the stagnation of growth, is hard to predict. The remaining potential source of aggregate demand for the world economy would be spending by workers in peripheral economies, which would require an increase in their incomes. Either a revaluation of domestic currencies, increasing the world purchasing power of wages, or a rise in wages in domestic currencies of these economies could support such an increase in spending. This observation explains why the U.S. would very much like China, for example, to revalue its currency.

3.4

Hegemony reconsidered

While the U.S. still claims world economic leadership, it nds itself in a position as a result of the nancial crisis of 2007-8 where it cannot create sucient world aggregate demand through its own policies, and, ironically, is equally powerless to divert aggregate demand to its own stagnating economy. These problems are inherent in the very institutions that support U.S. hegemony. One of the chief functions of U.S. world economic-nancial hegemony in the years after the Second World War was to prevent a recurrence of the nationalist capitalist conicts that wrecked European capitalism in the crises of the First World War and its aftermath.

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During the Cold War, the U.S. was able to keep the leading capitalist nations more or less in line with its overall imperialist strategy, despite some sharp disagreements, for example in the 1960s with Europeans over the nancing of the Vietnam War. Even after the watershed changes of the 1975-80 period in world capitalism and the collapse of the Soviet Union, U.S. leadership managed to suppress latent competitive conict among the advanced capitalist nations. The Plaza and Louvre Accords provided some degree of centralized regulation of currency values (and hence world aggregate demand). Keynes himself during the Second World War had been preoccupied with scenarios of competitive devaluation in conditions of world depression. He suggested the creation of a world central bank (an IMF with the power to create world money and regulate exchange rates) to put as much pressure on countries with current account surpluses as on countries with current account decits to adjust their economic policies. Keynes evidently hoped that the U.S. would accept such an immensely powerful international institution with the understanding that British governments would eectively ensure U.S.-British control of world monetary policy. The U.S. refusal to accept this deal set the stage for the post-War reconstitution of the world nancial system. Keynes ideas seem as relevant today as they were in 1944, but it is dicult to see much political will in the U.S. or other advanced capitalist nations to create international institutions powerful enough to resolve the aggregate demand problem. Inadequate world aggregate demand poses serious threats to continued economic cooperation among the advanced capitalist countries, as or more serious than the European imperial powers panic over control of natural resources posed in the period before the rst World War. The fate of the neo-liberal regime of globalized nancial capitalism hangs on the collision between its huge success as an engine of surplus value creation and its failure to solve the aggregate demand problem either through an increase in capitalist investment spending or through a more coherent world scal and monetary policy.

References
Dumnil, G. and Lvy, D. (2004). Capital Resurgent. Harvard Unie e versity Press, Cambridge MA.

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Dumnil, G. and Lvy, D. (2010). The Crisis of Neoliberalism. Harvard e e University Press, Cambridge, MA. Foley, D. K. (2006). Adams Fallacy: A Guide to Economic Theology. Harvard University Press, Cambridge, MA. Kalecki, M. (1971). Selected Essays on the Dynamics of the Capitalist Economy. Cambridge University Press, Cambridge UK. Sargent, T. J. (2008). Evolution and intelligent design. American Economic Review, 98(1).

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