Slaves versus Champagne: Capitalist Consumption in Marx

A central thesis of Marx is that the rate of profit is the major influence on the level of investment.  In Capital Vol. 1, throughout the chapters on the accumulation of capital it is implicit that it is competition which is driving accumulation.  The profitability achieved by a firm is the decisive test of its competitive success or failure.  Profits provide the key source of capital to finance increases in investment and accumulation.

However Marx does not see profits as determining investment in a process of mechanical causation.  He recognises that decisions about the allocation of capital take place in real time, and are made by capitalists who are making choices about their investment strategies while facing an uncertain future.  It is essential in political economy to acknowledge this moment of agency, otherwise we elide the dimension of risk in capitalist calculation and outcomes.

But of course, Marx is not an methodological individualist.  The investment decisions which capitalists take are subject to the selective processes implemented by the law of value.  This term summarises all the ways in which the competitive failure or success of companies are determined by how economically and efficiently they make use of the labour and means of production at their disposal.  And also by the balance of supply and demand in the markets in which they buy and sell.

Thus the choices of individual capitalists are subject to the discipines of technological and market competition. For example Marx documents in detail how the spread of steel spindles in textile production lowered costs of production. He sardonically notes that the capitalist does not have to use spindles made of steel just because his competitors do. But the price he gets for the product will be determined by steel spindle technology, if that has come into general use.

If the capitalist has a foible for using golden spindles instead of steel ones, the only value which counts for anything in the value of the yarn produced remains that which would be required to produce a steel spindle, because no more is necessary under the given social conditions [i.e. current technology]. (Capital Vol. 1, p. 295).

How much to invest and in what? These decisions are made in a situation of uncertainty. The laws of competition are coercive, but they are not automatic and entirely predictable.

Marx did not see a simple linear relationship of cause and effect between profit and accumulation.  Note, for example, his comment on a book by the Rev Richard Jones whom Marx considered to be less stupid than the other prominent parson economists of the period, Malthus and Chalmers.  ‘Jones is right to stress that despite the falling rate of profit, the “inducements and faculties to accumulate” increase’ (Capital Vol. 3, p. 375).  Here Marx quotes and endorses the comment by Jones that:

A low rate of profit is ordinarily accompanied by a rapid rate of accumulation, relatively to the numbers of the people, as in England … a high rate of profit by a lower rate of accumulation, relatively to the numbers of the people. Examples: Poland, Russia, India etc.

Marx emphasises that capitalists are conflicted about whether to reinvest their profits in the expansion of production, or use them to finance speculative ventures. Here again Marx stresses the moment of agency: ‘the individual capitalist … has the choice between lending his capitalist out as interest-bearing capital or valorising it himself as productive capital’ (Capital Vol. 3, p. 501, Penguin edition).

Profits can be used in luxury consumption, or to play the financial markets.

the progress of capital production not only creates a world of delights; it lays open, in the form of speculation and the credit system, a thousand sources of sudden enrichment (Capital vol. 1, p. 741).

The investment versus capitalist consumption dilemma was an important theme in the literature of political economy.  In the early phase of classical political economy, capitalists were urged to reinvest as much as possible.  In Marx’s concise summary, the message of Malthus and his contemporaries was as follows:

Accumulate, accumulate! That is Moses and the prophets … therefore save, save, i.e. reconvert the greatest possible portion of surplus-value or surplus product into capital! Accumulation for the sake of accumulation, production for the sake of production was the formula in which classical economics expressed the historical mission of the bourgeoisie in the period of its domination (p.742).

Marx notes, for example, that Thomas Malthus, recognised ‘the awful conflict between the desire for enjoyment and the desire for self-enrichment’.  Marx agrees with this: he notes that surplus value is divided into two parts: (1) revenue – used to meet the consumption needs of capitalists and their families, (2) capital – for accumulation by reinvestment.  (Capital Vol. 1 738-746).  The capitalist, says Marx, experiences all the agonies of a Faustian conflict between the passion for accumulation and the desire for enjoyment (p. 741).  (See Goethe’s Faust, lines 1112-3 – ‘Two souls, alas, do dwell within my breast; each seeks to sever from the other’. Faust is torn between the pleasures of the world and his longing to devote his life to the accumulation of knowledge and spiritual or magical power.)

Malthus’s solution to this dilemma was to advocate a division of social labour. He urged the capitalist class to live modestly and leave extravagant spending to other social groups – the landed aristocracy, the holders of sinecures, and the clergy.

But, after the 1832 July Revolution in France, and faced with a rising tide of industrial and social unrest in England, political economy altered course and began to celebrate not the acquisitive drive to accumulate of the entrepreneurial class – but rather the nobility and high moral mission of the capitalists.

As classical political economy degenerated into mere ideology, Marx notes for example how Nassau Senior begins to praise the self-sacrifice of the capitalist who, by his abstinence from consuming all of the surplus-value and surplus product, sacrifices his own consumption in order to provide workers with the machines and raw materials which they need for employment and wages. In Marx’s summary:

The capitalist robs himself whenever he ‘lends (!) the instrument of production to the worker’, in other words, whenever he valorises their value as capital by incorporating labour-power into them instead of eating them up, steam-engines, cotton, railways, manure horses and all (Capital Vol. 1, p. 745).

Surely, Marx continues, the simple dictates of humanity would enjoin the release of ‘that peculiar saint, that knight of the woeful countenance, the abstaining capitalist from his temptation and his martyrdom’ (p.746). (The knight of course is Don Quixotte – allusions to Cervantes’ novel are frequent in Marx’s writings).  And here Marx notes a new and happy development which has brought relief to one particular group of self-sacrificing capitalists.

The slave owners of Georgia U.S.A. have recently been delivered by the abolition of slavery from the painful dilemma over whether they should squander the surplus product extracted by means of the whip from their Negro slaves entirely in champagne, or whether they should reconvert part of it into more Negroes and more land’ (Capital Vol. 1,  p.745).

Consume or invest.  The capitalist dilemma remains as prevalent today as in Marx’s period.  The evidence is overwhelming that in recent years, in the high-income economies, consumption by the owners and controllers of capital has been winning out over accumulation.  As investment has lagged, an increasing proportion of the rise in the mass of profit since 2000 has been handed out to shareholders in dividends and share buy-backs, or used to pay large increases in executive salaries.

The Profits-Investment Disconnect

In the major advanced economies a large gap has now opened between profits and investment. Figure 1 shows the pattern for the United States and it is worth close study.

The data are from the Federal Bank of St Louis and derived from the US National Accounts. It may seem strange that investment, as shown here, is so much higher than profits. E.g. in 1993 when the data starts, profits are 4 per cent of GDP (left hand scale) but investment is more than 11 per cent of GDP (right hand scale).  But the figures are for net profits (after depreciation and taxation); but investment is gross (i.e. includes depreciation). Also, I use GDP here as if it were the same as gross domestic income.  Thus the comparison made here between profits and investment can only be approximate – but instructive nevertheless.

Figure 1.   Profits and Investment as a Percentage of United States GDP, 1993-2013.

US Profits and Investment - Krugman

Until the early 2000s the mass of profits and associated investment levels were closely correlated – just as Marxists would expect.  They were rising neatly in tandem in the mid-1990s.  Then there was a fall in profits in 1997, but a drop in investment duly followed a couple of years later.

However in the early 2000s, the pattern began to change.  The surge in profits in the recovery from the dotcom downturn was certainly followed two years later by a rise in investment – but one which was comparatively subdued.  The proportion of profits not reinvested was beginning to rise.  When profits crashed in the crisis of 2007, again investment tumbled two years later.  But notice, first, the remarkable fact that, though the crisis of 2007 was far more severe than the dotcom crisis of 2000, and devastated the US financial system – nevertheless the impact on the profits of the non-financial sector in the US was much less than would have been expected.

From a previous peak of 6.5 per cent of GDP in 2006, profits in the non-financial sector fell only by 2.5 per cent of GDP to 4 per cent in the 2008 downturn.  Compare that with the deeper fall to 3.5 per cent of GDP in the downturn of 2000.  What everyone rightly refers to as the deepest economic crisis since 1929 had actually a relatively limited impact on the profitability of the US industrial sector.

In addition, the recovery in the mass of profits after 2007 was speedy and dramatic.  By 2010 the proportion of profits in GDP was back to the peak figures reached in 1997 and 2006.  This rise then continued on to a new peak of over 7 per cent of GDP in 2014 – in many estimates, the highest level reached since 1945.  Profits remained at about that level through 2015.  There are signs that a fall is beginning in 2016 – but 1st quarter earnings of US non-financial companies were still not much less than an annualised 7 per cent of  GDP.

However the profits surge after 2007 was followed two years later by only a limited recovery in investment.  By 2013 it was still less than 12.5 per cent of GDP compare a peak of 14.7  per cent in 2000, and 13.5 per cent in 2007.  A very large disconnect between profits and investment had developed.

To show more clearly what has happened, in Figure 2 I have recalculated US National Accounts data – setting the 1998 figures for profits and investment at 100 – and comparing the investment figures for each year with the profits total for two years earlier.

Figure 2.  Profits and Lagged Investment in the US, 1998-2013.

Test wed 15th

Investment began to lag profits in 2001.  The size of the lag remained quite large through to 2009 – and then widened enormously as investment lagged the rise in the mass of profits over the past seven years.

The data above confirm the Marxist proposition that there is a clear connection between profitability and subsequent investment.  In a future post I will review a number of recent empirical studies which show that realised profits are a major causal influence on investment. However, there are other forces and factors which have an influence on investment levels.  It is also the case that the correlation between profits and investment is not fixed, but varies over time – as is evident over the 20 year period we have been looking at.

Too many Marxist economists have had an oversimplified view of the profits-investment connection.  Michael Roberts for example argues that,

There cannot be a closer connection in the capitalist system of production and exchange than that between profits and investment. The rise and fall in profits and profitability drives the rise and fall in investment.

There is an essential truth here, but the point is greatly overstated.  It is not because profits have fallen that investment levels have been lagging since 2001 – and increasingly so.  Apart from the temporary downturn of 2007, profits have been on the rise as a proportion of GDP since 2001, until the stabilisation in 2015, and (so far) a marginal fall in 2016.

Roberts and others will point out that in this post I have been dealing with the mass of profits as compared with the mass of investment.  Their argument is that it is the rate of profit (not the mass) which determines investment.

But the rate of profit also rose in the US in 2009-15.  The large rise in the mass of profit which occurred would only have produced a fall in the rate of profit if the total stock of capital advanced had been increasing even faster.  But it is precisely the lagging level of investment in this period which has made a large enough rise in the stock of capital highly implausible as a matter of simple arithmetic. A slow-down in investment means a lower rate of capital accumulation.

Past profitability is the most influential of the elements which enter into the current investment decisions of companies.  But apart from investment in new productive capacity, there are many other ways in which companies can use available capital to increase future profitability.  To take only one example, companies may choose to use profits to build-up cash reserves in order to increase their firepower in the highly competitive market for corporate control.  Mergers and acquisitions [M&A] have continued to run at high levels in recent years. Companies are spending large proportions of their profits in buying up their competitors and seeking profits through rationalisation to cut costs and limit competition by an increase in their control of markets.

There are increasing calls in the business press for governments in the high-income economies to strengthen anti-monopoly regulation as one means of combating the general stagnation in new investment. As a recent article in the Financial Times put it, the aim of such regulation would be:

to reorient the prioriies of large companies, to force them to expand the hard way by hiring staff, taking new premises, advertising and buying equipment, rather than buying a competitor and doing the opposite in the name of cost-cutting and greater efficiency… Restricting takeovers might also prompt a resurgence for stock-picking, forcing shareholders to search for the real operators and innovators.  Activist investors would have to do more than just champion M&A deal making.

But the present M&A system is highly profitable for the investment banks which set up and implement takeover deals.  They, and the companies directly active in the takeover market in corporate control, are able to deploy their immense political lobbying power to block such regulation.

So far I have looked only at US data.  The profits-investment disconnect, and the consequent accumulation of corporate reserves, has developed in several other major economies in the post-2000 period. Figure 3 below is drawn from a useful study by Gruber and Kamin of what they call the current corporate saving glut.  They show that three other G7 economies share the US pattern of exceptionally high levels of build-up of cash reserves.  Since 2000 the corporate sectors in Japan, the Canada and the United Kingdom have been net lenders to the rest of the economy on a very large scale.  In most years since 2000 by between 2 and 5 per cent of GDP.  Germany has also switched to being a net lender, though later and to a more modest extent.  Only France and Italy still conform to what historically has been the norm – the corporate sector drawing on net capital supplied by other sectors.

It is sometimes argued by Marxist economists that, apart from a general fall in the rate of profits, other diagnoses of the nature of the current crisis are amenable to reformist solutions.  This is not the case. The crisis of accumulation which confronts the system today is profound and intractable. In summary: a severe structural problem of lagging investment in new capacity, despite adequate profitability and the very low cost of capital, given that basic interest rates are near zero in many countries.

Figure 3.  G-7 Countries: Net Lending of Non-Financial Companies

NEW BIG JAPANNEW BIG CANADANEW BIG BRITAINNEW BIG GERMANYNEW BIG FRANCENEW BIG ITALY

Sources of Surplus Money Capital

Marx stressed the role of banks in collecting together money lying idle in the economy and converting it into active capital available to be lent out – loanable capital is one term he uses, interest-bearing capital is another.  He notes that this process involves a centralisation of available money capital.

The business of banking consists … in concentrating money capital for loan in large masses in the bank’s hands, so that, instead of the individual lender of money, it is the bankers as representatives of all lenders of money who confront the industrial and commercial capitalists.  The bankers become the general managers of money capital… they concentrate the borrowers vis-à-vis all the lenders. (Capital Vol. 3, Penguin, p. 528)

Marx adds that the cash reserves of industry and commerce are amalgamated with money saved, ‘by workers (by means of savings banks) as well as landlords and other unproductive classes‘ (p. 618).

A global surplus of money capital, relative to the level of demand by borrowers, was one of the main underlying causes of the financial crisis of 2007 and its lingering aftermath.  World  long-term interest rates have been falling over the past two decade, and in the advanced economies are currently even lower than the previous record set 5000 years ago in Babylon.

Such low rates are, in themselves, a strong indicator of a relative surplus of loanable capital. Of course loose monetary policy by central banks has also made a contribution to the fall in interest rates.  But central banks would certainly not have wanted the zero interest rates of the current period.  To stimulate their economies they have been forced to give additional impetus to a trend which was already happening as a result of market forces – a greater supply of money capital relative to the demand for loans.

The post-2000 build-up of excess money capital in the system had three main sources.

1] the corporate sector

After the short downturn of 2000-1, profitability in the corporate sector in the major economies recovered rapidly but investment lagged – and this remains the case in 2016. In identifying situations of excess money capital it is essential to consider not just the rate, but also the mass of profit.  In 2015, the influential Toronto-based research organization, the McKinsey Global Institute [MGI], published convincing evidence that the build-up of cash reserves in the corporate sector was only the latest phase of a trend which started in the 1990s.

In a comprehensive study, MGI analysed the accounts of 28,250 companies which had more than $200 million ( or equivalent) in annual revenue. The study covered private as well as listed public companies in 42 countries and 18 industrial sectors.

In the United States, Western Europe, Japan, and South Korea, the corporate sector’s share of national income had increased by 1.5 to 2 times since 1980. Corporate profits, before tax and interest payments, had risen from 7.9 per cent of world GDP in 1980 to almost 10 per cent  in 2013. Thus an enormous rise in the mass of profits extracted.

The mass of profits after payment of taxes and interest had risen even faster – from 4.4 per cent  of world GDP in 1980 to 7.6 per cent in 2013.

MGI estimates that the real growth rate for the total pool of global corporate profits was an average of 5 per cent a year from 1980 through to the present. It forecasts that this may now begin to slow, though only to a still respectable average real growth of 1 per cent a year.  But for the 1980-2013 period it concludes that, ‘the world’s biggest corporations have been riding a three-decade wave of profit growth, market expansion and declining costs’ (p. 3).

The MGI study also showed that investment lagged increasingly behind this profits surge. After the East Asian crisis of 1997, investment dropped by 10 per cent in South Korea and the South- East Asian economies affected.  In the US and Europe a similar fall took place after the dotcom crisis of 2000.  Profits recovered rapidly from the downturn of 2000. But investment in the productive sector did not revive to the same extent and has remained subdued right through to the present time.

The mass of uninvested cash built-up rapidly.  Much of it was handed out to shareholders in dividends and share buy-backs, and in pay increases to executives.  But despite this, in the major economies, the corporate sector quickly accumulated large reserves of unused money capital.  Here the MGI data is astonishing:

Since 1980 corporate cash holdings have ballooned to 10 per cent of GDP in the US, 22 per cent in Western Europe, 34 per cent in South Korea and 47 per cent in Japan. (p. 3).

These cash piles have mostly been lodged in banks or invested in the short-term money markets – often after having been passed through a tax haven to evade corporate taxation.

In Marxist commentary there has been a widely accepted belief that the level of the profit rate is virtually the only determinant of the level of investment that needs consideration. But in fact the relationship between profits and investment is quite variable over time. For example James Crotty in an important paper has shown that in the US, in the early 1980s when profit rates were low, the pressures of competition and rationalisation dictated that if companies were to survive and flourish they had to invest heavily.  This was what happened (Crotty calls it coerced investment), and where necessary, companies borrowed the extra capital required.  Thus, a combination of low profits and high investment.

But the reverse is also possible, and this has been the case over the past 15 years.From the 1990s onwards, as investment lagged and profits rose (though with periodic setbacks), the corporate sector in the major economies became a net financial lender to other  sectors of the economy.

2] The foreign currency reserves of governments

In the world economy after 2000 there was a rapid build-up of trade imbalances. The US was the major country which ran a trade deficit. This by 2006 had grown to equal no less than 6 per cent of US GDP.  The surplus countries included Germany, Japan, the oil-producers, and a number of low-wage manufacturing countries led by China.  In the Asian economies especially, resistance to a rising exchange rate became a major policy objective.  China itself had not been devastated by a crash in its exchange rate, as had South Korea and the other economies directly hit by the crisis of 1997.  But the message of 1997 was assimilated by China as well as other countries in Asia: build large stocks of international currency reserves; don’t let a trade surplus cause a rise in the exchange rate of your currency. Thus to stop their currencies rising against the dollar, the central banks of the Asian surplus countries used the surplus dollars earned by their exports to buy financial assets in the US. Treasury bonds were a favorite purchase, but also bonds issued by the quasi-government agencies (such as Fanny Mae and Freddie Mac) supplying mortgages in the vast US housing market.

Chinese international currency reserves which were tiny in 2000, had risen by 2014 to the equivalent of over $4 trillion (compare US GDP in that year – about $15 trillion). The combined reserves of the surplus countries, including China, rose from $2 trillion in 2002 to $12 trillion by 2014.  These large official reserves made a major contribution to the oversupply of money capital in the world’s credit markets.

3] the personal sector

A third channel for money capital accumulation is the personal sector.  Here the picture is complex.  There has been a huge rise in the overall levels of household debt in the world economy. Mortgage debt especially, but also hire purchase, credit card, and student loans. As is often noted, in the high-income economies, led by the US, it is borrowing by households which has been crucial in maintaining the level of consumer demand, given that for more than two decade, average real wages have scarcely increased.  Apart from government borrowing, the rise in household debt has been the major source of demand for loanable capital.

But there have been two ways in which the personal sector has added to the pool of loanable capital, rather than helped in its absorption by increases in borrowing.

(1) In China, although investment levels in the post-2000 period have soared to very high levels, the rate of saving by Chinese households has risen even higher. China is exceptional, but average household savings are relatively high in many other countries in the global South.  The much higher growth rate of the Southern economies in recent years has increased their relative weight in the world economy, and therefore the size of their contribution to the oversupply of loanable capital.

(2) There has been an enormous surge in the level of personal income and wealth secured by those in a position to capture large amounts of the rising surplus-value extracted directly or indirectly from the productive sector. Average levels of dividend payments have continued to rise in the high-income economies.  Extensive share buybacks have allowed shareholders to sell some of their shares at elevated prices.  There has been an enormous, and much discussed, increase in the salaries, and stock options which executives pay themselves.  In this period there has been a continuing acceleration in the numbers and average wealth of the rich. and the trend is as evident in the emerging as in the high-income economies.  According to the latest Credit Suisse Global Wealth Report the number of dollar millionaires worldwide grew from less than 13 million at the turn of the century to over 36 million in 2014. There are now over 1,800 billionaires.

Obviously the rich spend much of this extra money on luxury consumption.  But large quantities of their wealth are kept in liquid form and are saved rather than spent.  Growing amounts are passed over to the financial sector to be lent out or invested. A recent Oxfam Report quotes estimates that at least 8 percent of individual financial wealth is tax laundered through offshore tax havens, that’s a total of $7.6 trillion (compare world GDP in 2015 of just $78 trillion).

Corporate cash piles, plus official reserves of international currencies, plus personal wealth held in liquid money form – these are three of the major channels through which exceptional quantities of loanable capital have been accumulated in the period since around 2000.

A Marxist account of the current crisis has to trace the impact of this tide of money on the financial system, as it struggles to balance the seduction of possible large profits against the dangers and strains posed by ultra-low interest rates and an insufficient supply of creditworthy borrowers and safe financial investments in the global economy.

Falling Interest Rates and the Weakening of Central Bank Control

One of the major developments in the world economy over the past 15 years has been the extraordinary fall in average real interest rates. (after allowing for inflation.) As the graph below shows, the world average fell from 4 per cent in the 1990s, to 2 per cent in the period just before the financial crisis of 2007. There was then a further steep fall to the near zero real rates of the present time – the lowest in recorded history.  Interest rates have generally been lower in the high-income than in the emerging economies, but in both regions real rates have plummeted.

world interest rates dec 15

Part of the explanation is that in most of the major economies, governments have been encouraging their central banks to implement low interest rate policies. For example programs of quantitative easing [QE] have involved the large-scale purchase by central banks of bonds in the financial markets. This is often called printing money, but the term is misleading. It is not that governments have been financing their expenditure by getting the central banks to print money. More accurately, what is increased by QE is not the money supply, but the level of reserves in the banks. As Mian and Sufi explain in their outstanding book House of Debt, p. 154,

an increase in bank reserves leads to an increase in currency in circulation only if banks increase lend in response to the increase in reserves … bank lending plummeted during the Great Recession (2008-10) just as bank reserves skyrocketed.

QE and similar policies are part of the falling interest rate story. But other forces have been at work in lowering rates. These are set in the financial markets by the balance between the demand for money to borrow and the supply of money available to lend. The major central banks intervene powerfully in these markets. Despite the huge deregulation of finance – one of the central objectives of the post-1980 neoliberal agenda – until the early 2000s, the central banks in the big countries seemed still to have the power to determine short-term interest rates in their domestic economies, and also to exercise considerable influence on long-term rates.

But the fundamental reason for the fall in long-term real interest rates since 2000 is a global surplus of money capital. There has been a larger supply of money capital available to be lent out, than the demand for credit by borrowers. During the recent period in which central banks have been trying to lower the interest rate, they have been only adding a further impetus to processes that were happening anyway.

The strongest evidence in support of the surplus money capital thesis is that when, in 2004, the US central bank, the Fed, tried to raise long-term interest rates, it found itself unable to do so.

Alan Greenspan was Fed Chairman from 1987 to 2006. In his memoirs The Age of Turbulence (2007) he recounts his traumatic encounter with the limitations of central bank power in the epoch of deregulated neoliberal finance. After a three year policy of low interest rates to lift the economy from the downturn caused by the dot.com crisis of 2000, starting in Feb 2004, the Fed implemented a series of increases in short-term interest rates.

Normally the financial markets would respond in ways which caused long-term interest rates to rise as well. The Fed had decided that a increase in long-term rates, and notably the mortgage rate, was urgently required to cool out fast-rising prices in many sectors of the US housing market. (They sensed trouble ahead … though nothing remotely on the scale of the 2007 crash.) But in June 2004 Greenspan and his colleagues were shaken by the refusal of long-term rates to rise:

We had increased the [short-term] Federal funds rate, and not only had yields on ten-year Treasury bonds failed to rise, they’d actually declined … this was extremely unusual … market pressures seemingly coming out of nowhere drove long-term rates down instead of up … What were these market forces? They were surely global, because the declines in long-term interest rates during that period were at least as pronounced in major foreign financial markets as they were in the United States  (p.378).

Greenspan recognized that there were now forces at play in the world economy which were acting to lower interest rates. However, he was still taken aback by the inability of the world’s most powerful central bank to effect even the smallest rise  in long-term interest rates in the US economy. He continues:

Even though globalisation had reduced long-term interest rates, we had no reason to expect, in the summer of 2004, that Fed tightening would not carry long-term rates up with it… The unprecedented response to the Fed money tightening suggested that in addition to globalisation profoundly important forces had developed whose full significance was only now emerging. I was stumped. I called this historically unprecedented state of affairs a conundrum.

Looking back to this moment of revelation, Greenspan, in his memoirs, meditates on the deeper forces which have been influencing the global supply and demand for credit. He touches on a number of themes which need to be addressed in any Marxist account of the crisis. Because inflation had fallen worldwide since the early 1990s, lenders were willing to accept a lower rate of interest. This fall in price inflation owed much to the fact that more than a billion low-wage workers had joined the world industrial labour force after the integration of China, Russia and other centrally planned economies into the international production and trading system.

So – that’s one factor, says Greenspan. But connected with this, he says, is:

a worldwide increase in the supply of loanable capital, relative to the investment of those savings in productive activity. Excess potential savings flooded global financial markets, driving interest rates lower… during the past five years developing country growth has been twice that of developed countries. Their savings rates, led by China, rose from 24 per cent in 2002 to 32per cent in 2006 as consumption lagged and investment fell far short of the rise in savings (pp. 285-7).

The Fed found that it had no alternative but to go with the flow of market processes – to accept that monetary policy was now more limited in its capacity to control interest rates. Thus we find Greenspan writing that:

this decade’s decline in long-term interest rates, both nominal and real, is mainly a result of geopolitical forces, rather than the normal play of market forces … I very much doubt that either policy actions or central bank anti-inflationary credibility played a leading role in the fall of long-term interest rates in the past one to two decades… I doubt that we had the resources to counter the downward pressures on real long term interest rates which were becoming increasingly global. Certainly Japan did not. (pp.387-391).

In 2016 the major central banks are struggling to counter the global forces that are lowering interest rates, and also causing growth to falter. And they find themselves compelled to try and achieve this …by pushing interest rates even lower! Yet the prevalence of zero (and negative) interest rates in many sectors of world credit markets poses serious dangers for the system. Profitability in the banking sector is badly hit. Cheap borrowing provides the fuel for speculative booms in financial markets. General levels of debt tend to increase because the cost of servicing debt is low. Debt overstretch makes the weaker sectors in the world economy vulnerable to small increases in interest rates, or to whatever undermines their capacity to service debt – hazards such as a fall in the rate of growth, an increase in unemployment, or a decline in profitability.

Surplus Money Capital as a Crisis Mechanism

Profits are at the heart of the chain of crises which started in 2007.  But this is not because the rate of profit has fallen in the major economies.  Rather, a combination of a rising mass and rate of profit and lagging rates of investment has led to a global surplus of money capital. Levels of surplus value extraction have been higher than the capacity of the system to absorb them.

As surplus money capital piles up, it is transferred to the financial system which captures its share of surplus-value via the interest and fees it charges for lending out money entrusted to it. The rapid surge in flows of surplus money capital into the financial circuits in the years 2000-7, meant bonanza profits for the banks. In the US, for example, by 2006 the financial sector was absorbing more than 40 per cent of total profits.

But as became evident in the financial crisis which started in 2007, the banks in the US and Europe responded to the money surge in ways which threatened the very survival of the system.  The logics of profitability and competition within the financial sector, have:

(a) intensified pressures to maximise surplus-value extraction in the productive sector, and this has helped drive still faster the accumulation of surplus money capital;

(b) encouraged high risk levels of leverage and speculative instability within the financial system itself. The banks have lurched violently between lending too much up until 2007, and not enough since then.  Debt levels have increased worldwide to unprecedented levels.  But there is not a large enough supply of safe borrowers to lend to, or safe financial assets in which to invest.

To explain this, we have to consider the many reasons why the system is now plagued by a combination of high profits and relative stagnation in investment.  The processes involved are located deep within the system of production and exploitation; in the structure of interconnections between the productive and the financial circuits in neoliberal capitalism; and in the dangerous speculative pressures within the financial system.

The major crises of the post-2000 period have been – in the classic terminology of the Marxist tradition – crises of disproportionality.  The form taken is a disproportionate expansion of the financial circuits as compared with the productive circuits. This is not a falling rate of profit crisis as in the 1970s.  A crisis of excess money capital tends to arise if, and when, rates of average profit are on the rise.  Such crises may lead to a fall in profitability, but if that happens, it would be as a consequence of the hit to the productive system which can result from financial crises.  The system is distorted by a disproportion between high average profits and relative levels of reinvestment of those profits.  Stagnationary influences are then transmitted to the productive economy.  The impact on the labour markets means increasing job insecurity, and the creation of large numbers of low paid jobs.

That such a crisis is possible – and in certain circumstances likely – is implicit in Marx’s analysis of the unstable dynamics of a capitalist economy.  He has a long section in Capital Vol. 3 (chapters 30-32) on the relationship between money capital and real capital. The reserve  funds of industrial companies are passed to the banks and lent out by them in the form of what Marx variously refers to as interest-bearing capital, loanable capital or money capital.  Marx notes the possibly that what he calls a plethora of money capital might arise – i.e. an excess of money capital relative to the demand for loans from the banks. He asks: ‘Is the phenomenon of a plethora of capital, an expression used only of interest-bearing capital, i.e. money capital, simply an expression of industrial over-production, or does it form a separate phenomenon alongside this?’ (p. 607 Penguin Edition). Marx’s answer is that there are two phases of the business cycle in which a surplus money capital situation can arise independently and in which ‘loan capital lies idle on a massive scale’ (p. 616)  (1) In the aftermath of a large large contraction in production. This was the case, he says, after the crisis of 1847 in which production in the English industrialist districts was cut by a third.  Commodity prices and interest rates were low and there was a surplus of loanable capital.  (2) During the upturn phase of prosperity in the business cycle. Here Marx lists a number of processes which would reduce the amount of money capital needed to operate the productive circuits.  Wages have fallen, and, because business is brisk, the demand for an injection of extra working capital by industry and commerce is still relatively low (p.627).  Also, a favourable balance of payments would add to the total of available loanable capital.

Of course static pools of money in the industrial circuits are not the only source of loanable capital. There are also flows of money into the banks from other sectors of the economy.  Marx notes, for example, that there would be an increase in the supply of money capital in the system if there is a rise in saving by ‘the unproductive classes and those who live on fixed incomes’ (p. 622).

The specific mechanisms that underlie a surplus of money capital today are of course rather different from those operating in Marx’s period.  But a key piece of evidence in support of the excess money capital explanation for the current crisis is that, over the past 15 years, global rates of interest have fallen steeply, and to a much lower level than governments and central banks wanted, and tried to achieve by monetary policy. Demand for loans in the credit markets of the world has tended to be lower than the supply of money looking for borrowers.

The overall result is that the banks and financial markets have found themselves – in the commonly used phrase – awash with liquidity.  There are enormous pressures on the managers of these large flows of money capital to find secure ways of investing the money and at an acceptable rate of return.

Marx noted that when there is a bonanza of money in the financial system all kinds of swindles are able to flourish: ‘extraordinary swindling can very often go together with a low rate of interest’ (p. 484). The immediate trigger of the 2007 crisis was that $1 trillion had been handed out by the US banks to subprime house purchasers, many of whom had insufficient income to sustain their mortgage payments as their interest payments soared when the scam of an initial low interest rate (the so-called ‘teaser rate’) came to an end.  Securities based on the future flow of subprime mortgage payments had been widely sold to banks in Europe or retained in the shadow banking system of the US.  When the value of these securities was undermined by subprime default – major banks in the US and Europe were threatened with collapse.  In a similar way, the Eurozone crisis was triggered because the money capital surpluses of the North European economies were used to finance unsustainable land, housing, and property booms in the peripheral Europe economies.

The thesis I am proposing needs to be developed in detail and tested in number of ways which will be explored in future posts.  I am arguing for a quite specific form and timing of disproportion crisis – not a general tendency of the system towards overcapacity as in the many variants of under-consumption theory – that of Baran and Sweezy for example. My account has elements in common with what David Harvey calls a capital surplus absorption problem­. But my stress is on excess capital in the money form, and especially in the post-2000 period, not, as in Harvey, a general excess of productive capacity as recurrent throughout the history of capitalism.

At an empirical level many of the processes I emphasise are of course ones which policy makers in the major economies have been struggling with.  In these circles, the view that the international economy has, since 2000, been thrown into a deep maladjustment by a global savings glut has been widely accepted.  A particularly influential version was proposed by Ben Bernanke in 2006.

But from a Marxist point of view, the way in which mainstream economics conflates flows of productive capital and of money capital into a single amorphous category of ‘savings’ is a recipe for fundamental incoherence and lack of explanatory rigour.  It is essential to start from the clear distinction between productive and financial circuits which is at the core of Marxist political economy.

Which Profit Rate for the United States: Domestic or National?

The Marxist debate about profit trends in the US has focused mainly on data in the National Income and Product Accounts [NIPA] produced by the Bureau of Economic  Analysis, a government agency in Washington.  In this debate, what often gets overlooked is that NIPA uses two quite different ways of defining and measuring profits – and the differences between them are important. This is explained in the Handbook about Concepts and Methods in NIPA.  

NIPA publishes separate tabulations for national and for domestic profits.  National profits include the foreign earnings of US companies (i.e. those with headquarters in the US) as well as their domestic profits. The profits made in the US by foreign companies are deducted from the national total.  Domestic profits include all profits made by companies from operations in the United States as a geographical territory, irrespective of the nationality of the comp any. (i.e. where its headquarters are located)  Crucially, as the Handbook explains, “The profits component of domestic income excludes the income earned abroad by US corporations”. (Section 13 – 5).

For most Marxists, our concept of ‘the US profit rate’ would surely include the foreign earnings of US companies.  Thus the national definition of profits should be the key focus in Marxist research.  This would especially be the case given that the proportion of their profits which US companies make abroad has been increasing rapidly in recent years. In the 1990s it was about 15 per cent and now hovers around 33 per cent. Nevertheless in discussing the rate of profit in the US, and whether it’s going up or down, Marxist analysts  usually use the data for profits for the domestic economy only.  Sometimes this is not explicitly noted by authors. And it can be hard for readers to check, since it is quite common for profit rate data to be published and analysed without any indication of which section (and line!) of the many tables in NIPA is being used as source, and thus what precise definition of profits is being used.

This criticism, however, does not apply to Andrew Kliman.  His book-length study of profits in the US, The Failure of Capitalist Production (2012), is based almost entirely on NIPA data.  He explicitly notes that, throughout the book, his research is almost exclusively focused on domestic rather than national rates of profit. Kliman writes:

unless otherwise indicated, my analysis pertains to what the Bureau of Economic  Analysis [in NIPA] calls “domestic” corporations…. The domestic data include foreign-based corporations’ profits from their US operations and their fixed assets located in the US, but exclude US-based corporations’ profits from abroad and their fixed assets located abroad (p. 75).

Using this domestic evidence alone, Kliman reaches the main conclusion of the book , namely that, ‘a long decline in profitability in the US began in the later half of the 1950s’ (p. 77).

But can it be valid to give no attention to the one third of their profits which US companies have in recent years been making from their operations abroad?

There is a good reason why Kliman, and many others, base their analysis of US profit rates solely on activity within the domestic economy of the United States, and exclude the foreign earnings of US corporations. To calculate a profit rate you need a measure of capital advanced – the value of the capital stock used in production.  The Bureau of Economic Analysis [BEA] helpfully publishes estimates of the value of the total stock of productive assets in use in any given year. But figures are provided only for the stock of capital being employed within the US.  Data on the value of the capital stock operated abroad by US multinationals is simply not available.  And clearly the difficulties of providing a valuation of capital assets deployed abroad would be formidable, given the complex entanglement of US multinationals with networks of local subsidiaries and foreign affiliates.

To calculate his domestic rate of profit Kliman uses the data published by the BEA in its Fixed Asset tables.  The BEA makes it clear that this data refers to productive assets in the narrow means of production sense.  What is certainly not included in this definition is capital tied up in any holdings which companies may have of shares in other companies.  . Physical means of production – fixed machinery, buildings etc. software,  patents, intellectual productive capital are what the BEA domestic data refers to.  Financial claims – what Marxists call fictitious capital – are not included in the stock of capital advanced when US domestic profit rates are calculated

Kliman has a defence for his exclusive reliance on domestic profit rates to establish what he believes to be a declining rate of profit for US corporate capital as a whole.  He argues that the foreign operations of US based companies were less profitable than their domestic activities.  But to calculate a rate of profit for US investment abroad, Kliman uses data on foreign direct investment [FDI].  The term ‘direct’ is misleading.  This is not investment in the sense of money used to buy what are called ‘fixed assets’ in the domestic data – machinery and other means of production. Foreign direct investment means the purchase of shares in foreign companies in order to give the US purchaser a controlling interest in those companies.  FDI refers to financial operations which lead to the creation or control of foreign affiliates and subsidiaries – so is quite different from the stock of direct means of production which Kliman uses as the profit rate denominator for the domestic economy.

The BEA provides data on US FDI – i.e. the accumulated stock of equities in foreign affiliates held by US companies.  Also the annual flow of dividends and similar types of income derived from ownership of foreign companies.  For example the stock of US FDI was just under $4.9 trillion in 2014, nearly all of it in the form of equities ($4.7 trillion). The income derived by US companies from these holdings was $449 billion.  Thus a rate of return of 9.5 per cent.

It is this rate of return which Kliman calls a ‘rate of profit’, and says is lower than the rate of profit derived from the operation of fixed assets in the domestic economy of the US.

To measure the profit of US multinationals’ foreign investment, I computed their income from direct investment abroad as a percentage of their direct investment abroad (p.79).

He finds for example that the after-tax domestic rate of profit was 28 per cent lower in 2001 than in 1982, and the before-tax domestic rate  was 25 per cent lower – while the rate of return on foreign investments, over the same period, was 37 per cent lower.  He also finds that the foreign rate of return continued to be lower through to 2007.  Thus he concludes that:

Even though my analysis of declining profitability elsewhere in this book relies on data for domestic corporations only, the above comparisons suggest that this is not a serious limitation (p.80).

What is missed in Kliman’s approach is the huge surge in US FDI.  Certainly he exaggerates the downward trend in the rate of return on US FDI by a cherry picking procedure. He compares the 11.9 per cent rate in 1982 with the exceptionally low point of 7.5 per cent in 2001.  But after 2001 the rate recovered and in 2005-08 averaged over 12.0 per cent each year. However as Table 1 shows, he is right to identify a somewhat lower average rate of return for FDI profitability between the 80s and now.

Table 1.  Average annual rate of return on US FDI

  %
1982-89 12.8
1990-97 12.7
1998-06 10.2
2006-14 10.4

Note:  Withholding taxes are paid by US corporations in countries where they have investments. Rates up to 2006 are after-tax, from 2007 rates are before-tax.

Source: BEA Direct Investment Position, Table 2.1 (historical cost basis).

Kliman is thus correct in his contention that the rate of return on US FDI has been somewhat lower since 1998 than in the 16 years before.  But 10 per cent on capital invested is still quite a high rate of return.  It is only slightly less than the average after-tax rate of domestic profit in the US which, on Kliman’s figures, was around 11 per cent from the early 1980s till 2006.  This difference is surely not large enough to justify Kliman’s decision to base his analysis of US profitability on domestic profits alone.  The effect is that over the period he covers in his book the rate of profit he is studying becomes increasingly detached from the realities of US capitalist accumulation.

In 1982 US domestic corporate Fixed Assets totaled $2,009 billion (at historical cost ). The stock of FDI was $208 billion – i.e. equal to 10 per cent of domestic fixed capital. In 2013 domestic fixed capital was $10,737 billion and the stock of FDI was $4,693 billion – nearly 44 per cent of the domestic capital stock. Thus there was a much more rapid build-up of foreign than domestic investment over the 50 year period.

Kliman builds too much on a comparison which it is not at all clear can be meaningfully made.  That is – between the corporate rate of profit in the domestic economy and the rate of return on corporate holdings of equities in their foreign affiliates. When mainstream economists confuse the rate of profit on productive capital with the rate of return on financial assets (as Thomas Piketty does for example) Marxists are rightly scornful.  In any case, to avoid corporate tax US companies routinely and covertly transfer domestic profits to their foreign subsidiaries. In 2014 of total US FDI of $4,900 billion, more than 20% was located in the tax havens of Luxembourg, Bermuda and the UK Caribbean islands.  Kliman mentions FDI in tax havens in an obscure footnote (p. 215) but does not comment on whether tax evasion might raise questions about his main argument.

It may be that Kliman is right to argue that the profit rate for US foreign direct investment is not as high as it was in the 1980s.  But in a book with the ambitious title of The Failure of Capitalist Production it seems a damaging restriction to omit any treatment of the processes of US capitalist accumulation abroad. There is after all another way of looking at the export of American capital over the past three decades.  US corporations have been able to effect a vast expansion in their productive activities abroad and in their presence in world markets.  The importance of this development should not be set aside just because it is believed to have been at the cost of a small reduction in their overall rate of profit.

Profit rates on capital advanced are, and should remain, central in Marxist analysis.  But the rate of profit should not be studied, in a mechanistic way, as an isolated statistical variable.  But rather as embedded in a political economy in which questions of the scale of accumulation, and presence of the world market, are never ignored.

We need to use National Accounts data as an empirical source in Marxist analysis.  But we should try to get beyond the methodological nationalism which is built into such data.

US Profits and Corporate Tax Evasion

The Marxist debate about the causes of the  crisis of 2008-12 in the US and Europe continues to be sharply polarised. On the one hand, those who see it as basically caused by a fall in the rate of profit. On the other, those who think that it is, in a more complex way, a crisis of financialised capitalism.

Both sides agree, of course, that the financial sector – huge, greedy, and destabilising – was central in the immediate causation of the crisis. But a number of influential Marxists argue that the rapid growth of finance in the past two decades is itself a direct result of a fall in the rate of profit in the high-income economies.  Because profits have been inadequate, the story goes, companies have preferred to use their spare capital to speculate on financial markets rather than to invest in the expansion of productive capacity.  Low investment leads to low rates of growth in production, and high rates of unemployment.  Economies become over-reliant on a rising volume of household and government debt to sustain demand.   When levels of debt reach unsustainable levels, crisis is triggered.

The only book-length study of profit rates in the US is Andrew Kliman’s The Failure of Capitalist Production (2012). His conclusion is as follows:

A persistent fall in the rate of profit in the US was a key factor which set the stage for the Great Recession that started in 2008 and the malaise which continues after its official end. It led directly to a long-term decline in the rate of investment, and, indirectly, to a sluggish growth of output as well as rising debt burdens.

But a crucial step in this argument – namely that profit rates determine investment – has simply not been the case in the recent period. It is certainly true that business investment levels in the high-income economies have tended to lag since around 2000.  But this is not because there has been a fall in profit rates – in fact,  despite several brief downturns, they have been moderately, but persistently, on the rise ever since 1980.  Other causes have been at work. For example there has been, since the early 1990s, a general fall in the prices of means of production in the world economy.  This has reduced the amount of money capital which the average company has to advance to achieve a given level of investment in productive capacity.

Companies have used their spare capital to implement other strategies. They boost the price of their shares by making large payments to shareholders in the form of dividends and share buybacks.  They build up large war-chests of reserve cash to increase their competitive capability via merger and acquisition operations.  They evade taxation by stashing large amounts of their profits abroad.  Their executives pay themselves exorbitant salaries.

Profit rates in the US

In the dispute between falling rate of profit defenders and their critics, the major battleground has been the United States economy, and its National Account statistics, so I’ll start there.

profits 2 15 jab 16

Here is my own presentation of the data on the US rate of domestic profit since 1947. The trend line is roughly similar to that found by most researchers – including leading defenders of the falling rate of profit thesis such as Michael Roberts, Guglielmo Carchedi and Alan Freeman.  It is apparent that such data can be read either as supporting, or as refuting, the thesis of a decline in rates of profit.  The declinists stress that the rate of profit was higher on average in the 1950s and 1960s than it has been over the past 30 years.  Sceptics point out that, in the period since 1980, the trend in profit rates has been upward, though with a marked business cycle oscillation.

Corporate tax evasion

So far in these debates there has been surprisingly little discussion about whether the official profit figures we rely on will tend to underestimate profits because of the corporate tax evasion which has recently had so much attention in the media? Certainly the scale of such evasion is huge – through the use of such devices as transfer pricing, tax havens, and foreign subsidiaries.  At 35 per cent the US has the highest rate of corporate profit taxation in the 34 countries which belong to the OECD.  It is, however, 4th lowest in the rate of effective tax which corporations actually pay.  In theory profits tax is supposed to be imposed on the foreign, as well as the domestic earnings, of US companies.  But the system is riddled with loopholes.

A string of research reports has detailed the main devices used by US companies to evade taxation. One of the latest is Offshore Shell Games 2015,  published by Citizens for Tax Justice. This deals with the use of offshore tax havens by Fortune 500 companies.  The researchers were able to track down 7,622 tax haven subsidiaries operated by 358 companies out of the 500. They found that these companies were holding more than $2.1 trillion in accumulated profits offshore in order to evade US corporate taxation. This total had more than doubled in the six years since 2008.

The large US banks were prominent offenders.   Most of the big non-financial multinationals were also found to be sheltering large accumulations of profits in tax havens.  These included some exceptionally profitable companies such as Walmart, Pfizer, Nike, Pepsi, Microsoft and Google.  The $2.1 trillion in company cash piles is, of course, not actually kept in places like the Cayman Islands or Bermuda.  Creative accountancy is used to enable these reserves to be fed back into banks and money markets in Wall Street and other financial centres.  .

Profitability is central in Marxist political economy and accurate empirical data is indispensable in our debates. Do the National Accounts profits data which we use take full account of tax evasion?  I can find no direct discussion of this issue in the literature or on the internet.  If any reader of this blog knows of relevant material, please let me know.

However, it is pretty certain that there are large underestimations of profits in the National Accounts. But there are many loopholes which allow US companies to declare profits – but in ways which legally exempt them from US taxes on corporate profitability.  For example, if companies state that profits are ‘permanently reinvested’ abroad by their foreign subsidiaries, such profits can be declared to the tax authorities in the US [the IRS] and yet escape taxation.  If reported to the IRS, profits will be included in the National Accounts.  The use of tax havens does not necessarily mean that profits are concealed.

As the BEA Guide to National Accounts methodology explains, in arriving at their profits figures, the statisticians rely mainly on corporate tax returns, but they also cross-check these against company financial reports. There are good reasons why companies would not want too much to under-report their profits in their company accounts. Executive bonuses and stock options are closely linked to profit performance.  Also the current valuation of a company’s shares in the stock exchange.

But the Tax Justice report I quoted earlier stresses that straight concealment and non-reporting of US profits in tax havens is on the increase.  The widely discussed Panama Papers confirm the same trend in countries other than the US.  In Marxist debate we should recognise that corporate tax evasion leads to an underestimation of profits in National Accounts.

Note, however, that, for the US, most Marxist researchers use data on profits made in the domestic economy, and which excludes the foreign earnings of US companies. I’ll discuss why -and whether it matters – in my next post.