ThecausesoftheGreatRecession: mainstreamandheterodoxinterpretationsandthecherrypickers Abstract TheGreatRecessionof20089wasthedeepestandlongestcapitalisteconomic slumpsincetheGreatDepressionof192932.Yet,theofficialstrategistsofeconomic policyinalltheadvancedcapitalisteconomiesdidnotseeitcoming;thendeniedit wastakingplace;andafterwardswereunabletoexplainwhyithappened.Thevast majorityofmainstreameconomists(boththeneoclassicalorKeynesianwings)failed toforecastittoo. Afterwards,abitterdisputehasbrokenoutbetweenthesetwowingsonwhich theoreticalmodelbestexplainedtheGreatRecession.

n.Thispaperarguesthatneither winghasanadequateexplanationbecauseboththeoreticalmodelsare:obsessed withtheactionsormotivationsofindividualeconomicagents;refusetoprovide empiricalevidencefromhistory(thushavemodelslackinginanypredictivepower); andfocusonlyonflawsinthefinancialsectorforthecausesratherthanthewider capitalistproductionprocess. Thesefailingsalsoapplytoagreaterorlesserdegreetomanyheterodoxeconomic explanations,rangingfromthebehaviouraloranimalspiritsversionsofthe Keynesianmodel,theMinskyfinancialinstabilitysupporters,totheAustrian excessivecreditschool. ThispaperarguesthattheMarxistmodelofcapitalismbestexplainstheGreat Recession,rootedasitisintheinherentflawsinthecapitalistproductionprocess andthenitsindirectimpactonthefinancialsector.Thisrevealshowtheproximate causesarerelatedtotheultimate. ThemethodologicallessonsforeconomistsfromtheGreatRecessionare:1)turnto theaggregateandawayfromtheindividualinformingeconomictheory;2)provide empiricalevidencethatcanbetestedandretested;and3)lookatthebigpicture,not onesectorofthecapitalisteconomy.

TounderstandtheGreatDepressionistheHolyGrailofmacroeconomics.Ben Bernanke,2002speech. TheGreatDepressionwas(andinmanyways)remainsagreatpuzzleastherewere millionsoftheworldscitizenswhowantedtoconsumemorehousing,foodand clothing;andproducersbythehundredsofthousandswhowantedtomanufacture morehousing,foodandclothingandyetthetwosidescouldnotgettogether.Why? Whatwaspreventingtheseeconomicallyimproving,mutuallybeneficialexchanges fromtakingplace?Whatwasitthatpreventedpeoplefromworkingandproducing more?Atthismoment,(theanswer)remainslargelyunknown.RandallEParker, TheEconomicsoftheGreatDepression,2009 Thereareknownknowns.Therearethingsweknowthatweknow.Thereare knownunknowns.Thatistosay,therearethingsweknowwedontknow.Butthere arealsounknownunknowns.Thesearethingswedontknowthatwedontknow. DonaldRumsfeld HowgreatwastheGreatRecession? TheGreatRecessionof20089reallywasgreat.Itwasthelongestanddeepestinits contractionofoutputthattheglobalcapitalisteconomy,asrepresentedbythe30 advancedcapitalistnationsoftheOECD,hasexperiencedsincetheGreatDepression of192932. FromthepeakofthepreviousboominrealGDPgrowthfrom2007tothetroughof theGreatRecessioninmid2009,theOECDeconomiescontractedby6%pointsof GDP.Ifyoucompareglobaloutputin2009towhereitshouldhavebeenwithouta slump,thelossofincomewasevengreaterat8%points(1). AtthetroughoftheGreatRecession,thelevelofindustrialproductionwas13% belowitspreviouspeak,whileworldtradefell20%fromitspreviouspeak.World stockmarketsfellanaverage50%fromthepeakin2007(2). TheGreatRecessionwasalsothelongestsincetheGreatDepression.SincetheGreat Depression,theUSNationalBureauofEconomicResearch(NBER)hastriedtodate economicrecessionwithreferencetotheUSeconomy.Therehavebeen18 recessionsonNBERmeasuressincetheGreatDepression,now80yearsago.The averagelengthofthesehasbeentenmonthsandonaveragetheUSeconomygrows belowpotentialforabout19monthsduringthoserecessions(measuredbyrising unemployment).TheGreatRecession,stillnotofficiallydeclaredasoverbythe NBER,probablylastedabout20months,makingitmorethandoubletheaverageand thelongestbyfarsince192933,whichlasted43months(3). Thetaxonomyofeconomics Givenitsdepthandduration,theGreatRecessionmustbeoneofthemostimportant casestudiesforexplainingtheprocessesofthecapitalisteconomy.Sohowrobust werethevariousschoolsofeconomictheoryinpredictingandexplainingthenature ofthelargestandlongestslumpincapitalismsincetheGreatDepression?

TheshortansweristhateconomicsasasciencehaseggonitsfaceovertheGreat Recession.Mosteconomistsdidnotpredicttheoncomingoftheslumpandin hindsighthavestruggledtoexplainwhathappenedanditscauseorcauses. Wecanlookatthevariousexplanationsorrationalisationsofthevariousschoolsof economictheory.Wecancategorisetheeconomicsprofessionintovariousschools, withthemaindivisionbetweenmainstreamandheterodox.Taxonomy,ofcourse, willhaveitsexceptions,asDarwinianswillbethefirsttoproclaiminthefieldof biology. Inthemainstream,wehavetwogreatschoolswithsubdivisions.Thefirstisthe neoclassical(andbythisweshoulddistinguishfromthe19thcenturyclassical economistsofSmith,Ricardo,Malthus,JSMilland,ofcourse,Marx). TheneoclassicalschooliswhatMarxcalledthevulgareconomics.Thisschoolis ideologicallycommittedtoabeliefinthefreemarketasastartingassumptionrather thanasascientificallyobjectiveviewofeconomicorganisation. TheneoclassicalcanbesubdividedintotheWalrasiangeneralequilibriumanalysis; thetraditionalmonetarists(alaMiltonFriedman);andthemodernChicagoschool ofefficientmarkettheorists. Withinthemainstream,thereisalsotheKeynesianschool,whichrejectsthe microeconomiccategoriesoftheneoclassicalschoolasrelevanttomacroeconomic forces.Itisdividedagain.TherearetheneoKeynesianswiththeirsynthesiswith neoclassicalequilibriumtheory,namelythatslumpsarereallyaproductofsticky factorsofproduction,particularlywages.ForneoorNewKeynesians,slumpsare exogenoustotheeconomicmodel. AndthereareKeynesianswhoconcentrateonotheraspectsofKeynestheory;that slumpsaretheresultofthelackofeffectivedemand,whichinturnisinducedby liquiditypreferenceinthefinancialsectororisaproductoftheirrational movementsofanimalspiritsamongentrepreneursandthebehaviourofconsumers (thiswingofKeynesianismhasnowmigratedintoinvoguesocalledbehavioural economics). ThedivisionsbetweenthemainstreamKeynesiansandtheneoclassicalschoolhave becomeveryheatedintheaftermathofthefinancialcrashandtheGreatRecession. Butbotharestillfirmlyagreedonamarketbasedsystemastheonlyviableformof economy. Thenthereareeclecticswhositastrideboththemajormainstreamschoolsandcherry pickwhattheywanttouse.Theyparticularlyincludethefrontmenandwomenofthe officialbodiesofmonetaryandfiscalpolicylikethecentralbankers(AlanGreenspan, BenBernankeorMervynKing)andeconomistswithingovernmentlikeLarry Summers.

Theheterodoxschoolofeconomicscanalsobedividedbetweenthosewholookto themoreradicalaspectsofKeynesianthought:namelytheirrationalbehaviourof marketsandtheinherentinstabilityofthefinancialsector(HymanMinskyetal)as thebenchmarksfortheeconomiccrisis:andtheMarxistschoolthatlookstothe inherentinstabilityofcapitalismasawhole,namelyinitsnonfinancialsectorjustas muchas,ifnotmorethan,thefinancialsector. TheMarxistschoolcanbesubdividedbetweenthosewhoseethecauseofcapitalist crisisinoverproductionand/orunderconsumption;orinprofitability.Onceagain somesitastridethesevariousheterodoxschoolsandcherrypicksomuchfor accuratetaxonomyhere. Theofficialleaders:acompletemess Howdidtheofficialleadersofcapitalisteconomicstrategyactbefore,duringand aftertheGreatRecession? Before2007,noofficialstrategistofeconomicpolicyforecastanycrisis.USFed ChairmanGreenspanin2004toldusthatanationalseverepricedistortionismost unlikelyinrealestate.In2006,hetoldusthattheworstmaybeoverforhousing, justthehousingbubbleburst.UStreasurysecretaryHankPaulsonsaidthecrisisin theoveralleconomyappearstobecontained,March2007. Duringthecrisis,inOctober2008,thegreatfinancialmaestroGreenspantoldtheUS Congress,Iaminastateofshockeddisbelief.Hewasquestioned:Inother words,youfoundthatyourviewoftheworld,yourideologywasnotright,itwasnot working(HouseOversightCommitteeChair,HenryWaxman).Absolutely, precisely,youknowthatspreciselythereasonIwasshocked,becauseIhavebeen goingfor40yearsormorewithveryconsiderableevidencethatitwasworking exceptionallywell. Greenspaninhindsighttellsusthateconomistscannotpredictabubbleandwhenit happensthereisnothingyoucandoaboutit.Youcanonlybreakabubbleifyou breaktheunderlyingbasisoftheeconomy.October2007. Greenspanfinallysummedupwhathehadlearnedinareviewofthecrisisinhis paperTheCrisis,March2010.Hetoldusthatwhathappenedwasfinancial intermediationtriedtofunctionwithtoothinalayerofcapitalowingtoamisreading ofthedegreeofriskembeddedinevermorecomplexfinancialproductsandmarkets .Sosomethingassimpleasthelackofcapitaladequacywasthecause.Youd thinkhemighthavenoticedthat. Moreover,thebubblethatburstin2008cameaboutbyaconjunctionofeventsthat couldnotbeexpected.ItwastheserendipityoftheFalloftheWall,cheapinterest ratesandglobalisationthatcametogethertocreateexcessiverisktaking.Couldthe crisishavebeenavoided?No,becauseoftheseserendipityfactorscomingtogether, Idoubtit,hesays.

SoforGreenspan,itwaschance,aonehundredyearevent.Thedisasterswerethe resultsofmassivenaturalforcesandtheydidconstituteaperfectstorm.Thisidea wasechoedbyHankPaulson:thissortofthinghappensonlyonceortwiceina hundredyears.AseconomistDanielGrosscommentedonthechanceexplanation ofthecrisis:whatsthedifferencebetweenonceortwice?Inthisinstance,several trilliondollarsinlosses. Intheaftermath,theofficialleadersfellbackontheargumentofNassimTaleb,that thecrisiswasablackswansomethingthatcouldnothavebeenexpectedoreven knownuntilitwas,andthenwithdevastatingconsequences(4).AsDonaldRumsfeld putitduringtheIraqwar,itwasanunknownunknown. Greenspandefinedabubbleasaprotractedperiodoffallingriskaversionthat translatesintofallingcapitalratesthatdeclinemeasurablybelowtheirlongrun trendlessaverages.Fallingcapitalisationratespropeloneormoreassetpricesto unsustainablelevels.Allbubblesburstwhenriskaversionreachesitsirreducible minimum. HenotesthatseveralNobelprizewinnersineconomicswereembracingprofitable markettradingmodelsthatweresuccessfulonlyaslongasriskaversionmoved incrementally.Butusingonly2to3decadesofdatadidnotyieldamodelthatcould anticipatecrisisifriskmovedoutsidethatrange. TherewasnothingwrongwiththeBlackandScholesoptionpricingmodel:itsno lessvalidtodaythanadecadeago.Itisjustthattheunderlyingsize,lengthand impactofthenegativetailofthedistributionofriskoutcomesthatwasabouttobe revealedhadnotbeencomprehended. Greenspannowdoubtsthatstablegrowthispossibleundercapitalism(5).Iknowof noformofeconomicorganisationbasedonthedivisionoflabour(hereferstothe Smithianviewofaneconomy),fromunfetteredlaisserfairetooppressivecentral planningthathassucceededinachievingbothmaximumsustainableeconomic growthandpermanentstability.CentralplanningcertainlyfailedandIstrongly doubtthatstabilityisachievableincapitalisteconomies,giventhealwaysturbulent competitivemarketscontinuouslybeingdrawntowardbutneverquiteachieving equilibrium. Hewenton,unlessthereisasocietalchoicetoabandondynamicmarketsand leverageforsomeformofcentralplanning,Ifearthatpreventingbubbleswillinthe endturnouttobeinfeasible.Assuagingtheaftermathisallwecanhopefor. Ofcourse,theseofficialleadersarethepaidproponentsofvulgareconomics.You wouldnotexpectthemtoforecasttothepublicatlargethatcapitalismwasaboutto collapseorcouldcollapse.TheFedfailedtoforeseethegreatesteconomiccollapse sincetheGreatDepression.Anditisnotsurprising.Thereisacrudepecuniary connectionhere.AttheJournalofMonetaryEconomics,amuchpublishedvenueof mainstreameconomics,morethanhalfoftheeditorialmembersarecurrentlyonthe Fedpayrollandtheresthavebeeninthepast(7).Therewere730economists,

statisticiansandothersworkingattheFedanditsregionalbanksin1993,according Greenspan. Overathreeyearperiod,endingOctober1994,theFedawarded305contractsto209 professorsworth$3m.TheFednowemploys220PhDeconomists.In2008,theFed spent$389monresearchintomonetaryandeconomicpolicyand$433mwas budgetedfor2009.AccordingtotheAEA,487economistsareresearchingmonetary policyandcentralbanking,another310oninterestrates;244onmacroeconomic policy. TheNABEreckonsthat611ofits2400membersfocusonmonetaryandbanking. MostofthesehaveworkedfororwiththeFed.Manyeditorsofprominentacademic journalsareontheFedpayroll:84outof190editorialmembersinseventop economicsjournalswereaffiliatedwiththeFed. TrytopublishanarticlecriticaloftheFedwithaneditorwhoworksfortheFed complainedeconomistJamesGalbraith.EventhenowextinctMiltonFriedman expressedhisconcernsaboutthis:Icannotdisagreewithyouthathavingsomething like500economistsisextremelyunhealthy.Asyousay,itisnotconduciveto independentobjectiveresearch.Thereiscensorshipofmaterialpublished. AskedtobeaconsultantfortheFed.Itsapayoff,likemoney.Ithinkitsmore beingoneofpartofaclub,beingrespected,invitedtoconferences,haveahearing withthechairman,havingtheprestigeisasmuchasapaycheck.RobJohnson, Senatebankingcommitteeeconomist. BenBernankeisthecurrentFedchairmanandpresidedovertheGreatRecession. BernankeisaneconomistwhospecialisedintheGreatDepression.Ifevertherewas aneconomistwholookedatdepressioneconomics,touseKrugmansphrase,itis Bernanke. HeconcludedthatdepressioncouldbeavoidedbyFedaction.Followinghismentor MiltonFriedman,headvocatedprintingmoneyandevendroppingitfrom helicopterstothepopulacetoensurespendingissustained.Thismonetaristtheory ledhimtoconcentrateonmoneysupplyindicatorsasaguidetothestateoftheUS economy.IwouldliketosaytoMiltonFriedmanandAnnaSchwartzregardingthe GreatDepression.Youareright,theUShadaGreatDepression,butthankstoyou, wewontagainBernanke,2002speech.ButMrBernanke,theformerheadof PrincetonUniversityeconomicsdepartment,knowsallthereistoknowabouta depressionexceptwhatcausesthem(8). LikeGreenspan,Bernankedidnotseethecrunchcoming.Wedontexpect significantspilloverfromthesubprimemarkettotherestoftheeconomyfromthe financialsystem.May2007.ByJune,hewassayingthelosseswouldbeminimal between$50100bnatmost.Sofar,thelossesintheglobalfinancialsystemhave reachedjustunder$2trn.

TheheadoftheFederalDepositInsuranceCorporation,aUSgovernmentagency responsibleforregulatingandmonitoringthebankingsystem,reportedinJuly2007 thatthebanksinthiscountryarewellcapitalisedandmyviewisthatIwouldbe very,verysurprisedifanyinstitutionsofsignificantsizeweretogetintoserious trouble.AndlowehaveBearStearns,Countrywide,Lehmans,MerrillLynchetc. TheefficacyoftheeconomicsoftheworldsfinancialleadersintheGreatRecession hasbeenneatlysummedup.Centralbankshaveshedtheconventionalwisdomof typicalmacroeconomics.Butinitsplaceisapotpourrioffactoids,partialtheories, empiricalregularitieswithoutformaltheoreticalfoundations,hunches,intuitionsand halfdevelopedinsights. Isthisthebeginningofwisdomortotalbankruptcy(9)? Thebankruptcyofmainstreameconomics Thatmainstreameconomicswasequallynonplussedbythefinancialcrashof20078 andthesubsequentGreatRecessionof20089.Thedoyenoftheneoclassicalschool, RobertLucas,confidentlyclaimedbackin2003,thatthecentralproblemof depressionpreventionhasbeensolved.AndleadingKeynesian,OliverBlanchard, nowchiefeconomistattheIMF,toldusaslateasin2008thatthestateofmacrois good! Buttheneconomicforecastinghasnotbeenthestrongsuitofthemainstream.In March2001,justasthemildglobaleconomicrecessionofthatyearbegan,according totheEconomist,95%ofUSeconomistsruledoutsucharecession.Economists surveyedbythePhiladelphiaReserveBankinNovember2007forecastthattheUS economywouldgrow2.5%in2008andemploymentwouldrise. Howhasmainstreameconomicsrationalisedthisfailuretopredictandwhat explanationshasitcomeupwithsinceforthecausesoftheGreatRecession? Modernvulgarneoclassicaleconomicsstartswiththeassumption(givenandnot proven)thatthemarketisaperfectreflectionoftheunderlyingfundamentals.Asset pricesmaychangeoftendramatically,butmerelyasarationalandautomaticresponse tothearrivalofnewinformation. Thepriceofanygivenassetatanytimeiscompletelycorrect.Itcannotbeoveror undervalued.Itistherightprice,nothingmorenorless.Ifallpublicinformationis availableimmediately,itisincorporatedintotheprice.Soanymovementcannotbe predictedbecauseitdependsoninformationthatisnotyetknown.Youcannotbeat themarket. Thusthereisthefamous(infamous)efficientmarkethypothesis(EMH).Financial marketsalwaysgetpricesrightgiventheavailableinformation.EugeneFamafrom UniversityofChicagofirstpromulgatedtheEMT.AccordingtoFama,therewasno bubbleinhousingmarketsbecauseconsumershadalltheinformationtheyneededto buy,sothepricewasright.

TheusualeconomicjokeaboutEMHisthataneconomistandhisfriendcomeacross ahundreddollarbilllyingontheground.Thefriendgoestopickitup,butthe economistsaysdont,itsnotnecessary.Ifitwerearealbill,someonewouldhave alreadypickeditup! EugeneFamadismissedcriticismofEMHasuselessinpredictingorexplainingthe GreatRecession(A).Hedeniedthattherewasanycreditbubblethatburst.Idont evenknowwhatthatmeans.Peoplewhogetcredithavetogetitfromsomewhere. Doesacreditbubblemeanthatpeoplesavetoomuchduringthatperiod?Idont knowwhatacreditbubblemeans. WhenaskedwhatcausedtheGreatRecessionifitwasnotacreditbubblethatburst, Famaresponded:Wedontknowwhatcausesrecessions.Imnota macroeconomistsoIdontfeelbadaboutthat!Weveneverknown.Debatesgoonto thisdayaboutwhatcausedtheGreatDepression.Economicsisnotverygoodat explainingswingsineconomicactivity. Whatwouldbethelegacyofthefinancialcrisisformainstreamneoclassical economics?Idontseeany.Whichwayisitgoingtogo?IfIcouldhavepredicted thecrisis,Iwouldhave.Idontseeit.Idlovetoknowmorewhatcausesbusiness cycles. Butcanthemarketeconomybeconsideredefficientafterthiscrisis?Yes.Andifit isnt,thenitsgoingtobeimpossibletotell.Thusthegreatguruofneoclassical economicssumsuphisschoolscontributiontotheissue. PaulKrugman,theleadingUSKeynesianeconomistandcolumnistoftheNewYork Times,deliveredablisteringattackonthefailureofneoclassicaleconomicstooffer anyexplanationoftheGreatRecession(10).Krugmanpronounced:admitthat financialmarketsfallshortofperfection;admitthatKeynesianeconomicsisthebest frameworkwehavemakingsenseofrecessionsanddepressions.Incorporatethe realitiesoffinanceintomacroeconomics. TheChicagoSchoolrespondedequallysharply.JohnCochranedefendedtheEMT. ThecentralpredictionoftheEMTispreciselythatnobodycantellwheremarkets aregoingneitherbenevolentgovernmentbureaucratsnorcraftyhedgefund managers,norivorytoweracademics.Thisisthebesttestedpropositioninallthe socialsciences.ThusCochranetellsusthatthemainthesisofneoclassical economicscantellusnothingaboutthefinancialcrash!Alternatively,theEMTtells usthebleedingobvious:namely,thatifsomeonemakesmoneydoinganinvestment oractivity,thenotherpeoplewillcopyhim/herandwhittleawayhis/herreturnsover time(11). Fortheneoclassicalschool,assetpricescanmoveoutoflinewithanyreasonable expectationoffuturecashflows(underlyingvalue).Thismightbebecausepeopleare preytoburstsofirrationaloptimismandpessimism.Butitmightalsobebecause peopleswillingnesstotakeonriskvariesovertimeandislowerinbadeconomic times.Wejustdontknow,apparently.

Cochranecriticisesthosewhoreckoneconomicsneedssometheoreticalpowerin predictingcrises.Cryingbubbleisemptyunlessyouhaveanoperationalprocedure foridentifyingbubbles,distinguishingthemfromrationallowriskpremiumsandnot cryingwolftoomanyyearsinarow.Ineffect,Cochranesaysthateconomistsdont knowanythingaboutbubbles.Unlessyoucanpredictwhenabubblewillburst,stop complainingabouttheEMTpredictingbubblesareimpossible! CochranearguesthatneoclassicaleconomicsandtheEMThasnotbeenfound wanting.Peoplesaythatnobodyforesawthemarketcrash.Well,thatsexactly whatanefficientmarketisitsoneinwhichnobodycantellwhereitsgoingtobe. Theefficientmarketsthesisdoesntsaymarketswillnevercrash.Itcertainlydoesnt saymarketsareclairvoyant.Itjustsaysthat,atthatmoment,thereareasmany peoplesayingitsundervaluedasovervalued.Inotherwords,theEMTtellsyou nothing! Keynesianandbehaviouraleconomictheoryisnobetterthanneoclassicaltheoryin gaugingeconomiccrises,accordingtoCochrane.Aremarketsirrationally exuberantorirrationallydepressedtoday?Itshardtotell.AsCochranesays, Letsseeameasureofthepsychologicalstateofthemarketthatcouldcomeout wrong.Thatshardtodo.Behaviouraleconomicslacksmeasurableindicatorsbut thenCochranehasnonehimself. Cochranethusdismissesanyattempttoexplainmarketvolatilityandcollapse.For him,itisthecentralpredictionoffreemarketeconomics,ascrystallisedbyHayek, thatnoacademic,bureaucratorregulatorwilleverbeablytofullyexplainmarket pricemovements.Nobodyknowswhatfundamentalvalueis.Ifanyonecouldtell whatthepriceoftomatoesshouldbe,letalonethepriceofMicrosoftstock, communismandcentralplanningwouldhaveworked. Sotherewehaveit.Theonlyindicatorofvalueisthemarketpriceandnounderlying valuecanbeascertainedthisistheultimateinvulgareconomics.Butnotethe disingenuouswordsfullyexplain.Apparently,wecanexplainsomethingand thuswecouldevenmeasureperhapsafundamentalvalueforsomething(evenifwe cannotpredictmarketpricesatanyonetime). Fortheneoclassicalschool,thecaseforfreemarketswasneverthatmarketsare perfect.Thecaseforfreemarketsisthatgovernmentcontrolofmarkets,especially assetmarkets,hasalwaysbeenmuchworse.Onthisvulgarideologicalassumption, CochranedismissestheKeynesianattackontheEMT,butalsothekeyKeynesian policyprescriptionfortheslump,namelyfiscalstimulus. ButasNourielRoubini(seebelow)pointsout,Crisiseconomicsisthestudyofhow andwhymarketsfail.Muchofmainstreameconomics,bycontrast,isobsessedwith showinghowandwhymarketsworkandworkwell. ForCochrane,fiscalstimuluswontwork.Itcanhelpemploymentforawhilebut onlyattheexpenseofweakeningconsumerdemandgrowtheventually.Cochrane

fallsbackontheneoRicardiantheoremofRobertBarro.HereCochraneandBarro areonstrongergroundascurrentempiricalevidenceofpreviousfiscalstimulus packagessuggeststhatfiscalmultipliersintheKeynesiansenseareveryweakand evennegative. CochranearguesmischievouslythatifyouareaKeynesianyouwouldhaveto supportBernieMadoffsPonziscam,becauseittookmoneyfromrichsaversand gaveittothievingspenders.Itdoesnotmatterwhatitisspentonorhowyougetitas longasitspenditandnotsaveit,accordingtoKeynes,saysCochrane. PaulKrugmansattackonthefailuresoftheneoclassicalschoolexposedthefree marketersinChicagowhodenythatanyfrictionsorflawsexistinfreemarkets. Krugmantellsusthateconomicsasafieldgotintotroublebecauseeconomistswere seducedbythevisionofaperfect,frictionlessmarketsystem.Thisiswhytheyhave nothingtosayontheGreatRecession.ForKrugman,onlyKeynesiantheorycan providelightwherethereisdark. Krugmanisparticularlyupsetthattheneoclassicalschoolhasbecomeobsessedwith substitutingbeautifulmathematicalmodelsfortruthandreality.Theyturnedablind eyetohumanirrationality,tomarketimperfections.Economistsnowhavetolive withmessiness,theimportanceofirrationalbehaviourandimperfectionsinmarkets. Economicsasafieldgotintotroublebecauseeconomistswereseducedbythevision ofaperfectfrictionlessmarketsystem.Iftheprofessionistoredeemitselfitwillhave toreconcileitselftoalessalluringvisionthatamarketeconomyhasmanyvirtues butitisalsoshotthroughwithflawsandfrictions. KeynesianBarryEichengreenarguesthatthedevelopmentofmathematicalmethods designedtoquantifyandhedgeriskencouragedcommercialbanks,investmentbanks andhedgefundstousemoreleverageasiftheveryuseofmathematicalmodels diminishedtheunderlyingrisk. Mathematicalrigorhastheinherenttendencytoconcealtheweaknessofmodels andassumptionstothosewhohavenotdevelopedthemanddonotknowthepotential weaknessoftheassumptions. TonyLawsonarguesthatthefundamentalfailingofmodernmainstreameconomics is,asKrugmansays,isnotthatitcouldnotpredicttherecentcrisisbutthatits obsessionwithmathematicalmodellingandformalisticmodelswillneverproduce anysuccessfulpredictions(12).Mainstreameconomicisdominatedbythisfailed approachtoeconomicinsights. ButaretheKeynesiansreallysayingthatmathsarenotusefulineconomics.Surely thereisnotenoughmaths?Ortobemoreexact,thereisnotenoughlogicalanalysis aswellasempiricaldatatocheck.Shouldweabandontheattempttocompare theoriesquantitativelyagainstdata?

Theproblemisnotthemathsbutthattheneoclassicalschoolbuildsaneconomic modelonthetwinassumptionsofrationalexpectationsandindividualagents.Thisis afalsebehaviouralmodelandafalsemacroassumption.Humanbeingsmaynotact asexpectedandcertainlynotatanindividuallevel. Theeconomicsprofessionhasadutytomakethatclearjustasclimatescientistsdo todayovertheirmodelsandassumptions.Buteconomistsdidnotonthecontrary. Thisshowsthevulgarideologicalnatureofmainstreameconomics. Moreimportant,thepoweroftheaggregateandhistoryiscompletelyignored.The aggregateironsouttheirrationalortheunexpected(evenifsomewrinklesremain) andhistory,namelyempiricaldataandevidence,provideadegreeofconfidencefor anytheory(thegoodnessoffit).WiththeneoclassicalEFM,neitherisapplied. CarmenReinhartandKennethRogoffhavetakenastatisticalapproachwithmuch moresuccessinrevealingtheregularityofcapitalistcrises(13).Theycomplainthat Researchontheoriginofinstabilities,overinvestmentandsubsequentslumpshas beenconsideredasanexoticsidetrackfromtheacademicresearchagenda(andthe curriculumofmosteconomicsprograms).Thiswasbecauseitwasincompatiblewith thepremiseofrationalrepresentativeagents. Adeeperquestioniswhethereconomistshaveanyhandleonferretingout dangerouspricebubbles.Thereismuchliteraturedevotedtoaskingwhetherprice bubblesarepossibleintheoryintheory,rationalinvestorsshouldrealisethatthe chainofexpectationsdrivingabubbleisillogicalandthereforecanneverhappen. Areyoureassured?Backinmygraduatedays,IknowIwas. Butitalldependsonhowmarketparticipantscoordinatetheirexpectations.In principle,pricescanjumpsuddenlyandrandomlyfromoneequilibriumtoanotheras ifdrivenbysunspots. Surely,anystudyofstockmarketswouldshowthattheyaremuchmorevolatilethan thestandardmodelsofempiricalresearchthatCochranerelieson(14)? Butofcourse,statisticalanalysisisalsoinadequatewithoutarelationtotheory.The workofReinhartandRogofflacksthat.AsPaulKrugmansays,correlationmay notimplycausation...highdebtisarguablyaconsequenceofslowgrowthratherthan theotherwayround.(B) DavidColandersumsuptherelativesuccessoftheneoclassicalandKeynesian schoolsinexplainingthecrisis(15):thefailureofeconomicsisnotafailureof ClassicalorKeynesianeconomics.Instead,itisasystemicfailureintheentire economicprofession. Colandercorrectlytellsusthebankruptcyofmainstreameconomicsispartlybecause economicmodelsfailtoaccountfortheactualevolutionoftherealworldeconomy. Moreover,thecurrentacademicagendahaslargelycrossedoutresearchonthe inherentcausesoffinancialcrises.Therehasalsobeenlittleexplorationofearly

indicatorsofsystemiccrisisandpotentialwaystopreventthismaladyfrom developing. Colandergoeson:systemiccrisisappearslikeanotherworldlyeventthatisabsent fromeconomicmodels.Mostmodelsbydesignoffernoimmediatehandleonhowto thinkaboutordealwiththisrecurringphenomenon.Inourhourofgreatestneed, societiesaroundtheworldarelefttogropeinthedarkwithoutatheory. Whatweneedaremodelscapableofenvisagingsuchexceptionalcircumstances. Instead,macroeconomicsisconfinedtomodelsofstablestatesthatareperturbedby limitedexternalshocksandthatneglecttheintrinsicboomandbustdynamicsofour economicsystem. ButColanderwantsuseconomiststoretreattotheideathateconomicsisnotareally ascience,butanart.Itsnotthelackofmathsortoomuch.Itisthataneconomyis acomplexsystemandwedontknowhowtoanalyseit.Wemuststarttorelyon commonsense.Godhelpus! ForColander,thewayout,istoadmitbankruptcyofmainstreamtheoryandgiveup onscience.Economistshavehadnochoicebuttoabandontheirstandardmodels andtoproducehandwavingcommonsenseremedies.Butcommonsenseadvice, althoughuseful,isapoorsubstituteforanunderlyingmodelthatcanprovidemuch neededguidancefordevelopingpolicy. Animalspiritsschool TheKeynesianschoolseemstohavedesertedtheoldliquiditypreferenceelementof Keynesiantheoryforanexplanationofthiscrisis,namelythatmoneygetsstuckinthe financialsectorasindividualshoardcashandbanksdonotlenditontothereal economybecauserealinterestratesaretoohigh.Krugmanpreferstodrawonthe causesofthecrisisinKeynesperceptionoftheanimalspiritsofcapitalism(namely thechangesintheconfidenceofeconomicagents,consumersandbusinessleaders,to buy,borrow,invest,orspeculate. TheNewKeynesianswhoreconciledthemoreradicalaspectsofKeynestheory withtheneoclassicalmodelarguethatacutintheinterestratemighthelpraise effectivedemandorconsumptionnow,butlowerplannedconsumptioninthefuture. Thatwontendeconomicrecession.Sohowdoesacapitalisteconomygetoutof recession?Throughpixiedust!NewKeynesiansmustassumethatsometimeinthe futurefullemploymentwillbeestablished.SotheoldKeynesiancauseofrecession (anunemploymentequilibrium),namelyahighrealinterestrate,isnotright.The problemisthelackofaTinkerbelleffect,themagicofconfidence(E).Recessionis theresultofconfidencefallingandtheansweristorestoreconfidence.Itsassimple asthat. TheKeynesianshavealsodesertedtheirstandardeffectivedemandtheorybasedon thelackofconsumption.RobertFarmerisaleadingKeynesianeconomistand advisertovariousUSgovernments.Forhim,thekeyelementofaKeynesian explanationisinanimalspirits.Demanddependsonconfidenceandthatisbest

indicatedbythemovementinstockprices.Farmerdoesnottelluswhyconfidenceis subjecttosuchsuddenandsharpchanges.Itjustis. Afallinconfidenceleadstoafallinstockpricesandthentoemployment, consumptionandinvestment.Andthespiralcontinuesuntilconfidencereturns. Thenstockpricesriseandthewholeprocessreverses.Thusthecrisisiscausednot byalackofeffectivedemandleadingtoacollapseinwagesandemployment,butthe lackofspeculationinstockmarkets! Stockmarketscouldstaypermanentlyinabearmarket.Theanswerisnotsomuch toprovidefiscalstimulusbutforthegovernmentandthecentralbanktointervene throughthepurchaseofstockmarketindexestopumpprimetheinvestorsandrestore theiranimalspirits. Thebehaviouristculdesac TheKeynesianshavealsolookedtobehaviouralschoolofeconomistsforbetter explanationsofeconomiccrisis.Forsometime,thismicromotivationapproachto economicshasbeenpopularwithyoungeconomistswhohaveturnedawayfrom questionslikepoverty,inequalityorunemploymenttostudybehaviourontelevision gameshows. Forexample,theyoungeconomistsattheBankofEnglandwishtotellusthatsuchis theroleofuncertaintyineconomics(16)(asitisinclimatechangeortheweather) thatwemustacceptsharpchangesinexpectations,whichisexactlywhathappened inautumn2008,withthesuddenandsynchronouscollapseinbusinessconfidence aroundtheworld. Forthem,thewayforwardistolookmuchmorecloselyatthebehaviourofeconomic agents.Therearefourkeyaspects:1)consumerorbusinessbehaviourcanbe influencedbyrecentorpersonalexperience(adepressionforexample).2)economic behaviourcandependonhowtheissuesarepresentedtoeconomicagents(like whethertheirpensionsareassuredornot)3)peopletendtofollowtheactionof others(theherdinstinct,thewisdomincrowdsetc)and4)peoplehaveexcessivefaith intheirownjudgementsandwishfulthinking.Economistsarethusfacedwitha conundrum:theyneedtoprovideguidanceonthedirectionofaneconomybutsuchis theroleofpeoplesexpectationsanduncertainty,theycannotwithanydegreeof accuracy.Ohwoeisme. Apparentlypeopledonotoftenmakedecisionsintherationalfrontofbrainway assumedinneoclassicaleconomics,butmakedecisionsthatarerootedinthe instinctivepartofthebrainandthusproduceherdeffectsandirrationalmomentum swings. Accordingtoonesource(17),incrises,peopleknowtherisksbutirrationallydecide toignorethem.ThisviewofirrationalbehaviouristhekeyelementofKeynes GeneralTheoryandthusthecrisiswasmoreaKeynesmomentthanaMinskyone!

Weevenhavebehaviouristsdevelopingcomputermodelswheretheideaisto populatevirtualmarketswithartificiallyintelligentagentswhotradeandinteract andcompetewitheachothermuchlikerealpeople(18).Apparently,these computerisedagentbasedmodelsletmarketbehaviouremergenaturallyfromthe actionsofinteractingparticipants.Whatcomesoutmaybeaquietequilibrium (neoclassical)oritmaybesomethingelse.Well,thatshelpful!Apparently,whena modelofincreasedleverageisdevelopedwitheconomicagentslikecomputerised hedgefunds,wefindthatinstabilitygrows,butnotgraduallybutsuddenly.Thereisa tippingpoint,aqualitativechangealaMarxistdialectics.Thusthebehaviourof marketagentscanleadtofinancialcrisesbytheverynatureofmarkets.Thisis nothingnew,butchaosorcomplexitytheorypractisedinavirtualworldeconomy. Theheterodoxschools Austrianschool TheAustrianschoolofeconomicsisoutsidethemainstream(atleastaccordingtothe Whiginterpretationofthehistoryofeconomics)(19). TheAustriansstartfrommicroassumptions.Thisisnottheneoclassicalviewof rationalfullyinformedhumanagents,maximisingtheirutilityandprofits.Onthe contrary,humanactionarespeculativeandthereisnoguaranteeofsuccessin investment. Indeed,accordingtoCarlMenger,thefounderoftheschool,thefurtherouttheresults ofanyinvestmentare,themoredifficultitistobesureofsuccess.Thusinvestment ingoodsthatareforimmediateconsumptionareeasiertoestimatethereturnsonthan investmentingoodsneededforcapitalgoods.Savingratherthanconsumptionisa speculativedecisioninordertogainextrareturnsdowntheroad. Austriansreckonthatthecostofthissavingcanbemeasuredbythemarketinterest ratewhichpricesthetimeinvolvedindeliveringfutureoutputfromsavingsnow. Economiccrisiswouldnothappenifitwerenotforinterferenceinsettingthatmarket rateofinterestbycentralbanksandgovernments. Theboomphaseinthebusinesscycletakesplacebecausethecentralbanksupplies moremoneythanthepublicwishestoholdatthecurrentrateofinterestandthusthe latterstartstofall.Loanablefundsexceeddemandandthenstarttobeusedinnon productiveareas,inthecaseoftheboom200207inthehousingmarket.These mistakesduringtheboomareonlyrevealedbythemarketinthebust. ThustheGreatRecessionisnotaproductofthegreedoflaisserfairecapitalism,it istheunintendedconsequenceofverysignificantinterventionsintheoperationofthe marketprocess:theFedsexpansionarymonetarypolicyandasetofpoliciesthat artificiallyreducedthecostsandrisksofhomeownershipenablingthecreationof highlyriskyloanswhichthemselvesthenleadtoevenriskierinnovationsinthe financialindustry.

FromanAustrianperspective,theeventualcollapseofthehouseofcardsbuilton inflation(ofcredit)representsnotafailureofcapitalism,butalargelypredictable failureofcentralbankingandotherformsofgovernmentintervention. TheGreatRecessionwasaproductoftheexcessivemoneycreationandartificially lowinterestratescausedbycentralbanksthatonthisoccasionwentintohousing. Therecessionwasnecessarytocorrectthemistakesandmalinvestmentcausedby interferencewiththemarketpricingofinterestrates.AstheAustrianscorrectlypoint out,therecessionistheeconomyattemptingtoshedcapitalandlabourfromwhere itisnolongerprofitable.Andnoamountofgovernmentspendingandinterference willhelptoavoidthatcorrection. WithintheAustrianschool,thereisgeneralagreementthatbusinesscyclesare primarilycausedbyperiodiccreditexpansionandcontractionofcentralbanks. Businesscycleswouldnotbeafeatureofatrulyfreemarketeconomy.Aslongas capitalistswerefreetomaketheirownforecastsandinvestmentallocationsbasedon marketpricesratherthanbybureaucrats,therewouldbenobusinesscycles! Cyclesareduetothemanipulationofcreditbystateinstitutions.Thisdiffersfrom neoclassical/monetaristschoolwhichseesrecessionsasminorinterruptionsfrom growthcausedbyimperfectionsinmarketinformationormarketsnotbustscausedby artificialcreditbooms. Onthatbasis,puttingmorecreditintotheeconomytosolvetherecessionislike givingmorealcoholtoadrunkenman.AsKrugmansaysabouttheAustrianschool, theyreckonthatarecessionislikeahangoverafteraheavynightofboozing. Butifthemarketwaslefttosettheinterestrateandallowcapitaliststomake investmentdecisionsunfetteredormisguidedbythestate,wouldthatendthecycleof boomandslump? TheAustriansareperceptiveintheirhighlightingthatacreditbubblecanappearthat artificiallyextendsanyboombeyondanygrowthbasedonrealvalues.Thatcredit boomcanbecreatedbygovernmentandcentralbanksdesperatetosustaingrowth whenprofitsappeartobewaning(Ricardo)orconsumptionandinvestment weakening(Keynes). InMarxistterms,itmeansfictitiouscapitalisdramaticallyexpandedtocompensate foraslowingoftheaccumulationinrealcapital.Theresultisthatexcesscapitalis evengreaterattheheightoftheboomand,inthesubsequentbust,thereductionin overinvestment,malinvestmentorexcesscapitalmustbeevengreater(20).This producesaGreatRecessionasopposedtoanyrecession. FortheAustrians,theanswertoboomandslumpistodoawaywithcentralbanksand statestimulusandletmarketsdecidetherateofinterest(21).therateofinterestis oneofthemostimportantsignsofpricesignalsinanyeconomy.Anythingwhichacts todistortthatsignalwillproduceunintendedrealeconomyeffectsthatwilleventually havetobecorrectedbydownturnandrecession.Intheshortterm,theseeffectscan

beamelioratedoroffsetbyfastergrowthincredit,buteventuallythesewilllose traction.Malinvestedcapitalisthenexposedandeconomicactivityturnsdownasa result. Butistherateofinterestthedrivingforceofcapitalistinvestmentandthepricesignal thatcapitalistslookfortomakeinvestmentdecisions?AsMarxexplained,interestis justonepartofsurplusvalueanditisthelatterthatiskeytoinvestment.Valueand surplusvaluearecreatedintheproductionprocess,inparticularintheexchangeof moneyforlabourandthroughtheproductivityoflabourusingcapitalgoods. WhattheAustrianschooldonotexplainiswhyexcesscrediteventuallydoesnot work.Apparently,thereisapointwhencreditlosesitstractiononeconomicgrowth andassetpricesandthen,fornoapparentcause,growthcollapses. TheAustriansignorethefundamentalflawinthecapitalistprocessidentifiedbyMarx inhislawofprofitability.FortheAustrians,asforthemainstreameconomicschools, thereisnoproblemwithcapitalistproductionforprofittheproblemliesin imperfectinformationandimperfectmarkets(neoclassical);theperiodiclackof effectivedemandduetomercantilisthoardingand/orthevolatilityofanimalspirits (Keynesianism)orexcessivecreditcreatedbythestate(Austrian).Noneofthese schoolshasanythingtosayabouttheflawednatureofthesocialorganisationof production. LeftKeynesianschoolandMinsky AlsooutsidethemainstreamisasubdivisionoftheKeynesianschool,namelythose wholooktoaninherentinstabilityincapitalismtobefoundinthefinancialsector.In the1980s,HymanMinskyarguedthatKeyneshadbeenmisunderstoodbythe revisionistsofKeynes,whohadincorporatedhisideasintothemainstream. Incontrast,MinskyreckonedthatKeyneshadshowncapitalismtobeinherently unstableandpronetocollapse:instabilityisaninherentandinescapableflawof capitalism. Thisinstabilityistobefoundinthefinancialsector.Theflawexistsbecausethe financialsystemnecessaryforcapitalistvitalityandvigour,whichtranslates entrepreneurialanimalspiritsintoeffectivedemandinvestment,containsthe potentialforrunawayexpansion,poweredbyaninvestmentboom. ForMinsky,thereisnoflawinthecapitalistproductionprocesstherealeconomy butonlyintheveilofmoneyandfinancialintermediationbetweenproductionand consumption.Asdebtaccumulates,itbringsuncertaintyandinstabilityintothe process.Therearethreesortsofborrowers:hedgeborrowers,speculativeborrowers andPonziborrowers.Thefirstborrowsandpaysbacktheprincipalandinterest;the secondservicestheinterestonlyandrelyonassetpricestorisetopaytheprincipal. Thethirdgrouppaystheinterestonlybyborrowingmore. Inaboom,thefirstgroupdeclinesinproportionandthelatterrisesasashare, openinguptheriskofinstabilitywhenthepyramidofdebtstartstocrumble.The

actualtriggerforthisdebtcrisiscouldbeinthepropertymarketasin2007orin equitiesasin2000.Thegreatertherelianceisonleverageanddebttofinance investment,thegreateristhelikelihoodofcollapse.Oncehousepricesstoprising enoughtocovertheservicingofdebt,therecanbeasuddenaversiontoriskanda desiretodeleveragethisiswhathasnowbeendescribedasaMinskymoment,as in2007. MinskysupporterswillacceptthattheGreatRecessiondidnotfollowhisdepictionof afinancialcrisisbutarguethattheMinskyswayoflookingataneconomywould bestrevealthecauseoftheGreatRecession,namelyinaprocyclicalburstofcredit infinancialsectordominatedeconomy.Systemicriskinthefinancialsector eventuallycollapsesintodebtdeflation(22). SteveKeenhaswontheawardfromtheRealEconomicsReviewastheeconomist whobestforecastthefinancialcollapseon2008(seebelow).KeendrawsonMinsky forhistheoryendogenousmoneyandalsoonMarx.ForKeen,MarxhasaMinskyan viewoftheroleofmoneyincapitalistcyclesandinthepowerofthecreditsystemto disruptproduction(23). ForMarx,aswithFischerandMinskybeforehim,theessentialelementgivingrise toDepressionistheaccumulationofprivatedebtsaysKeen,referringtoFischers commentthatdeleveragingcanbespiralintodebtdeflationasthenominalvalueof debtisoutstrippedbyafallinprices.ForKeencapitalismisinherentlyflawed, beingpronetobooms,crisesanddepressions.Thisinstability,inmyview,isdueto characteristicsthatthefinancialsystemmustpossessifitistobeconsistentwithfull blowncapitalism.MinskyJournalofFinance,Vol241969 ForKeen,itisMarxsdistinctivecontributionthatthecostofborrowing,themarket rateofinterest,willgenerallybegovernedbytheaverageexpectationsoftheprofit ofthecapitalistclass.ThatdiffersfromtheAustrianschoolsviewthatthemarket rateisdeterminedbythedurationoftheinvestment.However,Keendeniesanyrole forprofitabilityinthecrisis:thecrisisistheproductofinsufficientdemandwhen capitalistexpectationsofrealisingprofitsarenotmet. Thecherrypickers NourielRoubiniisthedarlingofthefinancialpress,apparentlyforbeingalonein predictingthecreditcrunchandthesubsequentcrisis.HedismissestheTalebview greedilyendorsedbyWallStreetbankersandAlanGreenspanthatthefinancialcrisis wasafattaileventthatcouldnotpossiblybeforeseeninahundredyears. ThisideaofthemediafosteredbyRoubinievenonthecoverofhislatestbookis goodspin(24).Buttherewereseveralotherswhowarnedofanoncomingassetprice crisisorfinancialcrisis.AccordingtoRealWorldEconomicReview,theRevere wardforeconomicsvotedonby2500peopleforthethreeeconomistswhowarnedthe worldwenttoSteveKeen,theAustralianeconomist,withtwiceasmanyvotesas Roubiniwhofinishedsecond,whileDeanBakerfromtheCEPRcamethird.

Otherswhocouldclaimtobeprescientincludesomefromtheanimalspiritsschool, likeRobertShillerwhotalkedofthehousingbustasearlyas2006.Fromthe Austrians,WilliamWhitewaswarningofexcessivecreditbackin2004.Evenyour humbleselfproposedasearlyas2005ofthedangersofahousingbustandin2006 reckonedonthebasisofMarxisttheoryandempiricalevidencethatadeeprecession wasduein200910.Itcameayearearlier.Ofcourse,wedontcarrythemediaclout ofRoubini. Roubinicorrectlyarguesthatfinancialcrisesaremorelikeasuccessionofwhite swans,knownunknowns;inthesensethatthecrisisfollowsapatternthathas happenedbeforewithfinancialcrises(seeReinhartandRogoff).Crisesareneither freakeventsthatmoderneconomicshasmadethemseemnortherareblackswans thatothershavemadethemouttobe.Rather,theyarecommonplaceandrelatively easytoforeseeandtocomprehend.Callthemwhiteswans. Mostcrisesbeginwithabubbleinwhichthepriceofparticularassetrisesfar aboveitsunderlyingfundamentalvalue.Crisesarenotblackswansbutwhiteswans: theelementsofboomandbustareremarkablypredictable. Roubini,aneclectic,followstheAustrianschoolinlookingatexcessivecreditasthe indicatoroffuturecrises(seeWhiteandBorio).ButhefollowsMinskyforhis instabilityidea. RoubiniridiculestheEMHoftheneoclassicalschool.Butforhimasalways, pragmatisminformsourchoices.Keynesishere,asishismostradicalinterpreter, HymanMinsky,butsoaretheeconomistsofothercamps:RobertShiller,oneofthe mostvisibleproponentsofbehaviouraleconomics;JosephSchumpeter,thegrand theoristofcapitalistcreativedestructionandeconomistsofhistoricalbent,from CharlesKindlebergertoCarmenReinhartandKenRogoff.Theirdisparatestrands informouridiosyncraticapproach. Inthehistoryofmoderncapitalism,crisesarethenorm,nottheexception.Thats nottosayallcrisesarethesame.Farfromit,theparticularscanchangefrom disastertodisasterandcrisescantracetheiroriginstodifferentproblemsindifferent sectorsoftheeconomy. Roubinitellsusthatcrisescannotbeavoidedundercapitalism.Buttheycanbe preparedforandthenmitigatedbyregulationandreform.Forhim,thatmeans controlsonderivativesmarkets,betterratingagencies,capitalisationofthebanks, withnobanktoobigtofail,andinternationaleconomicgovernancethroughthelikes oftheIMF. ButhequotesHymanMinsky:Thereisnopossibilitythatwecaneversetthisright onceandforall.Instabilitywillbehavingtestedonesetofreforms,willaftertime, emergeinanewguise...nothinglastforeverandcriseswillalwaysreturn. However,Roubiniisoptimistic:atleastsevereinstabilityonlycomesalong infrequentlyevery80yearsfromGreatDepressiontoGreatRecession.Ifwe

strengthentheleveesthatsurroundourfinancialsystem,wecanweathercrisesinthe comingyears. Lessknowntothefinancialmedia,butperhapsmorediscerninginhisanalysisof crisesisWilliamRWhite,formerlyattheBankofInternationalSettlements,butnow chairoftheOECDseconomicreviewcommittee(25).ForWhite,mainstream economistshavemissedthekeyingredientthatleadstosystemiccrisis,thebuildup ofdebt.DrawingontheargumentsoftheAustriansandMinsky,Whitecriticisesthe traditionalKeynesianviewoftheeconomyasaseriesofflowsandwantseconomists toconcentrateontheeconomicbalancesheetanddebtstocksinparticular. ForWhite,itissignificantthatinKrugmansattackonmainstreameconomics,he mentionsdebtonlytwicein6000wordsandthenonlytoaboutsovereigndebt.But debtisthecentralproblem.WhendebttoincomeordebttoGDPdoubles,triplesor quadruples,youhavedoubled,tripledorquadrupledtheamountoffutureearnings youareusingtoday.Thatnecessarilymeansyouwillhavelesstospendinthefuture. Itsnotrocketscience. Whiteisnotrelyingonassertionortheory.Indeed,asearlyas2002,BISeconomist ClaudioBoriomadeempiricalestimatesofthecorrelationbetweencredittoGDP ratiosandsubsequentbankingorfinancialcrises(seebelow). ForWhite,thetheoryofrationalexpectationsfromtheneoclassicalschoolisshown tobeflawedwhenassetpricescanmovesofaroutofstepwithunderlyingvalues.If themarketissoefficient,whyisunemploymentorthepricesofmanykey commoditieslikeenergyunabletoadjust? WhiteisnomoreenamouredwithKeynesianthoughtatleastinitsmainstream(26). Theyhaveneverbeengoodatforecastingturningpointsinthebusinesscycle.The animalspiritsideahasmorevalidityinexplainingvolatility.ButtheKeynesian frameworkhasallitsfuzzinessanduncertaintiesimplicitintheprincipalfunctional formsbeingsubjecttoanimalspirits.Nowonder,noempiricalforecastingbythe mainstreameconomicbodiescanshowsomuchshortcomings. ForWhite,thecrisisisbothfinancialandreal.Theassociatedconcernthat weaknessinthefinancialsystemcouldfeedbackintotherealeconomythrough tightercreditconditionsalsofeedstheperceptionthatitisonlyafinancialcrisis. Forhim,acreditcrisisonlybecomesacrisisifitfeedsbackintotherealeconomy fromthecreditcrunchtotheGreatRecession.Onetendencythatmustberesistedis toseethisworkonimbalancesasrelatedsolelytofinancialstability.Inpart,this tendencyisrelatedtothemisconceptionthatourcurrentproblemsarelimitedto thoseofafinancialcrisis. Thatissurelyright:notallfinancialcrisesleadtoeconomiccontractionsorslumps. Butheoffersnoexplanationofhowthisprocessfromthefinancialtotherealmight work.

Theneedfortesting Predictioncanbeverydifficult,especiallyifitisaboutthefuture.NielsBohr. Therearesomemethodologicallessonsfromalltheabove,whetherfromthe mainstreamortheheterodox.Ifeconomistswanttounderstandthecausesof financialandeconomiccrisis,theyneedtolookawayfromindividualbehaviouror modelsbasedonrepresentativeagentsandinstead\looktotheaggregate:fromthe particulartothegeneral. Andtheyneedtoturnbackfromdeductiveapriorireasoningalonetowardshistory, theevidenceofthepast.Thehistorymaynotbeaguidetothefuture,butspeculation withouthistoryisevenlessbasedinreality.Economistsneedtheoriesthatcanbe testedbytheevidence. Mainstreameconomicsdoesnotseemtohaveanypredictivepower.Ivebeen forecastingfor50yearsandIhadnotseenanyimprovementinourcapabilityof forecasting,saysthegreatmaestro,AlanGreenspan(27).ChristineRomer,key economicadvisertoObamaarguesthat:economistscannotpredictrecessionsand economicdiscontinuitiesbecausetheyareinherentlyunpredictable.Itisimpossible toseetheshockscoming.Butisthatreallyso?Predictionsinvolvemodelling. Thedifferenceisthatformanypeoplethemodelsarepoorlyspecified,basedonlittle informationandcannotbetested.Thosewhorailagainstmodelsandthefollyof forecasting,whilestillmakingpredictions,arestilldoingmodellingbutdoingitvery poorly.(28). Ifwedesertdata,economistswillheadintoavirtualworld.Somehavealreadydone so(29).Manymacroeconomistsabandonedtraditionalempiricalworkentirely, focusinginsteadoncomputationalexperiments.Researcherschooseaquestion, buildatheoreticalmodeleconomy,calibratethemodelsoitmimicstherealeconomy alongsomekeystatisticaldimensionsandthenrunacomputationalexperimentby changingmodelparameterstoaddresstheoriginalquestion.Thelasttwodecades haveseencountlessstudiesinthismould,ofteninadynamicstochasticgeneral equilibriumframework.Whatevermightbesaidindefenceofthisframeworkasa toolforclarifyingtheimplicationsofeconomicmodels,itproducesnodirect evidenceonthemagnitudeorexistenceofcausalaffects.Anefforttoputreasonable numbersontheoreticalrelationsisharmlessandmayevenbehelpful.Butitsstill theory. Macroeconomicshastakenaturntotheoryinthelast1015years.Manyyoung economistsaremorecomfortablewithprovingtheoremsthanwithgettingtheirhands onanydataorspeculatingoncurrentevents(30). Sure,everysituationisdifferentbutanyonewhomakesalivingoutofdataanalysis probablybelievesthatheterogeneityislimitedenoughthatthewellunderstoodpast canbeinformativeaboutthefuture.Theprocessofaccumulatingempiricalevidence israrelysexyintheunfoldingbutaccumulationisthenecessaryroadalongwhich resultsbecomemoregeneral.

ClaudioBoriowasamongthefeweconomistsinamajorfinancialinstitutiontolook empiricallyforindicatorsofoncomingcrises.Hefoundasearlyas2002,that unusuallystrongincreasesincreditandassetpriceshavetendedtoprecedebanking crises(31).Thisworkistestableandthushassignificantpredictivepower.Borio andLowelookedatthelongtermrelationshipbetweencreditgrowthintheG10 economiesandthemovementofassetprices.Theyfoundthattherewere38crisis episodesbetween1970and1990,spreadover26countries.Whencreditasashareof GDPgrewto45%ptsabovetrend,itwasfollowedbyasomeformoffinancialcrisis onnearly80%ofoccasionswithinoneyear. Similarly,CarmenReinhartandKennethRogoffdidempiricalworkforover60 countiessince1820andfoundthatdebtcrisescomeinwaveslikeearthquakes.And weappeartobeinanotherwaverightnow(32). Marxistschool FortheKeynesians,whetheroftheanimalspiritsschool,thefinancialinstability school(Minsky),theflawsofcapitalismlieinthefinancialsectoronly.Modern KeynesianeconomistsusuallyignoreKeynesotherhintatthecauseofcapitalist crisis,namelyafallingmarginalefficiencyofcapital,theclosestKeynescomesin hisneoclassicalmodelofdiminishingreturnstoMarxsanalysisofdeclining profitabilityinthecapitalproductionprocess. Keyneswrote:Amoretypical,andoftenthepredominant,explanationofthecrisis is,notprimarilyariseintherateofinterest,butasuddencollapseinthemarginal efficiencyofcapital.(33).Themarginalefficiencyofcapital,stressedKeynes, dependeduponanimalspiritsasmuchasrealfactorssuchasthecausesofactual profits.However,thissuggeststhatKeynes,likeMarx,sawcrisesasoriginatingin therealeconomyandinattitudestheretomorethanthefinancialsystem,which meansit'snotclearthatourcurrentcrisisisespeciallyKeynesian.Asweknow, KeynesneverreadanyMarxandKeynesdidnotprovideanyexplanationofthis approachandhowitwouldworkinalongtermunemploymentequilibriumthat Keynesalsoposits(34). Marxpositstheultimatecauseofcapitalistcrisesinthecapitalistproductionprocess, specificallyinproductionforprofit.Thisisanaggregatetheory,nota microeconomicone.Ifitissaidthatoverproductionisonlyrelative,thisisquite correct;buttheentirecapitalistmodeofproductionisonlyarelativeone,whose barriersarenotabsolute.Theyareabsoluteonlyforthismode,i.e.,onitsbasis.How couldthereotherwisebeashortageofdemandfortheverycommoditieswhichthe massofthepeoplelack,andhowwoulditbepossibleforthisdemandtobesought abroad,inforeignmarkets,topaythelabourersathometheaverageamountof necessitiesoflife?Thisispossibleonlybecauseinthisspecificcapitalistinterrelation thesurplusproductassumesaforminwhichitsownercannotofferitfor consumption,unlessitfirstreconvertsitselfintocapitalforhim.Ifitisfinallysaid thatthecapitalistshaveonlytoexchangeandconsumetheircommoditiesamong themselves,thentheentirenatureofthecapitalistmodeofproductionislostsightof; andalsoforgottenisthefactthatitisamatterofexpandingthevalueofthecapital, notconsumingit.Inshort,alltheseobjectionstotheobviousphenomenaofover

production(phenomenawhichpaynoheedtotheseobjections)amounttothe contentionthatthebarriersofcapitalistproductionarenotbarriersofproduction generally,andthereforenotbarriersofthisspecific,capitalistmodeofproduction. Thecontradictionofthecapitalistmodeofproduction,however,liespreciselyinits tendencytowardsanabsolutedevelopmentoftheproductiveforces,which continuallycomeintoconflictwiththespecificconditionsofproductioninwhich capitalmoves,andalonecanmove.(Capital,vol.III,p.366)7. Inshortthislawgoes:ascapitalismdevelopstheamountofconstantcapitalrisesin relationtovariablecapital.Becauselabourpowerpurchasedwithvariablecapitalis theonlypartofcapitalwhichproducesurplusvalue,theamountofsurplusvaluefalls inrelationtothecostofthecapitalists,thisdepressestherateofprofitunlessthereis anacceleratingincreaseintherateofsurplusvalue.Thelawhasmanycounteracting features(cheapeningofthemeansofproductionisoneofthemostimportantones) whichwewillnotdiscusshere,butMarxprovesinchapter13and14thatitwill assertitselfsooneralaterasconcretereality. Marxlinksthisdirectlywiththeideaofoverproduction:Thesocalledplethoraof capitalalwaysappliesessentiallytoaplethoraofthecapitalforwhich thefallintherateofprofitisnotcompensatedthroughthemassofprofitthisis alwaystrueofnewlydevelopingfreshoffshootsofcapitalortoaplethorawhich placescapitalsincapableofactionontheirownatthedisposalofthemanagersof largeenterprisesintheformofcredit.Thisplethoraofcapitalarisesfromthesame causesasthosewhichcallforthrelativeoverpopulation,andis,therefore,a phenomenonsupplementingthelatter,althoughtheystandatoppositepoles unemployedcapitalatonepole,andunemployedworkerpopulationattheother. Overproductionofcapital,notofindividualcommoditiesalthoughover productionofcapitalalwaysincludesoverproductionofcommoditiesistherefore simplyoveraccumulationofcapital.(Capital,vol.III,p.359) Thatdoesnotmeanthefinancialsectorandinparticular,thesizeandmovementof creditdoesnotplayanyroleincapitalistcrisis.Onthecontrary,thegrowthofcredit andfictitiouscapital(asMarxcalledspeculativeinvestmentinstocks,bondsand otherformsofmoneyassets)picksuppreciselyinordertocompensateforthe downwardpressureonprofitabilityintheaccumulationofrealcapital. Afallintherateofprofitpromotesspeculation.Ifthecapitalistscannotmakeenough profitproducingcommoditiestheywilltrymakingmoneybettingonthestock exchangeorbuyingvariousotherfinancialinstruments.Thecapitalistsallexperience thefallingrateofprofitalmostsimultaneouslysotheyallstarttobuythesestocksand assetsatthesametimedrivingpricesup.Butwhenstocksandassetspricesarerising everybodywantstobuythemthisisthebeginningofbubbleonexactlythelines whichwehaveseenthemagainandagainsincetheTulipCrisisof1637. If,forexample,thespeculationtakesplaceinhousingthiscreatesanoptionfor workerstoloanandspendmorethantheyearn(morethanthecapitalistshavelainout asvariablecapital)andinthiswaytherealizationproblemissolved.Butsooneror laterbubblesburstwheninvestorsrealizethattheassetsarenotworthwhattheyare

payingforthem.Therealizationproblemreoccursinanexpandedformcompared withbeforethebubble:nowtheworkershavetopaybacktheirloansandthiswith interest,theyhavetospendlessthantheyearn.Theresultisevengreater overproductionthanwasavoidedtemporarilyinthefirstplace.Whileconsumer creditonlyincreasesdemand,producercreditalsoincreasessupply. Thebasicproblemisstillthefallenrateofprofitwhichdepressesinvestmentdemand. Iftheunderlyingeconomywerehealthyanimplodingbubbleneedsnotcauseacrisis, oratleastonlyashortone.Whenworkersandcapitalistspayinterestsontheirloans, thismoneydoesnotjustdisappear,somefinancecapitalistscollectthem.Ifthetotal economyishealthyandtherateofprofitishighthentherevenuegeneratedfrom interestpaymentswillinonewayoranotherbereinvestedinproduction. Thecrisisisnecessarytocorrectandreversethefallingrateandmassofprofit.The periodicaldepreciationofexistingcapitaloneofthemeansimmanentincapitalist productiontocheckthefalloftherateofprofitandhastenaccumulationofcapital valuethroughformationofnewcapitaldisturbsthegivenconditions,withinwhich theprocessofcirculationandreproductionofcapitaltakesplace,andistherefore accompaniedbysuddenstoppagesandcrisesintheproductionprocess.(Capital, vol.III,p.358).Inthissense,thecauseofcrisisforMarxisnotjustintheanarchyof themarketbutintheanarchyofproduction(35). JosephChoonarahasprovidedaveryusefulaccountofthevariousMarxist explanationsoftheGreatRecessionand,inparticular,thedebateaboutwhetherthe crisisisaproductofthefinancialsectoralone,ortherealeconomyoradialectical relationshipbetweenthetwo(36). Carchediattacksthefinancialsectoronlyargumentanddoingsogivesthe underconsumptionthesisofcrisisanotherworkingover(37).ForCarchedi,theflight ofmoneytothefinancialandspeculativesectorsoftheeconomyisreallya countertendencyresponsetothefallingrateofprofitintheproductivesectors.A higherrateofprofitcanbegeneratedforawhileintheseunproductivesectors,helped bythemonetaryauthoritieskeepingthebasicrateofinterestlowandstimulating credit. Anartificialandtemporaryinflationofprofitsintheunproductivesectorshelps sustainthecapitalisteconomyandresisttheimpactofafallingrateofprofitinthe productivesectors.Theincreasingshareofdebtorswhocannotfinancetheirdebt (Minskysdebtors)eventuallycausesdefaultandthecrisiseruptsinthefinancial sector.Thebasicpointisthatfinancialcrisesarecausedbytheshrinking productivebaseoftheeconomy.Apointisthusreachedatwhichtherehastobea suddenandmassivedeflationinthefinancialandspeculativesectors.Eventhoughit looksasthoughthecrisishasbeengeneratedinthesesectors,theultimatecause residesintheproductivesphereandtheattendantfallingrateofprofitinthissphere SomeMarxistshavearguedthatthecreditcrunchof2007andtheensuingGreat RecessionisnotaclassicalMarxistcrisisofprofitability(38).Marxwouldhavealso seenthecrisisasfinancialincause.ItstruethatMarxdistinguishedbetween

differentsortsofmonetarycrisisThemonetarycrisisdefinedasaparticularphase ofeverygeneralindustrialandcommercialcrisis,mustclearlybedistinguishedfrom thespecialsortofcrisis,alsocalledamonetarycrisis,whichmayappear independentlyoftherestandonlyaffectsindustryandcommercebyitsbackwash. Thepivotofthesecrisesistobefondinmoneycapitalandtheirimmediatesphereof impactisthereforebanking,thestockexchangeandfinance. Goingfurther,somearguethatthecrisiswastheproductofabrandnewdevelopment incapitalism:theglobalisationoffinancecapitalanditsnowoverwhelming dominanceofthecapitalisteconomy.Crisescannowtakeplaceinthatsectoralone andcauseeconomicrecession.Marxslawofprofitabilityisnolongerrelevant. Butfinancialglobalisationisnothingnew:In1875,bankerKarlvonRothschild assignedthebankingcollapsethentothewholewordbecomingacity.The interdependenceofstockmarketsandcredittotherealeconomyisnotnew. ItstruethattheshareofUSgrossdomesticincomeaccruingtofinanceandinsurance rosedramaticallyfrom2.3%in1947to7.9%in2006.ButasGreenspansaid,canwe saythatthegrowthofthefinancialsectorwasthecauseoftheGreatRecessionifit hadbeenexpandingforsixdecadeswithoutacrisisofproportionsof2008? AsMickBrooksputsit:Movementsintherateofprofithavetheireffectonthe financialsector.Thisisparticularlythecaseinthemodernerawhenthevery predominanceoffinancecapitalandthesheerscaleoffictitiouscapitalmeanthat bubblesareconstantlybeingblown.Bubblestendtobeginasprofitsreviveaftera downturn.Theywaxfatinthegoodyears.Ascrisisimpends,capitalpanicsand takesflight.Theburstingofthebubblesseemsanaccidentalaffair,butaccidentis themanifestationofnecessity.Inotherwords,financialisationaddsanother complicatingfactorinouranalysis,butdoesnotfundamentallychangetheoverall picture(39). Acyclicalview Inmybook,TheGreatRecession,Iapproachedthequestionfromadifferentangle thatcanreconcileMarxslawofprofitabilitywiththegrowthofthefinancialsector, thecreditbubbleanditseventualbursting.Istartedwiththedata.Igenerateda seriesofdatabasedontheUSeconomytomeasuretheMarxistrateofprofittoseeif itcanprovideacausalexplanationoftheGreatRecessionandpreviousslumpsin capitalism.Inthegraphbelow,VROPstandsforthevaluerateofprofitandOCC standsfortheorganiccompositionofcapital.Themethodologyandsourcesforthe datacanbefoundinmybook,TheGreatRecession,pp30510.

USVROP(%)andOCC 23.0 21.0 19.0 17.0 15.0 13.0 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 2013
17yrs 17yrs 15yrs

2.30 2.20
17 yrs?

2.10 2.00 1.90 1.80 1.70 1.60

VROPLHS

OCCRHS

Fortheperiodsince1948,thedataconfirmMarxslawofprofitability,namelythat theprofitabilityoftheUScapitalisteconomymovedinverselywiththeorganic compositionofcapital.Asearlyaslate2005,thisapproachyieldedaforecastthatUS capitalismwasnowinacycleofdownturnforprofitabilitywhichwouldeventually leadtoseriesofdeeperandlongereconomicrecessions.Inaddition,Iarguedthat othereconomiccycles(housing,employment,investmentandinventories)were coincidingattheirtroughswhichwouldproduceasignificantlylargeeconomicslump around200910.ThisprovedtobeoutbyoneyearastheGreatRecessionstartedin 2008. Thethesis(drawnfromthedata)wasthattheunderlyingcausaldriveofeconomic cyclesundercapitalismwasthemovementoftherateofprofit.Butthereareother lawsofmotionundercapitalism;likethedomesticconstructionorthehousingcycle, theemploymentbusinesscycleandtheshorterbusinessinventorycyclealongwith theevenlongerpricesofproductioncycle(Kondratiev).Theywereallcombiningto reachtroughsaroundthistime,astheyhaddoneintheGreatDepressionperiod. Accordingtomydata,theUSrateofprofitmovesincyclesofabout3236years (withmoreorlessequalupanddownphases)fromtroughtotrough.Inthepostwar period,thatisfrom194664(upphase),196482(downphase),198297(upphase) andinthecurrentdownphasethatshouldendby201416.Ialsofoundthatthestock marketcyclefollowsasimilarcyclewithalagofaboutonetotwoyearsbehindthe profitcycle.Ifright,thissuggeststhatweareinwhattheinvestmenthousescalla secularbearmarketthatwontenduntilabout2018,acoupleofyearsafterthe troughinprofitability,havingpeakedin2000inthelastbullmarketphase. IfMarxslawofprofitabilityiscyclicalinthisway,itcansignificantlyhelpinthe debateaboutwhetheritisrelevanttotheGreatRecessionorwhetherthatwasjusta

financialcrisis.Onmydata,profitabilitypeakedin1997,fellbacktoalowin2001; thenroseagainto2006,beforestartingtofallagain. Ifthecyclicalapproachiscorrect,itwouldsuggestthataftertheGreatRecession, profitabilitywillrecoveruntilabout2013beforeitheadsdowntoanewcyclicallow by2015orso.Atnotime,willprofitabilityexceedthepeakof1997,althoughthere havebeenshorterdurationralliesaftereacheconomicrecession(2001)andnow (2008). First,wearestillinadownphaseforprofitabilitythatbeganin1997andwontend until2015orso.Thatmeansanotherrecessionisintheoffingbeforecapitalis sufficientlydevalued(andinthecaseoflabourweakened)tocreatetheenvironment forrisingprofitability.Onmydata,therateofprofitdidrisefrom1982,suggesting supportforthefinancialisationsupportersofthecausesofcrisis.Butithasbeen fallingsincethen(the1997peakhasnotbeensurpassed).Despiteashortrally between2002and2006,therateofprofitintheUSeconomywaslowerin2006than in1997andforthatmatterwaylowerthanin1964. AsMarxputsit:Themaindamage,andthatofthemostacutenature,wouldoccur inrespecttocapital,andinsofarasthelatterpossessesthecharacteristicofvalueit wouldoccurinrespecttothevaluesofcapitals.Thatportionofthevalueofacapital whichexistsonlyintheformofclaimsonprospectivesharesofsurplusvalue,i.e., profit,infactintheformofpromissorynotesonproductioninvariousforms,is immediatelydepreciatedbythereductionofthereceiptsonwhichitiscalculated. Partofthecommoditiesonthemarketcancompletetheirprocessofcirculationand reproductiononlythroughanimmensecontractionoftheirprices,hencethrougha depreciationofthecapitalwhichtheyrepresent.Theelementsoffixedcapitalare depreciatedtoagreaterorlesserdegreeinjustthesameway.(Capital,vol.III,p. 3623) Ifweextendthedatabackto1929,thereisasignificantriseinprofitabilityfrom1938 to1944.Afterthatprofitabilityfallsto1964,whichdoesnotmatchmyargumentthat thiswasanupphaseforprofitability!Ofcourse,thisperiodcoversthesecondworld war.Themechanismofthecycleisariseintheorganiccompositionofcapitalanda fallinprofitabilityeventuallyleadingtoaslumporrecession.Thatcrisisdrivesdown thecostofcapitalleadingtoariseinprofitability.Aftereveryslumpsincethesecond worldwartherehasbeenarecoveryinprofitabilityforatleastafewyears. Butwaraddsanewdimensiontocreativedestruction.Physicaldestructionofthe stockofcapitalaccompaniesvaluedestruction.Thisproducesadramaticfallinthe costofcapital.Warisanexogenouseventthatcansharplyinterfereinthe endogenouslawofprofitability. Marxconsideredtheimpactofphysicaldestructiononvalues.Thisismostclearly seeninthephysicaldestructionofcommodities.Thiscanevenhappenindirectlyin theformofstoppages:Although,inthisrespect,timeattacksandworsensallmeans ofproduction(exceptland),thestoppagewouldinrealitycausefargreaterdamage tothemeansofproduction.However,themaineffectinthiscasewouldbethatthese

meansofproductionwouldceasetofunctionassuch,thattheirfunctionasmeansof productionwouldbedisturbedforashorterorlongerperiod.(Capital,vol.III,p. 362) Whatwouldhavehappenedtoprofitabilitywithouttheworldwarof193945?The rateofprofitwasturningdownin1938.Withoutwaritmayhavedroppedtoa cyclicallowby,say1946,beforeenteringanupwardphaseupto1964.Ifthatis right,thenthe194664periodisanupwardphase.Thegraphbelowsuggestshow thatmightlookusingtwodifferentmeasuresforconstantcapital(historicand replacementcost).

34.0 32.0 30.0 28.0 26.0 24.0 22.0 20.0 18.0 16.0 14.0 2013 2010 2007 2004 2001 1998 1995 1992 1989 1986 1983 1980 1977 1974 1971 1968 1965 1962 1959 1956 1953 1950 1947 1944 1941 1938 1935 1932 1929 Historiccostmeasure Replacementcostmeasure
Whererateof profitwould havebeen withoutwar

30.0 28.0 26.0 24.0 22.0 20.0 18.0 16.0 14.0 12.0

Thecorrectmeasurementoftherateofprofitisobviouslykey.Beforegoingfurther inthisempiricallybasedexplanationoftherelationbetweentherateofprofit,the massofprofit,theroleofcreditandtheGreatRecession,itisnecessarytorefertoan importantdebateabouthowtomeasuretherateofprofit. AndrewKlimanhasproducedapowerfulpieceofempiricalworkthatshowsthatthe rateofprofitneverrosebetween1982and2005(40).ThusKlimanconcludesthatthe argumentthatMarxslawwasirrelevanttothecrisisismisplaced.Healsomakesa compellingtheoreticalargumentthattheMarxistrateofprofitshouldbemeasured againstthehistoricfixedcostsofconstantcapitalandnotthereplacementorcurrent costs.Ifthatisnotdone,thenitdoeslookasthoughprofitabilityroserightuptothe startofthecrisisin2007anditwouldseemtoprovethattheMarxistlawof profitabilityisirrelevantafterall. IfyouacceptthatKlimanistheoreticallycorrectabouthistoriccosts,andthereare compellingreasonstodoso,thenitisessentialthatyouusehistoriccostsin measuringthevalueoffixedcapital.SoIhaverevisedmydatatousehistoriccosts.

MydatadonotsignificantlydifferfromKlimansifIdothis,althoughthereareother differencesinthewaywemeasurepostwarprofitabilityintheUS. Sousingthehistoriccostmeasuredoesnotinvalidatethecyclicalview.Thereisstill adiscernableriseinprofitabilitybetween1982and1997andasubsequentdecline. ThecyclicalnatureofMarxslawisstillvisibleifyouusehistoriccosts(HC)andnot replacementcosts(RC).

50 40 30 20 10 0 10 20 30 40 50 2938 3865
HC Changeinrateofprofitfrompeaksandtroughs(%)

6582

8297

9709
RC

9715F

Marxneverarguedthattherateofprofitwasthedirectcauseofeconomiccrisisand slump.Instead,itprovidedtheunderlyingpressure,upordown,intheeconomic cycleofcapitalism.Iftherateofprofitwasinitsdownphase,thenatacertainpoint, thefallingratecanturnintoafallingmassofprofit.Itisthisthatsetsthetrigger pointforeconomiccollapse. Again,thedatafortheUSeconomyshowthatconnection.TheUSrateofprofit peakedin2006andbegantofallfromthere.Asweknow,theUSeconomycontinued togrowwellinto2007,justasthefallingprofitfrom1997didnotimmediately deliveraneconomicrecessionuntil2001,afterastockmarketcrash. WecanusestrictMarxistdatatoshowthemassofprofits,butwelackquarterly datatodoso.IfweusetheofficialpretaxprofitfiguresagainstGDP,wecanseehow themassofprofitstartstofallbeforetheUSeconomywentintorecession.Themass ofprofitstartedtocontractattheendof2006.RealGDPgrowthstartedtoslowa yearlaterandthencontractedfromthebeginningof2008.Profitsrecoveredfromthe endof2008,butGDPdidnotexpanduntilayearlater.

8.0 6.0 4.0 2.0 0.0 2.0 4.0 6.0 8.0 Q22002 20.5 20.0 19.5 19.0 18.5 18.0 17.5 1990 Q42002

USpretaxprofits($bn)andrealGDPgrowthqoqann%

1700 1600 1500 1400 1300 1200 1100 1000 900 800 Q22009

Whataboutcredit?Anaccelerationofcreditgrowthistheresponseofcapitaliststoa fallingrateofprofit.From1990to1997,astheUSrateofprofitreachedapeak, globalcreditgrowthgenerallyslowedandevenfellbelowzero.From1997inthe downwardphasefortherateofprofit,creditgrowthacceleratedintodoubledigit growthbeforethecreditcrunchofmid2007andtheensuingeconomicslump(41).

CostasLapavitsasarguesthatthereisnocausalconnectionbetweenMarxslawof overaccumulation(ashecallsit)andthefinancialcrisisof20079(C).Oneofhis mainargumentsisthatthereisnoevidencethattherateofprofitfellbeforethecrisis: nosignificantdeclineinprofitratesoccurredontheapproachtothecrisis.

Q22003 1991

RateofprofitLHS

Q42003 1993

Q22004 1994

GDPgrowthLHS

Q42004

Q22005

Q42005

Q22006

Q42006

Q22007

ProfitsRHS

Q42007

Q22008

Q42008

18.0 16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2.0 1992 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

CreditgrowthyoyRHS

Profitabilityamongmanufacturingandotherfirmsappearstohaveheldeveninthe depthsoftherecessionof2009.So,hearguesthatthecrisisof20079haslittlein commonwithacrisisofprofitabilityasin19735,asisapparentfromthe extraordinaryroleofcreditandtheindebtednessofpoorworkers(p18). LapavitsascitiesDumenilandLevy(D)ashisreferenceforthis,sayingthat DumenilhasstatedcategoricallyattwoRMFconferences(May2008and November2009)thatthecrisisof20079isnotduetofallingprofitability. IdontknowwhereDLgettheirevidenceforthisassertionorhowLapavitsas reacheshisconclusionaboutprofitsholdingup.Myevidenceisclearlytothe contrary.MymeasureshowsthattherateofprofitintheUSeconomybegantofall wellbeforethefinancialcrisisbeganinsummer2007.Onanhistoriccostbasis,the Marxistrateofprofitactuallypeakedin2005at24.84%andfellby3%totroughin 20089. Theseareannualfigures,sotheydontrevealthestoryaswellasquarterlyones would.IfyouusetheBEAofficialfiguresforcorporateprofitthatarequarterly,you getaclearerpicture.Themassofcorporateprofit(pretaxadjusted)peakedinQ306 at$1655bn,falling32%toatroughinQ408of$1124bn,beforerecovering.That seemsprettysignificanttome. Yougetthesameresultifyoubreakdowntheprofitsfigurebynonfinancialand financial.Onthatbasis,financialsectordomesticprofitspeakedat$447bninQ206 anddropped73%toatroughof$122bninQ408!Butnonfinancialsectordomestic profitsalsoplummeted,peakinginQ306at$988bnandthenfallingto$629bnin Q109,adropof36%.Onlyprofitsfromtherestoftheworldheldup,atleasttothe beginningofthecrisis(Q407),beforeslipping30%toatroughinQ209. WecanusearoughmeasureoftherateofprofitbylookingattheprofittoGDP ratio.Itsthesamestoryhere.TheoverallprofittoGDPratiopeakedinQ306at 12.3%beforedroppingto7.8%inQ408.Thedomesticfinancialsectorprofitto grossproductratiopeakedasearlyasQ105at43.4%,beforecollapsingto11.7%in Q408.ThenonfinancialdomesticprofittogrossproductratiopeakedlaterinQ306 at14.5%andthenfellto9.4%inQ109. Anywayyouwanttomeasureit,profitabilityand/orthemassofprofitsfellwell beforethefinancialcrisisbegan,whichatleastsuggeststhedirectionofthecausality istheoppositeofwhatDumenilclaimedandalsoputsindoubtLapavitsasargument thatthereisnocausalrelationonewayortheother. Excessivecredit,stockmarketspeculationandtheexpansionoffictitiouscapitalin allitsnewandexoticformswasaresponsetofallingprofitabilityintheproductive sectorsoftheeconomy.Itdelayedtheinevitablebuteventuallymadethecrisis deeperandlongerasaresult.

Inthisway,thetoolsprovidedbyfinancialengineeringusedasinstrumenttohedge riskareturnedintoweaponsoffinancialmassdestruction;asWarrenBuffetpointed out. Conclusion Forhistorianseacheventisunique.Economics,however,maintainsthatforces insocietyandnaturebehaveinrepetitiveways.Historyisparticular;economics isgeneral.CharlesKindleberger Insum,thedominantmainstreamneoclassicalschoolofeconomicsandtheofficial economistsofthefinancecapitalwerenonplussedandnoncommittalaboutthe financialcrisisandtheGreatRecession.Theydidnotpredictitandtheycouldnot explainititjustwasnotagoodfit.Inhindsight,theyfellbackontheaphorismsof DonaldRumsfeld,blackswansandserendipity. ThemainstreamKeynesianswerelittlebetter.Theydidnotseeitcomingandcould notexplainit,apartfromsomefuzzystuffaboutthevolatilityofanimalspirits.The troublewiththiseffectivedemandtheoryisthatitisonlyeffectiveinhindsight.In hindsight,theKeynesiansonlycrywasthatKeyneswasright.Buttheyremain devoidofexplanationofthecauseoftheGreatRecessionandtherightpolicy prescriptionsforavoidinganother. OnlysomepragmaticcherrypickerssittingastridetheAustriantheoryofexcess creditandtheMinskyinstabilitythesiswereabletoforecastafinancialcrisis,ora Minskymoment.Andsomeempiricalresearchersdidprovidesomeindicatorsofa likelycrashinadvance(althoughtheirworkwaspublishedaftertheevent). WithintheMarxistschoolfewpredictedacrisisexceptthattosaythatcrisisisalways inherentincapitalismastheunderconsumptiontheorysupporterswouldsay.The financialisationexplanationisverymuchoneofhindsight.Themoreorthodox Marxistprofitabilityexplanationremainsthemostpowerfulinpredictivevalue. Threelessonsforeconomistsemerge.First,mainstreamobsessionwiththebehaviour ormotivationofindividualeconomicagentsshouldgivewaytopowerofthe aggregate;fromthesubjectivetotheobjective. Second,economistsobsessionwiththeoreticalmodelsshouldberebalancedwiththe needforempiricaldata.Letususehistory,preferablywithsomepredictivepower. Finally,boththemainstreamandheterodoxhavefocusedtoomuchonthefinancial sector,dismissingthecontradictionsinthecapitalistproductionprocessonwhich Marxfocusedasanexplanationofcapitalistcrisis.Thatisnottodenytheimportance ofthecreditsystemandinherentspeculativenatureofthefinancialsector. References 1.MRoberts,TheGreatRecession,November2009

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