DRAFT: do not quote,

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The “Millennium Crisis” and the Profit Rate[1]


by Jim Devine

October 29, 2002

I.                  Introduction.

A.     The Millennium Crisis.

At the turn of the Millennium, the cusp between 2000 and 2001, a combination of astonishing economic events shook the United States, and by extension, the world. Central to this “Millennium Crisis” was a dramatic reversal, i.e., the move from the “New Economy” boom of the late 1990s to a sudden and sharp slow-down of the U.S. and world economies. This event – measured by a fall of inflation-corrected Gross Domestic Product (GDP) during most of 2001 and a dramatic fall in industrial production – led the semi-official National Bureau of Economic Research to decide that a recession or business-cycle downturn started in March 2001.

Though there was a recovery at the end of 2001, due to strenuous efforts of the Federal Reserve (the Fed, the government-sponsored bank that regulates overall interest rates) and the government, the problems that I describe below still remain. In fact, at the time of this writing (October 29, 2002), the U.S. economy remains in the doldrums and is threatened by a “second dip” recession, so that the economy’s path follows that of a “Dubya,” which in turn would push down the rest of the world’s economy. That is, it is very likely that the hard times for working people around the world have just begun.

1)      What is a Crisis? The word “crisis” stands out – what do I mean here? In the abstract, a crisis is a situation in which even the capitalists aren’t getting what they want as a class, instead seeing recession, runaway inflation, financial bubbles, severe scandals, social movements that disturb the status quo, and the like. As noted, recession hit the U.S. in early 2001, as seen in the fall in the economy’s level of marketed production, as gauged by GDP. In addition, profitability and corporate investment fell drastically. The absence of inflation was good news in this dreary scene, but many fear deflation, i.e., falling prices, which would make people’s debt loads worse (see below).

Getting the most press, of course, was the rapid decline in stock markets, even though those markets are much less important than most people think. Most dramatic was the rise of corporate scandals (Enron, Global Crossing, etc., etc.), which shed doubt on the efficacy of the country’s financial regulation system (and on the government’s move toward greater laissez-faire, i.e., blatantly pro-business policies).[2] Meanwhile, growing popular movements against capitalist globalization and the attack on Iraq threaten to weaken the pro-capitalist consensus. The focus here, however, is on the recession and its causes, though this ends up being connected to the other dimensions of the Millennium Crisis.

GDP is not a good measure of what’s good for working people, the environment, or human happiness in general, since it is a measure of production of only those goods and services sold in markets. However, in a capitalist country such as the U.S., almost everyone is dependent on the health of the market economy for getting the goods and services needed for day-to-day survival and for living up to their responsibilities in life. That means that a fall in GDP has a wide impact: a recession typically hurts not only the ruling groups but also the “middle class,” the workers, and ethnic minorities suffer.

In the case of the Millennium Crisis, the official overall unemployment rate soared from 4.0% in September 2000 to 5.6% in September 2002. If we take into account the fact that many job-seekers gave up in disgust and were thus not counted as “unemployed,” the overall unemployment rate rose more dramatically between Septembers, from 4.0% in 2000 to 6.1% in 2002.[3] Of course, this surge hit minority communities and youth more severely. Again adjusting for the surge of workers giving up on job-seeking, the unemployment rate for Blacks rose from 7.3% to 10.2% between Septembers, while that for Hispanics rose from 5.7% to 11.3%. For young workers (ages 16 to 19), the adjusted unemployment rate rose more than 10 percentage points, from 13.0% to 23.5%.[4]

This meant that the transitory New Economy prosperity of the late 1990s – during which official poverty rates fell and the incomes of the least-paid workers surged – was over. That temporary working-class affluence, after decades of stagnation, was replaced by a rise in poverty.[5] Though average wages have not begun to fall in a big way, they have stopped rising in a significant way, while wage cuts become increasingly likely as high unemployment persists. Further, inequality of incomes has risen in the recession: between 2000 and 2001, whereas the average annual income of the richest 20 percent of households fell slightly, from $146,240 to $145,970 (less than two-tenths of a one percent drop), that of the poorest 20 percent fell almost 2 percent, from $10,440 to $10,136.[6] Though this divergence means a return to the long-run trend toward increased inequality seen since the 1960s, there had been a short-lived convergence in 2000.

In short, the New Economy hype of the previous decade, which said that the business cycle had been tamed and prosperity was to be shared by all, collapsed into dust.

2)      The International Dimension. Further, in 2001, the International Monetary Fund (I.M.F.) and other international forecasters dramatically down-graded their predictions for the world economy, pointing to largely synchronized recessions of the rich countries. Similarly, recent international forecasts have been relatively pessimistic. Most of this followed the U.S. lead, since U.S. has been acting as the “consumer of the last resort” for the rest of the world, buying more from the world than they buy from us, counter-acting world-wide stagnation tendencies. This relationship will continue for the foreseeable future, so my focus is on the United States, as the engine of world demand growth.

3)      Policy Response. Since the middle of 2001, there was a concerted effort to get the economies moving again. The Fed lowered interest rates 11 times in 2001, encouraging people and corporations to borrow and spend, counteracting the plummeting of GDP. Some other central banks in other countries followed, though rarely as energetically. On the fiscal front, the U.S. Federal government has cut taxes – a pitiful cut for the middle classes and a larger long-term cut for the rich. In addition, largely as a response to 911, the Federal and state governments raised spending. These forces have stimulated the economy by giving people more purchasing power, causing a partial revival of the economy.

4)      A Workers’ Recession. The economy isn’t booming enough yet to help workers beyond preventing a deeper recession – and I doubt that it will do so soon. To start lowering unemployment rates again, capitalism needs to grow vigorously enough to counteract the normal rise of unemployment. This latter rise occurs due to the typical technological unemployment, the unpublicized day-to-day “downsizing” that occurs as technical change makes workers more productive and thus less necessary to the boss. Unemployment also rises if growth is stagnant due to the normal growth of the number of job-seekers as people graduate from full-time schoolwork, the return of women to the paid labor force from house-keeping and family-raising, and the like.

This means that, even if there’s a capitalist recovery with rising GDP, there can still be a workers’ recession, with high and/or rising unemployment. Even without a “second dip,” this outcome is likely in the foreseeable future.

B.     My Purpose. The purpose of this pamphlet is to get beyond the standard journalistic approach above, to understand the current economic collapse or recession in historical perspective. This will help us understand why it’s unlikely that the U.S. economy will enjoy a recovery enough to help workers in the near future – unless military Keynesianism and bail-outs for the rich save the day. This historical focus should help us understand what happened at the cusp of the Millennium even once a business-cycle recovery has occurred for not just capitalists but for workers.

II.               The Rate of Profit’s role in Capitalism.

A.     The ROP’s double role. For simplicity, the wealth of possible data on recent events will be ignored. Following the Marxian tradition, I’m going to focus the rate of profit (ROP), explaining the role of its fall in causing the “Millennium Crisis.” There are two main threads:

1)      In the trend, the rate of profit’s has risen since 1980, reflecting the political and economic victories of the capitalist class.

2)      But the actual profit rate fell, after 1997, partly because these victories have gone too far, even from a capitalist perspective.

The “Millennium Crisis” resulted from both of these and really isn’t over yet. As we’ll see, the U.S. economy avoided the problems implied by the falling profit rate after 1997 mostly by borrowing, getting deeper into debt. But such delaying of the crisis simply made the actual downturn of 2001 that much worse.

B.     The ROP and Accumulation. To make understanding the economy simpler, use an analogy: capitalism is like a speedboat race in uncharted waters. Being unplanned and irrational, this “race” goes too far, causing a crisis.

1)      In terms of its short-term impact on the economy, the actual rate of profit could be seen as a measure of the amount of “gas” in the average capitalist speedboat. A high ROP means that businesses are currently earning high profits, which provides them with funds for further expansion (accumulation of capital, including new factories, equipment, and the like). Of course, in the real world, they can “import” gas from other sectors of society or from outside the country. This is one thing that happened in the 1990s, as billions of dollars of funds flowed into the U.S. from overseas, increasing the country’s debt to the rest of the world.

2)      Expectations of future profitability are also important to individual capitalists: if a boater thinks that fuel is available at the dock, he or she will drive the speedboat’s tank toward empty. Further, winning the race provides a prize, encouraging such behavior. On land, of course, if the funds are available, individual businesses can borrow to finance investment if they expect profitability to rise in the future. That is, they can run even if the gas-tank is beyond empty, using “other people’s money.”

The trend rate of profit helps explain capitalists’ expectations of future profitability, which provides the motivation to invest: if the trend is upward, capitalists will most likely expect profitability to continue to rise in the future. Thus when the trend rate rises, capitalists want to go fast because they see their prosperity as continuing. They’re doing the right thing (to their eyes) so they continue.

There’s also a subjective side to expectations of profitability, unexplained by the trends in the ROP, that can’t be measured.[7] Such events as the giddying expansion of the stock market of the late 1990s and the general trend of capitalist political and social victories since the 1970s encouraged an optimistic tone, so that capitalists were more likely to pooh-pooh the falling profit rates after 1997 and to accentuate the positive.

3)      Our story is not simply that of pleasure boaters, but of a race. The over-all process is out of control because the system is unplanned (or as Marx said, anarchic). Further, competition among capitalists drives individual capitalists to run as quickly as possible if they can, since each fears that he or she will be driven out of business by the others.[8] (Of course, competition at the expense of other capitalists is also pursued, using tools varying from advertising to lawsuits to dirty tricks.) This expansionism persists unless there exist barriers to further expansion, as explained below.

4)      As long as capitalism avoids hitting things, etc., avoiding a crisis, working people do well (within the capitalist framework, of course), since there are lots of jobs. The capitalists need crews to operate the “boats.”

5)      Given the uncharted territory, the capitalist speedboat race’s tendency to go beyond a reasonable speed (to over-accumulate) means that it is quite likely to hit things, spring a leak, or run out of gas. Running into such barriers – which vary between historical eras – causes a crisis.

6)      After a crisis, the painful slowdown of the boats may represent some opportunities for changing the nature of the vehicles or their governance. But history has shown again and again that the capitalists can refuel and take off again – unless a popular movement is in place to tame or depose these wild drivers.

7)      A severe collapse can mean that the speedboat stays in the dry-dock for months, even years. That is, as the aftermath of the recession of the early 1990s (the “jobless recovery”) showed and that of the Millennium Crisis has shown so far, the capitalist recovery isn’t always quick. For example, problems of unused capacity (empty factories), excessive debt, and pessimistic expectations can block accumulation (while keeping unemployment high). These results of a crisis delay the start of a new race.

C.     Source of Data. I use the government figures for the rate of profit (Larkins, 2002). See chart 1 below.

1)      Because they are most relevant to understanding the behavior of capitalist investment in the U.S. domestic non-financial corporate sector. The government economists calculate its average “rate of return” to see what the impact is on business.[9]

2)      A small drawback is that my data are for only the non-financial corporate business sector, but that sector mostly pulls the U.S. economy as a whole along. In many ways, this sector is the “leading sector” of the whole non-financial economy.

3)      The big drawback is that the data are not for the entire world, in an era when capitalism is operating more and more on a world scale. So we need to remember that our focus is on only the United States. Even though the U.S. leads the rest of the world along these days, we are clearly leaving important factors out of the analysis.

III.           From the 1960s to the 1990s: the Neo-Liberal Revolution.

A.     Overview. The graph above shows both the trend and actual rates of profit, along with the share of profits.

1)      The trend rate – shown by the thick line and measured on the left-hand axis – is drawn up until right before the Millennium Crisis (from 1960 to 2000). The 2001 number is dropped in calculating the trend since its low level reflects the effects of the recession, since falling demand has a direct and obvious effect on the realization of profit incomes: falling demand prevents capitalists from using their factories and other capacity completely, hurting profitability. Before that, the smoothing of the curve corrects for the “normal” ups and downs of profitability due to the business cycle. The trend shows clearly that the profit rate fell after 1965 until 1980 and then generally rose since then.

2)      The actual rate of profit is marked by diamonds and is also measured on the left-hand axis. This series continues all the way up to 2001, where the recession itself hurt profitability. But the fall in the profit rate preceded the 2001 recession by several years: the peak profit rate was in 1997.

3)      The share of profits, the percentage of total income received by property-owners, is shown in chart 1 by the line marked with the squares – measured on the right-hand axis. As seen in the graph, most of the short-term changes – and much of the trend – of the ROP are due to changes in the share of profits.

4)      However, for the long-term trend, changes in the efficiency of the use of capital equipment plays a big role.[10] This is shown in chart 2, discussed below.

B.     The Rate of Profit’s Trend. To attain an understanding of what has happened in recent decades, start with the trend, since that defines the general context of the U.S. political economy in any era. As noted, the profit rate’s trend is similar to the profit share’s trend.

1)      There was a massive decline of the trend ROP from 1965 to 1980 or so, shadowing similar movements of the actual ROP. This cut-off in the fuel that capitalists crave encouraged the transition from what some call the “golden age” of U.S. capitalism during the 1950s and 1960s to the “time of troubles” of the 1970s and early 1980s. This in turn encouraged the severe inflation and economic recessions of that era, what’s sometimes called a “structural crisis” – because the old way of organizing U.S. capitalism wasn’t working very well. It was also dubbed a “stagflation crisis,” because of the combination of high unemployment and high inflation. Elsewhere (in Devine, 2000), I present evidence for the close connection between the falling profit rate and the rise of stagflation.[11]

2)      This falling profit rate and the associated time of troubles in turn encouraged a change in the structure of U.S. capitalism. This took the form of a “one-sided class war” (a phrase from former UAW leader Doug Fraser) against labor and other progressive forces. In the U.S., this effort centered on Reaganism and other efforts to restore profitability. It was symbolized by the Reagan Administration’s mass firing of the air traffic controllers in 1981 – but represented by a larger shift in labor and social policies toward favoring the short-term interests of business.

This employer’s offensive as central to the world-wide neo-Liberal policy revolution that began on September 11, 1973, when General Pinochet used bayonets and torture to impose neo-Liberalism (laissez-faire economics) on the Chilean people. It was followed by Thatcherism in the U.K. and Reaganism in the U.S. and the spread to many other countries under the thumb of the I.M.F.

3)      To some extent, Reaganism and its successors – including Clintonism – have been successful: there’s been a trend rise in the ROP since then. These also have encouraged increases in the degree of inequality of the distribution of income between the rich and the poor, along with the shrinkage of the “middle class.”[12]

Despite the victories of the neo-Liberal movement, the slowness of the rise in profit rate and the profit share – despite the steady weakening of the working class and other resistance – has been notable. Its magnitude is nothing like the previous fall in the profit rate, while profitability has hardly returned to the levels seen during the “golden age.” The slowness of the profit recovery simply encouraged those pursuing the one-sided class war to redouble their efforts.

There are two major reasons for the slowness of the ROP’s rise:

(a)   Wages have done poorly compared to profits, but the rise in international competition – often from foreign branches of U.S.-based companies or from upstarts such as South Korea – kept prices from rising. (In recent years, in fact, business leaders have become quite vehement in their complaints about their lack of “pricing power.”) This in turn prevented the profit share and thus profitability from rising steeply. Further, the exchange rate of the dollar rose dramatically after about 1995 implied increased international competition for U.S. businesses: if the dollar is high, that means that those of us with dollars can afford lots of imports, while those with foreign currencies cannot afford many U.S. exports.[13] This also encouraged a soaring deficit in international trade.

(b)   Another reason why the profit share didn’t rise as much as many would expect from reading the newspaper is that the extremely high and rising salaries of top executives are counted as part of compensation (salaries) rather than profits. If we were to calculate the ROP to include the effects of the extreme rise of salaries of the CEOs relative to those of rank-and-file workers, the profit rate would have rise even more steeply since 1980.

(c)    A possible reason is that the profit rate in the graph above is before tax. The after-tax profit rate rose even more than the numbers in the graph, because corporate taxes were cut, especially during the early 1980s. However, changes of this tax rate since the 1980s have not been major, so this doesn’t explain the slowness of the rise of the profit rate. The changes in tax laws during the last 35 years have mostly encouraged inequality in personal income, however.

4)      Though the profit rate rose more slowly per year than it fell in the previous period, the upward trend lasted for more years. Since this pushed the capitalist speedboat race ahead, it encouraged prosperity in the 1990s, compared to the 1970s, as measured by GDP growth. However, as seen below, a lot of the problems of that era remain (in a new form) and new problems have arisen.

(a)   From capital’s point of view, as mentioned, we still haven’t seen a return to the “golden age” of profitability seen in the 1960s. However, the profit rate’s rise does represent the rational basis for the stock-market surge in the1990s, until it became a speculative bubble at the end of the decade. Rising profitability means rising dividends and/or capital gains for stockholders, so that they speculated that these would continue. This became a bubble as the boom became a self-fulfilling prophecy: thinking that prices would rise, richer people bought stock, causing prices to rise further.

(b)   From labor’s point of view, the benefits of this “prosperity” have been distributed in an extremely unequal way. For the vast majority of workers and especially for the minority communities, it’s been a “false prosperity” similar to that of the 1920s. The exception was temporary, at the tail-end of the 1990s, when workers started benefiting from the boom (as mentioned above). Of course, the falling profit rate during this period meant that the temporary worker’s prosperity would end soon.

C.     The Rising “Efficiency of Capital Goods.” The changes that boosted the profit rate were not simply at the expense of labor, but due to changing production technology. Chart 2 shows the effects of these changes in technology and other factors that affect how effectively labor uses the means of production (or capital goods) in production. The trend line is marked with the solid line: it continues only up to 2000, after which falling demand for business products meant that factories and machinery were increasingly unused, obviously depressing the measures of the efficiency of the use of capital equipment. In other cases, the smoothed curve erases the effects of cyclical changes due to the normal business cycle.

1)      A fall in the “efficiency of capital goods” (ECG) is the basis for the kind of theory of crisis that Marx developed in volume III of his magnum opus, Capital. This roughly corresponds to a rise in what he called the “organic composition of capital” or economists since them have called the “capital intensity” of production. In the chart above, it is measured as the ratio of total income to the amount of fixed capital goods owned. Even if the share of profits had been constant, a fall in the efficiency of capital goods depresses the rate of profit, as seen after 1966 until the early 1980s. Thus, falling profit rates during the 1960s and 1970s were not simply due to a battle over the production and distribution of the output. There was also something with the production process, such as the use of equipment made obsolete then by the rise of international competition.[14] My rough-and-ready calculation is that changes in the profit share explained about 55% of the rate’s fall from 1965 to 1980, while the rest (about 45%) is due to falling capital-goods efficiency.

But then the ECG rose steadily after that, attaining a level comparable to that of the 1960s. This helps explain most of the rise of the trend rate of profit. My calculation is that 62% of the profit rate’s increase from 1980 to 2000 was due to changes in capital-goods efficiency, while only 38% is due to the one-sided class war.[15] Of course, these two sides of the determination of the ROP are interrelated and thus hard to separate.

2)      This rise in ECG – indicating a rise in the efficiency in the use of fixed equipment and the like – seems linked to several different events which were combined with factors that encouraged a rising share of profits. These include:

(a)   the 1980s and 1990s shake-out of U.S. manufacturing (disinvestment from old equipment and plant). This destruction of old means of production that had become obsolete in the face of increased international competition also led to the destruction of the heart of organized labor outside of the government sector and the shrinkage of the power of workers to resist the one-sided class war.

(b)    investment in more modern fixed capital equipment in new sectors or even modified versions of old sectors (as with the rise of steel mini-mills). This usually involved a move to areas of the country such as the South or West where unionism was more poorly established. Of course, much  new investment occurred outside the U.S., but this does not show up in the statistics reported here.

(c)    the falling prices of some capital goods (e.g., computers). It’s possible that in the late 1990s, the so-called New Economy (the boom of telecommunications and computer-related technology) encouraged that trend.

(d)   the falling price of important raw materials such as oil (until early 1999).

IV.            The Downside of the Upward Trend.

In sum, the economic boom of the late 1990s was based on rising profit rates and profit shares, along with increasing output per unit of fixed capital goods used. Being rewarded more encouraged capitalist investment to rise, pulling the rest of the economy ahead and boosting GDP. As will be discussed below, the forces pushing the U.S. economy toward stagnation intensified after 1997, so that capitalist accumulation and private-sector debt accumulation became increasingly important. Even before that, the Neo-Liberal policy revolution was sowing the seeds of its own destruction. Or, returning to the original analogy, by letting the speed-boat drivers go wild, by loosening the rules of the race and by not enforcing the rules that remained very well, the laissez-faire tilt produced an interesting race, but one in which collisions became well-nigh inevitable.

The problem is that capitalism creates its own barriers, so that prosperity breeds crisis. The Neo-Liberal solution to the barrier of falling profit rates during the 1970s simply created a new barrier later on. In the historical era of the late 1990s, this was the “Underconsumption Undertow.”[16]

A.     The Underconsumption Undertow. The upward trend of the ROP allows us to understand the general context of the 1990s and the 2000s. The original story in Marx’s Capital says that a fall in the ROP is bad for capital, causing crises. This is true, but the implication that a rise would always be good for capital is not. My research on the origins of the Great Depression of the 1930s (Devine, 1983 & 1994) suggests that one of the key causes of that Depression was that the profit rate rose too steeply in the 1920s.[17] The problem arises from the rise of both of the main determinants of the ROP, the share of profits seen in chart 1 and the “efficiency of capital goods” as measured in chart 2.

B.     The Rising Share of Profits. The distributional shift toward capitalists is crucial because it involves a suppression of consumer demand by workers: workers’ spending are the main source of consumer markets, one that is reliable and long-lasting. However, workers find it hard to sustain the market when wages are stagnant. (The alternative, i.e., for them to borrow or to dip into very limited savings, is discussed below.) But if the profit share is rising, that means that output is rising faster than what workers can spend on (consume).

1)      One might argue that the recent rise of this ratio wasn’t steep enough to cause problems of the sort seen in the late 1920s. However, there has been a sustained rise, over two decades.

2)      More importantly, and making things worse in the 1990s and after, the suppression of consumer demand has been global: the world-wide “race to the bottom” – the downward equalization of wages relative to labor productivity, spurred by the international mobility of investment and by organizations such as the I.M.F. and the World Bank – encouraged the presence of an under-consumption undertow. This involves “competitive austerity,” with transnational corporations rewarding only the lowest-waged countries with new investment (unless other lures are provided) and the I.M.F. encouraging many countries to engage in austerity and export promotion. (Such policies have been seen most recently in the I.M.F.-induced disaster in Argentina.) Further, this stagnationary tendency has been encouraged by the economic slow-down encouraged by the establishment of the European Union and the depression in Japan.

3)      This “undertow” refers to the slow growth of wages and salaries relative to the productiveness of labor, which in turn encourages the slow growth of consumer purchases – the largest percentage of total spending – relative to the economy’s ability to produce. If the other elements of total spending do not change – and there is no factor to encourage consumer spending to grow faster than wages and salaries – then the economy stagnates. This logic applies to either the world economy or the U.S. economy.[18],[19]

4)      However, the underconsumption undertow does not imply that the economy automatically stagnates.[20] Rather, it implies that the short-term health of the economy – and measured by the demand for goods and services in markets (gross domestic product) is increasingly dependent on other sources of demand. As seen below, in the late 1990s, in practice it meant that profit-driven accumulation of capital was the only factor driving the economy. For awhile, the rising trend rate of profit and general capitalist optimism meant unprecedented surge of private investment was central to the prosperity. Not surprisingly, the recession of 2001 centered on a fall in this investment, unlike previous recessions in the post-World War II era.

C.     Rising “capital efficiency.” The rising CGE simply means that capitalists can produce more output per unit of their fixed capital equipment. This intensifies the demand problems implied by the underconsumption undertow.

1)      As noted, in a regime characterized by an underconsumption undertow, the short-term health of the economy is dependent on the accumulation of capital. That is, a GDP boom requires an investment boom. But the combination of faster capitalist accumulation and a rise in capital efficiency means that the existing stock of machinery and the like can be used to produce more and more output. A rising stock of fixed capital goods combined with greater efficiency in its use means that the economy’s potential supply booms as consumption demand threatens to stagnate.

2)      This means that simply to keep business operations at “normal” capacity, we need faster demand growth than before. The speedboat race – the economy as a whole – must go really fast. It’s as if the boats have a leak in their bows, so that they must go quickly or it will sink. Of course, this makes it more likely that it will run into snags and shoals. An economy that faces a rising profit rate in the trend is more and more likely to have a recession or similar event; it is increasingly unstable. That is, it is more and more prone to shocks that cause a sudden and painful stoppage.

V.               The Credit Bubble.

The late 1990s represented a collision between conflicting tendencies that encouraged simultaneously recession and economic boom. For awhile, the latter dominated. Many economic observers now say that  the U.S. suffers the consequences of the imbalances that developed during that period, so that recovery will be long, drawn-out, and painful, especially for working people.

A.     Recessionary Forces. As noted, the existence of the under-consumption undertow does not rule out the possibility of economic booms such as those of the mid-1990s until mid 2000. The speedboat race could accelerate. However, there are signs that it couldn’t do so anymore after 1997 and should have stopped – except that the credit bubble “saved the day.”

1)      As mentioned, the actual rate of profit fell after 1997. The speedboat was running out of “gas.” Ignoring other changes, this suggested that private fixed investment – the driving force of the U.S. economy – was likely to stall. I interpret the falling profit rate as being due to two phenomena:

(a)   the rising value of the U.S. dollar in foreign exchange markets, which hurt U.S. exports and encouraged competition from imports. This had a lot to do with the attraction that the dollar had as a “safe haven” in a world disrupted by the financial crises of 1997 and 1998 and the continued financial turmoil in many countries, especially in Latin America.

(b)   lower unemployment rates allowing wages to start catching up with (slowing) inflation, despite the weak organizational power of labor. This produced the temporary late-1990s workers’ prosperity mentioned above.

2)      Further, the increasing stagnation in most of the rest of the world destroyed U.S. exports and swamped the domestic market with cheap imports (mostly from East Asia), reinforcing the effects of the high value of the dollar. This corresponded to the increasing U.S. trade deficit. The rising trade deficit means that more than ever before and to increasing extent, people in the U.S. are purchasing foreign goods and not domestically-produced ones and people outside the country are refusing to buy U.S. goods. Again, though this foreign trade competition discourages inflation, it encourages stagnation or recession in the U.S.

3)      During the periods of Presidents Reagan and Bush (version 1.0), large government deficits had prevailed. This behavior – often dubbed “irresponsible” by fiscally conservative Democrats – provided an important counteracting force that prevented the underconsumption undertow from having an effect. Despite the propaganda that shows up in the business pages of newspapers, a government deficit actually helps the growth of GDP (at least in the first few years). As John Maynard Keynes had pointed out, a budget deficit means that the government is taking less money from people in the form of taxes than it is giving back in terms of spending on goods and services or in terms of transfer payments. This increases the ability of the economy to spend. Ignoring other changes, this actually boosts profitability by allowing businesses to use their capacity more completely and thus accumulation and the GDP.

But with budget-balancing agreements in Congress and the accession of Bill Clinton, such Keynesian stimulus went into reverse: the government did not provide deficits to stimulate the demand for business production following the Keynesian mode. Instead, the government budget moved more and more into surplus (until the 2001 recession and the onset of the “war against terrorism”), dragging down the economy.

B.     What allowed the prosperity of the late 1990s? Given the underlying pull of economic stagnation and these recessionary forces, it may seem a miracle that the U.S. economy boomed in the 1990s. But there was no miracle. Instead, the boom was allowed by credit, which pushed off the problems into the future, i.e., until 2001. After 1996 or so, Alan Greenspan’s Fed allowed the rapid expansion of loans, especially in response to the East Asian and Russian financial crises, which threatened to cause a world recession.[21] This had the effect of also avoiding a domestic U.S. recession while pumping up the stock-market bubble by providing it with funds. That is, just as the falling profit rate of the 1970s was “solved” by the neo-Liberal policy revolution, the late 1990s recession – a result of the underconsumption undertow – was temporarily “solved” via debt accumulation.

1)      The capitalists borrowed “gas,” accumulating debt. Corporate debt (measured relative to their cash flow, i.e. their ability to pay interest) soared after 1997, as shown in chart 3. They were willing to borrow & invest because of the upward trend of the ROP and the capitalist triumphalism of the late 1990s. This triumphalism was reflected even more dramatically in financial speculation, i.e., the growth of the stock market’s bubble. That bubble also encouraged business expansion by allowing companies to raise funds cheaply by selling stock at high prices (as in Initial Public Offerings).

2)      Even though there is an underconsumption undertow, consumption spending can also rise due to borrowing.[22] After the early-1990s recession, consumer debt rose relative to their after-tax or disposable income. Naturally enough, this occurred at the same time that saving rates (the percentage of income that people put away for a rainy day or retirement) fell dramatically.

3)      Why the surge of consumer borrowing and spending?

(a)   A lot of the surge in luxury spending occurred because of the late 1990s stock-market bubble, which encouraged stock-holders to spend their paper winnings. A lot of that of accumulation is associated with the high-tech (information and communications) sectors or was encouraged by the upward trend of profitability and the New Economy optimism of the late 1990s.

(b)   Despite stagnant wages, workers struggled to keep their living standards from falling by borrowing. The growth of credit-based spending by workers eased in the late 1990s (when the boom finally paid off in terms of higher wages), but still remained an important source of demand.

4)      Where did the funds come from for all this borrowing? To a small extent, the funds that corporations and individuals borrowed came from the U.S. government surpluses: this meant that the government purchased its debt obligations (bonds), providing their owners with funds. But the lion’s share came from abroad, so that the U.S. debt to the rest of the world increased.[23] Originally, the rise in the U.S. debt to the rest of the world, also called the “external debt,” was due to large government deficits (themselves the result of the Reagan program and economic stagnation), but in the 1990s, the debt “torch was passed” to corporations and consumers. Nowadays, the U. S. is borrowing money from abroad at a rate of more than $500 billion a year.

C.     The downside of debt. Again, capitalist prosperity helped create its own demise. This time, the problem was debt. Rising borrowing and spending stimulated the economy, but because of the increase in private-sector (household + corporate) debt and external debt, the boom became increasingly unviable. In 2001, the extreme corporate debt was crucial to causing the manufacturing recession. Despite the partial recovery, these debt problems persist.

1)      The debt accumulation meant that something like what has happened since 2000 became increasingly inevitable. That is, the economy became more and more prone to collapse, so that events such as the combination of the popping of the stock market bubble in 2000 and the over-investment in fiber optics, communications, malls, movie screens, etc. – or the post-911 shut-down of the airline system – could stimulate a more general collapse.[24]

2)      The existence of debt left over from the boom encourages waves of bankruptcy and severe cuts in spending in the future. This is a crucial reason why private-sector debt is so important relative to government debt: unlike the U.S. federal government, private-sector individuals and companies can go bankrupt. As bankruptcy rates rise, this encourages creditors to apply tighter standards, encouraging further bankruptcies.

This nasty fate becomes more likely as the economy stagnates – or as it slips into the second dip of the Dubya. Persistently high unemployment and low incomes mean that individuals are less able to pay interest and principle on debt. Not surprisingly, consumer debt delinquencies peaked in 2001 during the recession, before policy-makers engineered the recovery.[25]

Consumer debt becomes much more serious if prices and wages start falling, i.e., if there is deflation. Even though the amount of money earned by the debtors falls in a deflation, the amount of their debts and interest obligations stay the same. This squeeze encourages cut-backs in spending and further deflation.

These possible events threaten to knock the last prop out from under the economy. The partial recovery from the 2001 recession was largely centered on consumer spending (including on housing). With falling consumer confidence, consumer spending is likely to follow, spurring a second recession.

3)      Further, the accumulation of debt and unused capacity in manufacturing means that the current stagnation is likely to deepen for a few years – since businesses don’t want to expand either investment or hiring. It will take a few years of non-borrowing and refinancing to get rid of the debt load. In the meantime, slow growth encourages business pessimism.

4)      The external debt implies that the U.S. is now paying debt service to the rest of the world, a major role-reversal from the era when the country was a net creditor. It also means that the dollar is unlikely to stay highly valued.

(a)   If the value of the dollar falls quickly, as some observers think it will, then there would be an inflationary shock to the economy: suddenly imports would become much more expensive, while exporting and import-competing companies will face much less competition and will regain pricing power. It seems likely that the Fed’s Alan Greenspan will hike interest rates in order to avoid this inflationary impulse, causing another recession.

(b)   Even if the dollar falls gradually, as economic observers hope it will, it will weaken a major bastion against U.S. inflation, international competition. This will discourage the Fed from allowing recovery.

(c)    The more that U.S. external debt accumulates, the more likely it is for the dollar to fall quickly rather than slowly.

(d)   I doubt that the dollar will lose its status as the world currency, since U.S. military, financial, and industrial power is still high. Thus, the dollar will likely not fall into worthlessness. Nor is it likely that other currencies, such as the Yen or the Euro will replace the dollar in international exchange.

VI.            Policy Responses

The 2001 recession in the U.S. encouraged world recession: as the U.S. abandoned its role as the consumer of last resort for a short period. This threatened to cause a ricochet effect, as recessions overseas hurt the U.S. economy. But then there were responses.

A.     Monetary Policy. The Fed repeatedly cut rates last year. Given the low profit rate, excessive private-sector indebtedness, unused capacity, and pessimism about the future, monetary policy did not help GDP in the textbook way, i.e., by encouraging borrowing and spending. Instead, it worked by encouraging a housing price bubble (an unsustainable rise in the price of houses) and keeping the stock market from falling further. Having highly-valued assets, encouraged even greater consumer indebtedness (since it boosted the value of collateral). This stopped the recession, but if monetary policy is the only tool, simply delays the inevitable. Eventually consumer spending will drop, encouraging the second dip of the Dubya. Already, many forecasters – including Alan Greenspan – see recovery as being slow because it is unlikely that consumer spending will rise much in the future.

B.     Fiscal Policy. There’s a potential savior at hand. After a temporary assist from the state & local governments, the Federal government is stepping in with what might be seen as the “Reagan package”:

1)      Keynesian stimulus based on military expansion; and

2)      tax cuts for the rich.

It remains to be seen if this stimulus is large enough or not to prevent the second dip of the Dubya recession. Even if it does, it should be noted that just as with previous solutions to the problems of the economy, it creates new barriers. Here, it encourages the already-existing trend toward increasing inequality to intensify, it encourages waste, and war.



Bleaney, Michael. 1976. Underconsumption Theories, New York: International Publ.

Blinder, Alan and Janet Yellen. 2001. “The Fabulous Decade: Macroeconomic Lessons from the 1990s.” In Alan B. Krueger and Robert M. Solow, eds. The Roaring Nineties: Can Full Employment Be Sustained? New York: Russell Sage Foundation and Century Foundation Press.

Brenner, Robert. 2002. The Boom and the Bubble: The U.S. in the World Economy. London: Verso Press.

Devine, James. 1983. “Over-Investment, Underconsumption, and the Origins of the Great Depression,” Review of Radical Political Economics, 15(2), Summer: pp. 1-27.

______. 1994. “The Causes of the 1929-33 Great Collapse: A Marxian Interpretation,” Research in Political Economy (Paul Zarembka, ed.) vol. 14, 1994: 119-94. (For an annotated version, see: http://bellarmine.lmu.edu/~jdevine/depr/D0.html.)

______. 2000. "Rising Profits and Falling Inflation: An Empirical Study," Review of Radical Political Economics, 32(3): 398-407.

Godley, Wynne and Alex Izurieta, 2000. “The Developing U.S. Recession and Guidelines for Policy” available at http://www.levy.org/.

Larkins, Daniel. 2002. “Note on Profitability of Domestic Nonfinancial Corporations, 1960-2001.” U.S. Department of Commerce. Bureau of Economic Analysis. Survey of Current Business. September, 17-20 (http://www.bea.doc.gov/bea/ARTICLES/2002/09September/0902CorpProfit.pdf).

Mishel, Lawrence, Jared Bernstein, and John Schmitt. 2001. The State of Working America, 2000/1. Cornell University Press (ILR Press and Economic Policy Institute).


James G. Devine

Professor of Economics

University Hall (Rm. 4227)

Loyola Marymount University

One LMU Drive, Suite 4200

Los Angeles, CA 90045-2659 USA

office phone: 310/338-2948; FAX: 310/338-1950

e-mail: jdevine@lmu.edu



[1] This paper was presented as a talk to the Student International Forum and the Social Welfare Action Alliance, at Ohio State University in Columbus, OH in May, 2002. It is based partly on a talk that I gave in Sacramento, CA, in December 2001 (see http://bellarmine.lmu.edu/~jdevine/FROP/sacramento.htm) and on other public speaking (including to “Concerned Citizens” of Leisure World in El Toro, CA, in May). Thanks to Tom Michl for his comments on a draft of the Sacramento talk, to the folks at the Sacramento Marxist School for their excellent questions, and to Fred Moseley and the participants of pen-l for their criticism. Of course, I am to blame for all acute or degenerative diseases that afflict this draft.


[2] In theory, laissez-faire refers to “free market” policies, but in practice it means government subsidies for the rich and powerful, combined with free market polices for the working class and the poor.


[3] These and the other unemployment numbers were calculated from Bureau of Labor Statistics numbers assuming that the labor force (those employed in, or looking for, paid jobs) rose in 2002 following the trend from 1992 and after. (For the original data, http://www.bls.gov/webapps/legacy/cpsatab1.htm and http://www.bls.gov/webapps/legacy/cpsatab2.htm). All numbers presented here are seasonally adjusted.


[4] These estimates were adjusted so that they equaled the official estimate for 2000. For Blacks and youth, it should be noted that my estimated unemployment rate was lower than the official rate in 1999, indicating one way that they benefited from the short-lived boom.


[5] From 1979 to 1993, the U.S. Census Bureau’s overall poverty rate rose from 11.7% to 15.1%. It then fell to 11.3% (31 million people) in 2000. It then rose to 11.7 percent (32.9 million people) in 2001. (See http://www.census.gov/prod/2002pubs/p60-219.pdf, page 21.) Mischel, Bernstein, and Schmitt (2001: 295, figure 5B) alternative measure of poverty shows similar trends (and higher rates).


Mischel, Bernstein, and Schmitt (2001: table 2.6, page 124) show that during the 1995-99 period, the real (inflation-corrected) hourly wages of the poorest decile of workers rose 9.3%, compared to a total 9.3% fall for the overall period from 1979 to 1999.


[6] All of these are inflation-corrected 2001 dollars. The source is the U.S. Census Bureau (at http://www.census.gov/hhes/income/histinc/ie1.html). However, based on the shares of total income of the richest 5 percent versus those of the poorest 20 percent, inequality has increased steadily – with no convergence during the late 1990s – since 1980 (see http://www.census.gov/hhes/income/histinc/h02.html). Increasing inequality is also with respect to wealth ownership.


[7] This is the emphasis of John Maynard Keynes and his followers.


[8] Though capitalism is very competitive – especially on the international plane – it is also monopolistic. Each capitalist strives to attain and/or maintain a monopoly at fellow capitalists’ expense.


[9] As far as I can tell, there is no incentive for these economists to lie, especially since these data are not widely disseminated or known.


[10] The ROP is R/K (profit income/stock of capital invested). The share of profits is R/Y, where Y is the total income of the non-financial corporate business sector. The effect of changes in the efficiency of capital use (ECG) is here measured by Y/K. A fall of the ECG captures the effect of the combination of a rise in Marx’s organic composition of capital (“capital intensity” of production, K per worker) and one of the major counter-tendencies, the rise in labor productivity (Y per worker). (For more analysis, see the web-site referenced in note 1. There I deal with the inverse of the ECG, i.e., K/Y.)


[11] Similarly, during the 1990s, when profit rates were rising, “disinflation” was encouraged: inflation subsided and businesses allowed lower unemployment rates to prevail.

[12] See the sources cited in notes 5 and 6, above.


[13] These international forces have been the emphasis of Bob Brenner (2002), who writes about the importance of international competition in hurting or helping a country’s profit rates.


[14] An explanation of this change is beyond the scope of this pamphlet.


[15] These calculations are explained in the web-site referenced in note 1 above.


[16] In some other eras, such as the 1960s, supply-side barriers blocked accumulation and depressed the profit rate. The role of a falling ECG (a “supply-side” factor) in depressing the profit rate can be seen clearly in chart 2.


[17] The implication is that capitalism could avoid both falling-profit-rate crises (when profitability is “too cold”) and those resulting from rising profit rates (“too hot) by attaining a “just right” profit rate. However, the dynamic of accumulation prevents this profit rate from being attained except temporarily. It should also be stressed that the international political economy is crucial to determining how crisis tendencies are manifested.


[18] In theory, the U.S. could export more to than it imports from the rest of the world, so that these cases are different. In practice, it hasn’t done so in several decades.


[19] Now, it is possible (in theory) that growth of the world economy as a whole might be so dynamic (and the supplies of labor-power so limited) that it would pull up wages to catch up with labor productivity, so that this undertow would go away, as I believe happened within the U.S. during the 1950s and 1960s. But this scenario seems extremely unlikely, since neo-Liberalism is struggling mightily to prevent it. Further, the seriousness of the current crisis prevents this cheerful scenario from being realized.


[20] This statement makes my theory different from classical underconsumptionism (Bleaney, 1976).


[21] See Blinder and Yellen (2001) for an orthodox but still useful summary of the Fed’s changing policy stance during the 1990s. My approach differs most clearly from theirs because of my emphasis on the roles of profitability, indebtedness, and the dynamic irrationality of capitalism.


[22] Charts 3 and 4 are from Wynne Godley and Alex Izurieta (2000). A lot of my short-term analysis follows their lead.


[23] The chart that follows was made using Federal Reserves Flow-of-Funds data and the National Income and Product Accounts, available from economy.com’s data page, http://www.economy.com/freelunch/.


[24] In fact, if the recession had occurred in 1997, it probably would have been milder than what’s to come, because the 1997-2000 boom created imbalances – excessive debt – that hadn’t existed before to their current degree.


[25] See the chart at http://www.abiworld.org/stats/personalbk.pdf presented by the American Bankruptcy Institute.