[main depression article] [a talk on current events] [recent profit rates]

 (The article will be published in the "Caderno PUC - Economia", in April 1999. Caderno is a semi-annual review edited by Department of Economics, Pontifícia Universidade Católica de São Paulo (Catholic University), Brazil.)

by James Devine

Economics Department

Loyola Marymount University

Los Angeles, CA 90045

January 27, 1999

In view of the growing stagnation -- and in some places collapse -- of the global economy, it is important to consider the last time that the world suffered from such conditions, the 1930s. Given some historical background, we can draw out some lessons for today.

The Past. The post-1929 breakdown of both the prosperity of the United States and the shakier growth of Germany heralded the world-wide Great Depression of the 1930s, as primary-product producers went bankrupt, trade wars flared, and the banking system disintegrated. Because this series of events shook popular faith in capitalism's ability to "deliver the goods," economic historians have dedicated much time to understanding it. In this research, most emphasis has been on either the U.S. economy's collapse (as with Romer, 1993) or the instability of the world economy (Temin, 1989).

The dominant neoclassical view of the causes of the 1929-33 collapse emphasizes the importance of accidents -- shocks from the outside -- to what is assumed to be an essentially stable system. Though some like Peter Temin (1976) and Christina Romer (1990) stress the largely unexplained fall of consumption or the exogenous stock-market crash during 1929 as "shocks," policy errors receive the most attention: Milton Friedman and Anna Schwartz (1965), for example, blame the Federal Reserve for the "Great Contraction" of the U.S. money supply. Others (including Romer) emphasize that country's government's efforts to balance its budget in a recession, further cutting aggregate demand. Even the "international Keynesians" who stress the structural instability of the world economy in the late 1920s accentuate misguided policy: while Charles Kindleberger (1986) argues that the U.S. should have lived up to its responsibility as leader of world capitalism to stabilize the system, Temin (1989) blames the deflationary bias inherent in the dominant policy regime of the time (including the gold standard).

Because they see the U.S. and world economies as being basically unstable during the late 1920s, leftist economists -- including Marxists -- put little stress on either accidents or bad policy. Of course, there are debates among the leftists, centering on three main theories of economic crisis. Since there is little evidence for those hypotheses, hardly any emphasize a fall in the rate of profit or a profit squeeze at high employment. Instead, underconsumption tendencies are stressed. Paul Baran and Paul Sweezy (1966) see underconsumption-induced depression as the normal state of monopoly capitalism; it was only World War I and the wave of U.S. spending on automobiles and related items during the 1920s that delayed the onset of stagnation. On the other hand, the France-centered "Regulation School" (cf. Michel Aglietta, 1979) see a structural disjunction between the rising importance of mass production and the limits of mass consumption. The depression was inevitable in the absence of "a monopoly mode of regulation," often called "Fordism."

A major problem with underconsumption theories is that they go against Marx's emphasis on the usual expansionism of capitalism, the drive by capitalists to accumulate wealth at all costs. In my research (1983, 1984), I developed a solution: I agree with Marx's vision of capitalist accumulation, seeing competition and class antagonism as driving the system to expand too far, to over-accumulate, aided and abetted by the credit system. In certain circumstances, i.e., "labor abundance" of the sort that prevailed during the late 1920s, this over-accumulation can show up as "over-investment relative to consumption." But it should be stressed that there are other forms of over-accumulation: with a different institutional context, i.e., the domestic "labor scarcity" in the late-1960s U.S., over-accumulation can imply wage squeezes on profits (and inflationary surges). Here consider only the 1920s.

Over-investment relative to consumption operates as follows: rising labor productivity combined with stagnant wages implies inadequate workers' consumption but rising profit rates (as long as aggregate demand remains sufficient), as seen in corporate sectors in the late 1920s. Aggregate demand can remain sufficient as long as high profit rates stimulate investment (profit-led growth). High profit rates are hard to sustain, however, given low workers' income because both investment and capitalist luxury spending (the other domestic private sources of demand) is more unstable than workers' consumption. So is workers' spending that goes beyond the limits set by their income, because it is based on credit. In addition, fixed investment creates new capacity that implies the need for further rises in investment, capitalist luxury consumption, and credit-based workers' consumption.

Because those are unstable, the U.S. economy became increasingly fragile (prone to collapse) as the 1920s progressed. This meant that prosperity was more vulnerable to "shocks" such as the stock market crash, which itself can be explained in terms of the late-1920s political economy.

After the collapse occurred, when unused capacity, excessive debt, and pessimistic expectations (based on a dismal economy) blocked further accumulation. Then, capitalist competition induced falling wages which in turn caused falling consumption and further recession. This "underconsumption trap" encouraged lasting stagnation, because it encouraged the persistence of the factors stopping accumulation. In addition, falling prices raised the real value of debts, encouraging wages of bankruptcy and further decline (cf. Fisher, 1933).

Of course, the U.S. is not the whole world economy. In my 1994 article, I argue that the seemingly excessive attention to the U.S. economy in the 1920s is justified by the relative stagnation of most of the rest of the industrial world and almost all of primary production (including in the U.S.) after World War I. Much of the prosperity that did occur in the 1920s in places like Germany was dependent on U.S. growth, so that the U.S. was the capstone of the world arch. The slow growth of the world also made it difficult for the U.S. to preserve rising profit rates by boosting net exports. Finally, it meant that financial crises outside of the U.S. could infect that country's prosperity and that when the U.S. collapsed, so did the world market.

World stagnation itself can be explained by the stage of capitalism prevailing between the two World Wars, involving intense contention among nation-states. The inter-imperialist rivalry that spurred World War I also stimulated the creeping protectionism of the 1920s which turned into trade wars in the 1930s, partly as a result of the U.S. shift to increased protection in 1930, with the Hawley-Smoot tariff.

Thus, I see the rampant "policy failures" of the inter-War period as being not merely a matter of ignorance of economics but results of the world political economy. Given the incomplete rise of the U.S. to superpower status and the large size of that country's primary-producing sector in the 1920s, that country could not shoulder the "responsibilities" (assigned to it by Kindleberger) of stabilizing the world until after World War II. The deflationary policy consensus that Temin describes can be explained as part of the post-World War I capitalist offensive that aimed to reverse workers' gains, end rampant inflation, and restore depressed profit rates. Given the ascendancy of this movement, it is no surprise that the policy elite was not interested in reversing the 1929-33 collapse until it was too late, as Epstein and Ferguson [1984] show.

The Future. To what extent can we use this historical sketch to understand the situation in 1999? We should not assume that history will repeat itself exactly, even though many parts of the world such as Indonesia are already in severe depression and places such as Brazil are suffering greatly. However, since there is enough similarity, a deepening world Depression seems increasingly likely, including the U.S. in the process.

Starting with the international economy, the differences between the 1920s and the 1990s at first seem to be overwhelming. Instead of the aggressive competition of the leading capitalist nations of the era after World War I, the U.S. has been the hegemonic power for more than 50 years. The European Union is part of the U.S.-dominated NATO, while Japan is also tied up in a web of international agreements. Further, if anything, the trend of tariff and non-tariff barriers has been downward for several decades. But the international competition the world is currently suffering from is very different but as disastrous in its impact.

Instead of protectionist competition, we see what might be called competitive austerity and trade promotion. After the second World War, the United States started the process of unifying the world under the General Agreement on Tariffs and Trade, now called the World Trade Organization. To a large extent, the old system of import-substituting industrialization that prevailed in much of Latin America, the Philippines, and elsewhere has been undermined or destroyed by GATT, especially when backed by pressure from the U.S., the World Bank, and the International Monetary Fund. Much more important than trade, however, has been the related increase in the international mobility of capital in search of low wages, obedient workforces, general tax breaks, and generous treatment of polluters. The nations of the world, especially the middle layers above the very poor countries of Africa and the poorest developed countries of Europe, have increasingly found themselves in competition to attract this investment and have thus been trying to lower their standards. More and more of the world's working class finds itself in a global competition for capital's favor, a kind of labor abundance on a world scale.

The new deflationary consensus is based not on the global weakness of capitalism but on the strength of the U.S., the World Bank, and the I.M.F. The power of this troika intensified with the debt crisis of the 1980s and the collapse of the Soviet Union (their main competitor) in the 1990s. Being more concerned with promoting the profitability of business and banks and the ideology of neo-liberalism, none of the policy elites at these institutions were conscious of the deflationary potential of competitive austerity and export-promotion as it becomes generalized: it is impossible for all countries to cut consumer demand and have a balance of trade surplus at the same time without inducing world depression.

This result was shown in 1997, when the "miracle" economies of East Asia collapsed financially and economically. Competitive devaluations reminiscent of those of the early 1930s failed to help these economies recover, while increasing the value of their external debt, debt service, and the price of crucial imports in terms of their currencies. Even countries that resisted devaluation found themselves hiking interest rates, encouraging world recession. This financial crisis spread to Russia in 1998 and Brazil in 1999. At the same time, Japan has been severely depressed and the European Union stagnant. The latter should be expected to remain that way, since the European central bank must prove the solidity of the new Euro by keeping interest rates high.

In this context, the U.S. is again one of the few bright spots in a generally dark global economy, helping to prevent further collapse by running record trade deficits. (See Evelyn Iritani, 1998.) Even though the U.S. has been restraining or cutting real wages and government civilian programs, and is thus part of the global competitive austerity, it is not yet part of the world-wide effort to cut imports and boost exports. It is unclear how long the U.S. can accumulate external debt, especially with the Euro's creation undermining he ability of the U.S. to simply print dollars to pay off external debts.

In my 1994 paper, I doubted the possibility of a repeat of the profit-led growth process of the 1920 and the possibility of a catastrophic collapse. However, since I wrote that paper, profit rates, investment, and perhaps labor productivity have surged upward. So I have changed my mind. U.S. capitalist power and ability to raise profit rates is going too far, just as in the 1920s. Just as in the 1920s, gaps between the rich and poor have been rapidly widening for more than a decade, profit rates have been soaring, and stocks have been booming. Like the 1920s, the atmosphere is tinged by the overweening hubris of laissez-faire economics and "New Era" rhetoric (now called "The New Economy"). The U.S. has benefited from the recent sag in oil and other import prices. But just as in the 1920s, low materials prices are symptoms of global stagnation, one that is hitting domestic primary producers. Just as in the 1920s, U.S. investment spending may be over-shooting. (See Charles Clough, 1998.)

Like in the 1920s, we see consumer demand (including the building of new housing) doing well. But increasingly it's based on accumulating debt, dipping into savings, and faith that the stock market will remain high forever. When these become less and less viable, this kind of demand will falter. It's unclear how long the U.S. consumers can accumulate debt and how long the onset of a "bear" market can be delayed.

So it's possible that the prosperity could end in the U.S. This would encourage the rest of the world to go deeper in recession, fulfilling the economic nightmare. But what about economic policy that might prevent such a fate?

The Federal government is no longer in the Keynesian business of stabilizing the economy. The main emphasis is on balancing the budget, which prevents it from saving the economy when and if it begins to fall. (President Clinton's current enthusiasm for spending budget surpluses will evaporate with those surpluses.) In fact, given the current mood, especially in the state governments, a recession would encourage tax hikes or program cut-backs, which would make a recession worse. Due to welfare "reform" and changes in the tax code, government spending no longer automatically rises as much as it used to do when recessions hit, so that the built-in moderation of recessions is weaker than it was decades ago.

So it's all up the Federal Reserve. In 1998, Alan Greenspan cut interest rates, trying to prevent financial disaster and recession. The central banks of Europe also cut rates, clearly alarmed at the situation. As a result, financial markets have been doing better. In theory, monetary easing might prevent recession: lower interest rates encourage spending, especially on housing. So far the central banks have been successful at stemming the tide, with some observers abandoning their previous fears about the future.

The problem is that if the Fed is successful at encouraging not only investment in housing but in plant and equipment, that creates capacity that requires further increases in demand, which could easily become unsustainable. Similarly, it will become increasingly difficult to sell the increased housing stock when consumer indebtedness is rising. And note that any success that the Fed achieves will be bought at the expense of increased accumulation of debt by private individuals and corporations. Since both industrial capacity and debt can represent barriers to growth in the future, this means that the longer the Fed is able to delay the next recession, the more imbalances accumulate that can sabotage the boom and then block recovery.

Put another way, to avoid a recession, interest rates will have to be cut again and again, until it undermines the value of the dollar and makes the rentiers scream. Eventually, limits will be faced and the US boom will falter. Further, the central banks' bail-outs of financial speculators encourages them to sin again, causing further speculative booms and financial shocks that disrupt the fragile growth process.

Given the very slow recovery of East Asia (including Japan), Russia, and elsewhere, and projected economic slowing in Western Europe, it is unlikely that the rest of the world will recover before the U.S. growth collapses. So the depression prediction is likely to hold.

 For a draft analysis of recent profit rate changes in the U.S., click here.

Aglietta, Michel. 1979. A Theory of Capitalist Regulation: The US Experience. London, UK: New Left. David Fernbach, transl.

Baran, Paul and Paul Sweezy. 1966 Monopoly Capital. New York: Monthly Review Press.

Clough, Charles. 1998. Too Much of a Good Thing, New York Times, November 17.

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: 119-94.

Epstein, Gerald, and Thomas Ferguson. 1984. Monetary Policy, Loan Liquidation, and Industrial Conflict: The Federal Reserve and the Open Market Operations of 1932. Journal of Economic History 44(2) December: 957-83.

Fisher, Irving. 1933. The Debt-Deflation Theory of Great Depressions. Econometrica 1: 337-57.

Friedman, Milton, and Anna Jacobson Schwartz, 1965. The Great Contraction, 1929-33. Princeton, NJ: Princeton U.P.

Kindleberger, Charles P. 1986. The World in Depression, 1929-1939 rev. & exp. ed. Berkeley: University of California Press.

Iritani, Evelyn.1998. U.S. Is Globe's Last Hope to Halt Recession, L.A. Times, August 2, p. A1.

The Journal of Economic Perspectives. Special Issue on the Great Depression, Spring 1993.

Romer, Christina. The Great Crash and the Onset of the Great Depression. Quarterly Journal of Economics. 105(3), August: 597-624.

Temin, Peter. 1976. Did Monetary Forces Cause the Great Depression? New York: W.W. Norton.

_______. 1989. Lessons from the Great Depression Cambridge, MA: MIT Press.

[main depression article] [a talk on current events] [recent profit rates]