Tuesday, May 11, 2010

The Case For Pessimism

I've been feeling for quite some time that economic stagnation is our future. Things will not improve much for the forseeable future:
The strongest case for gloom that I’ve read has been made by UCLA economic historian Robert Brenner in a new introduction that he wrote to the Spanish edition of his 2006 book, The Economics of Global Turbulence.

...Brenner’s analysis of the current downturn can be boiled down to a fairly simple point: that the underlying cause of the current downturn lies in the “real” economy of private goods and service production rather than in the financial sector, and that the current remedies—from government spending and tax cuts to financial regulation—will not lead to the kind of robust growth and employment that the United States enjoyed after World War II and fleetingly in the late 1990s. These remedies won’t succeed because they won’t get at what has caused the slowdown in the real economy: global overcapacity in tradeable goods production.

Global overcapacity means that the world’s industries are capable of producing far more steel, shoes, cell phones, computer chips, and automobiles (among other things) than the world’s consumers are able and willing to consume. Companies can still sell their goods but at prices that undercut their rate of profit. In the 19th century, the redundant and less productive firms would have folded, and as wages fell, and profit rates went back up, the economy would start to revive. But that no longer happens. Firms have become too big and powerful to fail; and the citizens of democratic nations will justifiably no longer tolerate unemployment above 20 percent. Instead, the average rate of profit falls, private and public debt rises, and the danger of a large crash looms.

Brenner traces this problem of global overcapacity to the early 1970s when the countries decimated by World War II had rebuilt their industrial base and were capable of competing equally with the United States, and when newly industrializing countries in Asia and Latin America were beginning their ascent. At that point, global overcapacity manifested itself in declining rates of profit. In the United States, for instance, average profit rates in manufacturing fell from 24.5 percent in the 1960s to 13.4 percent in the 1970s and 11.8 percent in the 1980s. As profit rates declined, firms were less inclined to invest and expand, leading to a decline in overall growth in the economy and to higher average unemployment over a decade.

...Of course, the dot-com bubble burst in 2001.... How then was recovery possible at all? What happened was that the fundamentals behind the dot-com boom and bubble were replicated in the housing and commercial real estate markets. The rush of foreign dollars into the U.S. from the trade deficit helped the Federal Reserve keep interest rates near zero. With the interest rates plummeting, home sales rose. And as sales rose, the price of homes rose. Homeowners used their newfound home equity to purchase cars and other homes. Construction boomed, even while manufacturing floundered. When home prices threatened to discourage new purchases, banks and brokers, with encouragement from the Fed, offered new subprime mortgage deals. When the banks and brokers became worried about risk from these mortgages, they invented elaborate financial instruments to cushion and spread the risk. And when housing prices finally stalled, the whole Ponzi scheme collapsed, and the recession, the most severe since the 1930s, commenced.

Did the housing bubble cause the recession? Yes, in the same sense that a patient suffering from lung cancer finally dies as a result of pneumonia. The bursting of the bubble precipitated the recession, but the underlying condition, which made possible the financial chicanery of the last 15 years, was the global overcapacity in tradeable goods. With American firms no longer eagerly seeking funds for expansion, the banks and shadow banks had to look elsewhere for profitable outlets. And with the economy that produces tradeable goods not producing new jobs, a government that took its responsibility for maintaining employment had to look elsewhere to stimulate demand and growth. Ergo, two bubbles, and two recessions.

So what now? There are good reasons to re-regulate finance—among them, to prevent fraud and to create transparency—but financial reform will not necessarily create an incentive for banks to loan money to firms that want to invest and expand. The problem right now is primarily that firms are fearful that they won’t make a sufficient rate of return on their investments, and are holding back. There is also good reason to make expenditures for infrastructure that will create jobs and make American industry more productive. But, Brenner argues, Keynesian spending is at best a palliative that temporarily creates jobs and that, over the long run, exacerbates the problem of excess capacity.

...And by Brenner’s logic, there is no lasting solution to global overcapacity and falling rates of profit short of the kind of depression that shook the world in the 1930s. This depression, it should be recalled, had some pretty terrible political repercussions of its own. It not only threw millions out of work, but also fed the growth of fascism and Nazism and contributed, if not led directly, to World War II. The combination of the Depression and World War II created the conditions for the Golden Age of capitalism that occurred from 1945 to 1970.

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