Declining Profitability and the Evolution of the US Economy: A Classical Perspective (Routledge Frontiers of Political Economy) [1 ed.] 1032538155, 9781032538150

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Declining Profitability and the Evolution of the US Economy

The 1970s were a pivotal decade for the US economy: deindustrialization broke the power of the labor unions and made possible the redistribution of income in favor of corporate profits; globalization and offshore investments opened alternatives to domestic nonfinancial capital accumulation; domestic productivity growth declined; and labor-saving technology empowered superstar corporations to rapidly gain market share. This book argues that the persistent fall in profitability, leading to the stagflation crisis, was a direct result of the transition from the Fordist phase of capital accumulation, based on large-scale manufacturing, to the neoliberal phase and the rising power of finance. Neoliberalism restored the power of rentiers but not the profit rates of nonfinancial corporations. Falling accumulation rates weakened the growth capacity of nonfinancial corporate firms and secular stagnation became the norm. Neo-Keynesian economists, Larry Summers and Paul Krugman, explained the persistence of secular stagnation with arguments borrowed from Alvin Hansen in the 1930s, such as the declining birth rate or the falling relative prices of investment goods, hence a shortfall of demand. In the Classical paradigm, profitability drives capital accumulation and falling profitability slows down growth. As the accumulation rate declined and the capacity growth diminished, breakdowns in supply links, due to the COVID-19 pandemic, prevented large infusions of purchasing power to find matching levels of supply, hence the stagflation crisis returned. The book will be a great asset to researchers and scholars interested in the development of Classical Political Economy concerning issues related to inflation, stagnation, growing inequality, and the next phase of neoliberalism. Ascension Mejorado is Clinical Professor and Economics Faculty Chair in the Liberal Studies program at New York University, USA. She is co-author with Manuel Roman of Profitability and the Great Recession: The Role of Accumulation Trends in the Financial Crisis (Routledge). Manuel Roman taught economics at New Jersey City University, USA, for over 25 years and is now retired. He is co-author with Ascension Mejorado of Profitability and the Great Recession: The Role of Accumulation Trends in the Financial Crisis (Routledge). He is the solo author of Heterodox Views of Finance and Cycles in the Spanish Economy and Growth and Stagnation of the Spanish Economy: The Long Wave, 1954–1993.

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Marxist Political Economy and Bourdieu Economic and Cultural Capital, Classes and State George Economakis and Theofanis Papageorgiou New Institutional Economics as Situational Logic A Phenomenological Perspective Piet De Vries Human Economics Paradigms, Systems, and Dynamics Sara Casagrande The Knowledge Problems of European Financial Market Integration Paradoxes of the Market Troels Krarup Beyond Ecological Economics and Development Critical reflections on the thought of Manfred Max-Neef Edited by Luis Valenzuela and María del Valle Barrera New Economic Statecraft China, the United States and the European Union Zhang Xiaotong The Scottish Economy and Nationalism Constructing Scotland’s Imagined Economy James Foley The Meaning of Shared Value New Perspective on Creating Shared Value Floriana Fusco, Patrick O’Sullivan and Paolo Ricci Declining Profitability and the Evolution of the US Economy A Classical Perspective Ascension Mejorado and Manuel Roman For more information about this series, please visit: www​.routledge​.com​/Routledge​Frontiers​-of​-Political​-Economy​/book​-series​/SE0345

Declining Profitability and the Evolution of the US Economy A Classical Perspective

Ascension Mejorado and Manuel Roman

First published 2024 by Routledge 4 Park Square, Milton Park, Abingdon, Oxon OX14 4RN and by Routledge 605 Third Avenue, New York, NY 10158 Routledge is an imprint of the Taylor & Francis Group, an informa business © 2024 Ascension Mejorado and Manuel Roman The right of Ascension Mejorado and Manuel Roman to be identified as authors of this work has been asserted in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library ISBN: 978-1-032-53815-0 (hbk) ISBN: 978-1-032-53817-4 (pbk) ISBN: 978-1-003-41380-6 (ebk) DOI: 10.4324/9781003413806 Typeset in Times New Roman by Deanta Global Publishing Services, Chennai, India

Table of Contents

Acknowledgments List of figures   1 Introduction

vi vii 1

  2 Classical Economics: Growth and the Stationary State

30

  3 Profitability and the limits of Fordism

62

  4 Productivity and wages: The scissors effect

95

  5 Production, labor, and income trends

120

  6 The deindustrialization quagmire

137

  7 Falling interest rates, banking, and financial crises

166

  8 Keynes and secular stagnation

192

  9 The neo-Keynesian retreat

219

10 The Classical advance: Schumpeter and Grossman

247

11 From secular stagnation to stagflation

268

Index

297

Acknowledgments

Professor Anwar Shaikh’s life work inspired the conceptual scaffold of our book’s argument and we cherish him as a teacher and friend. Ascension appreciates the support received from Global Liberal Studies faculty members at New York University, allowing her time to complete this book. Manuel remembers Professor Thomas Vietorisz of the New School for Social Research as an inspiring teacher and friend. Professor Lefteris Tsoulfidis’ and Professor Persefoni Tsaliki’s dedication to the advance of Classical Economics sustained our efforts to do the same. Finally, we thank Andy Humphrey, publisher at Routledge, for his continued support.

List of figures

1.1 U.S. business sector’s average profit, nonresidential capital accumulation, and real GDP growth rates 1.2 Japan nonfinancial corporate average profit and accumulation rates 1.3 U.S. 10-year government bonds yield and mortgage liabilities/ disposable personal income 2.1 U.S. and U.K. Kondratieff long-waves, 1834-2021 2.2 Seven years centered moving average of U.K. interest rates, 1600-2018 2.3 Profit and real GDP growth rates 2.4 Output/capital trend, 1760-1980 3.1 U.S. business sector profit and accumulation rates 3.2 U.S. business sector incremental profit rate and nonresidential investment growth rate 3.3 U.S. business sector average profit rate on current cost, gross capital stock 1900–1993 3.4 U.S. nonfinancial corporate average profit rate, retained earnings/ current cost net capital stock, and nonfinancial corporate rate of capital accumulation 3.5 U.S. net-value-added/current cost net capital stock and Loess trends in the business and nonfinancial corporate sectors 3.6 France, Germany, Japan, and U.K. GDP/Gross capital stock, 1891–1991 3.7 A. Shaikh’s U.S. ‘slack’ coefficient and GDP deflator growth rate 3.8 A. Shaikh’s U.S. ‘slack’ coefficient and the effective federal funds rate 4.1 U.S. net output/net fixed capital ratio and profit shares in net value added 4.2 U.S. hourly non-farm productivity and real earnings for all employees, including ‘production and nonsupervisory’ as well as ‘supervisory’ and managerial employees 4.3 U.S. actual trends of hourly labor productivity for all workers and real hourly earnings, plus a counterfactual trend of real hourly earnings located mid-way between the previous two, 1974 = 100 4.4 U.S. real average profit rate and the counterfactual profit rate, had hourly earnings grow in an intermediate position between their actually repressed growth rate and the growth rate of labor productivity.

3 6 13 46 48 58 59 64 64 70 72 76 77 80 81 108 114 115

116

viii  List of figures 4.5 U.S. similar paths for the counterfactual profit rate and the actual profit rate after excluding the FIRE sector 5.1 U.S. income shares of top 10 percent and union density 5.2 U.S. union density, productivity, and earnings growth 5.3 U.S. real nonresidential fixed capital growth, Fixed Assets Table 2.1 and NIPA Tables 6.9BCD; real growth of hourly labor productivity; real hourly earnings of all employees; and real hourly earnings of ‘production and nonsupervisory employees’ 5.4 U.S. all employees versus production and nonsupervisory employees’ earnings shares in business sector net value added 5.5 U.S. average hourly labor productivity/average hourly compensation of business sector employees; average hourly earnings of production and nonsupervisory employees as share of total private employee compensation; and share of ‘production and nonsupervisory employees’ in total private employment 5.6 Output/capital ratios in seven OECD countries: Canada, France, Germany, Italy, Japan, Spain, and the U.S. 5.7 Average profit rates in selected OECD countries: France, Germany, Italy, Japan, and Spain 5.8 Average profit rates in China, Italy, and the U.K. 5.9 Wage shares in selected OECD countries’ GDP 5.10 Capital accumulation rates in France, Germany, Italy, Japan, and Spain, 1960–2020 6.1 U.S. structural change in the business sector: manufacturing share of corporate profits versus financial share of corporate profits 6.2 U.S. nonfinancial corporate shares of financial flows including interest payments, equity share buybacks, and dividends in net operating surplus versus shares of net fixed capital investment in net operating surplus 6.3 U.S. manufacturing output/capital ratio, manufacturing labor productivity, and manufacturing real compensation per worker 6.4 U.S. manufacturing average profit rate, manufacturing profit rate adjusted for capacity utilization, and manufacturing accumulation rate 6.5 U.S. manufacturing net income/current net fixed capital stock and manufacturing net profits (operating surplus) share of net manufacturing income 6.6 U.S. manufacturing capital accumulation, net investment/capital stock, and retained earnings/capital stock 6.7 U.S. manufacturing and nonmanufacturing profit rates 6.8 U.S. manufacturing profit rate; nonmanufacturing profit rate, excluding mining, transportation, and utilities; mining, transportation, and utilities profit rate 6.9 U.S. manufacturing and nonmanufacturing incremental profit rates 6.10 U.S. and Japan incremental manufacturing profit rates 6.11 U.S. manufacturing incremental profit rate and manufacturing investment growth rate

117 126 127

128 130

131 133 134 134 135 136 138

139 147 148 149 150 150 152 156 156 157

List of figures  ix 6.12 Japan manufacturing incremental profit rate and gross manufacturing investment growth 6.13 U.S. and Japan average profit rates in manufacturing 6.14 U.S. incremental and average profit rates 6.15 U.S. contrasting developments in manufacturing and ‘stagnant’ service sectors 6.16 U.S. percentage change contrast between manufacturing and services employment and value added 6.17 U.S. business sector average profit rate including and excluding the FIRE sector 6.18 U.S. manufacturing and ‘stagnant’ service sectors average profitability paths 7.1 The great wave in nominal interest rates, 1948–2020 7.2 Nonfinancial corporate borrowing, share buybacks, and equity funds 7.3 Nonfinancial net new equity purchases relative to net fixed investment 7.4 Contrasting trends of wealth shares of top 1 percent of households and that of the 50 to 90 percent percentile 7.5 Share of net financial wealth of top 10 percent including equity, fund share, and offshore accounts 7.6 Percentage of corporate shares and mutual funds owned by the top 10 percent and top 1 percent of households, 1989:Q3 to 2021:Q1 7.7 Declining labor union density and falling share of ‘production and nonsupervisory’ workers’ compensation in net value added 7.8 Gibson Paradox flat trends of price and interest rate levels 1833–1947 versus rising prices from 1947–2012 and rising interest rates 1947–1984 7.9 Net interest margins (left axis) and number of banks, 1984–2020, based on FRED USNIM and USNUM. 7.10 The declining number of banks and asset concentration in five top banks, FRED DDOI06USA156NWDB and USNUM. 7.11 Nonfinancial corporate average profit rate on current cost nonfinancial corporate gross capital stock and average profitability on stock market valuation of the sector’s fixed assets 7.12 Co-movement of financial business profitability and the sector’s share of corporate profits due to expanding financialization 7.13 Gravitational pull between the nonfinancial corporate average profit rate and the financial average profit rate 7.14 Accumulation rates in nonfinancial and financial sectors 7.15 Corporate (financial and nonfinancial) incremental profit rates and stock market incremental profit rates 8.1 U.S. nonfinancial corporate liquid assets relative to total financial assets and nonfinancial corporate liquid assets relative to nonfinancial corporate fixed assets 8.2 U.S. nonfinancial corporate retained domestic earnings normalized by the nonfinancial corporate net capital stock and nonfinancial corporate rate of accumulation

158 158 160 161 162 163 164 169 173 173 175 176 177 177 178 180 181 182 187 188 189 190 203 205

x  List of figures 8.3

9.1 10.1 10.2

10.3 10.4 11.1 11.2 11.3 11.4 11.5 11.6 11.7 11.8 11.9 11.10

U.S. nonfinancial corporate sum of equity shares buybacks, net dividends, and net interest payments relative to nonfinancial corporate net operating surplus, and nonfinancial corporate net investment relative to net operating surplus U.S. nonresidential fixed capital investment growth versus effective federal funds rate Simulation of H. Grossman’s extension of O. Bauer model of capital accumulation, 34 periods, and the disappearance of capitalist consumption: the breakdown of accumulation Simulation of Bauer–Grossman model with modified characteristics: accumulation rising at 3 percent YOY; rising rate of surplus value = 3 percent of wages YOY transferred to profits. Ending of capitalist consumption delayed Simulation of the Bauer–Grossman rate of accumulation reflecting changes in profitability Simulation of new modifications to the Bauer–Grossman growth model U.S. nonfinancial corporate average profit rates as previously sourced and the rise of ‘zombie’ companies U.S. quarterly real personal income excluding transfer receipts, billions of chained $2012 BLS household employment survey and exponential growth trend, 1950–2022 Evolution of U.S. employment during the COVID-19 pandemic: percentage employment losses in high-wage, middle-wage, and low-wage categories relative to January 2020 Evolution of U.S. business revenues in three categories: low, middle, and high revenue businesses U.S. total net bank credit flow/GDPt-1 and nominal GDP growth U.S. total net bank credit flow/GDPt-1 and inflation growth rate Parallelism between golden-price Long Waves and long capital accumulation rate in the U.S. U.S. real GDP 1992Q1–2022Q1 and real nonfinancial corporate operating surplus Data approximation to the U.S. rate of surplus value

205 230 262

263 265 265 274 283 283 285 285 288 289 290 292 294

1

Introduction

The immediate effect of The Federal Reserve’s efforts to keep the federal funds rate near the zero bound after the financial crash of 2007–2008 and again in 2020 was to set financial markets off to ever-higher valuations. That policy, however, failed to have any significant effect on expanding nonfinancial capital investments or productivity growth because the business sector’s profitability level was too low. Since 1984, falling interest rates proved to be ineffective in stimulating capital accumulation in nonfinancial corporate sectors. Conceivably, the wealth effect of rising valuations in financial markets played a positive role in stimulating the restoration of consumption spending by the upper 10 percent of households that own the lion’s share of financial assets. When inflation signs appeared in 2021, following the massive injections of cash and credit engineered by the Federal Reserve to jumpstart the COVID-19 post-lockdowns return to ‘normal’, rising interest rates did not restore the broken supply chains or reversed the financial fragility of ‘zombie’ corporations that constrained aggregate supply. Both after the 2007–2009 Great Recession and the 2021 surge of the stock market, class inequality between the top ten percent of elite households and the rest increased substantially because declining interest rates boosted financial markets but not capital accumulation in nonfinancial sectors with the potential for employment and income gains (Jones, 2019; Mejorado and Roman, 2014). Raising interest rates to combat inflation will not dampen investment growth if business profitability is high enough as it was in the 1970s, and lowering interest rates will not increase nonfinancial corporate investment when profitability is low or falling as it has been since 2000 (Leijonhufvud, 2000). As we argue in Chapter 7, falling interest rates had a major impact on the structure of the banking industry and contributed to its concentration and centralization and the promotion of the subprime housing crisis. Falling interest rates induced banks to make up for the loss of net interest margins with expanding loan volumes, thus motivating mortgage originators to attract impecunious buyers, often without jobs or collateral, into buying mortgages they could not afford. Once housing prices ceased rising, many mortgage-backed securities linked to them ended in default and precipitated the Great Financial Crisis. In our view, the inflation signs that emerged after the COVID-19 lockdowns ended have their origins in the increasing reliance on global supply chains that provide the goods no longer produced in the U.S. economy due to neoliberal deindustrialization. When the collapse of effective demand cut off revenue flows to the DOI:  10.4324/9781003413806-1

2  Introduction supply networks during the 2020 COVID-19 lockdowns, indebted suppliers went into default. Neoliberal principles of good business practice advise minimal inventory stocks and the largest possible leverage in order to maximize net revenues. The unexpected interruption of sales and revenues caused by the pandemic shock was bound to provoke cascading defaults, supply bottlenecks, and economy-wide inflation outbreaks. Raising interest rates ‘to combat inflation’ is likely to unravel financial markets and reverse the wealth effect that carried the economy forward in the neoliberal phase. Cutting somewhat the discretionary consumption spending of the upper ten percent and reducing residential investment (for that is the chief impact of rising interest rates) is likely to bring in recession and growing unemployment. But it will fail to have a discernible effect on the inflation pressures affecting the larger number of households, including those classified as belonging to ‘essential workers’. ‘Essential’ workers are a good part of the ‘production and nonsupervisory’ classification of the Bureau of Labor Statistics that make up 80 percent of all employees (Botwinick, 1993; Temin, 2017, William, 2017; Lind, 2020; Chibber, 2022). As the coming slump gathers momentum, their real wages will fall and their unemployed numbers will rise, even though they did not cause the inflation. The growing level of debt that deepened the financial fragility of households and so-called ‘zombie’ firms will continue to undermine the prospects of real recovery from the coming stagflation crisis (Roubini, 2022). From the standpoint of Classical Political Economy, income distribution reflects the class structure of capitalist production and explains why, in the midst of the pandemic, those workers classified as ‘essential’ because they saved lives or delivered goods were likely to receive the lowest wages. According to Larry Summers, inflation threatens the financial wealth acquired by the top ten percent during the pandemic lockdowns, and the Federal Reserve needs “to be absolutely clear on two propositions that Volker took as axiomatic. First price stability is essential…while overheating the economy leads to stagflation…I hope the Fed will make it clear that inflation reduction is its principle objective and that it will wind down efforts to promote worthy but nonmonetary goals such as social justice and environmental protection” (Summers, 2022). In the ‘post-pandemic’ phase, whether inflation or recession or both predominate, interest rates will rise until unemployment is sufficiently deep, and real wages have fallen enough for the profits share to rise above the level reached in the aftermath of the Great Recession. Our central argument It is our contention, as that of all great economists, including Marx and Keynes, that business profitability drives the accumulation of capital and that at the advanced stages of that process, the system’s growth rate declines because falling profitability

Introduction  3 saps the incentive to expand the stock of fixed capital assets. In Figure 1.1 we show the empirical evidence behind our claim that long-term falling profitability led to corresponding periods of falling capital accumulation rates, periodically punctuated by ‘recessions’ and brief recoveries. The collapse of effective demand associated with the COVID-19 lockdowns broke the global supply chains and led to the shortages and bottlenecks that ushered in a new stagflation crisis. In this book, we trace the roots of the ‘secular stagnation’ weighing down the growth prospects of the U.S. neoliberal economy since the early 1980s to the protracted decline in profitability that starting in the mid-1960s continued until the early 1980s, when its trough fell well below that of any other postwar recession (Bischoff, Kruger, and Lieber, 2018; Anselmann, 2020). In the decades leading up to the stagflation crisis of the 1970s, declining profit rates undermined the foundations of capital accumulation, and created the crisis atmosphere that for managerial elites justified dismantling the Fordist configuration and bringing in the neoliberal construct (Gordon, 2016). Transitioning from deindustrialization to financialized neoliberalism in the 1980s, declining interest rates spurred financial bubbles and paved the way for major financial crises in the 21st century (Dumenil and Levy, 2014; Gerstle, 2022). The evidence shown in Figure 1.1 regarding the long-term decline in nonfinancial corporate profitability explains why, before and after the pandemic shock, nonfinancial corporations preferred equity share buybacks rather than long-term fixed capital investments. In Figure 1.1, from 2001 to 2020, the gross profit rate, defined as business sector net operating surplus on current cost net capital stock, 20% 18% 16% 14% 12%

Business sector average profit rate Business sector fixed capital accumulation rate Real GDP growth rate Business sector capital accumulation rate 1965-2020 Linear (Business sector average profit rate) Linear (Business sector capital accu mulation rate 1965-2020)

10% 8% 6% 4% 2% 0% -2% -4% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 1.1  U.S. business sector’s average profit, nonresidential capital accumulation, and real GDP growth rates, based on NIPA Tables 1.1.1, 1.9.5, 1.10, 1.13, 6.2; Fixed Assets 2.1, 4.1, 4.7, 7.1.

4  Introduction averaged 8.6 percent. At that level, it was 28.2 percent lower than in the first three decades of the postwar period, when it reached a 13 percent average. Similarly, the average rate of capital accumulation in the nonfinancial corporate sector, from 2001 to 2020, at an average of 2.82 percent, was 22 percent lower than in the first three decades of the postwar, when it reached 3.6 percent average. Contrary to the neoclassical conventional wisdom, the Federal Reserve’s policy of lowering interest rates since 1984 had very little effect on nonfinancial capital expenditures. The long-term trend of non-residential capital accumulation in the real economy declined from 1965 to the present. As we will show, interest rate movements had a major impact on the acquisition of mortgages and contributed significantly to the rise of household debt and the outbreak of the financial crisis in 2007. Profitability and secular stagnation in Japan When we attribute the tepid rate of GDP growth to the falling trend of capital accumulation in the U.S. economy since the mid-1960s and point to falling profitability as its structural cause, our interpretation is consistent with the centrality of falling profitability in the Classical theory of secular stagnation as in Ricardo, Mill, and Marx. Our findings in Japan’s case confirmed the parallel relationship between falling profitability and capital accumulation rate found in the U.S. economy. Takuya Sato appears to agree that “Marx’s law of the tendency of the rate of profit to fall” provided a “consistent explanation” of stagnation in Japan from the early 1960s to 1990. He concluded, however, that “since the collapse of the 1990s,” Marx’s law failed to account for the growing bifurcation in Japan between the rising rate of profit and the falling accumulation trend (Figure 3 in Sato’s article). This bifurcation of profitability and accumulation, Sato claims, reflects the transformation of competitive capitalism into monopoly capitalism in Japan. This change in industrial organization freed the ‘monopolies’ from the constraints of coercive accumulation and set the foundations for rising profitability. Our research, however, proves that the relationship between falling profitability and the capital accumulation trend is structurally binding. We disagree, therefore, with Takuya Sato’s claim that Marx’s law of the falling rate of profit does not apply to 21stcentury Japan (Sato, 2018, 2022). While claiming the relevance and consistency of Marx’s falling rate of profits as a theory, bringing up the emergence of ‘monopoly capitalism’ in the 21st century to explain the bifurcation between the falling accumulation trend and the rising profit rate from the year 2000 to the present bypasses the structural determination of related trends. Sato’s present argument merely recovered Steindl’s old claim that, the law of the declining rate of profit…we may conceive it as a potential tendency, which is never realized, but may nonetheless be important…the capitalists do not, in fact, carry out certain possible changes in the capital structure, because they would lead to a decline in the rate of profit…By thus

Introduction  5 refraining from making production more capital-intensive, they do of course invest less than they otherwise might...How far the law of the declining profit rate…has operated in the course of capitalist history to restrict the adoption of capital-intensive methods…it is hard to judge. (Steindl, 1976, p. 242) Robert Solow found the relation between rising capital intensity and profitability to be the central question for the analysis of accumulation in the advanced capitalist countries. Assessing the possibility that capitalists would voluntarily choose to refrain from investing in capital-intensive technology because they feared falling yields, Solow insisted from his own neoclassical standpoint that the tendency for the capital intensity of production to rise is an inescapable consequence of rising, not falling, competitive pressures today. As Clifton has been arguing since the late 1970s, the nature of competition changed with the level of capitalist development. As corporations grew larger and more diversified, competitive wars became more lethal and destructive for those who fell behind (Gourvitch, 1966; Clifton, 1977, 1983; Frey, 2019). The idea of rising profitability based on oligopolistic industrial organization begs the question, what would such corporations do with their higher profits? If they enjoy higher profit rates than the smaller firms that presumably operate in markets resembling the ‘perfect competition’ of neoclassical economics, will they invest in such markets or in their own privileged line of business? Why would they reject all investments in their own more profitable, successful business? Would they really abstain from expanding because they feared the decline of profitability? The rate of profit defines the ratio of total profits relative to the capital stock used to produce them, π = Π/K. Given the profit rate, the mass of profits is the product of the profit rate times the capital stock, and its growth rate, Πδ = πα Kβ, depends on the sum of the growth rate of capital, β, and the percentage decline of the profit rate, α. In symbols, the mass of profits, Π, would rise as long as the sum of both growth rates (–α + β) is positive, that is the growth of the capital stock, +β, is higher than the rate at which profitability declines, -α. Considering the reality of free capital movements and industries with global boundaries, what would assure the domestic oligopolies of being able to preserve their privileged position without tempting other capitalists (domestic or foreign) from encroaching on their market share? This was precisely what U.S. corporations in the 1970s learned when they found powerful competitors from Japan and Germany taking away their market share. Even if there were no competing rivals in sight, what are the options for a single powerful ‘monopolist’ enjoying a high rate of profits? As long as the conditions of production in its line of business are reproducible, where would they reinvest their high profits? Would such a monopolist not choose to invest in its highly profitable industry to expand profits further? Of course, the larger output will reduce the market price and profitability will be impaired, but that is the winning strategy to capture the highest market share. Refusing to invest monopoly profits and simply distributing them as dividends,

6  Introduction

28% Nonfinancial corporate profit rate

24%

Net fixed capital accumulation rate 20%

16%

12%

8%

4%

0%

202 0

201 7

201 1

201 4

200 5

200 8

200 2

199 6

199 9

199 0

199 3

198 7

198 1

198 4

197 5

197 8

197 2

196 6

196 9

196 0

196 3

195 4

195 7

-4%

Figure 1.2  Japan nonfinancial corporate average profit and accumulation rates, based on Financial Statements Statistics of Corporations by Corporations, Ministry of Finance, Japan: operating profits, fixed assets minus land.

retaining them as cash hoards, or spending them in share buybacks are short-term options that suggest the loss of profitable alternatives. In any event, our calculations of nonfinancial corporate profitability and accumulation rates, produced different results from Sato’s, even though they draw the data from the same source Sato used, the Financial Statements Statistics of Corporations by Corporations compiled by the Policy Research Institute of the Ministry of Finance, Japan. As Figure 1.2 shows, the relationship between the profitability trend of nonfinancial corporations and the capital accumulation trend in Japan, with a correlation coefficient of .8438, confirms the existence of a remarkable parallelism between them from 1954 to the year 2020, not a bifurcation in the 21st century. Japan’s economic development confirms the structural links binding profitability and accumulation trends at the higher stages of capitalist development. In our view, the long-term decline of profitability and accumulation in Japan vindicates the classical theory of secular stagnation. Our perspective, anchored in Classical Political Economy Our approach derives from the research program of Classical Political Economy concerning the sources of the wealth of nations and its distribution (Shaikh and Tonak, 1994). The guiding principle of such program focused on profitability as the driver of capital accumulation and assumed that its evolution provided the necessary clues to delineate the historical trends of capitalist growth and stagnation. Our

Introduction  7 research strategy relies on tracking the empirical evidence that allowed Classical economists to make reliable causal connections between profitability and capital accumulation in order to explain the historical trajectory of the capitalist system. While personal experience of business practices helped Classical economists to evaluate the accuracy of their theoretical views on profitability and capital accumulation, we rely on the available data banks to trace the historical path. After outlining in Chapter 2 the conceptual structure of the growth model imbedded in the Classical paradigm, we go on to explore the empirical evidence on profitability and accumulation spanning centuries. In Chapter 3, we show the results of calculating profit and interest rates time series from the 17th century to the 1980s. Our source is the Bank of England’s “A Millennium of Macroeconomic Data,” version 3.1, and Bank of England Staff Working Paper, No. 845, “Eight Centuries of Global Real Interest Rates, R-G, and the Supra Secular Decline, 1311–2018” by Paul Schmelzing, version 1.2, January 2020. Because Adam Smith did not have access to such facilities, he relied on his own retrospective knowledge of long-term falling interest rates as a proxy for profit rates, assuming that, as a rule, the path of falling interest rates would settle around half the level of the profit rate (Smith, 1965, p. 88). More recently, John Smith noted that “the interest rate…is related to the broadest definition of the rate of profit…Its descent to historically low levels is therefore a sign of a deepening crisis of profitability” (Smith, 2016, p. 285). In Imperialism: A Study (1938), Hobson advanced the notion that, as capital accumulation went on, profitability would decline. He noted that “As one nation after another enters the machine economy and adopts advanced industrial methods, it becomes more difficult for its manufacturers, merchants, and financiers to dispose profitably of their economic resources…Everywhere appear excessive powers of production, excessive capital in search of investment” (Freeden, 2020, p. 160). In the conceptual structure of Classical Political Economy, David Ricardo and Karl Marx identified the evolution of profitability as the chief driver of capital accumulation. While their theories offered different accounts of the profit rate dynamics and the mechanisms that powered the accumulation of capital, they shared a vision of capitalist development bringing about the decline in average profitability and the weakening of the power behind the system’s extended reproduction (Reich, 2020). In Ricardo’s case, the rising costs of growing food in marginal lands caused the falling rate of profit, as rising food costs increased nominal wages and landowners in better tracts of land received higher differential rents at the expense of falling profits for the entire capitalist class. Falling profitability diminished both the incentive and the means to maintain a high accumulation rate, eventually leading to the slowdown in capital accumulation and the relentless approach of the stationary state. Technical progress reduced the rise in food costs but when introduced across the various gradients of land did not alter the conditions of production, hence maintained the existing array of differential rents. The stagnation tendency could be delayed, but not prevented. In Marx’s work, profitability played the decisive role in the accumulation of capital but, in contrast with all other Classical economists, introducing technical

8  Introduction progress did not increase profitability but instead lowered it. Technical change allowed competitive firms to fight the battle of competition relying on its power to lower unit costs as a precondition to cheapen the commodity’s price (Basu, 2021). Capital-intensive technology replaced labor power in a relentless effort to increase the productivity of labor. The employment of production labor (as opposed to servants) was the source of profits, as production workers created more value than they received for their maintenance. Despite the rise in labor productivity and the reduction in the necessary labor time per unit of output, the profits share grew at a declining rate, as the wage share got smaller. As capital intensity increased relative to productive employment, the source of new value declined relative to the value accumulated in machinery and structures. The profit rate, measuring the growth of capital, would tend to fall in the long run. In Volume 2 of Capital, Marx developed detailed schemes showing the sectoral balances necessary for the extended reproduction of capital in the absence of both technical change and competition (Landes, 2008). In these schemes, the organic composition of capital remains constant and the profit rate does not decline. It is the pursuit of profits as such that powers the accumulation of capital and technical change that lowers its growth rate due to the rising share of fixed capital and the falling share of labor’s compensation. Similarly, in Chapter 25 of Volume 1 of Capital, Marx outlined a cyclical model of accumulation without labor-saving technical change, driven by fluctuations in the rate of accumulation caused by changing wage rates in response to employment fluctuations, not technical change. Finally, we need to point out with the benefit of historical hindsight that Ricardo’s rising rents, collected by the landed aristocracy as beneficiaries (and villains) of the accumulation of capital, did not cause the arrival of the stationary state as Ricardo’s theory predicted. Instead, the landed aristocrats yielded to the entreats of financial speculators and after ‘investing’ the lion’s share of their rents in ‘secure’ consoles lost their fortunes in the periodic crashes that took place throughout the century. The monopoly diversion We reject the idea that the wide gap between the profitability of the top corporations and the zombies is the result of monopoly power exerted by companies at the peak of the corporate pyramid. On the contrary, it is a testimony to their superior competitive power and success in the ever-going race to conquer market share. As pointed out earlier, we interpret the profitability gap in the ‘dual’ economy consisting of superstar firms at one end and zombies at the other as the end result of competition-as-war (Shaikh, 2016), not evidence of monopoly power as liberal critics like Stiglitz and Mazzucato insist (Stiglitz, 2019; Mazzucato, 2018). We seek to provide a Classical interpretation of the transition from secular stagnation to stagflation because we find in Adam Smith, David Ricardo, and Karl Marx’s Classical paradigm the scientific foundations to analyze the capitalist economy in the 21st century, and to understand the necessary structural changes that preceded the consolidation of neoliberalism. In Chapter 9, we also find the invaluable insights contributed by Maynard Keynes with regard to effective demand essential

Introduction  9 to our presentation of the book’s argument, as long as his “marginal efficiency of capital” translates as the expected profit rate of Classical economics (Hollander, 1987; O’Brien, 2004; Kurz and Salvadori, 2015). In Anwar Shaikh’s Classical theory of real business competition, rival firms engage in ruthless price wars against each other seeking to increase their market shares and achieve market hegemony. This concept of competition-as-war is best understood with reference to the laws of war (in war even winners suffer losses) not the rules of perfect competition resembling a minuet dance (choreography). Across global markets (the theater of war), the deployment of superior technology (the choice of weaponry) and achievement of economies of scale allow industry leaders to lower unit costs then reduce market price (and raise quality) below their competitors’ in order to push them out of business. If their own average profitability suffers a loss in the aftermath of the war, when the war is over, they gain a higher market share and expand their total profits. Moreover, since the losers disappear, the leaders end up enjoying the highest industry profit rate. Thus, attributing differential profit rates to the presence of monopoly in a given industry, due to the small number of large firms in it, reveals the overarching influence of neoclassical concepts upon liberal economic thinking, not reality. Shaikh’s concept of competition-as-war allows for a differentiated structure of production within each industry, scaled along the relative unit costs of the various firms making up the industry and using a variety of methods of production. While the industry product price will likely converge, it is the dominant firm operating with the most advanced but accessible technology that sets or ‘regulates’ the industry’s market price, reflecting its ability to attain the lowest unit cost and, thus, to enjoy the highest profit rate. There will be a dispersion of production methods, unit costs, and profit rates. Marginal producers with the worst methods of production, the highest unit cost, and the lowest profit rates will remain under pressure to exit the industry. New entries will seek to emulate and improve the efficient conditions of production as deployed by the cutting-edge industry leaders. Heterodox views on competition and monopoly In Anwar Shaikh’s book, Capitalism: Competition, Conflict, Crises, particularly Chapters 8 and 9, we find a comprehensive conceptual structure of real competition, which renders the whole neoclassical microeconomics completely irrelevant. Understanding real competition requires taking into account what actual business competitive practices are and not what hypothetical firms would do if they possessed perfect knowledge of markets and the future. Real competition is not a prelude to equilibrium of the industry but a race to displace the lesser rivals from effective participation in the industry’s dynamics. It is a war played with technological advances capable of lowering unit costs and raising profit margins to compensate for increasingly higher capital to output ratios. It is the command over superior technology that decides victory for the top innovator firm, but it is a victory that, as Marx put it “must be paid for” in ever-growing fixed costs. The successful competitive firm will have the lowest unit cost in the industry and there will be a hierarchy of costs among remaining firms hierarchically arranged

10  Introduction in terms of unit costs. The most likely firms to fail will be those operating with the highest unit cost and which will remain in a precarious position given the fact that the industry price will be set by the most successful producers, those with the lowest unit cost. At all times the structure of profit rates will not be equal at all; the marginal firms will have the lowest profit rates and the highest unit costs. Such competitive industries will exhibit a constant outflow of failed companies unable to keep up with the more dynamic and usually larger innovator firms. It is crucial to understand that in real competition the industry is not necessarily restricted to national boundaries; the regulating capitals set the going price in the industry and do so scattered throughout international borders. Big size-regulating capitals have advantages not accessible to smaller ones, the degree of automation matters and therefore to maintain the top rank in the profitability schedule the regulating capital needs to have the highest profit margin along with the lowest unit cost (Ramtin, 1991; Moody, 2017; Benanav, 2020; Smith, 2020; Acemoglu, 2021). While its profit rate is the highest in the industry, the regulating capital needs to accept the inevitable effect of deploying ever more capital-intensive technology, i.e., rising capital/output ratios. Obviously, this is far from the concept of ‘perfect competition’ proclaimed in neoclassical economics. It is closer to the concept of ‘free competition’ that distinguished Classical economics from the neoclassical interpretation. In real competition, the goal of the successful innovator that leads all others in the conquest of market share is to push the less capable out of the way, not to live and let live with marginal firms. While the average includes marginal firms like the growing number of ‘zombie’ companies cluttering various industries, equalization of profit rates across industries will be limited to the regulating capitals of each industry. Newcomers into the industry will not compete with marginal firms on their way out of the industry, due to inadequate technology and higher unit costs. The contender against the leading firms will have to command access to superior technology and the financial resources to put it in place. The higher profitability of the regulating capital will not provide evidence of their ‘monopolistic’ position but rather their competitive superiority. Finally, what will they do with their higher profit mass in view of their own higher profitability? They will invest their profits in their own business, the most profitable use, and not waste them in inferior alternatives. Occupying the industry’s leadership comes at a cost. The deployment of technology that reflects the growing intensity of capitalist production as an effective competitive strategy gives rise to increasing capital/output ratios that lower the profitability of the leading firms. They remain the industry leaders at the top because the laggards receive lower profit rates or, at the margin, no profit rate at all. Insisting on our Classical approach, we reject the notion found in the heterodox literature on the study of stagflation that, under modern capitalism, monopoly changed the system’s dynamics because corporations became immune to the pressures of competitive wars. As a distinguished radical economist put it, “It appears that the giant corporations have steadily reduced production costs per unit and that there have been powerful impulses toward innovation” as a result of which “Profit rates increase…Contrary to nineteenth century economists’ version of falling rates

Introduction  11 of profit, under monopoly the rate tends to rise” (Sherman, 1976, p. 150). Sherman’s argument maintains that because the industrial organization in many sectors does not resemble the perfectly competitive model of neoclassical microeconomics, it follows that “the economy of the United States has thus changed from a predominantly competitive to a predominantly monopolistic production situation” (ibid., p. 142). Sherman’s ‘monopolist’ corporations behave in ways that closely resemble the conditions of real, not perfect competition. They act like competitive businesses striving to achieve the “economy of scale that can be derived from large production units” in order to “turn out cheaper goods by using more specialized machinery” seeking to drive out rival firms that “cannot match the going market prices.” Sherman sees them as monopolies, nonetheless, because “The essence of the monopolist’s position is the ability to keep competitors out of the market by means of greater efficiency” (ibid., p. 143). Indeed, the gist of the problem is that Sherman and other economists of a radical persuasion are simply oblivious to the fact that they use neoclassical economic concepts wrapped in ‘radical’ rhetoric to interpret the evolving economy. The framework of free competition, not perfect competition, as Classical economists and Marx saw it (Marx, K. Capital, Volume 1, Chapter 25, Penguin, 1990), consists of firms battling to achieve the highest market shares by means of lowering their unit costs and prices in order to push their lesser rivals out of business. Marx understood that “The battle of competition is fought by cheapening of commodities,” taking advantage of advanced machinery in combination with economies of scale: “Therefore, the larger capitals beat the smaller” (ibid., p. 777). At any rate, according to Sherman “the 1970s and 1980s witnessed increased international competition, less U.S. productivity and lower U.S. profit rates…There was increasing corporate debt…an indicator of financial fragility…a doubling in the rate of business failures from 1979 to 1985” (Sherman, 1991, p. 278). In the interval between Sherman’s 1975 book on stagflation and his 1991 book on cycles, a major shakeup of industrial corporations had taken place, and many of the so-called monopolies were no longer in business. Due to falling profitability and the deindustrialization sweep that attended the emergence of neoliberalism, many behemoth corporations had disappeared. We show in Chapter 3 empirical evidence that Classical economists, including Adam Smith, recognized the long-run fall in the profit rate as accumulation advanced because they were keen observers of business trends, and, for over a century, experience showed that profitability had declined. Smith had access to historical data on interest rates and he understood perfectly well that, historically, profit rates and interest rates followed similar trends, although interest rates were kept at a lower level (Smith, 1965, p. 88). In Stagflation, Sherman’s ‘radical’ interpretation of Marx and Keynes denies the relevance of their approach, as well as that of Classical economists, to understand the dynamics of advanced capitalism. Despite the fact that Keynes and Marx insisted on the need to place the falling rate of profit argument at the center of the prospects for secular stagnation, Sherman excluded it. For him, monopoly grants the ability (denied to competitive firms) to set prices “that will insure their

12  Introduction maximum long-run growth—and maximum long-run profits” (Sherman, 1976, p. 168), giving rise to stagflation. Sherman’s assertions of rising profitability, like that of Sato’s, do not accord with our empirical evidence. In Table 5.1 of his Stagflation book (ibid., p. 99), he showed “profit rates on stockholders’ equity” rising from 1965 to 1974, while suggesting that “propaganda from Wall Street has even convinced a few radical economists that…the overall profit rate of U.S. corporations has been falling since at least 1965” (ibid., p. 99). In multiple cases shown in Chapter 3, such as Figure 3.1 and Figure 3.3 when applying the Bureau of Economic Analysis NIPA and Fixed Asset Tables relevant data, we found average profit rates on current cost net fixed capital stock, as well as current cost gross capital stock, did substantially fall after 1965. In our view, the emphasis on monopoly and its abuses allows liberal economists to play the radical card while conjuring nostalgic visions of perfect competition and perfect markets. For Sherman, and other neoclassical economists, their attachment to the concept of perfect competition, requires that across industries, as well as within each industry, “all profit rates should be equalized in the long run.” But they find in the modern U.S. economy “the smallest corporations have low or even negative profit rates” and mistakenly these differentials are taken as “proof of the existence of monopoly power and imperfect competition.” In our view, the essence of radical economics consists of taking a critical stance against so-called monopolistic industrial organizations using neoclassical economic concepts (Eeckhout, 2021; Stiglitz, 2019; Adler, 2019; Mazzucato, 2018; Reich, 2020). Interest rates’ double edge In Chapter 12, we interpret the Federal Reserve’s decision to maintain near-zero short-term interest rates for the next decade after the 2007–2009 Financial Crisis ended, as a commitment to boost equity markets and to keep insolvent ‘zombie’ companies in business. This monetary policy failed to anticipate the signs of financial fragility that emerged out of the bifurcation of frothy financial markets from the real tepid growth path of nonfinancial sectors. After the downsizing of manufacturing and the structural change that followed in its wake, the wage repression that stabilized profit shares since the mid-1980s underpinned the growing financialization of household needs (Chesnais, 2016; Durand, 2017). As we noted, falling interest rates and the need on the part of banks to expand mortgage lending to compensate for decreasing net profit margins set into motion the chain of events that intensified financial fragility in the banking sector and led to the Financial Crisis of 2007–2009. Falling interest rates did not spur nonfinancial corporate investment. Falling interest rates did stimulate mortgage buying by households, as Figure 1.3 shows an inverse relationship between interest rates and the share of disposable income households devoted to the purchase of mortgages. When interest rates rose from the mid-1960s to 1984 mortgage demand did not rise but, after that year, the demand for mortgage loans rose through the decade and, from the mid1990s to 2007, skyrocketed as interest rates continued to fall. Mortgage originators

Introduction  13 sold the mortgage debt to the banks that previously advanced the funds, and these banks sold these mortgage-backed securities to unsuspecting buyers all over the world. These securities contained mixtures of sound and toxic mortgages because the pressure to expand mortgage sales attracted insolvent customers who relied on rising house prices for collateral. The bundles included mixes of solvent and insolvent mortgage-backed securities. These different ‘tranches’ commanded different prices because they contained various proportions of solvent and insolvent mixes. Individual banks did not publicize the precise mixture in each tranche, hence, at some point they grew suspicious of each other’s good faith and refused to trade with each other. 15%

110%

14%

104%

13%

98%

12%

92%

11%

86%

10%

80%

9%

74%

8%

68%

7%

62%

6%

56%

5%

50%

4%

44%

3%

32% Mortgage debt/Disposable income

1% 0% 1964

38%

10-year government bonds' yield

2%

1968

1972

1976

1980

1984

1988

1992

1996

2000

2004

26%

2008

2012

2016

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20%

Figure 1.3  U.S. 10-year government bonds yield and mortgage liabilities/disposable personal income, based on Federal Reserve total mortgages, FL153165005.A, over disposable income, NIPA table 2.1.

In other words, the policy of lowering interest rates in the context of falling wages and low bank profitability kindled a housing bubble blown by households’ need to buy and banks’ need to sell mortgages. In the wake of the Financial Crisis rising financial fragility of mortgage buyers and sellers resulted in the eviction of about 10 million mortgage clients from their houses and, according to Investopedia, “more than 500 banks failed between 2008 and 2015, compared to a total of 25 in the preceding seven years” (Singh, 2022). The return of stagflation We attributed the return of ‘secular stagnation’ after the recovery from the Financial Crisis to the fact that Federal Reserve measures to prop up the banks contributed to the preservation of insolvent ‘zombie’ companies, despite their unsustainable

14  Introduction foundations. The presence of ‘zombie’ companies continued to plague the recovery of nonfinancial corporate sectors, their survival aided by near-zero interest rates, rising debts and even rising stock market valuations. As the crisis matured, the combination of 1) growing flows of capital into financial markets with the breakdown of global supply chains, 2) shortfalls in effective demand with declining labor force participation, and 3) large government transfers of money to taxpayers and businesses led to sharp inflation outbreaks which pointed to a new manifestation of the stagflation crisis. In the context of low profitability and secular stagnation, these supply-demand imbalances increased the prospects of a second stagflation crisis. This time, the long experience with low rates of capital accumulation weighed on the effective supply side more drastically than in the 1970s. In 2022, the Federal Reserve’s growing signs of a commitment to raise interest rates to combat high inflation in the midst of an admitted ‘technical recession’, the first two-quarters of negative growth in 2022, threatened to reverse the support of ‘zombie’ corporations and set the stage for their disappearance. The impact of rising interest rates on the sustainability of unprofitable companies will clearly bring into the limelight the conflictual nature of Anwar Shaikh’s real competition theory (Shaikh, 2016). ‘Zombies’ represent the losers in past competitive battles, failing companies surviving on cheap credit. As capital accumulation advances and financial power increases, the corporate technology deployed as weapons in the competitive battles for market share becomes ever more lethal. Losers can only remain standing as long as central banks provide them with low interest rates and the possibility of accumulating debt. Estimates of the share of ‘zombie’ public companies in the U.S. economy that cannot even meet their interest obligations out of their revenues rose from around single-digit percentage to about 20 percent in 2020. ‘Zombie companies’ can only survive by taking on unprecedented levels of debt, At the end of 2021, the Federal Reserve estimates that total U.S. nonfinancial corporate loans totaled approximately $7.66 trillion, most of which have variable rate coupons. Bonds add another $6.65 trillion. That is a total of $14.3 trillion in debt! In terms of near-term maturities, more than $1 trillion in bonds, loans, and credit facilities will refinance at higher rates over the course of 2022 and 2023. With so many public companies on proverbial life support, higher interest rates would effectively lead to a massive wave of bankruptcy filings and an economic recession, if not an outright depression. (https://www​.creditriskmonitor​.com​/resources​/blog​ -posts​/federal​-reserve​-understates​-proliferation​-zombie​ -companies) Historical trends of capital/output ratios Our Classical approach highlights the importance of establishing ‘historical patterns’ to interpret empirical evidence, especially with regard to profitability and ‘factor’ shares. Thus, we reject Kaldor’s ‘stylized facts’ as presented in his

Introduction  15 celebrated “Capital Accumulation and Economic Growth” (Kaldor, 1965), asserting the constancy of profit and labor shares because they were not ‘facts’ empirically confirmed, not then and not now. The fallacy of Kaldor’s claim was fully noted in Matthew Rongnlie’s 2015 paper “Deciphering the Fall and Rise in the Net Capital Share: Accumulation or Scarcity?” presented before a select group of top neoclassical economists, including Robert Solow. Solow had attended the 1958 Round Table Conference on the Theory of Capital held in the Island of Corfu between September 4 and 11 when Kaldor presented his celebrated growth model. In Rognlie’s paper Kaldor’s claim is dismissed as empty rhetoric, The aging Kaldor (1957) facts have retreated in the face of experience. Today, macroeconomists no longer claim that factor shares are constant— but what should replace the old consensus? (Rognlie, 2015, p. 50) While most neoclassical economists accepted Kaldor’s claim of historically validated constant income shares because it somehow fitted their beliefs, selected heterodox economists, whether Keynesians, Ricardians, or followers of Marx, doubted Kaldor’s stylized facts were real since they were not backed up by any empirical evidence. On the other hand, the real issue behind the controversy was that “The real subject of Rognlie’s paper is the effect of increasing capital intensity on the rate of return” (Solow’s Comment to “Deciphering the Fall and Rise in the Net Capital Share: Accumulation or Scarcity?,” p. 61), as Solow put it commenting on Rognlie’s paper. Further, he stated that “This question of diminishing returns to capital intensity has preoccupied economists for a long time, from Ricardo and Mill to Keynes and Schumpeter” (ibid., p. 60). In a further comment, Robert Solow offered the neoclassical translation of the central issue that runs through every chapter of this book. As Solow saw it, the problem understanding the forward movement of capital accumulation, circles around a fundamental question in medium-run macroeconomics: how strongly, if at all, does the rate of return on capital fall as capital intensity increases? I describe it as fundamental because it lies at the heart of at least two important and contentious issues. Capital intensity may be increasing for some time in developed economies if only because the growth of population will slow with no commensurate reduction in saving. Then the behavior of the return on investment will certainly affect the demand for investment and thus the plausibility of secular stagnation. In addition, the response of the rate of return will affect the functional distribution of income between compensation and profits. (Solow, 2015, pp. 59–60) Unexpectedly, in his comments to the Rognlie paper, Solow provided the neoclassical translation of the Classical/Marxian argument concerning the growing intensity of production methods,

16  Introduction The fundamental question of interest is this: How far would the rate of return have to fall for the economy to absorb a likely increase in capital intensity? One way the economy does that is by substituting capital for labor in the production of final output. That is why that elusive elasticity of substitution enters the story. But there is another route by which the economy can absorb capital. When the return on capital falls, capital intensive goods should become cheaper relative to labor-intensive goods…If these cost changes are passed into prices, consumers may shift toward more capital-intensive goods. The same process may affect producers’ choices among alternative intermediate inputs. (Solow, 2015, p. 65) We interpret Solow’s argument to say that the rise in capital intensity of capitalist production is the main force behind the rising productivity of labor and the decline in the relative prices of its product. The growing intensity of capitalist production in turn cheapens both consumer and producer goods, and hence leads to the spread of such methods throughout the production system. The decline in product prices then increases the demand for the product and therefore raises the demand for the more capital-intensive new technology. In light of the connection between the rising capitalization of production methods and lower unit costs and prices, the set of accumulation patterns that best fits the secular trend in advanced capitalism will include increasing capital/output ratios. Such ratios reflect the growing capital intensity of production, and despite rising profit shares, their deployment will lower the long-run profitability trend. Solow found such tendency for a declining rate of return a necessary condition “for the economy to absorb a likely increase in capital intensity” (Tsoulfidis and Paitarisies, 2019). Since we posit profitability, not interest rates, as the chief driver of capital accumulation subject to competitive pressures, we would normally find the capital accumulation trend running parallel to that of profitability, albeit at a lower level, because a portion of profits will be normally diverted to capitalist consumption. The maximum notional rate of accumulation with zero capitalist consumption would equal the rate of profit, and, when actual accumulation approaches the profit rate via deficit financing, the system’s expanded reproduction will generate increasing price pressures due to the emergence of widespread bottlenecks and shortages. The 1970s stagflation manifested the stress of an industrial economy driven beyond its potential growth rate due to falling profitability. The expansion of financial and service sectors in the two decades after the U.S. deindustrialized led to the declining capital accumulation rate in the nonfinancial sectors that lowered the growth potential of the U.S. economy below that of the 1970s. The growth potential depends on the expected profitability at different levels of capital accumulation (Mann, 2017). As we show in Chapter 3, for three decades after 1945 profitability levels were much higher in manufacturing industries than they were in the 1980s in all business sectors of the system. The structural transformation from manufacturing to financial and other services ended the large concentrations of workers in behemoth enterprises

Introduction  17 that once empowered labor unions in a fast-growing economy to achieve wage-bargaining gains, at times surpassing productivity growth that undermined profitability. The deindustrialization drive, running parallel with globalization and the export of manufacturing capital to low-wage countries, allowed large conglomerates to import cheaper consumer goods to prevent real wages from rising any further to deter a sharper decline in profitability from threatening the viability of capital accumulation in the U.S. economy. Nonetheless, the long-run trend in nonfinancial capital accumulation continued to fall throughout the neoliberal phase from the early 1980s to 2001 and U.S. profitability never reached the 1970s levels, let alone the trend levels of the earlier postwar period. In 2001, profitability fell to its lowest trough and as we show in Chapter 12, since the recovery from the Great Recession, the search for profitable investment opportunities was hampered by the fact that from 2012 to 2019 the mass of real profits in the nonfinancial corporate sector stagnated. The impact of structural breakdowns on supply chains and the effect of changing patterns of demand on the underlying financial fragility created by ‘zombie’ companies laid the grounds for a second bout of stagflation. The reason for such an appraisal of the post-pandemic recovery prospects takes into account the extended period of secular stagnation or ‘silent depression’ in which “Private sector balance sheets grew faster than income over many decades; thus, aggregate debt grew faster than aggregate income, and aggregate assets grew faster than aggregate income” and considering that “Each successive crisis, with more bloated balance sheets to stabilize, was more difficult to resolve and therefore required the government to engineer dramatic new lows in interest rates, heavy fiscal stimulus, and other measures to stabilize economic conditions” (Levy, 2019, p. iii). In short, we anticipate that the disastrous economic consequences of the pandemic will not be easily overcome within the fragile structure that emerged in the neoliberal phase. The conditions that Irving Fisher wisely recognized in the early 1930s as constituting depression would apply in today’s ‘recovery’, when several million workers withdrew from the labor force (‘the great resignation’) and the prospects of stagflation grow stronger as 2022 goes on. In Fisher’s words “A depression is a condition in which business becomes unprofitable. It might well be called The Private Profits disease. Its worst consequences are business failures and wide-spread unemployment” (Fisher, 1932, p. 3). Before the pandemic devastated the services sector, Federal Reserve monetary policies provided the cheap credit that enabled insolvent companies to stay in business, while post-pandemic fiscal deficits propped up effective demand seeking to jumpstart the economic engine on the road to recovery. Without the disappearance of ‘zombie’ corporations, the prospect of a coming depression albeit of a new ‘silent’ variety cannot be discarded. In this connection, the current concern with monopolistic practices as a source of stagnation expressed by Stiglitz, Mazzucato, and other liberal Keynesian economists, overlooked the fact that industrial activities, including manufacturing, are more capital intensive than services. The tendency for the equalization of profit rates among the leading corporations of each industry and sector requires them to attain higher profit margins to compensate for higher capital/output ratios. Such a characteristic profile of what Anwar Shaikh

18  Introduction called ‘regulating capitals’ has nothing to do with the liberal view of monopolistic industrial organization. The book’s structure In Chapter 2 we elaborate on the major theoretical insights of the Classical approach in order to provide the conceptual framework that will add consistency to our argument concerning the emergence of secular stagnation and its transition to stagflation from mid-2021 to mid-2022. In Chapter 3, we deploy the empirical evidence that informed the Classical economists’ views of profitability trends. We identify in that chapter the first phase of the postwar decline in profitability that eventually led to the dismantling of Fordism, the once robust configuration of industrial activities centered on manufacturing. As Fordism unraveled the new neoliberal structure of capital accumulation emerged replacing manufacturing with a service economy dominated by financial activities, globalization and growing systemic fragility. In Chapter 3, we track the evolution of the postwar economy from a manufacturing powerhouse to the U.S. economy’s stagflation crisis of the 20th century. Between 1945 and 1975, the growth potential of the postwar U.S. economy appeared to be strong and no signs of the system’s fragility emerged. Throughout the ‘thirty glorious years’ following the conclusion of World War II, profit rates remained historically high, though falling. Then, the question is how did the stagflation crisis of the 1970s break out? We examine the nature of the growth potential anchored in the so-called Fordist characteristics of the ‘technocratic’ New Industrial State (Galbraith, 1978). In Chapter 3, we show the extraordinary record of high profitability achieved in this period, including nearly full employment and high rates of fixed capital accumulation giving rise to foreign trade surpluses of astonishing dimensions. We proceed to ask why this configuration of successful partnership between capital and labor, high profits, employment, and wages growth ended and show that, underlying the spectacular signs of visible prosperity, the falling rate of profits was undermining the system’s capacity to go on growing. The very nature of technical progress at the center of the impressive performance drove the loss of growth potential but the ease with which breakdown intervals (mild recessions) led to recovery clouded the clear vision of the approaching denouement. After the mid-1960s, as deficit spending from private and public sources waned and capacity utilization declined, profit rates collapsed. But after three decades of steady high rates of capital accumulation, barely falling despite declining profitability, capital expenditures did not reflect the declining profitability trend. In the 1970s, deficitfinanced investment budgets increasingly met with shortages that raised input costs and led to rising prices that undermined the growth potential of manufacturing. In that decade, company managers and labor unions still lived in a world of high expectations but mired in widespread bottlenecks that led to higher input prices. Labor unions pursued higher wages to match rising prices accustomed to sharing in the productivity growth of previous decades. The rising tensions eventually rent the consensus built in managerial circles throughout the postwar years about the desirable level of class collaboration and,

Introduction  19 finally, the project was replaced with a neoliberal configuration. The stagflation crisis of the 1970s tipped the odds in favor of dismantling the Fordist regime and legitimated the rationale for the implementation of the neoliberal order. Chapter 3 strengthens the argument for secular stagnation due to the growing bifurcation between a progressive sector, including manufacturing, so-called information technology firms dominating world markets, and a growing sector of relatively small business offering personal services. The progressive corporations rely on technical advances to achieve high rates of labor productivity growth while standing side by side with a crowded sector made up of small businesses offering labor intensive personal services to the upper middle class as beneficiaries of the stock market. Due to the very nature of these personal services, the success of the personal service sector depends on the optimistic expectations of the major financial beneficiaries of successive bull markets and their discretionary spending. As it happens, the downsizing of manufacturing, a central channel of technical progress and the expansion of personal services largely inimical to its impact, contributed to the changing character of the U.S. economy in its overall dynamic characteristics. We argue in chapter 3 that the 1970s stagflation crisis gave rise to the motivation to carry out the ‘de-industrialization’ of the American economy because the protracted fall in profitability after the mid-1960s called for changes in the class distribution of aggregate value added in favor of profits. A. Shaikh’s Classical theory of inflation links the emergence of inflation to the tensions building in the structure of production when increasing investment spending runs up against the growth potential derived from the current profitability level. In the Classical and Marxian perspectives, the aggregate average profit rate sets the ceiling for the maximum accumulation rate. The theory argues that the ratio of net business investment to net operating surplus in the business sector drives the inflation rate. As von Neumann demonstrated (1945–46, p. 1–9), in a growing economic system the rate of profits sets the limits to the accumulation rate, the rate of its expansion, when the system’s growth is fully dependent on the internal growth of its capital funds. Achieving that notional maximum growth of output would require that capitalists spend the entire surplus on capital goods and that workers’ wages be set at the lowest level compatible with their social reproduction. In this model, any portion of the surplus (profits) diverted to satisfy the consumption needs of the capitalist households would be a subtraction from the surplus to achieve maximum capital accumulation. Such growth rate also implies that a real system’s ‘throughput’ ratio, the timely transformation of system-wide inputs into something approaching full engineering capacity, will encounter growing bottlenecks and input shortages as the rate of accumulation rises closer to the rate of profit. The higher the internal pressures exerted on the system’s structure to expand as a result of rising investment the more disruptive the bottlenecks encountered along the way. A falling rate of profit due to the deterioration of the soil’s quality in marginal lands, as in Ricardo’s growth model, will reduce the capitalist incentive to accumulate capital: investment will decline and the system’s growth will fall. In the 1970s, the average profit rate sharply declined in the U.S. economy, not as a result of the deterioration of natural conditions, but rather because, contrary to neoclassical

20  Introduction growth theory, the capital/output ratio rose due to the capital intensive nature of technical progress. As corporate managers did not perceive the profit rate descent from the historically high levels of the late 1940s as a permanent reality, and the rate of net investment did not reflect that decline, the economic system experienced hitherto unprecedented pressures that brought into question the viability of the Keynesian mixed economy. As investment spending rose above corporate internal funds in sectors experiencing falling profitability, intractable bottlenecks emerged that clogged production throughout the system and led to rising prices and growing unemployment. Since profit rates are unequal across industries and growth capacity depends on profitability, credit-financed investment spending by the leading companies contributed to increasing supply chain disruptions from the standpoint of sustainable growth. Sectors enjoying higher profitability encountered rising input prices when they expanded, due to ‘bottlenecks’ created in sectors with lower profitability and shrinking employment, and their rising costs stoked output inflation. Growing unemployment and rising prices strained the viability of the capital-labor accord and finally led to its abrogation. We deploy our empirical evidence in Chapters 4 and 5 demonstrating that the principal goal of neoliberalism was to repress wage growth in order to restore the profitability level previously attained. In order to accomplish such redistribution of incomes, drastic changes in the structural composition of the system were necessary. Because the material foundations of Fordism were located in manufacturing and the labor unions in that sector, over one-third of the workforce stood in opposition to the reduction of wages affecting their members. Redistributing the net value added in favor of profits required the disappearance of industrial unions and this could only happen with the disappearance of the behemoth corporations that employed them. The stagflation crisis, however, along with the threatening competitiveness of industrial latecomers in Japan and West Germany made restructuring absolutely urgent from the standpoint of corporate elites. Early in the 1980s, after the long and tortuous decline in profitability reach a trough, the Federal Reserve added its weight to the gathering pressures to usher in neoliberalism. Setting historically high interest rates the Federal Reserve first induced large waves of foreign capital to provide U.S. markets with massive liquidity. Then the Federal Reserve reversed course, launching a policy of falling interest rates for decades that remained in place from the mid-1980s to the outright quantitative easing in the wake of the 2007–2009 Financial Crisis to become the mainstay of the COVID-19 recovery for banks and corporations. Focusing on the structural trends that underlined the stagflation crisis of the 1970s, we devote chapter 4 to contrast the ideology of neoliberalism, raising ‘competitiveness’ as a national goal while ignoring its practical objectives. The real goals included, first, increasing profit shares and lowering wages for the majority of workers, and secondly, the creation of a dual economy with a progressive and stagnant sectors. The unavoidable consequence of these unstated purposes was the growing income inequality between those workers in the capital-intensive sectors and the majority of services. Neoliberal ideology focused on the restoration of ‘competitiveness’ a euphemism for the reversal of profitability trends. Given the

Introduction  21 fact that productivity growth remained subpar, the neoliberal view blamed rising wages for the decline in profitability, arguing that excessive wage increases could not be fully absorbed by higher domestic prices in order to prevent international competitors from gaining market shares with cheaper products of comparable quality. From then on monetary policy played a decisive role in the consolidation of neoliberalism. The Federal Reserve’s policy of high interest rates enacted in 1984, laid the grounds for two central pillars of the emergent neoliberal regime. The policy attracted large flows of foreign capital into U.S. financial markets and laid the foundation for the consolidation of financialization. The management of financial assets, insurance, and real estate became a major source of profits without production (Krippner, 2012). In the face of persistently low profitability outside financial markets, corporations increasingly channeled their available funds to pay dividends, buyback shares, and interest payments to buyers of their corporate bonds. Chapter 6 lays out the foundations of financialization, representing a new configuration of capital flows that favored the use of corporate funds for purposes unrelated to promoting fixed capital accumulation. Such diversion of funds limits the growth of labor productivity and expands the role of speculative financial activities. Financialization and spreading deindustrialization were parallel developments that substituted financial services for industrial activities. We argue in Chapter 7 that the reduction of the manufacturing sector’s share in aggregate value added and the enlargement of the services’ share contributed to the emergence of secular stagnation. Technical progress brought on high rates of labor productivity in manufacturing but for the most part did not contribute to the growth of labor productivity in the business and personal services sectors. In Chapter 7, we show the extent to which financial institutions became the system’s chief staying power, particularly the mega banks and FIRE sectors. They attracted rising volumes of capital flows, expanded their trading activities, successfully enlarged their share of corporate profits at the expense of nonfinancial corporations, and stoked the speculative overvaluation of financial assets. In this chapter, we highlight the contrast between the subpar performance of the nonfinancial sectors, their falling profit and fixed capital accumulation rates with the expansion of financial capital flows into financial sectors attracted by recurrent bouts of speculative asset bubbles (Prins, 2022). From the mid-1980s to 2019, the divergence between the higher profitability level of real nonfinancial corporate profitability, measured as the ratio of net operating surplus over current cost gross fixed capital stock, and the lower level, dividing nonfinancial corporate net operating surplus over the inflated stock market capitalization of their net worth, provides a good measure of distorted market valuations. Nonfinancial corporations sought “financial products as a means of maintaining and expanding their money capital…financial institutions stepped forward with a vast array of new financial instruments: futures, options, derivatives, hedge funds” (Foster, 2007). We undertake in Chapter 8 to evaluate the question of secular stagnation as presented in Keynes’ early confrontation with the outbreak of depression, leading to concerns with the likelihood of extended periods of tepid economic growth after running its course. In Chapter 9, we point out the significance of Keynes’

22  Introduction interpretation regarding the depression’s origins and the outstanding conceptual parallelism found with his Classical predecessors, acknowledging the power of profit as the decisive force behind the accumulation breakdown. In Chapter 9, we emphasize the distinction between Keynes’ own view of the prospects for secular stagnation and the modern neo-Keynesian version starting with Hansen and ending with Larry Summers, Ben Bernanke, and Paul Krugman. In our view, the modern interpretation adds nothing substantial to Hansen’s initial concept of secular stagnation. Their use of Hick’s IS-LM model notwithstanding, the neo-Keynesian focus on the natural rate of interest provides a concept that cannot serve to understand the dynamics of investment in the context of depression. The model would not solve Keynes’ conundrum: depression will continue unless investment increases, but investment will not increase unless profitability has risen; profitability will not rise unless investment spending first grows. In order to break the depression’s impasse investment spending needs to increase, but such increase would require first a rise in profitability. Our explanation of secular stagnation as a consequence of falling profitability is a more effective argument because it carries all the weight added to it by Classical economists such as Marx and Keynes himself and it is empirically sound. In fact, we demonstrate in Chapter 10 that from the perspective of Classical economics, Joseph Schumpeter and Henryk Grossman’s views of secular stagnation would support the contention that falling profitability, as an alternative explanation, reflects the actual historical patterns of the postwar U.S. economy. Finally, in Chapter 11 we conclude that the long-term prospects of capital accumulation in the aftermath of the COVID-19 pandemic will depend on the power of managerial elites to shape the distribution of value added between capital and labor. Considering the so-called ‘great resignation’ that supposedly enticed workers to leave the labor force, after the ravages of the pandemic threatened their wellbeing and created the much vaunted ‘labor shortage’, it would be reasonable to expect a higher wage share once the system recovered its pre-pandemic normalcy, and then the average profit rate would fall. But the outbreak of high inflation rates put an end to that alternative. In Chapter 11, we track the phase transition from secular stagnation to the stagflation that marred the recovery from the lockdowns of the COVID-19 pandemic, first to the initial collapse of effective demand and, secondly, to the breakdown of global supply chains that followed. We associate the remote cause of the inflation outbreak in 2021 with the slow growth pattern that characterized secular stagnation since the consolidation of neoliberalism in the 1980s. In 2013, Larry Summers revived Alvin Hansen’s hypothesis of the late 1930s to account for this new trend. In this connection, let us recall that as David Ricardo insisted, and the Classical economics paradigm maintains, the dynamics of aggregate demand are not independent from the formation of effective supply and both are regulated by the trend of business profitability (Ricardo, 1952, p. 346). Average profit rates failed to rise above their long-run trend in the recovery from the COVID-19 lockdowns, and the large injections of money and credit that the Federal Reserve made to prop up effective demand in 2020 and 2021 bumped

Introduction  23 against the limited capacity growth achieved after the 2007–2009 Great Recession. In addition, by 2022, once the external financial stimulus subsided, the breakdown of aggregate supply and demand links caused by the pandemic lockdowns created labor shortages and goods bottlenecks, which magnified the initial disruption and produced stagflation. We focused on the evolution of profitability as a driver of capital accumulation throughout the book, and surprisingly, in Chapter 11, we report that, according to our calculations, the mass of real profits between 2012 and 2019 stagnated. We interpret such profit stagnation as the harbinger of a forthcoming crisis in capital accumulation that will usher in an extended recession. Our appraisal rejects Haberler’s view that while “Fluctuations in profits (and losses) are frequently regarded as the essential characteristic of the business cycle,” they are not helpful because “the term ‘profit’ is vague and misleading” (Haberler, 2014, p. 263). On the contrary, we have shown empirical and historical evidence that the pursuit of profitability drove business investment decisions since 1901. We deployed ample empirical evidence of the actual association between falling profits and declining investment. We therefore showed across this book that the level of profitability and its trend are the leading factors of both recessions and depressions. Our empirical evidence confirms the persistence of ‘secular stagnation’ or a ‘silent depression’ syndrome extending beyond the stagflation crisis. The period covered in the stagnation of the real mass of nonfinancial corporate real profits from 2012 to 2020 coincides with the decline of our estimated Marxian rate of surplus value in the same period. Such juxtaposition of the two findings suggest the emergence of a structural change in income distribution designed to reverse both the stagnation of real profits and the decline in the rate of surplus value. Recurrent conceptual themes There are several conceptual themes that underpin the book’s progress in tracking the emergence of secular stagnation and provide the context in which the Federal Reserve policies to jumpstart the U.S. economy after the disruption of the COVID19 pandemic paved the way for the resurgence of stagflation. First, and foremost, it is the role of profitability as a driver of capital accumulation and primary force in the systemic changes that led to the dismantling of Fordism and the consolidation of neoliberalism. Profitability and historical materialism

The significance that we attach to profitability in the analysis of capitalist development appends the traditional focus of historical materialism on technological change as an engine of structural change. We do not regard technical progress as an independent force, but as a process subordinated to the test of profitability. Neoliberalism replaced the Fordist configuration because the manufacturing-led economy and the postwar capital-labor accord drove the U.S. economy into a profitability slump of historical proportions, not because technical progress in transportation, communication, and management appeared capable of handling industrial

24  Introduction activities on a global scale. Indeed, these technological advances made possible the transition to the neoliberal order, but the decisive drivers were the restoration of profitability from its free fall in the 1970s, as well as the opening of finance as an alternative channel for the acquisition of profits. Similarly, the structural changes emerging in the post-pandemic recovery will undoubtedly advance laborsaving technology to overcome the so-called labor shortages that appeared to empower the bargaining position of labor. Instead, the new technology will allow corporate managers to shore up profits in the post-pandemic phase of neoliberalism. In Marx’s work, the development of the forces of production played a leading role in the context of war-like competition among rival capitals. Increasingly powerful firms seeking to achieve or maintain market hegemony deploy lower cost technology as weaponry to destroy rivals and gain market dominance. Ultimately, the litmus test is profitability: the top firms will enjoy the highest profit rate in the industry because deploying the most capital-intensive technology will lower their unit costs sufficiently to wipe out their rivals. This strategy, while enabling the industry leader to reduce the market price, will also have a negative impact on the leader’s profit rate, even though the profit rates of the laggards will be much lower or nonexistent. From the standpoint of Classical economics, we disagree with M. C. Howard and J. E. King’s claim that a historical materialist interpretation would necessarily explain the emergence of neoliberalism as a result of technological progress in communications, management techniques, and transportation (Howard and King, 2008). We rather agree with Greta Krippner that the neoliberal project’s design did not emerge out of a well-thought-out blueprint. No ready-made plans were required for the transition (Krippner, 2012). Neoliberalism emerged in opposition to Fordism, challenging the centrality of manufacturing industry, questioning the role of full employment and high rates of accumulation because falling profitability made it necessary. In short, the emergence of neoliberalism was not due to technical progress as such but rather as a means to the restoration of profitability. On the one hand, under neoliberalism, a major reorientation of capital investments from domestic to offshore manufacturing and the expansion of domestic services created a dual economy with financial trading in the lead. In combination with the compression of wages, neoliberal changes improved business ‘competitiveness’ and slowed down the decline in business profitability. Neoliberalism stressed the centrality of profitability and the necessity of improving competitiveness, but through financial engineering rather than industrial engineering. It favored the growth of financial rather than manufacturing profits, and, in fact, capital accumulation outside finance never recovered the privileged position manufacturing enjoyed in the previous three decades of the Fordist regime. Due to offshore capital investments, the decline in manufacturing share of value added led to trade deficits replacing Fordist surpluses, but after the mid-1980s, housing and financial asset price inflation outpaced inflation of goods and services and attracted large flows of foreign investors. The paucity of wage growth laid the grounds for the growing inequality of incomes and wealth.

Introduction  25 The central insight of Classical economics placing the power of profits behind the accumulation of capital allowed us to identify falling profitability as the decisive factor in the decline and eventual breakdown of Fordism. It is important to stress, however, that we do not see the changes brought about by the neoliberal project amounting to an alternative mode of production but rather a new phase in the evolution of capitalism to preserve its viability. For over four decades accommodating monetary policy drove interest rates to unprecedented low levels reaching into the post-Great Recession years of ‘recovery’, and yet the mass of profits stagnated for almost one decade. In this period, Wall Street banks launched unprecedented waves of financial products intended to meet rentiers’ buoyant demand for higher-yield instruments. Since the 1990s, rising debts and stagnant profits led to successive financial crises, the spread of bankruptcies, mergers and acquisitions, and, last but not least, the rise of ‘zombie’ or insolvent companies. Given the extended path of secular stagnation, low capital accumulation trends in the real sectors, and the build-up of financial fragility in the banking scaffold that fueled asset bubbles, a state of ‘silent depression’ (Peterson’s) or ‘secular stagnation’ (Summers’) is likely to persist in the recovery from the COVID-19 pandemic, conceived as, “a chronic condition of subnormal activity for a considerable period without any marked tendency either towards recovery or towards complete collapse” (Keynes, 1977, General Theory, Chapter 18, Section 3, p. 249). The accumulation trend in the U.S. nonfinancial sectors fell in the neoliberal phase in contrast with its rising course in the Golden Age. Both labor productivity growth and real capital accumulation collapsed in the 21st century because neoliberal financialization offered a profitable alternative to business fixed capital expenditures. The diversion of capital to purchase financial assets contributed to the decline in labor productivity growth and the widening of financial fragility, thus undermining the prospects of long-lasting crisis-free growth. Falling interest rates led to intermittent bouts of euphoria and inflated financial assets and the wealth effect replaced fixed investment-led growth with high-income discretionary consumption spending. Rising financial valuations, however, were not sustainable when they transgressed the income growth limits of the real sector. ‘Zombie’ companies and secular stagnation

The general argument underlying the various issues covered in this book is that for three decades after 1945 high profitability rates in U.S. industrial sectors underpinned the consensus among managerial elites that supported the mixed-economy configuration and justified the acceptance of the capital-labor accord. Beginning in the mid-1960s, however, under the pressure from falling profitability trends, the elites’ consensus moved to their timely dissolution and the necessity of drastic regime change. From the late 1970s through the 1990s, the search for a reversal of the falling profitability trend and the discovery of new channels for the accumulation of capital led to the consolidation of neoliberalism and finally to the extended slowdown in growth rates characteristic of secular stagnation.

26  Introduction From secular stagnation to the new stagflation crisis

We are persuaded that extended periods of secular stagnation that produced the separation of a small number of technologically advanced, highly profitable superstar corporations from a crowded sector of highly indebted and nearly insolvent companies will likely plunge into a deeper crisis when the Federal Reserve ends all forms of ‘quantitative easing’ in the post-pandemic recovery. Our view of the post-pandemic recovery takes into account the extended period of secular stagnation that preceded it. We anticipate that the disastrous economic consequences of the pandemic will not fade away due to the rising financial fragility characteristic of the neoliberal phase. The falling rate of profit played a key role in the emergence of the 1970s stagflation crisis because at the time corporate investment exceeded the limits set by falling levels of corporate profitability and firms relied on external credit to finance investment. Since normal capacity profitability determines the system’s maximum growth, the actually falling average profit rate constrained the parameters of corporate growth and limited the feasible level of investment spending. In the first stagflation crisis of the 1970s, as credit-funded corporate investment pushed against the potential limits set by falling profitability, shortages and bottlenecks developed that fueled inflation outbreaks and led to the demise of the Keynesian configuration. Our projection of the post-pandemic stagflation, as the economy emerged from a long period of secular stagnation, consistently builds on the idea that, without raising the average profitability level that underpinned secular stagnation since the mid-1980s, the wall of money injected by the Federal Reserve into corporate budgets will bump against the global supply breakdowns to push up inflation pressures. Secular stagnation remained entrenched for so long because the rising weight of competitive losers, relative to surviving leaders, reached a high threshold in the division of profits and market shares. The growing number of such firms unable to recover average profitability will prevent the restoration of balanced growth and thus reinforce the legacy of secular stagnation as long as Federal Reserve policies aimed for preservation rather than extinction of ‘zombies.’ The issues considered in every chapter of this book make up the conceptual underpinnings of our contention that the evolution of profitability, and specifically its long-term falling trend from the mid-1960s through the early 1980s, played a decisive role in the unravelling of the Fordist configuration of capital accumulation, the emergence of stagflation, and the consolidation of neoliberalism. When normalcy arrives after the COVID-19 recovery, the balance sheets of ‘zombie’ companies will have deteriorated beyond repair, and as the Federal Reserve shifts from accommodating policy to fighting inflation, rising interest rates will restrict their access to credit and accelerate their collapse. Let us remember that the prospects of recession were rated high months before the pandemic broke out. The flood of money gushing into the system to prevent its collapse (about $120 billion per month as of March 2021) raised effective demand but clogged the supply chains previously disrupted by global lockdowns. Previously in 2020, sharp cutbacks in aggregate demand caused major bankruptcies

Introduction  27 of high and low-end consumer goods suppliers. These losses in turn played havoc with the global supply chains. Hence, when unprecedented flows of new money encountered restricted supply outlets, inflationary pressures spread across all sectors. These inflationary outbursts, jointly with labor shortages, strengthened the resolve of low-paid workers to catch up with previously lost ground. It is therefore reasonable to assume that the average profitability in the business sector as well as in the nonfinancial corporate sector will settle back to its pre-pandemic level. With a large share of companies classified as insolvent ‘zombies,’ a further deterioration of business conditions would bring about the wholesale disappearance of the vulnerable ‘zombies’ and a new realignment of class forces between capital and labor. Significant numbers of so-called ‘zombie’ companies will be in jeopardy once the Federal Reserve resorts to raising interest rates in response to rising inflation (Aguila and Graña, 2022). References Acemoglu, D. 2021. Redesigning AI. Work, Democracy, and Justice in the Age of Automation, Boston Review Forum. Adler, P. 2019. The 99 Percent Economy, Oxford University Press. Aguila, N. and Graña, J. 2022. “Not All Zombies Are Created Equal. A Marxist-Minskyan Taxonomy of Firms: U.S. 1950–2019,” International Review of Applied Economics, https://doi​.org​/10​.1080​/02692171​.2022​.2045911, 3/7/22. Anselmann, C. 2020. Secular Stagnation Theories. Springer. Bank of England. n.d. Research Datasets, “A Millennium of Macroeconomic Data,” version 3.1., https://www​.bankofengland​.co​.uk​/statistics​/research​-datasets Basu, D. 2021. The Logic of Capital. An Introduction to Marxist Economic Theory, Cambridge University Press. Benanav, A. 2020. Automation and the Future of Work, Verso. Bischoff, J., Kruger, S. and Lieber, C. 2018. “Secular Stagnation and the Tendency of the Rate of Profit to Fall in Marx’s Critique of Political Economy,” in The Unfinished System of Karl Marx, edited by J. Dellheim and F.O. Wolf, Palgrave. Botwinick, H. 1993. Persistent Inequalities. Wage Disparity under Capitalist Competition, Princeton University Press. Chibber, V. 2022. The Class Matrix. Social Theory after the Cultural Turn, Harvard University Press. Chesnais, F. 2016. Finance Capital Today, Brill. Clifton, J. 1977. “Competition and the Evolution of the Capitalist Mode of Production,” Cambridge Journal of Economics, Vol. 1, No. 2, Oxford University Press. Dumenil, G. and Levy, D. 2014. La Grande Bifurcation. En Finir Avec le Néolibéralisme, Éditions La Découverte. Durand, C. 2017. Fictitious Capital. How Finance is Appropriating Our Future, Verso. Eeckhout, J. 2021. The Profit Paradox, Princeton University Press. Fisher, I. 1932. Booms and Depressions, Adelphi Co. Foster, J.B. 2007. “The Financialization of Capitalism,” Monthly Review, Vol. 58, No. 11 (April). Freeden, M.J.A. 2020. Hobson, A Reader. Routledge. Frey, C.B. 2019. The Technology Trap. Capital, Labor, and Power in the Age of Automation, Princeton University Press.

28  Introduction Galbraith, J.K. 1978. The New Industrial State, Houghton Mifflin. Gerstle, G. 2022. The Rise and Fall of the Neoliberal Order, Oxford University Press. Gordon, R. 2016. The Rise and Fall of American Growth. The U.S. Standard of Living Since the Civil War, Princeton University Press. Gourvitch, A. 1966. Survey of Economic Theory on Technological Change & Employment, Augustus M. Kelley Publishers. Haberler, G. 2014. Prosperity and Depression. A Theoretical Analysis of Cyclical Movements, Transaction Publishers. Hollander, S. 1987. Classical Economics, Basil Blackwell. Howard, M.C. and King, J.E. 2008. The Rise of Neoliberalism in Advanced Capitalist Economies: A Materialist Analysis, Palgrave Macmillan. Jones, P. 2019. The Falling Rate of Profit and the Great Recession 0f 2007–2009, Brill. Kaldor, N. 1965. “Capital Accumulation and Economic Growth,” The Theory of Capital, Lutz, F.A. and Hague, D.C. (eds.), Macmillan. Keynes, J.M. 1977. The General Theory of Employment, Interest and Money, Royal Economic Society: The Macmillan Press. Kurz, H. and Salvadori, N. 2015. Revisiting Classical Economics, Routledge. Krippner, G. 2012. Capitalizing on Crisis, Harvard University Press. Landes, D. 2008. The Unbound Prometheus. Technological Change and Industrial Development in Western Europe from 1750 to the Present, Cambridge University Press. Leijonhufvud, A. 2000. “Monetary Regimes and Inflation,” in Macroeconomic Instability and Coordination, Part II, Edward Elgar. Levy, D. 2019. “Bubble or Nothing,” The Jerome Levy Forecasting Center, (iii), https:// www​. levyforecast​. com​/ core​/ wp​- content​/ uploads​/ 2019​/ 09​/ Bubble​- or​- Nothing​. pdf​ ?834430. Lind, M. 2020. The New Class War, Penguin Random House. Mann, G. 2017. In the Long Run We Are All Dead. Keynesianism, Political Economy, and Revolution, Verso. Marx, K. 1990. Capital, Vol. 1, Chapter 25, Penguin. Mazzucato, M. 2018. The Value of Everything. Making and Taking in the Global Economy, Allen Lane. Mejorado, A. and Roman, M. 2014. Profitability and the Great Recession. Routledge, Frontiers of Political Economy. Moody, K. 2017. On New Terrain. How Capitalism is Reshaping the Battleground of Class War, Haymarket Books. O’Brien, D.P. 2004. The Classical Economists Revisited, Princeton University Press. Prins, N. 2022. Permanent Distortion: How the Financial Markets Abandoned the Real Economy Forever, PublicAffairs. Ramtin, R. 1991. Capitalism and Automation. Revolution in Technology and Capitalist Breakdown, Pluto Press. Ricardo, D. 1952. The Works and Correspondence of David Ricardo- Volume 5: Speeches and Evidence, edited by Piero Sraffa, with the collaboration of M.H. Dobb, Cambridge University Press. Reich, R. 2020. The System: Who Rigged It, How We Fix It, Knopf. Rognlie, M. 2015 “Deciphering the Fall and Rise in the Net Capital Share: Accumulation or Scarcity?,” Brookings Papers on Economic Activity, Spring, The Johns Hopkins University Press.

Introduction  29 Roubini, N. 2022. Megathreats. Ten Dangerous Trends that Imperil Our Future, and How to Survive Them, Little, Brown and Company. Sato, T. 2018. “Japan’s “Lost” Two Decades: A Marxist Analysis of Prolonged Capitalist Stagnation,” World in Crisis, edited by G. Carchedi and M. Roberts, pp. 157–182, Haymarket. Sato, T. 2022. “Japan’s Secular Stagnation, Marx’s Law of the Tendency of the Rate of Profit to Fall, and the Theory of Monopoly Capitalism,” Historical Materialism, Vol. 30, No. 2., pp. 91–134. Schmelzing, P. 2020. “Eight Centuries of Global Real Interest Rates, R-G, and the Supra Secular Decline, 1311–2018,” Staff Working Paper, No. 845, Bank of England, version 1.2. Sherman, H. 1976. Stagflation: A Radical Theory of Unemployment and Inflation, Harper & Row. Sherman, H. 1991. The Business Cycle: Growth and Crisis under Capitalism, Princeton University Press. Shaikh, A. 2016. Capitalism: Competition, Conflict, Crises, Oxford University Press. Shaikh, A. and Tonak, E. 1994. Measuring The Wealth of Nations, Cambridge University Press. Sherman, H. 1976. Stagflation: A Radical Theory of Unemployment and Inflation, Harper & Row. Singh, M. 2022. “The 2007–2008 Financial Crisis in Review,” Investopedia, https://www​ .investopedia​.com​/articles​/economics​/09​/financial​-crisis​-review​.asp. Smith, A. 1965. The Wealth of Nations, Chapter IX, The Modern Library. Smith, J. 2016. Imperialism in the Twenty First Century, Monthly Review Press. Smith, J.E. 2020. Smart Machines and Service Work. Automation in an Age of Stagnation, Reaktion Books. Solow, R. 2015. Comment to Rognlie’s “Deciphering the Fall and Rise in the Net Capital Share: Accumulation or Scarcity?,” Brookings Papers on Economic Activity, Spring, The Johns Hopkins University Press. Summers, L. 2022. “The Fed is Charting a Course to Stagflation and Recession,” The Washington Post, March 15. Steindl, J. 1976. Maturity and Stagnation in American Capitalism, Monthly Review Press. Stiglitz, J. 2019. People, Power, and Profits, W.W. Norton & Company. Temin, P. 2017. The Vanishing Middle Class, MIT Press. Tsoulfidis, L. and Paitaridis, 2019. “Capital Intensity, Unproductive Activities and the Great Recession in the US Economy,” Cambridge Journal of Economics, Vol. 43, pp. 623–647. Williams, J. 2017. White Working Class, Overcoming Class Cluelessness in America, Harvard Business Review Press.

2

Classical Economics Growth and the Stationary State

In this chapter, we formulate a general outline of Classical Political Economy’s views on the historical traverse facing the accumulation of capital, from a phase of high growth to a long period of secular stagnation before reaching the stationary state. Classical economists identified the relentless pursuit of profits as the driving force behind the accumulation of wealth and took the class division of society including capitalists, landowners, and workers as the social foundation that governed the principles of its distribution. Adam Smith unabashedly proclaimed that “The consideration of his own profit is the sole motive which determines the owner of any capital to employ it either in agriculture, in manufactures, or in some particular branch of the wholesale or retail trade. The different quantities of productive labor that it may put into motion never enters into his thoughts” (Smith, 1965, p. 355). In the language of Classical Political Economy, “if the owner of capital employed it himself in this way as a farmer, manufacturer or merchant, his income was called profit or ‘the profits of stock’; if he lent it to others, his income was called interest” (Tucker, 1960, p. 55). When Classical economists identified the pursuit of profits as the driving force of capitalism, they considered the possibility that investment projects with good profit prospects might become increasingly scarce as the aggregate stock of capital grew larger, implicitly assuming that in time the expansion of the capital stock itself contributed to declining profitability. In the early phases of capital accumulation, a small capital seeking to expand would find plenty of opportunities to earn high profits. Business experience taught Classical economists that the initially wide array of good profit options available in the early stages of capital accumulation was likely to shrink, although as capital accumulation reached maturity, a bigger mass of profits would compensate capitalists for the smaller profit rate. In Adam Smith’s view, a growing division of labor fostered by the use of more efficient tools raised the productivity of labor and yielded higher profits, which in turn led to expanded rates of capital accumulation, employment, wages, and profits. Because Classical economists followed closely the vicissitudes of business practices, the historical experience of falling profitability played a central role in their analysis of long-run capital accumulation. David Ricardo, John Stuart Mill, McCulloch, and Marx agreed that falling profitability would eventually cause capital accumulation rates to decline, ushering in a protracted crisis of low or zero growth known to them as the stationary DOI:  10.4324/9781003413806-2

Classical Economics  31 state, something akin to the 20th-century concept of secular stagnation. For both Mill and Marx, entering such phases of low-profit growth typically induced a search for alternative sources of speculative gains, “over-trading and rash speculation” leading to the “waste of capital…in the commercial revulsion by which such times are always followed” (Mill, 1987, pp. 733–734). According to J. S. Mill, vanishing profitable investment opportunities led to extended periods of low growth that paved the way for speculative booms, as capitalists were prone to embrace harebrained ventures and fads that inevitably ended up in destructive crashes. In his view, the appeal of speculative ventures grew in intensity once the decline in profitability reached a critical threshold. The euphoria feeding speculative waves inflated unsustainable asset bubbles that, after bursting, spread from financial markets to the real economy, causing bankruptcies and the wholesale destruction of capital assets. The general crisis, in turn, destroyed enough capital to restore profitability for the surviving business, and the capital losses experienced allowed the profit rate on capital to recover sufficiently to start a new round. Marx clearly accepted that the growth engine of capitalism ran on the power of profits, and because “profit is indeed the stimulus to accumulation” (Marx, 1972, p. 50), it followed that the decline of the profit rate would lower the accumulation rate and lead to secular stagnation. Since the expansion of capital value, measured by the rate of profit, was for Marx the prime objective of capitalist production, “a fall in this rate slows down the formation of new, independent capitals” and “it promotes overproduction, speculation and crisis” (Marx, 1991, Volume III, pp. 349–350). Classical economists distinguished between active capitalists who organized the labor process for profit and capital owners who provided them with capital loans to carry on their investment plans. Active capitalists organizing the labor process for profit played a decisive role in the determination of the interest rate charged by capital lenders. As a critical theorist of Classical economics, Marx agreed that profits of enterprise accrued to active capitalists employing productive labor, workers who added new value during their working time in excess of the value received in wages. Ricardo clearly stressed the primacy of the profit rate over the interest rate, as attested in testimony before a commission of enquiry on the Usury Laws in 1818. He did not hesitate to place the importance of the rate of interest below that of the profit rate, arguing that, in the credit market, the rate of interest “is regulated by the demand and supply, in the same sense as any other commodity; but the demand and supply itself is again regulated by the rate of profit to be made on capital” (Ricardo, 1952, p. 346). Classical economists regarded profits “as the principal source of savings; savings was identified with investment; the growth of capital was assumed to cause a more or less proportionate increase in the demand for labor; it was believed that a fall of the rate of profit would lead to a slackening of the growth of capital” (Tucker, 1960, p. 105). Classical economists indeed feared that, after traversing the earlier stages of capital accumulation, the decline in the rate of profits would slow down growth and usher in a long-term phase of secular stagnation. In the advanced stages of capitalist development, before the onset of the

32  Classical Economics stationary state, the over-accumulation of capital would offer no further incentive for capital expenditures. Technical progress, profitability, and crisis For Classical economists from Adam Smith to David Ricardo and Karl Marx, the power of profits set into motion Baumol’s ‘Magnificent Dynamics’ linking technical progress to profitability, the accumulation of capital, and the employment of labor (Baumol, 1970; Gourevitch, 1966). Beginning with Ricardo’s Principles of Political Economy, the dynamics of falling profitability came to occupy a decisively central role in the development of Classical Political Economy. The worsening quality of marginal lands bumped against the growth of population to set up increasingly thicker barriers to capital accumulation than Adam Smith had anticipated. With Ricardo, the process of capital accumulation led to the expansion of the demand for labor and the growth of the laboring force’s need to consume food increasingly produced in areas of declining soil fertility. The marginal lands required more labor time per bushel of wheat produced. Increasing the labor time per bushel reduced the time devoted to the production of the surplus product that accrued in profits to the capitalist cultivator. Even though the price of wheat would increase, so would the price of food required to purchase the necessary nutrition per worker. The profit margin would decline and the profit rate would fall, not only in agriculture but also in industry, as capital mobility equalized the rate of return in agriculture and industry. The rising real wage compressed the profit surplus that generally powered the dynamics of accumulation. The rise in food prices in turn allowed landowners of the better intra-marginal tracts of land to appropriate the difference between the unit cost of production in their land and at the margin of cultivation. The rising differential rents accruing to landowners would capture the lion’s share of the profits, while capitalists’ profit margins declined. Thus, as the process of capital accumulation progressed and the labor force expanded, the falling net surplus that capitalists received weakened their incentive to accumulate. The decline in capital accumulation, in the form of land under cultivation, eventually would lead to the dreaded phase of secular stagnation. In Ricardo’s time, eliminating the Corn Laws, and reforming the Poor Laws, “became crucial areas of interest…as both the idle rich and the idle poor were seen by them as inefficient agencies in their scheme of social progress.” The opponents alleged that the Laws maintained corn prices and wages unnecessarily too high, to the detriment of capitalist profits and the prospects of capital accumulation. Classical Political Economy provided the ‘scientific’ rationale for the successful political defeat of both types of Laws. Consequently, the capitalist “objectives were to be almost wholly realized, and by 1846 the political economy of laissezfaire…the policy of severing the links of state power with the aristocracy and the poor-had waxed triumphant” (Kanth, 1986, p. 3). Understanding how Classical economics sought to study capitalism as a system unfolding in an ever-rising spiral of capital accumulation allowed Lowe’s model to analyze all versions of the Classical growth dynamics as variations of Adam

Classical Economics  33 Smith’s initial schema. In such system, intrinsic laws regulated the movement of wages and thus the division of the net product, the profit share, and finally the profit rate. While Classical economists formulated a more or less comprehensive theory of labor value, they differed in the specific structure of such law. Marx’s effort in his Theories of Surplus Value to sort out the inconsistencies found in his predecessors led to the development of his own labor theory of value. J. S. Mill’s theory of falling profitability laid the framework for his theory of crises, recovery, and the approaching stationary state preceded by an extended phase of secular stagnation. Random shocks impinging upon a slow-growing system would likely trigger a general breakdown of its sectoral input-output balances and trigger the kind of distortions that we associate with the gathering momentum of stagflation today. In the absence of shocks, falling profitability would just lower the system’s growth path in a manner consistent with the symptoms experienced as secular stagnation. In Mill’s analysis, the growth slowdown historically laid the ground for speculative euphoria and unjustifiable pricing of exotic products to offset the falling yields of bonds and equity shares. Prospects of higher available yields in financial assets were likely to attract rising capital flows away from productive sectors and gave rise to unsustainable booms and predictable crashes. Despite their different theoretical formulation of capitalist development, Mill and Marx shared with Ricardo the conviction that falling profitability weakened the incentive to accumulate capital in nonfinancial sectors and instead chose to blow speculative bubbles in risky financial assets that inevitably triggered the slump after they crashed. In Mill’s theory of recurrent crises, the arrival of secular stagnation was delayed by recurrent breakdowns of the accumulation process that postponed but did not cancel the final denouement. After repeated crisis episodes ruined the weaker capitals, accumulation would start again, but the growth path would retake its downward drift. After reaching some critical threshold, a few more years of high capital accumulation would enlarge the stock of capital sufficiently to precipitate a new crisis. Before entering the stationary state, a succession of cyclical growth outbursts followed by disastrous downturns would highlight the vanishing of profitable investment opportunities. Mill’s theory of the tendential decline of the rate of profit rested on the premise that profitable investment outlets declined in tandem with the growth of the capital stock. The stationary state, therefore, could be delayed but not prevented by occasional disruptions of capital accumulation. Marx’s connection with J. S. Mill Although seldom recognized, on the eve of the 1929 stock market crash, the Marxian economist Henryk Grossman accurately pointed out the similarities between Mill’s and Marx’s views on falling profitability and the recurrent stock market speculative fever: Whoever compares the relevant points in the third volume of Capital, which deal with the tendential fall in the rate of profit and insufficient valorization as a consequence of the accumulation of capital, with Mill’s breakdown

34  Classical Economics theory, described here, will immediately realize that Marx’s theory of breakdown set out from Mill’s. (Grossman, 2021, p. 134) Both in Mill and Marx, the depressing consequences of falling profitability on capital accumulation induced surges in stock market speculation that periodically ended in collapse. Thirty years after Grossman’s publication of his book, Bela Balassa, a mainstream economist, acknowledged the similarities between Mill and Marx (Balassa, 1959, pp. 263–274). Following Mill’s and Marx’s views on the role of responses to falling profitability trends, Grossman pointed out that, as long as the perception of profit differentials favoring financial investment prevailed, business excess savings would be diverted from real capital formation to speculative financial assets. The slowdown in accumulation would reduce the negative effects on capital overaccumulation, hence postponing the breakdown crisis. The slowdown in real capital accumulation following the rise in speculative investments arrested the increase in capital intensity and temporarily interrupted if not reversed the decline in profitability. If the speculative excesses led to a financial crisis and the collapse of effective demand led to a deep recession, the destruction of capital values would pave the road for the eventual upsurge in profitability and then promote the rebound of capital accumulation. Symptoms of secular stagnation might fade for a time, as long as capital gains in speculative activities effectively obscured the underlying weakness in profitability of the real economy, With the advance of capital accumulation and growth in the mass of larger and smaller capitalists, it becomes necessary to extend securities speculation to broad layers of capitalists because the mass of capital that lies idle and seeks investment in the crisis and depression grows ever greater... Speculation is a means of replacing the insufficient valorization in productive activity with profits made from the stock market losses of broad layers of smaller capitalists, with a ‘weak hand’, and it is therefore a powerful means of concentrating money capital. (Grossman, 2021, p. 457) Even in the absence of a crisis, low levels of profitability reduce the managerial tolerance for shortfalls in corporate sales and produce high levels of resistance to risky investments. In modern managerial practice, heightened fear of financial losses or mere uncertainty of their outcome played havoc in the formation of investment plans. Investment plans collapsed when business confidence faded due to low profit expectations. In a system with a long history of declining profitability, once managers cannot reverse the system’s growth path, prospects of secular stagnation would lead corporate managers to avoid new failures and cut planned investment. They will respond to marginal losses with sharp cutbacks in capital expenditures, favoring options minimizing risks of default rather than costlier alternatives. As Dumenil and Levy theorized, extended periods of low profitability

Classical Economics  35 are likely to generate systemic instability. Avoiding future losses involved present cutbacks: The alteration of adjustment behavior increases the macro instability of the economy. The link in the chain which relates profitability to stability is therefore paradoxical, since it appears that more efficient individual management is, in fact, detrimental to macro stability. (Dumenil & Levy, 1992, p. 295) Historically low levels of profitability may give rise to systemic instability and increasing risks of corporate investment breakdowns. The empirical evidence marshalled in a previous study of the role of profitability in the 1930s depression showed that: High returns are an inducement to invest, and conversely for low returns. It also conditions the management of firms in relation to their situation of liquidity. Thus, it determines to a large extent the stability of the economic system. (Dumenil, Glick, and Rangel, 1987, p. 336) The Classical theory of economic growth Seeking to overcome the neglect of Classical economics exhibited by neoclassical economists, Adolph Lowe’s “Classical Theory of Economic Growth” (Lowe, 1954, pp. 127–158) brought out the chief elements of the complex dynamical model that underpins the development process formulated in the economic theories of Smith, Ricardo, Mill, and Marx. Their comprehensive analysis of the system’s dynamics focused on the reinvestment of profits realized in previous rounds of the capital circuit to hire workers and buy materials and machinery in order to create an open-ended spiral of self-contained economic expansion. Rising investment gave rise to the development of new tools that allowed increasing labor productivity when workers acquired new skills and further promoted the division of labor, contributing to the extension of the market. In the Classical model, Malthus and Marx among other ‘Worldly Philosophers,’ insisted that a laissez-fair regime unfolded its own laws of development and took for granted that general crises would break out periodically (Heilbronner, 1986b). J. S. Mill understood that, as a result of successful waves of capital accumulation, crisis episodes would occur with predictable regularity, and that “By the time a few years have passed over without a crisis, so much additional capital has been accumulated, that it is no longer possible to invest it at the accustomed profit: all public securities rise to a high price, the rate of interest on the best mercantile falls very low, and the complaint is general among persons in business that no money is to be made” (Mill, 1987, p. 734). At this stage of ascending confidence and rising optimism, markets reach a new critical phase. The relentless search for yield confronting “the diminished scale of

36  Classical Economics all safe gain inclines persons to give a ready ear to any projects which hold out, though at the risk of loss, the hope of a higher rate of profit; and speculations ensue, which, with the subsequent revulsions destroy, or transfer to foreigners, a considerable amount of capital, produce a temporary rise of interest and profit, make room for fresh accumulations, and the same round is recommenced” (Mill, 1987, p. 734). In Lowe’s presentation of Smith’s dynamics, the deployment of new technologies required specialized tools that enabled capitalists to broaden the division of labor and achieve increases in labor productivity. The decisive role of technological progress in the progress of capital accumulation not only raised labor productivity but also expanded the division of labor and promoted the acquisition of skills. Such improvements yielded higher profits and in turn prompted new investments that in their wake laid the ground for further increases in labor productivity: “the quantity of materials which the same number of people can work up increases in a great proportion as labor comes to be more and more subdivided” (Smith, 1965, p. 260). New technology raised the growth rate of labor productivity at given wages and also increased profits. Profit reinvestments, expanding the scale of circulating capital, including raw materials and labor, led to a higher rate of capital accumulation and promoted employment growth, “an improved farm may very justly be regarded in the same light as those useful machines which facilitate and abridge labour, and by means of which an equal circulating capital can afford a much greater revenue to its employer” (ibid., p. 265). All Classical economists except Marx assumed that wages regulated the longterm labor supply in conjunction with a biosocial law of population. Higher wages led to improved living conditions and a rise in net birth survival rates, thus a rise in population, and eventually a larger labor force. In the long-run growth dynamics of the Classical model, rising spirals of activity led to higher labor productivity and increasing division of labor, expanding profits, stimulating faster accumulation, and expanding employment. Ultimately, with the growth of the working population, the demand for food would increase and the market would widen. As we noted, it is evident that for Adam Smith the pursuit of profit brought about a rising spiral of capital accumulation: “labour can be more and more subdivided in proportion only as stock is previously more and more accumulated. The quantity of materials which the same number of people can work up, increases in a great proportion as labour becomes more and more subdivided…a variety of machines come to be invented…the division of labour advances, therefore, in order to give constant employment to an equal number of workmen, an equal stock of provisions, and a greater stock of materials and tools than would have been necessary in a ruder state of things” (ibid., p. 260). In this quotation, it is evident that Smith projected the secular trend of capital accumulation to raise the gross capital-net output ratio, and consequently he expected that development to pave the ground for a long-run falling rate of profit. The declining profit rate would in turn trigger in its wake the sharpening of competition among rival capitals. Smith came to the conclusion that “In a country which had acquired that full employment of riches which the nature of its soil and climate, and its situation with respect to other

Classical Economics  37 countries, allowed it to acquire, which could, therefore, advance no further, and which was not going backwards, both the wages of labor and the profits of stock would probably be very low” (ibid., pp. 94–95). This being the case, of course, as J. S. Mill reminded us “It is…an almost infallible consequence of any reduction of profits to retard the rate of accumulation” (Mill, 1987, p. 842). Adam Smith’s open-ended growth spiral Smith’s law of population ensured a labor supply tied to the wage rate: on the one hand, as capital accumulation raised the demand for labor (relative to the current supply), wage rates increased, and the profits share declined. But such improvement in living conditions of the working class would bring forth an increase in birth survival rates that in due course expanded the population labor force supply and reversed the previous wage increase that had previously compressed profit shares. With a constant real wage level across persistent cyclical adjustments, the long-run dynamics of capital accumulation produced benign cycles of rising productivity, increasing profits, higher investment, and an extended market, setting the stage for a new phase of the growth spiral and a further extension of the division of labor, productivity growth, profits, employment, and capital accumulation. In Marx, on the other hand, the nature of labor-saving capitalist technical progress preserved the Reserve Army of Labor as the regulator of wage and profit shares, while replacing the biosocial population law of previous Classical economists with one intrinsic to capitalism itself. In Adam Smith’s version of the Classical dynamics of capital accumulation, fluctuations in the rate of accumulation and profits followed the introduction of new technology and superior tools, along with the growing improvement in skills required to use them. In his system’s dynamics, the incessant search for profits drives capitalists to promote the use of specialized tools that required workers to acquire new skills to use them. The new technology imposed a new division of labor based on the breakdown of production chains into more specialized tasks that raised the overall output per worker. In the long run, rising investment and technical change jointly increased the scale of production while expanding employment increased total wages in tandem with productivity, leading, consequently, to the steady widening of markets. The rising labor productivity achieved with the introduction of more specialized tools and the greater division of labor they required led to higher profits, higher demand for labor, and rising wages. Rising wages, however, triggered the increase in population that, relative to the demand, lowered wages once again. In the long run, despite the expansion of the market, the wage rate remained unchanged at the subsistence level. As capitalists increased the rate of accumulation, they ran up against the barrier of insufficient population and labor force growth, and a shortage of labor set the limits of growth. A rising demand for labor that exceeded the labor supply pushed the wage rate higher and lowered profitability. In the short term, such results weakened the incentive to expand capital accumulation. In the long run however, this cyclical barrier disappeared once the iron law of population

38  Classical Economics intervened, as higher wages improved the birth survival rate, raising the size of the population and expanding the labor force. Once both the population and the labor force reached a higher growth rate, the larger labor supply would lower wage rates, thus laying the grounds for a new upturn in the accumulation cycle. At each stage in the ascending growth spiral of capital accumulation, the wage rate fluctuated with each turn of the short-term investment cycle. Wage rates rose when the accumulation rate exceeded the growth in the labor force and declined when the Classical law of population drove the labor force growth rate above the growth in labor demand. In the long-run trend of the system’s growth, the wage rate remained at a historically determined subsistence level. The higher profits accruing to capitalists provided the necessary funds to finance successive rounds of investment and growing employment of workers. At the start of each cycle, higher labor productivity followed the extension of the market, yielding higher profits and expanding the funds available in the next round of accumulation to employ larger numbers of productive workers. For Classical economists, rising wages triggered increases in population that provided a growing supply of labor, returning wage rates to their subsistence levels but with a larger employment base. In the long run, the secular growth trend in population and employment consequently increased the demand for food, forcing the expansion of land under cultivation in order to meet the higher demand for basic consumption staples. The limits of good land and wage rates The extension of cultivated land beyond the boundaries of those high soil fertility areas already cultivated and into lower quality soils required greater labor time per unit of output to compensate for its poorer quality. Given the length of the working day, using more labor time to produce the product quantity necessary for the reproduction of the working force (and the equivalent wages) reduced the surplus labor time working to produce the surplus product equivalent appropriated by the capitalist employer in the form of profits. As the system reached the higher bounds of the growth spiral and the rising food needs of the growing population led to higher wages and lower profits, Ricardo feared the accumulation drive would weaken and eventually come to a standstill known as the stationary state (Brandis, 1989). Since that terminal stage would not be abruptly reached, a long period of falling investment opportunities would precede the final breakdown of capital accumulation. In contemporary language, progressively declining investment and consumption spending would lay the path leading to the stationary state, that is to say, as described in current theories of secular stagnation, effective demand would weaken. The difference between the modern version of secular stagnation and the pre-Marxian Classical perspective is that, in the Classical theory of growth, it is the erosion of profitability caused by higher food costs, due to the diminishing productivity of the soil in marginal lands, that brings about the lower accumulation and weaker demand for labor characteristic of the stationary state. Given the extent to which the marginal land areas under cultivation raised the unit cost price of

Classical Economics  39 production and reduced the mass of profits, the incentive for capitalists to maintain the rate of capital accumulation in future waned, and the prospects of the stationary path for the system’s evolution grew stronger. Technological change and the welfare of workers In response to the decline in profitability and the likely arrival of a stationary state with minimal or no capital accumulation projected by Classical economists, Ricardo was first to proclaim the negative effects of technical change on the working class. Contrary to Smith and McCulloch’s benign notion of technology’s impact on labor demand, Ricardo concluded that capital-intensive technical progress would play a decisive role in the effort to palliate the impact of the secular decline in profitability on capitalist development. It was obvious to him that, to prevent that decline, capitalists would favor the deployment of mechanized techniques requiring more fixed capital and less labor. In the third edition of his Principles of Political Economy, Ricardo changed his previous view on the beneficial effects of technical change on labor because now believed “a fall of the rate of profit would lead to a slackening of the growth of capital” (Tucker, 1960, p. 105). Ricardo foresaw the beginning of the rising tide of labor-saving machinery that extended beyond his life as having a detrimental effect on labor’s welfare and leading in future to either lower wage rates, outright unemployment, or both. Whereas technical change in Ricardo’s thinking counteracted the effects of diminishing returns in marginal land and mitigated the impact on profitability, in Marx technical change stood out as the chief force behind the secular decline in profit rates and the weakening in capital accumulation rates. For Marx, technical change raised the productivity of labor by means of increasing mechanization and the larger economies of scale that it promotes. Technological trends in Marx reflected the war-like nature of competitive struggles and the efforts made by innovating firms to come out of such battles as industry leaders. Such technologies will allow innovators to lower total unit costs in order to achieve price reductions and then lower prices to gain market share over their competitors. In a war driven by the desire to enlarge market shares, higher levels of mechanization allowed innovators to raise labor productivity and, despite incurring higher unit fixed costs, reduce total unit costs as long as the reduction in variable costs was proportionately greater. After a substantial reduction in total unit costs, innovators can proceed to lower unit prices, drive rivals out of business and enlarge their market shares. But such competitive wars to wipe out the solvency of laggard firms require market strategies that cause losses in profitability for the winners. In competitive wars, failure to win portends disaster and taking the initiative preempts retaliation. For market leaders, the stakes involved in rising to market leadership narrow the range of available options. Innovating firms seek to defeat potential contenders for market leadership through radical price reductions, and automated technology provides the means to do it. That type of technology involves large unit fixed capital costs replacing larger unit variable costs in order to achieve lower total unit costs. Innovators are then able to reduce market prices lower than industry rivals are

40  Classical Economics capable of so doing and, thereby, take away market share from them. As innovators gain higher sales at a lower price after raising their unit fixed costs, their net output fixed capital ratio will decline, and (wage shares remaining constant) their profit rate will fall relative to its previous level. The competitive battle imposes losses on the winner as well as the laggards, while the leader’s profitability, although falling relative to its previous level, remains the highest when the ‘zombies’ emerge. As Marx saw it, the pursuit of profits laid the grounds for persistent growth cycles around the long-term trend of capital accumulation. Each successive upturn gained strength before overshooting past its structural limits and reversed the thrust of its buildup: “If we consider the turnover cycle in which modern industry moves inactivity, growing animation, prosperity, overproduction, crash, stagnation, inactivity, etc.” (Marx, 1991, p. 482). The falling rate of profit and Classical economists Starting with Adam Smith, all Classical economists presaged increasing difficulties in maintaining a steady growth rate once capital attained some critical mass in the advanced stages of capital accumulation. Looking ahead, they anticipated entering the path leading to the stationary state. They feared that in contrast with the conditions prevailing in earlier stages of capital accumulation, vanishing profitable investment opportunities would lead to long-term stagnation. They reached these conclusions because their theoretical views reflected closely the empirical evidence derived from business practices. The available historical data of business success and failure alerted them to the fact of falling profitability and its future consequences for the accumulation of capital. They knew that in the advanced stages of capital accumulation, the increasing dearth of profitable investment opportunities would exacerbate the ferocity of competitive wars, as capitals, struggling to take advantage of the dwindling profitable outlets drove their lesser rivals out of business. Adam Smith already feared that as capital accumulation advanced, the composition of capital tilted in favor of the fixed capital component, so that the fixed capital to net output ratio increased, and absent a rise in profit shares, the profitability trend accordingly declined. As Smith put it, “The continuous increase in the stock of capital will require an increase share of output to be devoted to the replacement of capital,” and not to its expansion because “That part of the annual produce, therefore, which, as soon as it comes either from the ground or from the hands of the productive laborers, is destined for replacement of capital, is not only much greater in rich than in poor countries, but bears a much greater proportion to that which is immediately destined for constituting a revenue either as rent or profit” (Smith, 1965, pp. 318–319). In Smith’s experience, as capital accumulation proceeded, the expanding capital stock faced a declining number of profitable opportunities at the same time that it required an increasing share of the gross output to be used as replacement for the rising depreciation share needed to maintain it and, consequently, yielded a lower profit rate. In his chapter on technical change, Ricardo underscored his concern for the welfare of the working class stemming from the impact of a rising fixed capital ratio

Classical Economics  41 on the demand for labor. Ricardo approvingly quoted from his contemporary John Barton’s Condition of the Labouring Classes of Society to manifest his appreciation of the socioeconomic consequences derived from the changing composition of capitalist technical change: “As arts are cultivated and civilization is extended, fixed capital bears a larger and larger proportion to circulating capital. The amount of fixed capital employed in the production of a piece of British muslin is at least a hundred, probably a thousand times greater than that employed in the production of a similar piece of Indian muslin” (Ricardo, 1981, p. 396; Barton, 1934, pp. 17–18). According to Jacob Hollander’s introduction to the 1934 edition of Barton’s book, “it seems reasonably clear that Barton’s essay paved the way for that alteration of Ricardo’s opinion as to machinery and wages which not only harrowed McCulloch’s soul,…but influenced perhaps to a greater degree…the accompanying theory of capital through John Stuart Mill” (Barton, 1934, p. 5). In a letter to John Barton included in Barton’s book, Ricardo clearly acknowledged the laborsaving character of technical knowledge, arguing that “It is undoubtedly true that in proportion as the accumulations of capital are realized in fixed capital, such as machinery, buildings, &c. they will give less permanent employment to labour” (Barton, 1934, p. 68). In our view, the economic historian Agnus Walker’s early efforts to locate Marx’s economics within the perspective of Classical economics, including his connection with stagnation, deserves special attention because he perceptively noted that Classical economists “held a view of economic change in which the rate of profit fell as a function of the increase in capital accumulated, and with which was associated a belief that the progress of society, as a result, came to a halt” (Walker, 1977, p. 372). In our view, however, Walker’s understanding of Marxian economics, as well as his aspersions regarding the empirical foundations of Adam Smith’s and Ricardo’s theoretical views, is totally out of place. According to Walker, while “Marx was a man of great intelligence” (ibid., p. 365), he fell in for such a misguided concept as the Classical theory of the falling rate of profit purely on faith. Walker argued that the “Smith-Ricardo analytical engine was a powerful one, and elegantly refurbished by John Stuart Mill…It was Marx’s intellectual misfortune that these factors were to hold him, as they held others, in thrall to Political Economy…Marx found most of his economic problems, not in the real world, but in the teachings of the British Classical economists…For Marx could not have known whether profits tend to fall or not” (ibid., p. 373). Walker’s implication, of course, is that Marx could not have known whether the rate of profits fell because the “British Classical economists” did not have any empirical evidence to support their claims. Walker’s conclusions derived from Bernice Shoul’s misgivings regarding Marx’s analytical abilities expressed in Science and Society, ostensibly an independent Marxist journal. In her article “Similarities in the Work of John Stuart Mill and Karl Marx,” she concluded that “Marx …confuses use of physical capital per man with the rise of the value of capital per man, that is, the organic composition of capital” (Shoul, 1965, p. 281). On a simpler matter, Shoul confused the identity of two very different things, stagnation and breakdown: “while Marx's

42  Classical Economics state of stagnation (here deduced from a systematization of the many references in his analysis rather than from any one explicit statement) is a state of capitalist breakdown” (ibid., p. 281). In Walker’s view, the intellectual appeal of Classical economics was able to overcome Marx’s critical judgment and explains why it was “Marx’s intellectual misfortune that these factors were to hold him, as they held others, in thrall to Political Economy, itself a phase in the development of social and economic thought…Marx found most of his economic problems, not in the real world, but in the teachings of the British Classical economists…Nowhere is the extent of the intellectual hold of Classical Political Economy over Marx more clearly demonstrated than in his acceptance of the doctrine of the declining rate of profit… (Moreover) Marx could not have known whether profits tend to fall or not; and yet he adopted the thesis” (Walker, 1977, p. 373). According to Walker, the reason why Marx “could not have known” is that the Classical economists presumably did not have any empirical evidence at their command. Considering the centrality of the theoretical construct of the falling rate of profit as a ‘law’ in Classical Economics, the question of its empirical content is paramount. To begin with, it is quite likely that the immersion of Classical economists, including Adam Smith, Ricardo, Mill, and Marx, in the world of actual business practices surpasses the experience of neoclassical economists today. Adam Smith dwelled on the need to relate concepts to practices early in the Wealth of Nations, particularly concerning profitability trends. The long view of secular stagnation In our view, the analysis of secular stagnation from the standpoint of profitability does not only offer a persuasive explanation of prolonged periods of low-growth trends but also opens new vistas for a theory of crisis. Both David Ricardo and J. S. Mill theorized that falling profitability would bring about the decline of capital accumulation rates leading to a more or less distant stationary state characterized by zero growth. In addition, Mill went on to consider falling profitability and extended phases of low growth as conditions promoting the formation of speculative booms inevitably destined to crash. In his view, the mirage of higher returns in speculative ventures rose in periods of low profitability for industry and led to destructive crises, which partially restored capital profitability and allowed capital accumulation to proceed. J. S. Mill’s theory of falling profitability, leading to the stationary state, laid the foundation to frame not only a theory of secular stagnation but also a theory of systemic crises. Before reaching the stationary state, when growth ceases, falling profitability will lower the system’s growth. Symptoms will emerge consistent with the theory of secular stagnation, that is, short upturn periods followed by long intervals of low growth. In Mill’s analysis, the growth slowdown would also trigger the rise of speculative activities seeking to offset the low yields of normally productive sectors. Prospects of higher yields in financial assets would attract rising capital flows away from productive sectors and lead to the creation of unsustainable booms.

Classical Economics  43 Despite their different views of capitalist development, Mill and Marx agreed with Ricardo that falling profitability trends would weaken the accumulation of capital before reaching the state of crisis. Both of them stressed the rise of speculative activities at critical junctures before the outbreak of crisis. Speculative investments surged as the dearth of productive expenditures deepened. For Mill and Marx, such phases of low profit growth typically induced a search for alternative sources of gains, “over-trading and rash speculation” leading to the “waste of capital…in the commercial revulsion by which such times are always followed” (Mill, 1987, pp. 733–734). Since for Marx, the expansion of capital value, measured by rate of profit, was the prime objective of capitalist production, “a fall in this rate slows down the formation of new, independent capitals” and “it promotes overproduction, speculation and crisis” (Marx, 1991, pp. 349–350). Classical political economy today Our perspective on secular stagnation benefitted from the groundbreaking theoretical advances of A. Shaikh, L. Tsoulfidis, and P. Tsaliki. These writers aimed to recover Classical economic thought a superior alternative to the neoclassical interpretation of mainstream economics (Shaikh, 2016; Tsoulfidis and Tsaliki, 2019). Both of these works contributed to sharpening the theoretical significance of the dynamics of advanced capitalism found in the works of Adam Smith, David Ricardo, J.S. Mill, and Karl Marx and are invaluable references to understand the current conjuncture of advanced capitalism. They helped us focus on the turbulent process of capital flows in the pursuit of profitability differentials rather than the equilibrium state of perfect competition depicted in neoclassical economics. The historical development of Classical economics that concentrates on the so-called ‘surplus’ approach (Kurz and Salvatori, 2015) demonstrates how the progress made expanding its 19th-century analytical concepts provides a rigorous conceptual framework for the empirical validation of Classical findings and leads to methodological and theoretical breakthroughs in the study of contemporary capitalism. In contrast with the flat world of neoclassical economic theory where the future is simply a mere extension of the present conjuncture, in the early 1970s William Baumol shared our appreciation of Classical economics. When appraising the ‘magnificent dynamics’ of Classical economics, Baumol feared that ignoring the Classical contributions would lead neoclassical economics to a theoretical impasse, for they “represent an approach of which there are few recent examples.” For Baumol, “the approach is of a magnificent cast, ambitiously attempting to analyze the growth and development of entire economies over relatively long periods of time-decades or even centuries” (Baumol, 1970, p. 13). Employing the sophisticated methodology of modern economics, moreover, Shaikh, Tsoulfidis, and Tsaliki provided us with extensive empirical verification of their theoretical findings, something beyond the scope of neoclassical economics. Their work, however, place a theory of long waves at the center of their vision describing the long-run rhythms of capital accumulation that apply in the past as well as the present. These long waves emerge out of the relationship between

44  Classical Economics wholesale (producer prices) and the price of gold, a kind of ‘golden’ prices and are driven by Schumpeterian technical progress lifting profit expectations. Secular stagnation theory plays a minor role as an explanation of advanced capital accumulation: this is our task in this book. Long cycles and historical trends In his Capitalism: Competition, Conflict, Crises (Oxford University Press, 2016), Anwar Shaikh integrated his theory of long waves with the Classical view on turbulent patterns of capital accumulation driven by expected profitability. Building on Kondratieff’s discovery of long waves in economic activity reflected in price index cycles spanning several decades from peak to peak (longer than Goodwin’s conventional business inventory or fixed capital growth cycles), Shaikh was able to prove their continued existence beyond Kondratieff’s mid-1920s. After dividing his price indexes by gold prices, ‘golden price’ long waves emerged all the way to the present. As an explanation, he argued that changes in profitability expectations underlay the formation of long waves of capital accumulation trends that underpinned the system’s growth (Goodwin, 1970; Goodwin and Punzo, 1987, p. 160). Since ‘golden prices’ consist of ratios in the producer price indexes relative to gold price indexes, the rising side in each long wave requires producer price indexes to rise faster than the gold price indexes. Rising business confidence in response to higher profit expectations precede the upturn momentum characteristic of the boom phase, followed by feedbacks from rising investment and the all-round expansion of financial markets. In the upturn of a long wave, producer prices are rising faster than gold prices, and gold production is losing its initial profitability differential because the input prices in the gold mining sector are rising faster than the gold exchange rate, the output of gold mines. In the rising phase of the long cycle, profitability will be falling in the gold industry and the incentive to curtail the scale of gold production will accordingly strengthen. The long wave’s amplitude will depend on the strength of confidence attached to long-run profit expectations in the real economy and the extent to which the expected profit growth comes to fruition. As the boom continues and unemployment declines, wages are likely to increase and profit margins to fall. If profitability trends sully expectations and business confidence weakened, once investment plans fall apart, the upturn will end. For Keynes, “There are not two separate factors affecting the rate of investment, namely, the schedule of the marginal efficiency of capital and the state of confidence. The state of confidence is relevant because it is one of the major factors determining the former, which is the same thing as the investment demand-schedule.” The amplitude of the rising wave will depend on the strength or intensity of the state of confidence behind it. Keynes placed the formation of business confidence at the center of his analysis of long-term investment. He was prepared to argue that “changes in the values of investments were solely due to changes in expectation of their prospective yields and not at all to changes in the rate of interest at which these prospective yields are capitalized” (Keynes, 1977, General Theory, Chapter

Classical Economics  45 22, Section II). He also anticipated, however, that the state of confidence that initially prompted the investment plans in expectation of high yields, with the passing of time, would unravel, for “The actual results of an investment over a long term of years very seldom agree with the initial expectations” (ibid., Section IV). Declines in investment spending will lower the rise in effective demand and the upward momentum will wane if profit expectations decline. On the downward side of the long wave, price indexes will no longer rise faster than gold prices but, instead, more slowly. As financial markets become increasingly ‘risk adverse’ and asset values unravel, the demand for gold as a safe asset will rise. The flight to safety prompted by declining profitability across the system will boost the demand for gold and gold prices will rise faster than the general price level. When the reversal in profit expectations is not belied by actual experience and business confidence is increasingly eroded, rising gold prices will drive the downturn to a new trough. The trough’s level of the long cycle could then serve as a gauge of the confidence loss and the crisis’ depth. Explaining why the secular trend of our long waves entered a downward path after the 1960s begs the question of clarifying what the long waves represent. In our interpretation, long waves capture the elusive state of ‘confidence’ shaping the business mind in its search for profit opportunities. Avoiding ‘uncertainty’ and securing ‘confidence’ may require a general consensus of optimism regarding the likelihood of rising opportunities to deliver high profits and a decline in the number of perceived dangers clouding these expectations. To this end, the decisive role of optimism in the formation of confidence gains support from social, political, and military measures depending on the circumstances. In other words, the ascending side of the wave coincides with a phase of rising business confidence, driven by rising profit expectations and good prospects of success that, at some point in the future, will prove to be untenable. Similarly, the descending side will reflect the lingering effects of a loss in overall confidence that at some point reversed the world outlook of the business class. Our Figure 2.1 shows four long waves spanning 187 years of capitalist development in the U.S. and the U.K., from 1834–2021. The contours of our waves seem very close to Shaikh’s Figure 2.11 on p. 66 of Capitalism (2016); Shaikh’s theory of long waves, however, was formulated earlier (Shaikh, 1992). In both cases, the construction of these waves included producer price indexes in the respective countries normalized by gold price indexes. The results demonstrate the remarkable similarity of these waves in both countries. These similarities suggest to us that the long waves of business booms and busts and the formation of business confidence follow one another regularly in both countries. Such common patterns of long waves in business confidence driving the actual investment trends in both countries allow us to understand the long-run dynamics of the system as a whole (van Duijn, 1983). It is critical to observe that major changes in accumulation rates coincided with the midpoints of each descending side of our four long waves. For example, the stagflation crisis in the early 1970s broke out around the midpoint in the descending side of the third long wave recorded in Figure 2.1. On the other hand, the

46  Classical Economics

150

US Long Waves 125

UK Long Waves

100 2nd Great Depression 1929-1939

1st Great Depression 1873-1896

75

3rd Great Depression 1973-1982

4th Great Depression 2007-?

50

25

0

1834

1845

1856

1867

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Figure 2.1  U.S. and U.K. Kondratieff long-waves, 1834-2021, based on U.S. and U.K. wholesale price indexes/New York gold price indexes.

excesses of financial speculation driven by asset price inflation and secular stagnation in the real economy characterized the consolidation of neoliberalism in the 1980s. In the ascending side of the fourth long wave, as the speculative euphoria that followed reached its peak and the fourth wave receded, once again at the midpoint of the descending side, the financial excesses previously built up shattered the speculative claims of financial capital and triggered the Great Recession of 2007–2009. Furthermore, observing the long span covered by our long waves, we sought to identify what might be considered the historical trend of economic activity across the historical span covered by almost two centuries of capitalist development. Instead of de-trending the cyclical path of these four long waves, as found in Figure 16.1 of Shaikh’s Capitalism, our loess filter clearly highlights a phase break in the long waves detected after World War II, from 1947 to the present. The downward turn of the secular trend sunk lower after the mid-1960s, anticipating the structural changes that changed the mixed economy into neoliberalism. While the preceding two waves displayed a slightly rising secular trend up to the Great Depression of the 1930s, the long wave initiated in the 1940s, after rising to almost previously reached heights, lost its underlying momentum and eventually collapsed faster than it had previously done, reaching the lowest trough ever since 1834. Since recovery from that trough in the early 1980s, the new peaks reached lower heights and the cyclical troughs sunk even deeper than ever before. This historical trend followed the secular trajectory that paved the way to the Silent Depression in the 1970s and laid the grounds for the neoliberal regime that led to the Great Recession of

Classical Economics  47 2007–2009, thus, configuring the financialization and secular stagnation of productive capital. We readily acknowledge the significance of long waves in economic activity as real (empirically verifiable) patterns of accumulation. In their rising phase, such waves reflect the self-fulfilling buoyant expectations driving the boom as long as disappointing results do not weaken confidence and falling profitability leads to panic undermining the upturn. Instead, we adhere to the Classical notion that as accumulation advances, rising capital net output ratios in conjunction with the unsurmountable limits to the rising share of profits are effective drivers of falling profitability and the declining capital accumulation rate underpinning secular stagnation. Ours is a theory of secular stagnation that does not depend on contingent events such as declining demographic growth, insufficiently low interest rates, under-consumption tendencies, monopolistic industrial organization, falling prices of capital goods, inequality, and so on. Instead, our theory applies to the immanent dynamics of capital accumulation and the profit rate. In his magisterial book on Capitalism, Shaikh provides empirical evidence that the Classical approach to profitability’s secular trend is largely shaped by the relentless drive to automate the production process. Capital-intensive technical change penetrates every sector of the production system, a proposition thoroughly substantiated in Shaikh’s empirical findings: The normal maximum profit rate falls steadily, strongly supporting the notion that technical change steadily reduces the output-capital ratio, in neoclassical terms, it reduces the average productivity of capital; in Marxian terms, it raises the monetary equivalent of the ratio of constant to living labor. (Shaikh, 2016, p. 251) And, as the output/capital ratio declines, the downward pressure on profitability increases. It is clear that technical change steadily erodes the level of the normal profit rate…and that it is only in the neoliberal era that a rising normal profit share (steadily decreasing normal wage share) is able to counteract the effect of the steady fall in the normal maximum profit rate. (ibid., p. 730) Our empirical evidence will show that, despite rising profit shares in the corporate sectors in the neoliberal period extending roughly from the early 1980s to the present, the average profit rates on the net capital stock data found in the Fixed Asset tables of the Bureau of Economic Analysis for the business and nonfinancial corporate sectors remained well below the levels attained in the 1960s and 1970s. It is remarkable that average profitability in the business and nonfinancial corporate sectors, including few superstars like Amazon, Apple, Facebook, Microsoft, etc. (but also the estimated 20 percent of corporate ‘zombie’ companies barely able to survive), did not recover neither a rising trend nor the higher level experienced in

48  Classical Economics past decades. This is why our interpretation of the impact of profitability on capital accumulation, and its connection with secular stagnation, benefits from the findings of Classical economists, and retains and develops their valuable conceptual framework. The secular empirical evidence The U.K. empirical evidence appears to confirm the Classical economists, including Marx’s observation regarding the long-term nature of this tendency, We have shown in general, therefore, how the same causes that bring about a fall in the general rate of profit provoke counter-effects that inhibit this fall, delay it and in part even paralyse it. These do not annul the law, but they weaken its effect. If this were not the case, it would not be the fall in the general rate of profit that was incomprehensible, but rather the relative slowness of this fall. The law operates therefore simply as a tendency, whose effect is decisive only under certain particular circumstances and over long periods. (Marx, 1991, p. 346) As we show in Figure 2.2, it is clear that powerful structural changes led to the nontrivial 50 percent decline in profitability between 1760 and 1860, the heyday of Classical economics. The partial recovery of profitability in the next four decades did not raise it to its previous levels, and after the plunge of 1919–20, average profitability remained stuck at its lowest level until 1980, entering the neoliberal 21% 18% 15% 12% 9% 6% 3% 0% -3% -6% -9% -12% -15% 1600 1622 1644 1666 1688 1710 1732 1754 1776 1798 1820 1842 1864 1886 1908 1930 1952 1974 1996 2018

Figure 2.2  Seven years centered moving average of U.K. interest rates, 1600-2018, based on Bank of England Staff Working Paper No. 845: "Eight centuries of global real interest rates, R-G, and their 'suprasecular' decline, 1311-2018.

Classical Economics  49 phase. We believe that in order to understand the significance of Marx’s theory of the falling rate of profit, it is crucial to view it as a conceptual development within the framework of Classical Political Economy. Lowe’s growth model shed a bright light on the decisive role of falling profitability in Marx’s dynamics of capital accumulation, but it failed to highlight a similar trend in Adam Smith’s work or any other of his followers, including J.S. Mill. It is important to underscore that in Classical Political Economy as well as Marxian economics the tendency for the rate of profit to fall is directly tied up with capital accumulation, technical change, and vanishing profitable investment opportunities. Ricardo became critically aware of the growing role of fixed capital in the struggle against the diminishing marginal productivity of land. In Marx’s view, the rising share of fixed capital in capitalist development brought about the falling rate of profit: “This is in every respect the most important law of modern political economy, and the most essential for understanding the most difficult relations. It is the most important law from the historical standpoint” (Marx, 1993, p. 748). The ‘law’ played a decisive role in the emergence of secular stagnation. Beginning with Adam Smith, war-like competition provided the framework in which rival capitalists fought each other to secure for themselves the ‘vanishing investment opportunities’ remaining, but it was the deployment of capital intensive technology that led to rising labor productivity and falling profitability, As capitals increase in any country, the profits which can be made by employing them necessarily diminish. It becomes gradually more and more difficult to find within a country a profitable method of employing any new capital. There arises in consequence a competition between different capitals. (Smith, 1965, p. 336) The misinterpretation of Smith’s theory of falling profitability may have started with Ricardo’s formulation of the problem in his Principles of Political Economy where he provided a generally correct view of Adam Smith’s view regarding the connection between advanced stages of capital accumulation and declining profitability: “Adam Smith, however, uniformly ascribes the fall of profits to accumulation of capital and the competition which will result from it” (Ricardo, 1981, p. 289). Inadvertently, however, he may have opened space for misinterpretation by placing ‘competition’ immediately after capital accumulation: competition will even out differential profit rates but will not determine the prevailing average level. This is important because the correct interpretation of Smith’s, Ricardo’s, and Marx’s view provides a historic thread of their evolving conceptual structure and facilitates understanding of its development (Verdera, 1991; Tsoulfidis and Paitaridis, 2012). Marx was fully aware of the central role that profitability played in Classical political economy: “It is the rate of profit that is the driving force in capitalist production…Hence the concern of the English economists over the decline in the profit rate. If Ricardo is disquieted even by the very possibility of this, that precisely shows his deep understanding of the conditions of capitalist production”

50  Classical Economics (Marx, 1991, p. 368). His view mirrored Mill’s analysis of the central role of profitability in the dynamics of the growth and crisis tendencies of capitalism and is based on the undisputed fact that “the rate at which the total capital is valorized, i.e., the rate of profit, is the spur to capitalist production…a fall in this rate slows down the formation of new, independent capitals and thus appears as a threat to the development of the capitalist production process; it promotes overproduction, speculation and crises, and leads to the existence of excess capital alongside a surplus population” (Marx, 1991, Volume 3, Chapter 15, pp. 349–350). As capital accumulation proceeded with cyclical regularity, Marx noted “the mass of small fragmented capitals are thereby forced onto adventurous paths: speculation, credit swindles, share swindles, crises” (Marx, 1991, p. 359). Marx argued that in the context of real competition-as-war cutting edge capitals bent on gaining market share would seek to reach market hegemony lowering unit costs, deploying more capital intensive, labor-saving technology that involved a decline in their own profitability. He recognized the central role of the falling rate of profit in the conceptual structure of Classical economics underpinning his critical stance and deemed it to be “in every respect the most important law from the historical standpoint” (Marx, 1993, p. 748). Ramsey McCulloch, a prominent Ricardian, argued that “A relative lowness in the rate of profit, not only lessens its power to accumulate power, or to add to that fund by which its populations and industry must always be regulated; but it also creates a strong temptation to transmit a part of it to other countries…if capitalists are once assured that their stock can be laid out with tolerable security, and with considerably greater advantage in foreign states, an efflux of capital…will certainly take place” (McCulloch, 1870/2010, p. 202–203). Mill criticized Ramsey McCulloch’s interpretation of the law’s significance on the grounds that, for McCulloch, “prosperity does not mean a large production and a good distribution of wealth, but a rapid increase of it,” and instead, “his test of prosperity is high profits; and as the tendency of that very increase of wealth, which he calls prosperity, is towards low profits, economical progress according to him, must tend to the extinction of prosperity” (Mill, 1987, p. 747). Marx himself also resented that McCulloch’s “only fear, driven to ridiculous extremes, is the tendency of profits to fall; he is perfectly contented with the position of the workers, and in general with all the contradictions of bourgeois economy which weigh heavily upon the working class…his whole tender anxiety is reserved for the poor capitalists, considering the tendency of the rate of profit to fall” (Marx and Engels, 1989, Volume 32, p. 353). Marx deplored the dire consequences of falling profitability for the welfare of the working class because he was aware of its structural significance as the effective driver of employment and accumulation trends. He recognized the theoretical contributions made by Classical economists, Smith, Ricardo, and Mill in their various interpretations of the falling rate of profit. Adolph Lowe’s masterful study of the Classical growth dynamics from Adam Smith to Karl Marx came to the conclusion that “This law of the falling tendency of the rate of profits is probably the most controversial of Marx’s propositions, although it follows logically from

Classical Economics  51 any consistent theory of labor value” (Lowe, 1954, pp. 127–158). After Marx, the ‘tendential’ law of the falling profit rate continued to arouse controversy, engaging both friends and foes of Classical economics. Even Keynes sought its rehabilitation as a result of the accumulation of capital leading to the decline in capital’s scarcity value and therefore its marginal yield: “If capital becomes less scarce, the excess yield will diminish, without its having become less productive—at least in the physical sense” (Keynes, 1977, Chapter 16, section II). A historical quirk Ricardo’s contribution to the Classical theory of the falling rate of profit built upon Smith’s notion of a rising spiral of capital accumulation, increasing population, and growing demand for food derived from the expanding market. The growing employed population required an increasing amount of food for its maintenance, which generated relentless pressure to expand the cultivated fields into marginal lands of progressively declining fertility. This phenomenon would not fit neoclassical theories of diminishing returns because here the increasing factor used was not homogeneous in quality and its declining marginal product is not the consequence of an abstract ‘law of diminishing returns.’ Rising demand for food as a result of the expansion of capital and the larger labor force employed met with the reality of falling output per unit of labor employed in lower quality marginal lands. More labor time per unit of output involved higher prices and unit costs leading to a higher wage share and lower profit rates. In order to maintain the share of workers’ consumption constant at the socially accepted level, nominal wages would have to rise with prices and, as real wage costs per unit of output rose, the profit share diminished. Ricardo defined the goal of Political Economy to discover the laws that governed the distribution of wealth among the main three classes of capitalist society, capitalists, landowners, and the working class. Repealing the Corn Laws that provided institutional support for the landowners and prevented the importation of cheaper corn was a central concern in Ricardo’s formulation and in light of Ricardo’s analysis we might wonder why the industrial capitalists and not the landed aristocracy survived as the beneficiaries of the accumulation of capital. Which of the three classes would reap the benefits of capital accumulation so thoroughly analyzed in the “Magnificent Dynamics” of Classical economics? (Baumol, 1970). As we know, the rise in food costs implied that maintaining real wages constant (at survival levels) involved falling profits because more working time was needed to produce the corn equivalent of workers wage and, given the length of the working day, less time was left for the production of a surplus product. In turn, the discrepancy of production costs tied up with the quality of soil allowed those landowners who owned the better grades of land to extract differential rents amounting to the difference between their land’s unit cost of production and the food price set at the cost of production in the marginal lands. It seemed obvious that the landowning aristocracy, by merely owning the land but without facing the risks of capital accumulation, received the fruits of enterprise

52  Classical Economics and even technological progress. The rising food costs of capitalist farmers cultivating marginal lands set the market price for all food cultivated in intra-marginal lands whose unit costs of production were lower. Rising productivity derived from technological change applied across all lands would not eliminate differential costs but merely reduce the level of unit costs throughout the various grades of land. These were not just abstract conclusions but theoretical truths that informed the class struggle between capitalist cultivators and the ‘idle’ aristocracy. Implications of secular stagnation and crisis The socioeconomic impact of increasing differential rents emerging from the rising cost price of extracting food from marginal lands brought about the secular enrichment of the landowning class and the compression of capitalists’ profits. The weakened incentives for capital accumulation in turn paved the ground for a long phase of secular stagnation. The deteriorating composition of the soil in the marginal lands under cultivation in conjunction with the binding law of labor value combined to shape the contrasting fortunes of the capitalist and landowning classes, or so it seemed in Ricardo’s analysis. But as Blatt has observed, at the time Ricardo formulated his impeccable analysis “the landlords emerge as the winners…the proprietors of land ruled Britain. Fifty years later, individual landed proprietors were still wealthy but the real wealth and the real power had gravitated to the ‘owners of stock’ or capital” (Blatt, 1984, p. 305). This unexpected outcome cannot be explained arguing that Ricardo’s analysis underrated the capacity of technological change to reverse the declining marginal product in peripheral lands, since cost differentials would persist among all the various grades of land. Technical change would have to eliminate all differences in production costs between the best, the worst, and the intra-marginal lands. Blatt’s interpretation argued that landowners indeed received the lion’s share of the capitalist rents as Ricardo predicted, but their economic fate as a class fell outside Ricardo’s growth model. Following their good instincts the landowners placed their revenues in the London money market, directly or through their banker, in order to obtain “a good rate of interest on their money,” expecting higher returns than placing their money into consoles (ibid., p. 307). Thus, Blatt argued, for as long as general trade advanced the landowners increased their wealth, but “good trade did not last forever. Sooner or later, on average once every ten years or so, it all ended in panic. In the panic, creditors as a group lost not merely their interest entitlement, but their principal. This, averaged over the trade cycle, investment (placement) proved counterproductive to the landed proprietors, who were the main creditors” (ibid., p. 307) and the landowners’ entire capital disappeared. Grossman, Classical economics, and secular stagnation In his celebrated The Theory of Capitalist Development, Paul Sweezy criticized H. Grossman’s The Law of Accumulation and Collapse of the Capitalist System on the false basis that Grossman had accepted as valid the premises and artificial numerical schema created by Otto Bauer to show the possibility of balanced capital

Classical Economics  53 accumulation with a growing composition of capital but a constant rate of surplus value. This misunderstanding allowed Sweezy to claim that “By a breath-taking mental leap Grossman concludes that the capitalist system must also break down from a shortage of surplus value” and from this perspective, Sweezy concluded that “Grossman’s theory exhibits in extreme form the dangers of mechanistic thinking in social science” (Sweezy, 1970, pp. 210–211). In reality, Grossman’s theory of crisis is grounded on the premise of vanishing ‘profitable’ investment opportunities in the advanced stages of capitalist development that resulted in a diversion of investment from productive sectors into speculation and financial assets as theorized in Mill’s and Marx’s works on crises. In the face of falling profitability, the appearance of ‘superfluous’ capital in productive sectors leads to speculative investments and eventually unsustainable booms that eventually trigger a general crisis, shatter confidence, and usher in protracted stagnation. Grossman stressed that in a crisis “capital is either exported or switched to speculation” (Grossman, 1992, pp. 191–192) and with a highly contemporary relevance observed that “Speculation is a means of balancing the shortage of valorization in productive activity with gains that flow from the losses made on the exchange by the mass of smaller capitalists, it is a powerful mechanism in the concentration of money capital” (ibid., p. 192). As we show in Chapter 10, Grossman’s interpretation provided a complete theory of capital accumulation which, under certain conditions of the class struggle, led to an extended period of secular stagnation similar to Keynes’ anticipation of “a chronic condition of sub-normal activity for a considerable period without any marked tendency either towards recovery or towards complete collapse” (Keynes, 1977, p. 249). Monopoly and the theory of stagnation Classical economists understood the intrinsic link between capital accumulation and the development of real competition. As capitalism develops the forces of production, the complexity and force of real competition grows with it (Clifton, 1977, pp. 137–151). Real competition involves antagonistic relations among capitalist firms, each vying for supremacy in the race to reach top position in their respective industries or markets, waging a war against rivals for higher market share, carrying on an offensive to raise labor productivity and limit wage growth in order to minimize unit costs: it is a conflict in which laggards risk bankruptcy and oblivion. Competition is central to the analysis of capital accumulation in the Classical perspective because its pressure secures the persistence of development patterns, including the growing capitalization of production and the gains from economies of scale. In our view, replacing the analysis of coercive systemic tendencies derived from the pressure of real competition with the notion of unrestrained monopoly power would deprive political economy of understanding the real significance of capital’s concentration and centralization trends. Simply put, dissociating Marx from the research program of Classical economics in a quest to replace the binding patterns imposed by the forces of real competition with alleged monopoly power to evade them deprives Marx’s theory of the binding outcomes of

54  Classical Economics Classical economics. New developments in the direction of higher concentration and centralization of capital simply heighten the lethal power of the technological weaponry deployed in competitive wars and effectively shape the behavior of big and small capitals, Now the patterns and tendencies of Classical economics emerge even more distinctive as the intensity of capitalist production rises with the concentration and centralization of capital. Despite Keynes’ reticence to acknowledge the legacy of Classical economists, he shared with Adam Smith the view that capital’s expected rate of profit tended to decline. Keynes’ marginal efficiency of capital tended to fall because after a sustained period of capital accumulation, capital’s scarcity value declined. Both took the scarcity of capital as the reason for its command over profits, and therefore it followed that extended periods of capital accumulation would diminish its scarcity value. Keynes confidently expected that the implementation of his recommendations to overcome the 1930s slump, chiefly through the command of “communal saving through the agency of the State to be maintained at a level which will allow the growth of capital up to the point where it ceases to be scarce,” would bring capital “to a point where its marginal efficiency had fallen to a very low figure,” and rentiers would disappear, “nothing sudden, merely a gradual but prolonged continuance of what we have seen recently in Great Britain.” The application of Keynesian policies, however, needed no revolution to end the “cumulative oppressive power of the capitalist to exploit the scarcity value of capital” (Keynes, 1977, Chapter 24, Section II). This Keynesian endpoint of the accumulation of capital strongly resembled John Stuart Mill’s view of the stationary state and its beneficent characteristics. In the perspective of the socialist journal Monthly Review, the “current crisis of production associated with the COVID-19 pandemic…is a manifestation of the inner contradictions of monopoly finance” (Foster, Jonna, and Clark, 2021). Such conclusion is simply a follow-up built on the argument previously developed in The Great Financial Crisis regarding the consolidation of the “monopoly-capitalist economy” (Foster and Magdoff, 2009). According to John Bellamy Foster and Fred Magdoff, what caused The Great Financial Crisis was that the “enormous productivity of the monopoly-capitalist economy, coupled with oligopolistic pricing, generated a huge and growing surplus, which went beyond the capacity of the economy to absorb…Effective demand remained insufficient even when civilian government spending was added,” and as a result “a tendency to ‘secular stagnation’ could be attributed in part to the emergence of ‘maturity’ in capitalist economies,” very much in line with Hansen’s interpretation of “the long-term implications of Keynes’s thinking.” Bellamy Foster and Magdoff agreed with what “Joseph Schumpeter, in a polemic against Hansen, characterized as a theory of ‘vanishing investment opportunities’” (Foster and Magdoff, 2009). The theory of vanishing investment opportunities and monopoly combined with selected Marxian themes framed the Monthly Review’s perspective on the crisis of neoliberalism and “The Contagion of Capital” (Foster, Jonna, and Clark, 2021). In that document the writers stressed the fact that “Economic crises in capitalism, whether short term or long term, are primarily crises of accumulation, that

Classical Economics  55 is, of the savings-and-investment (or surplus-and-investment) dynamics” and they linked falling investment to the “existing excess capacity in plant and equipment, a product of the monopolistic structure of accumulation” caused by “a long-term decline in capacity utilization in manufacturing, which has averaged 78 percent from 1972 to 2019.” As a consequence of such high growth rates in labor productivity, “mature, monopolistic economies of the United States, Europe and Japan over the last half century” generate a growing surplus at the same time that investment opportunities are vanishing and capacity utilization is falling. Linking the onset of secular stagnation to falling profitability differs from Hansen’s and Schumpeter’s theories of ‘vanishing investment opportunities’ because our interpretation derives from the structural trends of capital accumulation itself, chiefly the growing intensity of capitalist production, and not extrinsic factors like falling population growth in Hansen or the spread of entrepreneurial dystopia in Schumpeter (Hansen, 1939; Schumpeter, 1928 and 1947; Bloch, 2000; Heilbroner, 1981; Foster and Magdoff, 2009; Foster, Jonna, and Clark, 2021). In our view, the actual data on capital/output ratios reflect the increasing capitalization of capitalist production and demonstrate the increasing level of corporate profits necessary to survive. The maturity argument achieved in the so-called monopoly stage, moreover, implies the decline in average profitability that led from abundant options of high profits in the earlier ‘competitive’ stages to the mature ‘monopolistic’ phase in which ‘vanishing investment opportunities’ prevail: in its own terms the theory implies that profitability must have declined. What the ‘vanishing investment opportunities’ theory implies is that previously existing profitable investment opportunities gradually disappeared. The alleged decline in manufacturing capacity utilization is a figment of the neoclassical imagination (adopted by the Monthly Review theorists) and not the core reason for the crisis in manufacturing. In fact, our estimates show that normal capacity utilization is fairly trendless. As we show in Chapter 6 the decline in manufacturing profitability was not related to falling capacity utilization or sharper international competition but rather the result of falling profitability caused by rising capital/output ratios. The Monthly Review theorists asked the question “what happens to that part of the economic surplus held by corporations and individual capitalists that is not invested in new capacity?” and correctly mentioned such growing outlets as stock buybacks, “speculation, including mergers, acquisitions’ practices that represent “the progressive financialization of the capitalist economy” where “asset accumulation by speculative means has replaced actual accumulation…generating a condition of ‘profits without production’” (Foster, Jonna, and Clark, 2021). We certainly agree that the free flow of capital among the different sectors of the system brings about the tendential equalization of the leading capitals (Shaikh’s ‘regulating capitals’) profit rates. The ‘profits on alienation’ that James Stuart interpreted to be the result of exchange, not production, led to a diversion of capital flows from the nonfinancial to the financial spheres. This is not evidence of monopoly but rather of the search for yield in financial assets because the alternative profit rate in the real sector remained lower on average and attests to the free flow of capitals characteristic of competition. As A. Clifton demonstrated “the capitalist

56  Classical Economics mode of production has become far more competitive through the two hundred years of development…the requirement of free capital mobility in a theory of competition finds its closest approximation in the real world in the corporate structure and competitive strategy of the modern corporation, rather than the atomistic firm of neoclassical theory. This proposition pertains to the nature of the adjustment mechanism when capitalism is viewed as a process which is continually emerging in history: one in which the growth and development of the capitalist firm gradually establish the conditions of free capital mobility necessary to competition” (Clifton, 1977, pp. 137–151). Thus, it is now when global corporations, operating in various geographical markets and marketing different products are able to implement better than ever the allocation of capital according to profitability differentials, pulling investment from areas where profitability is lower to sectors where is demonstrably higher, thus strengthening the tendency to profit equalization. Classical economics perhaps could not survive its own theoretical achievements coping with recurrent crises of capitalist reproduction in the era of neoliberalism. Even the language underwent recasting to serve ideological preferences: ‘depressions’ disappeared and only recessions survived; the ‘market system’ replaced capitalism as the object to study in mainstream economics. In the world of neoclassical economics, all failures are due to imperfections and monopoly distortions. Neoclassical economics was designed to study the optimal conditions necessary for the analysis of market systems under perfect competition in order to show how they are able to reach the equilibrium growth path assisted by technical change of the right kind. Neutral technical change that does not interfere with factor shares is assumed to be always available to counteract the ‘law’ of diminishing marginal product imposed on capital and labor. Formally this feat requires upward and fortuitous shifts of the concave production function (delivering higher output without an increase of the variable input) to break the otherwise implacable barrier of ‘diminishing marginal products.’ The outcome will then confirm the impact of technical change on a capital/output ratio that allows the system to remain on the growth path. In neoclassical economics, relative income shares of capital and labor remain constant while in the real world of competitive strategies innovators gain market share after lowering unit costs and underselling rival firms. Historical evidence of falling profitability With regard to the empirical knowledge of Classical economists, it is interesting to note that when the Nobel prize winner George Stigler raised the question “Did Ricardo have a labor theory of value--did he believe that the relative values of commodities are governed exclusively by the relative quantities of labor necessary to produce them?”, his answer assumed that Ricardo was in touch with the real world of business: “there is no doubt that he held what may be called an empirical labor theory of value, that is, a theory that the relative quantities of labor required in production are the dominant determinants of relative values.” Stigler was prepared to grant the empirical accuracy of Ricardo’s labor theory of value, the proposition that relative prices of two goods were generally proportional to their relative

Classical Economics  57 labor values, but challenged its standing as an analytical law (Stigler, 1958, pp. 357–367). In retrospect, even though Classical economists roughly between 1760 and 1860 lacked the extensive data banks of the Bank of England they were much closer to the business practices of their time than neoclassical economists are today and therefore we conclude that in their minds their ‘stylized facts’ regarding the falling rate of profit as capital accumulation advanced were derived from observing the actual experience of profitability trends in their own time. Their own business experience was more likely to play a decisive role in the formation of expectations regarding the impact of technical change on profits than business practices have on neoclassical economics and the alleged ‘stylized facts’ assumed by heterodox growth models to produce neoclassical outcomes of equilibrium growth paths (Kaldor, 1965, 1996). As Adam Smith pointed out, “But though it may be impossible to determine with any degree of precision, what are or were the average profits of stock, either in the present, or in ancient times, some notion may be formed of them from the interest of money. It may be laid down as a maxim that wherever a great deal can be made by the use of money, a great deal will commonly be given for the use of it; and that wherever little can be made by it, less will commonly be given for it. According, therefore, as the usual market rate of interest varies in any country, we may be assured that the ordinary profits of stock must vary with it, must sink as it sinks, and rise as it rises, therefore, may lead us to form some notion of the progress of profit” (Smith, 1965, p. 88). The empirical evidence presented in Paul Schmelzing’s Staff Working Paper No. 845, Bank of England comprehensive Data Appendix on interest rates (“Eight Centuries of Global Real Interest Rates,” https://www​.bankofengland​.co​.uk​/working​-paper​/2020) clearly shows a consistently downward trend of real interest rates falling from the lofty heights of the year 1557 to the 1799–1800 trough. Crop failures and famine associated with the War of the Second Coalition between France and the U.K. produced this historical collapse. After recovering from the negative values reached in the crisis outbreak at the turn of the century, as Figure 2.2 shows, real interest rates once again went on a long descending trend ending one century later. Evidence of this kind would indicate that when Adam Smith pointed to the close relationship between interest and profit rates as a guide to the long-run trend of average profit rates he was on solid grounds. In fact, Classical economists from Smith through Ricardo, Mill, and Marx were not closet theorists, on the contrary, they were thoroughly familiar with business practices and the business world around them. Thanks to the comprehensive data bank on the British economy collected by the Bank of England, we now have access to a retrospective view of the profitability prospects capitalists faced in the world experienced by Classical economists. It is clear that Classical economists reflected something real in their systemic theories of falling profitability and that their theoretical outlook was not based on imaginary facts but rather on what later came to be known as ‘stylized facts’ of emerging capitalist development. Deploying the comprehensive data bank collected by the Bank of England (Bank of England, “A Millennium of Macroeconomic Data,” Ver. 3.1, https://www​

58  Classical Economics .bankofengland​.co​.uk​/statistics​/research​-datasets), our estimates clearly showed an overall secular decline in average profitability. Between the years 1760 and 1980, the long-run profitability trend displayed in Figure 2.3 was punctuated by middle-run cycles interspersed within the overall downward historical tendency of the profit rate. A partial recovery between 1860 and 1870 followed the sharp profitability decline from 1780 to 1860, concluding with the final descent between 1940 and 1980. The tendential decline of the average profit rate exhibited in Figure 2.3 reflected the downward trend in output/capital ratios (gross income minus depreciation to capital stock ratio) of Figure 2.4. Output/capital ratios measure all net income consisting of maximum profits on the assumption that all value added consists of profits and that wages are zero (in Sraffian terms, all value added is ‘surplus’ and we have reached the notional ‘maximum’ rate of profits). Since the profit rate is the product of the profits share times the (net) output/capital ratio, the deeper descent of the (net) output/capital ratio (‘the maximum profit rate’) requires a countervailing movement of the actual profits share. Figures 2.2 through 2.4 convey the long-run dynamics of capitalism that underlay Marx’s conceptual framework, reading the official statistical reports on profits, wages, and technical change to confirm his theoretical views. As Marx made clear at the end of Chapter 14 in Volume 3 of Capital, Only when the relationships that form the rate of profit have been understood will statistics be able to put forward genuine analyses of wage-rates in different periods. The profit rate does not fall because labor becomes less

41% 38% 35%

UK average profit rate

32%

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UK real GDP growth rate, three-year centered average

26% 23% 20% 17% 14% 11% 8% 5% 2% -1% -4% -7% -10% -13%

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Figure 2.3  Profit and real GDP growth rates, based on Bank of England’s, “A millennium of macroeconomic data for the U.K,” version 3.1.

Classical Economics  59

0.85

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Figure 2.4  Output/capital trend, 1760-1980, based on Bank of England, “A millennium of macroeconomic data for the U.K,” version 3.1.

productive but rather because it becomes more productive. The rise in the rate of surplus-value and the fall in the rate of profit are simply particular forms that express the growing productivity of labour in capitalist terms. (Marx, 1991, p. 347)

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60  Classical Economics Foster, J. B., Jonna, R.J. and Clark, B. 2021. “The Contagion of Capital,” Monthly Review, January 1. Goodwin, R. 1970. “Dynamics of Long-Run Growth,” Elementary Economics from the Higher Standpoint, Cambridge University Press. Goodwin, R. and Punzo, L. 1987. The Dynamics of a Capitalist Economy, Westview Press. Gourvitch, A. 1966. Survey of Economic Theory on Technological Change & Employment, Augustus M. Kelley Publishers. Grossman, H. 1992. The Law of Accumulation and Breakdown of the Capitalist System, translated and abridged by Jairus Banagi, Pluto Press. Grossman, H. 2021. Henryk Grossman Works, Volume 3, The Law of Accumulation and Breakdown of the Capitalist System: Being also a Theory of Crises, Brill. Hansen, A. 1939. “Economic Progress and Declining Population Growth,” American Economic Review, Vol. 29, No. 1., pp. 1–15. Heilbroner, R. 1981. “Was Schumpeter Right?,” Social Research, Vol. 40, pp. 456–471. Heilbroner, R. 1986. The Worldly Philosophers, Simon & Schuster. Kaldor, N. 1965. “Capital Accumulation and Economic Growth,” The Theory of Capital, edited by F.A. Lutz and D.C. Hague, Macmillan. Kaldor, N. 1996. Causes of Growth and Stagnation in the World Economy, Cambridge University Press. Kanth, R. 1986. Political Economy and Laissez-Faire, Rowman & Littlefield Publishers. Keynes, J. M. 1977. The General Theory of Employment, Interest and Money, Royal Economic Society: The Macmillan Press. Kurz, H. and Salvadori, N. 2015. Revisiting Classical Economics, Routledge. Lowe, A. 1954. “The Classical Theory of Economic Growth,” Social Research, Vol. 21, No. 2, Johns Hopkins University Press. Marx, K. 1972. Theories of Surplus Value, Part III, Chapter XIX, Lawrence and Wishart. Marx, K. 1991. Capital, Vol. 3, Penguin. Marx, K. 1993. Grundrisse, Penguin Books. Marx, K. and Engels, F. 1989, Collected Works, Vol. 32, International Publishers. McCulloch, J. R. 1870/2010. The Principles of Political Economy, Kessinger Legacy Reprints. Mill, J. S. 1987. Principles of Political Economy, Augustus M. Kelley Publishers. Ricardo, D. 1952. The Works and Correspondence of David Ricardo- Volume 5: Speeches and Evidence, edited by Piero Sraffa, with the collaboration of M.H. Dobb, Cambridge University Press. Ricardo, D. 1981. On the Principles of Political Economy and Taxation, Cambridge University Press. Schmelzing, P. 2020. “Eight Centuries of Global Real Interest Rates, R-G, and the Supra Secular Decline, 1311–2018,” Staff Working Paper, No. 845, Bank of England, version 1.2. Schumpeter, J. 1928. “The Instability of Capitalism,” The Economic Journal, Vol. 38, No. 151, pp. 361–386. Schumpeter, J. 1947. “The Creative Response in Economic History,” The Journal of Economic History, Vol. 7, No. 2, pp. 149–159. Shaikh, A. 1992. “The Falling Rate of Profit as the Cause of Long Waves: Theory and Empirical Evidence,” New Findings in Long-Wave Research, edited by A. Kleinknecht, E. Mandel and I. Wallerstein, St. Martin’s Press. Shaikh, A. 2016. Capitalism: Competition, Conflict, Crises, Oxford University Press.

Classical Economics  61 Shoul, B. 1965. “Similarities in the Work of John Stuart Mill and Karl Marx,” Science & Society, Vol. 29, No. 3. Smith, A. 1965. The Wealth of Nations, Chapter IX, The Modern Library. Stigler, G. 1958. “Ricardo and the 93% Labor Theory of Value,” The American Economic Review, Vol. 48, No 3. Sweezy, P. 1970. The Theory of Capitalist Development, Monthly Review Press. Tsoulfidis, L. and Paitaridis, D. 2012. “Revisiting Adam Smith’s Theory of the Falling Rate of Profit,” International Journal of Social Economics, Vol. 39, No. 5, pp. 304–313. Tsoulfidis, L. and Tsaliki, P. 2019. Classical Political Economics and Modern Capitalism, Springer. Tucker, G. 1960. Progress and Profits in British Economic Thought, 1650–1850, Cambridge University Press. Van Duijn, J. J. 1983. The Long Wave in Economic Life, George Allen & Unwin. Verdera, F. 1991. “Adam Smith on the Falling Rate of Profit: A Reappraisal,” Scottish Journal of Political Economy, Vol. 39, No 1. Walker, A. 1977. “Karl Marx, The Declining Rate of Profit and British Political Economy,” Economica, Vol. 38, No. 152.

3

Profitability and the limits of Fordism

We argue in this chapter that the stagflation crisis of the 1970s reflected the confluence of the weakening growth potential of the economic system, caused by falling profitability, and the expansion of corporate and public deficit spending, supporting capital expenditures beyond the limits set by the retained earnings of corporate firms. It is our contention that, as pressures on the growth potential of corporate firms rose, inflation signals heralded the emergence of bottlenecks and shortages, hampering the expansion well before reaching full capacity growth. In turn, the disruptions of supply chains redounded in widespread business failures, unemployment growth, and deepening stagnation. In the wake of the stagflation crisis, we traced the emergence and consolidation of neoliberalism that followed in the 1980s to the measures taken by managerial elites to overcome the stagflation crisis and reverse the trends that caused it. Deindustrialization first sought to dismantle large U.S. industrial sites and to weaken the power of labor unions to prevent wage repression, and, second, to enlarge the profit share of domestic manufacturing firms as well as to facilitate the expansion of services as an alternative to manufacturing. These structural changes sought to allay the socioeconomic impact of deindustrialization and to take advantage of the progress in information technology, in order to manage capital investments in low-wage and higher-profit countries (Howard and King, 2008). As an overarching transition, the neoliberal project brought on the consolidation of investment banking as a major promoter of financial capital’s growth and as an alternative to the conflicted relations of the manufacturing sector. Profitability and Fordism Our strategy consists in drawing stylized patterns of structural change from the history of U.S. Capitalism without resorting to fictitious constructs such as the constancies of profit shares and profit rates, capital/output ratios, and full employment that Kaldor proposed in his ‘stylized facts’ of 1963. Kaldor’s ‘stylized facts’ were simply artificial constructs necessary for his growth model to reach, and stay on, the equilibrium growth path, the so-called ‘magic constants’ that Bronfenbrenner attributed to Kaldor’s imagination (Bronfenbrenner, 1971, p. 417). Proceeding with our recurrent themes, in this chapter we provide a comprehensive account of the forces that led to the decline of the Fordist configuration and the rise of neoliberalism. The structural foundation of Fordism, the postwar DOI:  10.4324/9781003413806-3

Profitability and the limits of Fordism  63 Keynesian U.S. mixed economy set up in the wake of the Great Depression, relied on the high levels of profitability made possible by the price and wage controls set up to sustain the war effort. Initially, the Fordist configuration, involving high rates of technological progress and efficient corporate governance at the hands of technocratic managers, sustained optimistic business expectations of limitless growth. After the mid-1960s, when the deficit spending associated with the Vietnam War diminished, and effective demand declined, falling capacity utilization turned the previously mildly falling profitability trend into a free fall affecting all sectors of the economy for the remainder of the decade. The outbreak of the 1970s stagflation crisis, in conjunction with the falling profitability trend that undermined the managerial elites’ confidence in the prospects for continuing growth, strengthened corporate resolve to replace the Fordist configuration with a more viable structure. From the standpoint of the system’s preservation, the elites concluded that without reversing the trend in falling profitability, the future of U.S. capital accumulation was in jeopardy, hence, it would be necessary to drive down U.S. labor costs and raise productivity across all sectors. The consensus reached to reverse the falling profitability trend would require a radical transformation of the existing socioeconomic compact between capital and organized labor. From the elites’ perspective, the stagflation crisis of the 1970s highlighted the challenge posed by the loss of market share in key U.S. manufacturing industries, and the gains of Germany, Japan, and other emerging international competitors that were able to lower unit prices with more efficient technology. As the managerial elites saw it, the foreign encroachment into domestic U.S. markets justified the ‘destruction’ of the old industrial ‘model’ and the creation of a new platform for unhindered growth, the dismantling of the old manufacturing basis, and the expansion of finance. From the late 1970s through the 1990s, the measures taken to achieve a reversal of the profitability trend, including deindustrialization and the flight of capital to offshore areas, where lower wages and high labor productivity made investment attractive, led to the consolidation of neoliberalism. Only after the new configuration of sectoral flows was in place could the full consequences of the transition emerge. The dismantling of the Fordist structures and the replacement of manufacturing with services involved the growing diversion of corporate funds from productive investment to financial assets, and the growing disbursement of corporate funds as dividends, share buybacks, and interest payments. The reallocation of nonfinancial corporate earnings to dividends and share buybacks increased the share of rentier’s income and reduced the labor share for the majority of workers. Productivity growth declined and secular stagnation reared its dreaded face. Launching the neoliberal project was necessary to reverse the decline in profitability and the fall in accumulation because the system’s viability was at stake. Confirming the sound cornerstone of the Classical paradigm, Figures 3.1 and 3.2 show the remarkable association between the evolution of profitability in the corporate and business sectors and capital accumulation rates since the beginning of the 20th century, not only throughout the postwar Golden Age period but also in the neoliberal phase. The full century’s parallelism between profit and accumulation rates represents the presence of a feedback loop between current capital

64  Profitability and the limits of Fordism

36% 33% 30% Business sector average profit rate

27%

Business sector accumulation rate

24% 21% 18% 15% 12% 9% 6% 3% 0% -3% -6% 1901 1908 1915 1922 1929 1936 1943 1950 1957 1964 1971 1978 1985 1992 1999 2006 2013 2020

Figure 3.1  U.S. business sector profit and accumulation rates, based on, 1900–1925, from L. R. Klein and R. F. Kosobud “Some Econometrics of Growth: Great Ratios of Economics,” Table 3; wages, from Dumenil and Levy’s data, version 2015. NIPA and Fixed Assets Tables as in Figure 1.1. 160%

120%

Incremental profit rate Nonresidential fixed capital growth rate

80%

40%

0%

-40%

-80%

-120% 1902

1911

1920

1929

1938

1947

1956

1965

1974

1983

1992

2001

2010

2019

Figure 3.2  U.S. business sector incremental profit rate and nonresidential investment growth rate, based on NIPA Tables 1.9.5, 6.2 and Fixed Assets Table 4.7.

Profitability and the limits of Fordism  65 accumulation rates and realized past profit expectations. In the Classical perspective, corporate saving is not theorized as constituting a fixed proportion of the corporate net operating surplus unless expectations remain fixed. Current profit expectations, however, are framed considering the extent to which past investments validated the profit expectations that motivated them. The realized profits of past capital expenditures will certainly play a decisive role in current assessments of investment plans and, therefore, will set the feedback loop between future accumulation rates and profitability trends. Retained earnings represent the corporate funds available to carry out new investments without incurring additional debts, and their size depends on the strength of profit expectations assessed in the light of past experience. As Figure 3.4 will show, the retained corporate earnings in the nonfinancial corporate sector reflect concurrent profit expectations and the internally available funds to carry them out. The current investment plans that such expectations underpin are partially drawn by taking into account the extent to which past expectations were fulfilled. Empirical estimates of profitability We calculated the average profit rate from 1947 to 2019 in the business sector, rt, as the ratio of net operating surplus of corporate and non-corporate businesses, including self-employed proprietors, over the lagged nonresidential capital stock in the business sector. Following the accounting procedure used in NIPA Table 1.14, to derive the net operating surplus of nonfinancial corporations, we estimated the net operating surplus in the business sector. This is a gross measure of business profits inclusive of net interest payments, representing the difference between net value added in the business sector, Yt, and private sector employee compensation plus the imputed compensation of proprietors minus taxes on production and imports for corporate and non-corporate businesses. Classical Political Economy consistently viewed profits as the driver of capital accumulation. Profits provided the necessary funds to maintain and expand the means of production to fuel the system’s growth. Starting from historically high levels of profitability, the mild downward trend of the postwar became sharply negative after 1965 and the decline did not end until reaching a trough in the early 1980s. Because capacity expansion depends on profitability and in the 1970s the profit rate plummeted, the business sector’s credit borrowing applied unsustainable pressure on the diminished supply capacity, and, as a result, sectoral supply bottlenecks appeared. The rise in input prices due to spreading supply shortages led to a decade-long stagflation crisis combining price inflation, sectoral supply shortages, and growing unemployment. The profitability collapse of the 1970s eventually led to the abrogation of the capital-labor accord. The secular trend of U.S. business profitability Our century-long estimates of the U.S. business sector profit and accumulation rates as displayed in Figure 3.1 benefit from different sources. We used Dumenil

66  Profitability and the limits of Fordism and Levy’s Data Base (version 2013) for wages and net capital stock and we took our data for the Net National Product from L. R. Klein and R. F. Kosobud (Klein and Kosobud, 1961, pp. 173–198, Table 3). We completed Figure 3.1 with the official NIPA and Fixed Asset Tables from 1925 to 2020. The business sector’s profitability and accumulation measures include financial and nonfinancial businesses, corporate and non-corporate firms, but exclude government activities except those carried out by government enterprises like the post office. Two observations follow: first, in Figure 3.1 it is empirically evident that for over a century of major sociopolitical upheavals, the Classical assumption connecting the profitability trend with that of capital accumulation holds well as the overall parallelism between these two time series makes evident. Of course, the accumulation trajectory validates the profitability trend, but it is the pursuit of profit that sets off the evolution of investment. From 1901 through the 1920s and beyond the great divide of the 1930s depression, from the early 1940s recovery to the Golden Age and on to the stagflation crisis and the consolidation of neoliberalism, the Great Recession of the 21st century, it is clear that the falling trend of the profit rate anticipated the secular trajectory of capital accumulation taking an acute downward turn from the mid-1960s to the present. In Figure 3.1, changes in capacity utilization played a significant role in the actual fluctuations of the average profit rate. Those changes reflected contemporaneous twists in fiscal policies associated with public deficits, as well as wars. Vietnam War spending in the early 1960s, the energy crisis of the 1970s, the internet, and housing and stock market bubbles of the 1990s led to their respective bursts and had their impact on ever-changing profit expectations. Such fluctuations in effective demand brought about prolonged changes in capacity utilization that resulted in significant deviations from the actual average profit rate. Overall, however, the trend and fluctuations of the accumulation rate reflected rather closely the trend and fluctuations of the average profit rate. Competitive industries, however, are not usually made up of firms endowed with the same vintage methods of production. A spectrum of technologically advanced industry leaders using the most advanced methods may coexist for a time with marginal firms on the edge of departure. Hence the top firms operating with the lowest unit costs and setting the market price low enough to drive the less advanced firms out of business will enjoy the industry’s highest profit rates. For as long as the less advanced firms remain active in the industry operating with higher unit costs than the leader, but selling the product at the same industrywide price, their profit rate will be lower and the industry average will reflect their marginal status. Hampered by less-than-competitive methods of production, new investments will not seek to emulate their results, but instead, they will replicate the methods of production employed by the industry’s leaders because they deliver the highest profit rate. Figure 3.2 shows the remarkably close association between the incremental profit rate in the business sector and the growth of nonresidential investment and, because the fluctuations of the marginal profit rate generally precede investment changes, we conclude that it is the spur of profit that drove investment growth.

Profitability and the limits of Fordism  67 The geopolitical singularity of postwar Fordism In the early postwar era, a general consensus among power elites concluded that the U.S. economy required a capital-labor accord to provide stability in the pursuit of high rates of capital accumulation. The unique circumstances of the geopolitical Cold War, favored measures of class partnership in order to minimize industrial conflict and enhance social cohesion (Bartel, 2022). At some point, however, the capital-labor accord strategy unraveled when the stagflation crisis of the 1970s sapped the state of confidence in the existing pattern of accumulation. While high rates of investment allowed for rising labor productivity growth, full employment policies strengthened the bargaining position of labor and wage rates went up in tandem with productivity. Capital-intensive technical change raised capital/output ratios and weighed down profitability hampering the dynamics of growth. High investment flows, supported by credit and fiscal deficits, raised effective demand, eventually leading to inflation and rising unemployment, the dreaded stagflation crisis. In the 1970s, the malaise caused by this unexpected ‘Silent Depression’ paved the way for the radical transformation of the sectoral structure of capital accumulation. Deindustrialization, the dismantling of labor unions, the flight of capital overseas and, after the mid-1980s, the expansion of services overhauled the sectoral structure of capital accumulation and ushered in neoliberalism. In this book, we provide empirical evidence that calculating the evolution of the average profit rate on current cost net capital stock understates the extent to which it declined. As Anwar Shaikh demonstrated in his Capitalism: Competition, Conflict, Crises, measuring profitability on gross capital provides a more accurate view of the level and evolution of profitability from a business standpoint. Despite the shortcomings of the neoclassical concept of net capital stock (which leaves out the accumulated depreciation funds necessary to replace aging equipment), our estimates of average profitability based on the net capital Fixed Asset Tables of the Bureau of Economic Analysis clearly show a significant decline separating the period 1947–1981 from 1982–2020. The structural changes brought about in the neoliberal phase, specifically the dismantling of manufacturing and the expansion of services, significantly contributed to the stagnation tendencies at the core of neoliberalism. Those changes, in fact, hollowed out the industrial capacity of the economy and made it more vulnerable to the impact of systemic shocks like those associated with the COVID-19 lockdowns of 2020. The shrinking manufacturing share of employment and value added, parallel with the expansion of employment in services, including the financial sector, exposed the meager gains in labor productivity growth and share in value added between 1987 and 2019. We interpret the hollowing-out of the manufacturing industry in the U.S. as the necessary casualty of the corporate elite’s determination to weaken the power of unions and suppress wage gains. Breaking up the large concentrations of industrial union workers in behemoth corporations and expanding the number of union-free service activities contributed to falling wages and lower wage shares. While falling profitability undermined the postwar structure of capital accumulation, its neoliberal replacement, specifically the

68  Profitability and the limits of Fordism expansion of low-productivity growth services, turned the tendency of ‘secular stagnation’ into a structural manifestation of the system’s blocked dynamics. The breakdown of the capital-labor accord We attribute the breakdown of the capital-labor accord that framed the Golden Age of capitalism between the mid-1940s and mid-1970s to the impact of the longrun decline in profit rates upon nonfinancial capital expenditures, in light of the persistently rising capitalization of production, near full employment policies, and relatively constant profit shares. Postwar strategies to secure high growth rates of accumulation, employment, and wages within the framework of the capital-labor accord involved comparatively large fixed capital investments, rising capital/output ratios, high labor productivity growth, and real wage shares increasing in tandem. After the breakdown of the postwar class compromise, the subpar GDP growth experienced after the early 1980s prompted the Federal Reserve, in 1984, to initiate a long-range monetary policy aiming to lower interest rates for as long as deemed necessary. After deindustrialization had shrunk the nation’s industrial capacity, falling interest rates clinched the neoliberal structure of capital flows privileging financial markets and foreign investment. We specifically argue that, between 1984 and 2000, the expanding opportunities for speculative financial investments, associated with secularly falling interest rates and the geopolitical changes that opened the door to massive offshore investments, undermined the systems’ productivity growth potential. The expansion of the personal services sector caused by the wealth effect derived from financial markets, failed to make up for the decline in labor productivity brought on by weak nonfinancial capital accumulation. Falling interest rates induced intermittent bouts of euphoria and inflated financial assets became the growth attractor that replaced previously highly profitable nonfinancial capital expenditures with financial assets. In the neoliberal phase from the mid-1980s to the present, despite frequent financial crises giving rise to temporary reassessments, financial investments seemed more profitable than the prospects of nonfinancial fixed capital expenditures and, as a result, labor productivity growth declined, paving the way for secular stagnation. Through its cycles of boom and bust, however, the rising trend of financial valuations proved unsustainable whenever it transgressed the profit growth potentials of the real nonfinancial sector. Profitability at the margin Estimating the average profit rate across the capitalist world economy requires reliable data on national capital stocks, whether gross or net, which is not readily available, and not easily estimated. Calculating the ‘incremental’ profit rate, r, involves an alternative procedure that is much easier to perform with the available data in national income accounts, including business gross value added, capital consumption, gross nonresidential investment, and business sector’s employee compensation. The first step consists in the estimation of the ‘net operating surplus’ in the business sector. It involves subtracting capital consumption from gross value

Profitability and the limits of Fordism  69 added to derive net value added; second, subtracting employee compensation from net value added and the equivalent share of self-employed workers. We can define the net operating surplus, Πt, as the profits yielded by past investments, Π*, and the profits derived from the most recent investment, Πt – 1. Thus, Πt = Π* + Πt – 1. Then, if we express Πt – 1 as the product of the profit rate, r, and the most recent investment, we can rewrite it as r × It – 1. From the expression Πt – Πt – 1 = r × It – 1 + (Π× – Πt – 1), we derive the incremental profit rate, r = ΔΠt = r × It – 1, because (Π* − Πt – 1) represents a negligible change. The incremental profit rate reflects the total profit change contributed by new investments (the most recent) to the industry’s total profits as derived from the past accumulation of capital. Figure 3.2 clearly shows that the growth of gross nonresidential fixed capital investment could be anticipated by the fluctuations of the marginal profit rate that preceded it in time after the early 1900s. Accordingly, we have prima facie evidence of the power of profit to shape investment growth, especially after the more accurate data from 1947 to the present are applied. We may also note that the range of these fluctuations, both in profitability and investment growth, shifted down after the early 1980s, precisely when the financial markets grew sufficiently to become the leading sectors of the neoliberal phase. Measuring profitability Figure 3.3 shows the secular trend of the current cost gross average profit rate in support of our view of falling profitability derived from Raymond Goldsmith’s gross fixed capital stocks measures from 1897 to 1949 and spliced to the now defunct gross capital stock time series BEA published from 1929 to 1993, because neoclassical concepts replaced the concept of capital in the National Accounts (Goldsmith, 1956, Tables W1, W3, pp. 14–21). Because the BEA stopped issuing gross capital stock estimates in 1993 and, even though in our view (and that of business accounting), gross capital measures are preferable, for the most part in this book, we present our profitability estimates based on current cost net capital stocks. Because Anwar Shaikh showed in his book on Capitalism the method for calculating gross measures of capital stock by exploiting the BEA Fixed Asset Tables, we now have gross measures of business and corporate fixed assets that reflect the Classical concept of gross capital value, stretching from the late 1940s to the present (Shaikh, 2016, Appendix Tables 6.8.I.1, 6.8.II.3, 6.8.II.5: Measurement of the Business Sector). Classically oriented average profit rates are ratios of net operating surplus over gross capital stock estimates, excluding notional, non-transaction imputations made in the official BEA Fixed Asset Tables. The adjusted net operating surplus divided over Shaikh’s current cost gross capital stock, not the conventional NIPA current cost net capital stock of neoclassical economics, reveals a stronger downward trend throughout the whole postwar period and it reinforces our conviction that from the managerial elites’ perception of systemic crisis, the transition from Fordism to neoliberalism was inevitable. Guided by the notion that profitability is the driving force of capital accumulation, and that capital growth is the central

70  Profitability and the limits of Fordism

20% 18% 16% 14% 12% 10% 8% 6% 4% 2%

19 00 19 03 19 06 19 09 19 12 19 15 19 18 19 21 19 24 19 27 19 30 19 33 19 36 19 39 19 42 19 45 19 48 19 51 19 54 19 57 19 60 19 63 19 66 19 69 19 72 19 75 19 78 19 81 19 84 19 87 19 90 19 93

0%

Figure 3.3  U.S. business sector average profit rate on current cost, gross capital stock 1900– 1993. Authors’ calculations based on NIPA Table 1.9.5. Raymond Goldsmith’s gross capital stock 1900–1947, in Study of Savings in the United States, Volume 3, Table W-3, p. 14, Princeton University Press, 1956, spliced with BEA 1947– 1993 current cost gross Fixed Reproducible Tangible Wealth in the United States, Table 21, Survey of Current Business, 1994, August.

goal of business enterprise, it is understandable that the long-term decline in profitability was the chief motive behind the dismantling of the mixed-economy and the transition from Fordism to neoliberalism. Profitability and the stagflation crisis Structural pressures on profitability derived from the impact of capital-intensive technical change since the late 1960s, undermined the system’s profitability and drove the economy into an intractable ‘stagflation’ crisis, combining rising inflation with growing unemployment. The profits share in net value added reached historic lows as full employment policies strengthened labor’s bargaining position (Glyn and Sutcliffe, 1972). Expansive fiscal policies propped up effective demand but failed to arrest the profit rate’s downward trend, and, instead, bumped against supply limitations manifest as shortages, stoking inflation (oil shortages being the most crucial) to unprecedented levels, and fueling an atmosphere of crisis. In turn, the crisis strengthened the resolve on the part of ruling elites to revamp the dynamics of capital accumulation with a radical transformation of the sectoral structure of production, downsizing manufacturing and expanding services, particularly

Profitability and the limits of Fordism  71 financial. Hollowing out the footprint of real sectors involved in manufacturing and shifting to portfolio investments effectively dismantled the physical foundations underpinning the historic confrontations between labor and capital. The neoliberal configuration that replaced the previous phase of high growth, rising wage shares, and falling profitability sought to reverse the declining path of business profitability but, in hindsight, we can see that it failed. The factors underlying the stagflation crisis of the 1970s are very different from the situation today. They reflected the postwar structure of capital accumulation chiefly characterized by falling profitability from a historically high level and high rates of capital accumulation, high levels of employment, and a strong labor movement capable of bargaining for wages in tandem with the inflation rate. In today’s configuration of low corporate profitability and a labor movement in disarray, the strength to bargain with corporate management to secure wages rising with inflation or keeping up with productivity growth is absent. In our view, the growing disparity between a falling profitability trend and fairly steady accumulation rates throughout the postwar period, especially when the accelerated decline in profit rates from the mid-1960s through the late 1970s laid the ground for the stagflation crisis of the 1970s, doomed the postwar class collaboration between capital and labor, and ended the capital-labor accord. The stagflation crisis of the 1970s unraveled the neo-Keynesian consensus and highlighted the urgency for dismantling the institutions underpinning the ‘mixed economy’ model in favor of neoliberalism. From the neoliberal perspective, the stagflation crisis of the postwar ‘mixed-economy’ demonstrated that the capital-labor accord, so valuable in maintaining profitability and growth in the postwar period, was unsustainable, precisely because in the 1970s it was not designed to contain the irreconcilable claims on income advanced by labor in favor of profits. The crisis brought forth a new corporate, academic, and political climate of opinion stressing the benefits of ‘unleashing’ the market forces inherent in laissez-faire capitalism to secure full employment growth without inflation (Glyn, 2006). To do away with any pretense of class collaboration, advocates of the neoliberal model insisted on its efficiency and fairness as long as competitive markets remained free from government regulations, monopolies, ‘excessive’ labor union claims, and other institutional-wage ‘distortions.’ Figure 3.4 shows the association between the average profit rate in the nonfinancial corporate sector, the ‘retained earnings’/nonfinancial capital stock ratio, and the rate of accumulation in the nonfinancial corporate sector. These three ratios share a common long-run downward trend, but the fluctuations between the corporate ‘retained earnings’ and corporate fixed capital accumulation rate are of especial significance. They show the extent to which corporate savings reflect the profit expectations that will motivate investment and the anticipated corporate budget available in the form of ‘retained earnings’ to carry out the planned investment. Nonfinancial corporations will generally adjust their savings propensity in advance of planned investments to limit their dependence on external credit sources to finance their growth. This savings propensity will vary each year taking

72  Profitability and the limits of Fordism into account the finance required for projected net capital spending in light of the expected profitability in each period and, on average, will cover over 100 percent of the net investment expenditures actually made. Except in the late 1990s, corporate borrowing covered financial investments, not fixed capital accumulation needs.

19%

19% Net operating surplus/Net fixed assets 17%

17% Retained earnings/Net fixed assets

15%

Fixed capital accumulation rate

15%

13%

Linear (Net operating surplus/Net fixed assets)

13%

11%

Linear (Fixed capital accumulation rate)

11%

9%

9%

7%

7%

5%

5%

3%

3%

1%

1%

-1% -1% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 3.4  U.S. nonfinancial corporate average profit rate, retained earnings/current cost net capital stock, and nonfinancial corporate rate of capital accumulation, based on NIPA Table 1.14, Flow of Funds FA105050005.A, and Fixed Assets Table 6.1.

The rising capitalization of production In the 1970s, the actual capital accumulation path only partially reflected the extent of the profitability decline. Profitability provides the upper bound of the accumulation rate, and retained earnings (corporate profits after deducting taxes, dividends, and interest payments) sets the upper limit for the internal financing of capital accumulation. If accumulation exceeds retained earnings and external finance is needed, profit expectations should be high enough to justify the acquisition of new debts. But in the face of falling profitability, only a confident view that current low profitability will revert to the high level of the past could possibly justify a less than proportional decline in capital accumulation: that would explain the relatively high accumulation rates of the 1970s. While rising inflation impacts the system as a whole, the rise in oil prices in the 1970s may have served as a focal point of the stagflation crisis. Throughout the postwar period oil prices remained fairly low and stable. The rise in accumulation and the rising consumption of oil since the 1960s did not have a high impact on oil prices. But such price stability would play a major role in the high profit levels of the postwar years. Steady increases in the consumption of oil, so central

Profitability and the limits of Fordism  73 in industrial technology, would raise pressures on producers to lift prices once the occasion allowed. Capital accumulation rates finally declined when profitability fell further, unemployment increased, and industrial activity slowed down. But the failure of accumulation rates to fully reflect the profitability shortfall led to bottlenecks and shortfalls across the system, including unprecedented oil price hikes. It is important to note that the chief factor persistently weighing down the secular profit rate trend is the ever-rising capitalization of production required to improve competitive results. It is a generally accepted fact in managerial efforts to gain market share that the most mechanized technology will bring about the lowest unit costs and will enable corporate prices to beat competitors in the race for market leadership. This is how corporations grow in size and achieve market supremacy (Buzzell, Gale, and Sultan, 1975). Their great size is not a sign of ‘monopoly’ but proof of successful competitive struggles to dominate markets. Monopolies restrict output and raise prices; large corporations, on the other hand, reach industrial dominance by lowering prices and enlarging output (i.e. Amazon). However, they must remain vigilant, because as capital grows the means to achieve supremacy become increasingly more costly and rivalry persists. But the necessary growth of fixed capital in the form of automated equipment and costly structures finds their match in the great accumulation of financial capital that is ready for lending when prospects are profitable. In short, large capitals must keep growing to remain competitive and viable. While the growth strategy of rising expenditures on fixed capital per unit of output lowers unit costs, securing a competitive edge requires lowering prices sufficiently to knock the rival firms out of the race, and the combination of higher unit fixed costs and falling prices leads to falling profit rates and a larger mass of profits. The aggregate rate of capital accumulation is likely to decline, however, despite the larger share of fixed capital invested by the industry leader due to the ‘creative destruction’ of weaker corporations in the field of competitive battle. Challenging the current interpretation of rising monopoly power due to the rising concentration of corporate industry as a basis for high profitability, Joe Kennedy, a senior fellow at the Information Technology and Innovation Foundation (ITIF) pointed out that the trend-line for domestic, nonfinancial profits is down from the 1950s, and since the 1980s it has fluctuated around 6 percent, falling from the recent peak in 2013. In other words, profits are below the levels when antitrust policy was characterized by more aggressive cases. (Kennedy, 2020) Figure 3.4 shows profitability in the 2000s above the 6 percent level because it is constructed on the basis of the ‘net operating surplus’ of nonfinancial corporations, which is inclusive of taxes, interest payments, and dividends, whereas NIPA corporate profits are calculated after interest payments.

74  Profitability and the limits of Fordism The structure of the argument outlined in this chapter regarding the end of the capitalist-labor accord and the emergence, consolidation, and legacy of neoliberalism shares with Krippner (Krippner, 2005, 2012) that the neoliberal structure, as a new socioeconomic configuration needed to sustain capital accumulation, did not spring fully developed from the minds of its ideological advocates. We argue instead that its adoption depended on the extent to which it proved effective as a means of reversing the falling profitability trend that, since the mid-1960s, laid the grounds for the ‘stagflation’ crisis of the 1970s. The downward trend in profitability experienced through the early 1980s, without attaining a full recovery in the following decades, provides the key to the stagflation crisis. As nonfinancial corporations expanded their own equity buybacks during the neoliberal phase and disbursed larger amounts of dividend payments to their stock holders, the retained share of net operating surplus, out of which net fixed capital investment is normally financed, declined. In the last decade of the 20th century and the first decade of the 21st century, while seeking to avoid falling profit rates in productive sectors, the diversion of capital flows from productive to financial sectors laid the grounds for the emergence of financial fragility and speculative bubbles. Despite the fact that speculative waves in financial markets, decoupled from real capital accumulation, offered a temporary escape from the low profitability of the real economy, they laid the ground for the emergence of bubbles followed by the inevitable crash. In the aftermath, slow recoveries lent support to theories of secular stagnation. In our view, breaking out from secular stagnation will require rising profit rates and a sustainable resurgence of capital accumulation in the real sectors of the economy. Absent this rise in the profitability trend, the current levels are bound to reduce managerial tolerance for potential shortfalls in effective demand and thus foster a restrictive investment outlook. When current low profitability shapes future expectations, heightened fear of financial losses combined with sound management principles and practices exert their influence upon investment strategies. In a system with a long history of declining profitability, prospects of secular stagnation will cloud the outlook for investment possibilities. Corporate management will seek to secure any capital investments from failure, not to recklessly evaluate a reversal of the stagnation trend. In that spirit, small losses will lead to sharp cutbacks in capital expenditures, favoring options minimizing risks of default rather than major gains involving high risks: The alteration of adjustment behavior increases the macro instability of the economy. The link in the chain which relates profitability to stability is therefore paradoxical, since it appears that more efficient individual management is, in fact, detrimental to macro stability. (Dumenil and Levy, 1992, p. 295) As a result, low levels of profitability may give rise to systemic instability and the increasing danger of corporate investment breakdowns. The empirical evidence

Profitability and the limits of Fordism  75 marshalled in a previous study of the role of profitability in the Great Depression of the 1930s shows that: High returns are an inducement to invest, and conversely for low returns. It also conditions the management of firms in relation to their situation of liquidity. Thus, it determines to a large extent the stability of the economic system. (Dumenil, Glick, and Rangel, 1987, p. 336) Profit rates will fall if vigorous investment spending favors capital-intensive technical change that raises capital/output ratios, but the share of profits in new value added remains constant. We argued that when the balance of class power between capital and labor codified in previous agreements interfered with the reversal of profitability trends, pressures mounted to maintain wage growth below productivity growth, and hence such practices nullified previous accords. For the most part, our empirical evidence backing up these conclusions refers to averages regarding profitability, although we disaggregate results in various sectors of the private economy, including the broad business sector of corporate and non-corporate businesses (especially manufacturing), nonfinancial corporate, and financial business sectors. We are mindful of the fact that these averages in business sectors consist of very different enterprises, including marginalized ‘zombies’ (Banerjee and Hofman, 2018). Since the average profit rate reflects the operating conditions across the system of different types of enterprise, the overall trend emerges as a balance of very disparate firms in a variety of industries (Farjoun and Machover, 1983). Technical change and falling output/capital trends We obtained values for the net value added/net capital normalized trends in the business and nonfinancial corporate sectors extending from 1947 to 2019 using Loess filters of the actual net value added/net capital stock data in NIPA and Fixed Assets Tables. Our Loess filters have a .6 bandwidth and include exact evaluation with local weighting and four robustness iterations. Cointegration of net value added and capital stocks in both sectors confirmed that the Loess filter results are equivalent to normalized estimates of the net output/capital long-run trends. Such trends in the business sector and nonfinancial corporate net output/capital trends reflect levels of effective demand consistent with full capacity utilization, defined as Y/Y* = 1, the ratio of actual net output level divided by capacity estimates taken from the cointegration equation. Normalized values of the net output/capital stock ratios coincide with the lowest points in the business firms’ total unit costs schedule and therefore are the gravity centers for competitive war strategies. As Figure 3.5 shows, the long-run normalized trend of the net output/net capital ratio in both the business and nonfinancial corporate sectors steadily declined from the late 1940s to the present. Between 1947 and 2019 the net output/net capital stock

76  Profitability and the limits of Fordism

0.80 Business sector net output/Business net capital stock

0.75 0.70

Business sector y/k Loess trend Nonfinancial corporate net value added/net capital stock Nonfinancial corporate y/k Loess trend

0.65 0.60 0.55 0.50 0.45 0.40 0.35 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 3.5  U.S. net-value-added/current cost net capital stock and Loess trends in the business and nonfinancial corporate sectors, based on NIPA Tables for Net Value Added and Fixed Assets.

trend fell by 33.5 percent in the business sector and 31.5 percent in the nonfinancial corporate sector. Because the nonfinancial corporate sector’s capital intensity per unit of output is higher than in the larger business sector which includes smaller non-corporate businesses, the curves for the actual and normalized values in this sector lie below those in the business sector. In both cases the actual net value/net capital ratio around these falling trends reflects the impact of excess (±) effective demand associated with fiscal deficits, austerity measures, booms, and recessions on capacity utilization (Mattei, 2022). But it is the relentless spread of automation, associated with the growing capital intensity of production in all sectors of the system, that separates transitional deviations from the underlying long-run trend. In the postwar years of the U.S. economy, when adjusted for capacity utilizations, or as a Loess filter of the actual values, a steadily rising capital/output ratio, K/Y, caused the profit rate, Π/K, to decline. The falling rate of profit induced a decline of the capital accumulation rate, I/K, which in turn, lowered the growth rate of labor productivity, Y/L, and dimmed the prospects of finding high profitable investment opportunities. After 1966, the cyclical rise in unemployment intensity, u*, reflected the downward trend of the accumulation rate. But coming off the postwar years of high profitability expectations, the decline in gross business investment failed to recognize the extent of the profitability downturn. From 1960 to 1966 net bank credit growth and large fiscal deficits jointly boosted effective demand beyond the limits afforded by normal levels of wages and profits. In the 1970s, on the other hand, as growing gross investment spending pressed against the structural limits

Profitability and the limits of Fordism  77

1.8

1.6

GDP/Gross Capital Stock, Geary-Khamis $1990, Maddison Data, The World Economy, Vol. 2, Historical StatisticsTable 1b (p.428, p430)OECD 2006

France Japan

Germany UK

1.4

1.2

1.0

0.8

0.6

0.4

0.2 1891 1896 1901 1906 1911 1916 1921 1926 1931 1936 1941 1946 1951 1956 1961 1966 1971 1976 1981 1986 1991

Figure 3.6  France, Germany, Japan, and U.K. GDP/Gross capital stock, 1891–1991.

provided by the system’s falling profitability, decreasing labor productivity growth and widespread resource bottlenecks led to production cutbacks that increased unemployment. Figure 3.5 shows the actual output/capital ratios in the U.S. business and nonfinancial corporate sectors and the respective long-term output/capital trends calculated as Loess filters in both cases. Figure 3.6 displays the declining secular trajectory of the output/capital ratio in four advanced capitalist countries. It is significant that in the more restricted corporate sector, actual ratios and long-run trends are lower than in the more inclusive business sector. As is generally the case, nonfinancial corporations will normally operate with more mechanized, capital-intensive technology than the unincorporated smaller firms generally will. Despite significant medium-term cycles reflecting changes in capacity utilization caused by effective demand fluctuations, both secular trends fell (capital/output increased) from the late 1940s to the present. The evolution of the business sector average profit rate strongly reflected the fluctuations in the net output/net capital stock ratio along with the income shares of employee compensation and the selfemployed which we used to calculate it in that sector. Figure 3.5 also shows the Loess filter of the net output/capital ratio falling from the late 1940s to the present due to the capital-intensive, labor-displacing nature of capitalist technical change. The downward pressure exerted on the profitability trend, despite major cyclical fluctuations of capacity utilization, unraveled the foundations of economic prosperity of the ‘golden’ years of capital accumulation, from 1945 through the late 1970s. From 1947 to 1960, the business sector’s profit rate fell by over 40

78  Profitability and the limits of Fordism percent. After its sharp descent in the 1950s, the spectacular boom of the early 1960s brought about by a major boost in capacity utilization linked to Vietnam War deficit spending, the average profit rate peaked in 1966. After this year, effective demand returned to normal levels, and the boom turned into a bust. Four more years of declining profit rates ended in a trough lower than the cycle’s starting point in 1960. In the 1970s, business profitability failed to reach the levels attained in the 1950s and when that decade ended business profitability reached its lowest trough yet in 1982. Our interpretation of the 1970s stagflation crisis argues that the sharp profitability downturn experienced after 1966 set the stage for the ensuing stagflation crisis, linking high unemployment levels with historically high inflation. While the decline in profitability lowered the extent of profit projections, the unprecedented high profitability trend experienced in the past 15 years of the capital-labor accord weighed heavily on the side of business confidence regarding prospects for high future profit yields to validate equally high levels of investment spending. As a result, while the profit rate remained stuck in a plateau no higher than the lowest level of the late 1950s, the accumulation rate in the 1970s did not show a proportional decline: despite sharp fluctuations, its peaks rose above the 1950s highs. This means that gross investment spending rose faster than gross profits. The 1970s erosion of business profitability required the use of accumulated excess funds from the previous decade to finance relatively high corporate investment levels, and such spending pressing against the structural limitations of capital growth led to widespread bottlenecks of input resources and runaway price inflation of goods and services. After the mid-1960s, the decline in accumulation rates did not fully reflect the extent of falling profitability in the business and corporate sectors. We assume that taking the high profitability levels experienced between 1945 and 1965 as benchmarks for future yield projections, corporate investment planning after 1965 did not immediately adjust to the prevailing lower profit trend experienced throughout the economy. Instead increased corporate borrowing filled the financial gap between retained profits and corporate accumulation, stoking inflationary pressures that for a time appeared to mitigate the accumulation of corporate debt in real terms. Our calculations based on NIPA data for the nonfinancial corporate sector show that although profit rates fell by 50 percent from the mid-1960s to the early 1980s, and corporate retained profits mirrored that decline, the profitability levels in the mid-1960s were so high that their descent did not weaken profit expectations appreciably until the early 1980s, judging by the fact that capital accumulation rates did not fall in tandem with profitability. Behind past and present inflation outbreaks The decline in capacity utilization and effective demand that followed declining public deficits after the Vietnam War ended exacerbated the profitability collapse of the late 1960s. In the 1970s, corporate accumulation rate declined less than the average profit rate because business profit expectations did not fall as much as actual levels of profitability. As public deficits abated, the excess corporate savings

Profitability and the limits of Fordism  79 accumulated during the 1960s above capital expenditures allowed corporations to maintain accumulation rates far in excess of their current capacity to use internal funds. In the 1970s, falling profitability forced corporations to retain lower earnings, but the exceptionally high corporate profitability of the postwar period induced them to maintain high investment levels. The maintenance of investment plans out of line with actual retained profits exceeded the system’s growth capacity and gave rise to bottlenecks that, spreading to all sectors, fueled the surge of ‘stagflation.’ Falling profitability reduced the growth capacity of average firms in the nonfinancial corporate sector as a whole, but rising deficit spending raised the pressure on prices and costs further reducing the profitability of marginal corporate business and forcing them to default. The sustained boom of the postwar economy, however, exhausted the limits of its potential capacity when capital accumulation exceeded the available labor supply. At this point, as the expansion of plant and equipment could not keep up with increasing labor bottlenecks, the growing imbalance between labor supply and demand led to wages rising faster than productivity. Between the mid-1960s and the early 1980s, the long-term decline in profitability experienced in the U.S. economy reduced the potential output growth of the system but net investment spending did not decline in tandem. Capital accumulation rates at the time did not fully reflect the sharp decline in profitability experienced because firms borrowed from outside sources to finance their expansion plans. In our interpretation of Anwar Shaikh’s theory of the inflation outbreak in the U.S. economy between the mid-1960s and the early 1980s, the divergence between the trends of productive capital accumulation and profit rates in that period is of central importance. In the ‘normal’ run of capital accumulation, profit expectations, derived from past profitability trends and current evaluation of competitive pressures from rival firms to increase market shares, contributed to the formation of corporate capital expenditure plans. Depending on the weight attached to the prospective benefits of using corporate profits, the range of options includes disbursement of dividends to shareholders, spending on the renovation of plant and equipment, or diverting funds for equity share buybacks. In the Classical tradition, the expanded reproduction of capital, worked out in detail by Marx in Volume 2 of Capital, exclusively relied on the availability of internal funds and ignored external borrowing as well as speculation in financial markets except in times of crisis. At the start of a new and expanded round of accumulation, capitalists reinvested their previously realized profits in fixed and variable capital, allowing for their own consumption revenues. Normal accumulation could proceed or be extended only when previously retained profits were transformed into new fixed and variable capital investment. The structural link between profitability and capital accumulation provided a gauge of maximum potential growth. Raising the rate of capital accumulation in the face of a falling or stagnant average profit rate would lead to supply bottlenecks in sectors originating in firms with low growth potential due to low profitability and hence rising prices, which in turn increased input costs for others or caused shortages leading to falling production and growing unemployment. Signs of inflation would emerge when investment spending exceeded the supply capacity of low profitability firms or

80  Profitability and the limits of Fordism when broken supply chains were unable to respond to bottlenecks and shortages. In turn, rising input prices caused further deterioration of profitability in marginal firms and led to growing unemployment alongside inflation. A falling potential growth ratio, measuring the diminished degree of flexible supply capacity in response to rising levels of demand or the disappearance of supply links altogether, will lead to mounting price pressures spreading throughout the system’s structure. Once the investment/profits ratio fell as a result of recession or secular stagnation, the inflation pressures abated while the unemployment rate increased. The emergence of inflation signs will normally prompt the Federal Reserve to raise interest rates in order to reduce the excess demand that caused their appearance. The lower the growth potential and the stronger the structural resistance to growth (depending on the percentage of marginal firms standing) the more extensive the emergence of bottlenecks and the higher the interest rates necessary to bring down the inflation rate. Considering the impact of global disruptions to the supply chains of key industries, like food, oil, and gas to the sustainable growth potential of the post–COVID-19 recovery period, raising the federal funds rate to achieve inflation-free growth, while financial markets are in disarray after their decades-long frenzied growth, will likely cause a severe contraction before weakening the inflationary momentum. Figure 3.7 traces a Long Wave starting in the late 1940s and ending in 2020, showing the evolution of the coefficient of potential growth defined as the ratio of gross investment to gross profits and the growth rate of the GDP deflator. Our coefficient estimate measures business nonresidential capital spending over the gross operating surplus of the business sector, showing the impact on inflation of the diminishing slack as the limits of full potential growth are approached (as the accumulation rate approaches the profit rate). In the postwar period, the accumulation 85% 80%

Inflation rate

14% 12%

70%

11%

65%

9%

60%

7%

55%

5%

50%

3%

45%

2%

40%

0%

35% -2% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 3.7  A. Shaikh’s U.S. ‘slack’ coefficient and GDP deflator growth rate.

Inflation Rate

Coefficient of Potential Output

75%

16% Slack coefficient = gross investment /gross operating surplus

Profitability and the limits of Fordism  81 share of the profit rate rose to a peak between the mid-1960s and 1979 and then sharply fell throughout the 1980s, as the growth momentum weakened and profitability recovered from its deepest trough. The rising half of the Long Wave from the early 1960s through the 1980s clearly is evidence of investment buoyancy despite declining profitability. Between 1980 and 1984 the potential growth coefficient declined significantly showing that actual investment sharply declined from its potential limit. We can now appreciate the impact of regime change on the relationship between the investment/profits ‘slack’ coefficient and inflation. With neoliberalism consolidated in the 1990s as investment rose relative to profits during the heyday of global internet connection, the structural resistance to potential growth rose, reaching a peak in the year 2000 but the inflation rate remained subdued. The lower inflation of the 1990s confirmed the nature of the structural changes brought on by neoliberalism firmly entrenched in what Alan Greenspan characterized as the emergence of ‘traumatized workers’ unable to bargain for higher compensation after the downsizing of manufacturing and the loss of union power despite the favorable conjuncture of higher employment levels. In the absence of an industrial base for traditional labor union bargaining, the neoliberal subordination of wages to the preservation of profitability preempted wage growth from contributing to inflation. On the other hand, as the falling investment/profits ‘slack’ coefficient declined because nonfinancial gross investment relative to profits significantly shrunk at the end of the 1990s, the decline in inflation allowed interest rates to fall, thus strengthening the driving force of financial activities. The boom in financial assets, triggered by low interest rates, largely compensated for the collapse of 21st-century nonfinancial capital accumulation and ultimately led to the Great Financial Crisis, which was promptly classified as a ‘black swan’ by the supporters of financialization. 82%

Thruput Ratio

74%

production slack=a measure of structural limits to accumulation Effective federal funds rate

18% 16%

70%

14%

66%

12%

62%

10%

58%

8%

54%

6%

50%

4%

46%

2%

42%

0%

38%

-2%

34% -4% 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 3.8  A. Shaikh’s U.S. ‘slack’ coefficient and the effective federal funds rate.

Federal funds rate

78%

20%

82  Profitability and the limits of Fordism Figure 3.8 actually shows an even better fit between the ‘slack’ coefficient (rising as the coefficient falls) and the federal funds rate than in Figure 3.7 between the slack coefficient and inflation. This is so because in Figure 3.7, the regime change from Fordism to neoliberalism altered the transmission mechanism linking expansion to labor bargaining strength and the degree of inflationary pressures. In the neoliberal period after the mid-1980s, the transmission mechanism was largely absent. Expansions may occur without raising wage rates and causing inflationary pressures. This change however does not invalidate the driving force behind the ‘slack’ coefficient and its gravitational pull on inflation and the consequent adjustments of the federal funds rate. Because the share of real investment in profits declined (profitability being so low), the system’s growth potential was not topped and this justified the Federal Reserve’s steady reduction of interest rates, which in turn energized financial markets. In this situation, secular stagnation in the real sectors coexisted with vigorous growth in financial markets because it guaranteed the permanence of low interest rates (zero bound being the limit) and future capital gains not based on currently low profitability levels. Contrasting interpretations of the 1970s crisis Well before the stagflation crisis unraveled the Golden Age of capitalism, Keynesian and Marxian predictions of its demise shared a common argument. Both saw gross profits increasing faster than new investment outlets could be found and therefore, as Gillman saw it, capitalism was “too productive for its own continuing health” (Gillman, 1958, p. 126). While in 1958 Gillman rejected Hansen’s Keynesian concept of secular stagnation because it failed to adequately describe capitalism’s long-run prospects, he reluctantly adopted Hansen’s thesis in his Prosperity in Crisis (1965), including the leading role of monopolies in bringing about its breakdown. In our view, Hansen’s argument of secular stagnation due to declining relative prices of capital goods, falling population growth, and the “development of imperfect competition, monopoly, and oligopoly” did not grasp the structural foundations of secular stagnation (Hansen, 1954, p. 409). Despite their neglect in neoclassical economics, the significance of profits as the central stimulus to capital accumulation is emphasized, to their credit, in the Blanchard, O. and Johnson, D. textbook Macroeconomics, 6th Edition, Pearson, 2013, pp. 348–351. In their textbook, Figure 16-3 p. 349, these writers showed the close relationship between profits and capital accumulation. For their part, Nell, Glyn, and Sutcliffe (1972) also identified profitability as the central driver of accumulation. In Capitalism in Crisis (1972), they identified the crisis of capitalism with the ‘profit squeeze’ that powerful unions carried out when they succeeded in raising wages faster than prices in the 1970s because strong international competition from Germany and Japan prevented employers from raising prices sufficiently to compensate for the wage growth. The structural changes that transformed the laissez-faire economy of the 1920s into a Keynesian welfare state appeared to possess sufficiently strong resilience to qualify as the foundation

Profitability and the limits of Fordism  83 of a qualitatively different economic system. The old capitalist system no longer existed; a new socio-economic formation was here to stay. They found that belief in managing the ‘mixed economy’ and avoiding crisis was accepted during the Golden Age, whereas “The persistence of stagnation” belied the proposition. In their view, the ‘stalemate between the classes’ led to the stagnation of the 1970s as “Employers, faced by a working class enormously strengthened by the boom” were unable to maintain the profitability achieved in the postwar period (Armstrong, Glyn, and Harrison, 1984, p. 453). According to Bowles, Gordon, and Weisskopf (1990), the central cause of the labor productivity slowdown was the achievement of near full stable employment that laid the ground for workers’ slowing pace and the associated decline in labor productivity growth. Heightened demands of “the domestic working class, the domestic citizenry, and foreign suppliers and buyers” inevitably led to a falling business average profit rate and the stagflation crisis. The emphasis placed by Bowles, Gordon, and Weisskopf on workers’ slacking job performance might be considered valid in the context of the technological change that preceded the stagflation crisis of the 1970s, for as Hobsbawm noted, “The major characteristic of the Golden Age was that it needed constant and heavy investment and, increasingly, that it did not need people, except as consumers” (Hobsbawm, 1996, p. 266). Gamble and Walton (1976), on the other hand, attributed the resulting inflation not to wages rising faster than productivity but to the growth of money and credit required to finance state expenditures sufficiently high to sustain profitable demand for private industry and hence to maintain a semblance of prosperity. Fourastie failed to understand why the golden economy in France and elsewhere broke down in the mid-1970s because he saw technological change as the development engine but ignored the driving power of profits to keep it going. From the mid-1970s on, the high accumulation path previously achieved within the framework of the ‘capital-labor accord’ drastically collapsed: the U.S. manufacturing sector was steadily ‘downsized’ (Glyn and Sutcliffe, 1972; Gamble and Walton, 1976; Bluestone and Harrison, 1982; Armstrong, Glyn, and Harrison, 1984; Harriston and Bluestone, 1988; Bowles, Gordon, and Weisskopf, 1990; Harrison, 1997; Baumol, Blinder, and Wolff, 2003), and the industrial labor unions weakened or disassembled. Employment in the services sector made up of smaller and more financially strapped firms replaced the stable and rewarding manufacturing jobs of the postwar years. After 1980, profitability on net capital stock meandered around a much lower trend and at no point reverted to the high levels of the pre-1970s. International competition and falling profitability Measuring profitability on gross capital stock, the falling trend stretched to 2020. Since the 1980s, secular stagnation and falling real capital accumulation proved to be a drag on the real economy, while financial markets experienced successive cycles of boom-and-bust asset prices. The labor share of the majority of workers declined for the next 40 years. The falling share of manufacturing net value added and profits stood out in contrast with the rising weight of financial businesses. In

84  Profitability and the limits of Fordism the 21st century, the financial sector replaced manufacturing as the leading sector from the standpoint of corporate profits and employee compensation shares. Why then did manufacturing cease to be the “critical component of U.S. industry”? (Averitt, 1968, p. 3). In this book, we identified the rising capitalization of industrial production as the chief cause of the profitability crisis that buffeted manufacturing in the advanced capitalist countries since the 1970s. But this transformation took place throughout the economic system, not just in manufacturing sectors. Robert Brenner (1998, 2002), on the other hand, picked up the argument initially used by Glyn and Sutcliffe in 1972 to interpret the profitability crisis applying Adam Smith’s theory of how competitive pressures pushed down prices until profit rates settled at their lowest level. For Brenner, the domestic success in postwar manufacturing floundered once foreign competitors took advantage of their lower unit costs to undermine the U.S. market share. According to Brenner, the decline of U.S. supremacy in manufacturing industries was due to the ability of German, Japanese, and other foreign companies to undersell U.S. domestic producers due to their deployment of newer technology and lower labor costs. Brenner argued that the new technology, built after World War II ended, allowed foreign producers a significant cost advantage over U.S. companies saddled with older plants. Lower foreign wages clinched their successful penetration of U.S. markets. Because international trade is predominantly based on manufacturing goods, it was the core U.S. domestic industries that suffered the brunt of the competitive assault: they could not match the lower prices of foreign companies, but could not easily exit their markets due to the massive fixed capital sunk and not yet depreciated. The linchpin of Brenner’s theory of the crisis is also its weakest link, for Brenner went on to argue how after manufacturing lost market share for not being able to match its competitors’ prices, its contraction dragged the rest of the economy down. Brenner’s argument posits foreign competition and trade impinging mainly on manufactured goods, but in addition, he insists that non-tradable goods and services also suffered because the retrenchment in manufacturing markets lowered effective demand in the rest of the economy: lower sales reduced demand for non-tradable goods as well. But Brenner’s argument that the lower prices of foreign competitors took market share from domestic manufacturing corporations and, therefore, reduced the manufacturing profit rate cannot explain why the non-manufacturing profit rates also declined. It is clear that lower manufacturing prices would reduce the input costs of all non-manufacturing activities and, ceteris paribus, would raise, rather than lower, the profit rates of non-manufacturing activities. The historical limits of Fordism Fordism gained its support in the world following the Great Depression, the conclusion of World War II, and the start of the Cold War. We identified the stagflation crisis of the 1970s, the joint appearance of falling profitability, higher unemployment, and rising inflation as the catalyst that made Fordism unviable.

Profitability and the limits of Fordism  85 The stagflation crisis provided the plausible rationale for powerful elites to abandon Fordism, as a relic of the postwar mixed economy, opting instead in favor of the neoliberal configuration of capital accumulation. The 1970s stagflation crisis set the historical limits of Fordism and opened the path to neoliberalism. Fifty-odd years later, as COVID-19 shook its foundations and tested its resilience, will the second historical stagflation allow it to survive without a major overhaul? In the war economy of the post-depression period, the early price and wage controls, associated with the economic restructuring of the U.S. economy to accommodate the needs of the war effort, were indispensable to jumpstart the postwar growth engine, and avoid inflation. We have no doubt that in their absence, maintaining price stability for an extended period, while applying Keynesian policies to boost employment, would have eroded profitability earlier than was the case in the 1960s. Without price controls during the war, the deterioration of profitability would have precipitated an earlier collapse of capital accumulation, hence shortening the Golden Age character of postwar capitalism. Emerging from the 1930s depression with a low wage share and high profits, in order to prevent Keynesian policies to maintain the full employment of labor and capacity utilization from reversing relative profit-wage shares, or unleashing inflation, price and wage controls played an essential role. As a result, the expansive fiscal policies that such controls allowed contributed to delivering the high profit and accumulation rates of the next three decades underpinning the Golden Age of American Capitalism. Following the “great industrial strike wave” that preceded the Fordist phase of capital accumulation, improved capital-labor relations in 1945–1948 (Levy, 2021, p. 464) provided the institutional support that sustained the historically high profitability levels enjoyed by U.S. manufacturing industries in the postwar years. The post-depression emergence of high manufacturing profits allowed establishment elites and their top corporate management to accept a ‘capital-labor accord’ that delivered high employment levels, rapid technological change, and agreed-upon rules of conduct for labor unions and management. The accord secured the stable environment required for the planning of long-term corporate investments while safeguarding managerial prerogatives over investment decisions and the allocation of corporate funds. The high employment levels facilitated in the accord enabled unions to conclude wage contracts stipulating increases more or less in tandem with productivity growth (Marglin and Schor, 2007). In addition, the ‘capital labor accord’ contributed to the transformation of large manufacturing corporations into global ‘behemoths’ operating in all major industrial sectors while strengthening the role of labor unions as corporate partners in the competitive race to dominate world markets. After 1945 these comprehensive reforms jointly configured the social structure of capital accumulation that for 30 years delivered unprecedented high corporate profit rates, a historically strong rate of labor productivity growth, and steadily rising wages, hence a fairly stable distribution of income. In order to maintain full or near full employment, expected profitability needs to be high enough to bring about sufficient capacity expansion to absorb the labor displaced by technical progress. The growing capital intensity of technical progress, however, involving a higher

86  Profitability and the limits of Fordism fixed capital investment per unit of output exerts a downward pressure on profitability that cannot be reversed unless the wage share falls. Throughout the 70-odd years covered by our time series for profit rate and capital accumulation in the nonfinancial corporate sector of the U.S. economy, including the ‘glorious’ 30 years extending from 1945 to the stagflation of the 1970s as well as the neoliberal phase from the early 1980s to 2019, profitability trends preceded those of capital accumulation. Between the late 1940s and the mid-1960s profitability was exceptionally high and investment spending equally strong; the New Industrial State appeared to render moot Hansen’s fears of postwar secular stagnation. The lower level of profitability that characterized the neoliberal phase following the recession of the early 1980s, however, accentuated the long-run falling trend of capital accumulation in the nonfinancial sectors of the system. According to our estimates of profitability on current cost net capital stock in the nonfinancial corporate sector, the average profit rate between 1947 and 1979, 32 years, was 11.45 percent. The average between 1979 and 2019, 40 years, was 8.67 percent, a decline of 24.26 percent. The accumulation trend followed a similar cyclical path with a steeper downward trend: the average accumulation rate between 1947 and 1979 was 3.31 percent, and between 1979 and 2019, 2.39 percent, a significant reduction of 27.81 percent. We contend that the decline in both average profitability and capital accumulation throughout the entire 70-odd years, reflect the longterm system’s evolution, and that the dismantling of the capital-labor accord and its replacement with the neoliberal order was necessary for the system’s continuing viability. In his lucid delineation of the unfolding phases of U.S. capitalism, historian Jonathan Levy interprets the outlook of corporate management in the 1950s and 1960s as not being the product of an “overriding short-term profit motive,” and is fully aware that “capitalists as a group tend to earn more when they are willing to spend more” and, therefore, is enthusiastically opened to the idea that “the high rate of investment on behalf of a commitment to production, rather than profit, paradoxically resulted in high profits” (Levy, 2021, p. 525). Levy insists throughout his book that “the profit motive [is] key but not enough” (ibid., pp. xviii–xix) because the subjective judgments of key players must be considered as a material force. In support of his contention, Levy reminds us of the widespread presence of self-serving delusions found among exalted business leaders, such as Lloyd Blankfein, Goldman Sachs CEO, who in the midst of the 2007–2009 Great Recession declared that his bank was engaged in “doing God’s work.” While Levy thought Blankfein “likely believed it,” in his judgment, it was a case of “selfdeception.” But these rhetorical displays of theological wisdom do not dictate corporate policy. In our view, a deeper understanding of the perspective shared by all Classical economists, from Adam Smith to Thomas Malthus, David Ricardo, and Karl Marx would enhance Levy’s framework as a historian, providing the conceptual structure of the system’s dynamics. For, the primacy of profits under capitalism does not depend on the attitudes or beliefs of capitalists but rather on the allocation of

Profitability and the limits of Fordism  87 profits, as drivers of the system’s extended reproduction. In Classical economics, the profit rate at a given time, πt, represents the excess (surplus) capital value, svt, accrued after the circuit of capital is completed with the sale of the product, in relation to the capital value advanced, kt-1, when the circuit of capital started, πt = svt/kt-1. Therefore, the profit rate sets the potential limit of the rate of capital accumulation when the next round of the capital circuit starts all over again, a*kt = It/kt-1 = πt-1. In his deeply perceptive analysis of the capitalist system, The Nature and Logic of Capitalism, Robert Heilbroner expressed most forcefully the connection between profits and capital accumulation at the deepest level the logic of capitalism must also express the imperatives of accumulation. The fundamental force that drives the system through history is the search for profit—a search on whose outcome hinges on the historical fate of the social formation as a whole. This relentless and insatiable process…therefore, sets into motion the central tendencies of the system. (Heilbroner, 1986a, p. 142) In the postwar period, capital-intensive technical change satisfied corporate needs for high rates of labor productivity growth, and union contracts delivered parallel wage rises that contributed to confirming the soundness of the accord for capital and labor. High rates of profit at levels never-to-be-reached again in the next 80 years confirmed the corporate advantage of this class partnership as the foundation of postwar prosperity and as a model of desirable class collaboration. Historian Joshua Freeman concluded that the postwar institutional partnership of capital and labor “From the early 1940s through the 1960s it became common among political intellectuals and academics especially in the United States to argue that the United States…represented a universal phase of historical development, the actual successor to capitalism” (Freeman, 2018, p. 226). For as long as the capital-labor accord lasted the working class’ standard of living improved significantly “including pensions, unemployment insurance, disability insurance and health insurance” (ibid., p. 235). Indeed, for three decades after World War II high profit rates and substantial fiscal deficits associated with military spending sustained high levels of investment and effective demand, leading to high labor productivity, wages, and employment growth rates. Under this façade of shared prosperity and high growth rates, however, the system’s profitability trend steadily declined from its postwar lofty heights, while the actual profit rate exhibited sharp fluctuations, plunging from the mid-1960s before reaching its trough in the early 1980s. After the mid1960s, the record of plunging profit rates presaged the unraveling of capital accumulation and the necessity of radical structural change (Gillman, 1965). Starting in the 1970s, the rise in unemployment along with inflation rates wiped out the positive features associated with the welfare state so fondly remembered by Keynesians as the Golden Age of Capitalism (Marglin and Schor, 2007). Increasingly so after the mid-1960s, the very same features of the guided economy,

88  Profitability and the limits of Fordism previously hailed as delivering prosperity for three decades, were increasingly blamed for destroying ‘competitiveness’ and needing repairs if not elimination. Public deficits Beginning in the mid-1960s, the economic scaffold underpinning the expectations of the postwar regime began to buckle under the weight of large fiscal deficits that did not prevent the decline of manufacturing profitability. On the contrary, as the powerful assault of German and Japanese manufacturing goods wreaked havoc on the U.S. economy, foreign competitors in key manufacturing sectors gained market share and challenged the hegemony of domestic producers with low prices and good-quality products signaling the end of an era. But we will show that foreign competition was not the cause of falling average profit rates across all sectors. After 1947, the long-term trend in manufacturing and non-manufacturing profitability, corporate and non-corporate sectors not only declined, but it did so along a path very similar to that of its chief competitors, Germany and Japan. Despite the fact that measuring government deficits as a share of GDP tends to underestimate their magnitude (because GDP rises as the deficit increases, the denominator in this ratio rises with the numerator) government deficits increased in the 1970s and were enlarged in the 1980s. The share of government deficits in GDP rose from a near-zero trend throughout the postwar period ending in 1969 to 6 percent in 1975; and while the fiscal deficit diminished to less than 2 percent in 1979, it remained stubbornly high during the 1980s, reaching nearly 6 percent in 1983 and 1992. After reaching such high levels in the 1980s, U.S. deficits experienced a remarkable reversal in the remaining decade of the 1990s, resuming their expansion in the first decade of the 21st century and reaching over 10 percent of GDP in 2009. Despite the major fiscal boost applied in the 1980s, the average real GDP growth rate in that decade was lower than in the 1970s. The Keynesian compromise intended to deliver full or nearly full employment, a stable accumulation of capital, and low inflation could not survive the mounting pressures that led to the intractable stagflation crisis. Sustaining high employment levels strengthened the bargaining position of labor and set the grounds for wages to rise. Under the Keynesian compromise, to maintain full or near full employment raising labor productivity at least in tandem with wages was the only way to prevent the profit rate from falling. But, steadily rising labor productivity, ceteris paribus, is contingent upon an equally rising capital per worker strategy. If the share of profits remains constant because wages rise in tandem with labor productivity and the innovators’ capital/output ratio rises, the profit rate in the industry will decline. In turn, since profit expectations crucially depend on current and past experience, falling average profit rates undermine the incentive to invest. In turn, lower investment spending will fail to raise labor productivity sufficiently to match wages growth, thus leading to a further decline in profit shares again unless wages correspondingly decline. In the absence of price and wage controls to ensure the maintenance of profitability, if the investment spending level necessary to achieve the corresponding labor productivity growth compatible with the expected wage

Profitability and the limits of Fordism  89 increases failed to materialize, the mounting pressures would lead to a falling accumulation rate, lowering either the employment level or wage growth. How, then, can we explain the remarkable resilience of the accumulation rate in the 1970s, the period of so-called ‘regulated capitalism,’ despite lower profitability? Such fiscal stimuli, as well as other neoliberal policies, failed to have a significant effect on average real GDP growth rates. The deficit reversal of the 1990s produced an average real GDP growth rate of 3.23 percent, slightly higher than the high-deficit decade of the 1980s at 3.15 percent although no higher than the average growth rate of the 1970s. Fiscal stimuli in the neoliberal phase failed to provide the boost necessary to match the postwar growth experience of the Golden Age. Because capital’s growth hinges on the redeployment of profits across all sectors of the system in the pursuit of the highest possible yield, we have argued that a long-run falling profitability trend shattered the hegemony of the manufacturing sector in the overall economy, and its intractable nature led to a radical overhaul of the system’s capital flows. The changes that followed reflected the new channels of sectoral capital flows seeking to place the system’s expanded reproduction on a more consistent path of profit growth. Given the specific framework of the capitallabor accord, the falling profitability trend blocked the continuation of the historic partnership designed to achieve inclusive participation of capital and labor. The agreement to promote wages in tandem with productivity growth ended. Because the depth and scale of the necessary profitability reversal depended on the strength of the forces that undermined it in the postwar period, the emerging neoliberal regime dismantled the structural components of the capital-labor accord, including support for manufacturing industry, and related unions, to lay the grounds for financialization and a new accumulation path. The singularity of the postwar ‘Golden Age’ There is a general sense pervading critical accounts of capitalism’s golden years, the so-called ‘thirty glorious’ years from 1945 to 1975 (Fourastie, 1979, 1963) that the social and political compromises underpinning its stellar economic performance could not be replicated in today’s world. Some unique characteristics of that period could not be replicated today. In addition to the removal of the price and wage controls scaffold that sustained postwar high profits, the geopolitical environment included the symbolic descent of an ‘iron curtain’ separating Eastern Europe from the West and the outbreak of a global Cold War pitting two mutually hostile socioeconomic camps: western capitalism versus eastern state socialism. The Golden Age of capitalism emerged after the economic controls associated with the war’s economic planning overcame the social and economic ravages of the 1930s Great Depression and victory over the Axis powers provided the political framework to consolidate a new social structure of capital accumulation based on a class compromise between capital and labor. Historian Eric Hobsbawm reminded his readers that in the ‘golden years’ previously accepted terms among western allies to describe their economic systems were systematically shunned to comply with the Cold War’s ideological exigencies: “the word ‘capitalism,’ like

90  Profitability and the limits of Fordism ‘imperialism’ was avoided in public discourse, since it had negative associations in the public mind. Not until the 1970s do we find politicians and publicists proudly declaring themselves ‘capitalist’” (Hobsbawm, 1996, p. 273). In addition to major changes in the state management of economic policy, the capital-labor accord preserved the welfare programs enacted in the New Deal supporting the unemployed, the elderly, and the disfranchised. Building on the national mobilization of resources necessary to fight the war against Nazi Germany and imperial Japan, moreover, enabled corporate acceptance of significant government regulation of industrial relations laying the ground for a wide political and economic accord between capital and labor. In the wake of the 1930s Depression and World War II mobilization of national resources, the Cold War confrontation between the east and west adversary camps cleared the way for the capital-labor accord that strengthened national resolve to surmount the prevailing geopolitical challenges. A paramount concern of the national consensus centered on the need to promote high rates of economic growth to match the adversary’s claims of crisis-free development plans. Such performance required high levels of private fixed nonresidential investment endogenously financed with steady high flows of corporate retained earnings, aided if necessary by expansionary fiscal and monetary policies. High profitability levels sustained the new configuration for more than two decades but trended lower and after the mid-1960s the Keynesian project unraveled. In order to maintain the social support required to overcome the ideological challenge mounted by Soviet consolidation of its centrally planned economy, a reversal of the 1920s laissez-faire corporate consensus preceded the implementation of the new capital-labor accord. As Pivetti observed, The conditions of ‘challenged’ capitalism of the first 30 years following the Second World War constitute, in my view, the most significant example we have of the type of absolutely exceptional conditions that are required for a situation of relative prosperity of the working class to persist. (Pivetti, 2015, p. 152) Pivetti felt compelled to reach this conclusion because only under those historical conditions would the management of “advanced capitalism” feel the need “to prove itself capable of overcoming its chief historical shortcomings—unemployment, enormous disparities in the distribution of wealth and income, widespread poverty” (ibid., p. 151). As far back as 1932, Keynes had proposed “a new conception of the possible functions of government…It is called planning-state planning; something for which we had no accustomed English word even five years ago” (Keynes, 2010, p. 75). The unmistakable Keynesian nature of the accord relied on high rates of capital accumulation to promote employment, wages growth, and consumption in tandem with productivity growth. and in the late 1940s historians like E. H. Carr noted “The economic impact of the Soviet Union on the rest of the world may

Profitability and the limits of Fordism  91 be summed up in the single word ‘planning’” (Carr, 1947, p. 20). Historian Eric Hobsbawm reminded his readers in the late 1990s that Averrel Harriman, generally recognized as an outstanding U.S. diplomat and political figure in the 20th century acknowledged in 1946 that “People in this country are no longer scared of such words as ‘planning’…people have accepted the fact that government has got to plan as well as individuals in this country” (Hobsbawm, 1996, p. 273). It would follow from our contention that the Cold War geopolitical environment was decisive in the motivation to frame the spirit of collaboration around the capital-labor accord that the disappearance of the global adversary would have a major impact on the critical appraisal of western capitalist economies and would, therefore, further require the abolition of any vestiges of the capital-labor accord. In this connection, in a section entitled “Capitalism Triumphant” (Krugman, 2009, p. 14), Krugman’s review of the unresolved problems in capitalism after the disappearance of the socialist adversary in the early 1990s lent credence to Pivetti’s observations. With regard to contemporary capitalism, Krugman could find no major blemishes undermining the system’s stability. Despite the book’s title, Krugman found no structural challenges rising to the category of Pivetti’s ‘shortcomings,’ but instead noted a few ‘unpleasant aspects’ of the “market system–inequality, unemployment, injustice—are accepted as facts of life…capitalism is secure…because nobody has a plausible alternative.” The sharp downgrade from ‘shortcoming’ to ‘unpleasant aspect’ in a mere ten years after the official ending of the Great Recession, led Stiglitz to express some concern that absent the geopolitical competition of the past and the disappearance of the capital-labor accord, economists like Krugman lacked the incentive to appreciate the significance of the growing inequality that followed, When the U.S. was competing with Communism for the hearts and minds of those around the world, we had to show that our economic system delivered for all. After the collapse of the Soviet Union, it seemed that there was no competition, and the system lost its incentive to deliver for everyone (Stiglitz, 2019, p. 28) In the Golden Age of capitalism the effective management of geopolitical pressures clearly required a more inclusive cooperation between capital and labor involving the stability of aggregate wage and profit shares. The liberal historian Gary Gerstle recently proposed as a working hypothesis of the motives for the radical dissolution of the postwar socioeconomic class compromise that, the threat of communism…inclined capitalist elites to compromise so as to avert the worst…The dismantling of the welfare state and the labor movement…marched in tandem with communism’s collapse…The very real communist threat in the period from the 1930s to the 1960s facilitated the class compromise between capital and labor that sustained the New Deal order. The disappearance of that threat between 1989 and 1991 facilitated the scuttling of that compromise and the triumph of the neoliberal order. (Gerstle, 2022, p. 12)

92  Profitability and the limits of Fordism The accord acknowledged the need for high corporate investment levels and high labor productivity growth; wages rising roughly in tandem with labor productivity; the state supporting policies aiming to maintain full employment and accepting a more decisive role for labor unions than the laissez-faire consensus of the 1920s allowed, including the acceptance of collective bargaining. The emergence of ‘zombies’ The secularly falling rate of profit, more explicit when derived on current cost gross capital than on current cost net capital stock, underpinned the structural changes that allowed innovating corporations to achieve the highest market share in their industry or sector, while relegating the rest of the firms to a precarious condition, as the victims of competitive ‘creative destruction.’ Cutting-edge innovators possessed of the technical and financial wherewithal gained market share after successful efforts to automate their business activities, raising labor productivity, lowering total unit costs, and underselling their competitors (actual and potential rivals). Winning the competitive war allowed the ‘superstars’ to climb to the top as they enlarged their market share, even if their victory required accepting higher unit fixed costs and lower (but more secured) profit rates. Their loss is merely the price of victory. Accruing a lower profit rate is preferable to the alternative fate of the industry’s losers, the so-called ‘zombie’ companies. Instead of exiting the industry after losing solvency status, increasing numbers of so-called ‘zombie’ companies remain in business as profitless enterprises, unviable if not sustained by central bank’s policy of cheap credit aided by indulging ‘investors.’ After 2016, the business euphoria caused by tax cuts and deregulation dissipated well before the pandemic magnified the plight of over 20 percent of profitless ‘zombie’ companies in the nonfinancial corporate sector. These companies remain actively piling up ever increasing levels of debt: nonfinancial corporate debt rose from about $10 trillion in early 2020 to reach 47 percent of U.S. GDP (Armstrong, 2020). Since 2013, the growth of ‘zombie’ companies accelerated: Nonfinancial business debt grew in the first quarter (2020) by almost 19 percent, the biggest percentage jump in at least 40 years. Businesses took on more than $3 trillion in new debt in the first three months of 2020, almost 10 times as much as in the previous three months. (Lynch, 2020) It is significant from the standpoint of Classical economics that the number of ‘zombie’ companies increased, as average profit rates reached new lower levels, increasing exponentially in the aftermath of the Financial Crisis of the COVID-19 pandemic when one in about five public corporate businesses reached that status. Despite the extended decline in the average profit rate that decimated the ranks of marginal nonfinancial corporations, starting in the early 1990s, the open-ended policy of providing low-interest credit to insolvent businesses maintained by the

Profitability and the limits of Fordism  93 Federal Reserve enabled a growing number of unprofitable enterprises to survive while accumulating debt. Under neoliberalism, the impact of Schumpeterian ‘creative destruction,’ wreaked by the juggernaut of capital-intensive innovations, on marginal firms led to the proliferation of bankrupt businesses that remained active so long as the Federal Reserve policy of low interest rates enabled them to stretch their credit debts. Since the pandemic broke out about 200 corporations, many of which were once considered “America’s corporate titans,” joined the ‘zombie’ ranks and raised their debt level to nearly $1.4 trillion dwarfing the mere $500 billion accumulated at the peak of the Great Financial Crisis (Aguila and Graña, 2022; Lee and Contiliano, 2020). As a result of these practices, the Wall Street Journal carried a critical assessment that reflects the conservative view: “Our growing intolerance for economic risk and loss is undermining the natural resilience of capitalism and now threatens its own survival,” and, consequently, “Today an astonishing number of the survivors are, quite literally, creatures of credit…and by the eve of the pandemic, accounted for 19% of U.S.-listed companies” (Sharma, 2020). It is now clear that a growing number of companies “will have to divert even more cash to repaying these obligations at the same time that their profits sink” (Seligson, 2020). References Aguila, N. and Graña, J. 2022. “Not All Zombies Are Created Equal. A Marxist-Minskyan Taxonomy of Firms: U.S. 1950–2019,” International Review of Applied Economics, https://doi​.org​/10​.1080​/02692171​.2022​.2045911, 3/7/22. Armstrong, P., Glyn, A. and Harrison, J. 1984. Capitalism Since World War II, Fontana. Armstrong, R. 2020. “Companies Are Dangerously Drunk on Debt,” Financial Times, May 6. https://www​.isabelnet​.com​/share​-of​-u​-s​-zombie​-companies/. Averitt, R., 1968. The Dual Economy, W.W. Norton. Banerjee, R. and Hofmann, B. 2018. “The Rise of Zombie Firms: Causes and Consequences,” BIS Quarterly Review, September. Bartel, F. 2022. The Triumph of Broken Promises. The End of the Cold War and the Rise of Neoliberalism, Harvard University Press. Baumol, W., Blinder, A. and Wolff, E. 2003. Downsizing in America, Russel Sage Foundation. Blanchard, O. and Johnson D. R. 2013. Macroeconomics, 6th edition, Pearson. Bluestone, B. and Harrison, B. 1982. The Deindustrialization of America, Basic Books. Bowles, S., Gordon, D., Weisskopf, T. 1990. After the Waste Land, M.E. Sharpe. Brenner, R. 1998. The Economics of Global Turbulence. A Special Report on the World Economy, 1950–1998, New Left Review. Brenner, R. 2002. The Boom and the Bubble, Verso. Bronfenbrenner, M. 1971. Income Distribution Theory, Aldine-Atherton. Buzzell, R., Gale, B. and Sultan, R. 1975. “Market Share: A Key to Profitability,” Harvard Business Review, January. Carr, E. H. 1947. The Soviet Impact on the Western World, The Macmillan Company. Dumenil, G. and D. Levy. 1992. “Profitability and Stability,” Profits, Deficits and Instability, edited by D. Papadimitriou, Chapter 15, St. Martin’s Press.

94  Profitability and the limits of Fordism Dumenil, G., Glick, M. and Rangel, J. 1987. “The Rate of Profit in the United States,” Cambridge Journal of Economics, Oxford University Press, Volume 11, No. 4, December. Farjoun, E. and Machover, M. 1983. Laws of Chaos, Verso. Fourastie, J. 1963. Le Grand Espoir du XX Siecle, Editions Gallimard. Fourastie, J. 1979. Les Trente Glorieuses, Librairie Artheme Fayard. Freeman, J. 2018. Behemoth: A History of the Factory and the Making of the Modern World, W.W. Norton. Gamble, A. and Walton, P. 1976. Capitalism in Crisis: Inflation and the State, Humanities Press. Gerstle, G. 2022. The Rise and Fall of the Neoliberal Order, Oxford University Press. Gillman, J. 1958. The Falling Rate of Profit, Cameron Associates. Gillman, J. 1965. Prosperity in Crisis, Marzani & Munsell. Glyn, A. 2006. Capitalism Unleashed, Oxford University Press. Glyn, A. and Sutcliffe, B. 1972. Capitalism in Crisis, Pantheon Books. Goldsmith, R. 1956. A Study of Saving in the United States, Volume III, Princeton University Press. Hansen, A. 1954. “Growth or Stagnation of the American Economy,” The Review of Economics and Statistics, Volume 36, No. 4. Harrison, B. 1997. Lean & Mean, The Guilford Press. Harriston, B. and Bluestone, B. 1988. The Great U-Turn, Basic Books. Heilbroner, R. 1986. The Nature and Logic of Capitalism, W. W. Norton. Hobsbawm, E. 1996. The Age of Extremes, Vintage Books. Howard, M. C. and King, J. E. 2008. The Rise of Neoliberalism in Advanced Capitalist Economies: A Materialist Analysis, Palgrave Macmillan. Kennedy, J. 2020. “Concentration is Not Producing Higher Profits or Markups,” Information Technology and Innovation Foundation (ITIF), November 22, 2020. https://itif​.org​/ publications. Keynes, J. M. 2010. Essays in Persuasion, Palgrave Macmillan. Klein, L. R. and Kosobud, R. F. 1961. “Some Econometrics of Growth: Great Ratios of Economics,” The Quarterly Journal of Economics, Volume 75, No. 2. Krippner, G. 2005. “The Financialization of the American Economy,” Socio-Economic Review, 3, 173–208. Krippner, G. 2012. Capitalizing on Crisis, Harvard University Press. Krugman, P. 2009. The Return of Depression Economics and the Crisis of 2008, Norton. Lee, L. and Contiliano, T. 2020. “America’s Zombie Companies Have Racked Up $1.4 Trillion of Debt,” Bloomberg, November 17. Levy, J. 2021. Ages of American Capitalism, Random House. Lynch, D. 2020. “Troubling Rise in Number of U.S. Companies that Can’t Make Enough Profit,” Washington Post, June 13. Mattei, C. 2022. The Capital Order. How Economists Invented Austerity and Paved the Way to Fascism, The University of Chicago Press. Marglin, S. and Schor, J. 2007. The Golden Age of Capitalism, Clarendon Press. Pivetti, M. 2015. “Marx and the Development of Critical Political Economy,” Review of Political Economy, Volume 27, No. 2. Seligson, P. 2020. “Corporate America is Choking on Debt and Imperiling the Recovery,” Bloomberg​.com​, August 21. Shaikh, A. 2016. Capitalism: Competition, Conflict, Crises, Oxford University Press. Sharma, R. 2020. “The Rescue Ruining Capitalism,” WSJ, July 24. Stiglitz, J. 2019. People, Power, and Profits, W.W. Norton & Company.

4

Productivity and wages The scissors effect

In this chapter, we trace the emergence of neoliberalism and the wage repression that followed, to the strategy designed by managerial elites in the mid-1970s to reverse the free fall in business profitability that triggered the stagflation outbreak earlier that decade. The system’s crisis, linking rising inflation and growing unemployment, put an end to three decades of exceptionally high levels of profitability, accumulation, employment, productivity growth, and real wages, not only in the U.S. but in other advanced capitalist countries as well. In the neoliberal phase that followed, the Fordist economic structure that John Kenneth Galbraith described in his New Industrial State, after three decades of high rates of technological change and investment, disappeared. The labor productivity growth that made it possible for unit costs to fall, and manufacturing corporations to penetrate world markets, came to an end. Steadily increasing capital/output ratios in the Fordist phase reflected the rising capitalization of industrial production and exerted downward pressures on corporate profit rates. In the Golden Years of the postwar period, legislation to protect the role of labor unions in bargaining for wages and working conditions and the extended use of Keynesian policies, designed to sustain high employment levels, brought a measure of prosperity to the working class across the advanced capitalist countries. It also contributed to the long-run decline of profit rates across all business sectors, not only in manufacturing. In previous chapters, we argued that after the mid-1960s, plunging profitability undermined the Golden Age foundations of the advanced capitalist countries. When the stagflation crisis broke out in the early 1970s, the postwar structure of capital accumulation could not survive. We insisted that the downward trend in profitability experienced from the late 1940s through the early 1980s undermined the foundations of capital accumulation before triggering the stagflation crisis. We consistently linked the strategies advocating the dismantling of the postwar capitallabor accord, the manufacturing downsizing that followed, and the globalization of investment and trade with the interest of corporate elites in reversing the intractable fall in profitability that eventually triggered the stagflation outbreak. The transition to neoliberalism For roughly 30 years, leading industrial corporations managed mass production plants employing large concentrations of organized workers enjoying the benefits of DOI:  10.4324/9781003413806-4

96  Productivity and wages collective bargaining, with wage increases tracking productivity growth. Industrial corporations’ profit share in value added remained roughly constant up to the mid1960s, but exceptionally high profit rates ensured manufacturing the dominant position in the industrial sector, not only in the U.S. but in the world economy as well. As we argued in Chapter 3, this regime could not survive the stagflation crisis of the 1970s, directly linked to a sharp fall in profitability. With the deterioration of profitability, the capital-labor accord exhausted its viability and lost the support of corporate management. In the aftermath of the stagflation crisis of the 1970s, recovering profitability required more than reining in wage increases surpassing labor productivity growth. Deindustrialization involved weakening the structural foundations of labor’s bargaining strength. Abrogating the postwar capital-labor accord allowing for aggregate wages to rise in tandem with productivity growth required ushering in the neoliberal phase of capital accumulation. Neoliberalism emerged as a new structure of capital accumulation, adopted by corporate and managerial elites to overcome the limitations placed by Fordist wage bargaining practices to rising profit shares in value added. Without increasing the corporate profit share, and therefore reducing the labor share as a counterbalance to the rising capital/output ratios, the growing capital intensity of industrial production would accelerate the decline in manufacturing profitability, and jeopardized the survival of accumulation. Neoliberalism and structural change From the mid-1960s to the early 1980s, the fiscal policies adopted to increase growth overlooked the fact that capitalism’s real growth path depends on the evolution of profitability, but profitability both in the nonfinancial as well as the financial corporate sectors fell sharply during that period. In the 1980s, as nonfinancial corporate bank borrowing declined and inflation subsided, falling capital accumulation reduced the nonfinancial corporate financial gap. After experiencing a steady but mild decline between the mid-1960s and 2000, only reversed in the late 1990s, the nonfinancial accumulation trend after 2000 practically collapsed. Sorting out the reasons why monetary policy failed to spur real capital accumulation requires distinguishing between policies designed to strengthen effective demand and those motivating the growth of business capital expenditures, that is to say, between financing higher consumer demand and rising net capital investment. The structural changes that transformed the fast-growing U.S. economy from an industrial powerhouse into a service economy range from the spread of ‘innovating’ financial services to the proliferation of ‘stagnant’ personal services, whose intrinsic characteristics interfere with the acceleration of the system’s growth. We consistently argue that the evolution of profitability from 1945 to 1975 caused the phase transition from the Golden Age of high profitability, strong capital accumulation rates, and rising real wages to the neoliberal phase characterized by lower profitability trends, wage compression, and a falling fixed capital accumulation rate. We show how the structural changes that followed the dismantling of manufacturing industries, and the expansion of financial markets, sought to reverse

Productivity and wages  97 falling profitability in the business sector but, instead, caused the slowdown in capital accumulation and laid the ground for the emergence of secular stagnation. Our empirical evidence supports the contention that extended periods of comparatively low growth from the mid-1980s to 2019 characterized the consolidation of neoliberalism and set the stage for successive booms and busts in financial markets. Raising financial markets to the leading role of sustaining consumption spending (the wealth effect), and relying on rising private and public debt accumulation to support effective demand, increased financial fragility and weakened the foundations for a real post-pandemic recovery. The corporate restructuring that characterized the consolidation of neoliberalism in the 1980s along with the build-up of debt associated with it led to the 1987 stock market crash that opened the road to financial fragility and set the stage for the pattern of internet, housing, and stock market crises that broke out in the 1990s. We link the growing symptoms of secular stagnation to the sectoral changes associated with neoliberalism, namely deindustrialization, financialization, and globalization. After a comprehensive analysis of how, after 1984, a low profitability trend caused the U.S. long-run decline in real capital accumulation, we conclude that neoliberalism failed to reverse the postwar profitability decline and instead arrested its rate of descent. As the economic blight inflicted by the Great Recession of 2007–2009 spread into the next decade, Alan Greenspan in 2011 mused that: The US recovery from the 2008 financial and economic crisis has been disappointingly tepid. What is most notable in sifting through the variables that might conceivably account for the lackluster rebound in GDP growth and the persistence of high unemployment is the unusually low level of corporate illiquid long-term fixed asset investment. (Greenspan, 2011) By 2013, the slow growth path that had been achieved since neoliberal restructuring began over three decades earlier led Larry Summers to conclude that the specter of secular stagnation, appearing as extended periods of low growth, a condition previously detected in the late 1930s, had returned in full regalia. Rising debt, low interest rates, and secular stagnation caused the proliferation of profitless corporate ‘zombies’ that were barely able to pay the interest on their rising debt and remained insolvent. Going forward, the likelihood of an extended period of low growth, after stagflation abates, will depend on the extent to which public grants and low interest loans manage to preserve ‘zombie’ companies (around 20 percent) as Federal Reserve waifs. From our perspective, the longer secular stagnation undermines the financial solvency of nonfinancial businesses and households once the recovery measures expire, the prospect of depression rises. It is sobering to think that, as Schumpeter’s gale of ‘creative destruction’ gathered momentum during the pandemic and the reconversion of the post-pandemic industrial sectors began, the destruction phase will precede the creative one this time, and the recovery outcome will remain uncertain in time and scope.

98  Productivity and wages The sharp profitability decline from the mid-1960s through the early 1980s left no room for delaying the implementation of the neoliberal transition and the gutting of the Fordist structures of capital accumulation. By the early 1980s, Paul Volker’s unprecedented interest rate hikes brought in the deepest recession and the fastest rise in unemployment since the 1930s, thereby shaping the new institutional arrangements surrounding the tug-of-war wage disputes between a weakened labor force and a militant managerial class. In order to reverse the unsustainable decline of capital accumulation, the obstacles to launching neoliberalism lost the elites’ support. The message advanced by corporate elites argued, that as the postwar foundations of capital accumulation had lost their purpose, the neoliberal changes would unleash the system’s growth potential. Replacing investments in domestic manufacturing with offshore lower-cost projects, based on a well-trained labor force and lower wages, would raise profit margins, providing cheaper goods that would gainsay domestic wage increases. After accomplishing the change in expectations that the high interest rates and deep recession brought about, interest rates would fall, financial regulations would be lifted, and idle domestic and foreign capital attracted to financial markets. Expansive monetary policies promoted imports from offshore locations where manufacturing had taken root. Eventually, corporate rules were changed and the purchasing of own shares allowed. Rising valuations attracted foreign capital and euphoric periods of asset inflation confirmed the apparent soundness of the financial innovations. Confidence in the accommodating stewardship of the Federal Reserve strengthened confidence and sustained rising equity prices. The strength of the neoliberal set-up eventually came under suspicion in 2007 when some major banks collapsed. We have previously argued that the full transition to the neoliberal social structure of capital accumulation proceeded along two fronts. First, it required breaking up the corporate structures that promoted rapid growth and high employment levels in the postwar period: deindustrialization and weakening of labor unions facilitated the abrogation of the capital-labor accord, allowing for wage growth in tandem with productivity growth. Second, financialization played a major role in the transition to neoliberalism. The over 62 percent reduction in nominal short-term interest rates brought about by the Federal Reserve between 1984 and 2015 sparked a major consolidation of the banking sector, and laid the grounds for the rise of financial activities as the leading growth sector in capital accumulation. The structural crisis of the banking sector reduced the overall number of banks, eliminated the smaller ones, and fostered the rapid growth of the five largest institutions, whose assets rose from 22.3 percent in 1996 to nearly 48 percent of the $15.3 trillion total held in 2014. We contend that, in contrast with the falling trend in real fixed capital accumulation experienced, the concentration of financial assets in a small number of behemoth banks benefited from the growing capital flows that caused the ‘long boom’ in financial markets. The rising share of corporate profits received by the financial business sector relative to total corporate profits, as well as the increasing share of total corporate financial investments relative to fixed capital spending, is often noted as evidence supporting the claim that the financial sector played a decisive role in the consolidation of a neoliberal ‘long-boom’ in the 1990s.

Productivity and wages  99 The growing tendency for nonfinancial corporations to finance their net fixed capital investment out of retained earnings, on the one hand, and consumers to finance their mortgage and other purchases with debt on the other, prompted banks to reorient their practices from business to household lending. In addition, the compression of net interest margins brought about by lower interest rates encouraged banks to accept unprecedented lending risks in their practices, seeking to compensate for the decline in profit margins with higher lending volumes. The secular decline in interest rates failed to reverse the declining trend of capital accumulation in the nonfinancial sectors. Instead, speculative bubbles in financial, internet, and housing assets proliferated, as leading banks found meeting the growing demand for such financial products more profitable than servicing the declining demand for business fixed capital expenditures. Corporate debt rose substantially as borrowing to finance share buybacks overshadowed the growth of corporate profits. In the event, the growing gap between stagnating incomes in the real economy and the rising debts of corporations and households proved unsustainable. Finally, when mounting mortgage debts reached a critical point and prevailing securitization practices spread and obscured the risk of default, Lehman Brothers collapsed, unleashing an unexpected shock that broke the camel’s back, and triggered the Great Financial Crisis of 2007 (Sorkin, 2009). Government deficits The task of dismantling the mixed economy’s foundations, while increasing effective demand to counter stagnation in the 1970s, involved large government deficits. While injections of purchasing power through fiscal and monetary policies may achieve nominal growth, they will also raise the inflation rate if real growth fails to rise proportionately. Emerging from the deep downturn of the 1980s, neoliberal policies sought to increase expected profitability by keeping wage increases below productivity growth, achieving lower wage shares despite the employment recovery. Neoliberal pressure on wages succeeded in maintaining their growth below that of labor productivity, but the rising profit share failed to reverse the long-term decline in profitability that took place from the mid-1960s through the early 1980s, which remained well below 1970s levels. Effective demand expansion created by deficit spending, financed by net private or public credit growth, while leading to higher sales and growing output, as well as higher employment and rising wages, may have negative feedback on growth, if profitability falls in the process. While effective demand expansions will raise output and employment, such increases without a proportional growth in labor productivity, may result in a falling profit share and lower profitability. A falling rate of profit will drag down the potential rate of growth, and fiscal or monetary policies that strengthen effective demand and sales, will end up stoking inflationary pressures in the system. In the late 1970s and early 1980s, the bifurcation between the real growth path linked to profitability, and that of nominal growth related to net credit expansion, led to unprecedented increases in inflation and interest rates.

100  Productivity and wages Measuring the share of government deficits in GDP tends to underestimate their growth because the increase in the numerator itself will enlarge the denominator to some extent. Nonetheless, government deficits in the 1970s were enlarged in the 1980s. The share of government deficits in GDP rose from a near-zero trend throughout the postwar period ending in 1969 to 6 percent in 1975. Furthermore, while the fiscal deficit diminished to less than 2 percent in 1979, it remained persistently high during the 1980s, reaching nearly 6 percent in 1983 and 1992. But, despite the major fiscal boost applied in the 1980s, the average real GDP growth rate in that decade was slightly lower than in the 1970s. After reaching such high levels in the 1980s, U.S. deficits experienced a remarkable reverse in the 1990s, resuming their expansion in the first decade of the 21st century and reaching over 10 percent of GDP in 2009. Such fiscal stimuli, as well as other neoliberal policies, failed to have a significant effect on average real GDP growth rates. The deficit reversal of the 1990s produced an average real GDP growth rate of 3.23 percent, slightly higher than the high-deficit decade of the 1980s at 3.15 percent, although no higher than the average growth rate of the 1970s. On the whole, fiscal stimuli associated with the neoliberal phase failed to provide the growth boost necessary to match the postwar experience of the Golden Age. The ideology of neoliberalism In our view, the ideology of neoliberalism was formulated to justify the restoration of aggregate profitability in advanced capitalist countries. The architects of neoliberal ideology, including Hayek, von Mises, and Friedman advocated its propositions as essential for the construction of a new society centered on individual freedoms and enjoying all-round competition. Such principles were conceived as the only foundation for a free society to avoid the road leading from collectivist experiments to the iniquity of serfdom. As founding fathers of the neoliberal Mont Pelerin Society in 1947, they used the platform to launch the movement aiming to fight ‘collectivism’ and effectively undermine the appeal of both socialism and the welfare state (Stedman, 2014). Friedman’s 1951 paper entitled “Neo-liberalism and its Prospects” forcibly argued the case to establish a new order favoring global competition as the driver of social justice and the guardian of freedom against the ravages of collectivism. This new order would not simply replicate the 19thcentury laissez-faire role of markets, as the fulcrum of universal exchange, but introduce the essential element to achieve the markets’ general equilibrium. For Friedman, “Neo-liberalism would accept the nineteenth century liberal emphasis on the fundamental importance of the individual, but it would substitute for the nineteenth century goal of laissez-faire as a means to this end, the goal of the competitive order” (Friedman, 1951, pp. 89–93). In contrast with the laissez-faire view of 19th-century capitalism, Friedman’s neoliberal outlook assigned a decisive role to the state as the guardian and promoter of competition, dubbing the efforts of labor unions to protect employment and wages as monopolistic behavior that should be restrained. Friedman advocated active monetary and fiscal policies to shape competitive markets as legitimate interventions to protect neoliberalism as

Productivity and wages  101 a new configuration of capitalist society (Dardot and Laval, 2013). In the name of preserving competitive markets, neoliberal ideology most decisively justified aggressive measures to weaken the bargaining position of labor, starting with the actual dismantling of labor unions ostensibly to prevent the outbreak of inflation and avoid the rise of unemployment. We interpret Friedman’s neoliberalism as a term not simply describing the ideology of free markets, conceived as conduits for the efficient allocation of scarce resources, but as the ideology advancing a benign view of international free trade as an extension of national competition. Friedman’s neoliberal views overlooked the fact that real competition necessarily generates winners and losers, and links the prosperity of some to the misery of others. International competition extended the site of battles to global boundaries between workers in advanced capitalist countries against fellow workers in less developed ones. Within each nation, neoliberalism effectively justified ‘austerity’ to gain competitive advantage, lowering wage levels in advanced capitalist countries to comparable rates in less developed economies. Advocacy of such policies was consistent with the sustained effort on the part of corporate elites to reverse the decline in profitability that provoked stagflation in the 1970s. As neoliberalism strengthened its structural foundations, the wage share of production and nonsupervisory workers in the U.S. reached unprecedented low levels. The flip side of such wage compression was the return of wealth shares to high levels, comparable to those enjoyed by capitalist households in the early 1920s. After the mid-1980s, inequality rose to unprecedented levels because the wage share of 80 percent of workers sharply declined across the U.S. economy, while the rising price of financial assets expanded capital gains and the upper class ‘rentier’ elites captured the lion’s share of newly created wealth. Unleashing capitalism Classical economists acknowledged the tendency for the profit rate to decline, although they differed with one another in the reasons why. Keynes theorized that on the assumption that capital’s profitability derived from its scarcity, the accumulation of capital would depress the marginal efficiency of capital, and lead to underemployment equilibrium. The aggregate net output and employment would remain below the economy’s full potential without any tendency to reach full capacity and full employment. Keynes allowed that public policy could intervene in order to boost effective demand and, thus, fill in existing income gaps for as long as unemployment remained. The neoclassical synthesis of Keynesian economics that Hicks formulated to guide Golden Age economic policy offered simple, so-called ‘hydraulic’ solutions to the management of the desired level of employment and incomes. The synthesis offered government spending as a panacea for the management of effective demand at the full employment level. Keynesian economists assumed that saving propensities depended on income and interest rates, but monetary policy could set interest rates at the necessary level to control the supply of bank credit that would finance investment. Fiscal policies could also support effective demand and raise profit expectations. Thus, fiscal and monetary policies would

102  Productivity and wages raise the marginal efficiency of capital high enough to bring about the desired level of investment. Through injections of external finance and reliance on bank credit in the main, the income multiplier would work its magic expansion of aggregate incomes, lowering the unemployment level, and making depressions a thing of the past. The stagflation crisis, however, stubbornly highlighted the ‘inexplicable’ joint appearance of rising inflation and high unemployment, shattering confidence in the portents of the neo-Keynesian theory of ‘mixed economy,’ so highly celebrated in Paul Samuelson’s iconic textbook. Ushering in neoliberalism required abrogating the postwar capital-labor accord allowing for aggregate wages to rise in tandem with productivity growth. It is our contention, moreover, that the recovery of profitability following the stagflation crisis involved the comprehensive deindustrialization of the U.S. economy in order to weaken the institutional basis of labor’s bargaining strength. For roughly 30 years, leading industrial corporations managed mass production centers employing large concentrations of organized workers who experienced the benefits of collective bargaining as their wage increases tracked productivity growth. Industrial corporations received a roughly stable profit share in value added and, up to the mid1960s, exceptionally high profit rates ensured manufacturing the dominant position in the industrial sector, not only in the U.S. but in the world economy as well. This regime, however, could not survive the stagflation crisis caused by the sharp profitability fall of the 1970s and, in due course, the capital-labor accord exhausted its viability and was discarded: manufacturing lost its systemic supports as the leading sector in the accumulation of capital. We agree with Krippner (Krippner 2005, 2012) that the neoliberal order seeking a division of new value added in favor of the profits share in order to sustain capital accumulation in the long run did not spring fully developed from the minds of corporate elites and their think tanks. But neoliberalism needed to restrain the rise of wages in order to tame labor expectations and lay the ground for increases of the profits share. After achieving the task of dismantling the manufacturing capacity that sustained the previous regime, it had to find alternative venues to produce cheaper manufactured goods in order to alleviate the impact of switching to lower wages in service sectors without facing the rancor of union negotiations. The new financial channels would, in fact, promote the income and wealth of financial elites through compound channels while wages growth remained anchored below that of productivity. The rapid growth of financial assets reflected the worth assessment of discounted and (thoroughly uncertain) future yields, speculative revaluations of asset prices in housing, real estate, equity, consumer needs to fund education, health needs, and travel. The final configuration of neoliberalism’s various components depended on their proven effectiveness to overhaul the structure of the so-called mixed economy and, specifically, to reverse the profitability trend that, since the mid-1960s, undermined the long-run dynamics of capital accumulation. As an example, on August 23, 1971, two months before Lewis F. Powell became an Associate Justice of the Supreme Court of the United States, he wrote a ‘confidential memorandum’ entitled “Attack on the American Free Enterprise System” to his friend Eugene B.

Productivity and wages  103 Sydnor, Jr, who was Chair of the Education Committee of the U.S. Chamber of Commerce. In that memo, he proposed concrete measures to restore the hegemony of the business interests now under assault by the likes of Herbert Marcuse and Ralph Nader. As Powell put it, American business ‘plainly in trouble’; the response to the wide range of critics has been ineffective, and has included appeasement: the time has come – indeed, it is long overdue – for the wisdom, ingenuity, and resources of American business to be marshaled against those who would destroy it. (Powell, 1971, p. 9) For Powell the recovery of the lost hegemony involved a multi-prong strategy akin to war since Strength lies in organization, in careful long-range planning and implementation, in consistency of action over an indefinite period of years, in the scale of financing available only through joint effort, and in the political power available only through united action and national organizations. (ibid., 1971, p. 11) A little over a year later, in October 1972, following Powell’s call to arms, half of the 100 largest corporations in the United States set up The Business Roundtable, with a membership made-up exclusively of CEOs. They sought to defend and advance what they took to be the beleaguered interests of big business, and, by 1979, membership expanded to 70 percent of the top 100 industrial corporations. The strategy pursued abandoned the postwar alliance between large corporations and labor unions in favor of a political partnership with small business interests. Such an alliance replaced the previous strategy of support for long-term investment planning with the shibboleth of “competitiveness” applied to the radical program of deindustrialization and the growth of services (Kotz, 2015, p. 72). Shortly after its founding, The Business Roundtable defining statement of goals alleged that the hostile array of forces, so vividly outlined in the Powell memorandum, was responsible for the declining profitability trend that in 1973 afflicted corporate industry. Specifically, the statement pointed out that “After-tax profits peaked in 1966…but declined sharply in the ensuing period of cost-squeeze,” insisting that “profits as a percentage of national output were lower in the early seventies than in any year in the entire postwar period,” offering as an explanation the impact of “rising wages and stagnant productivity” (ibid., p. 77). As the 1970s decade ended, neoliberal claims replaced the principles on which the postwar structure of capital accumulation stood. The Keynesian-inspired role of government, as a partner in the maintenance of full employment and effective demand, lost its legitimacy. Markets, instead, gained credibility as vehicles to achieve optimal results. Deindustrialization gainsaid the power of labor unions to bargain for wages and, instead, worker organizations stood accused of distorting labor markets. Shareholders came to exercise control over corporate investment

104  Productivity and wages plans, and exerted their influence on share buybacks and market valuations. As the full-fledged neoliberal configuration replaced the high-minded technocrats of Galbraith’s New Industrial State, with shareholders evaluating their short-term financial options, the constraints on real capital accumulation multiplied. Nowhere is this contrast made more explicit than in the following comments by Robert Buckland, an exalted guru of a major Wall Street bank, as the head of global equity strategy at Citi. In the Financial Times of April 10, 2014, Buckland explained that a) corporate investment must be subordinated to shareholder supervision, and b) that estimates of the impact of corporate investment on share valuations trumped any other considerations, including corporate growth for the sake of ‘competitiveness’: Since 2010 global listed company capex is up 26 per cent to $2.6tn. Cash paid out through dividends and buybacks is up 40 per cent to $1.4tn…it appears there has been a structural rebasing of the capex/payout relationship. In 2001, US listed companies spent twice as much on capex as shareholder payouts. In 2013 they spent the same…US companies have been responding to signals from investors. There is a clear relationship between shareholder payouts and valuation. The more a global sector pays out in dividends and buybacks, the greater the value attributed by the market. Conversely, there is little relationship between capex and valuation. This investor suspicion of capex is supported by the data. The more an industry spends on capex, the lower future profitability tends to be…But if they collectively over-invest future industry profitability is likely to suffer…the evidence suggests equity investors have become increasingly wary of capex. Why has the US stock market been transformed into a capital recycler…As the market sees a company’s profitability fall, so the shares derate. This raises the opportunity cost of capex versus share buybacks. (Buckland, 2014) Neoliberalism strengthened its foundation throughout the world driven by a burgeoning financial sector that promoted geopolitical changes favoring the dismantling of global barriers to the penetration of capital. Contributing to its consolidation, these developments provided new channels for the expansion of profits and the compression of wage shares. With the downsizing of manufacturing, the provision of bank credit switched from financing corporate investments to the increasing share of household financial needs covered by debt rather than income. The share of bank profits derived from lending to households and mortgage originators, increased in the face of the diminishing share of nonfinancial corporate capital expenditures depending on bank credit. As Kregel pointed out, financialization replaced the neo-Keynesian phase, a period in which relatively high rates of capital accumulation and labor productivity growth produced the returns necessary to validate the business debts incurred. “Money manager capitalism,” as its successor, generalized the pursuit of “arbitrage or capital gains,” based upon speculative predictions of future asset prices, rising sufficiently to justify the debt incurred (Kregel, 2018).

Productivity and wages  105 Deliberate policy decisions contributed to this transformation, including monetary policy. Direct support of expansive monetary policy contributed to the launching of neoliberalism, along with a major restructuring of industrial production and the consolidation of banking into larger units. While the initial rise in interest rates of the early 1980s laid the ground for the consolidation of financialization as a distinct alternative to capital accumulation in nonfinancial sectors, secularly falling nominal interest rates, after 1984, opened the way for a more profitable alternative to long-term fixed capital accumulation. Such a transformation effectively increased the income and wealth of the top 10 percent owners of financial assets at the same time that the wage incomes of the majority of workers designated as ‘production and nonsupervisory employees’ stagnated. The neoclassical theory behind neoliberalism replaced Adam Smith’s absolute cost advantage trade principle, as a basis to promote international trade, with its own version of Ricardo’s comparative costs argument, allegedly providing welfare improvements to all traders engaged in global markets. Globalization allowed U.S. corporations to deindustrialize at home while benefitting from lower costs abroad and permitting them to gain international competiveness. As U.S. corporations transferred production facilities to ‘emerging markets,’ where wage standards were lower despite employing similar technologies, U.S. workers lost bargaining power. As factories relocated into lower-wage countries, the so-called ‘emerging markets,’ globalization enforced wage austerity at home as a byproduct of achieving competitive gains abroad but overall corporate profit margins rose. Free trade and deindustrialization undermined labor union density in all sectors, and as neoliberalism spread throughout the advanced capitalist countries, wage shares declined and profit shares increased, raising the incomes and wealth shares of the elites behind these changes. In the neoliberal phase, wealth and income inequality in the U.S. reached levels not seen since the 1920s. We will show that in the end, and well into the 21st century, the consolidation of neoliberalism had not yet achieved the expected reversal of profit trends. From the early 1980s to the present, the previous sharply declining trend stabilized, but after the initial bounce-back from the trough in the mid-1980s, the average profit rate followed a meandering path (when measured on current cost net fixed capital) without a clear-cut reversal of the post-1982 trend. This neoliberal profitability reversal failed to materialize, as technical change advanced across the nonfinancial corporate sectors. Capital-intensive technology raised the capacityutilization-adjusted capital/output ratio and the higher profit shares in new value added insufficiently countered its depressing effect on profit rates. The reversal lost momentum as the wage share and employment growth declined. Despite the balance of class power favoring capital over labor in the absence of the Fordist capital-labor accord, neoliberalism did not accomplish its goal because keeping wage growth below productivity gains was not sufficient to counterbalance the depressing effect of rising capital/net output ratios on profitability. Empirical evidence backing up these conclusions refers to profitability averages, although we disaggregate results applying to various sectors of the private economy, including the broad business sector of corporate and non-corporate businesses, nonfinancial and financial business sectors, as well as manufacturing, transportation, mining,

106  Productivity and wages and utilities. Averages in these sectors involve very different enterprises, including ‘zombies’ (Banerjee and Hofman, 2018). Since the average profit rate reflects the operating conditions across the system of different types of enterprises, the overall trend emerges as a balance of very disparate firms in a variety of industries (Farjoun and Machover, 1983). Was wage repression necessary? Our account of the transition from the postwar regime of U.S. industrial hegemony to the neoliberal structure of capital accumulation shares many of the analytical insights of post-Keynesian economists regarding the decline in manufacturing and the rise in services employment, as labor unions disappeared along with the dismantling of industrial conglomerates. Wage repression replaced the time-honored practice of raising wages along with productivity growth. Capital flows increasingly favored financial rather than fixed assets and credible measures of productivity growth in financial activities are hard to interpret. We have insisted on the centrality of profitability to understand the consolidation of neoliberalism because leading post-Keynesian macroeconomists such as Lance Taylor, while agreeing that the transition was deliberately carried out, considered that it was not necessary (Taylor, 2020). If Taylor’s empirical claims were correct, there would be no basis to argue, as we do, that the profitability crisis, extending from the mid-1960s to the early 1980s, was the decisive catalyst behind the disappearance of the old Fordist regime and the establishment of neoliberal social relations of production. In his book, Lance Taylor contends that throughout the neoliberal period, “In the American economy the macroeconomic capital/output ratio has fallen and the profit share of output has gone up” (ibid., pp. 6–7), but offers no clues to the empirical bases for these conclusions. Taylor claims as facts that his research in his Figure 3.1 “show that across U.S. business cycles, the output/capital ratio u and the profit rate r have drifted upward since around 1980,” and surprisingly “The profit share goes up and the real wage has been stable” (ibid., p. 46). Taylor does not make clear whether this conclusion flows from his own data construction or is derived from the official sources of the Bureau of Economic Analysis (BEA), that is, NIPA and Fixed Asset Tables. Throughout his book, Taylor develops sophisticated arguments standing on flimsy empirical foundations. Clearly, the data used must be compatible with the concepts and paradigm tested, especially when, as Taylor confides, he sought to enlist “help from Karl Marx” to reach conclusions that presumably prove the irrelevance of Marx’s views on profitability. Without any specification of the data sources and method applied, we cannot find the empirical underpinnings of Taylors’ business sector value added, whether it referred to net value added or business gross value added; whether his data included the nonprofit public sector or excluded it; whether or not it included monetary imputations. He does not specify whether his data on capital stock reflected estimates on private current cost net capital stock or current cost gross capital stock; whether or not it included corporate and non-corporate business capital stock; financial or nonfinancial corporate fixed assets. In Lance Taylor’s view, his empirical findings presumably reverse the neoclassical view of

Productivity and wages  107 capitalist growth models: “this history is consistent with the Solow-Swan model running in reverse. The economy appears to have ‘too much’ capital per worker” (ibid., p. 46). Is this a coincidental admission of Marx’s concept of capital overaccumulation as a foundation for crisis, and rising profit shares as the system’s response to it? We, nonetheless, agree with his overall conclusion that, as Taylor put it, “wage repression over decades is the basic cause of distribution malaise… undoing unequal distributions of income and wealth will take as much time as was needed to create them” (ibid., p. 2). James Galbraith (2014, 2016), on the other hand, attributed the revival of interest in rising inequality across the advanced capitalist countries to the groundbreaking findings of Harrison and Bluestone’s book, The Great U-Turn, published in 1988. We find the significance attached to the abandonment of the capital-labor accord by Bluestone and Harrison as well as Bowles, Gordon, and Weisskopf (Bluestone and Harrison, 1982; Harrison and Bluestone, 1988; Bowles, Gordon, and Weisskopf, 1990) to be a remarkable contribution to our understanding of the emergence of neoliberalism, not least because they linked the structural transformation of U.S. industry to the profitability crisis that affected the U.S. and all advanced capitalist countries from the mid-1960s through the early 1980s. Galbraith interprets Harrison and Bluestone’s study of deindustrialization, downsizing, and closing of plants not as an effective way for corporate managers to weaken the bargaining position of labor, lower wages, and raise profitability, but as a byproduct of inevitable technological progress. In that light he finds that “manufacturing workers, especially those in the heavily unionized States of the North and Midwest, faced major competitive pressures from the 1970s forward” (Galbraith, 2016, p. 76). Galbraith claims that “wage concessions were not the main response to competitive pressures. Instead factories moved, workers lost their jobs, taking less-well paid ones elsewhere” (ibid., p. 76) and in the final analysis technological change drove the restructuring of American industry, not the dismantling of the capital-labor accord. In manufacturing, Galbraith writes, “The larger reality seems to be that newer technologies in new locations win out in the end, and that lower wages are only a small part of that competitive struggle” (ibid., p. 78). The effects of technological change need to be evaluated in the context of the falling profitability trend that unraveled the postwar capital-labor accord. For Galbraith, the “digital revolution” allowed “technologists in the big corporations” to branch out on their own as “independent technology firms” (ibid. p. 86) forcing the industrial behemoths to shrink. In our view, on the other hand, while digital technologies provided the means to break up the large concentrations of worker power that framed the capital-labor accord, the restoration of corporate profitability played the decisive role in their adoption. The profits share versus the output/capital ratio Examining the long-term time series of business profitability from 1900 to the present, the immediate impression is one of finding two distinct historical periods, the first from 1900 to 1929, the second from 1929 to the present, separated by the fact that the Bureau of Economic Analysis’s data generally starts in 1929, except

108  Productivity and wages for investment flows that begin in 1900. Estimates of the empirical decomposition of the average profit rate into the net output/net fixed capital ratio and profit shares from 1901 to 2021 will uncover a deeper contrast between these two phases. Right after the plunge of the Great Depression, the output/capital ratio rose to unprecedented heights. It descended cyclically from there on, pulled down by the force of capital-intensive technology and the changing structure of capitalist production. The output/capital trend fell between 1900 and 1929 and its upward jump after the Great Depression reflected a momentous technical change in industrial organization that increased the normal rates of capacity utilization. As M. Foss put it in a series of well-documented reports from the early to the mid-1980s, “To summarize: the rise in average weekly plant hours in manufacturing from 1929 to 1976 is explained in part by the rise in capital intensity and a related increase in continuous operations in industry” (Foss, 1981, p. 61; 1963, 1985). The cyclical aspects of the output/capital ratios were caused by changes in capacity utilization reflecting the fluctuations of effective demand caused by fiscal deficits. The persistent downward trend of the output/capital ratio reflected the choice of technical change shaped by business competition-as-war and the strategy of leading firms. In conjunction with the output/capital ratio, the profit share sets the level of the average profit rate and its evolutionary path. As Figure 4.1 shows while the profitshare fluctuated significantly from 1900 through the mid-1940s, reflecting the great transformation of the U.S. economy undergoing industrialization, depression, wars, and recoveries, from the mid-1940s and up to the Great Recession, the profit share remained almost constant. This does not mean that income distribution experienced

69%

1.4 1.2

Net output/net fixed capital ratio Profit shares in business sector net value added

60%

1.1

52%

0.9

43%

0.8

34%

0.6

25%

0.5

16%

0.3

8%

0.2

-1%

-10% 0.0 1901 1908 1915 1922 1929 1936 1943 1950 1957 1964 1971 1978 1985 1992 1999 2006 2013 2020

Figure 4.1  U.S. net output/net fixed capital ratio and profit shares in net value added; decomposition of business profitability as previously calculated.

Productivity and wages  109 little change within the labor force as a whole. Why was the depressing effect of falling output/capital ratios not counterbalanced by a rising profit share able to shore up the average profit rate? Answering this question requires focusing on the growing socioeconomic inequality that the constant path of the profit shares hides. Declining profitability and inflation In fact, the pressure of the falling capacity-adjusted net output/net capital stock after 1965 lowered the average profit rate to unprecedented levels in the 1970s. Such protracted decline aggravated the survival of firms that, experiencing lower profit rates, failed to raise labor productivity growth sufficiently to maintain their profit share. Under the circumstances, the output contraction of distressed firms created input shortages for viable firms that, after affecting their production plans, amplified dislocations in the supply chain and contributed to unemployment growth. Keynesian-inspired policies intended to sustain effective demand and prevent unemployment from further rising, instead led to inflationary pressures that sustained both inflation and unemployment growth. Shortages from strapped firms combined with rising prices to produce a stagflation crisis combining rising unemployment and rising inflation. In that situation, high levels of investment alongside falling profitability signaled the arrival of a crisis in the making. Mainstream explanations of the stagflation crisis, consisting of supply cutbacks and higher inflation, blamed government regulations and rising taxes for rising production costs. In addition, workers’ resistance to wage reductions prevented the re-establishment of competitive prices at a time when international competitive pressures prevented business firms from raising prices (Evans, 1983; Musella and Pressman, 1999, pp. 1099–1101). Despite rising unemployment, the so-called efficiency-wage theory allowed neo-Keynesian economists close to the neoclassical mainstream (Bruno and Sachs, 1985) to attribute the downward rigidity of wage rates to business policies designed to preserve the productive skills of a loyal workforce. A heterodox explanation of the stagflation crisis, such as that of Bowles, Gordon, and Weisskopf (1990), emphasized the role of the full employment policy pursued by government in the Golden Years in strengthening the bargaining position of labor, as well as contributing to falling productivity growth, rising wages, and the profit-squeeze that preceded the stagflation crisis. Throughout this book, we use the concept of neoliberalism to describe the social structure of capital accumulation that, after the mid-1980s, replaced the postwar dynamics behind the ‘glorious thirty years’ (“Les Trente Glorieuses”). We share Heilbroner’s conviction that the pursuit of profits shapes the historical development of capitalism. As Heilbroner saw it, the fundamental force that drives the system through history is its search for profit…the trajectory of capitalism is immediately recognizable as a movement guided by the imperious need for profit—indeed, as a movement incomprehensible without an awareness of this central element of its nature. (Heilbroner, 1986a, p. 142)

110  Productivity and wages From this perspective, we view the emergence of neoliberalism in the 1980s after the demise of the Keynesian capital-labor accord as a response to the erosion of profitability in the previous two decades. The consolidation of neoliberalism after the early 1980s in the U.S. and elsewhere involved the entrenchment of practices related to the new configuration of the social structure of capital accumulation in response to profitability trends blocking the expanded reproduction of capitalism. Neoliberal reforms sought to bring about the redistribution of income in favor of capital and, to that end, promoted financial capital and financial profits as chief drivers of accumulation. The neoliberal theory of Hayek, Friedman, and the Mont Pelerin Society concerning the social benefits of all-round competitiveness provided the ideological scaffold from the standpoint of those classes poised to reap the greatest wealth benefits. While neoliberal ideology developed decades earlier, its implementation required conditions favoring its adoption as a structural framework best suited to restore the power of profit as the central driver of capital accumulation. Neoliberalism is not simply a reflection of the desire to systematize the pursuit of individual freedoms against any collectivist encroachment. It is a new phase of capitalist development seeking to reverse the postwar downturn in profitability through structural changes favoring financialization, globalization, and a weakening of labor’s bargaining position. We view the legacy of neoliberalism from the standpoint of Classical Political Economy, the theoretical approach developed by Smith, Ricardo, Malthus, and Marx (Shaikh, 2016; Tsoulfidis and Tsaliki, 2019) as the most fruitful research program to study the dynamics of contemporary capitalism and, in particular, its neoliberal configuration. Focusing on the evolution of profitability as the chief driver of capital accumulation we will trace the legacy of neoliberalism to the wholesale dismantling of industry and offshoring investment strategies. Neoliberal ideology justified the growth of financialization and globalization in pursuit of higher profitability as options in bringing down the barriers to capital flows between real and financial sectors and widening the range of investment destinations between domestic and foreign investments. The search for higher profitability underpinned the rise of financialization, defined as the growing weight of financial investments in the allocation of surplus capital with limited alternative opportunities to find profitable opportunities, propped up by low interest rates. Globalization refers to the expanding share of foreign direct investment in corporate capital allocations that offer a wider range of profitability outlets. These shifts in capital flows, however, led to declining rates of domestic fixed capital accumulation in nonfinancial sectors that lowered labor productivity growth rates and kindled corporate pressures for a sustained compression of wages to avoid the persistence of secular stagnation. We propose to evaluate the corporate necessity of wage repression from the perspective of Classical Political Economy on the centrality of profits as the driver of capital accumulation. We will also consider the extent to which its implementation altered the actual profitability and capital accumulation trends of U.S. capitalism from the mid-1980s to the present. As we provide evidence for every one of the major arguments proposed in its defense, we aim to prove

Productivity and wages  111 the relevance of the Classical approach to analyzing long-term trends in capitalist development. From the standpoint of Classical Political Economy, the profit rate regulates the accumulation of capital, and the strength or weakness of accumulation in turn will have an impact, positive or negative, on profitability. The degree of capacity utilization reflects changes in effective demand, and may alter the long-term path of the average profit rate. But capacity adjustments follow changes in capacity utilization, as rising capacity utilization eventually leads to increases in capacity itself that restores the profitability trend, as determined by the combined effect of profit shares in value added and the fixed capital/value added ratio. In other words, changes in capacity utilization alter the transitional profit rate and lead to capacity adjustments that restore the normal competitive profit rate. From this perspective, from the mid-1980s to the present, neoliberalism emerged as an alternative to Fordism seeking new channels for capital accumulation and higher profitability. The visible hand of neoliberalism As we have insisted throughout this book, from the perspective of the ruling elites, neoliberalism replaced a historically dysfunctional configuration of capitalism in order to preserve capital’s profitability and spur the accumulation of capital as the chief component of its global expansion. The free mobility of capital among sectors, markets, and nations in response to profitability differentials is the central concept of Friedman’s competitive order. In this connection, the Federal Reserve policy pursued from 1984 to the present, in mid-2022, directly contributed to launching and expanding financialization, the driving force of the financial sector in the overall allocation of capital. Despite successive financial crises and growing awareness of its pitfalls, proclaimed by a growing albeit inchoate populist movement across advanced capitalist countries, neoliberalism remains unchallenged, its global financial architecture supreme. And yet, the prospects of secular stagnation did not go away as a byproduct of the new order. As a first step, launching neoliberalism required dismantling the corporate structures surrounding the capital-labor accord. The exercise of union power when negotiating to raise wages and improve working conditions in tandem with productivity growth could no longer take place. Deindustrialization provided the structural settings to downsize the concentration of workers in large industrial centers in order to weaken their bargaining strength and carry out the compression of wages. From the mid-1970s on, deindustrialization and the growth of the service sector became two prongs of the structural changes leading to neoliberalism. Because worker concentration in service centers is typically small, the rise of the service sector to a dominant position decisively served the purpose of weakening labor’s capacity to bargain for wages and benefits. By 1984, deindustrialization and the breakup of the capital-labor accord reshaped the physical environment where traditionally workers gained consciousness of their relative strength in the tug-of-war for the division of new-value-added between wages and profits. Downsizing corporations included shrinking the mass of workers concentrated in

112  Productivity and wages large industrial corporations and the results set the stage for the ‘great moderation’ of labor demands under neoliberalism. It also set the stage for the growing schism between production and non-supervisory employee compensation and supervisory personnel as well as the wage disparities between low-skilled service workers and those employed in the financial sector (Baumol, Blinder, and Wolff, 2003). The growth of financial services added a new dimension to the neoliberal consolidation of corporate power. The financialization of capital flows offered an alternative channel to circumvent the profitability crisis in the real sectors. Contrary to Galbraith’s post-Keynesian interpretation, relying on the availability of new digital technologies to enhance managerial controls did not leave the accumulation path. After the mid-1960s, it is generally agreed that the nonfinancial corporate longterm path of fixed capital accumulation fell because the sector’s long-term profitability path declined. Firms would weigh the available options, choosing to commit their capital funds where the expected pay-off was highest. Considering risks and the length of the pay-off period, firms would favor fairly liquid financial investments if they showed better prospects than fixed capital investments. Neglecting fixed capital investments then could not be interpreted as the result of running out of funds due to the priority accorded to financial assets, but rather as a second best that would be neglected only if the real sectors improved their profitability potential. On the contrary, rising financialization in advanced capitalist countries stems from the lackluster profitability prospects in real sectors compared with financial markets. Neoliberalism gained ground in the 1980s because the ‘stagflation crisis’ of the 1970s unraveled the structural foundations of the postwar Keynesian regime. The ‘stagflation crisis’ itself was a manifestation of the declining trend of average profitability experienced in the nonfinancial sectors of the U.S. economy throughout the whole postwar period, particularly after the mid-1960s. After the mid-1960s, the average profit rate remained stuck at a much lower level than in previous decades and, therefore, how to raise it was the real force behind the neoliberal transition. We interpret neoliberalism as a compact of various interrelated developments designed to reverse the downward trend in business profitability experienced in the ‘golden age’ up to the mid-1960s and particularly the steeper decline that followed before reaching a trough in the early 1980s. Fiscal and monetary policies contributed to shoring up the transition to neoliberalism: restrictive monetary policies enacted in the early 1980s, ostensibly to fight inflation, attracted large inflows of foreign capital and played a crucial role in launching neoliberalism. Under neoliberalism, capital flows into financial sectors provided a profitable alternative to nonfinancial capital expenditures in fixed assets and opened the way for the growing role of financial speculation as a driver of capital accumulation. The drastic reversal in monetary policy initiated by the Federal Reserve after 1984 set off a secular downward trend in interest rates and led to a radical transformation of the banking industry. As falling net interest margins led to the disappearance of the smaller banks, and nonfinancial corporations increasingly became

Productivity and wages  113 self-financing in their fixed capital expenditures, the big banks reduced their dependence on business lending and the associated interest income and turned to consumer lending and mortgages as revenue sources. The comprehensive reliance on fees, consumer and mortgage lending and, increasingly, securitization, commonly defined as “the process of taking an illiquid asset, or group of assets, and through financial engineering, transforming it (or them) into a security.” The unexpected collapse of the Soviet system in the early 1990s boosted optimism that no barriers to the movement of capital (Heilbronner, 1989) would stop the forward march of the capitalist system (Krugman, 2009, pp. 10–14). Expanding globalization of fixed capital investments attracted by lower wage rates in ‘emerging markets’ allowed for more profitable investment outlets and provided a parallel option to financialization (Bivens, 2013; Wood, 2017). Exports of capital abroad, along with domestic deindustrialization, not only led to the vanishing of well-paid manufacturing jobs, but also brought home the potential threat of job losses for those remaining. Explicit or implicit job-outsourcing threats contributed to the “great moderation” in wage claims experienced after the 1980s, when the globalization movement attained full force. Such threat of business relocation obviously played a role in the restraining of wage expectations on the part of the working class. As Woodward noted, Alan Greenspan “hypothesized at one point to colleagues within the Fed about the ‘traumatized worker’—someone who felt job insecurity in the changing economy and so was accepting smaller wage increases” (Woodward, 2001, p. 168). After deindustrialization and the abrogation of the capital-labor accord, neoliberalism expanded the scope of corporate investments to include buybacks of corporate equity shares and rising capital exports to the so-called emerging markets, where lower wages prevailed. It is remarkable, however, that the neoliberal reforms, while successfully increasing income and wealth disparities between corporate elites and the majority of workers, ultimately failed to achieve their primary goal of reversing the low profitability level prevailing after recovering from the early 1980s recession. Instead, financial investments drew capital away from real production sectors, while globalization enabled the outsourcing of production to lower-wage countries. On the whole, with the exception of the second half of the 1990s, a low level and trendless profit rate steered the nonfinancial rate of capital accumulation to ever lower values, held back progress in raising labor productivity growth, and provided the structural underpinnings of secular stagnation. Contrary to the conventional theories of secular stagnation that focus on demographic factors, such as the decline in the population growth rate leading to lower demand for residential investments; high rates of labor productivity growth prompting the decline of aggregate nonresidential investment spending, our interpretation highlights the opposite line of causation. That is to say, it is the slow rate of nonfinancial capital accumulation that is responsible for the slow rate of labor productivity and the relative rise of capital goods prices vis-à-vis other goods. It is clear to us, that the evidence for the slow renovation of capital goods, given by their increasing average age profile, is a sign of the vanishing profitable investment opportunities that led to the quagmire of neoliberalism and its sequel of secular stagnation in advanced capitalist countries.

114  Productivity and wages The growing gap between productivity and wage growth While index measures of average hourly labor productivity and real average hourly earnings for all employee categories rose in tandem from the late 1940s to the mid1960s, beginning with the 1970s they started to diverge. From the 1970s on, the gap between real hourly labor productivity in the non-farm sectors and real hourly earnings of ‘production and nonsupervisory employees,’ making up about 80 percent of all employees, increased significantly. The difference between their earnings and those of the ‘supervisory’ segment of employees also increased because the average hourly real earnings of the ‘supervisory’ component of all employees continued to grow in tandem with productivity, but not that of the ‘production’ workforce. Before the late 1990s, the neoliberal effort to raise the profit share, that is, the residual after subtracting all employee compensation from net value added (excluding ‘imputations’), floundered. According to our calculations in Figure 4.2, the average real hourly earnings of the supervisory segment continued to rise in tandem with average labor productivity until the mid-1990s, so the brunt of the earnings compression fell on the ‘production and nonsupervisory’ employees, whose average real hourly earnings in 2001 was no higher than in 1973. From this perspective, it is significant that the moderate rise in real hourly earnings of 80 percent of all employees in the 21st century coincided with the stagnation of real average earnings of the supervisory employee segment. After sharply weakening the bargaining position of labor in the drive to deindustrialization, the consolidation of neoliberalism as a global hegemon Contrasting Compensation Trends 1947 = 100

580 530

Business sector all employees real output per hour

480

Non-production ('managerial') real hourly earnings All employees real hourly earnings Production & nonsupervisory real hourly earnings

430 380 330 280 230 180 130 80 30 1946

1951

1956

1961

1966

1971

1976

1981

1986

1991

1996

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Figure 4.2  U.S. hourly non-farm productivity and real earnings for all employees, including ‘production and nonsupervisory’ as well as ‘supervisory’ and managerial employees, based on FRED data.

Productivity and wages  115 in the 1990s allowed the system’s elites to flatten the path of hourly real earnings of ‘supervisory’ labor and then succeeded in raising the profit share. To demonstrate the significance of linking the repression of wage compensation, largely impacting the 80 percent of workers classified as production and nonsupervisory employees with the need to avoid the breakdown of capital accumulation, we tested a counterfactual experiment. In Figure 4.3 we show a counterfactual path of labor compensation rising halfway between the ceiling of labor productivity and the floor of the actual compensation received. We then corrected the actual BLS data to reflect the values in this counterfactual compensation path and we applied the counterfactual values for wages compensation to determine the net operating surplus in the business sector. Figure 4.3 makes it clear that from the standpoint of sustaining the viability of capital accumulation, the neoliberal counter response to the threat posed by the falling rate of profit, not only in the 1970s but also since the late 1940s, required repressing the growth of real hourly earnings for the majority of workers. Given the falling net-output/capital trend, if the real hourly earnings for all workers continued to grow in the 1980s at the same rate as they increased from the mid-1940s to 1975, the average profit rate in the business sector would collapse. To demonstrate the weight of this conviction, we plotted a counterfactual path of real earnings standing between the actual productivity and the actual earnings paths. What would happen to the average profit rate and to the capital accumulation path based on that hypothetical profitability trajectory? As we show in Figure 4.4, the business 250 Real hourly compensation

230

Hourly labor productivity 210

Counterfactual real hourly compensation

190 170 150 130 110 90 70 50 30 1946

1951

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1976

1981

1986

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2021

Figure 4.3  U.S. actual trends of hourly labor productivity for all workers and real hourly earnings, plus a counterfactual trend of real hourly earnings located mid-way between the previous two, 1974 = 100, based on BLS PRS84006093 and PRS84006153.

116  Productivity and wages

Business Sector Average Profit Rate 19% 17%

Actual business profit rate

15%

Counterfactual profit rate

13% 11% 9% 7% 5% 3% 1% -1% 1947 1951 1955 1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003 2007 2011 2015 2019

Figure 4.4  U.S. real average profit rate and the counterfactual profit rate, had hourly earnings grow in an intermediate position between their actually repressed growth rate and the growth rate of labor productivity.

sector average rate of profit would have plummeted to unsustainable low levels if the full repression of employee compensation for production and non-supervisory workers had not materialized. The repression of the real hourly wages of production and nonsupervisory workers was necessary because the real hourly earnings of the supervisory contingent rose much more than the real hourly earnings of the majority (80 percent) of private sector’s employees since they kept up with productivity growth through the late 1990s (Figure 4.2). The separate earning paths between the production and nonsupervisory workers majority and the supervisory category would also indicate the necessity of earnings concessions to the ‘managerial’ class charged with the task of setting and enforcing the work rules. Their recent loss of earnings growth momentum, however, may indicate that only by reducing their share of total earnings could the value added that business appropriates be consistently raised, since further lowering of the real hourly earnings of the production and nonsupervisory employees creates more problems than it solves. After the mid-1980s, the FIRE sectors (finance, insurance, and real estate) became the driving growth poles of advanced capitalism. The rise of financialization made it possible for the profit share of the FIRE sector to rise as that of manufacturing diminished. From the standpoint of such collapse of profit rates, projecting that the prospects for high growth rates of real capital accumulation are bound to be weak, comes clearly across once we remove, from our profit calculations, the contribution to business profitability (as in Figure 4.4) made by the

Productivity and wages  117

25% 22%

Profit rate minus FIRE Counterfactual profit rate

19% 16% 13% 10% 7% 4% 1% -2% -5% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 4.5  U.S. similar paths for the counterfactual profit rate and the actual profit rate after excluding the FIRE sector, based on BEA Industry Data.

FIRE sectors. The average profit rate in Figure 4.5, calculated after excluding the FIRE sectors, appears to follow the same trajectory as the counterfactual profit rate derived from our hypothetical experiment. In our view, the conventional theories of secular stagnation, insofar as they ignore the persistent weakness of business profitability, deprive themselves of the most powerful argument to explain the problem. The ‘recovery’ from the Great Recession mainly took place in financial markets, while capital accumulation in the real sectors of the economy remained subdued. The long boom in the stock and property markets was sustained by the Federal Reserve’s determination to maintain interest rates near the zero bound. The real ‘investment dearth’ afflicting the nonfinancial sectors since 2009 shaped the lopsided ‘recovery’ path: euphoric financial markets provided the ‘wealth effect’ from rapidly rising asset prices and made up for the weakening effective demand of low business investment and falling labor productivity growth in nonfinancial sectors. By 2020, long periods of low growth or secular stagnation since 2009 (Summers, 2013a, 2013b) hollowed out the system’s supports and made it vulnerable to the ravages of the COVID-19 pandemic and the associated breakdown of effective macro-balances. The decline in labor participation rates, from 67.1 percent in 2000 to 63.1 percent in 2019, and 61.7 percent in 2021, led to the breakdown of global supply chains and to the Wall Street Journal asking on October 14, 2021 for the whereabouts of 4.3 million workers who withdrew from the labor force. Suddenly the specter of high inflation, becoming more acute in 2022 as an after-effect of the 2020 COVID-19 lockdowns, returned to challenge

118  Productivity and wages the Federal Reserve’s ability to keep financial markets from crashing while avoiding a new ‘stagflation’ outbreak (an argument we develop further in Chapter 11). References Banerjee, R. and Hofmann, B. 2018. “The Rise of Zombie Firms: Causes and Consequences,” BIS Quarterly Review, September. Baumol, W., Blinder, A. and Wolff, E. 2003. Downsizing in America, Russel Sage Foundation. Bivens, J. 2013. “Using Standard Models to Benchmark the Costs of Globalization,” Economic Policy Insitute, EPI Briefing Paper, March 22. Bluestone, B. and Harrison, B. 1982. The Deindustrialization of America, Basic Books. Bowles, S., Gordon, D. and Weisskopf, T. 1990. After the Waste Land, M.E. Sharpe. Bruno, M. and Sachs, J. 1985. Economics of Worldwide Stagflation, Harvard University Press. Buckland, R. 2014. “Investors are Right to Resist High Capex,” Financial Times, April 10. Dardot, P. and Laval, C. 2013. The New Way of the World: On Neoliberal Society, Verso. Evans, M. 1983, The Truth About Supply-Side Economics, Basic Books. Farjoun, E. and Machover, M. 1983. Laws of Chaos, Verso. Foss, M. 1963. “The Utilization of Capital Equipment: Postwar Compared to Prewar,” Survey of Current Business. Foss, M. 1981. “Long-Run Changes in the Workweek of Fixed Capital,” The American Review, Volume 71, No 2, pp. 58–63. Foss, M. 1985. Changing Utilization of Fixed Capital: An Element in Long-Term Growth,” Monthly Labor Review, May. Friedman, M. 1951. “Neo-Liberalism and Its Prospects,” Farmand/Human Events, February 17, pp. 89–93. Galbraith, J. 2014. The End of Normal, Simon & Schuster. Galbraith, J. 2016. Inequality, Oxford University Press. Greenspan, A. 2011. “Activism,” International Finance.March 2, https://doi​.org​/10​.1111​/j​ .1468​-2362​.2011​.01277.x Harriston, B. and Bluestone, B. 1988. The Great U-Turn, Basic Books. Heilbroner, R. 1986a. The Nature and Logic of Capitalism, W. W. Norton Heilbroner, R. 1989. “The Triumph of Capitalism,” The New Yorker, January 16. Kotz, D. 2015. The Rise and Fall of Neoliberal Capitalism, Harvard University Press. Kregel, J. 2018. “Minskyan Reflections on the Ides of September,” Working Paper, Levy Institute, September 14. http://multiplier​-effect​.org​/minskyan​-reflections​-on​-the​-ides​-of​-september/. Krippner, G. 2005. “The Financialization of the American Economy,” Socio-Economic Review, Volume 3, No. 2. Krippner, G. 2012. Capitalizing on Crisis, Harvard University Press. Krugman, P. 2009. “Depression Economics Returns,” New York Times, November 14. Musella, M. and Pressman, S. 1999. “Stagflation,” Encyclopedia of Political Economy, edited by P.A. O’Hara, Routledge. Powell, Lewis F. 1971. “The Memo,” Powell Memorandum: Attack on American Free Enterprise System. 1. https://scholarlycommons​.law​.wlu​.edu​/powellmemo​/1. Shaikh, A. 2016. Capitalism: Competition, Conflict, Crises, Oxford University Press. Sorkin, A.R. 2009. Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System: And Themselves, Viking Press.

Productivity and wages  119 Stedman, D. 2014. Masters of the Universe, Princeton University Press. Summers, L. 2013a. Speech at the IMF Economic Forum, 14th Annual IMF Research Conference: Crises Yesterday and Today, Nov. 8: https://www​.facebook​.com​/notes​/ randy​-fellmy​/transcript​-of​-larry​-summers​-speech​-at​-the​-imf​-economic​-forum​-nov​-8​ -2013​/585630634864563. Summers, L. 2013b. “Why Stagnation Might Prove To Be the New Normal,” Financial Times, London, December 15. Taylor, L. 2020. Macroeconomic Inequality from Reagan to Trump, Cambridge University Press. Tsoulfidis, L. and Tsaliki, P. 2019. Classical Political Economics and Modern Capitalism, Springer. Wood, A. 2017. “How Globalization Affected Manufacturing Around the World,” Center for Economic Policy Research, March. https://cepr​.org​/voxeu​/columns​/how​-globalisation​ -affected​-manufacturing​-around​-world. Woodward, B. 2001. Maestro: Alan Greenspan and the American Economy, Simon and Schuster.

5

Production, labor, and income trends

In previous chapters, we analyzed the historical trends of average profitability in the business sector of the U.S. economy from 1947 to 2020 and the evolution of its components, including the capital/labor ratio, net output per worker, aggregate labor share, and the production plus nonsupervisory employees’ labor share in net output. While major waves of fiscal stimuli raised capacity utilization and significantly increased the amplitude of profit cycles throughout the postwar period, the underlying profitability trend declined from its high point in the late 1940s. After the mid-1960s, its descent accelerated before reaching a trough in the early 1980s. We traced the structural factors that in the early 1970s led to the breakdown of the capital-labor accord and ushered in neoliberalism as a new configuration of the sectoral capital flows searching for yield. We have argued that the postwar capital-labor accord unraveled because falling profitability in manufacturing undermined the chief reason for its preservation. For nearly three ‘glorious’ decades this implicit class compromise provided the sociopolitical framework for the distribution of net value added in the business sector allowing for relatively high corporate rates of profits and robust rates of capital accumulation, as well as high rates of labor productivity growth, wage increases, and high employment levels. The slow but persistent fall of profitability after the late 1940s, however, became an accelerated cascade from the mid-1960s on, and its descent paved the ground for the stagflation crisis of the 1970s. The demise of the class compromise between capital and labor followed. The stagflation crisis threatened the system’s capacity for extended reproduction, signaling the historical exhaustion of the Fordist regime. After 1965, as profitability plummeted from its postwar highs and the prospects for extended reproduction faded, the pressure to transform the Fordist configuration into a neoliberal compact intensified. The postwar commitment on the part of managerial elites to rapid technological change translated into high levels of fixed capital investment that steadily raised the capital intensity of production. High growth rates of fixed capital per worker contributed to high rates of labor productivity growth but led to falling profitability, widespread bottlenecks, and the outbreak of stagflation. After the mid-1960s, the intractable pressures exerted by falling profitability on the existing structure of capital accumulation, from the corporate standpoint, undermined the viability of the industrial economy (Galbraith, 1978). The new consensus called for dismantling the Fordist industrial foundation and lowering the high rates of capital DOI:  10.4324/9781003413806-5

Production, labor, and income trends  121 accumulation in manufacturing that led to falling profitability across the economy. The high rates of capital accumulation achieved in the postwar period up to the mid-1970s initially reflected higher levels of profitability but, as the downward profitability trend persisted, lowered profit expectations eventually brought the accumulation rate down. From the managerial elite’s standpoint, the structural distortions and sector bottlenecks that flared up in the stagflation crisis of the 1970s were a manifestation of the unsustainable accumulation pattern of the postwar. The ineffective fiscal policies adopted to counter the emergence of stagflation highlighted the urgent need for the neoliberal transition. Decomposition of the compact expression for the profit rate



æ ö 1 - ç W/L ÷ Y/L ø p= P = Y-W = è K K æ K/L ö ç Y/L ÷ è ø

The profit rate, π, depends on the distribution of value added, that is, the relative strength with which capital and labor face each other as vying parties for the division of value added. After deducting the value transferred from constant and circulating capital value to the final product as depreciation, net value added combines the shares of wages and profits. Net value added consists of the combined movement of real hourly wages, W/L, and labor productivity, Y/L, real hourly output, times the total labor employed, L. The denominator of the profit rate formula reflects the trajectory of the capital/net output ratio, the path followed by the capital intensity of production, K/L, relative to that of labor productivity, Y/L. The structural variables whose evolution shapes the trajectory of the profit rate, π = Π/K, include the product of two ratios, the profit share in net value added, ρ = Π/Y, and the net output/capital ratio, κ = Y/K, π = (Π/Y)*(Y/K). A secular decline of the output/capital trend caused by the deployment of capital-intensive technical change in conjunction with high employment levels will bring the profit rate down unless rising profit shares (falling wage shares) increase sufficiently to block it. Business interests will favor capital intensive techniques first because that kind of technology allows managers to set the tempo of production according to the potential capacity of the plant and equipment used, and, secondly, because more automated technology renders the production process relatively independent from and hence immune to workers’ interference during bargaining disputes regarding wages and working conditions. In any case raising profit shares, (lowering wage shares in net value added) across the system involves weakening the bargaining position of labor and enhancing the power of capital, a transformation of the social relations of production. The profits-share depends on the strength of labor to receive its due share from the growth of labor productivity, (Y/L), real output value per hour of labor. The growth of labor productivity opens the space for the tug-of-war between capital and labor for the division of gains, a

122  Production, labor, and income trends contest of sociopolitical strength central to the determination of profitability trends. Profitability will fall if the real wage rate outpaces the growth rate of labor productivity and vice versa if it falls behind it: wage rates rising below productivity growth provide the basis for acceptable outcomes from the standpoint of capital and labor. The denominator in the profit rate’s expression, linking the rising trajectory of labor productivity growth to increasing mechanization and the spread of automation, brings out the crucial role played by capital-intensive technology and capital/net-output trends. The combined effect of both trends determines the movement of the profits mass and in conjunction with changes in the capital/output ratio, K/Y, the trajectory of profitability. Achieving higher labor productivity generally presupposes a rising capital/output ratio, and the theory of growing mechanization of production provides the structural link between the two variables. A rising capital/output ratio imparts downward pressure on profitability, regardless of the extent to which the growth in labor productivity is able to outpace the growth of wage rates. Real competition and the capital/output ratio Growing mechanization reflects the intrinsic drive of profit-driven capitals to secure and control all aspects of the labor process, seeking to raise labor productivity as a preliminary to lowering market prices below competitors’ reach. The theory of real competition, as presented in A. Shaikh’s Capitalism: Competition, Conflict, Crises (2016) provides the analytical framework necessary to interpret the market strategy pursued by industry leaders in their struggle against rivals to gain market share. In the pursuit of larger profits, industry leaders concentrate their efforts on cutting unit total costs. In each industry, cutting-edge firms seek to expand their market shares, vying against rivals for top positions, locked in combat with potential challengers across the global economy. In this war, success hinges on harnessing technological power to the winning strategy, lowering unit costs by raising output per hour of labor, and finally reducing the market price without lowering quality. Effective strategies seek to increase labor productivity sufficiently to allow innovators to reduce total unit costs before they are able to lower market prices. A successful competitive strategy achieves the desired goal of capturing the biggest possible market share when the rivals’ chances of challenging the results are nil. As in all wars, however, there are losses incurred in the battlefield. As in military conflicts, contenders select weaponry and technologies, allowing them to defeat their rivals, but they must pay a cost. Capital-intensive, labor-displacing technology allows firms to secure economies of scale, extend control over labor activities, rationalize every facet of production, secure uninterrupted performance, and crucially lower total unit costs. Deployment of automated capital-intensive techniques is viable, as long as a larger decline in total variable (largely labor) costs compensates for the increase in total fixed costs. After victory, however, success comes at an unavoidable cost in terms of lower profitability. Indeed, while the firms emerging victorious from these competitive battles will enjoy the highest profit rates in the industry, they will

Production, labor, and income trends  123 also experience the consequences of deploying more capital-intensive technology, as lower output/capital ratios depress their profitability. Lower average profit rates but higher market shares may deliver a larger mass of profits, hence compensation for the profitability loss. In addition, lower market prices will push out of business or render uncompetitive firms unviable for lack of sales, at the margin of bankruptcy, as ‘zombie’ enterprises. Taking into account the technological laggards on their way to extinction, the aggregate capital expenditures in the industry are likely to decline, as losing firms exit the industry. Hence in the aggregate, fixed capital accumulation may well decline, even though the leader’s deployment of capitalintensive technology raised the overall fixed capital/output ratio. Financialization: the neoliberal alternative The consolidation of neoliberalism gained momentum in the early 1980s after Paul Volker of the Federal Reserve raised interest rates, ostensibly to fight inflation. The policy attracted massive inflows of foreign capital contributing to ‘financialization,’ the rise of the financial sector, and its share of corporate profitability. The high interest rates that attracted foreign capital also provided the lever to empower financial markets to capture over 40 percent of corporate profits by 2002, five years before the outbreak of the 2007 Financial Crisis. After inflation subsided, unemployment expanded, and labor’s strength to bargain for higher wages diminished, the Federal Reserve’s policy reversal that lowered interest rates for the next three decades became the chief driver of financialization. Under neoliberalism, the capital gains accruing to the upper 20 percent of households who own the lion’s share of equity shares sustained financial markets’ euphoria and created the ‘wealth effect’ that propped effective demand in the 1990s. Under neoliberalism, the discretionary consumption spending of the ‘supervisory and nonproduction’ segment of employees replaced sharply falling rates of nonfinancial corporate investments. Indeed, the growth of banking, insurance, and real estate profits made up for the falling share of profits on current production in nonfinancial corporate sectors. The share of financial sector profits in all corporate profits increased from a little over 10 percent in 1965 to almost 20 percent in 1970. After falling to levels comparable to the mid-1960s in the early 1980s, the financial sector profit share in all corporate profits almost tripled in the early 1990s, reaching nearly 40 percent of all corporate profits in 2002. In the aftermath of the 2007–2009 ‘Financial Crisis,’ the profit share of financial corporate businesses still retained 25 percent of corporate profits and, after a few years, it resumed its climbing. On the other hand, since the mid-1960s, the long-run trend in capital accumulation of nonfinancial corporations declined substantially, and the descent was particularly sharp in manufacturing. In the neoliberal phase, the share of labor compensation, and in particular the share of ‘production and nonsupervisory’ labor compensation in the net value added of the private business sector, sharply contracted across all industries. After removing manufacturing from its role as the leading driver of capital accumulation, the neoliberal order downplayed the relative decline of nonfinancial corporate growth and, instead, deregulated financial activities in order to unleash the

124  Production, labor, and income trends full power of speculation in the pursuit of capital gains. The new financial architecture, built upon the unshakable confidence of the elites in the Federal Reserve’s ability to deliver expanding profits, sustained the growth of banks, insurance business, and real estate to unprecedented heights. The ‘wealth effect,’ tied to capital gains in financial markets, boosted demand for personal and business services, providing entry-level employment for workers made redundant in downsized manufacturing. The compression of wages: part one We interpret the structural changes underpinning the consolidation of neoliberalism as measures taken to reverse the falling long-term profitability trend that threatened the viability of future capital growth. From that critical premise, shifting income from wages to profits, the neoliberal transformation sought to achieve a favorable redistribution of net value added in order to restore confidence in the minds of corporate elites that the system’s capacity to grow remained viable. The measures taken to bring about this redistribution of net value added in favor of capital, including the compression of wage shares (‘earnings’), affected chiefly workers in the ‘production and nonsupervisory’ classification, which make up 80 percent of total employees, and they were not ad hoc responses to a cyclical decline in profitability. As the 1970s ended, the transition to a new configuration of the structural weights assigned to industry and services, financial and nonfinancial sectors, guided the need to raise profit shares, restore profitability, and ensure a vigorous pace of capital accumulation from then on. The income redistribution patterns that emerged in all advanced capitalist countries after 1980 confirmed the systemic pattern of wage shares compression that the protracted traverse to neoliberalism had intended to achieve. It is our contention that, absent the structural changes that ushered in neoliberalism, had the accelerated descent of profitability experienced after the mid-1960s continued unchecked, it would have led in the early 1980s to a system breakdown akin to a major depression. The dismantling of industrial U.S. corporations and the destruction of related labor unions preceded the expected repression of wages that finally took place under neoliberalism. Offshoring, the flight of investment abroad in search of cheaper labor markets, followed deindustrialization at home, while financialization strengthened the role of banks in the provision of household finance, as well as the underwriting of successive speculative waves and asset revaluation that placed the rentier elites at the top of the income pyramid. The Federal Reserve’s long-run reduction of interest rates to boost asset prices and expand the power of finance in the new structural configuration completed the consolidation of neoliberalism. The neoliberal reforms advocated to overcome the stagflation crisis sought to reverse the high rates of capital accumulation in manufacturing. While the Fordist manufacturing configuration expanded employment levels and promoted high rates of labor productivity and wages to rise in tandem, it failed to raise the profit share in new value added to counter the downward pressure on profitability of increasing

Production, labor, and income trends  125 capital/net output ratios. As a result, management investment plans increasingly shifted their aim away from upgrading the technical makeup of domestic manufacturing and instead searched for profitable opportunities overseas. The development of computer and information technology facilitated the global search for investment sites abroad, focusing on areas where lower wages prevailed but a disciplined labor force was available. The compression of wages: part two Starting in the early 1980s, the dynamics of capital accumulation in the neoliberal phase successfully reversed the rising wage trends of the postwar period, and even the employment boom of the 1990s produced the “great moderation” of workers’ expectations. Bob Woodward attributed the term “traumatized” worker to Alan Greenspan, who used it to portray the radical insecurity of the typical worker “who felt job insecurity in the changing economy and so was accepting smaller wage increases.” Greenspan reached this conclusion after “He had talked with business leaders who said their workers were not agitating and were fearful that their skills might not be marketable if they were forced to change jobs” (Woodward, 2001, p. 168). The shrinking share of labor compensation received by 80 percent of all employees, those classified as ‘production and nonsupervisory employees’ that we highlighted in Chapter 4, demonstrates the power of ruling corporate elites to effectively control the system’s income distribution in order to secure a higher share of new value added. In order to reverse the falling trend of the profit rate and achieve a significant compression of real wages, abandoning the postwar capitallabor accord reached in the late 1940s was a necessary but not a sufficient change. Accomplishing such a historic turnaround in the class relations of the neoliberal project required the long-term weakening of labor’s presence and power of craft unions, in fact, the actual shrinking of the labor movement as a whole. It is reasonable to relate the trends in union participation to the success of managerial strategies in weakening the bargaining position of organized labor. The decline in union density should be associated with higher profit shares, one being inversely related to the other. Historically rising labor union participation in collective bargaining resulted in strengthened wages and reduced profit shares. The strength of union participation, or lack of it, would provide a strong sign of the class power available for workers to resist managerial efforts to lower their income share. Reaching the long-run goal of raising profit shares required, and was associated with, falling ‘union density.’ Such inverse relationship is a reflection of managerial and capitalist class power to engineer the expansion of profit shares. A few years after Alan Greenspan spoke of ‘traumatized workers,’ in a New York Times article entitled “In Class Warfare, Guess Which Class Is Winning,” Ben Stein confided that meeting with Warren Buffet, known as the “Oracle of Omaha” for his business acumen, in conversation it came up that Mr. Buffett doesn’t use any tax planning at all. He just pays as the Internal Revenue Code requires. Even though I agreed

126  Production, labor, and income trends with him, I warned that whenever someone tried to raise the issue, he or she was accused of fomenting class warfare. ‘There’s class warfare, all right,’ Mr. Buffett said, ‘but it’s my class, the rich class, that’s making war, and we’re winning’. (Stein, 2006 ​) For a sophisticated analysis of the significance attached to the concept of class struggle, Losurdo provides a good foundation (Losurdo, 2016). As Figure 5.1 shows, the union density path from 1918 to the present, and that of the income compensation share of the wealthiest 10 percent of households, follow inverse trajectories. The top 10 percent is preponderantly comprised of wealthy shareholders, corporate managers, and executives. As we can see, the postwar years were relatively stable, both, in union density, and income shares of the 10 percent managerial elite. The 1930s and early 1940s were good for workers’ unions and bad for the income shares of the top 10 percent because these fell from a little over 45 percent to about 35 percent. After the mid-1960s, and especially after the early 1980s, in the neoliberal phase, the gap between the two trends steadily widened. It seems plausible to conclude that the changes in the income shares of the classes in the top 10 percent reflected their success or failure in containing the wage claims of the 80 percent classified as production and nonsupervisory employees, the majority of workers most likely to belong and benefit from union membership. The decline in union density, however, was not a positive change for labor productivity growth. Clearly, hourly labor compensation growth also experienced a protracted decline. As Figure 5.2 indicates, the deindustrialization process that ran parallel with the decline in labor union density took its toll on the growth of real 50% 45% 40% 35% Income shares of top 10 percent 30%

Union density

25% 20% 15% 10% 5% 1918 1924 1930 1936 1942 1948 1954 1960 1966 1972 1978 1984 1990 1996 2002 2008 2014 2020

Figure 5.1  U.S. income shares of top 10 percent and union density, based on unionstats​.co​ m, Historical Statistics of the U.S., and Piketty and Saez Top Income Database.

Production, labor, and income trends  127

9% 8% 7%

Business nonfarm labor productivity growth Hourly real labor compensation growth in business sector Union density ratio, measured on a 10 % basis

6% 5% 4% 3% 2% 1% 0% -1% -2% 1947 1951 1955 1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003 2007 2011 2015 2019

Figure 5.2  U.S. union density, productivity, and earnings growth, based on BLS PRS84006092 and PRS84006153.

hourly output. The structural transformation of the Fordist economy from the leading role of manufacturing to services played a decisive role in both developments. Labor unions predominated in manufacturing and are largely absent in the service sectors. Outside of financial services, personal and business services are laborintensive activities in comparison with manufacturing industries. Productivity growth is higher in manufacturing industries than in services. Real hourly compensation along with productivity growth is lower in services than in manufacturing. Capital per worker and capital/output ratios are lower in service activities than in manufacturing. The structural composition of profitability Figure 5.3 shows how all four variables under consideration behaved in two phases of the U.S. economy, from 1947 through the mid-1970s, the so-called Fordist phase, and thereafter, including a transitional stage from the mid-1970s to the early 1980s, before the consolidation of neoliberalism. In the Fordist period, all the variables under consideration grew pretty much in tandem, in the transition period their paths separated, and in the neoliberal phase, their paths separated much further from each other. The structural variables in Figure 5.3 include current cost real fixed capital value per hour of labor, real hourly labor productivity, real hourly employee compensation, and real hourly compensation of ‘production and nonsupervisory employees.’ From the late 1940s until the mid-1970s, these time series

128  Production, labor, and income trends

333%

% Change Relative to 1947

313% 293%

Increase in real net capital stock/hour of labor

273%

Increase in real net output per hour of labor

253%

Increase in all employees real hourly compensation

233%

Increase in real hourly compensation of production and nonsupervisory employees

213% 193% 173% 153% 133% 113% 93% 73% 53% 33% 13% -7% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 5.3  U.S. real nonresidential fixed capital growth, Fixed Assets Table 2.1 and NIPA Tables 6.9BCD; real growth of hourly labor productivity; real hourly earnings of all employees; and real hourly earnings of ‘production and nonsupervisory employees.’

of the U.S. economy changed at comparable rates, forming an integrated whole. After the early 1980s, however, that integration unraveled. In the early period, the growth paths of fixed capital, productivity, and earnings of all ‘employees’ grew in tandem as a whole and the earnings of ‘production and nonsupervisory’ workers followed a common trend. We attribute the breakup of this trend integration to the decline in profitability caused by the higher hourly real growth of fixed capital than the hourly real growth of labor productivity, as well as the rising hourly real employee compensation. We strongly emphasize the fact, however, that after the early 1980s, had all employees continued to receive compensation at the same rate as in the earlier three decades, the decline in profitability would have been catastrophic for the viability of capital accumulation. Accumulation was preserved because, after the consolidation of neoliberalism in the early 1980s, the wages of the 80 percent of all employees classified as ‘production and nonsupervisory’ bore the brunt of the wage compression. The wage repression of 80 percent of the workforce allowed the ‘supervisory’ 20 percent to avoid a drastic compression of their ‘earnings.’ The pressure on profitability, derived from the fast-growing fixed capital per worker, made the breakup of the integrated system inevitable. Real fixed capital per hour of labor relative to its initial value in 1948 increased more than the other measures because the stock of real fixed assets per hour of labor in the business sector rose the fastest, compared to the growth path of real hourly labor productivity right below it.

Production, labor, and income trends  129 We can therefore conclude that, after adjusting for capacity utilization, the longrun normalized trend of the capital/output ratio rose substantially relative to its value in 1948 and therefore exerted strong downward pressure on the profit rate. The labor productivity growth outstripped the overall growth path of real hourly earnings, and because of that, although the profit share rose to some extent, except in the period 2019–2020, it did not increase sufficiently to arrest the fall in profitability. The widening gap between the labor productivity curve and that of labor compensation provided a measure of the successful efforts to depress the labor share, especially after the late 1970s and early 1980s. But the path of real employee hourly compensation as a whole was dominated by the real earnings share of ‘production and nonsupervisory’ employees who make up around 80 percent of all employees. For these employees, their real hourly earnings rose in tandem with the system as a whole from the late 1940s until the mid-1970s. After that decade, their real hourly earnings fell steadily until the mid-1990s, when they began to recover the lost ground in previous years, but only to reach in 2020 the same level as they had in the early 1970s. The earnings dual track The reality contained in Figure 5.3 throws light on the gap in earnings separating 80 percent of the labor force from their nonproduction and supervisory elites. It shows that when the ‘earnings’ of all employees, the managerial and the rankand-file ‘production’ workers, are combined, the long-term trend of their earnings’ share in the business sector’s net value added in fact rose from the late 1940s through the year 2000. The decline that took place thereafter placed their share of net value added at the not much lower level of the 1970s. For the ‘production and nonsupervisory employees, however, after benefitting like all other ‘employees’ from a significant rise between the late 1940s and 1960, the share of earnings in the net value added of the business sector underwent a significant contraction from nearly 60 percent in 1960 to less than 40 percent in 2005. In light of the rising share of earnings in the aggregate, while 80 percent of that aggregate experienced a 30 percent decline of their earnings share between 1960 and the present falling profitability could be explained by rising earnings without first clarifying the role played by supervisory ‘employees.’ Compression of business sector compensation shares We have argued that the chief object of the neoliberal project centered on the reversal of the downward trend of postwar profitability caused by falling output/capital trends. Bringing about such path correction required increasing profit shares, that is, a compression of the system’s total wage compensation share. Judging by the evidence presented in Figure 5.4, however, the overall trend of business sector employees’ wage compensation share rose from about 63 percent in the mid-1960s to 71 percent in 2001 and its 5 percent retraction in the next twelve years placed it where it was in 1970. On this count, neoliberalism would appear to

130  Production, labor, and income trends

80% 75%

All business sector employees compensation/Business net value added Business sector production & nonsupervisory employees compensation/Business net value added

70% 65% 60% 55% 50% 45% 40% 35% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 5.4  U.S. all employees versus production and nonsupervisory employees’ earnings shares in business sector net value added.

have failed its mission, although a closer look at the data reveals a more nuanced conclusion. In the official statistics of the Labor Department, over 80 percent of the labor force is classified as production and nonsupervisory employees, and their wage compensation share, despite remaining lower than the overall labor share, after reaching a peak of 57 percent in 1973, experienced a drastic downturn away from the trajectory of the overall labor share. While from 1948 through 1973 the wage compensation share of ‘production and nonsupervisory employees’ paralleled the evolution of all employees’ shares, from 1973 to 2006 their wage compensation share in net value added steadily declined, settling at the 38 percentage share between 2005 and 2018. Thus production and nonsupervisory employees bore the brunt of the wage compensation compression while supervisory and management personnel only lost the gains made between 1985 and 2001. Figure 5.5 shows the BLS data for the evolution of labor productivity and real labor compensation. After the consolidation of neoliberalism in the early 1980s, the compensation of production and nonsupervisory workers failed to preserve the share of labor productivity growth received in the previous three decades. In our view, allowing the gap between the two paths to grow for over four more decades demonstrates the extent to which the repression of wage compensation was necessary from the standpoint of preserving the viability of the system’s extended reproduction. The necessity of wage compression to restore profitability It is our contention that the neoliberal changes that replaced the institutional structure of the postwar decades sought to reverse the falling profitability trend in order

Production, labor, and income trends  131

180 165 150

Index ratio of (real) labor productivity/average real hourly earnings of business sector employees Production & nonsupervisory compensation share in total private employee compensation Production & nonsupervisory employees share in total private employment

135 120 105 90 75 60 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 5.5  U.S. average hourly labor productivity/average hourly compensation of business sector employees; average hourly earnings of production and nonsupervisory employees as share of total private employee compensation; and share of ‘production and nonsupervisory employees’ in total private employment.

to prevent the breakdown of capital accumulation from triggering a devastating depression and a return to open class conflict. In that light, the neoliberal measures to restore profitability from its depressed levels in the early 1980s by means of the compression of compensation wage shares for over 80 percent of the lowerpaid ‘production and nonsupervisory’ workers successfully mitigated the decline of business profitability after the mid-1980s. Undoubtedly they added a historically significant breathing spell for capital’s elites to gain control of the accumulation engine. From the early 1980s through 2019, however, the profit rate did not return to the high levels of the 1970s and did not approach its high postwar levels; it is clear that the measures taken to shape the neoliberal regime did not prevent the collapse of capital accumulation in the aftermath of the Great Recession of the 21st century. After the early 1980s, the actual profit rate in the business sector recovered somewhat from the sharp decline experienced after the mid-1960s, but it never regained the levels achieved in the previous three decades. Thus the profit rate at the highest point of this recovery in the mid-1980s rose marginally above the recession level of 1958. From 1983 to 2009 the recovery path unfolded in three cycles, from 1983 to 1991, 1991 to 2001, and 2001 to 2009. After each of the second and third cycles ran their course, the ending trough fell lower than the previous one. A decade after 2009, extraordinary monetary and fiscal policies prevented the profit rate in the business sector as a whole from turning lower, even though in the corporate and nonfinancial corporate sectors of the business economy, the profit rate

132  Production, labor, and income trends sharply declined from 2013 on. With the exception of the upturn in the mid-1990s, the accumulation rate in the business sector continued the downward trend initiated in the mid-1960s, collapsed in the 21st century, and remained lower than in any previous accumulation cycles thereafter. After the 2009 recovery from the financial crisis, the accumulation rate never rose above levels previously reached during former recession episodes. Without the drastic compression of real wages for the majority of ‘production and nonsupervisory employees,’ the profit rate in the business sector of the U.S. economy would have declined to levels incompatible with the maintenance and continuation of the profit system. As we showed in our Figure 4.4 with the counterfactual path of wages, any compromise with the actual compression of wages, say at mid-distance between productivity and the actual wage path, far from letting wages rise in tandem with productivity, would have brought the profit rate in 2019 within the one percent range. The repression of wages, instead, allowed the actual profit rate to meander, with a slight downward tilt, within the 8 percent range. OECD profitability trends We found trends in the advanced capitalist countries of the OECD (The Organization for Economic Cooperation and Development) that replicate those running through the U.S. economy. On the whole, however, their study is made more onerous because outside the U.S. their data collections are much less comprehensive. By and large in most cases rising labor productivity is associated with a falling (net) output/fixed capital trend known to neoclassical economists as ‘capital productivity.’ This is so due to the fact that in order to empower labor to increase hourly net output usually more capital-intensive methods are necessary before lowering prices to undersell competitors. We are grateful to acknowledge A. Marquetti’s comprehensive extension of the latest World Penn Tables, the “Extended Penn World Tables 7.0,” as an indispensable data source for key components of comparative studies of advanced capitalist economies, now extending from 1950 to 2019. The Extended Penn World Tables are available on Professor Duncan Foley’s personal homepage (https://sites​ .google​.com​/a​/newschool​.edu​/duncan​-foley​-homepage​/home​/EPWT). Marquetti and his collaborators provided the basic data on capital stocks for OECD members that enabled us to extend our estimates beyond the U.S. economy. Figure 5.6 shows that in the seven OECD countries that experienced rapid industrialization in the 1950s, including Canada, France, Germany, Italy, Japan, Spain, and the U.S., their relatively high initial output/fixed capital ratios rose to a peak in the late 1960s from which they sharply declined in the 1970s. With the spread of neoliberal structures in the 1980s such as financial globalization in the U.S. and a slowdown of capital accumulation in others, output/capital ratios flattened in the 1980s but from the 1990s on, they resumed their long-term decline and continued to fall in the 21st century. As technical progress spread throughout the system, the falling output/capital ratios reflected the growing intensity of capitalist production and, in our view, the evolution of these ratios stands on firmer empirical grounds than Kaldor’s fictional ‘stylized facts’ to the contrary.

Production, labor, and income trends  133

0.54 0.51

Canada

0.48

Italy

Germany Japan

France Spain

US

0.45 0.42 0.39 0.36 0.33 0.30 0.27 0.24 0.21 0.18 0.15 1951 1955 1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003 2007 2011 2015 2019

Figure 5.6  Output/capital ratios in seven OECD countries: Canada, France, Germany, Italy, Japan, Spain, and the U.S., based on Marquetti Extended Penn World Tables 7.0, 1951–2019.

Because generally the long-term falling trend of the output/capital ratio dominates the evolution of profitability, the decline of average profit rates in seven advanced capitalist countries shown in Figures 5.7 and 5.8 follows a common pattern. Our profitability estimates for the seven OECD countries, as well as China, are based on data from the official Penn World Tables, ver. 10 (not Marquetti’s extension). We included China’s average profit rate because the trajectory of its average profit rate is so singularly close to that of the U.K. and Italy and yet they are, literally, worlds apart. These average profit rates in Figures 5.7 and 5.8 confirmed the existence of two distinct phases in the accumulation of capital. Profitability rose from the early 1950s through the mid-1960s, spurring the accumulation of capital in all cases. In the second phase, stretching from the early 1980s to the present, the profit rate is much lower and the rate of capital accumulation distinctively smaller. Finally, in the case of China and the U.K., the spectacular decline in profitability throughout the first three decades of the postwar period, suggests the presence of major systemic breakdowns in capital accumulation. In the 1980s, the recovery of profitability did not match the levels experienced in the previous two decades. Finally, Figure 5.9 shows evidence that the OECD’s long-term tendency of the output/capital ratio to fall spurred systemic pressures by corporate elites to counteract its depressing impact on profitability. Measures designed to raise the profits’ share in GDP required labor-saving technical change and further compression of labor’s wage shares. Once again, Figure 5.9, using AMECO data, shows the relevant signs of two distinct stages in the evolution of advanced

134  Production, labor, and income trends

43% 38%

Germany Japan

France Spain

Italy

33% 28% 23% 18% 13% 8% 3% -2% -7% 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 2020

Figure 5.7  Average profit rates in selected OECD countries: France, Germany, Italy, Japan, and Spain, based on AMECO and OECD Economic Outlook.

23% 21% 19%

UK average profit rate China average rate profit rate Italy average profit rate

17% 15% 13% 11% 9% 7% 5% 1951 1955 1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003 2007 2011 2015 2019

Figure 5.8  Average profit rates in China, Italy, and the U.K., based on Penn World Table, version 10.0.

Production, labor, and income trends  135

85% Japan

80%

France

Germany Italy

Spain

75%

70%

65%

60%

55%

50% 1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

2020

Figure 5.9  Wage shares in selected OECD countries’ GDP, based on AMECO data.

capitalist countries. In the first phase, we find generally constant wage shares between 1960 and 1980. Since 1980, wage shares in these major OECD countries have been falling. The most recent exception reflects the emergence of COVID19 and the withdrawal of many workers in the supervisory contingent from inperson work. The AMECO data bank, from which we took the relevant data, does not include such distinction as is available in the U.S. between ‘production and nonsupervisory’ personnel and the better-paid ‘supervisory’ component of all ‘employees.’ Without such distinction in the data, we chose to apply it in relation to GDP, even though we are aware that depreciation charges or the ‘capital consumption’ share of GDP rose, precisely because of the business preference for automated, capital-intensive methods of production. Nevertheless, the distinction between the two stages appears clearly, separating the first 20 years from the next 40. In the first 20 years, wage shares held their ground, and in the following 40, they declined, highlighting the pressure on wage shares to fall built into the neoliberal order. As we show in Figure 5.10, the nonresidential fixed capital accumulation rate in five selected advanced capitalist countries for which data was available in AMECO attained very high levels in the 1960s and 70s. Their trajectory, from 1960 to 2020, largely paralleled that of the corresponding profit rates in Figures 5.7 and 5.8. After 2008, profit rates reached their lowest level, ranging from less than 5 percent to slightly over 7 percent. The reality of secular stagnation, closely related to low profitability and low accumulation rates, appeared to define the late stage of development reached by advanced capitalist countries after the Great Recession.

136  Production, labor, and income trends

20% 18% 16% France

14% Italy

12%

Germany Japan

Spain

10% 8% 6% 4% 2% 0% -2% -4% 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 2020

Figure 5.10  Capital accumulation rates in France, Germany, Italy, Japan, and Spain, 1960– 2020, based on AMECO and OECD Economic Outlook.

References Galbraith, J. K. 1978. The New Industrial State, Houghton Mifflin. Losurdo, D. 2016. Class Struggle. A Political and Philosophical History, Palgrave Macmillan. Shaikh, A. 2016. Capitalism: Competition, Conflict, Crises, Oxford University Press. Stein, B. 2006. “In Class Warfare, Guess Which Class Is Winning,” The New York Times, November 26. Woodward, B. 2001. Maestro: Alan Greenspan and the American Economy, Simon and Schuster.

6

The deindustrialization quagmire

We argue in this chapter that falling profitability in manufacturing propitiated the downsizing of its footprint in the national economy and spurred the transition to neoliberalism, a reordering of sectoral priorities in which financial profits and financial investments rose and nonfinancial profits and real investment declined along with overall GDP growth. The singularity of the postwar experience From the late 1940s until the early 1970s high levels of fixed capital expenditures in the manufacturing sector of the U.S. economy led to rising labor productivity that, for extended periods, sustained near full labor employment. As a consequence of the relative improvement in working conditions, and keeping up with labor productivity growth, the strengthened bargaining position of labor managed to secure earnings growing in tandem with labor productivity—not only for employee aggregates but also including the earnings of supervisory as well as production and nonsupervisory employees. In the same period, however, the growth trend of real fixed capital per hour of labor surpassed the growth trend of labor productivity and, as such, this trend proved to have system-wide repercussions. Undoubtedly, the growing intensity of production methods, implied in the faster growth of fixed capital relative to productivity growth, underpinned the rising trend in labor productivity, but along with a rising fixed capital/net output ratio and a relatively stable profit share, it brought about the declining trend of the manufacturing corporate average profit rate. In the postwar period, technological progress played a decisive role in the outcome of real competitive wars that pitted global manufacturing corporations against each other across national boundaries and, in the context of free trade, offered no protection from market invasions. Shaikh’s concept of ‘real competition’ is diametrically opposed to the neoclassical theory of ‘pure competition,’ in which firms passively accept the price dictated by the market and adjust production levels according to their marginal cost schedules. In the ‘real competition’ perspective, firms do not passively respond to the market price but, instead, behave as combatants in a war for market shares along similar lines to those that apply in a shooting war. Rival firms vie with each other to introduce the most effective capital-intensive cost-cutting technology that would allow them to lower unit total DOI:  10.4324/9781003413806-6

138  The deindustrialization quagmire costs sufficiently to gain leverage and push rivals out of business. It is a struggle to gain market share by lowering unit prices and achieving higher sales of the best quality goods. In pursuit of higher market shares, industry leaders seek to destroy rivals’ capacity of becoming an effective threat, even if doing so involves a lower market price (after reducing the unit cost) that causes the transitional average profit rate to fall. Winning the struggle for higher market share compensates market leaders for the relative loss in profitability caused by lowering the product’s unit market price to a level that rivals cannot match. In the tradition of Classical Political Economy, we have argued throughout this book that the strength and evolutionary trajectory of capital accumulation reflects the level and long-term trend of average business profitability. From this perspective, the fall in manufacturing profitability experienced since the late 1940s explains its eventual downsizing in the 1970s that paved the way for the comprehensive deindustrialization that followed in the 1980s and 1990s. As a result, the Schumpeterian process of ‘creative destruction’ was reversed, as the ‘destruction’ part preceded the establishment of the neoliberal order where advances in information technology guided the growth of financial markets, and services rather than manufacturing provided employment. As Figures 6.1 and 6.2 show, under neoliberalism the share of corporate profits allocated for purposes other than fixed capital investments sharply increased and, correspondingly, the share directed to finance plant and equipment declined. The share of financial profits relative to all corporate profits rose from less than 10 percent in the late 1940s to nearly 40 percent in 2002 before settling down to over 25 percent in the aftermath of the

70% Manufacturing profits share in corporate profits

60%

Financial corporate profits share in corporate profits

50%

40%

30%

20%

10%

0% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 6.1  U.S. structural change in the business sector: manufacturing share of corporate profits versus financial share of corporate profits, based on NIPA Tables 1.14 and 6.16BCD.

The deindustrialization quagmire  139

120% 110% 100%

Equity buybacks plus net interest and net dividends/Net operating surplus Net fixed investment/Net operating surplus

90% 80% 70% 60% 50% 40% 30% 20% 10% 0% -10% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 6.2  U.S. nonfinancial corporate shares of financial flows including interest payments, equity share buybacks, and dividends in net operating surplus versus shares of net fixed capital investment in net operating surplus, based on Flow of Funds FA103164103.A, FA105013005.A FA106300005.A, and NIPA Table 1.14.

Great Financial Crisis of 2007–2009. Between the late 1940s and the early 1970s, nonfinancial corporations spent about 25 percent of their net operating surplus on interest charges, dividends, and equity share buybacks. The spending share of net fixed capital investment started at about 20 percent on average from the late 1940s through the early 1960s. That figure doubled by the late 1960s, reaching nearly 45 percent of their net operating surplus in 1980. From that date to 2020, the share of net investment in nonfinancial net operating surplus declined, except in the second half of the 1990s, when it recovered to a peak of 40 percent in the year 2000. From that peak, however, it plunged to about 15 percent in 2020. Deindustrialization and globalization As we show in Chapter 5, major manufacturing corporations sought to reverse the decline in profitability with a frontal attack on wage costs achieved through ‘downsizing’ the productive capacity of their major plants, and offshore relocation to countries with a low-wage labor force. Deindustrialization leveled the big and powerful manufacturing corporate structures and weakened the foundations that supported industrial labor unions in negotiation for higher wages (Freeman, 2018). It is tempting to conclude that technical advances in information technology and computer power brought forth the necessary means to manage global chains of production from a corporate center and, therefore, the management of global

140  The deindustrialization quagmire corporations did not feel circumscribed to any particular geographic center. In other words, technological progress in management systems led the way for changes in the social and geographic conditions of production that followed (Howard and King, 2008). In our view, while the evolution of technical change and profitability proceeds jointly, profitability trends played a decisive role in the nature of the forthcoming structural changes. The corporate ‘downsizing’ applied chiefly to the breakup of large concentrations of recalcitrant workers seeking to preserve their bargaining power and negotiate wages and working conditions. Large corporations remained and grew larger and more powerful, but only because they managed to scatter their labor force across multiple geographic centers and layers of supply chains without a common institutional foundation (Harrison, 1997). It is clear that, as historian Joshua Freeman argued, The giant factory may have reached its apogee…many manufacturers have moved in other directions seeking to lower labor costs and avoid the possibility that—as has happened in the past—their workers will take advantage of the concentration of production to assert their power. (Freeman, 2018, p. 317) Deindustrialization in the U.S., and expansion of direct foreign investments in lowerwage countries, sought to lower the price of wage-goods in order to mitigate the impact of falling wage shares on ‘production and nonsupervisory employees’. The serendipitous growth of the demand for services largely due to the discretionary spending of ‘supervisory’ elites endowed with much larger incomes than those accruing to rankand-file workers spurred the expansion of services that, using labor-intensive technologies, provided employment to workers made redundant in the manufacturing sector. Along with the superstar corporations in the information technology sector that enjoy high rates of labor productivity growth, a large segment of service firms consolidated their business practices to create a dual structure in the national economy. As the deindustrialization process gained momentum, the rise in the share of services, the expansion of financial activities, and the decline in nonfinancial capital accumulation combined to significantly reduce hourly labor productivity growth. The decline of nonfinancial capital accumulation rates brought on by the sharply falling rate of profit in the 1970s continued unabated in the 1980s and collapsed in the first two decades of the 21st century. Even though nonfinancial corporate falling profitability bounced back somewhat from its 1982 trough, it never recovered the levels attained in the 1970s. When the Great Recession of 2007–2009 ended, the growing weight of the service sector in the share of net value added and employment confirmed the emergence of a dual economy, consisting of a small advanced information technology sector, side by side with a labor-intensive sector providing services in restaurants, hotels, and entertainment that slowed down the system’s growth dynamics. Starting with the neoliberal reforms of the 1980s, the contraction of manufacturing activities and the expansion of finance and personal services introduced structural barriers to growth that reinforced the depressing force of low profitability and paved the way for the emergence of secular stagnation.

The deindustrialization quagmire  141 Stagflation and the manufacturing crisis Disregarding the impact of capital-intensive technical change on profitability and the dynamics of inflation, Keynesian economics failed to account for the stagflation crisis of the 1970s and lost the credibility it gained in the postwar years. The behavior of profit rates depends on the combined movement of profit shares and output/capital ratios, thus the profit rate,

p=

P æPöæY ö = K çè Y ÷ø çè K ÷ø

Falling profitability may reflect either the decline in the profits share, Π/Y, or the decline in the net output/capital ratio, Y/K. With both ratios falling, the decline in profitability is much harder to reverse and its impact on inflation stronger, unless the rate of accumulation declines. Keynesian economics generally ignores issues of new value added distribution, or changing capital-labor coefficients, focusing instead on fluctuations in effective demand. We show empirical evidence that the average profit rate in manufacturing industries, the flagship sector of the U.S. postwar economy, fell substantially in the postwar heyday of U.S. capitalist development. In Classical economics, profitability drives the rate of accumulation, but the relationship between the profit rate and the accumulation rate is one of mutual dependence. The profit rate at any given time measures the growth of capital value initially deployed after the circuit of capital is completed. In a regime governed by internal finance, the available sum of money initially converted into means of production (machinery) and hiring of the workforce (labor-power in Marx), derives from the profits accrued in the previous time period of the capital circuit. The maximum rate of accumulation at any time depends on the profit rate accrued in the previous round of the capital circuit, and investment at a given time, It, depends on the available profit mass obtained earlier, Πt-1, hence, the maximum rate of accumulation implies the ratio (It/Πt-1) = 1. A falling output/capital ratio would require a rising profit share to prevent the profit rate from falling, and falling profitability would provide no incentive to increase the rate of accumulation, but rather to reduce capacity utilization. In those circumstances, the weakest marginal firms operating with higher unit costs will shrink output the most, leading to the substantial laying off of workers. Their contraction, in turn, will affect the aggregate industry supply, creating bottlenecks and shortages that, at some point, will lead to rising prices. Deficit financing and the use of external credit when profit rates are falling, or remain low, will not induce firms to expand, instead, pressures will mount for prices to rise. Falling profitability will shrink aggregate employment and output, on the one hand, while deficit spending, private or public, will increase effective demand and set off inflationary pressures. The emerging imbalance between falling profitability, causing some firms to cut back output and employment, and deficit-financed investment in other firms, raising effective demand, will lead to inflationary bottlenecks unanticipated in Keynesian economics.

142  The deindustrialization quagmire Three decades of unprecedented high profit rates drove the rapid capacity expansion, productivity, and employment growth rates that characterized the industrial economy before it all ended in the intractable stagflation crisis. It is our contention that a theoretical understanding of the origins of the stagflation crisis of the 1970s is possible only when the long-term dynamics of capitalism are examined through the lens of Classical Political Economy as demonstrated in A. Shaikh’s magisterial treatise on Capitalism: Competition, Conflict, Crises (Oxford University Press, 2016). In our view, the Classical theory of inflation is organically connected with that of falling profitability. A coherent explanation of the 1970s stagflation crisis outside the conceptual framework of the neoclassical synthesis, or the Keynesian perspective on effective demand, needs to account for the simultaneous increase of inflation and the growth of labor unemployment. From the standpoint of the conventional Keynesian perspective, inflation rises only after aggregate demand has reached the full employment level. Following Shaikh’s approach, however, the inflation growth rate reflects the evolution of the investment/profits ratio, I/Π. As the investment level approaches the maximum volume of profits, the system attains its maximum growth with increasing difficulty. Well before the accumulation rate rises to equality with the profit rate, the system’s potential growth, measuring the actual growth relative to its maximum feasiæ I ö çK÷ ble value, t = è ø = 1, will signal the growing difficulties found in approaching æPö çK÷ è ø the potential full-capacity growth, by way of emerging partial bottlenecks and shortages. Maladjustments reflecting interindustry input-output imbalances caused by the uneven growth of unequal profitability, firms in each sector will clog or retard the overall output growth and, instead, give rise to price inflation. For firms experiencing average profitability, those shortages and bottlenecks will increase their input costs and hinder their ability to expand output in response to increasing effective demand. As Shaikh summarized, his theoretical approach to inflation, if the normal-capacity rate of profit were falling, as it has done for most of the post-war period in the United States, then one would expect growth rates of capital (which depend on expected profitability of investment), also to fall. But if the accumulation rate fell more slowly than the profit rate, the throughput coefficient (which is the ratio of the former to the latter) would rise. In this way it becomes possible to understand how falling profitability can induce both rising unemployment through slowed growth and also increased inflationary pressure. (Shaikh, 1999, pp. 89–105) In the 1970s, absent a coherent theory explaining the connection between stagflation and the crisis of industrial profitability, widespread unease and vanishing confidence in the viability of the established order prevailed,

The deindustrialization quagmire  143 we all know that around 1970 something very important changed, making us believe that we have since crossed a fundamental divide. It is no longer automatically possible to believe in a future climate of unlimited growth and development. We are aware of our precarious situation in the world economy, to a large degree because the resources we believe to be necessary are in fact only available increasingly from foreign nations. (Veysey, 1982, p. 68) Seemingly uncontrollable stagflation and rising unemployment, along with the unexpected incapacity of Keynesian policies to palliate its effects, shattered the socioeconomic compromise that characterized the Fordist phase of capital accumulation. The crisis heightened the sense of structural breakdown and reverberated well beyond the boundaries of corporate boards to reach broad public awareness. In our view, the radical restructuring of the U.S. economy that followed the stagflation outbreak in the 1970s reflected the emergence of a consensus among business and power elites around the need to overhaul the established patterns of capital accumulation. The hitherto reputable neo-Keynesian synthesis failed to produce theories or policies capable of ending the scourge of rising unemployment and inflation. The dark forebodings unleashed by sharply falling profit rates on the expectations of the manufacturing sector undermined business confidence and increased uncertainty of the prospects for recovery. The spreading economic malaise prompted the dismantling of existing industry as the first step toward the construction of a neoliberal order capable of rescuing profitability. Soon enough, the financialization of the corporate sector emerged as the leading candidate for the transition to neoliberalism. The consolidation of the neoliberal project involved downsizing the unprofitable industrial behemoths of the postwar period and replacing them with smaller but profitable enterprises while enlarging the role of banks, the stock market, and services. The expansion and promotion of personal services, as a natural extension of the production of goods, attracted the massive entry of women into the labor market and facilitated the consolidation of the neoliberal regime. In the early 1980s, Paul Volker justified raising interest rates to unprecedented levels as a first step in the fight against inflation, providing the magnet necessary to attract and steer major flows of global capital into financial assets. The post-industrial ideology Projecting the deindustrialization drive underway into the future, Daniel Bell in 1973 forecast the actual transition to a post-industrial society to be completed “in the next thirty to fifty years” (Bell, 1999, p. x). Bell interpreted this transformation to be a major structural change, moving away from a society dependent on industrial activities to one ruled by scientific and engineering priorities that never materialized outside information technology to the wide-open expansion of service sectors. In our view, Bell totally missed the nature of the changes that transformed the structure of capital accumulation from a robust Fordist foundation, with large manufacturing at its center, into the quagmire of financialization: finance,

144  The deindustrialization quagmire insurance, and real estate (FIRE). The new structure repeatedly triggered systemic breakdowns after the 1980s, and the personal services sector gainsaid all efforts to raise labor productivity for long periods, thus contributing to secular stagnation. As the stagflation crisis of the 1970s deepened, Bell’s book articulated the ideological support needed for the transition from new-deal institutions to neoliberalism. Despite sharp criticism from other sociologists, who pointed out that, as formulated, its message “is not unified in the sense of presenting a linearly developed and integrated thesis,” according to Marvin Olsen in his review of Bell’s book (Olsen, 1974, pp. 236–241), eventually, the concept of the post-industrial society carried the day. Bell’s main concern throughout his book was to identify changes in the socioeconomic structure created by technological change to replace the role of industrial labor at the center of manufacturing with more compliant elites of scientists, engineers, managers, etc., in order to conjure away the risk of industrial strife and slay, once and for all, the specter of socialism. As Morris Janowitz pointed out in his review of Bell’s book, there was no question that sociologists saw Bell “Building on the observations of Michael Oakshott, Raymond Aron, Edward Shils, and others, he came to be regarded as an opponent of socialism” (Janowitz, 1974, pp. 230–235). Bell projected “a shift from goods producing to a service economy, a move in occupational distribution away from manual labor to the preeminence of professional and technical work” (Dyer-Witheford, 1999). Bell’s sentiments here ran parallel with the views of John Galbraith on technocratic management and his view of the New Industrial State. In our view, Bell’s ability to theorize the consequences of downsizing manufacturing industry and expanding services failed to account for the major developments that, instead, led to the consolidation of neoliberalism and opened the way to secular stagnation in that period. From our standpoint, Laurence Veysey is justified in concluding “The important question is not whether the prophets of post-industrialism saw the future correctly, for it is by now clear, in an era of contracting possibilities, that their vision of the future was ludicrously optimistic” (Veysey, 1982, pp. 49–69). We find, however, prescient Bell’s intuition, that “The change from goods to services…in a postindustrial society…(principally in health, education and social services)…The expansion of these services…becomes a constraint on economic growth” (Bell, 1999, p. xv), because “the simple and obvious fact is that productivity and output grow much faster in goods than in services” (ibid., p. 155). This is a profoundly accurate observation of the unintended consequences found in the transition. In fact, we contend that the gutting of manufacturing and the expansion of services brought about structural changes in the U.S. economy that in themselves provided the foundations for secular stagnation. In this context, it is relevant to observe that an increasing share of the workforce, now approaching 50 percent, is laboring in service activities subject to very small gains in labor productivity and wages. On the other hand, the impact of high productivity growth in manufacturing continues to underlie the shrinking share of its new value added in the overall economy.

The deindustrialization quagmire  145 As the Fordist configuration of manufacturing-driven growth gave way to the sectoral transformation of neoliberalism, corporate elites saw the capital-labor compact prevailing in the postwar period as constricting the means to achieve higher profit shares and a stronger competitive stance. In the first three decades of the U.S. postwar economy, the growth sector of the New Industrial State (Galbraith, 2001, pp. 55–90) centered around the manufacturing corporate sector, exhibiting “vertically integration with emphasis on marketing and raw material procurement, and horizontal combinations involving pools, trusts, and holding companies” (Averitt, 1968, p. 9). These corporations successfully carried out long-term investment planning with a view to survive any crisis and to expand “in perpetuity.” Profitability levels remained quite high even though falling from their postwar peaks, leading mainstream economists like Paul Samuelson and others to popularize notions of capitalism having evolved into a ‘mixed economy.’ This conceit gained such prominence that increasingly popular views extolling corporate and economy-wide planning gained popularity by avoiding any reference to ‘capitalism.’ The high tempo of accumulation that underpinned the relatively high employment levels achieved, in the end reached its structural limits once the depressing impact of rising capital/output ratios on profitability exerted its full weight counteracting that of the increasing profit share. In these conditions, as falling profitability threatened the viability of capital accumulation, the institutional framework that promoted the capital-labor accord became incompatible with the determination to raise profit shares in order to reverse the falling profit rate. As we argued earlier, from the standpoint of the managerial elite, radically weakening the bargaining position of labor to overcome the quagmire of falling profitability called for concerted action. Preserving the viability of capital accumulation required the dismantling of the industrial platforms that provided the bargaining scaffold for industrial labor unions. Our general argument runs directly contrary to John K. Galbraith’s central claim, made in the 1967 edition of The New Industrial State, that “Profit maximization is inconsistent with the behavior of the technostructure in the mature corporation” (Galbraith, 2001, pp. 80–81). Distancing himself from the profits imperative, even by name, Galbraith in his 1963 essay “Economics and the Quality of Life” bemoaned the fact that the “economic condition must be the dominant influence on social thought and action” (ibid., p. 90). He saw the economic system as serving society’s interests, not the other way around, We have developed an economic system of great power. We have reason to be grateful for its achievements. But it has its purposes and it seeks naturally to accommodate people and the society to these purposes. If economic goals are preoccupying, we will accept the accommodation of society to the needs of the great corporations” and therefore we ought to question “the commitment to economic priority. (ibid., p. 101) As we know in hindsight, the system’s pursuit of profits prevailed under neoliberalism as it did in its preceding phase even though, despite the wrenching transition to neoliberalism, the full reversal of profitability trends did not materialize.

146  The deindustrialization quagmire As Richard McCormick of The American Prospect summed up, the record of 42,400 factories closing since 2001, including “36 percent of factories that employ more than 1000 workers…and 38 percent of factories that employ between 500 and 999 employees,” he decried losing A once-robust system of ‘traditional engineering’—the invention, design, and manufacture of products—has been replaced by financial engineering. Without a vibrant manufacturing sector, Wall Street created money it did not have and Americans spent money they did not have. Americans stopped making the products they continued to buy: clothing, computers, consumer electronics, flat-screen TVs, household items, and millions of automobiles. (McCormick, 2009) McCormick is at a loss to explain why did it happen, but suggests that the loss of manufacturing profitability was responsible for prompting the overhaul that followed. We shall deploy empirical evidence showing that, after the sharp profitability downturn initiated in the business and manufacturing sectors of the U.S. economy from the mid-1960s to the earlier 1980s, closing plants and disbanding labor unions were measures designed to lower the labor share in manufacturing and all other sectors of the economy. As an unintended consequence, however, the offshoring and replacement of manufacturing production with financial activities and services that characterized the consolidation of the neoliberal phase, in the long run undermined the productivity growth of the system and led to a significant decline in its long-term growth path, the hallmark of secular stagnation. In contrast with Galbraith’s liberal flight-of-fancy, including his reference to the “economic priority,” Schumpeter’s identification of “The Capitalist Economic Process” as the “profit economy” is a view less mystifying than Galbraith’s and closer to our own perspective. Schumpeter distinguished between two kinds of societies, a profit economy and a socialist economy. Schumpeter clarified the difference between those two economies: In the organization of the profit economy as well, the social whole engages in economic activity for the social whole, but this no longer happens as it does in the socialist economy, by the social whole, but by the interlocking of individual or ‘sub-group’ motives and initiatives. (Schumpeter, 2014, p. 113) Of course, the individual motives and initiatives vary, but the “profit economy” anchors the multitude of separate interests onto the scaffold of profits and the Classical law of value then applies. Instead, Galbraith’s early 1960s concerns with the importance of quality-of-life improvements prematurely anticipated the fulfilment of Keynes’ 1930 musings that “the economic problem may be solved, or be at least within sight of solution, within a hundred years” (Keynes, 1932; 2015, p. 81). In the last chapter of his General Theory, we find Keynes’ declaring to “feel sure that the demand for capital is strictly limited in the sense that it would not be

The deindustrialization quagmire  147 difficult to increase the stock of capital up to a point where its marginal efficiency had fallen to a very low figure.” Keynes admitted to not being particularly concerned if such trends continued, “yet it would mean the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital” (Keynes, General Theory, chapter 24, section 2). Instead of celebrating the “euthanasia” of rentiers, declining profit rates in manufacturing and the business sector, along with falling financial markets, the 1970s ended with the shrinking of the manufacturing share of aggregate value added; the contraction of the compensation share of production and non-supervisory compensation in net value added. As financialization advanced, the “apotheosis” of the rentier class replaced its projected “euthanasia.” Falling net output/net capital stock ratios in manufacturing As Figure 6.3 shows, the decline in the share of net output in net capital stock (net sector’s income/current cost net fixed capital stock) was sharp and sustained from late 1948 to the present. The introduction of capital-intensive technological change in manufacturing, a subset of the industrial sector, caused downward pressure on profitability, both in the halcyon years of the postwar recovery from the late 1940s to the early 1970s, as well as in the neoliberal period that followed. The rate of decline in the net output/capital trend from 1982 to 2020 merely declined somewhat compared to the previous period, but the downward path persisted. In this context, after a thorough analysis of the available empirical evidence, Anwar Shaikh found that “the maximum profit rate falls steadily throughout the postwar period” and that “technical change is consistently capital biased” (Shaikh, 2016, p. 730).

Manufacturing Output-Capital Ratio

120 110

700 Manufacturing net value added/Capital stock Manufacturing labor productivity Manufacturing real compensation per worker

640 580

100

520

90

460

80

400

70

340

60

280

50

220

40

160

Manufacturing Labor Productivity

130

30 100 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 6.3  U.S. manufacturing output/capital ratio, manufacturing labor productivity, and manufacturing real compensation per worker, based on BEA Industry Files.

148  The deindustrialization quagmire As a result of this downward pressure, the manufacturing profit rate in 2020 was lower than in 1982, the threshold of the transition from the dominance of the manufacturing industry to the rise of neoliberalism, and the transition from manufacturing hegemony to the unleashing of finance. Manufacturing profitability, in fact, only rose above its 2002 trough because the profit share in this sector sharply increased for the next 13 years and, by then, the least profitable enterprises had ceased to exist. Figure 6.4 highlights the striking parallelism between the manufacturing rate of capital accumulation, representing net manufacturing investment over the current cost of manufacturing net capital stock, and the average profitability in manufacturing. This co-movement confirms the profit-driven path of capital accumulation: the realized profitability of the past contributing to shaping the new investment plans in light of current profit expectations formed again. Figure 6.4 also shows that the decline in profitability was acute from the late 1940s until the start of the 21st century. As Figure 6.5 shows, the partial reversal in 2000 required more than a doubling of the manufacturing profit share in net income (equivalent to net value added), from nearly 15 percent in 2001 to over 35 percent in 2013. It is instructive that the significant reversal in the profit share started in the mid1980s as the deindustrialization drive gained momentum to close down unprofitable plants so that the remaining ones would raise the average level for the sector as a whole. In the aftermath of the Great Recession, however, the recovery did not prevent the average profit rate from resuming its fall, albeit from a higher point than early in the 21st century. 50% 45% 40%

Manufacturing average profit rate Manufacturing fixed capital accumulation rate Manufacturing profit rate adjusted for capacity utilization

35% 30% 25% 20% 15% 10% 5% 0% -5%

1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 6.4  U.S. manufacturing average profit rate, manufacturing profit rate adjusted for capacity utilization, and manufacturing accumulation rate, based on NIPA Tables 6.15BCD, 6.16BCD and Fixed Assets Table 4.1.

The deindustrialization quagmire  149

180% 165% 150%

50% (left axis) Manufacturing net income/current cost capital stock Manufacturing net surplus/manufacturing net income

46% 42%

135%

38%

120%

34%

105%

30%

90%

26%

75%

22%

60%

18%

45%

14%

30% 10% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 6.5  U.S. manufacturing net income/current net fixed capital stock and manufacturing net profits (operating surplus) share of net manufacturing income, based on NIPA Tables 6.1BCD and Fixed Assets 4.1.

Figure 6.6 shows that retained earnings by manufacturing corporations have been the main source of investment finance since the late 1940s. The manufacturing savings out of gross profits reflects the changing needs of manufacturing investment depending on expected profitability and, judging from the long-term trend between accumulation and retained earnings (both normalized by net capital stock), the savings ratio varied with the funding needs of investment. In other words, the expected profitability determined the future investment plans and the funding needs determined the corporate retained earnings. Borrowing and interest rates played a minor role in the evolution of manufacturing capital accumulation.

Was manufacturing exceptionally profitable? At first sight, after computing profit rates in the business sector as a whole, and manufacturing by itself, it would appear as if the manufacturing industries were indeed initially privileged to operate with higher profitability than that enjoyed by the nonmanufacturing sector. Figure 6.7 shows much higher profitability levels in manufacturing than in nonmanufacturing from 1947 to the late 1990s. If we reached this conclusion, we would have to account for the fact that manufacturing profitability declined faster than the nonmanufacturing profit rate from its postwar heights, and we might adduce special factors that might explain the narrowing gap between the two profit rates. Robert Brenner followed this track (Brenner, 1998, 2006).

150  The deindustrialization quagmire

24% 21% 18%

Manufacturing retained earnings/capital stock Manufacturing fixed capital accumulation rate

15% 12% 9% 6% 3% 0% -3% -6% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 6.6  U.S. manufacturing capital accumulation, net investment/capital stock, and retained earnings/capital stock, based on NIPA Tables 6.21BCD.

47% 43%

Manufacturing Profit Rate

39%

Nonmanufacturing Profit Rate

35% 31% 27% 23% 19% 15% 11% 7% 3% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 6.7  U.S. manufacturing and nonmanufacturing profit rates.

Brenner assumed, that “the reduction in the average rate of profit on capital stock, particularly in manufacturing, over the past quarter-century is particularly striking because the rate of profit is not only the basic indicator but also the central determinant of the system’s health” (ibid., p. 6). He argued, moreover, that, in fact,

The deindustrialization quagmire  151 falling profitability in manufacturing caused the observed decline in the business sector’s profitability. The fundamental cause of the decline in manufacturing profitability in turn, according to Brenner, was “the intensified, horizontal inter-capitalist competition” resulting from “the introduction of lower-cost, lower goods into the world market” (Brenner, 1998, pp. 8–9; Brenner, 2006, pp. 7–8). More specifically, Brenner argued that: From the early 1960s, especially as a consequence of the dramatic reduction of trade barriers at the end of the 1950s, the growth of trade accelerated spectacularly and unexpectedly U.S. producers suddenly found their markets, both abroad and at home under radically increased pressure from the lower cost, lower price exports of the later developing blocks, especially Japan. As a consequence of the resulting downward pressure on prices, they were unable to realize their existing investments at the previously established rates of profit. (Brenner, 1998, p. 36; Brenner, 2006, p. 38) As Figure 6.7 shows, it would appear that manufacturing profits from 1947 to 2000 remained at a higher level than outside manufacturing, that somehow manufacturing profitability, although sharply falling, was set on higher grounds. Thus, we need to explain both why they were higher and why they fell so steeply until the early 2000s. During that stretch of time nonmanufacturing profitability did not exhibit the steep decline experienced in the manufacturing industries. In the 21st century, however, they shared something of a common trend, while the amplitude of manufacturing fluctuations exceeded that of nonmanufacturing. But as Dumenil and Levy pointed out, almost 20 years ago (Dumenil and Levy, 2002, pp. 45–48), three sectors in nonmanufacturing, including mining, utilities, and transportation, accounted for the disparity in profitability levels between manufacturing and the combined nonmanufacturing sectors. On average, these three sectors combined share of value added in the business sector amounts to 7.3 percent and is uniform throughout the whole range. On the other hand, the combined average fixed capital/ net value added ratio (the net capital/output ratio) in these three sectors, between 1947 and the present, is exceedingly high but constant at 17.4 percent. The capital/ output ratio of the business sector as a whole is not as high as in manufacturing but displays a rising trend after adjusting for persistent cycles of capacity utilization. As Figure 6.8 shows, removing those three activities (mining, utilities, and transportation), whose capital composition reflects an unusually large and fairly constant share of fixed capital while contributing a small share of the business sector’s new value added, leads to average profitability levels in nonmanufacturing that place it right within the range of manufacturing profitability. Figure 6.8 shows a complex spectrum of average profit rates in which those in the modified nonmanufacturing sectors rise to the manufacturing level and follow the downward path of manufacturing profitability. The business sector profit rate is higher than

152  The deindustrialization quagmire

49% 44% 39%

Manufacturing profit rate Nonmanufacturing profit rate, excluding mining, transportation & utilities Mining, transportation & utilities profit rate

34% 29% 24% 19% 14% 9% 4% -1% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 6.8  U.S. manufacturing profit rate; nonmanufacturing profit rate, excluding mining, transportation, and utilities; mining, transportation, and utilities profit rate. Based on NIPA Tables 6.2BCD.

nonmanufacturing profitability because the average for the entire sector includes both low profit rate sectors (mining, utility, and transportation) and high profitability sectors, such as those in manufacturing industries. Now, removing the exceptional weights of mining, utilities, and transportation from our profitability estimates confirmed the Classical dynamics of free competition. Capital flows, moving across different sectors in search of higher profitability, achieved the tendential equalization of manufacturing and the modified nonmanufacturing sector’s average profit rates in the U.S. economy. That average profit rates in manufacturing and the wider business sector reached comparable levels should direct our attention to the dynamics involved. As we have insisted in previous chapters, the historical record of technical change and the dynamics of profitability would not make sense without Anwar Shaikh’s concept of real, not perfect, competition involving war between rival firms seeking market leadership (Shaikh, 2016, chapter 13). A falling long-term net output/net capital stock (rising capital/output ratio) underscores the capitalintensive bias of choices made by firms adopting technologies as weapons in competitive wars. Capital-intensive techniques and economies of scale are the most effective means to lower total unit costs, reduce market prices, and achieve industry leadership. Their adoption raises the capital/output ratio because lowering costs per unit of output requires higher unit fixed costs, and to gain market share the market price needs to fall, hence variable unit costs must decline proportionately more than fixed unit costs increase. In the aftermath of such competitive battles, while

The deindustrialization quagmire  153 retaining higher profit rates than industry laggards, innovators need to accept lower profit rates in exchange for larger total profits. For industry leaders, “The bigger the firms, the larger the share of fixed costs in total costs” (Galbraith, 2014, 101), but for the system as a whole, as Roy Harrod pointed out, the long-run growth path tends to fall because profitability is impaired: A continuing increase in the required capital output ratio (Cr) is conjugated with a deceleration in the warranted growth rate. Rather a paradox! Capital intensity increasing, and, by consequence, growth rate declining. (Harrod, 1973, p. 30) Empirical evidence derived from using capital/output ratios in the business and nonfinancial corporate sectors of the U.S. economy as proxy for capital intensity, does not support claims that the falling weight of fixed capital investment spending weakened effective demand and played a role in the development of secular stagnation. The long-run path of profitability trends in the business and nonfinancial corporate sectors reflects trends in the capacity-adjusted output/capital ratio and the profit shares of both sectors. Even if labor productivity growth in the capital goods sector allowed relative unit prices of capital goods to fall, it would not imply that total fixed costs of industry leaders using increasingly mechanized technology would decline relative to labor costs. On the contrary, rising competitive pressures and declining investmentgoods relative prices are likely to speed up the adoption of such capital-intensive innovations, while downward wage pressures, associated with the displacement of labor caused by automated systems, enlarged the labor supply and weakened its bargaining strength. In a comprehensive study of international differences in labor productivity and unit costs, Robert C. Allen concluded that since the early 19th century: technological progress has been biased towards raising labour productivity by increasing capital intensity…there has been no improvement in labour productivity for countries that did not accumulate capital…When technical progress and capital accumulation occur concurrently, separate contributions cannot be identified. (Allen, 2011, p. 4–5) Foley and Marquetti found that technical change not only raised the average capital intensity of production as a precondition for achieving higher levels of labor productivity, but it also raised capital/output ratios. While the diffusion of technical change raises labor productivity and lowers unit costs in sectors producing capital as well as consumer goods, the growing mechanization and capital intensity of production implies a rising fixed capital cost per unit of output. International studies of growth patterns across the world find that: The comparative analysis of the pattern of development of the EU as a unified economy with the USA and Japan reveals a general pattern of convergence

154  The deindustrialization quagmire among the advanced capitalist economies…these economies have followed a development path of rising labor productivity, decreasing capital productivity and increasing capital intensity. The diffusion of technology appears as the main factor affecting the macroeconomic structures of these advanced economies. (Foley and Marquetti, 1999, p. 298) Anwar Shaikh’s theory of real competition (Shaikh, 2016, pp. 259–322) challenges the traditional interpretation of free competition focusing on the tendency of average profit rates to equalization across different (global) sectors of the system. In Shaikh’s theory of real competition-as-war among rival capitals, within each industry in addition to capital flows across industries, there is a crucial distinction between the changing spectrum of profit rates within each industry and the tendential equalization of profit rates across the leading firms of diverse industries. Real competition within each sector or industry tends to differentiate the profit rates of the relevant firms. The relentless effort of competitive firms to achieve the highest market share with the lowest unit cost-price requires the successful deployment of the most advanced technology, providing the leader with the means to secure a ‘regulating’ influence in the sector. Industry leaders downgrade the laggards to the lower rungs of the industry and set them on their way out. While the leading competitive firm succeeds in this endeavor and its technological prowess allows it to operate with the lowest unit costs and the highest profit rate in the industry, it will face competitive challenges from outside the industry threatening its hegemonic position. External capital flows will not seek to replicate the production methods used by marginal firms but, rather, those employed by the leading ‘regulating’ capital compatible with the successful price and cost structure. External capital flows will challenge the hegemonic position of the ‘regulating capital,’ seeking to displace its best-practice technology and replace it with a superior alternative, a more effective way to lower market prices after achieving a deeper cut in unit costs. This permanent threat, in turn, forces the leading capitals to continually seek innovative methods of production that distance their performance from the laggards on the way to extinction as well as the financial agony of profitless ‘zombies.’ Incremental profitability in manufacturing The tendential equalization of profit rates across different sectors and industries is the result of new investments made by applying the most advanced production methods of ‘regulating’ capitals in each industry, those delivering the highest available profit rate, that is, the ‘incremental’ not the average profit rate of the spectrum of rates of return in the industry (Shaikh, 2016, pp. 298–300). The ‘incremental’ rate of profit, IROP, is the rate of return obtained from the most recent investment by industry leaders or ‘regulating’ capitals in projects employing the best available production methods. The total profits accruing to such capitals may be decomposed into two components: the new or added profits from

The deindustrialization quagmire  155 the last period investment, the expected profit rate times the one period-lagged capital invested plus the profits derived from all past investments, Π*,

P t = rI t-1 + P *

Subtracting from both sides, Πt-1, we have, Πt − Πt-1 = ρIt-1 + (Π* − Πt-1), and considering that the term change in profits from earlier periods (Π* − Πt-1) is relatively small compared to the one period-lagged investment, we may practically compute the ‘incremental’ rate of return, ρt, as the change in total profits associated with one period-lagged investment,

r1 »

dp I t -1

In manufacturing as well as nonmanufacturing sectors as a whole, the IROPs display significant variability while sharing approximately a common mean. In addition, while their cyclical patterns are similar, manufacturing, on the whole, exhibits an even greater variance than nonmanufacturing both in its postwar heyday, extending from 1949 through the early 1970s, and throughout its restructuring in the neoliberal phase. One important factor in the empirical work on profitability trends is that incremental profit rates are comparatively easier to estimate than average profit rates because they do not require using time series with capital stock data which is notoriously difficult to find in national accounts. The time series necessary to derive profits and business investment in order to obtain empirical estimates of incremental profit rates are readily available in National Income accounts, the OECD Economic Outlook, and the European Union’s AMECO. Figure 6.9 shows our calculation of the U.S. manufacturing and nonmanufacturing incremental profit rates. It confirms a certain tendency toward the equalization of both rates. International evidence of converging manufacturing IROPs The empirical strength of the convergence in incremental profitability of manufacturing across industrial sectors of advanced capitalist countries is strong enough to confirm Shaikh’s theory of capital flows among regulating capitals. In fact, because pursuing the highest possible profitability motivates industrial investments directed to the best-practice methods of production across all industries, we can verify the tendency to (rough) equalization of incremental profit rates across advanced capitalist countries. Figure 6.10 shows the two nations’ incremental profit rates in the manufacturing sectors of Japan and the U.S. The remarkable extent to which they move in tandem for long periods, despite the higher variability of Japanese profitability, attests to the underlying similarities in the structure of both industries. Profitability differentials, in the best-practice methods of production across industries and countries, provide the incentive for inflows and outflows of domestic and foreign capital investments.

156  The deindustrialization quagmire

100%

80%

U.S. manufacturing incremental profit rate U.S. nonmanufacturing incremental profit rate

60%

40%

20%

0%

-20%

-40%

-60% 1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

2020

Figure 6.9  U.S. manufacturing and nonmanufacturing incremental profit rates, based on profits and accumulation, data previously sourced.

120% U.S. manufacturing incremental profit rate

100%

Japan's manufacturing incremental profit rate 80% 60% 40% 20% 0% -20% -40% -60% -80%

20 20

14

11

08

05

02

99

17 20

20

20

20

20

20

19

93

96

90

87

84

19

19

19

19

81

19

19

75

78 19

72 19

19

66

63

60

57

69 19

19

19

19

19

19

54

-100%

Figure 6.10  U.S. and Japan incremental manufacturing profit rates based on profits and accumulation, data previously sourced.

The deindustrialization quagmire  157 In the pursuit of higher returns, domestic or foreign investment directed to profitable activities will expand and, eventually, overshoot its mark, triggering falling rates of return that will signal the reversal of capital inflows. Throughout the advanced capitalist countries, such capital flows, in pursuit of the highest rate of return exhibited by the practices of the ‘regulating’ leaders of industry and commerce, achieve a substantial degree of “tendential equalization of inter-industry profit rates” (Tsoulfidis, and Tsaliki, 2019, p. 237) between U.S. and Japanese manufacturing as evidenced in Figure 6.10. While average profit rates approximately anticipate or determine the rate of capital accumulation, the incremental profit rate determines the growth rate of gross capital investment. The incremental profit rate does not only measure the success or failure experienced by ‘regulating’ capitals out of their most recent investment but, at the same time, it represents the profit rate that motivates the growth rate of gross investment in the following period. Indeed, fluctuating incremental profit rates anticipate (cause) the growth path of sectoral capital investment expenditures (Figures 6.11 and 6.12). Figure 6.13 shows the impact of technical change and capital accumulation on average profit rates in the U.S. and Japanese manufacturing sectors. In both countries, the development of manufacturing industries provides the best example of sectors where capital-intensive technical change spurred relentless price-cutting strategies and intensified competitive battles. In both cases, moreover, despite the high growth in labor productivity and decline in unit costs, the nature of the strategy pursued through capital-intensive technology lowered profitability on the regulating capitals of both countries. Long-term profitability trends in both countries

100% 80%

U.S. manufacturing incremental profit rate U.S. growth rate manufacturing investment

60% 40% 20% 0% -20% -40% -60% -80% -100% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 6.11  U.S. manufacturing incremental profit rate and manufacturing investment growth rate, data previously sourced.

158  The deindustrialization quagmire

140% 120%

Japan manufacturing incremental profit rate Japan manufacturing gross investment growth

100% 80% 60% 40% 20% 0% -20% -40% -60% -80% -100% -120%

20 20

20 17

20 14

20 11

20 08

20 05

20 02

19 99

19 93 19 96

19 87 19 90

81 19 84

19

19 75 19 78

19 72

66 19 69

19

19 60 19 63

19

54 19 57

-140%

Figure 6.12  Japan manufacturing incremental profit rate and gross manufacturing investment growth, based on Financial Statements Statistics of Corporations, Ministry of Finance, Japan: operating profits.

44% 40%

U.S. average manufacturing profit rate

36%

Japan average manufacturingl profit rate

32% 28% 24% 20% 16% 12% 8% 4% 0%

20 20

17 20

11

14 20

20

20 08

20 02

20 05

19 99

19 96

90

19 93

19

19 87

19 84

19 81

75

19 78

72 19

19

19 69

19 66

19 60

19 63

54 19

19 57

-4%

Figure 6.13  U.S. and Japan average profit rates in manufacturing, data previously sourced.

The deindustrialization quagmire  159 reflected the pressure of steadily rising fixed capital/net output ratios on profit rates, and rising profit shares proved insufficient to counterbalance the rising capitalization of production to arrest the profitability decline. Japan’s data from the Policy Research Institute provided the essential evidence from early 1954 to the present, and in the U.S., NIPA Tables, the more complete data, starting in 1948. While the long-term decline in average profitability is evident in both cases, the Japanese downturn in manufacturing profitability displays a radical contrast between the extremely high level of its profitability, from the mid-1950s through the late 1970s, and the steep rate of decline for the next 30 years until reaching a trough in 2009. The steadily falling trend in U.S. manufacturing profitability from the mid-1950s through 2002 reversed its trajectory in the next four years as a result of a significant increase in the profit share of new value added. In the 21st century, the radical downsizing of manufacturing capacity had eliminated all low profitability plants in the U.S. and boosted the performance of the remainder. Since 2012, however, average profitability resumed its descent in both countries with the implication that the profitability crisis had not ended. In the case of Japan, absent the deindustrialization experience of the U.S., the recovery of the average profit rate after the Great Recession did not lift it above the level of the late 1990s. The contrast between average and incremental profit rates The trend of incremental profitability, strongly driven by the rate of return on the most recent investment made by competitive firms, is not capable of highlighting the level and significant decline of the long-run average profitability on all previously accumulated capital in the industry. In Figure 6.13, we can appreciate the significant declines in the average profit rates of the U.S. and Japan that the incremental profit rates in both countries cannot reveal. Average profitability includes all capitals in a given industry or sector, not just the leading firms, and takes into account the weight of accumulated capital by all firms, including the less successful, in waging competitive wars. Despite the deindustrialization sweep that wiped out the less profitable capitals in U.S. manufacturing, the lower level reached by the incremental profit rate in the last two decades of the 20th century is a good indication of the protracted nature of the crisis (Figure 6.14). The emerging dual economy From 1947 until the early 1970s, all sectors of the national economy, including manufacturing and services, developed as an integral whole, exhibiting similar growth rates. From the early 1970s to the present, however, the system’s growth patterns in manufacturing industries and services diverged and the previous structural cohesion vanished. Between 1947 and the late 1960s, the relative shares of value added for manufacturing and services in the business sector did not noticeably change. In 1968, a perceptive study of the ‘dual economy’ could distinguish the core of “top 500 industrial U.S. corporations” that employed “nearly three fifths of all workers in U.S. mining and manufacturing” from the ‘periphery’ sectors, comprising small

160  The deindustrialization quagmire

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Figure 6.14  U.S. incremental and average profit rates, data previously sourced.

firms struggling to survive. Since the 1970s, the structural gap between a relatively small dynamic core of large corporations and a large number of relatively small low productivity service firms (‘stagnant’) widened sufficiently to comprise a ‘dual economy’ with distinct characteristics (Averitt, 1968). By 2019, the share of value added in the private sector contributed by the relatively ‘stagnant’ services sector, compared to 1947, rose nearly 40 percent while the share of manufacturing value added in the same period declined by almost 60 percent. After the 1970s, the dismantling of the large industrial conglomerates that powered the U.S. postwar recovery for 30 years of unprecedented growth rates splintered the formerly integrated national economy into a dual economy. The new economy consisted of a ‘progressive’ segment, using high capital-intensity technology and small contingents of highly qualified labor, side by side with a ‘stagnant’ sector of labor-intensive technology, delivering low productivity growth but high employment shares. The high labor productivity growth rates of the dynamic sector did not expand employment shares, in contrast with the labor-intensive ‘stagnant’ sector of personal services, including hospitality, restaurants, entertainment, business services, and health care. We contend that while the managerial elites justified the comprehensive deindustrialization of the U.S. economy as an imperative to gain global competitiveness, the underlying motivation concerned the reversal of current profitability trends in the manufacturing and business sectors. This transformation entailed measures designed to preserve the viability of capital accumulation under pressure from sharply falling profitability in the manufacturing sectors of the U.S. economy. With the consolidation of neoliberalism, the rising share of financial profits in contrast with the falling share of manufacturing profits arrested

The deindustrialization quagmire  161 the steep decline in overall profitability. As Figure 6.3 showed, between the early 1950s and 1982, the dual of sharply rising labor productivity was the fast-falling output/capital ratio, the so-called ‘capital productivity,’ further extending its fall between 1987 and 2019 albeit at lower pace. Since the 1980s, rising labor productivity in manufacturing, in sharp contrast with the paucity of labor productivity growth in personal services, excluding the finance and business sectors, also gained momentum under neoliberalism, as the threat of offshoring industrial production weighed heavily on the labor force’s fears of unemployment. After the mid-1970s, falling average profitability across the business sector led to the radical restructuring of the U.S. economy. As Figure 6.15 shows, from 1947 through the present, the growth trend in the capital intensity of manufacturing production, defined as real fixed capital per worker, surpassed that of labor productivity. From 1947 through the mid-1970s, labor productivity and employee compensation growth in the U.S. economy rose in tandem across all sectors, including that of ‘production and nonsupervisory’ workers in various lines of activity across manufacturing and services. We interpret these common trends as the special characteristic of an integrated economy’s balanced growth, responding to the challenges of the Cold War’s confrontation between competing socioeconomic systems, and the policy constraints imposed by the postwar capital-labor accord. After the mid-1970s, however, the growing structural gap between the declining share of the ‘progressive’ manufacturing industries in the business sector, and the increasing share of the ‘stagnant’ service activities, such as accommodations, education, entertainment, food, health, but also construction, transportation, and

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390 290 190 90 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 6.15  U.S. contrasting developments in manufacturing and ‘stagnant’ service sectors, based on BEA GDP and Components Industry data, Fixed Assets Table 3.1ESI, NIPA Tables 6.9BC.

162  The deindustrialization quagmire utilities, reflected a radical transformation of capital accumulation patterns. Labor productivity growth declined in a significant cluster of ‘stagnant’ sectors. This bifurcation would eventually lead to a situation where “the net result must be a ceteris paribus decline in the economy’s overall productivity growth rate.” As time went on, it appeared that “the U.S. labor force has been absorbed predominantly by the stagnant sector of the services rather than the services as a whole” (Baumol, Blackman, and Wolff, 1985, pp. 806–817). Real compensation and labor productivity in most of these services declined between the mid-1970s and the mid-1990s. Labor productivity barely increased between 1987 and 2000 and by 2019 it rose by only 20 percent with respect to 1987. Real compensation per employee did not regain lost ground with respect to 1987 until the first decade of the 21st century and, in 2019, rose less than 8 percent with respect to 1987. The services value added share in the private sector (Figure 6.16) rose from 22 percent in 1987 to 25 percent in 2019, an increase of 13.6 percent. While in the same period, the total employee compensation rose from about 27 percent to 34 percent of the private sector employee compensation, an increase of nearly 26 percent, the employment share of the ‘stagnant’ service sectors in private sector employment rose from 32 percent to nearly 48 percent, an increase of 50 percent. Outside the stagnant service sectors, between 1947 and 2019 labor productivity rose 300 percent and compensation per worker increased 190 percent. The noted breakup of the accumulation patterns characteristic of the postwar capital-labor accord replaced the productivity growth dynamics of manufacturing industries with the ‘stagnant’ growth patterns of personal services. It is our contention that such structural changes paved the way for the emergence of secular stagnation in the nonfinancial economy and propitiated the channeling of 140% 120%

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Figure 6.16  U.S. percentage change contrast between manufacturing and services employment and value added, 1947–2019, as previously sourced.

The deindustrialization quagmire  163 capital flows to speculative finance. With the decline of manufacturing under neoliberalism, financial activities gained weight in the structural makeup of the national economy. Financial profits rose from an average of 30 percent of manufacturing profits in the years between 1947 and 1987 to equality with manufacturing profits in 1990. By 2002, financial profits rose to 300 percent of manufacturing profits, then collapsed in the so-called Financial Crisis back to the 30 percent average of the first three postwar decades. By 2009, financial profits reached 200 percent of manufacturing profits, remaining around 37 percent higher than all manufacturing profits since then. After the 1980s, this increase in the share of financial profits, including the sharp increases in finance, insurance, and real estate (FIRE) sectors aggregate profitability, contributed to the substantial recovery of business profit rates, so much so that, if excluded, the business sector average profit rate would have collapsed (Figure 6.17). In contrast with the growing employment share of the stagnant sector activities, the manufacturing sector lost employment share but achieved rising productivity growth due to the growing accumulation of fixed assets per worker. The manufacturing share of employed labor, however, declined from around 36 percent in the early 1950s to less than 10 percent in 2019. The manufacturing compensation share fell from around 25 percent, holding from the late 1940s to the early 1970s, to well below 10 percent after the Financial Crisis of 2007–2009. Labor productivity in manufacturing increased by more than 205 percent in the 40-year span between 1947 and 1987, and in the next 32 years, between 1987 and 2019, it further rose another 222 percent. This happened, of course, as a result of the rising capitalization of manufacturing production reflected in the growing capital/output ratio, defined as the nominal net fixed assets divided over the manufacturing net value added, which grew 135 percent between 1948 and 1987, and an additional 58 percent between 22%

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Figure 6.17  U.S. business sector average profit rate including and excluding the FIRE sector, as in Figure 1.1 and BEA Industry Tables.

164  The deindustrialization quagmire

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Figure 6.18  U.S. manufacturing and ‘stagnant’ service sectors average profitability paths, based on BEA Industry Tables.

1987 and 2019. The loss in manufacturing employment and employee compensation was persistently replaced with the steadily rising compensation share of FIRE employees, especially in the 1980s when the transition from the postwar accumulation regime to full-blown neoliberalism took place. From 2004 on, the share of FIRE employee compensation in the private sector surpassed that of manufacturing, even though, after the 1980s, the share of FIRE employment declined. The structural changes that transformed the U.S. economy from an industrial powerhouse into a ‘service’ economy of low labor productivity gains and limited wage growth potential, excepting the financial services lavish compensation practices, laid the foundation for a slower tempo of systemic growth that contributed to secular stagnation. In Figure 6.18, we show the empirical evidence available supporting our conclusion that, if the hypothesis defended in this book is correct regarding the link between the falling profitability of manufacturing and the rise of neoliberalism, the expansion of ‘stagnant’ services did not raise the average profit rate in the business sector. It is perfectly clear that after the expansion of services, the profit rate in that sector followed the same path as that of manufacturing. References Allen, R. 2011. “Technology and the Great Divergence,” Discussion Paper Series, N. 548, Department of Economics, University of Oxford.

The deindustrialization quagmire  165 Averitt, R., 1968. The Dual Economy, W.W. Norton. Baumol, W., Blackman, S. A. B., and Wolff, E. 1985. “Unbalanced Growth Revisited: Asymptotic Stagnancy and New Evidence,” The American Economic Review, Volume 75, No. 4, pp. 806–817. Bell, D. 1999. The Coming of Post-Industrial Society, Basic Books. Brenner, R. 1998. The Economics of Global Turbulence. A Special Report on the World Economy, 1950–1998, New Left Review. Brenner, R. 2006. The Economics of Global Turbulence. The Advanced Capitalist Economies from Long Boom to Long Downturn, 1945–2005, Verso. Dumenil, G. and Levy, D. 2002. “Manufacturing and Global Turbulence: Brenner’s Misinterpretation of Profit Rate Differentials,” Review of Radical Political Economics, Volume 34, No. 1, pp. 45–48. Dyer-Witheford, N. 1999. Cyber Marx, University of Illinois Press. Foley, D., and A. Marquetti. 1999. “Productivity, Employment and Growth in European Integration,” Metroeconomica, Volume 50, Issue 3, pp. 277–300. Freeman, J. 2018. Behemoth: A History of the Factory and the Making of the Modern World, W.W. Norton. Galbraith, J. K. 2001. The Essential Galbraith, Houghton-Mifflin Co. Galbraith, J. K. 2014. The End of Normal, Simon & Schuster. Harrison, B. 1997. Lean & Mean, The Guilford Press. Harrod, R. 1973. Economic Dynamics, The Macmillan Press. Howard, M.C. and King, J.E. 2008. The Rise of Neoliberalism in Advanced Capitalis Economies. A Materialist Analysis, Palgrave Macmillan Janowitz, M. 1974. “Reviewed Work: The Coming of Post-Industrial Society: A Venture in Social Forecasting, by Daniel Bell,” American Journal of Sociology, Volume 80, No. 1, pp. 230–236. Keynes, J. M. 1932. “An Economic Analysis of Unemployment,” Unemployment as a World Problem, Lectures on the Harris Foundation, University of Chicago Press. Keynes, J. M. 2015. The Essential Keynes, edited by Skidelsky, R., Penguin Classics. McCormick, R. 2009. “The Plight of American Manufacturing,” The American Prospect, December 21. https://prospect​.org​/special​-report​/plight​-american​-manufacturing/ Olsen, M. 1974. “Reviewed Work: The Coming of Post-Industrial Society: A Venture in Social Forecasting, by Daniel Bell,” American Journal of Sociology, Volume 80, No. 1, pp. 236–241. Schumpeter, J. 2014. Treatise on Money, WordBridge Publishing. Shaikh, A. 1999. “Explaining Inflation and Unemployment: An Alternative to Neoliberal Economic Theory,” Contemporary Economic Theory, edited by A. Vlachou, St. Martin’s Press. Shaikh, A. 2016. Capitalism: Competition, Conflict, Crises, Oxford University Press. Tsoulfidis, L. and Tsaliki, P. 2019. Classical Political Economics and Modern Capitalism, Springer. Veysey, L. 1982. “A Postmortem on Daniel Bell’s Postindustrialism,” American Quarterly, Volume 34, No. 1, Spring, pp. 49–69.

7

Falling interest rates, banking, and financial crises

In the wake of the stagflation crisis of the 1970s, the share of net value added and profits imputed to financial capital grew as the equivalent shares of manufacturing industries diminished. After scuttling the class compromise that had secured the place of manufacturing as the leading growth sector of the U.S. economy in the first three decades of the postwar period, the simultaneous outbreak of inflation and unemployment strengthened the determination of managerial and financial elites to bring about the radical transformation of the national economy. As the profitability trend in manufacturing and other nonfinancial sectors declined, capital flows circumvented long-term fixed capital investments into those activities and increasingly opted for short-term financial ‘investments’ that offered better opportunities for capital gains. With the advent of neoliberalism, the consolidation of financialization, understood as the widening scope of financial activities, contributed to shaping the capital allocations of nonfinancial corporations, boosting the profit share of financial, insurance, and real estate firms in total corporate profits, and leading to their increasing weight in the national economy. After the stagflation crisis of the 1970s cut off the path for further continuation of the Fordist economy, the structural changes that transferred the growth engine of the U.S. economy from capital accumulation to the finance, insurance, and real estate sectors represented a new configuration of the sectoral structure of advanced capitalism. The transition opened new avenues for the expansion of profits and the survival of capital accumulation. After the mid-1980s, the Federal Reserve’s unwavering policy of lowering longterm interest rates promoted the expansion of financial markets, boosting housing and stock market asset valuations. Financialization replaced manufacturing as the driving sector of capitalist growth. Spurred by the prospect of capital gains, enhanced by the maintenance of persistently low interest rates, and the absence of inflationary pressures on wages, overconfidence took over the expectations of financial speculators and their reckless behavior stoked successive stock market crises, including the collapse of mortgage-backed subprime housing shares in the 2007–2009 Great Financial Crisis.

DOI:  10.4324/9781003413806-7

Falling interest rates, banking, and financial crises  167 The road to neoliberal financialization In our view, understanding the significance of financialization requires taking into account the following propositions: 1. The long-run decline in profitability experienced after the late 1940s affected not only the manufacturing industries of the U.S. economy but the business sector as a whole. In other advanced capitalist countries, the decline of the profit rate also accelerated during the 1970s, reducing the system’s growth potential and motivating influential elites to explore alternatives to reverse it. 2. From the mid-1960s through the 1970s, high flows of private and public net credit added sufficient stimulus to prevent investment spending from falling as expected from the profitability decline that had undermined potentially sustainable growth, and the discrepancy stoked the rise in inflation. 3. The prevailing interpretation of the persistent high inflation, the spreading of input shortages, and rising unemployment in the affected sectors, blamed the ‘monopolistic’ wage pressures of industrial unions for ‘excessive’ wage demands when supply chains were broken. Launching financialization We interpret the sharp increase in interest rates carried out by the central bank in the early 1980s as a transitional policy chiefly intended to precipitate a slump strong enough to vanquish the specter of inflation and any lingering doubts of its possible return. Attracted by the interest rate hike, large increases of foreign capital inflows not only improved the external balance of payments of the U.S. (but whether or not the chairman of the Federal Reserve, Paul Volker, at the time anticipated the consequences), foreign capital provided the necessary liquidity expansion to launch financial markets into hitherto unexplored growth paths. After the success achieved in fighting inflation, a drastic strategy change regarding interest rates followed. After the initial shock of unprecedented high rates in the early 1980s, Federal Reserve policy, well into the 21st century, sought to maintain interest rates as low as possible confident that inflation outbreaks would not happen again. This policy strengthened the high expectations and unbridled optimism that led to discarding any possible threat of future mishaps. Despite various financial crises that burst the bubbles in internet, housing, and stock market booms, overconfidence led to the Great Financial Crisis of 2007–2009. The strategy of the Federal Reserve sought to support asset revaluation of housing and financial assets by any means necessary. It was carried out as a consistent, long-run policy of lowering interest rates and “quantitative easing,” including purchases of long-term treasury bonds and mortgage-backed securities, with the expressed purpose of encouraging risk-taking in asset purchases and preventing skeptical players from abandoning the ongoing game of musical chairs. From 1984 until 2001, the valorization of the stock market acquired unprecedented levels, even though profitability and capital accumulation in the real corporate sectors did not reverse their historic downturn from the 1970s. In the 1980s, monetary policy was highly effective in paving the way for the rise of financialization. Financial transactions became a distinct configuration in support

168  Falling interest rates, banking, and financial crises of extended reproduction to replace flagging manufacturing profits with the lure of capital gains in financial markets (Lapavitsas, 2013a and 2013b; Lapavitsas and Mendieta, 2016). In response to the decline in interest rates and the reality of corporate retained earnings proving sufficient to fund net investment spending, while depreciation allowances covered the corporate needs for the replacement of worn-out plant and equipment, banking priorities changed. Most significantly, banks reduced their role as providers of business loans to finance productive investments in industry, hence, the diminished weight of business interest income in their balance sheets, but higher share from consumer loans beyond the provision of home mortgages. From 1942 to 1963, interest related income in U.S. banks grew at 9.82 percent annually; from 1963 to 1979 interest income expanded at the unsurpassed rate of 15.15 percent annually. From 1984 to 2020, overhaul of the practices in the banking industry reduced interest income growth, falling to 2.56 percent yearly growth while simultaneously non-interest related income growth rose to match nearly half of total interest received. As Mariana Mazzucato noted to great acclaim, with these changes “as the twentieth century progressed, banks’ role in fueling economic development steadily diminished in theory and practice-while their success in generating revenue and profit, through operations paid for by households, firms and government, steadily increased” (Mazzucato, 2018, p. 105). Falling interest rates did not reverse the declining nonfinancial corporate accumulation trend and, in general, falling interest rates did not incentivize the rise of fixed capital long-term investments but, instead, contributed to strengthening the attraction of speculative financial investments. Building on the presumption that ‘herd’ asset purchases would stretch current valuations, leading to capital gains, successive booms in internet shares, housing, and technology, unleashed the confidence of financial markets in their pursuit of ever-higher price/earnings ratios. The monetary policy implemented by the various governors of the Federal Reserve, lowering interest rates, sought to facilitate the transfer of capital flows from the nonfinancial sectors, including manufacturing, into increasingly risky financial speculation. In his General Theory, Keynes did not agree with the view that falling interest rates would have a significant impact on nonfinancial investment. For Keynes, absent the incentive of a sufficiently high ‘marginal efficiency of investment’ in the advanced stages of capitalist development, as Classical Political Economy would teach, neither traditional monetary policy nor innovative ‘quantitative easing’ would bring about the desired expansion of nonfinancial investments. In his own words, For my own part I am now somewhat skeptical of the success of a merely monetary policy directed towards influencing the rate of interest. I expect to see the State, which is in a position to calculate the marginal efficiency of capital-goods on long views and on the basis of the general social advantage, taking an ever greater responsibility for directly organising investment; since it seems likely that the fluctuations in the market estimation of the marginal efficiency of different types of capital, calculated on the principles I have

Falling interest rates, banking, and financial crises  169 described above, will be too great to be offset by any practicable changes in the rate of interest. (Keynes, The General Theory, chapter 12, section 8) In the early 1980s, Federal Reserve policy raised the federal funds rate to unprecedented levels and provoked the outbreak of a deep slump causing massive unemployment of labor and a sharp contraction of output. 4. The slump and growth of unemployment not only quelled inflation; for the next 40 years, removed any trace of inflationary pressures stemming from U.S. labor wage demands. In the early 1980s, after succeeding in the suppression of any ‘excessive’ wage expectations from what Alan Greenspan referred to as ‘traumatized’ workers, for the rest of the century and beyond, the Federal Reserve switched to a policy of lowering the federal funds rate more or less steadily until it reached the zero bound in 2020. As Figure 7.1 shows, after the early 1980s, a period of secular decline in interest rates and the disappearance of inflation for several decades contrasted with the previous phase, from the late 1940s through the early 1980s, of rising inflation and interest rates. 5. While the downward thrust in profitability lost its momentum after reaching its trough in the early 1980s, the recovery that followed never placed the path of the profit rate at a level comparable to those attained in the 1960s and 1970s. In conclusion, insofar as the Federal Reserve interest rate hikes of the early 1980s (Figure 7.1) effectively triggered the deep slump that drastically undermined the bargaining power of labor, neoliberalism achieved its intended goal. However, after the 1970s collapse of profitability, the average profit rate did not reverse its 18% 16% 14% 12%

U.S. treasury Securities, 3 months Discount rate Federal Reserve Bank of New York Effective Federal Funds rate

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Figure 7.1  The great wave in nominal interest rates, 1948–2020, Economic Report of the President.

170  Falling interest rates, banking, and financial crises course from its low-level path for the next 40 years. The growth drivers of capital accumulation drastically changed and, in only one period, the second half of the 1990s, did nonfinancial corporate capital accumulation regain a steadily upward trend lasting more than five years. While the ten-year government bond yield rose from 2.85 percent in 1953 to 13.91 percent in 1981, once the 1980 deep recession removed from the system the structural pressures that sustained inflation, it fell steadily to reach below 1 percent in 2020. As Henry Kaufman saw it, “The magnitude of this long up-and-down yield movement dwarfs by a very wide margin all four previous secular swings in American financial history” (Kaufman, 2009). Despite minor cyclical fluctuations, the steadily falling trend of interest rates enhanced the prospects of financial investments, including mortgages and stock market valuations but, since nonfinancial corporations finance their investment plans out of ‘retained earnings,’ falling interest rates did not have any significant effect on nonfinancial profit expectations or corporate investment expenditures. Falling interest rates supported ‘bull’ markets in housing as well as the stock market at the expense of the nonfinancial sectors’ capital accumulation, thus helping to shape the chief characteristics of neoliberal financialization. Capital accumulation in nonfinancial corporate sectors remained hampered by low profit expectations, and the long-run trend of nonfinancial accumulation rates steadily declined, with the exception of the second half of the 1990s. Monetary policy, interest rates, and ‘zombie’ companies As the 2007 Financial Crisis came to its conclusion, Henry Kaufman, the veteran Wall Street sage, observed that the secular swing in yields of 30-year U.S. Treasury bonds, from 1946 to 2009, was “the greatest secular swing in interest rates in U.S. history,” ranging from 2.5 percent in 1946 to 15 percent in 1981, and then falling to 2.69 percent by 2009. Kaufman concluded that the amplitude of this wave-like movement exceeded that of any other secular swing in American financial records. Kaufman pointed out the contrast between the postwar environment and that in 2009. In the early postwar period, households emerged from the war experience with large savings and very low debts. The financial system avoided risky practices and experienced no financial fragility. In 2009, on the other hand, both households and the public sector were overwhelmed with debts and the blight of the Financial Crisis spread throughout the economy (Kaufman, 2009). In fact, lowering interest rates from the mid-1980s to the present allowed the survival of insolvent firms and contributed to the maintenance of a dual economy. The structure of the dual economy consists of a few highly profitable and capital-intensive corporations, employing a relatively small, highly skilled, and well-paid labor force, separated from the growing number of tottering businesses employing large numbers of lower-wage workers. The chasm between the few profitable superstars and the rising numbers of ‘zombie’ corporations required the maintenance of low interest rates and ever-rising debt levels. The persistent low profitability trend in wide segments of the real economy derailed capital investments into financial markets,

Falling interest rates, banking, and financial crises  171 sustained the falling trend in the buildup of real productive capacity (the falling accumulation trend in nonfinancial sectors), and caused the growing capitalization of financial assets. Low interest rates facilitated corporate financing of buybacks, rising dividend payouts, and growing corporate debts. These diversions of funds highlight the low growth pattern of the neoliberal regime, as declining profitability after the mid-1960s caused profit expectations to fall, lowered the accumulation trend, and reduced the labor productivity growth rate (McGowan, Andrews, and Millot, 2017). The golden years of the postwar period lasted for as long as high profit shares and high levels of capacity utilization mitigated the impact of rising capital intensity in the formation of industrial profit rates. While wages rose in that period, their initial level in the early 1940s was relatively low, but fiscal policies consistently boosted effective demand up to the mid-1970s and favored relatively high investment patterns. The steady rise in the capitalization of industrial production and the growing intensity of foreign competition from Germany, Japan, and other industrial powers, limited the scope of price increases and drove U.S. profit rates to unprecedented low levels. Under neoliberalism, tepid labor productivity growth narrowed the options for increasing profitability. Our empirical evidence shows that the business sector average profitability trend not only did not regain the lofty levels attained in the postwar period but, in some measures, its downward trend persisted from the early 1980s into the 21st century. Since we theorized the emergence of neoliberalism as a new configuration of the social relations of capital accumulation intended to revive profitability, the evaluation of its legacy will hinge on whether or not it managed to reverse its downward trend. While neoliberalism successfully achieved a substantial increase in the share of profits in net value added, it failed to arrest the relentless drive of technological change to automate the production of goods and services. In the context of global competition, such a trend led to rising capital/net output ratios and, hence, maintained the downward pressure on profit rates. Absent the reversal in profitability and capital accumulation in the nonfinancial sectors of the economy, the structural drivers of sustained growth failed to gain momentum. Neoliberalism increased social inequality and, despite cyclical booms in financial markets, led to secular stagnation in the overall economy. From this perspective, the legacy of neoliberalism is not only detrimental to workers displaced by deindustrialization and technological progress, but a failure in its own terms, that is, raising the average profit rate. Prospects of revival The measures taken to jolt the system back to full capacity employment after the COVID-19 pandemic will bring about a new version of the 1970s stagflation, but this time not goaded by the strength of investment spending pressing against sharply falling profitability. The new stagflation stems from the unprecedented public deficits created in the presence of low average profitability and the hollowed supply capacity of the large number of zombie companies kept in business from

172  Falling interest rates, banking, and financial crises the 2007–2009 Financial Crisis to the COVID-19 outbreak of 2020 thanks to nearzero interest rates and the pileup of debt. As rising interest rates disrupt the buoyant financial markets and the central pillars of neoliberalism lose their luster, it remains unclear whether or not secular stagnation patterns can persist without a systemic breakdown. Our interpretation of the historical patterns studied in this book suggests that when capital accumulation reached an impasse due to falling profitability at the end of the 1970s, powerful managerial elites forced the system’s structure to undergo radical changes that culminated in the consolidation of neoliberalism. We, therefore, conclude that some transformation of the neoliberal regime is likely to follow as an escape from the gathering crisis. Nonfinancial corporate sources of financial investments The gross operating surplus of nonfinancial corporations is the income left after deducting employees’ compensation costs from the gross value added realized in sales. After subtracting capital consumption funds from the gross operating surplus and ‘taxes on production and imports less subsidies’ (basically excise taxes), the net operating surplus provides the funds out of which nonfinancial corporations pay for their net interest liabilities and assess their before income-tax corporate profits. After deducting income-tax on profits, gross ‘retained earnings’ provide the operational budget out of which, on average, nonfinancial corporations weigh their options regarding the use of these funds, including financing over 90 percent of their corporate capital expenditures, disbursing dividends, or purchasing their own equity and fund shares. The portion of retained profits allocated to each category will depend on the evaluation of the profitability prospects of new investment spending on plant and equipment. Thus, the higher (lower) the expected profitability looms in the assessment, the higher (lower) the share of internal funds allocated to capital accumulation and the lower (higher) the share of dividends and equity shares earmarked for equity buybacks. Starting in the mid-1980s, however, as interest rates fell, and capital accumulation declined because the average rate of profit remained at historical lows well below those of the 1960s and 1970s, corporate borrowing to fund share buybacks expanded. Corporations continued to adjust their saving propensity according to the funding needs of their fixed capital investments but found it advantageous to increase their liabilities when buying their equity shares. It is reasonable to suppose that, despite the slow aggregate growth of nonfinancial corporate profits, the buybacks enabled equity shares to reach valuations otherwise unattainable. Figure 7.2 shows the distinctive separation between the healthy phase of capital accumulation when corporations sold their shares and the post-industrial stage when corporations bought their own shares and built up their debts. From the late 1940s to the early 1980s, successful corporations did not buy their own equity shares they sold them. The approval of rule 10b-18 in 1982 legalizing corporate shares’ buybacks, however, was a landmark on the road to financialization that facilitated the switch from nonfinancial corporate fixed investments to equity shares buybacks. Figure 7.3 provides confirmation of the increasing ratio of

Falling interest rates, banking, and financial crises  173

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Figure 7.2  Nonfinancial corporate borrowing, share buybacks, and equity funds, based on Flow of Funds FA103181005.A, FA103164103.A, and FA104190005.A. 225% 200% 175% 150% 125% 100% 75% 50% 25% 0% -25% -50% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 7.3  Nonfinancial net new equity purchases relative to net fixed investment, based on Flow of Funds FA103164103.A, FA105019005.A.

share-buybacks relative to corporate net investment separating the postwar period integrated economy with manufacturing, in command from the neoliberal phase, with financialization as the leading growth pole. With the advent of neoliberal financialization and falling interest rates, the ratio of buybacks to net fixed capital

174  Falling interest rates, banking, and financial crises investment rose sharply, confirming the growing expansion of financial investments relative to nonfinancial capital accumulation. The consolidation of financial markets in the 1990s, providing an alternative to real capital investment, raised the ratio of shares buybacks relative to net fixed capital investment to the unprecedented level of 200 percent, both before the Great Financial Crisis and right after its conclusion before settling at an average ratio of 100 percent. Falling interest rates revalued the equity share yields and were the harbinger of capital gains. Despite (rising) valuations out of proportion with the growth of corporate profits, confidence in capital gains simply required conviction in the neverending support of the Federal Reserve’s policies. In the conventional wisdom of Wall Street, the advantages of financial investments, including the prospects of short-term capital gains, surpassed those of fixed capital investments fraught with a long history of falling profitability. Class rewards and financialization With the upward revaluation of financial assets that followed the decline in interest rates after 1984, the previously falling trend of net financial wealth shares accruing to the top 10 percent of rich households was reversed and, in the wake of the Great Financial Crisis of 2007–2009, their share of net financial wealth surpassed the level achieved in 1960. The rise in financial wealth of the top 10 percent contrasted with the fortunes of rank-and-file workers who saw the share of their income in net value added and the weight of their union organizations steadily decline from the mid-1950s until 2020. From the standpoint of the top 10 percent of households, the financial earthquake that shook banking achieved what Thomas Palley called the “domination of the macro economy and economic policy by financial sector interests,” and from the standpoint of financial wealth, redistribution achieved its objectives. But it was a matter of class power expressing its capacity to redress a historical anomaly, namely the divergence between political and economic privilege. Palley’s belief that because “Economists have played a critical role in constructing and supporting the financialization paradigm,” neoclassical theorists effectively paved the way to the transition from Fordism to neoliberalism and deemed the theory of finance ‘domination’ unwarranted. In our view, it is not the axioms of neoclassical economic theory, vacuous as they may be, but the material interests of rich managerial elites exercising their power to alter the balance of capital flows that were decisive. The structural changes that followed deindustrialization, including falling wage shares of ‘production and nonsupervisory employees’ and rising wealth and income inequality, were natural consequences of the effort to restore profitability as the driving force of neoliberalism, in line with the interests of the managerial elites that promoted it. Of course, neoclassical economists promptly developed a comprehensive rationale for the beneficial effects of the neoliberal phase, first advocating the efficiency of markets in general and liquid assets in particular. Palley interprets their defense of financialization as supporting the ideological axioms of perfect competition. The claim of long-run Pareto efficiency, a situation providing the

Falling interest rates, banking, and financial crises  175 maximum well-being of consumers (when no one can be made better off without making someone else worse off), assumes that resources are fully and efficiently employed, firms operate at their minimum average cost, and the lowest possible price remains equal to consumers’ marginal utility. Figure 7.4, on the other hand, shows the absence of any semblance of Pareto optimality, as the movement of wealth shares for the 1 percent of households is the inverse of the wealth shares of the 50–90 percent of households from 1990Q1 to 2021Q3. The inability of fiscal policy to jumpstart the growth engine of neoliberalism on a sustained basis in the early 1980s appeared to persuade the Federal Reserve in 1984 to reverse its monetary policy, lowering the interest rate from its over 14 percent peak in 1981 to virtually a zero bound in 2020. That reversal set the stage for a regime change of unprecedented proportions in which financial investments rose to the leading position in the overall accumulation of capital, replacing the role of manufacturing two decades earlier. In addition, the neoclassical justification for financialization also includes the apologetic defense of speculation as a vehicle for stabilization in the stock market and the claim that, because of it, equity share prices typically reflect fundamental values in the real economy. It is thus claimed that, because speculators push prices up or down, depending on the deviation of share prices from the relevant fundamental values, they provide the needed arbitrage to justify the benefits of speculation. Moreover, those with the wherewithal to save, the rich, are able to lend their surplus money to those who do not save, the poor, thereby expanding the chances of people without capital to embark on 38% 50-90% percentile wealth share

36%

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Figure 7.4  Contrasting trends of wealth shares of top 1 percent of households and that of the 50 to 90 percent percentile https://www​.federalreserve​.gov​/releases​/z1​/dataviz​ /dfa​/distribute​/table/​#quarter​:118​;series​:Liabilities​;demographic​:networth​ ;population​:1​,3​,5​,7​;units​:levels.

176  Falling interest rates, banking, and financial crises entrepreneurial ventures. They can do so, comforted with the knowledge that liquid financial assets can be obtained or easily transferred, if necessary (Palley, 2013). As mentioned earlier, and Figure 7.4 illustrates, the claim of Pareto optimality hardly applies as a justification of financialization. As Figure 7.5 shows, in the wake of the Financial Crisis of 2007–2009, the neoliberal consolidation of financial markets restored to the top 10 percent of households the 70 percent share of net financial wealth they owned in the early 1960s. The 11.4 percent decline of the net financial wealth share of the top 10 percent of households registered between 1961 and 1984 would explain why the stagflation crisis of the 1970s acted as the strong catalyst for transitioning to a new configuration of capital flows. The changes to the structure of the national economy brought about a wealth distribution in line with their financial interests. From 1984 to 2012, the inflows of global capital that raised asset valuations, not only recovered the share of net financial wealth lost by the top 10 percent of households between 1961 and 1984, but topped it. In the aftermath of the COVID-19 pandemic, despite lockdowns and disruptions of supply chains, the upper classes secured a substantial increase of their wealth share. From the standpoint of reversing the postwar trend in the distribution of wealth, the financialization alternative was an unequivocal success for the richest 10 percent. As Figure 7.6 shows, their ownership of corporate shares and mutual funds rose from 78 percent in 1999Q1 to near 90 percent in 2021Q1. One percent of the richest households owned near 54 percent of corporate shares in 2021Q1, while in 2001Q1 they owned ‘only’ about 40 percent. As Figure 7.7 shows, along with deindustrialization, the neoliberal project brought about the disappearance of labor unions and falling wage shares for

74%

72%

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66%

64%

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60%

1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015 2018 2021

Figure 7.5  Share of net financial wealth of top 10 percent including equity, fund share, and offshore accounts, https://wid​.world​/data/.

Falling interest rates, banking, and financial crises  177

98%

88%

78% Percentage of corporate shares & mutual funds owned by top 10 percent

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Percentage of corporate shares owned by top 1 percent

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Figure 7.6  Percentage of corporate shares and mutual funds owned by the top 10 percent and top 1 percent of households, 1989:Q3 to 2021:Q1. https://www​.federalreserve​ .gov​/releases​/z1​/dataviz​/dfa​/distribute​/chart/​#quarter​:127​;series​:Net​%20worth​ ;demographic​:income​;population​:all​;units​:shares. 40%

35%

64.8% Union density

union density

Production & nonsupervisory share of employee compensation in business sector net value added

60.5%

30%

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20%

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15%

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5% 35.0% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 7.7  Declining labor union density and falling share of ‘production and nonsupervisory’ workers’ compensation in net value added, as previously sourced.

178  Falling interest rates, banking, and financial crises ‘production and nonsupervisory employees,’ roughly about 80 percent of all employees. The parallel decline of union density in manufacturing contributed to weakening the bargaining power of labor and the reversal of the falling trend of profitability. Neoliberalism did not arise spontaneously after the stagflation crisis discredited the Fordist configuration. The crisis merely highlighted the urgency of structural change. The monetary policy implemented by the Federal Reserve, from the early-1980s through the second decade of the 21st century, played a crucial role in the emergence of neoliberal financialization (Greenwald, et al., 2021). Monetary policy and the ‘Gibson Paradox’ For centuries, interest rates and the price level moved in the same direction. Price movements determined the banks’ input costs, including their fixed plant and equipment as well as operating costs, while the level of interest rates affected the bank’s output revenues. For banks to remain profitable, the level of lending interest rates must cover the input costs associated with banking activities plus an average profit margin, in common with any other business sector. As in all industries, banking unit costs plus the average profit rate comprise the competitive level of interest rates in the leading institutions of the sector, and therefore, when movements in the general price level raise input costs, banks need to adjust their interest rate accordingly, to preserve profit margins. As we show in Figure 7.8, the parallel movement between (short-term) interest rates and U.S. producer prices from the early 19th century to the early 1980s broke down after 1984 when a sharp bifurcation between them occurred that was never reversed. 225 U.S. Producer Price Indexes

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U.S. Short-term (consistent) interest rates

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-25 1833 1844 1855 1866 1877 1888 1899 1910 1921 1932 1943 1954 1965 1976 1987 1998 2009 2020

Figure 7.8  Gibson Paradox flat trends of price and interest rate levels 1833–1947 versus rising prices from 1947–2012 and rising interest rates 1947–1984, based on BLS-FRED PPIACO and https://www​.measuringworth​.com​/interestrates​/ intstudy​.pdf.

Falling interest rates, banking, and financial crises  179 It is remarkable that despite Keynes’ early focus on the significance of the Gibson Paradox, the banking consolidation provoked by the bifurcation of the average price level and interest rates after 1984 played no role in mainstream accounts of the build-up to the first Financial Crisis of the 21st century in 2007–2009: For the extraordinary thing is that the ‘Gibson Paradox’—as we may fairly call it—is one of the most completely established empirical facts within the whole field of quantitative economics, though theoretical economists have mostly ignored it. (Keynes, 1950, p. 198) Falling interest rates, the banking and financial crises As deindustrialization progressed apace, the sustained policy of the Federal Reserve to lower the long-term trend of interest rates played a decisive role in boosting asset prices, including equity shares and housing, as alternative channels for financial investments. The unintended consequence of that policy, however, contributed to the unfolding of two major structural crises. The sustained decline in interest rates carried out by the Federal Reserve since the mid-1980s lowered the net interest margins of all banks and caused the smaller and lesser-capitalized institutions to fail, leading to the disappearance of thousands of banks. Falling interest rates eventually laid the grounds for the outbreak of the Great Financial Crisis. As a consequence of their disappearance, a handful of behemoth financial entities acquired a rising proportion of financial assets, much as had happened earlier in the Fordist postwar period in the rising centralization of the manufacturing sector (Dos Santos, 2013). As Figure 7.8 shows, the genesis of the banking crisis derives from the sharp reversal of interest rates after the mid-1980s. After 1984, the growing bifurcation of the general price level, which kept rising for decades while Federal Reserve policy persistently lowered interest rate levels and the ‘price’ of bank credit. Traditional banking profitability depends on the spread between loan and deposit rates. On the one hand, the sustained decline in the Federal Funds Rate led to a falling ceiling for loan rates and reduced U.S. banks’ ability to set competitive profitable margins. On the one hand, interest rates representing the banks’ output, the credit price, declined, while the cost-price of banking inputs kept on rising. This dichotomy provoked an irreversible profit squeeze in those banks that failed to achieve productivity growth of sufficient magnitude to catch up with their rising input costs. Tony Norfield provided an insightful view of the problem banks faced when interest rates declined: From the 1990s onwards, bank profitability had been coming under pressure from narrower interest margins—the gaps between their borrowing and lending rates. These had tended to fall in line with the trend towards lower money-market interest rates. For example, if market interest rates for borrowing between banks are close to 10 percent, then a bank might offer its

180  Falling interest rates, banking, and financial crises customers deposit rates of 7 percent, but only lend to companies and individuals at 12 percent, giving it a premium of five percentage that then contributes to its revenues. However, if the market interest rate drops to 4 percent, then it becomes more difficult for the bank to charge a five percentage point margin, for example by making its rates to depositors 2 percent and its rate for borrowers 7 percent. (Norfield, 2016, p. 132) As Figure 7.9 shows, the long-term falling trend in interest rates brought about the long-run disappearance of large numbers of smaller banks and facilitated the concentration of bank assets into a progressively smaller number of increasingly large size institutions with centralized power. Norfield calculated that, by 2006, the compression of net interest margins that resulted from the falling interest rate reduced net revenues in the U.S. banking sector “to less than $35 million for every $1 billion lent out, rather than being $40–45 million, a drop of some 20 percent” (ibid., p. 132). Declines of that magnitude brought about one of the major transformations of the financial industry, consisting of drastic changes in its business model, from lending to corporate business to advancing loans for household needs, including mortgages, health, education, vacations, etc. The most radical change derived from the long-term falling trend in interest rates in contrast with the rising level of wholesale prices, was the equally longterm falling trend in net interest margins that effectively drove large numbers of smaller banks into bankruptcy and consolidated the banking sector into a few giant institutions. The crisis broke out because smaller banks could not counter the profit 0%

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Figure 7.9  Net interest margins (left axis) and number of banks, 1984–2020, based on FRED USNIM and USNUM.

Falling interest rates, banking, and financial crises  181 compression brought about by declining net interest margins with enough volume expansion, in contrast with larger banks that enjoyed economies of scale and were able to attain lower unit costs. Despite the reduction in the number of banks (Figure 7.10), as asset concentration increased, the share of financial corporate profits in total corporate businesses rose while the share of manufacturing profits diminished. As the remaining sectors adjusted to the neoliberal configuration, nonfinancial corporations became increasingly self-reliant as far as their capital expenditures were concerned. The prevailing low average profitability made them more dependent on their own retained profits as the principal source of investment funding. On the other hand, the prevailing low level of interest rates raised corporate interest in borrowing funds for share buybacks: nonfinancial corporations sold bonds and used the proceeds to buy their own shares. The large banks reoriented their lending practices to service every aspect of household needs, and widened these markets sufficiently to outweigh the losses incurred when nonfinancial corporations adopted the practice of selffinancing their investment needs. As the post-Keynesian Mariana Mazzucato put it: In modern capitalism the financial sector has greatly diversified as well as grown in overall size. Asset management in particular has greatly diversified as well as grown in size. Asset management in particular is a sector which has risen rapidly and secured influence and prominence; it comprises the banks which have traditionally been at the centre of the value debate but also, now, a broad range of actors. Hyman Minsky argued it was reshaping the economy into what he called ‘money manager capitalism.’ (Mazzucato, 2018, p. 141) 53%

0% % decline number of commercial banks relative to 1984

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Figure 7.10  The declining number of banks and asset concentration in five top banks, FRED DDOI06USA156NWDB and USNUM.

182  Falling interest rates, banking, and financial crises Falling interest rates and stock market valuations The main impact of the Federal Reserve’s policy on lowering interest rates was the rising capitalization of stock market values. Figure 7.11 displays two profitability long-run estimates, one presents the results of dividing the net operating surplus of nonfinancial corporations over their gross fixed capital stock as developed in Anwar Shaikh’s Appendix 6.8 of his Capitalism book; the other shows the results of dividing the same net operating surplus over the stock market valuation of the nonfinancial corporate sector’s stock of capital assets. Throughout the whole period between 1948 and 2020 the profitability trend, based on estimates of the nonfinancial net operating surplus divided over the stock market valuation of nonfinancial corporate fixed assets, circled around the real profitability trend of the same operating surplus divided over the current cost of the actual estimates of gross capital assets of nonfinancial corporations. Between 1978 and 2001, a ‘bull’ market in corporate equities set off a declining trend in nonfinancial corporate profitability that only ended in 2001. Periods in which the profitability trend based on stock market valuations rose above the profitability trend based on the real current cost of the gross capital stock were obviously periods in which the stock market undervalued the gross capital stock deployed. On the other hand, during periods when the stock market valuations of the existing fixed assets were unrealistically high the profit rate fell below the profitability trend reflecting the actual estimates of the gross capital assets. Between the late 1940s and 1960, years of actually high profitability levels, the stock market valuations appeared to be surprisingly low despite the low interest

35% Nonfinancial corporate profits/Current cost gross capital stock

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0% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 7.11  Nonfinancial corporate average profit rate on current cost nonfinancial corporate gross capital stock and average profitability on stock market valuation of the sector’s fixed assets, based on NIPA Table 1.14 and Flow of Funds FL103164113.A.

Falling interest rates, banking, and financial crises  183 rates and high profits associated with U.S. manufacturing. From 1960 to 1972, the stock market capitalization of nonfinancial corporations improved considerably and the profitability estimates from this source fell below those pertaining to the actual current cost of the gross capital deployed. In the 1970s, rising interest, inflation, and unemployment had a negative impact on the stock market valuations of the real fixed assets of nonfinancial corporations and, as expected, the average stock market yield rose above the real estimate of the average profitability calculated on the actually deployed current cost gross capital stock of nonfinancial corporations. After 1984, the stock market valuations trend started rising and the ‘bull’ market continued until the onset of the 21st century. It would be fatuous to interpret this rise as a reflection of a real boom in the system at large. Rather, as Solow commented when reviewing “Matthew Rognlie’s excellent paper…the difference between the stock market value of a corporation and the ‘book value’ of its assets is interpreted as the present discounted value of the anticipated stream of rents” (Solow, 2015, p. 64). The 1984 rise in interest rates attracted foreign capital flows and provided the liquidity necessary to generate the wherewithal that set off the stock market expansion through the 1990s. The long-run falling trend of interest rates that followed the early 1981 peak opened the initial floodgates of foreign capital that triggered the euphoric expectations of ‘bull’ markets in the 1990s. From 2001 to 2008, downpressures on equity shares valuations (‘fictitious’ capital) appeared to align our two profitability schedules but this convergence dissipated after 2011. From 2001 to 2020, the profitability trend based on equity shares valuations shaped the contours of a near 20-year-long wave of expectations that had no foundation in the real economy. The banking crisis and the Financial Crisis of 2007–2009 The full set of institutional steps configuring the consolidation of the neoliberal order did not spring fully articulated from the minds of corporate power elites searching to maintain capital accumulation as a viable system. The restoration of profitability required the dismantling of the foundations of the Fordist economy and that led to the dispersal of plants and employment to offshore locations along with the massive creation of (basically unskilled) jobs in relatively small-scale service activities (Kalleberg, 2011; Temin, 2017; Lind, 2020). While the sustained decline in interest rates engineered by the Federal Reserve, lowering them from the mid-teens in 1984 to near zero by 2015, did not produce a ‘long boom’ in the real economy, it brought about a profound reorganization of the banking system. The consolidation of neoliberalism did not happen in one fell swoop but in stages. Due to falling profitability, the neoliberal project of capital accumulation first required shrinking the share of manufacturing in employment and output; second, it had to fill in the space lost in manufacturing with the bulk of service sectors, including finance, insurance, and real estate (FIRE). These measures were necessary in order to absorb an increasing share of current profits out of the remaining productive activities. Third, to complete the neoliberal order, it was necessary to

184  Falling interest rates, banking, and financial crises establish cheaper offshore supply chains capable to substitute for the previously available domestic industrial production. This last component of the neoliberal project secured the dispersal of workers in compliance with the new laissez-faire settings that replaced the former capital-labor accord. Financialization enlarged the scope of stock market activities for professional speculators to gain at the expense of small ‘investors’ in a game of few winners at the expense of many losers, capturing the so-called ‘profits on alienation’ that James Stuart and Marx distinguished from profits on production. The new strategy of the managerial elites sought to circumvent that decline with the expansion of financial markets: “Whenever capital is not reinvested in production because firms consider the rate of industrial profit insufficient to justify new investments, a part of profit is hoarded and ends up fueling financial accumulation” (Chesnais, 2016, p. 45). Shifting their strategy from financing corporate capital expenditures to underwriting financial transactions and housing mortgages, large banks not only survived the industry-wide restructuring but consolidated their leading positions in the overall economic structure without contributing to shoring up the viability of the nonfinancial corporate sector. Falling interest rates drove the surviving banks to change their business model, curtailing their lending to nonfinancial businesses in light of their reduced capital expenditures and, instead, expanding their fee-related lending to households, including mortgages and other consumer loans. The disappearance of large numbers of uncompetitive banks, as well as the thorough revamping of business practices by the surviving top banks, successfully secured their leadership position and laid the ground for reactivating their role as the dominant drivers of financialization. After the waves of euphoria that inflated successive asset bubbles in financial assets dissipated and the boom unraveled, the memories of the 2007 Financial Crisis faded, and the five largest banks retained uncontested power. The Financial Crisis that led to the Great Recession in 2007 terminated the complacency of banking practices in the subprime mortgage sector. It would be shortsighted to gloss over the circumstances that led to it and instigated its expansion worldwide. As neoliberalism took root after the early 1980s, nonfinancial profitability declined in the advanced capitalist countries from its high levels in the 1960s and 1970s, and in varying degrees throughout the world in the 21st century. The decline reached such low levels that the accumulation of real capital came to a standstill, or, at best, to a path of secular stagnation. By 2007, nominal interest rates were very low, the incomes of the majority in real terms had advanced very little in the last four decades, and the banks had found in the needs of households a substitute for the needs of nonfinancial corporate business. The nonfinancial corporate businesses’ capital expenditures progressively declined. Bank profits depend on the volume of lending, and falling interest rates compressed net profit margins. What then could the largest banks do to raise profits but to find ways to enlarge their markets? Households whose real income was not rising had many needs but low savings, and they would normally not qualify for large loans from well-capitalized banks. These banks, however, needed to expand their markets to compensate in volume for the compressed net interest margins

Falling interest rates, banking, and financial crises  185 available due to low interest rates. This scenario combined customers (although impecunious) willing to acquire mortgage loans with bankers and mortgage originators needing to make them because their fees and profits depended on widening the lending market. Originators could agree to make loans because banks were willing to finance them, and both intended to securitize those loans and sell them to global buyers looking for bargains since other profitable outlets were not available. The frenzied nature of asset buying in the subprime market ensured that housing prices would keep rising to provide otherwise nonexistent collateral. Buyers and originators of these securities lacked knowledge of the extent to which loans to insolvent clients were bundled with credit-worthy ones. Then underwriting banks could remain safe because the final buyers of the bundled securities would bear the full risk of default, or so they thought. When this operation reached a certain threshold, defaults suddenly started to rise and, at some point, the foundation of the Ponzi scheme collapsed. In a world of low growth earnings, mortgage buyers defaulted on their payments because their income could not be stretched. Banks found themselves in possession of bundled masses of unsold securitized mortgages not accepted as collateral for borrowing funds from other banks. The banking sector seized with fear of defaults. Buyers of bundled mortgage-backed securities shared with those buying the mortgages the belief that they could transform fictitious capital assets into real ones, in a world of diminished real investment opportunities. All of them ignored the fact that in such a world, falling profitability leads to the stagnation of real capital accumulation, raising the risk level of all financial transactions, especially those leading to the formation of ephemeral bubbles that eventually burst. The Great Financial Crisis and secular stagnation The idea that financial engineering could replace industrial engineering as a profitable alternative, free from the hassles and conflicts of bargaining with labor unions, was central to the neoliberal project. The diversion of real investment flows into speculative trading in financial assets had an impact on labor productivity growth and undermined the system’s resilience in the face of widespread defaults. Marx noted how for bankers the circuit of capital…appears as the circuit of money capital because industrial capital in its money form, as money capital, forms the starting point and the point of return of the whole process…The production process appears simply as an unavoidable middle term, a necessary evil for the purpose of money-making. Engels, in the second (1893) edition of Capital Volume 2 added, “This explains why all nations characterized by the capitalist mode of production are periodically seized by fits of giddiness in which they try to accomplish the money-making without the mediation of the production process” (Marx, 1992, p. 137).

186  Falling interest rates, banking, and financial crises In 1987, Seymour Melman observed that the sharp downfall in profitability that plunged the system into the unprecedented stagflation crisis of the 1970s ended the Keynesian consensus, and opened the way to neoliberalism and the proliferation of financial storms. As Melman saw it, by 1982 it is impossible to identify a single major American industrial firm that has embraced the fundamental changes of policy required to move from the ambitions of profit and power to the service of production. And as long as finance capital can be kept mobile, the top managers of major U.S. industrial firms have a secure escape route: they can move their hoard of money to other industries, other locations, other forms of investment that involve no production: They can ship their money out of the United States altogether. (Melman, 1987, p. 275) With the passing of time, each of these components of the neoliberal phase exposed its structural limitations. Shrinking manufacturing as the quintessential industrial activity deprived the system of a fast- growing productivity sector. The growth of personal services, centered in labor-intensive but low- productivity venues resistant to technical progress, provided employment but also low wages and dead-end jobs for a growing mass of employees. The growth of financialization and the proliferation of financial engineering opened the gates for the promotion of speculation in the housing, internet, and financial markets that led to explosive bubbles and recurrent financial crises. Financialization facilitated the concentration and centralization of new conglomerates in the so-called ‘information technology’ (IT) sector but failed to promote capital accumulation in nonfinancial activities, except in the so-called technology, pharmaceuticals, oil, and gas sectors. Instead, easy credit burdened consumers with unsustainable debts that prevented fast recoveries from recessionary episodes. Judging neoliberalism by the extent to which its implicit goal of reversing the previous profitability trend was accomplished, the litmus test of its success, the conclusion must be negative. The consolidation of neoliberalism bypassed the earlier sociopolitical restraints weighing in on the Fordist economy regarding the distribution of new value added in favor of profits. But despite the eventual increase in the profit share, falling capital accumulation rates, declining labor productivity growth, and persistent financial crises kept aloft the specter of secular stagnation. Financial versus nonfinancial sector profitability In our view, the contrasting paths of the average profit rates in the nonfinancial and financial sectors between 1982 and 2007 provide the key to an understanding of the structural changes that gave financial investments the leading role in the dynamics of neoliberalism. In Figure 7.12, the growth of the profit share of the financial sector relative to all corporate profits provides the necessary benchmark to interpret the fluctuations in financial sector average profitability. The average profit rate tracked the movement of financial profit shares, suggesting that profitability on

Falling interest rates, banking, and financial crises  187

22% 20%

42% Financial corporate average profit rate

38%

Financial sector share of corporate profits

18%

34%

16%

30%

14%

25%

12%

21%

10%

17%

8%

13%

6%

9%

4%

5%

2%

1%

0% -3% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 7.12  Co-movement of financial business profitability and the sector’s share of corporate profits due to expanding financialization, based on Flow of Funds data and NIPA 1.14.

financial capital depends on the share of profits captured by banks and insurance corporations. As Figure 7.13 shows, the average profit rate in the nonfinancial corporate sector rose to nearly 15 percent in the mid-1960s from a relatively high average level of 13 percent in the previous decades of the postwar period. From the mid-1960s into the early 1980s, the profit rate plunged. Having reached an unprecedented trough in 1982, profitability experienced a mild recovery after which it fell again to its lowest trough in 2001, nearly 50 percent lower than in the early postwar period. In contrast, the profit rate in the financial sector rose in a Long Wave, whose upturn phase extended from 1950 to about 1970, followed by a sharp decline from 1970 to its 1982 trough. After 1984, in the neoliberal phase, the financial sector (FIRE) profit rate on capital experienced an unprecedented upturn that lasted through 2006, kindling the speculative euphoria that eventually led to the system’s financial collapse in 2007 triggering the Great Recession. The profitability downturn experienced in the financial sector between 1970 and 1982 reflected the pattern of decline experienced in the nonfinancial corporate sector after private and public fiscal deficit spending failed to counteract the effects of falling profitability. The trend reversal in interest rates engineered by Federal Reserve policy from 1982 through 2007 paved the way for the structural overhaul of the banking sector that eventually led to the sharp upturn of the sector’s profit rate. With the rate of capital accumulation falling and the share of accumulation financed internally rising, the profit-making targets of the larger banks changed from capital lending to nonfinancial corporations to intermediation in mergers and acquisitions, expansion

188  Falling interest rates, banking, and financial crises

25%

25%

23%

Financial business profitability

23%

21%

Nonfinancial business profitability

21%

19%

19%

17%

17%

15%

15%

13%

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9%

9%

7%

7%

5%

5%

3%

3%

1%

1%

-1% -1% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 7.13  Gravitational pull between the nonfinancial corporate average profit rate and the financial average profit rate, based NIPA Tables, Fixed Assets, and Flow of Funds.

of household mortgages lending, and multiple other household needs, service fees, and stock market trading. Rising from its 1982 trough, financial profitability surpassed the level achieved by the nonfinancial profit rate until the 2007 crash reversed its trend. The new banking strategy to increase profitability above the level of nonfinancial corporate business placed the financial sector in the leading role as the promoter of the neoliberal ‘long boom.’ The remarkable recovery of the financial sector profit rate emerged from the protracted banking crisis that decimated the industry as thousands of banks did not survive the falling interest rate policies of the Federal Reserve. Deploying automation technologies, the largest banks emerged from the competitive battles unscathed and more powerful than ever, consolidating their control over banking assets and the allocation of capital flows. The rise in profitability experienced in the financial sector, in contrast with the trendless path experienced in the nonfinancial corporate sector, affected the flows of capital seeking nonfinancial and financial investment outlets, in and out of the corporate sectors. From the late 1940s to the early 1980s, the combined corporate sector, especially in the case of nonfinancial corporate businesses, relied heavily on credit to finance the investment gap between internal funds and planned capital expenditures. The ratio of financial investments relative to fixed capital spending remained negative in the first three decades of the postwar period, but after 1984 it rose from an average of −20 percent in the 1960s to over +30 percent in 2009. During the same period, financial profits relative to corporate net operating surplus tripled, rising from 10 percent in 1984 to 30 percent in the

Falling interest rates, banking, and financial crises  189 early 2000s. The path of the financial sector’s average profit rate followed the path of the financial business’ share of corporate profits. Figure 7.13 shows the gravitational pull exerted by the nonfinancial corporate profit rate over the financial sector’s average profit rate. Circling around the nonfinancial average profit rate, the financial business average profit rate appears to be dependent on the power of nonfinancial capital to maintain its profitability trajectory. A good portion of financial profits represents rents appropriated by banks and insurance companies in exchange for the provision of credit to households and nonproduction activities. Still, part of realized financial profits are ‘profits on alienation,’ the losses made by trade partners betting on the wrong side of the speculative issue. As in the opening years of the 21st century, the financial euphoria behind the housing bubble led to a great bifurcation of financial and nonfinancial profitability levels and only the eventual crash of 2007–2008 closed the gap between the two. Figure 7.14 represents the reaction of capital markets to the trends in profitability in their respective sectors. It is evident that from the late 1940s until the outbreak of the Financial Crisis of 2007–2009 the accumulation of financial (fictitious) capital closely followed the profitability trend in that sector, but its growth fluctuations did not match those in profitability. It is important to note that financial profitability is much more volatile than in the real sectors and its roots lie in totally different foundations. The recovery from the Financial Crisis did not raise the expansion rate of financial profitability in the 21st century to any level comparably as high as those experienced in the past, even though the profitability level rose to match the level reached in the nonfinancial corporate sector.

22% 19% 16%

Financial business accumulation rate (financial & fixed capital) Nonfinancial corporate accumulation rate

13% 10% 7% 4% 1% -2% -5% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 7.14  Accumulation rates in nonfinancial and financial sectors, Flow of Funds FA795090005.A, FA796300003.A, FL795013265.A, FL795013665.A, FA793061705.A, FA794022605.A, and FA794122605.A.

190  Falling interest rates, banking, and financial crises

50% 40%

Corporate incremental profit rate S&P composite real marginal rate of return

30% 20% 10% 0% -10% -20% -30% -40% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 7.15  Corporate (financial and nonfinancial) incremental profit rates and stock market incremental profit rates, based on Shiller’s S&P returns data and previously sourced data.

We can observe in Figure 7.15 a rather remarkable correlation between corporate and stock market incremental profit rates from 1948 to 1984, but not in the following decades of assets’ price inflation and the reappearance of bubbles and their inevitable collapse. The reciprocal gravitational pull remains in place but exerts a weaker force because, in the neoliberal phase, speculation trumps long-run profit expectations in the nonfinancial sector. References Chesnais, F. 2016. Finance Capital Today, Brill. Dos Santos, P. 2013. “On the Content of Banking in Contemporary Capitalism,” in Lapavitsas, C. (ed.) Financialization in Crisis, Haymarket Books. Greenwald, D. L. et al. 2021. “Financial and Total Wealth Inequality with Declining Interest Rates,” NBER, WP 28613, April. Kalleberg, A. 2011. Good Jobs, Bad Jobs, Russel Sage Foundation. Kaufman, H. 2009. “The Great Interest Rate Wave,” The Wall Street Journal, February 14. Keynes, J. M. 1950. Treatise on Money, Volume 2, Macmillan. Lapavitsas, C. 2013a. Profiting Without Production, Verso. Lapavitsas, C. 2013b. “The Financialization of Capitalism: ‘Profiting Without Producing’,” City, Volume 17, No. 6, DOI: 10.1080/13604813.2013.853865. Lapavitsas, C. and Mendieta, I. 2016. “The Profits of Financialization,” Monthly Review, New York, July. Lind, M. 2020. The New Class War, Penguin Random House. Marx K., 1992. Capital, Volume 2, Penguin.

Falling interest rates, banking, and financial crises  191 Mazzucato, M. 2018. The Value of Everything. Making and Taking in the Global Economy, Allen Lane. McGowan, A., Andrews, D., and Millot, V. 2017. “Insolvency Regimes, Zombie Firms and Capital Reallocation,” OECD Economics Department Working Papers, No 1399, June 30. Melman, S. 1987. Profits Without Production, University of Pennsylvania Press. Norfield, T. 2016. The City and the Global Power of Finance, Verso. Palley, T. 2013. Financialization: The Economics of Finance Capital Domination, Palgrave Macmillan. Solow, R. 2015. Comment to Rognlie’s “Deciphering the Fall and Rise in the Net Capital Share: Accumulation or Scarcity?,” Brookings Papers on Economic Activity, Spring, The Johns Hopkins University Press. Temin, P. 2017. The Vanishing Middle Class, MIT Press.

8

Keynes and secular stagnation

Keynes first advanced the possibility of secular stagnation in the introduction to three lectures devoted to “An Economic Analysis of Unemployment” at the University of Chicago in 1931. In those lectures, Keynes ‘took for granted’ that the primary cause of the current depression was the vanishing profit opportunities and plunging investment that preceded the loss of business confidence. The problem facing recovery was, Keynes argued, that while the restoration of business confidence was essential for the revival of investment to pre-depression levels, this could only happen when business profits increased, and higher profits would not come through unless investment spending first rose to pre-depression levels. Thus, breaking the “vicious cycle” required restoring business confidence by other means, and doing so would need initiatives capable of stoking business expectations. But business expectations could only be buoyed up on a firm foundation, “not on the vague expectations or hopes of the business world, but on a real improvement in fundamentals.” Facing this conundrum under the pall of the Great Depression, Keynes expressed his premonition that extended periods of subpar growth would follow the acute phase of depression. Keynes feared that there is the possibility…that when this crisis is looked back upon by the economic historian of the future…the duration of the slump may be much more prolonged than most people are expecting…Not of course the duration of the acute phase of the slump, but that of the long dragging conditions of semi slump, or at least subnormal prosperity which may be expected to succeed the acute phase. (Keynes, 1932, p. 3) In 1938, Hansen identified such a description “as the essence of secular stagnation” (Hansen, 1939, pp. 1–15). Keynes astutely rejected the option of breaking the impasse by lowering nominal wages “as an ugly and a dangerous thing” to increase profits, on grounds that such practices would “shake the social order to its foundations” (Keynes, 1932, p. 31). He reminded his audience that a major negative consequence of lowering money wages to increase profits was that such reduction of wages would reduce consumption demand and drag down prices along with it, thereby strengthening the deflationary effect of rising real debts. Keynes clearly understood the magnitude of DOI:  10.4324/9781003413806-8

Keynes and secular stagnation  193 the challenge involved in his policy recommendations if they were to reach the critical level necessary to turn the business gloom surrounding the slump into the high spirits needed to spur confidence and raise investment spending. Stressing that “the problem is to cause business receipts to rise relatively to business costs,” Keynes argued that carrying out any effective measures to bring about the revival of profits and investment would raise the price level but that it would also become part of a recovery plan that would contribute to higher profits, without provoking the kind of social unrest that cuts in nominal wages were bound to create. Keynes proposed two policy options that would reduce unemployment as they contributed to the revival of investment and profits: first, promoting the growth of government deficit spending and, second, bringing about drastic reductions of long-term interest rates. In his 1931 lectures, five years before the publication of the General Theory, Keynes already argued that he favored launching “new construction programs under the direct auspices of the government…For a government program is calculated to improve the level of business profits and hence to increase the likelihood of private enterprise again lifting up its head” as the most effective way of breaking the depression’s impasse (ibid., p. 37). Keynes himself suggested that trusting in drastically lower long-term interests to lift investment might be foolhardy because although “a reduction in the long-term rate of interest” might help business to emerge from the doldrums of depression, he feared that “when confidence is at its lowest ebb the rate of interest plays a comparatively small part…It may also be true that, in so far as manufacturing plants are concerned, the rate of interest is never the dominating factor.” Even though, in 1931, Keynes believed that “the main volume of investment always takes the form of housing, of public utilities and transportation” sectors where interest rates undoubtedly played a crucial role, it is clear that Hicks’ IS-LM neoclassical interpretation of Keynes’ General Theory overlooked Keynes’ misgivings about the power of interest rate policy to deliver full employment simultaneous equilibrium in the monetary and real sectors of the system. It could be argued that in its latest incarnation the neoclassical version of Hicks’ IS-LM model made a fetish out of the efficacy of a hypothetical equilibrium interest rate bringing about full employment and thereby abandoned its Keynesian heritage. When Keynes returned in 1943 to consider the possibility of prolonged economic stasis, unemployment was no longer the pressing issue of the day, the depression’s scourge had faded in time and instead Keynes faced “The Long-Term Problem of Full Employment.” This would be a ‘golden age’ characterized by features similar to John Stuart Mill’s conception of the stationary state, one in which “It becomes necessary to encourage wise consumption and discourage savings… and to absorb some part of the unwanted surplus by increase leisure…Eventually depreciation funds should be almost sufficient to provide all the gross investment that is required” (Keynes, 2013, pp. 320–325). Consolidation of the dual economy Our aim in Chapter 8 is to distinguish the early Keynes’ focus on profits and investment from the late neo-Keynesians’ emphasis on autonomous changes of effective

194  Keynes and secular stagnation demand. This will clarify our argument that the reduction of real nonfinancial corporate investment and the rising ‘hoarding’ of ‘cash’ reflect the switch from longterm fixed capital expenditures to financial speculation and share buybacks since the mid-1980s. This growth of liquid assets reflects the contrast between investment strategies of long-run fixed capital assets and financial speculation. They are based on the growing bifurcation between two sectors of the neoliberal regime. One consists of a relatively small but progressive sector, including manufacturing and so-called information technology firms that today dominate world markets. This sector relies on technical advances to achieve high rates of labor productivity growth. Second, a largely stagnant sector of health, education, business services, transportation, hotels, and restaurants employs nearly half of the labor force and registers little productivity growth as well as a small percentage in aggregate value added. In our view, the transition from manufacturing to the service economy outside finance secured the growth of the stagnant sector and strengthened the institutional tendency for secular stagnation in addition to the direct effect of falling profitability. Because the characteristic nature of such personal services drastically limits the deployment of automated technology (and labor productivity and wages barely grow), the stagnant sector provides employment for the large number of workers expelled from the progressive industries. On the other hand, the growing weight of finance, including stock market speculation and related activities, injects effective demand into the real economy through the ‘wealth effect.’ In this regard, the impact of monetary policy and near-zero interest rates on booming financial markets essentially contributes to the expansion of the stagnant sectors and the consolidation of the ‘dual economy.’ As deindustrialization proceeded apace in the early 1980s and the neoliberal structure of capital accumulation gained traction, sharp sectoral bifurcations emerged. Increasingly, the labor displaced from the technologically advanced sector found employment in the relatively large and stagnant service sector characterized by low productivity and low wage rates. Beginning early in the 21st century, nearly 50 percent of the private labor force was employed in the delivery of personal services. Because this laggard sector is a central component of neoliberalism, its fast expansion strengthened the structural tendencies driving the emergence of secular stagnation in the system as a whole. In addition, since the 1990s, the persistence of low average profitability spawned a growing number of insolvent nonfinancial corporations, reaching nearly 20 percent of the whole sector and falling into a ‘zombie’ status, unable to meet their interest obligations without taking additional debt. Under these conditions, for the system to enter a high growth path would require the reversal of its profitability trajectory and the disappearance of such ‘zombie’ companies along with the cheap credit policies that kept them viable. A small, technologically advanced group of superstar companies, surrounded by a large number of small, labor-intensive firms delivering personal services and saddled with low productivity growth, contributed to the patterns of capital accumulation that underpinned ‘secular stagnation.’ In this structural framework of stagnant manufacturing and burgeoning services, the falling average rate of profit in the business sector drove marginal companies into bankruptcy. A growing number of

Keynes and secular stagnation  195 such corporations that failed to achieve minimum profitability levels would have disappeared without large injections of cheap credit but were kept going by the low-interest policies of the Federal Reserve. Keynes’ affinities with the Classical/Marxian perspective We find Keynes’ explicit recognition of the intrinsic relationship between investment spending and profitability trends in his 1931 analysis of the linkage between profits and investment, akin to the dynamic approach of Classical and Marxian economics. In our view, Keynes’ insistence on the power of profits to set the capital accumulation engine in motion, followed by the centrality of investment for the realization of profits, is not only compatible but essential to the conceptual stockin-trade of Classical and Marxian economic dynamics. Keynes’ conviction, that for profits to grow investment needs rising, provides the organic linkages between profitability and the rate of capital accumulation. We cannot derive or interpret the long-run trend of the profit rate independently of the long-run trend of capital accumulation. In our empirical work, we demonstrate that corporate saving provides the bulk of funds necessary to carry out corporate investment plans. But the profit expectations formed facing the future are highly correlated with the profits yielded by previously made investment expenditures of comparable worth. Capital accumulation trends provide a record of the extent to which past profit expectations were fulfilled after investment took place. Hence, in our analysis, corporate savings do not cause investment but rather provide the wherewithal for corporate investment plans to be carried out. These plans will be evaluated in light of the results of previous investment spending relative to the profit expectations that motivated that spending. In his 1931 lectures, Keynes not only emphasized the centrality of profits to power the engine of capital accumulation, but also articulated the feedback loop between capital accumulation and realized profits in the past. That connection served as an anchor for the formation of investment plans in the present and future. It is these feedback loops between earlier profitability expectations and past investment that mediate the uncertain nature of anticipated profitability, linking the present conjectures with the experienced past results. From a dynamic standpoint, expected profitability drives the decision to invest and corporate savings provides the means to carry out that decision, but in a world of uncertain outcomes, the average experience of past accumulation is likely to set the parameters for profit expectations that shape the accumulation rate in real time. If, as Keynes argued, investment must increase for profits to rise, in a dynamic perspective, when the empirical evidence of accumulation shows a long-run falling trend, we would expect the rate of profit long-run trend to move in the same direction, showing a significant degree of parallelism. In our view, Keynes’ approach to establishing the organic link between profitability and investment is closer to Ricardo’s, Mill’s, and Marx’s than the post-Keynesian perspective emphasizing uncertainty and variation in effective demand. Six years after the Chicago lectures on unemployment, and seeking to clarify the issues raised in his General Theory book, Keynes reiterated the centrality of

196  Keynes and secular stagnation his conviction that of all the factors impinging on the “level of output and employment” such as such “the propensity to hoard…the state of confidence concerning the prospective yield of capital-assets, the propensity to spend and on the social factors which influence the level of the money-wage…as a whole depends on the amount of investment” but that investment was the “most unreliable” (Keynes, 1937, pp. 209–223). Hoarding ‘cash’ and financial investment under neoliberalism The corporate rationale for ‘hoarding cash’ by nonfinancial corporations and their shareholders derives from the nature of the radical shift in corporate investment strategies from capital expenditures on plant and equipment to speculative investments in financial assets, primarily centered in equity markets. The new strategy centered on quick gains in volatile markets as an attractive alternative to delayed returns from fixed capital projects of long gestation. Given the short-term nature of financial investments and the advantages of good timing in trading shares, ‘hoarding cash’ allows corporations to build collateral funds as a hedge against excessive dependence on margin-borrowing and the build-up of debt. Heavy trading in equity shares led to significant rises in corporate debt as purchases required net margin borrowing exceeding the price growth rate of stock markets shares. After the early 1980s, adding to corporate savings of nonfinancial corporations the net revenues derived from new sales or acquisitions of equity shares, the net new liabilities incurred in purchasing financial assets, and fixed capital investments, show nonfinancial corporate balance sheets subjected to increasing financial turbulence. Deficit periods increase in frequency and depth, the early 2000s being an exception, while the effects of recession dissipated. After 2004, only the onset of the Great Recession in 2008 set limits to rising deficits unrelated to the financing needs of net fixed capital accumulation. The growing liabilities incurred in financial investments led to growing corporate deficits. Between 2004 and 2008, ‘excess savings’ in the financial account fell from a positive $300 billion level to a negative excess over −$1,550 billion, as anticipated in Thomas Palley’s book Financialization (2013, p. 33) due to net borrowing for the repurchasing of equity shares. Our Figure 7.2 shows the mirror-like effect in the joint movement of corporate buybacks and debt, extended beyond Palley’s calculations to 2020. Since the fixed capital accumulation trend reflects that of profitability, the mildly falling path of nonfinancial corporate accumulation from the mid-1960s to 2001 could not persist after the Great Recession ended in the absence of a significant profitability boost. Nonfinancial corporate profitability trends, after the Great Recession ended, failed to bring about the restoration of confidence needed to reverse the declining path of capital accumulation experienced in the 21st century. Following a two steps decline, net fixed capital accumulation rates collapsed after 2000, stabilized two years later but took, after 2007, the final tumble reaching lows unprecedented since the 1930s. A little more than a year before the 2007 Financial Crisis broke out, the IMF noted in chapter 4 of its annual World Economic Report (“Globalization and Inflation,”

Keynes and secular stagnation  197 April 2006) that corporations were “Awash With Cash: Why are Corporate Savings so High?” Pointing out that nonfinancial corporations were accumulating excessive liquid assets, the IMF failed to connect their low level of profit expectations and their neglect of long-term capital projects as the cause of their hoarding ‘cash.’ Nonfinancial corporations changed their ‘investment’ strategy, switching from long-term fixed capital expenditures to shorter-term speculative purchases of financial assets and, more specifically, buybacks of their own equity shares. When repurchasing their own corporate shares became a central practice of nonfinancial corporations, building up ‘hoards’ of liquid assets provided the wherewithal for fast trades at convenient junctions, and the predominance of the Keynesian speculative motive for holding ‘cash’ became perfectly understandable. After 1984, shifting from long-term to short-term ‘investment’ strategies in financial assets, moreover, was the main consequence of the falling capital accumulation trend in that sector. If the IMF had examined the long-term trajectory of nonfinancial corporate profitability and the parallel trajectory of its fixed capital accumulation, the IMF would have been able, in its annual World Economic Report, to signal the alarm for the impending global Financial Crisis. In light of Keynes’ insistence on the linkage between investment spending and profitability, the IMF report failed, however, to pursue the implications of their own puzzlement; why the simultaneous buildup of nonfinancial corporate liquid hoards and the declining accumulation rate? From our standpoint, the answer would clearly reveal the presence of low profit expectations in the real sectors of the system anticipating the collapse of accumulation and the possibility of crisis. For the IMF, instead, the excess hoarding simply reflected “excess saving (undistributed profits less capital spending in the Group of Seven (G-7) countries in 2003–04,” accumulated in recent years as a result of the decline in the nominal volume of corporate capital expenditures due to declining capital-good prices, reflecting the rising labor productivity in manufacturing. The decline in the long-term capital accumulation of nonfinancial corporations, from 1965 to the present, is part of the secular trend that cannot be understood in the absence of the equally long-run falling profitability trend. We would expect the IMF’s account of the excess hoarding of liquid assets in its 2006 report to come to the opposite conclusion than they did. In line with the standard neoclassical theory of the relationship between factor intensities and the relative prices of capital and labor, the unit price declines of capital goods relative to labor wage rates would favor the more intensive use of cheaper capital goods, not a decline in the capital intensity of production. The lower relative prices of capital goods should have elicited bigger expenditures on capital goods. This argument gains strength when mainstream secular stagnation theories rely on rising labor productivity in the capital goods and lower growth rates of the working population to produce labor shortages and rising wage pressures. It is labor-intensive technologies that become comparatively less efficient, meaning more expensive. Keynesian interpretations of secular stagnation in the neoliberal phase tend to conclude that, as a result of technical change and rising labor productivity, the falling relative prices of investment goods brought about the slow growth of corporate

198  Keynes and secular stagnation capital expenditures and, consequently, weakened effective demand and lowered system growth (Froomkin, 2012; Lenzner, 2013). Multiple ‘cash hoarding’ reports in Bloomberg’s business reports gratuitously appeared to suggest, instead, that corporations built up their liquid reserves because they felt no pressure to expand their capital expenditures to upgrade their plant and equipment, since they felt secure on their oligopolistic perch. Early forebodings of secular stagnation In the aftermath of deindustrialization, the growing impact of financialization on the falling rate of capital accumulation, rising debt in all sectors, and the flight of capital overseas, in the context of globalization, had a major impact on the growth prospects of the U.S. national economy. We have argued throughout the book that secular stagnation derived from the long-run decline in profitability in the nonfinancial sectors of the economy coupled with the growing diversion of corporate funds into share buybacks, dividends, and interest payments. As a result, declining corporate capital expenditures reflected the diminished volume of corporate retained earnings in the neoliberal phase. Such decline of the use of corporate earnings, in turn, reflected decreasing rates of fixed capital accumulation, falling labor productivity growth, and lower real GDP growth rates. The empirical evidence of secular stagnation, from the early 1980s on, confirmed the forebodings expressed by Alvin Hansen in the late 1930s concerning the future growth prospects of advanced capitalist economies once the postwar recovery was completed. The earlier interpretations advanced by ‘Keynesian’ Hansen and ‘Marxist’ Gillman (Gillman, 1965) referred to weakening effective demand due to the impact of declining population and, therefore, labor force growth rates, as one of the factors behind the fall in residential investment. In addition, Hansen and Gillman anticipated the IMF argument that technical advances in the production of capital goods led to lower relative prices and, therefore, required less money to buy the same stock of capital goods, thus weakening the effective demand share of business investment. Gillman’s interpretation of secular stagnation trends added a kind of ‘Marxian’ twist to Hansen’s Keynesian weakening of effective demand, implicitly suggesting that under ‘monopoly capitalism’ the under-consumption tendency would grow stronger as capitalism’s production capacity was likely to grow faster than aggregate consumption demand. Steindl’s addition of monopoly and oligopoly to the ‘Marxian’ interpretation of postwar secular stagnation (Steindl, 1976) provided a new dimension to Hansen’s Keynesian hypothesis and contributed to its contemporary resonance in heterodox accounts of secular stagnation. Lawrence Klein’s influential book, The Keynesian Revolution, fully acknowledged as “incontrovertible…that some of the modern Marxists who think seriously about economic affairs have supported Keynesian economics” (Klein, 1964, p. 130). But Marx’s theory of the falling rate of profit capital per worker, posits the intensity of capitalist production, K/L, growing faster than labor productivity, Y/L, thus giving rise to an increasing capital/output ratio. The war-like nature of real competition causes this bifurcation between the paths of

Keynes and secular stagnation  199 K/L and Y/L as competitive pressures compel the leading firms to deploy the most capital-intensive technology available in order to lower their product unit costs, or improve the product’s quality. Lowering the unit price sufficiently drives rivals that cannot match it out of business, or relegates them to the category of ‘zombies.’ In order to understand why strategic planning to engage competitors would favor capital-intensive, labor-saving technology despite the fact that doing so undermines the profitability of the innovators, we need to see it in the context of real war-like capitalist competition forcing the contending firms to accept losses in order to succeed. The investment strategy for competitive war planning seeks to increase labor productivity through ever more powerful, complex, and automated methods that seamlessly allow all process operations to be regulated in order to maximize the throughput per unit of labor time. Such methods not only maximize output per unit of labor time but, more importantly, provide the means to engage industry rivals in competitive battles aimed at gaining market share. Victory in that endeavor imposes a price that leaders must pay when the war ends. The unit price reduction intended to push rivals out of business, jointly with the higher unit fixed cost incurred, will lower the average profit rate, squeezed by lower prices and higher unit fixed costs. In our view, taking into account the structural setting of real capitalist competition and the parameters that drive investment decisions provides a more fruitful interpretation of the true nature of secular stagnation. From real fixed investment to financial investment We interpret the diversion of investment flows from nonfinancial to financial sectors as an indication of how the changing paths of financial and nonfinancial profitability (Chapter 7) guided the allocation of profit-seeking capital allocation and led to the consolidation of neoliberalism. Anwar Shaikh’s potential growth coefficient, the existing ‘slack’ measuring the share of business investment in profits (unity being the potential maximum), shows that the inconclusive profits recovery engineered by neoliberal policies failed to ignite the business investment engine and, instead, the decline of the investment/profits ratio extended from the mid-1980s to the present. In response to this dearth of profitable investment opportunities, as Figure 8.3 will show, after 1984 the share of equity buybacks in nonfinancial corporate net operating surplus relative to that of fixed capital investments increased, obviously driven by prospects of better returns on financial investments. In addition, the shares of interest rate payments for borrowed credit to acquire financial assets and dividends paid to shareholders for their own consumption and speculative activities sharply increased. Since the year 2000, around 80 percent of the net operating surplus of nonfinancial corporations covered these needs. After the consolidation of neoliberalism and the expansion of financial activities from the mid-1980s on, the ‘slack’ coefficient declined, which is to say, the gap between actual and potential growth increased. Nonfinancial investment went down relative to the low level of profitability prevailing. Capitalist consumption and the acquisition of financial assets accounted for the net credit growth of corporate firms. In this connection, it is important to note that the successive bubbles in the internet, housing, and the

200  Keynes and secular stagnation stock market did not contribute to rising wages, even when employment increased. Indeed, since the 1990s, financial asset inflation far surpassed the conventional signs of inflationary pressures in the real sectors of the system’s overall structure. The incontrovertible empirical evidence for an economy-wide declining rate of fixed capital accumulation from the mid-1960s on, demonstrates that due to the high capital costs carried by leading ‘regulating’ producers, a declining number of laggard firms were able to expand their capacity. Industry leaders achieved economies of scale in their respective markets but the total number of producers remaining active declined and, after 1984, for most of the entire neoliberal period, except in the second half of the 1990s, the falling aggregate accumulation trend lowered the real GDP growth trend, thus providing evidence of secular stagnation. The modern Keynesian theory of secular stagnation articulated in 2013 by Larry Summers, supported by Paul Krugman, and largely adopted by Ben Bernanke repeated the same arguments advanced by Alvin Hansen without adding any new substantive facts. Marxian versions of secular stagnation We shall explore in Chapter 10 the implications of Lawrence Klein’s linking secular stagnation with Marx’s theory of the falling rate of profit and its impact on capital accumulation. Despite having interpreted Marx from a Keynesian perspective, Klein observed that Marx’s elaboration of the Classical tendency for the profit rate to fall provided a sounder argument to explain secular stagnation than Hansen’s Keynesian formulation. A previous version of secular stagnation, explicitly proposed by Henryk Grossman in 1929, provided a more developed form of the Klein/Marxian interpretation. Before Klein’s appreciation of the Marxian tendency of the profit rate to fall offered a Marxian alternative to explain secular stagnation, Henryk Grossman’s recently translated Marxian economic writings of the 1930s (Grossman, 2021, 2022) contributed to clarify the connection between his 1929 book, The Law of Accumulation and Breakdown of the Capitalist System, and secular stagnation. In Grossman’s view, the slowdown in capital accumulation underlying secular stagnation was not due to effective demand shortfalls for housing caused by lower population growth and the decline in residential investment, as in Hansen’s and Summer’s Keynesian versions. Grossman also rejected attributing secular stagnation to monopolistic supply restrictions, as in Steindl’s and Gillman’s Marxian–Keynesian views on the practices of oligopolistic corporations. Basing his argument on Marx’s labor theory of surplus value, Grossman viewed secular stagnation as a relatively late stage of capitalist development. When the deployment of labor-saving technology throughout all sectors of the economy reduced the employment of productive labor beyond a certain critical point, the results set definite limits to the further growth of surplus value, that is, gross profits. In Grossman’s analysis, the expanded reproduction of capitalism required the gross value added in Sector 1 producing capital goods and Sector 2 selling consumer goods to cover three major components of the production system, including: first, the capital consumption needs of both departments, the replacement of their

Keynes and secular stagnation  201 worn-out plant and equipment; second, it should provide additional capital goods for the expansion of productive capacity; third, it should produce the necessary consumer goods for the maintenance and reproduction of the employed workers, both current and newly added, as well as the upkeep and renewal of capitalist households. Grossman argued that in the highest stages of capital accumulation, with the widespread deployment of automation and high levels of labor productivity, restricting the employment growth of productive labor would lead to stagnant surplus value growth, and this, in turn, would strengthen the tendency to secular stagnation. Confronted with the decision to allocate the stagnant surplus value into new capital accumulation, working-class wages, and capitalist consumption, Grossman argued that capitalists would hesitate to lower wages beyond a certain critical point, as exacerbating the intensity of class struggle could conceivably lead to unexpected loss of political control. On the other hand, capitalists would not willingly accept reducing their standard of living with lower shares of the stagnating surplus. Hence, the third component, the portion of the aggregate surplus intended for accumulation, including the growth of fixed and variable capital, would likely be curtailed and hence lead to slow growth or secular stagnation. The neo-Keynesian version By year-end 2013, Paul Krugman and Larry Summers interpreted the slow recovery from the Great Recession triggered by the 2007–2009 Financial Crisis as a revised version of Hansen’s 1930s theory of secular stagnation. Their analysis centered on the fact that, despite persistent efforts of the Federal Reserve to lower interest rates, capital expenditures in the nonfinancial corporate sector of the U.S. economy remained significantly lower than they were before the financial crash. Paul Krugman’s September 2013 article (2013c) anticipated Larry Summers’ fears of ‘secular stagnation’ voiced at the IMF Research Conference on November 8, 2013. After Summers’ intervention at the IMF event, Krugman (2013a, 2013b) enthusiastically endorsed Summers’ version of the stagnation theory, stressing the fact that since the mid-1980s, despite repeated waves of assets’ revaluations in financial and housing markets, falling interest rates failed to raise net business investment above its low secular trend. Absent such asset bubbles, Krugman argued the U.S. economy would show “a persistent tendency towards depression” (Krugman, 2013a). In Krugman’s view, slow growth was due to the existence of a “liquidity trap” or perhaps a “savings glut” that did not respond to falling interest rates. In his November 17 article, Krugman worried that “depression-like conditions are on track to persist, not for another year or two, but for decades” (Krugman, 2013a). Steve Keen, a heterodox Keynesian and critic of the neo-Keynesian approach, questioned the relevance of the factors cited by Krugman and Summers to explain the slow recovery from the slump, instead of the depressing effects of the accumulated corporate and household debts on effective demand (Keen, 2013b). Martin Wolf for his part attributed the weak recovery from the Great Recession not to excessive savings but to an “investment dearth” (Wolf, 2013). Cardarelli and Ueda showed that ‘hoarding cash’ was widespread in the capital allocation of U.S.

202  Keynes and secular stagnation nonfinancial corporations as well as throughout all G-7 countries well before the Financial Crisis broke out in 2007. Cardarelli and Ueda blamed ‘excess’ business saving and the currently widespread reference to ‘cash hoarding’ as the responsible cause of secular stagnation. They specifically connected corporate ‘cash’ hoarding, referring to “currency and deposits plus short-term securities (including treasury bills, commercial paper and certificates of deposits)” with “excess saving (or ‘net lending’)…defined as the difference between undistributed profits (gross saving) and capital spending.” Their findings confirmed the growing gap between corporate profits and low (if not falling) trends of capital accumulation in the nonfinancial corporate sector of various OECD countries in the period before the recent Financial Crisis. After examining the available empirical evidence for the G-7 group of nations, Cardarelli and Ueda concluded that from the late 1970s to 2004, “Simply put, firms have been investing a smaller share of their profits in upgrading and expanding their capital stock” while enlarging their ‘cash’ hoards (Cardarelli and Ueda, 2006, pp. 136 and 140–141). In light of the evidence shown in Figure 8.1, we interpret corporate ‘hoarding’ of liquid assets not as a practice for building the needed sums to replace wornout plant and equipment, but as the buildup of funds to disburse as dividends, to carry out mergers and acquisitions, as well as to deploy in repurchasing corporate shares. These are uses that compete for funds with the accumulation of productive capital. From this standpoint, the decline of the share of total liquid assets held by nonfinancial corporations relative to their fixed capital stock, from the late 1940s through the early 1980s, represents a sign of vigorous commitment to corporate growth of plant and equipment. We see the evolution of the share of liquid assets relative to all other financial assets held as a measure of corporate commitment to long-term investment and growth. From that standpoint, a falling share of liquid cash hoards, with respect to fixed and financial assets, would denote a corporate management in pursuit of expanded accumulation rather than ancillary usage of funds for mergers and acquisitions, share buybacks, and stock market trading. As Figure 8.1 shows, our estimates for the U.S. confirmed Cardarelli and Ueda’s findings of rising liquid/fixed asset ratios from 1982 to the present, except in the run-up to the Great Financial Crisis of 2007–2009, when liquidity plunged as mortgage credit and debts soared. In the 1990s, buoyant trading in stock market shares of housing and internet companies required ‘hoarding’ liquid assets, as speculative transactions climbed to unprecedented levels. On the other hand, the long-term liquid/financial asset ratios fell from the late 1940s to 1990, and then climbed in the late 1990s, plunged to their former level by 2008, and resumed rising thereafter. Once the recovery from the Great Recession was underway, rising stock-market valuations underpinned the growing demand for financial assets. U.S. nonfinancial corporate net fixed capital investment share in net operating surplus experienced a mild decline from the mid-1960s to 2002 but, after 2002, that trend fell sharply for a brief period, experienced a mild reversal, and finally, after 2007, went on a free fall from which it barely recovered only recently. After the early 1980s, net financial investments and liquid assets, as shares in net operating surplus, decreased significantly. In Figure 8.2, for a measure of the relationship

Keynes and secular stagnation  203

55% 50%

Nonfinancial corporate liquid assets/Total nonfinancial corporate financial assets Nonfinancial corporate liquid assets/Nonfinancial corporate fixed assets

45% 40% 35% 30% 25% 20% 15% 10% 5% 0% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 8.1  U.S. nonfinancial corporate liquid assets relative to total financial assets and nonfinancial corporate liquid assets relative to nonfinancial corporate fixed assets.

between retained profits and net fixed investment, we use the ratio of undistributed profits/fixed capital stock and net fixed capital investment/fixed capital assets as the accumulation rate. Decoupling of real and financial sectors The Macro Trends Group of Bain & Company, a global financial consulting company, explained the worldwide decoupling of real and financial sectors denoted by the growing gap between the growth rate of the real economy and that of financial assets. After the 1980s, nonfinancial corporate profitability was only partially restored and, despite the rising gap between productivity growth and wages, the Great Recession did not set off a profitability boom. The analysts expressed surprise: We discovered that the relationship between the financial economy and the underlying real economy has reached a decisive turning point. The rate of growth of world output of goods and services has seen an extended slowdown over recent decades, while the volume of global financial assets has expanded at a rapid pace…Today, total financial assets are nearly 10 times the value of the global output of all goods and services. (Bain & Company Report by Harris, Schwedel, and Kim, 2012, p. 3)

204  Keynes and secular stagnation For much of the past decade, global capital market investors have relied on the alchemy of financial engineering to boost returns. Well before the 2008 global credit crash the rate of growth of the world economy had been slowing. But even as returns on investments in real goods and services were declining, the trend was obscured by healthy-looking gains that professional money managers were able to generate through asset price inflation (ibid., p. 17). Nonfinancial corporate saving and investment Figure 8.2 displays the paths of nonfinancial corporate retained earnings normalized by the fixed capital stock and the rate of fixed capital accumulation in the nonfinancial corporate sector. Domestic fixed capital accumulation includes the stocks of research and development, plus software recently added by the Bureau of Economic Analysis (BEA). The BEA note wished to recognize: Investment in R&D will be presented along with investment in software and in entertainment, literary, and artistic originals in a new asset category entitled ‘intellectual property products,’ beginning with 1929…The new treatment will recognize expenditures for both purchased and own-account R&D by businesses, NPISH, and general governments as fixed investment and the depreciation of these assets in consumption of fixed capital (CFC). (BEA, March 2013, p. 15) The need to add research and development to fixed asset estimates reflects George May’s 1957 proposal arguing that, because such activities preceded the actual implementation of production plans and frequently entailed larger expenditures than the actual production costs for the desired plant and equipment, they should be counted “as costs of capital formation” and not as “operating expenses” (May, 1957, pp. 194–195). The nonfinancial corporate capital accumulation rate reflects the growth of net fixed nonfinancial assets plus inventories relative to nonfinancial corporate capital stock. We brought out in Figure 1.1 the remarkable parallelism found between the average profitability trend and that of the accumulation rate. Figure 8.2 displays the even closer relationship between corporate retained earnings, the undistributed profits normalized by the capital stock, and the capital accumulation rates between 1965 and 2020. The shared trend provides empirical support for our claim of a systemic relationship between those two trends. The fact that corporate savings/net capital stock ratios precede the actual cycles of capital accumulation confirms its leading role as the chief source of funding for planned investment. Of course, that planned investment, in turn, depends on the available ‘retained earnings,’ which fluctuate according to the estimated funding for investment. The feedback between undistributed profits from the outcome of past capital accumulation and the funding needs of planned fixed investment provides the linkage between past results and current investment planning.

Keynes and secular stagnation  205

7%

6%

5%

Nonfinancial corporate savings/Nonfinancial corporate net capital stock Nonfinancial corporate net fixed capital investment/Nonfinancial corporate net capital stock plus inventories

4%

3%

2%

1%

0%

-1% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 8.2  U.S. nonfinancial corporate retained domestic earnings normalized by the nonfinancial corporate net capital stock and nonfinancial corporate rate of accumulation. 130% 117% 104%

130% Equity shares buybacks, net dividends & net interest payments/Net operating surplus Net fixed investment/Net operating surplus

117% 104%

91%

91%

78%

78%

65%

65%

52%

52%

39%

39%

26%

26%

13%

13%

0%

0%

-13% -13% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 8.3  U.S. nonfinancial corporate sum of equity shares buybacks, net dividends, and net interest payments relative to nonfinancial corporate net operating surplus, and nonfinancial corporate net investment relative to net operating surplus, based on NIPA Table 1.14, Flow of Funds FA105013005.A and FA106300005.A.

Figures 8.2 and 8.3 confirm the conclusions reached by the Bain & Company’s 2012 Report on global macro trends concerning the bifurcation between the real and financial sectors. After 2002, the relationship between corporate savings and net investment broke down, and, since 2007, retained earnings and fixed investment

206  Keynes and secular stagnation spending grew further apart. The increasing gap between them provides evidence of a recent propensity on the part of nonfinancial corporations to engage in ‘cash hoarding’ practices. After 2000, sharply falling accumulation rates in nonfinancial corporate sectors coincided with the high capital flows into housing and financial markets that, after inflating unsustainable bubbles, triggered the Financial Crisis of 2007–2009. Figure 8.2 highlights the corporate savings path tumbling after 1997 and not recovering until 2001 while the accumulation rate, after peaking in 2000, plummeted in two waves that brought it close to zero in 2009. From there on, it managed to reach a meager 1 percent in 2020 after a mere 2 percent in 2014. Is it growing uncertainty or inadequate profitability? Successful competitive strategies require aggressive investment plans, including innovative and costly research and development spending aimed at designing new technology capable of lowering unit costs or improving product quality. These are necessary strategies to achieve market leadership and secure higher market shares. Absent such fixed investments to stay ahead of rivals, nonfinancial corporations risk falling behind in the global economy. When rival firms contest market leadership in competitive wars, neglecting to deploy the best available technological weapon leads to defeat. With stakes as high in global competition, only financial barriers could possibly block access to the capital necessary to expand or upgrade their technological leadership. Why then is it that rising nonfinancial corporate profit margins in the 1990s failed to spur higher spending on fixed capital investment? Sanchez and Yurdagul, two economists of the Federal Reserve Bank of St. Louis, argued that discovering what caused corporate cash hoarding “may help us to tease out the reasons for the slow recovery from the Great Recession” (Sanchez and Yurdagul, 2013, pp. 293–325). Their conclusion centers on the climate of growing ‘uncertainty’ allegedly surrounding the future of corporate profitability, jointly with other unspecified ‘structural factors’ as the chief obstacle preventing a strong recovery from the slump. If the anxiety generated by the rise of uncertainty regarding the prospects of profitable investment opportunities was the decisive factor behind corporate cash-hoarding, what made it so intense? There were no objective grounds for excessive uncertainty among large corporations. While small business bankruptcies more than quadrupled between 1996 and 1999, rising from a 100 base in the first quarter of 1996 to 461 in the second quarter of 1999 (Equifax, 2011), the Great Recession did not bankrupt major nonfinancial corporations, and had no impact on their aggregate fixed assets, although capacity utilization sharply declined. Technical change and the need to upgrade long-lasting plant and equipment drove business savings and investment decisions, provided that other more profitable alternatives were not available. We believe that understanding the significance of nonfinancial corporations ‘hoarding cash’ instead of spending internal funds on new fixed assets requires focusing on current levels of corporate profitability. In our view, the buildup of corporate liquid assets before and after the Great Financial Crisis of 2007–2009 stemmed from the attraction of financial markets and the frenzy

Keynes and secular stagnation  207 of financial asset appreciation that preceded it, before the crash spread panic among speculators outside the real sectors of the economy. Before and after the Great Recession, corporations assessed the opportunity cost of fixed capital investments, not in terms of treasury bonds and their low-yields, but in the comparative advantage of trading financial assets such as equity shares, instead of buying new fixed capital assets. When weighing the expected yields between them, financial assets seemed preferable. The euphoric path of equity markets justified the accumulation of substantial liquid assets to serve as collateral funds for marginal debts, dividend payments, or successful bids for mergers and acquisitions. With unprecedented low interest rates holding constant for the foreseeable future corporate hoards of liquid assets provided the means to achieve financial short-term gains. We agree with Martin Wolf that, in Keynesian terms, the existence of an ‘investment dearth’ in the real economy makes more sense than a ‘savings glut’ as an explanation of the weak recovery from the Great Recession. We would add, however, that the real problem is a dearth of profitable investments. Our focus on the long-run profitability trend of nonfinancial corporations provides the clue to the current malaise. The collapse in nonfinancial corporate net investment after 2007–2009 went far deeper than in 2001 because the long-term decline in profitability after the bounce-back from the trough failed to significantly reverse its pre-crisis trend. Wolf was aware that “the crisis followed financial excesses, which themselves masked or, as I have argued, were even a response to pre-existing structural weaknesses,” and therefore “merely restoring a degree of health to the financial system or reducing the overhang of excessive pre-crisis debt is, then, unlikely to deliver a full recovery” (Wolf, 2013). Predictable uncertainty In an interview with John Cassidy, Nobel laureate Eugene Fama pointed to the state of the real economy as the real cause of the financial collapse, explaining that: What happened is we went through a big recession, people couldn’t make their mortgage payments, and, of course, the ones with the riskiest mortgages were the most likely not to be able to do it. As a consequence, we had a socalled credit crisis. It wasn’t really a credit crisis. It was an economic crisis. (Cassidy, 2010) Comparing the restoration of profitability for nonfinancial corporate business after the Great Depression with that of the Great Recession shows strikingly different paths. The profit rate plunged in the 1930s and by 1938 it fell substantially below the level reached in the late 1920s. Retained earnings predictably collapsed, but profit rates reached historically high levels in the 1940s and remained elevated for 20 years of the ‘glorious’ Golden Age. By contrast, the profit rate in 2009 was just slightly higher than in 2001. By the late 1940s, capital accumulation had recovered the ground lost since the mid-1930s but, after peaking in the mid-1960s, the capital accumulation trend took a downward turn that lasted over four decades, so that the collapse following the Great Recession did not come as a surprise. In contrast with

208  Keynes and secular stagnation the 1940s, reversing the decline in profitability that preceded it did not produce the strong investment revival that the 1930s slump had produced. How could the conditions for robust accumulation differ from the pre-recession years? After the Great Recession, the previous pattern of capital flows remained in place. Rising excess business savings, the difference between undistributed profits and net corporate fixed capital investments, found yields in equity markets that compared favorably with those available in the nonfinancial corporate sector. This differential did not increase because ‘uncertainty’ became more general but rather because the Great Recession failed to reverse the structural conditions that held back capital accumulation throughout the neoliberal period, including the low level of average profitability. Blending Keynes’ and Marx’s conceptual approaches, Skidelsky traced the origins of the structural imbalances leading to the Great Recession to the rise of a ‘new paradigm’ informing economic policy since the early 1980s, featuring among other things, asset price inflation (equities and housing); widening income inequality; detachment of worker wages from productivity growth; rising household and corporate leverage ratios measured respectively in debt/income and debt/ equity ratios; a strong dollar; trade deficits; disinflation or low inflation; and manufacturing job losses…With the membership and influence of trade unions sharply reduced and government weakened, business became the sole prevailing power. (Skidelsky, 2010) Skidelsky saw the emergence of neoliberalism in the 1980s as a reaction against the inflation and slow growth of the late 1970s. In his view, “the business class demanded lower taxes, freedom to export capital, free trade and an end to the full employment commitment” in order to “end what had become a vicious spiral of ‘stagflation’ that did not benefit its class interests” (Skidelsky, 2013). Skidelsky neglected to emphasize that the successful implementation of his ‘new paradigm’ required structural changes favoring the restoration of corporate profitability via higher profit shares. Indeed, after the early 1980s, implementation of the new neoliberal paradigm required labor productivity growth to outpace employee compensation, and the ensuing growing gap led to falling real unit labor costs. But as employee compensation shares declined and profit shares increased, the continuous shrinkage of the wage share reduced the profit share marginal growth: as the wage share approaches its zero limits, the profit share reaches its own maximum limit. For profits to rise steadily as the wage share diminishes, capital accumulation rates would need to expand employment faster than the wage share declines. In our view, failure to lay out the foundations for a vigorous recovery in nonfinancial corporate profitability from the mid-1980s through 2009, as outlined in Skidelky’s ‘new paradigm,’ weakened the profit expectations that motivate corporate fixed capital investments. After the 2007–2009 financial crash that ushered in the Great Recession, accumulation rates collapsed, and, since 2009, the nonfinancial corporate accumulation rate never surpassed the previous troughs reached in

Keynes and secular stagnation  209 the early 1990s. Despite the unsustainable euphoria generated by the housing bubble, the prospects for a vigorous accumulation recovery did not materialize beyond a mild reversal lasting a few years. We interpret the collapse in nonfinancial corporate capital accumulation on the eve of the crisis as a sign of vanishing confidence in the restoration of acceptable profitability levels under existing structural conditions. Despite sustained corporate efforts for the past 30-odd years, implementing the terms of Skidelsky’s ‘new paradigm’ to raise profit shares in nonfinancial corporate value added, the expected yields could not compete with those in financial investments. Before the Financial Crisis broke out, rising capital flows into financial and housing assets inflated unsustainable bubbles, and when they burst exposed the vulnerability of nonfinancial sectors to the collapse of credit sources. Despite the Great Financial Crisis, expectations of higher yields in net financial investments soon returned to new heights, especially equity shares, compared to profit expectations in nonfinancial sectors. It is difficult to envision any historical framework in which uncertainty was not a major factor in all phases of the business cycle. Given the recovery of financial markets and the lackluster return to ‘normalcy’ in nonfinancial sectors, there is no warrant to use uncertainty as a wild card to explain the emergence of secular stagnation under neoliberalism. The pattern of higher returns to financial investments from the mid-1980s through the 2000s remained in place after 2009, and became a permanent feature of business capital accumulation. Could ‘uncertainty’ explain falling capital accumulation in the absence of the underlying profitability trends? Why would uncertainty today be any higher than in the early 1980s and beyond, despite the socioeconomic tensions associated with the implementation of Skidelsky’s ‘new paradigm’? Under neoliberalism, corporate profitability and capital accumulation only experienced a moderate, albeit inconclusive, recovery from previous trends. In the wake of the Great Recession, the implementation of key terms in Skidelsky’s ‘new paradigm,’ particularly the “detachment of worker wages from productivity growth,” gained major traction, resulting in substantially higher profit shares in value added particularly in manufacturing sectors. Why would this business gain not diminish the uncertainty surrounding corporate views of future yields? We propose to follow an alternate approach initially suggested by Paul Sweezy (June, 1982). While seeking to explain “Why is the incentive to invest so weak?,” Sweezy’s considered response directed our attention to the postwar period when the answer was clear and the question was moot, but now “the answer is to be found in analyzing the long-period-twenty five years or so-which followed the Second World War, during which we did not have a problem of stagnation” (Sweezy, 2012). We can safely exclude ‘uncertainty’ from our account of secular stagnation as a meaningful option whose widespread use probably derives from its intuitive appeal. We favor, instead, focusing on the impact of long-run profitability trends on the evaluation of future yields. The period covered in Sweezy’s recommendation was one of exceptionally high levels of profitability and produced the highest accumulation rates of the postwar period, with no secular stagnation there. But it

210  Keynes and secular stagnation is clear that since the Great Recession ended, the business strategy mapped out in the 1980s, in order to reverse the decline in corporate profitability of the 1970s, has met with only partial success. The emerging profitability trend after the crisis ended was not significantly different from what it was in the years leading up to it. It is easy to understand how it would have a depressing effect on nonfinancial corporate business confidence regarding the long-term profitability trend because, despite the successful implementation of Skidelsky’s ‘new paradigm,’ profitability did not achieve a full reversal after the sharp decline of the 1970s. The prevailing view in heterodox literature refers to “the difficulties of finding profitable outlets for capital in the real economy” (Saros, 2013, p. 155). We interpret this failure of U.S. nonfinancial corporate profitability to substantially reverse its downward trend to be the chief reason for the diversion of capital flows out of this sector and into financial assets. We have consistently argued that substantial flows of capital sought higher yields in financial assets and blew unsustainable asset bubbles that eventually burst on the eve of the Financial Crisis of 2007 (Mejorado and Roman, 2014). Demography and the savings glut Krugman and Summers did not connect their secular stagnation forecasts with the absence of profitable investment opportunities (what Martin Wolf referred to as an “investment dearth,” 2013), but focused instead on the existence of a ‘savings glut’ or a ‘liquidity trap.’ Their view of secular stagnation is closer to Bernanke’s earlier concept of a global ‘savings glut’ (Bernanke, 2005). Their concern centered on real interest rates remaining too high to lift the economy out of its doldrums, and they regretted the fact that due to deflationary expectations, despite the extremely low nominal rates, real interest rates did not decline sufficiently to spur investment activity. Post-Keynesian economists like Axel Leijonhufvud and Randall Wray, on the other hand, acknowledged that profitability was central in Keynes’ thinking and they shared Wolf’s view that the problem consisted in the dearth of profitable investment opportunities. Leijonhufvud explained Keynes’ views on the slow growth of the British economy, from the ending of World War I up to the 1930s, to the fact that, “The background to the Great Depression in Britain, as Keynes saw it, was the declining trend in the return to investment since the end of World War I” (Leijonhufvud, 2008). For Leijonhufvud, as well as for Keynes, “it is the decline of investment expectations and the consequent contraction of output that prompts deleveraging” (Leijonhufvud, 2009, p. 744). Randall Wray (2013) also identified the expected profit rate in Keynesian economics as the crucial factor to explain crises, arguing that slumps occurred not because “the interest rate is too high but that the ‘marginal efficiency of capital’ (the return to investment) is too low.” In Wray’s view when the MEC is negative “there is no monetary policy that can induce firms to make losses” (ibid., 2013). Despite nominal interest rates falling from their heights in the early 1980s, the nonfinancial corporations’ average before-tax (but after net interest payments) profitability trend declined from the late 1940s to 2001. Indeed, sharply lower interest rates

Keynes and secular stagnation  211 after 2009 did not prevent the average profit rate in 2012 from falling below its 1997 level. The slump did not reverse the pre-crisis cyclical profitability pattern and, since financial investments were likely to have shorter horizons than those intended to expand plant and equipment, hoarding liquid assets appeared to be an attractive alternative. In the wake of the Great Recession, despite the sub-par growth performance in the nonfinancial sector, given the quick recovery of equity markets and the euphoria generated by the policies of the Federal Reserve, liquid ‘hoards’ provided the wherewithal for massive speculative trading. The intrinsic volatility of financial investments, and especially equities, rewarded traders with access to cash hoards, swiftly deployed or withdrawn from markets at a moment’s notice. Such practices reflected what Keynes called “speculation…the activity of forecasting the psychology of the market,” as opposed to “enterprise…the activity of forecasting the prospective yield of assets over their whole life” (Keynes, 1977, p. 158). Keynes explained holding ‘cash as the precautionary motive’ derived from “the desire for security as to the future cash equivalent of a certain proportion of total resources” (ibid.). As mentioned earlier, cash hoards are not chiefly piles of idle funds but rather funds ready for use as speculative investments in short-term financial assets. They are not reserves to fund long-term fixed investments in plant and equipment. Such speculative practices become more widespread because, contrary to the resolution of previous crisis episodes, a surge in nonfinancial corporate profitability did not occur after the Great Recession. The cyclical profitability pattern in the nonfinancial corporate sector remained virtually the same as it was before the slump. Equity markets, on the other hand, soon recovered, reaching unprecedented heights even though the accumulation rate in the nonfinancial corporate sector after 2001 had virtually collapsed. From the mid-1960s through the mid-1990s the nonfinancial U.S. corporate undistributed profits (business saving) largely covered the funding needed for net fixed capital investment. In Figure 8.2 our estimates show the accumulation trend in this sector roughly approximating the ratio retained profits/capital stock from the early 1950s through the mid-1990s. A rising accumulation rate in the first half of the 1990s reflected an upturn in profitability that peaked in 1997. In the second half of the 1990s, net fixed investment spending surged above corporate business savings and required increasing corporate borrowing, thus ‘excess savings’ turned negative. By contrast, after the year 2000, as the share of financial investments in internal funds (and liquid assets) grew larger, ‘excess savings,’ the difference between retained profits and net fixed capital investment in nonfinancial corporations, rose considerably. We assume that the formation of profit expectations in the nonfinancial (‘real’) corporate sector drastically differs from that of financial markets. Long-term profitability trends in nonfinancial corporate sectors reflect the long-term evolution of profit shares and capital/output ratios as they emerged from past struggles with organized labor and competitive rivals. Historical class confrontation between capital and labor brought about ‘the great moderation’ in workers’ expectations, following the breakdown of the capital-labor accord and the consolidation of neoliberalism. Given the intrinsic uncertainty of long-term profit expectations, past trends in nonfinancial sectors are more likely to impact current assessments

212  Keynes and secular stagnation of investment opportunities than financial decisions where payoff horizons are shorter. Minsky-type initial overconfidence is more likely to drive financial investments despite the likelihood of disappointing results as the time horizons increase. Preventing over-accumulation and crisis Withholding corporate internal funds from investment in new plant and equipment and diverting them to dividend payouts and equity buybacks lowers effective demand and reduces the system’s growth rate. Slowing down capital accumulation postpones the over-accumulation of capital and the further decline of profitability. From this standpoint, financialization prevents the onset of systemic crisis, providing alternatives to over-accumulation. As Kregel pointed out in his presentation of J. V. Neumann’s 1940s model of maximum growth (Kregel, 1971, pp. 12–18), achieving the maximum growth rate requires productive capacity, K, to grow at the highest possible rate in a capitalist economy. The maximum rate of capital accumulation must equal the system’s profit rate: the entire gross operating surplus, ‘gross profits,’ obtained in one round of the capital circuit must reenter the growth circuit as capital investment in the next one. This means that, in the absence of excess capacity, the corporate profit rate sets the potential growth limit to capital accumulation. It also means that diverting available savings into higher wages, or dividends to sustain either workers’ or capitalists’ consumption will reduce the share of profits available for capital accumulation and, consequently, will lower the growth rate. As the share of profits earmarked for investment in capacity expansion, SΠ, rises between zero and one, the system’s actual accumulation rate approaches its maximum growth potential. ‘Hoarding’ corporate cash weakens the feedback loop from realized profits to the capital accumulation necessary to maintain, let alone enlarge, the reproductive capital circuits. As a result, the diversion of profits undermines the foundations of future profitability. We view the slow growth recovery from the Great Recession as the consequence of low profit expectations in the nonfinancial corporate sector since the early 1980s reducing the accumulation trend. Looking back to the rationale for the neoliberal dismantling of the so-called mixed economy, centering on manufacturing as the leading growth pole, we conclude that despite achieving a steeper path of productivity growth than that of wages, the higher profit margins obtained by nonfinancial corporations failed to reverse that historical decline in profit rates during the 1970s stagflation crisis. On the other hand, the accumulation slowdown of the real sectors since the mid-1980s, characteristic of secular stagnation, prevented the over-accumulation of capital and the profit rate collapse that would have triggered the breakdown of capitalist production. Profitability in the financial sector As we showed in Figure 7.13, average profit rates in the financial sector, while highly volatile, generally outperformed those in nonfinancial corporate industries in the inflationary decade preceding the 1982 slump. Starting in the 1990s, the

Keynes and secular stagnation  213 financial profitability trend steadily rose through 1994 while the equivalent nonfinancial trend, after recovering somewhat in the first half of the 1990s, reached its lowest point in 2001. For purpose of comparison between our estimates of average profit rates in the two sectors, we chose, as our numerator, to calculate nonfinancial corporate profit rates before tax corporate profits with capital consumption and inventory valuation adjustment given in BEA Table 1.14. We did not use the measure of ‘net operating surplus’ offered in that table because, although it is more inclusive (it shows gross profits before subtracting net interest payments), it is less comparable with similar measures in the financial business sector. Net operating surplus is larger than ‘corporate profits’ in nonfinancial corporate business, but lower than corporate profits in the financial sector because the financial sector receives positive net interest from nonfinancial corporations. Financial sector profits generally exceed net operating surplus, that is, the difference between value added and employee compensation, due to the generally positive inflows of net interest drawn from nonfinancial businesses. The opposite movement holds for nonfinancial corporations, their interest payments exceed their interest inflows (Foley, 2011). In the first half of the 2000s, while nonfinancial profitability continued its previous cyclical pattern, the separation between the two profit rates achieved unprecedented proportions. In nonfinancial corporate business, the characteristic cyclical profitability pattern experienced since the 1990s continued after the Great Recession. In the second quarter of 2013, the average profit rate remained lower than in 1997 as well as 2006. Financial sector profitability, on the other hand, reached unprecedented heights in the new century before yields tumbled in advance of the Financial Crisis, entering negative territory in 2008. It is noteworthy that, despite its partial recovery after the Great Recession ended, current yields remain roughly where they were before the boom of the early 2000s. Staying within the conceptual framework of Classical Political Economy, Saros followed Hilferding in assuming that profitability differentials guided the allocation of capital flows between banking and nonfinancial corporate sectors (Saros, 2013, p. 155). Hilferding viewed banking as any other line of business: For capital…banking is a sphere of investment like any other, and it will only flow into this sphere if it can find the same opportunities for realizing profit as in industry or commerce; otherwise it will be withdrawn. The bank’s own capital must be reckoned in such a way that the profit on it is equal to the average profit…The reserves are, of course, the bank’s own capital. (Hilferding, 1981, pp. 172–173) Our estimates of financial profitability take into account that banking and other financial activities require the combined deployment of fixed and financial capital stocks and flows. Starting in 1960, estimates for U.S. fixed capital stocks, including research and development expenditures in the financial business sector, are now available in the data download program of the Federal Reserve Flow of Funds. Following Hilferding (ibid.,) and Shaikh (2009, pp. 187–190) with Bakir and Campbell’s (2013) disagreeing in their interesting paper, we identified as banks’

214  Keynes and secular stagnation own capital the stocks of currency and deposits, federal funds, open market paper, and agency and GSE-backed securities. While capital flows across sectors respond to profit differentials, we made no assumption of reaching equilibrium positions other than as transient episodes. In the financial sector, as in any other business sector, capital flows inevitably lead to overshooting and steep reversals of earlier movements, as evidenced by the implosions following the high profit rates of the 1970s and the unsustainable housing investments of the middle 2000s. Such excesses, however, do not justify ignoring the long-run trend emerging as an average of the deviations from balanced growth. Comparing the profitability estimates for both sectors provides a clear view of their structural ties as well as their systemic differences. Clearly, the average profit rate in the financial sector orbited around the profit rate path of the nonfinancial corporate sector. We view the reversal of local deviations between the two cyclical paths as evidence of the gravitational attraction exerted by the nonfinancial profitability path, acting as a central tendency of the financial sector, suggesting that the profit yields of financial assets depended on the performance of the real economy. The growing capital flows boosting asset prices originated both in corporate shares buybacks and shareholders receipt of liquid dividends that joined them in stock trading. As a result, profitable outlets in financial markets encountered falling yields and occasional downward reversals of proportional strength to the upturns. In the recovery period since the Great Recession, the persistence of secular stagnation framed the rising volatility of financial investments and the cyclical collapse of nonfinancial corporate net fixed capital investments. Figure 7.14 highlighted the volatility of financial markets and allowed us to identify the structural link between real and financial sectors. As we saw, the smoother nonfinancial corporate long-run accumulation trend of the financial sector appears to provide the gravitation center for the sharper cyclical fluctuations around it. Such volatility derives from the more liquid nature of financial as opposed to fixed investments. The steadily rising trend in financial sector profitability from the early 1980s through the late 1990s and beyond accounts for the rising accumulation trend (punctuated by sharp fluctuations) in that sector after the early 1980s. But the fact that the nonfinancial corporate profitability and accumulation trends failed to be lifted from their relatively low paths by the recurrent bubble episodes in the financial sectors proved their limited capacity to promote real growth. In the aftermath of the Great Recession a transitional convergence between the profit rates of both real and financial sectors finally occurred. In Figure 7.14 the two accumulation rates depicted have a downward long-term trend, more noticeable in the nonfinancial corporate sector than in the financial because banks and insurance companies expanded between the late 1940s and the mid-1960s. Since then the overall capital accumulation trends in both cases shared a downward common mean. But such common trends hide the fact that in the financial sector thousands of banks disappeared since interest rates started falling after the mid-1980s and a handful of banks took possession of an increasing portion of financial assets. This means that although both rates of accumulation share trends and cyclical patterns,

Keynes and secular stagnation  215 it is a decreasing number of banks that continue to retain the increasing amount of financial assets and manages to expand it. Can profits exist without value production? In our earlier discussion of business reports of corporate practices, ‘cash’ referred to the excess funds retained by nonfinancial corporations after covering their net fixed capital expenditures out of undistributed profits. After 2007, that gap between retained earnings and net capital expenditures grew significantly. While retained earnings as a share of nonfinancial corporate net operating surplus also increased, a smaller share of undistributed profits was allocated for net fixed capital investments than at any previous time. This is why the alarming reports about the sluggish recovery from the Great Recession are relevant in the context of secular stagnation. After 2009, Federal Reserve monetary policies aiming to boost risky financial asset prices continued to sustain new bouts of investor’s euphoria and stoke market bubbles without actually managing to jumpstart actual or potential growth in the real economy (Jacobson and Occhino, 2013). Because the 2007–2009 Financial Crisis dashed expectations of an early recovery and growth prospects remained subpar, fears of secular stagnation remaining entrenched in the system remained. Adding fuel to the pessimistic growth forecasts, Robert Gordon concluded that the U.S. economy “faces six headwinds that are…dragging long-term growth to half or less…the annual rate…between 1860 and 2007” (2012: Abstract). Larry Summers expressed concern that, despite falling interest rates since the 1980s and the recurrence of stock market and housing bubbles, growth recessions were inevitable. In his view, a liquidity trap hampered vigorous economic revivals. Martin Wolf detected the absence of investment opportunities as the cause of stagnation, in line with the Great Stagnation anticipated by Thomas Palley (2012) and Bellamy Foster and McChesney (2012). Since Paul Krugman (2009) proclaimed ‘Capitalism Triumphant’ after the Soviet collapse, the prospects of secular stagnation dominated the concerns of mainstream economics, and even Krugman turned his attention to the return of ‘depression economics.’ After the 1970s, it was clear to students of industrial competition and its evolution (Clifton, 1977), that in the current stage of capital accumulation, corporate management had switched investment strategies placing the growth of financial assets in its various forms ahead of expanding real production activities in any real sector of the system. The new corporate strategy required centralized allocation of all retained earnings flowing from individual corporate branches into a central corporate fund, so that “this pool of finance, rather than production itself” became the overriding concern of corporate growth planning (ibid., p. 147). A decade later Melman, an early critic of financialization, reiterated Veblen’s misgivings about business goals clashing with engineering excellence in the corporate pursuit of ‘profits without production’ (Melman, 1987, p. xiii). The balance deficit in the corporate capital account of the second half of the 1990s was higher than in any other decade because fixed capital investments in

216  Keynes and secular stagnation those years exceeded retained profits and borrowing was necessary. After 2000, a surplus balance in the capital account emerged leading up to the crisis of 2008 but the financial balance deteriorated in that period, reaching historic proportions as a result of growing debts associated with financial investments. While the Financial Crisis unfolded both balances experienced large surpluses because corporations, both financial and nonfinancial, stopped all new spending. As fixed capital investment collapsed, budget surpluses emerged in the corporate capital accounts. In the Crisis’ aftermath, however, the financial balance deteriorated as the recovery of stock valuations renewed the corporate incentive to borrow and, by 2013, Steve Keen judged the new stock market bubble had grown so big that ‘mere mortals’ were unable to detect it (Keen, 2013a). References Bakir, E. and A. Campbell. 2013. “The Financial Rate of Profit: What Is it, and How Has it Behaved in the United States?” Review of Radical Political Economics, Volume 45, No. 3, pp. 295–304. BEA. 2013. “Preview of the 2013 Comprehensive Revision of the National Income and Product Accounts. Changes in Definitions and Presentations,” Working paper, pp. 13-39. Bernanke, B. 2005. “The Global Saving Glut and the U.S. Current Account Deficit,” The Federal Reserve Board, March 10, https://www​.federalreserve​.gov​/boarddocs​/speeches​ /2005​/200503102/. Cardarelli, R. and K. Ueda. 2006. “Awash with Cash: Why Are Corporate Savings So High?” World Economic Outlook, Chapter 4, International Monetry Fund, pp. 135–159. Cassidy, J. 2010. “Interview with Eugene Fama,” The New Yorker, January 13, https://www​ .newyorker​.com​/news​/john​-cassidy​/interview​-with​-eugene​-fama. Clifton, J. 1977. “Competition and the Evolution of the Capitalist Mode of Production,” Cambridge Journal of Economics, Volume 1, No. 2, pp. 137–151, Oxford University Press. Equifax 2011. “Equifax Data Reveals Bankruptcy Landscape Blurred by Progress and Setbacks,” https://d1io3yog0oux5​.cloudfront​.net/​_b1b​57fd​0fd1​e5e5​07f3​95c2​ 5b91ce6ad​/equifax​/news​/2011​-07​-28​_Equifax​_Data​_Reveals​_Bankruptcy​_Landscape​ _Blurred_​_872​.pdf Foley, D. 2011. “The Political Economy of U.S. Output and Employment 2001–2010,” Schwartz Center for Economic Policy Analysis, The New School, Working Paper 20115, pp. 1-11. Foster, J. B. and R. McChesney. 2012. The Endless Crisis, Monthly Review Press. Froomkin, D. 2012. “Cash-Hoarding Companies Neither Spend nor Lend, Fouling Economy Further,” Huffington Post, July 7, https://www​.huffpost​.com​/entry​/cash​-hoarding​ -companies​-spend​-lend​-economy​_n​_1666424. Gillman, J. 1965. Prosperity in Crisis, Marzani & Munsell. Gordon, R. 2012. “Is US Economic Growth Over? Faltering Innovation Confronts the Six Headwinds,” National Bureau of Economic Research, Working Paper 18315, pp. 1–23. Grossman, H. 2021. Henryk Grossman Works, Volume 3, The Law of Accumulation and Breakdown of the Capitalist System: Being also a Theory of Crises, Brill.

Keynes and secular stagnation  217 Grossman, H. 2022. “Fifty Years of Struggle over Marxism, 1883–1932,” in Henryk Grossman Works, Volume 1, Haymarket. Hansen, A. 1939. “Economic Progress and Declining Population Growth,” American Economic Review, Volume 29, No 1, pp. 1–15. Harris, K., Schwedel, A. and Kim, A. 2012. “A World Awash in Money,” Bain & Company Report, http://www​.bain​.com​/publications​/articles​/a​-world​-awash​-in​-money​.aspx, November 14. Hilferding, R. 1981. Finance Capital, Routledge & Kegan Paul. Jacobson, M., and F. Occhino. 2013. “Behind the Slowdown of Potential GDP”, Economic Trends, Federal Reserve Bank of Cleveland, February 12. Keen, S. 2013a. “A Bubble So Big We Can’t Even See It,” Real-World Economic Review, No. 64, pp. 3–10. Keen, S. 2013b. “Secular Stagnation and Endogenous Money,” Real-World Economic Review, No. 66, pp. 2–11. Keynes, J. M. 1932. “An Economic Analysis of Unemployment,” in Unemployment as a World Problem, Lectures on the Harris Foundation, University of Chicago Press. Keynes, J. M. 1937. “The General Theory of Employment,” The Quarterly Journal of Economics, Volume 51, No. 2, pp. 209–223, Oxford University Press. Keynes, J. M. 1977. The General Theory of Employment, Interest and Money, Royal Economic Society: The Macmillan Press. Keynes, J. M. 2013. The Collected Writings of John Maynard Keynes, Volume 27, Moggridge, D. (ed.), Macmillan, Cambridge University Press. Klein, J. 1964. The Keynesian Revolution, Macmillan. Kregel, J. 1971. “A Model of General Economic Equilibrium,” in Rate of Profit, Distribution and Growth, Aldine. Krugman, P. 2009. The Return of Depression Economics and the Crisis of 2008, Norton. Krugman, P. 2013a. “A Permanent Slump?” New York Times, November 17. Krugman, P. 2013b. “Secular Stagnation, Coalmines, Bubbles, and Larry Summers,” New York Times, November 16. Krugman, P. 2013c. “Bubbles, Regulation and Secular Stagnation,” New York Times, September 25. Leijonhufvud, A. 2008. “Keynes and the Crisis,” Policy Insight No. 23, May, pp. 1–6, Centre for Economic Policy Research (CEPR): www. cepr​.or​g. Leijonhufvud, A. 2009. “Out of the Corridor: Keynes and the Crisis,” Cambridge Journal of Economics, Volume 33, Issue 4, pp. 741–757. Lenzner, R. 2013. “Households, Corporations and Banks Are Hoarding $14 Trillion Cash,” Forbes, July 16. May, G. 1957. “Changes in the Accounting Treatment of Capital Items during the Last Fifty Years,” Problems of Capital Formation: Concepts, Measurement, and Controlling Factors, NBER, Chapter, pp. 193–213, URL: http://www​.nber​.org​/chapters​/c5583. Mejorado, A. and Roman, M. 2014. Profitability and the Great Recession, Routledge, Frontiers of Political Economy. Melman, S. 1987. Profits Without Production, University of Pennsylvania Press. Palley, T. 2012. From Financial Crisis to Stagnation, Cambridge University Press. Palley, T. 2013. Financialization: The Economics of Finance Capital Domination, Palgrave Macmillan. Sanchez, J. and E. Yurdagul. 2013. “Why Are Corporations Holding So Much Cash?,” Federal Research Bank of St. Louis, January, pp. 5–8.

218  Keynes and secular stagnation Saros, D. 2013. “The Circulation of Bank Capital and the General Rate of Interest,” Review of Radical Political Economics, Volume 45, No. 2, pp. 149–161. Shaikh, A. 2009. “Economic Policy in a Growth Context: A Classical Synthesis of Keynes and Harrod,” Metroeconomica, Volume 60, No. 3, pp. 455–494. Skidelsky, R. 2010. “The Crisis of Capitalism: Keynes versus Marx,” The Indian Journal of Industrial Relations, Volume 45, pp. 321–335. Skidelsky, R. 2013. “Creative Destruction: Our Economic Crisis Was Wholly Predictable,” The New Statesman, May 17. Steindl, J. 1976. Maturity and Stagnation in American Capitalism, Monthly Review Press. Sweezy, P. 2012. “Why Stagnation?” Monthly Review, Volume 64, No. 2, June, https:// monthlyreview​.org​/2012​/06​/01​/why​-stagnation​-2/ Wolf, M. 2013. “Why the Future Looks Sluggish,” Financial Times, London, November 19. Wray, R. 2013. “Bow Down to the Bubble: Larry Summerian Endorses Bubbleonian Madness and Paul Krugman Embraces the Hansenian Stagnation Thesis,” EconoMonitor, November 21, www​.economonitor​.com​/rwray.

9

The neo-Keynesian retreat

Pessimistic views of sustainable growth paths emerged following each of the Great Depressions that punctuated the path of capitalist development since the late 19th century including the Great Depression lasting from 1873 to 1896 (Rostow, 1938), the Great Depression of the 1930s (Eichengreen, 2015), and the Great Recession of the late 2000s (Shaikh, 2011). Theories of secular stagnation generally sought to identify the structural changes behind low or falling real capital accumulation trends that led to major slumps and slow recoveries. In 1887, the notion that capitalist development undergoes radical phase changes, including that of secular stagnation, motivated Engels to write: The decennial cycle of stagnation, prosperity, over-production and crisis, ever recurring from 1825 to 1867, seems indeed to have run its course; but only to land us in the slough of despond of a permanent and chronic depression. The sighed-for period of prosperity will not come; as often as we seem to perceive its heralding symptoms, so often do they again vanish into air. (Marx and Engels, 1996, p. 35) We showed in Chapter 3, Figure 3.7, that the rising capital intensity of production in the U.S. business sector reduced average profitability. Cutting through short- and medium-cyclical deviations caused by changes in effective demand and capacity utilization, the long-term net output/capital trend (Sraffa’s maximum rate of profits, Y/K) steadily declined from 1948 to 2020. The falling long-term trend covered both the Fordist postwar period and the neoliberal phase from the early 1980s to 2020 and, therefore, continued to exert downward pressure on actual profitability, Π/K. Thus, despite declining wage shares in the business sector and unsustainable asset bubbles caused by falling interest rates, the accumulation path in the neoliberal phase remained at a low level and fell even further. Low profit expectations in the nonfinancial corporate sector sustained the low rates of nonfinancial capital accumulation in the 21st century, well before the 2007–2009 Financial Crisis initiated a new phase in the unfolding saga of secular stagnation. In Chapter 1 and throughout this book we identified profitability, Π/K, as the chief driver of capital accumulation, I/K, and the underlying force behind the growth rate of real GDP. We stressed the significant parallelism between profitability and capital accumulation in order to provide a consistent conceptual framework to interpret the stylized DOI:  10.4324/9781003413806-9

220  The neo-Keynesian retreat historical patterns of capitalist dynamics. In Chapter 3, we provided conclusive empirical evidence of the long-term profitability trend falling from the late 1960s into the early 1980s to account for the structural changes that replaced the Fordist configuration, relying on manufacturing as its main growth pole, with the neoliberal preference for speculation in the financial sectors. After explaining why contemporary theories of secular stagnation failed to grasp the systemic nature of the problem, we traced the theoretical roots of our critique in Classical Political Economy and compared it with similar concepts in Keynes. We have provided historical evidence of secular trends of falling profitability, declining rates of fixed capital accumulation, and tepid GDP growth rates in the U.S. economy from the mid-1960s and through the post-pandemic recovery. In this chapter, we contrast our analysis of these systemic growth patterns with those found in Hansen’s 1954 views and the late contributions by Summers’ neoKeynesian 21st-century explanations of secular stagnation based on demographic and other exogenous factors. Our research provides a systemic account of secular stagnation, not only because we interpret the linkage between accumulation and profitability from the theoretical perspective of Classical Economics, but also because we present empirical evidence to identify the secular stagnation trend in the neoliberal period. Identifying the role of profitability in the diversion of capital flows out of nonfinancial sectors and into financial assets allowed us to better understand the dynamics leading from secular stagnation to the Great Recession (Mejorado and Roman, 2014). The lackluster recovery from the Great Recession eventually alerted Larry Summers in 2013 to acknowledge the long presence of secular stagnation in the U.S. economy. Summers’ account of the causes underlying secular stagnation in the neoliberal phase of capital accumulation added nothing new to the conceptual framework of neo-Keynesian concepts first articulated by Alvin Hansen in the late 1930s. It included claims concerning the impact of falling (residential) investment weakening aggregate demand due to declining rates of population growth. Hansen also blamed the falling relative prices of capital goods for reducing the spending necessary to cover capital consumption needs. In the early 1950s, moreover, Hansen singled out the “development of imperfect competition, monopoly, and oligopoly” as the cause of the restriction of output and lower GDP growth rates (Hansen, 1954, p. 409; Blanchard and Johnson, 2013, pp. 348–351). The neoKeynesian interpretations of secular stagnation, mixed with Gillman’s (1958) and Steindl’s (1976) arguments from a ‘Marxist’ standpoint, provided the background for the recent revival of the concept by Summers (2013a,b; 2014a,b,c; 2015a,b) and Krugman (2014). In our view, they all represent a retreat from Keynes’ focus on low profitability as the underlying cause. Hansen’s initial formulation of the secular stagnation hypothesis (Hansen, 1939), in contrast with Summers’ interpretation, argued that although “fluctuations in the rate of interest have indeed at times played a significant role…more typically, changes in the liquidity preference schedule, induced by fluctuations in the marginal efficiency of capital, reinforce and supplement the primary factor.” In other words, the key to understanding secular stagnation was the falling marginal

The neo-Keynesian retreat  221 efficiency of investment, or, more plainly, the expected profit rate. In Hansen’s summary of Keynes’ view of business cycles, he emphasized that changes in the anticipated ‘marginal efficiency of capital’ played a leading role in determining the rate of investment and the unemployment level. Hansen’s legacy on secular stagnation The formulation of Hansen’s secular stagnation theory, in the early 1950s, relied “primarily on exogenous factors” (Hansen, 1954, p. 409), attributing falling capital accumulation, and the persistence of low growth periods, to a combination of demographic factors, chiefly declining population growth, and the capital-saving bias of technical progress. For Hansen, falling accumulation trends reflected falling demand for residential housing, due to declining population growth, and decreasing business investment caused by falling relative prices of capital goods due to technical progress. We agree with Hansen’s view that net investment and capital accumulation provides the income that sustains growing consumption and future growth. From his Keynesian perspective, Hansen argued that in order to provide the incentive to generate high capital accumulation rates, rising effective demand from a growing population was necessary to complement the benefits of innovating technology. In Hansen’s view, aggregate consumption demand was a function of the aggregate income created by investment. A growing economy requires high rates of capital accumulation to maintain full employment, but labor-saving technology to replace the depreciated plant and equipment reduced the overall demand for labor. Rising labor productivity growth in the capital goods sector, derived from capital-saving technology, led to falling relative prices of investment goods and a lower capital intensity of production, hence lower net investment outlays (Eichengreen, 2014, 2015). The chief elements of the secular stagnation hypothesis in Hansen included three claims: 1. Lower population growth caused a contraction in aggregate consumer demand growth. In addition, residential investment would fall, thus contributing to weakening aggregate demand. 2. Falling relative prices of investment goods due to faster labor productivity growth, combined with capital-saving technological progress, lowered the capital intensity of production and reduced the investment share of effective demand. 3. Firms in competitive markets deployed cost-reducing techniques of production to avoid losing market share, even if it involved capital losses. Oligopolistic firms, however, did not face such pressures and therefore could postpone replacing their plant and equipment for as long as the cost advantages of the new technology failed to compensate them for the capital losses incurred when scrapping the old one. Such behavior increased the shortfalls in effective demand, and as a result “progress slowed down, and outlets for new capital formation available under a more ruthless competitive society are cut off” (Hansen, 1939). As late as 1964, Hansen continued to maintain that his original concern 25 years earlier with “inadequate investment outlets” remained relevant. As the propensity to save had remained roughly constant for several decades after the recovery from

222  The neo-Keynesian retreat depression, his explanation for the low secular growth trend experienced since remained focused on declining investment opportunities. Hansen never strayed from his original thinking: the problem was not a secularly rising propensity to save but rather secularly falling investment outlets (Hansen, 1964). On the other hand, contrary to the recent versions of the secular stagnation hypothesis, Hansen emphatically argued that interest rates did not play a central role in the determination of investment and adequate levels of effective demand. While focusing on the primacy of net investment to secure sustained growth, Hansen downplayed the importance of interest rates as a determinant of capital accumulation trends, considering their subordinate role compared to the expected profit rate: few there are who believe that in a period of investment stagnation an abundance of loanable funds at low rates of interest is alone adequate to produce a vigorous flow of real investment. I am increasingly impressed with the analysis made by Wicksell who stressed the prospective rate of profit on new investment as the active, dominant, and controlling factor, and who viewed the rate of interest as a passive factor, lagging behind the profit rate. (Hansen, 1939, p. 5) From the late 1930s to the mid-1950s, Hansen’s endorsement of Keynes’ theory of a declining marginal efficiency of investment as the capital stock grew played a central role in his formulation of the secular stagnation hypothesis, In the early nineteenth century nearly all gross investment had to be financed out of current net saving. On the one side the capital stock was scarce and the marginal efficiency of capital was high…There was no problem of inadequate aggregate demand. Eventually, however, the society acquired a vast accumulated stock of capital…The marginal efficiency of capital tended to decline…Net savings thus found investment outlets less readily available than in early periods. (Hansen, 1954, pp. 411–412) We agree with Hansen’s perception that sustained full employment does not hinge on low interest rates but on high rates of business capital accumulation. As empirical evidence abundantly confirms, the expansion of productive capacity responds to above-normal capacity utilization levels achieved in the recovery from a previous downturn. The crucial factor in the expansion of capacity and the increase in labor productivity is investment in new plant and equipment rather than residential investment. In his latest formulation of the secular stagnation hypothesis, however, Hansen himself ignored his original insight on the connection between profitability and fixed investment spending. In this regard, Hansen’s failure to develop his initial view regarding the link between secular stagnation and profitability made it easier for Summers (2014a,b,c), Krugman (2014), and Bernanke (2015) to follow suit, ignoring Hansen’s initial thought on the centrality of profitability, and the relative irrelevance of the interest rate in corporate investment planning.

The neo-Keynesian retreat  223 In Hansen’s formulation of his secular stagnation hypothesis, the causes responsible for blocking the growth dynamics that preceded stagnation and eventually led to crisis, reduced the growth rate in the recovery phase. In the late 1930s, Hansen feared that secular stagnation would set in after the depression ended, meaning that in its aftermath recovery would not be smooth: “This is the essence of secular stagnation-sick recoveries which die in their infancy and depressions which feed on themselves and leave a hard and seemingly immovable core of unemployment” (Hansen, 1939, p. 4). The revival of secular stagnation theory in the 21st century was also a byproduct of depression economics: “a state of affairs like that of the 1930s in which the usual tools of economic policy — above all, the Federal Reserve’s ability to pump up the economy by cutting interest rates — have lost all traction” (Krugman, 2008). Capital scarcity and the ‘marginal efficiency of capital’ In Classical economics, the evolution of profitability provided the direct link with the dynamics of capital accumulation: the rate of profit measured the growth of newly invested capital relative to the accumulated capital stock. Investment spending made in response to the anticipation of profits set in motion the feedback flow underpinning the change in effective demand. In Keynes’ analysis, the profitability of capital depended on its scarcity, and, therefore, as capital accumulation advanced and its scarcity diminished, the return on capital declined. The characteristic uncertainty attached to estimating future revenue flows, and the applicable discount rate, increased with the extended gestation period of the capital project. Keynes anticipated that the steady accumulation of capital would lead to such drastic declines in yields, as to bring about the “euthanasia” of the rentiers. In the event, the top rentiers (from top 1 percent to top 10 percent of households) under neoliberalism were not ‘euthanized,’ and, on the contrary, flourished as never before. Persistent corporate share buybacks, despite low profitability in the real sectors, boosted asset prices and expanded their (fictitious) wealth shares even during the COVID-19 economic collapse of 2020. For his part, Marx insisted that the accumulation of capital would induce technical progress and bring about a changing composition reflecting the growing weight of the fixed capital component, embodying materialized ‘dead labor’ value and a declining share of its ‘variable’ part, living labor power. This transformation of its organic composition promoted labor productivity, the output produced per unit of labor (time), that is to say, reducing the quantity of labor value, and, therefore, surplus value per unit of output. As the compression of wages approaches its zero limits and therefore all new value added consisted of profits, the ‘maximum profit rate,’ the net output/capital ratio would fall with the rising intensity of production. The profit share, when (Π = Y) and (Π/Y = 1), would reach its limit, and the rising organic composition of capital, (κ/Y = Ω)↑, would sustain a falling rate of profit, (1/Ω)↓. At a distance, and without dwelling on the conceptual differences involved, Keynes’ and Marx’s views of the accumulation of capital bear a passing

224  The neo-Keynesian retreat resemblance in two ways. First, in both cases, the pursuit of profits motivates the decision to invest in a capital project so long as the expected sum of the discounted annual revenues exceeds the current cost by an acceptable margin. Second, as capital accumulation proceeds, the expected profitability of capital tends to fall. From a neo-Keynesian perspective, however, not necessarily in line with Keynes’ thinking, the decline in capital accumulation reflects exogenous trends including how low demographic growth rates’ impact on the demand for residential investment. Inelastic demand for investment goods, as the relative price of investment goods caused by labor productivity growth falls, will reduce the investment spending necessary to renovate the stock of capital and will weaken effective demand, thus causing secular stagnation. Profitability played the central role in Marx’s cycle model outlined in chapter 25 of Capital, Volume 1. Similarly, the force behind Keynes’ cycles in aggregate income and employment “consists primarily of fluctuations in the rate of investment..​.caus​ed mainly by fluctuations in the marginal efficiency of capital.” As Hansen made clear, the emergence of stagnation tendencies in Keynes was driven by the long-term tendency of the marginal efficiency of capital to decline as a result of “the growing abundance of capital (and therefore lower marginal productivity) of capital goods. This is an objective fact” (Hansen, 1953, p. 213). This is why Keynes anticipated that the growth of capital would depress profit yields sufficiently to bring about the “euthanasia” of rentiers as a class. As we emphasized in every chapter of this book, ignoring the role of profitability in shaping GDP’s growth path deprived the secular stagnation argument of a theoretical foundation consistent with the dynamics of capital accumulation. Since capital accumulation embodies capitalism’s raison d’être and the pursuit of profits provides the necessary force for its implementation, removing profitability from the account of secular stagnation severs its theoretical coherence. As we saw in Chapters 2 and 3, in the U.S. economy and that of other OECD countries, the evidence for the association of low profitability levels, falling accumulation rates, and secular stagnation in the post-1980 neoliberal phase is persuasive. Two periods are clearly in evidence, before and after the early 1980s. A large contrast emerged between the high profit and accumulation rates in the 1960s and 1970s and the much lower profitability and accumulation levels from the early 1980s to the present. The neoclassical view of secular stagnation From Alvin Hansen’s 1939 analysis of the prospects of a sustained recovery after the Great Depression to Larry Summers’ 2013 reformulation in the aftermath of the Great Recession of 2007, conventional theories of secular stagnation old and new predominantly identified falling population growth and capital-saving technical progress as the chief drivers of declining capital accumulation trends. In the real world of competitive wars considered by Mill and Marx, as well as Schumpeter and Hayek, firms would react to declining population/labor force ratios by taking advantage of falling unit prices in capital goods sectors to increase the capital

The neo-Keynesian retreat  225 intensity of production: they would increase the share of effective demand represented by net fixed investment. As David Gordon pointed out, in neoclassical theories of business cycles or depressions, neither profit rates nor profit shares are relevant variables (Gordon, 2010, p. 70). Instead, neoclassical economics presents the marginal product of capital under perfect competition, defined as the partial derivative of output with respect to capital, ∂Y/∂K, as the regulator of all firms’ rate of return. Given an excessive growth of capital intensity, ∂K, technical change will intervene (spontaneously appear) to raise ∂Y and prevent the persistent decline of profitability. After assuming that the inputoutput relationships of a so-called production function are well known, neoclassical theory explains the return to capital, the rate of return, as the clear-cut contribution of capital goods to output growth, other inputs held constant. Clearly, other essential inputs in the production function, such as labor and materials, cannot be held constant while output changes and, therefore, the concept of marginal product of capital fails to address the real processes of any production activity. A crucial conclusion of neoclassical economics holds that in the long run, since growth itself lowers the marginal product of capital to equality with the prevailing interest rate, the ‘economic profit rate’ in the industry disappears. From the Classical perspective, the neoclassical concept of a long-run equilibrium with zero ‘economic profits’ would characterize the lowest point of a historic depression, the breakdown of capital accumulation. After the Great Recession In the aftermath of the first Great Recession of the 21st century, Larry Summers and Paul Krugman revived earlier concerns expressed by Hansen for over 30 years that monetary policy alone would fail to lift the system’s growth path onto a sustainable full employment path. In their view, without the fiscal stimulus of public investment, it would be difficult to achieve growth rates high enough to maintain full employment (Summers, 2013a,b; Krugman, 2014). More to the point Hansen, Krugman, and Summers believed that without strong public deficits mature capitalism would be incapable of avoiding secular stagnation. On the other hand, Larry Summers’ 2013 revival of the secular stagnation hypothesis not only retained Hansen’s ‘exogenous factors,’ like falling population growth rates and capitalsaving technical progress, but added others that Hansen had rejected, including the canard that zero bound interest rates would fail to secure the balance between saving and investment at full employment levels. Addressing the 14th Annual IMF Research Conference: Crises Yesterday and Today on November 8, 2013, Larry Summers reminded his audience that, after the 1980s, the U.S. had experienced a lower annual real GDP growth than in the previous three decades. He feared that forecasts of future steady growth were “belied by the Global Crisis and the Great Recession” despite unprecedented reductions in real interest rates. In light of this evidence, Summers felt justified to argue that it was time to revive the secular stagnation hypothesis initially proposed by Hansen 75 years earlier. To that end, Summers argued that “the new secular stagnation

226  The neo-Keynesian retreat hypothesis responds to recent experience…by raising the possibility that it may be impossible for an economy to achieve full employment, satisfactory growth and financial stability simultaneously” (Summers, 2014a, p. 30). On November 22, 2015, noting that between 2013 and 2016 official IMF World Economic Outlook forecasts persistently overestimated real GDP growth in all advanced economies outside the eurozone, Larry Summers felt confident that despite falling real interest rates, his restatement of Alvin Hansen’s 1938 secular stagnation hypothesis two years earlier had been confirmed by events (Summers, 2015b). While his restatement of the ‘core idea’ of secular stagnation belied the unrealistic forecasts of real GDP growth persistently made by the IMF and World Bank following neoclassical assumptions, Summers’ analysis of secular stagnation used the same theoretical underpinnings. Summers’ and Krugman’s skeptical view on the ability of monetary policy to achieve vigorous recovery reflected a particular formulation of the neoclassical theory of loanable funds. In that theory, investment is a decreasing function of the interest rate and (that) saving is an increasing function of the interest rate and (that) the level at which equilibrium with full employment takes place requires a negative interest rate… This is the essence of the secular equilibrium hypothesis. (Summers, 2015a, pp. 61–63) Summers continued to argue that “secular stagnation is the hypothesis that the IS curve has shifted back and down so that the real interest rate consistent with full employment has declined” (Summers, 2015b) and cannot be reached. Larry Summers’ IS-LM neo-Keynesian model Summers’ recent focus on growing monopoly power (Summers, 2016) as the cause of the alleged bifurcation of profitability from investment, like Hansen’s previous reference to the retreat from competition, is inconsistent with the absence of price inflation during the extended recovery from the Financial Crisis. In the aftermath of the Great Recession, and before the fiscal measures taken following the collapse of effective demand associated with COVID-19 pandemic lockdowns, price inflation was subdued, despite persistent efforts made by the Federal Reserve to reach a 2 percent target (Barro, 2022). At the IMF Fourteenth Annual Research Conference in Honor of Stanley Fischer held on November 8, 2013, Larry Summers expressed his concern that a coherent theory explaining the lackluster economic recovery from the Financial Crisis of 2007–2009 did not exist. Summers noted that “in the four years since financial normalization, the share of adults who are working has not increased at all and GDP has fallen further and further behind potential as we would have defined it in the fall of 2009.” He then wondered, “if a set of older and much more radical ideas… that went under the phrase secular stagnation, are not profoundly important…and may not be without relevance to America’s experience today.” Summers, then, went on to apply the neoclassical IS-LM model, in which presumably interest rate

The neo-Keynesian retreat  227 adjustments suffice to achieve general equilibrium and maintain full employment as the framework to interpret the secular stagnation hypothesis. But he added: Suppose that the short-term real interest rate that was consistent with full employment had fallen to −2% or −3% sometime in the middle of the last decade. Then, what would happen?…Then, conventional macroeconomic thinking leaves us in a very serious problem, because we all seem to agree that whereas you can keep the federal funds rate at a low level forever, it’s much harder to do extraordinary measures beyond that forever and, consequently, full employment equilibrium will not be reached (http://larrysummers​.com​/imf​-fourteenth​-annual​-research​-conference​-in​-honor​-of​-stanley​ -fischer/). This is the reason why, in order to lower the real rate of interest, the Federal Reserve persistently sought to raise the inflation rate throughout the recovery, but without success. Outside Larry Summers’ mindset, it is not convincing that negative interest rates would necessarily bring about full employment and faster growth, as the assumptions behind the IS-LM model are highly questionable. It is clear, however, that John Hicks’ IS-LM (1937) model of monetary and product sectors general equilibrium model, served Summers as the conceptual framework to formulate the neo-Keynesian interpretation of secular stagnation in the 21st century. Reflecting on the fact that mainstream forecasts of world economic growth consistently failed to predict the anemic recovery that followed the Great Recession, Larry Summers reiterated that current events confirmed the relevance of reviving Alvin Hansen’s 1939 secular stagnation hypothesis several years earlier. After pointing out that, as of 2017, the recovery from the Great Recession of 2007–2009 was “very slow,” Summers looked back to the “unexciting” growth rates of “aggregate demand” recorded in previous decades despite loose monetary policies and “the erosion of credit standards and a mammoth housing bubble” that led to the outbreak of the “financial crisis.” In addition, he recalled how as the 21st century started, the internet bubble triggered the 2001 to 2003 recession, and concluded that since the mid-1990s, periods of “normal” growth were rare. The record showed, according to Summers, that the U.S. economy entered a phase of ‘secular stagnation’ after the 1980s (Summers, 2017, p. 557). Comparing IMF World Economic Outlook GDP growth forecasts for 2013– 2016 with actual ones, showed shortfalls in all advanced economies excepting the eurozone and real interest rates falling everywhere in the same period. While his restatement of the ‘core idea’ of secular stagnation accorded with the facts of recent economic growth, Summers’ analysis of secular stagnation remained anchored in a weak conceptual foundation. Summers continued to insist that “secular stagnation is the hypothesis that the IS curve has shifted back and down so that the real interest rate consistent with full employment has declined.” Summers’ use of the disputed IS-LM Hicks model to interpret the decline in investment, in the face of falling interest rates, fails to question why the fall in investment was not blocked or reversed by the lower interest rates, and, furthermore, neglects the evidence

228  The neo-Keynesian retreat showing that capital investment changes are insensitive to interest rate fluctuations. Interest rates are important factors behind residential mortgages and consumers’ credit, not corporate capital investment. The idea of finding a real interest rate “consistent with full employment” places an undue burden on interest rates (Gomme, Ravikumar, and Rupert, 2015, No.19). Hansen’s original hypothesis explicitly denied the significance of interest rates to understand secular stagnation and identified the decline of profitable investment opportunities as its major cause. Hansen’s secular stagnation hypothesis in 1939 explicitly denied the importance of interest rates and identified the decline of profitable investment opportunities as its major cause. After Keynes, we know that savings depends on income, not interest rates, investment decisions reflect profit expectations and, in the U.S., internal funds, drawn from past and current profits, are the main source of corporate capital expenditures. Therefore, Summers’ conclusion that “a reduction in demand,” despite declines in real interest rates, caused GDP growth rates to fall throughout the industrial world, clearly refers to low profit expectations and therefore the weak business investment that followed. On the other hand, Hansen’s and Summers’ argument for secular stagnation relies heavily on exogenous factors, such as the shortfall in effective demand caused by the decline of residential investment due to falling population growth, but labor force growth rates are not exclusively dependent on population growth. Other factors internal to the dynamics of capital accumulation determine the growth of the effective labor force, let alone employment growth. Labor participation rates substantially impact the growth of the active labor force regardless of its natural growth. The decline in capacity growth caused by low profit expectations will reduce the demand for labor as well as labor productivity growth, but it will also decrease the labor participation rate, the share of the population actively seeking employment. After Keynes, we know that saving depends on income, not interest rates, investment plans reflect profit expectations, and internal funds provide the bulk of corporate capital expenditures. Summers’ conclusion that “a reduction in demand” caused growth rates to fall as well as real interest rates overlooked qualifying the nature of the shortfall as profitable demand. Recurrent bubbles in the financial markets characterized the consolidation of neoliberalism. The internet bubble anticipated the 2001 recession, and the subsequent slow recovery led to the Great Recession of 2007–2009 (Summers, 2014c, p. 40). Seccareccia and Lavoie challenged the legitimacy of the IS-LM model (2015), two years after Summers originally raised the prospect of secular stagnation. Their criticism went beyond the fact that nominal interest rates could not fall below the zero bound, to challenge the conceptual significance of Hick’s IS-LM model, as a model purporting to achieve general equilibrium involving full employment and the equality between saving and investment. Seccareccia and Lavoie devastating critique of the IS-LM framework first pointed out that John Hicks himself, in 1980, had retracted his 1937 IS-LM model version of Keynes’ views regarding the feasibility of achieving full employment equilibrium by means of monetary policy and interest rate adjustments (Hicks,

The neo-Keynesian retreat  229 1980). Then they drew attention to the fact that in the IS-LM model “we must presume that there are independent functions of investment and saving and, at the same time, independent demand and supply functions for money” despite strong empirical evidence pointing out that they are not independently established. As the Ruggles (Ruggles, N. and Ruggles, R.) made clear in their “Economic Constructs in the National Income Accounts” (1970, chapter 3, pp. 38–60) the mutual dependence of savings and investment is crucially at odds with the IS-LM model’s conceptual framework. The Ruggles went on to cite conclusive empirical evidence that the close relationship between household saving and housing mortgage liabilities was also found in the corporate sector between planned saving (retained earnings) and corporate investment spending. Along similar lines, Seccareccia and Lavoie pointed out that “the supply of money is not some exogenous variable that can be independently pitted against a distinct demand for money function…it must be treated as a purely endogenous variable” and Seccareccia and Lavoie concluded, “then what use is the IS-LM analysis that presumes exactly that independence?” In their view, the relevance of the model’s assumptions is questionable in a “world characterized by uncertainty, crisis, and institutional transformations that hardly bring the economy towards any kind of partial equilibrium, never mind ‘general’ equilibrium.” Post-Keynesian critics agree that the conventional IS-LM model is not adequate to explain the emergence of secular stagnation. Conflating personal and business savings, business and residential investment, in a model where loanable funds and the interest rate, rather than profit expectations and flexible bank credit, play key roles in the accumulation of capital, deprives Krugman’s, Bernanke’s, and Summers’ interpretations of the secular stagnation hypothesis of a sound basis to explain secular stagnation (Seccareccia and Lavoie, 2015). In Seccareccia’s view, Summers’ and Krugman’s explanation of secular stagnation reflects adherence to the “outmoded New Consensus model that seems to be keeping even some of the brightest in the profession stuck in an intellectual cul-de-sac” (Seccareccia, 2013), and, we may add, it fails to provide a dynamic analysis of the underlying forces causing prolonged periods of low growth. Other factors, recently cited by neo-Keynesians as contributing to the vanishing of ill-defined investment opportunities, include the rising weight of oligopoly and its impact on restraining growth. Among the factors precipitating the stagnation of effective demand in the modern version of neo-Keynesian economics, Larry Summers and Ben Bernanke insisted on the alleged growing gap between aggregate savings and insufficient investment. In Hick’s (neoclassical-synthesis) IS-LM model, this discrepancy means that near-zero interest rates will not necessarily bring about the desired full employment static equilibrium. As a result, the adjustments in the monetary sector will fail to match the real demand for investment finance at the full employment level: excessive savings or insufficient investment opportunities, a savings ‘glut’ or an investment ‘dearth’ will be the hallmark of secular stagnation. Considering the low savings of nearly half of the current households, as 43 percent of this population “would have to borrow or sell something” in order to cover a $400 emergency, the existence of an excess savings problem seems farfetched. Any excess savings would be on the part of the top income

230  The neo-Keynesian retreat households, providing evidence of a significant maldistribution of income (Federal Reserve, 2020). Finally, questioning the realism of general equilibrium models, Boianovsky’s study of Samuelson’s contribution to the specifications of the stability conditions in dynamic modelling included Tobin’s story of Schumpeter telling him about his “reproach to Samuelson’s empirical stability argument: ‘Who could claim that capitalism is stable?’” (Boianovsky, 2019, p. 21). In their 2015 report, Gomme, Ravikumar, and Rupert questioned the assumption that interest rates are “most relevant for capital investment decisions” and, instead, suggested that supporters of the secular stagnation hypothesis should consider “the returns on productive capital more relevant for capital investment decisions than the returns on government debt.” They ignored, however, the empirical evidence linking declining fixed capital accumulation to falling profitability trends, and without that evidence proceeded to deny their own test of secular stagnation (Gomme, Ravikumar, and Rupert, 2015). The empirical validation of the IS-LM inverse relationship between interest rates and the growth of corporate capital expenditures is certainly missing from Figure 9.1. Instead, we have the positive growth of nonfinancial capital expenditures as the effective federal funds rate rose from 1952 to 1984 and from there on interest rates and fixed capital investment falling in tandem through 2020. As we show in Figure 9.1 rising interest rates from 1954 to 1980 did not deter the rising growth trend of nonresidential investment or GDP growth. On the other hand, falling interest rates from 1981 to the present did not stimulate rising investment

25%

Nonresidential fixed capital investment growth rate 20%

Effective Federal Funds Rate

15% 10% 5% 0% -5% -10% -15% -20% 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 9.1  U.S. nonresidential fixed capital investment growth versus effective federal funds rate, based on the Economic Report of the President and Fixed Assets Table 4.7.

The neo-Keynesian retreat  231 or GDP growth rates either. Throughout the whole period, nominal gross business investment and GDP growth rates preceded the movement of interest rates, as monetary policy reflected rather than caused the direction of their changes. Contrary to conventional wisdom on monetary policy, fluctuations of the federal funds rate had little impact on corporate investment plans because corporations seek to avoid unnecessary dependence on external credit. Investment spending instead depends on current use of previously retained corporate profits, adjusted to meet the level of net fixed capital investment warranted according to the strength of profit expectations. Summers use of Hicks’ disputed IS-LM model merging Keynesian and neoclassical assumptions while disregarding the uncertainty factor begged the question of why actually falling interest rates did not block, let alone reverse, the decline in investment after the mid-1980s. Multiple surveys of business practices showed that fixed capital investment is highly insensitive to interest rate movements and thus exposed the IS-LM model to the charge of irrelevance, lacking empirical support. As far back as the 1940s, company studies showed that the size of retained corporate profits earmarked for investment spending hinged on profit expectations, not interest rates movements. L. Klein pointed out as far back as the late 1940s, that econometric and questionnaire investigations had always shown the influence of the interest rate on savings and business investment to be small or absent (Tinbergen, 1942; Klein, 1947, p. 111). More recent surveys of corporate practices confirmed that fixed investment planning is insensitive to interest rates movements and was normally financed out of internal funds in response to profitability expectations (Blanchard, Rhee, and Summers, 1993; Kothari, Lewellen, and Warner, 2014; Sharpe and Suarez, 2014; Lane and Rosewall, 2015). Summers’ observation regarding the absence of any mechanism capable of achieving a positive equilibrium real interest rate between aggregate savings and investment spending, denied the empirical relevance of the standard IS-LM model of mainstream macroeconomics without challenging its theoretical foundation. As an artificial synthesis of neoclassical and Keynesian economics, the model showed the path to full employment by reconciling saving decisions made by households and investment decisions made by firms. Its central assumption was that the interest elasticity of business investment is high and therefore interest rate policy is crucial. Since nominal interest rates cannot fall below the zero bound, the system cannot reach full employment equilibrium when the intersection between the saving and investment schedules happens to fall in negative space. In the absence of an effective mechanism to achieve negative real interest rates, Summers found secular stagnation to emerge as a result of the rising gap between aggregate savings and planned investment. Once nominal rates reached zero levels without achieving the desired effect of full employment equilibrium, monetary policy would become ineffective unless accelerated price inflation lowered real interest rates sufficiently (Summers, 2014a). Undoubtedly, interest rates are important factors in the demand for residential mortgages and consumers’ credit for durable consumption goods, but not for corporate business fixed capital investment. The idea of finding a real

232  The neo-Keynesian retreat interest rate “consistent with full employment” places an undue burden on interest rates. In our view, Bernanke’s version of the secular stagnation hypothesis is more realistic arguing that, since interest rate levels depend on profitability, the required low ‘equilibrium rate’ is itself a clear sign of low profit expectations, therefore: In a rapidly growing, dynamic economy, we would expect the equilibrium interest rate to be high, all else equal, reflecting the high prospective return on capital investments. In a slowly growing or recessionary economy, the equilibrium real rate is likely to be low, since investment opportunities are limited and relatively unprofitable. (Bernanke, March 30, 2015: Part 1) Defining the ‘equilibrium rate of interest’ as the real rate ‘consistent with full employment of labor and capital resources,’ Bernanke explained real interest rate movements occurred in response to corporate investment plans requiring external finance for their implementation. Those plans, however, are generally linked to the size of available internal funds, and drafting investment plans sufficiently large to achieve ‘full employment of labor and capital resources’ normally respond to equally high profit expectations. As a rule, depreciation allowances and retained earnings, gross corporate savings, suffice to cover planned investment. Bernanke argued that Summers’ view linking depressed profit expectations and the zero bound real rate of interest, was not consistent with his secular stagnation forecasts of a “permanent dearth of profitable investment projects.” For as long as profitable investment opportunities were available “anywhere in the world,” U.S. secular stagnation was not likely to become a reality (Bernanke, March 31, 2015: Part 2). Despite Bernanke’s skeptical argument about low profit expectations, Summers adopted Bernanke’s original ‘global saving glut’ diagnosis (Bernanke, 2005) claiming that the “essence of secular stagnation is a chronic excess of saving over investment.” In the U.S. economy, changes in the labor participation rate since the 1940s closely reflected those in the employment/population ratios. Such a linkage suggests that the extent to which unemployed people remained in the labor force and actively sought employment hinged on their perception of employment prospects as signaled by employment/population ratios. A rising level of sustained employment caused by high rates of capital accumulation will likely induce unemployed workers to reenter the labor force. High employment/population ratios are likely to inspire confidence in finding employment for displaced workers and cause the labor participation rate to rise. Falling employment/population ratios will have the opposite effect thereby stemming the growth of the effective labor force. Summers’ contribution Summers’ analytical approach added nothing new to Hansen’s proposed hypothesis. While ignoring Hansen’s warnings against focusing on interest rates as the chief

The neo-Keynesian retreat  233 drivers of effective demand growth, he failed to pursue Hansen’s (undeveloped) insight regarding the central role of prospective profitability in the accumulation of capital. Summers agreed with Hansen that productivity growth was high enough to cause sustained reductions in capital-good prices, especially information technology, and such development would lower investment spending without impairing industry’s capacity to renovate its plant and equipment: reduced investments could purchase superior types of capital goods at lower prices. Until recently, Summers did not share Hansen’s view that the growth of monopoly power had led to rising profit shares but lower investment spending, weakening effective demand growth (Summers, 2016). Summers’ concern that the growth of income inequality as a result of rising profit shares and wage stagnation in the last three decades contributed to strengthening the prospects for secular stagnation raised a valid issue but he left it unresolved. Summers feared the rising volume of dividends accruing to wealthy shareholders weakened aggregate demand growth since the propensity to save out of dividends exceeds that of workers out of wages. He agreed with Hansen that the decisive factor in weakening effective demand was the combined effect of falling relative prices of investment goods caused by the growth of labor productivity and the capital-saving bias of innovations lowering the capital intensity of production. Both effects would reduce business investment expenditures and create significant shortfalls in aggregate demand (Summers, 2014). In the U.S. economy, net corporate fixed investment is funded largely out of undistributed profits (net business savings) while depreciation allowances added to undistributed profits generally suffice to finance gross corporate investment. In Classical, post-Keynesian, and Marxian accounts of capital accumulation, business net savings or ‘retained earnings’ (the share of profits retained after taxes, net interest, and dividend payments) provides the chief source of investment finance. Rather than compound their systemic risks with onerous debt, corporate firms typically rely on their own internal funds to finance investment plans. As a source of funding for corporate investment, household savings are not quantitatively significant: they are intended for the most part to acquire residential mortgages. In their comprehensive study of capital formation in various sectors of the economy, Ruggles and Ruggles (1992) found that households and businesses are mindful of their budget constraint set by their available net income and rely primarily on their own savings to finance their appropriate capital spending. Neoclassical economic theory generally considers the determinants of capital formation as being independent of budget constraints (savings). The close empirical relationship observed, however, between gross retained income (savings) and gross capital formation in business as well as household sectors suggests that the mainstream assumption is false: Household sector data…indicate that, on balance over the past 40 years in the United States, household sector net lending and net borrowing have been relatively insignificant…For enterprises…there is a close interrelationship among such circumstances as the ability of an enterprise to find attractive

234  The neo-Keynesian retreat investment opportunities, its past and current record of profitability and its ability to finance its capital formation out of retained earnings. (Ruggles and Ruggles, 1992, p. 159) Post-Keynesian economists disavow the IS-LM model as a guide to the authentic Keynesian interpretation of the calculus behind the investment decision, on the ground that it contradicts Keynes’ view of the key role played by uncertainty in determining the marginal efficiency of investment. Thus, they claim that the loanable funds model is not theoretically sound, or empirically verifiable, but rather an untenable theory that Wicksell rejected in 1936. At that time, he was perfectly aware of the fact that bank lending does not depend on previously saved deposits, but rather banks create new ones: No matter what amount of money may be demanded from the banks that is the amount which they are in a position to lend (so long as the security of the borrower is adequate). The banks have merely to enter a figure in the borrower’s account to represent a credit granted or a deposit created. When a cheque is then drawn and subsequently presented to the banks, they credit the account of the owner of the cheque with a deposit of the appropriate amount (or reduce his debit by that amount). The ‘supply of money’ is thus furnished by the demand itself. (Wicksell, 1936, p. 110) From 1948 through 2008, the mean value of nonfinancial corporate net investment financed out of domestic corporate savings exceeded 90 percent. From the early 1980s to the present, ‘excessive business saving’ did not cause the falling long-run trend of the federal funds rate. The fluctuations of nonfinancial corporate savings/ capital stock ratios since the late 1940s up to 2008 did not only mirror those of the average profit rate but generally preceded those in accumulation before the 2008 Great Recession shattered profit expectations. Since the 1980s, with the only exception being the buoyant second half of the 1990s, retained earnings surpassed corporate needs for accumulation finance as the accumulation rate was so much lower than it was since the mid-1960s and 1970s. The gap between business saving and net business fixed capital investment rose from 2002 to 2005, and then again in the aftermath of the Great Recession, reaching its peak level in 2018, as corporations engaged in large buybacks of equity issues. Capital expenditures are historically linked to profit expectations, formed on the bases of yields derived from current and past investment, not lower interest rates. As Fazzari’s empirical work showed, (falling) interest rates by themselves will not reignite the corporate accumulation engine because they are not essential drivers of business capital expenditure decisions. According to Fazzari, “The evidence shows that interest rates and the cost of capital play a small and uncertain role in the determination of investment compared with the strength of firms’ financial condition and the growth of their sales” (Fazzari, 1993, p. 2).

The neo-Keynesian retreat  235 At any rate, following Larry Summers’ speech to the IMF late in 2013, the surge in popularity achieved by the secular stagnation hypothesis among mainstream economists did not lead to a consensus view of its chief characteristics or any agreement on the necessary policies to overcome it. Six years after the global Great Recession officially ended, discord prevailed among its proponents regarding policies to stimulate a sustained recovery. As Stephanie Lo and Kenneth Rogoff recently noted, awareness of the problems created by slow economic growth in “many advanced economies” has not led to a consensus on fundamental issues regarding its underlying causes: Theories include a secular deficiency in aggregate demand, slowing innovation, adverse demographics, lingering policy uncertainty, post-crisis political fractionalization, and some mix of all of the above. (Lo and Rogoff, 2014) Despite the wide range of claims cited by Lo and Rogoff purporting to explain why secular stagnation occurred, it is clear that they failed to improve on Hansen’s earlier formulation of its root causes. The central significance of business profitability, singled out by Hansen in 1939 as the chief driver of net investment, in our view is an essential factor to explain the declining trend of capital accumulation and effective demand. It remains, nevertheless, conspicuously absent from any of the major strands of mainstream secular stagnation theories. The neo-Keynesian and neo-Marxist affinities: Gillman and Steindl In the late 1940s, Lawrence Klein suggested that Marx’s theory of the falling rate of profit provided a better conceptual foundation to interpret the secular stagnation hypothesis than Alvin Hansen’s views on monopoly: From a historical point of view it is also fitting to use the theory which first tackled the problems related to the stagnation thesis. The Marxian theory of the falling rate of profit is one of the first, and probably one of the best tools for analyzing the stagnation theory. (Klein, 1947, p. 118) Klein’s view played no role in the subsequent revival of secular stagnation theories, despite the fact that a parallel view gained acceptance. The similarity between Hansen’s Keynesian approach and Gillman’s and Steindl’s neo-Marxist views of monopoly capitalism replacing competition and giving rise to stagnation are striking. We have argued that the revived versions of secular stagnation proposed by Summers, Bernanke, and Krugman in the 21st century failed to improve on Hansen’s view regarding technological progress and other exogenous factors causing stagnation in the late 1930s. The views on secular stagnation derived from the monopoly-based Marxist school are equally deficient. For Marx, fixed capital accumulation required more capital investment per unit of output throughout the

236  The neo-Keynesian retreat postwar period as well as in the 21st century. Final sales growth and effective demand fluctuations produced persistent inventory changes and capacity utilization cycles around the long-term profitability trend. But after adjusting for capacity utilization, the empirical evidence of a long-run net output/capital trend does not support the claim that the intensity of capitalist production declined due to capitalsaving technological progress. Within heterodox economics, leading post-Keynesian researchers found “it is possible to observe some convergence among the various heterodox branches of economics” (Lavoie, Rodriguez, and Seccareccia, 2004, p. 127) sharing with Classical/Marxian economists’ similar assumptions on the short-term dynamics linking profitability and effective demand. Thus, seeking to achieve a synthesis of Keynes, Harrod, and Marx as a foundation for the relation between short-term fluctuations and long-term trends, Shaikh acknowledged “A great virtue of Keynesian theory is that it emphasizes the regulation of accumulation by profitability” (Shaikh, 2009, pp. 457 and 477). Hansen and Steindl agreed that “Stagnation is defined by reference to capital accumulation” (Hansen, 1954, p. 410). Our own interpretation shares with Hansen’s 1954 view the importance of expected profitability but differs from his subsequent formulations of secular stagnation. After reviewing Steindl’s Maturity and Stagnation in American Capitalism (Steindl, 1976), and praising the book, Hansen focused on its important contribution to stagnation theory (Hansen, 1954). Hansen saw two separate theoretical traditions converging on the harmful effects of oligopoly on capital accumulation, one deriving from Marx and the other inspired by Keynes. Hansen’s concerns with the weakening of competitive forces and the spread of oligopolistic market structures featured prominently in his 1939 original formulation of the stagnation thesis and his reading of Maturity and Stagnation in American Capitalism strengthened Hansen’s views on oligopoly’s role in secular stagnation. The idea that the rise of oligopolistic capital characterized 20th-century capitalism was the single most powerful cause of secular stagnation linking neo-Keynesian theories of secular stagnation with neo- Marxist interpretations of historical trends. Gillman’s view of the impact of technical progress on investment demand did not differ substantially from Hansen’s and, accordingly, his empirical study of U.S. manufacturing failed to confirm the Classical/Marxian theory of falling profit rates, thus removing its support for the stagnation thesis. While agreeing that net investment growth drove the system’s growth, Gillman agreed with Hansen’s view that technical progress led to lower levels of investment spending per unit of output but higher labor productivity growth. His analysis focused on the impact of oligopoly on effective demand and concluded that, because labor-saving technological progress fostered labor productivity growth and lowered unit labor costs in all sectors, the relative price of capital goods declined and the necessary aggregate investment expenditures to achieve a given increase in capacity did not materialize. In addition, the relative prices of investment goods exhibited a tendency to fall, the capital intensity of production declined, and the mass of profits rose over time. Consequently, falling capital/output trends raised the average profit rate, but

The neo-Keynesian retreat  237 since firms could satisfy their requirements for capital replacement and expansion with lower gross capital expenditures, their capital accumulation rate decreased as well. While the conventional theory of secular stagnation assumed that aggregate ‘savings’ exceeded investment needs, in Gillman’s version the mass of profits increased but the rate of capital accumulation declined (Gillman, 1958, p. 126). Falling rates of capital accumulation, in turn, prevented the employment of those workers previously displaced by labor-saving technology. As a result, effective aggregate demand weakened on two counts: gross investment expenditures per unit of output fell because productivity growth lowered the price of capital goods as well as the capital/output ratio, and aggregate consumption demand declined because as unemployment rates rose aggregate wages declined (Gillman, 1958; Eichengreen, 2014). Steindl linked the decline of growth prospects in the U.S. economy to the industrial practices of a growing number of oligopolistic firms and argued that the transition from competitive to oligopolistic industry gained momentum at the turn of the 20th century bringing about profound changes in the system’s growth potential. In contrast with the pressures felt by competitive firms to cut prices and expand their market shares, oligopolies gained the power to raise their profit margins without fear of entry by outsiders. The maintenance of high profit margins depended on restraining oligopolistic output to prevent market prices from falling. On the other hand, oligopolies marshalled superior technology that led to productivity increases, but they also fostered excess capacity that led to stagnation rather than growth. Seeking to salvage Marx’s theory of falling average profitability from Gillman’s findings, Steindl argued that even though Gillman’s empirical evidence failed to confirm secular declines in profitability, it did not follow that Marx’s law of the falling rate of profits was theoretically unsound. Marx’s analysis assumed firms operated in an environment of free competition that bounded their innovation options. But as capitalism developed, oligopolistic markets replaced competitive ones. According to Steindl, Gillman had overlooked the fact already stressed by Hansen that oligopolistic firms enjoyed the power to control innovation activities. Unlike competitive businesses, oligopolistic firms were able to reject precisely those capital-intensive methods of production that yielded falling profit rates because they enjoyed market power and could select the most profitable from their technical options. Hence, aware of the dangers posed by capital-intensive innovations, oligopolies guided their technical choices in favor of lower rather than higher capital-intensive methods of production. Such behavior explained the secular decline in accumulation rates that led to secular stagnation (Steindl, 1976, p. 242). Steindl did not explain why reductions in investment-good prices would not make oligopolistic firms more capital-intensive rather than less. In fact, capital/output ratios are higher (output/capital ratios lower) in nonfinancial corporate industries than in the business sector as a whole. The simple reason is that the business sector includes smaller and less technically advanced non-corporate firms. Because higher rather than lower capital-intensity techniques lower unit costs and market prices, leading oligopolistic firms fight competitive battles to gain market share at the expense of laggards. Rather than weaken competition for market

238  The neo-Keynesian retreat shares, the scale and power of new technologies allow large corporations (‘oligopolies’) to engage in global competitive wars of unprecedented destructive power against their rivals. Having rejected the Classical theory of real competition proposed by Marx, Gillman’s and Steindl’s arguments failed to dissociate their theories of secular stagnation from Hansen’s. Their emphasis on monopoly deprived the dynamics of capitalist accumulation of any systemic tendencies. In their view, monopolistic firms chose their own path to higher profits and lower accumulation because competitive pressures did not regulate their behavior in any systemic way. Thus, the bifurcation between rising profits and falling accumulation created structural imbalances between rising business savings and dwindling investment opportunities that led to secular stagnation. This is the ‘Marxist’ version of Summers’ and Bernanke’s neo-Keynesian ‘savings glut,’ positing excessive profits but vanishing (profitable) investment opportunities as the cause of secular stagnation, exactly the opposite of Marx’s falling profitability driving the falling capital accumulation rate. In our view, the concept of inadequate investment opportunities clearly points to a dearth of profitable investment outlets, but for that to happen profitability must have fallen from a higher level. Alvin Hansen identified business profitability as the key argument in his 1939 secular stagnation hypothesis, and downplayed the importance of excessive savings and low interest rates as determinants of business investment. His failure to consistently pursue this line of inquiry laid the grounds for future versions of the secular stagnation hypothesis that totally excluded profitability as a key driver of investment and growth. In the 20th century, Vatter, Walker, and Alperovitz explained the “persistence of secular stagnation” as a “product of insufficient demand Profitability trends had nothing to do with it: The term is used here to mean a secular rate of total annual output growth that is below the rate which the economy is capable of in peacetime” (Vatter, Walker, and Alperovitz, 1995, p. 598). Four decades after Gillman formulated his conclusions on secular stagnation, Vatter, Walker, and Alperovitz extended their stagnation claims further from 1910 to 1929. They found that 1910 was a watershed in the development of U.S. capitalism, “the rate of total output growth over the last century reveals a surprising break in trend around 1910…The economy has never recovered secularly from the disastrous drop in the growth rate that occurred around 1910” (Vatter, Walker, and Alperovitz, 1995, p. 591). In their view, the growth rate of the labor force, as well as the total hours worked, declined substantially, but rising labor productivity outpaced the increase in wages and unit labor cost fell substantially. Consumer demand growth lagged behind capacity expansion, and lower aggregate investment needs expanded the effective demand gap. The dynamics of productivity and wage growth driving the system in the 1920s remained in place and gathered momentum throughout the 20th century. According to these writers, in contrast with the views of Classical economists, profitability trends were not the drivers of accumulation and effective demand. But according to Schumpeter’s encyclopedic study of business cycles, falling profitability in the 1920s weakened the incentive for capital accumulation. On the other hand, for Schumpeter:

The neo-Keynesian retreat  239 The historic tendency of profit rates to fall, obscured by the trends culminating in the 1929 depression requires carefully selected evidence. Impressions to the contrary result from the habit to concentrate attention only on corporations reporting profits or even, in some cases, on samples that contain the peak successes. (Schumpeter, 1946, p. 7) Studying the evolution of profitability in the 1920s, Duménil, Glick, and Rangel argued that the upturn in profitability of the late 1920s failed to restore the levels achieved in the first two decades of the 20th century (Duménil, Glick, and Rangel, 1987, p. 354). The stock market bubble of the late 1920s eventually triggered the Great Depression, just as financial bubbles in the 1990s ushered in the accumulation collapse of 2001 and stoked the financial euphoria that preceded the Great Recession. Thus, linking the analysis of the causes behind falling capital accumulation and speculative bubbles to low levels of profitability in the real sectors Duménil, Glick, and Rangel widened the scope of secular stagnation theory to include a theory of crisis. It is clear to us, as it was in Keynes’ conceptual transition from the Treatise on Money to the General Theory, that it is essential to uphold the centrality of profit expectations as the underlying motive of investment and, therefore, the chief component of effective demand. But…profits (or losses) having once come into existence become…a cause of what subsequently ensues; indeed, [are] the mainspring of change in the existing economic system. (Keynes, 1950, p. 140) Business enterprise will not seek to expand until after profits have begun to recover. (Keynes, 2010, p. 354; emphasis in original) In The General Theory, Keynes argued that because uncertainty clouded profitability expectations, current and past profitability trends would weigh heavily on the decision to invest (Keynes, 1977, p. 148). Kalecki highlighted the importance of current profits as a source of internal finance as well as the basis to shape anticipations of future yields: “The expected rate of profit may be assumed to be an increasing function of ‘real’ current profits” (Kalecki, 2009, pp. 102–103). Past experience of falling or low profitability trends undermines the incentive to invest and causes shortfalls in effective demand that lead to lower capacity utilization. Axel Leijonhufvud contended that Keynes accorded falling profitability a major role in the unraveling of growth prospects in Britain leading up to the 1930s slump, and in fact, Keynes believed it was the decisive factor behind the slump: The background to the Great Depression in Britain…was the declining trend in the return to investment since the end of World War I…The combination

240  The neo-Keynesian retreat of a declining marginal efficiency of capital and interest rates that did not decline (what) propelled the country into a recession that was deep. (Cited in Leijonhufvud, 2008, p. 1) Students of Marxian economics are thoroughly familiar with the idea that falling profitability reduced investment spending, and, as Sardoni noted, changes in effective demand in turn impact on profitability: For Marx, an increase in the demand for idle money, at the aggregate level, takes place when the capitalist class as a whole is induced to regard investment and production as not profitable. In this way, Marx linked the analysis of effective demand to the analysis of the fundamental factors underlying capitalist production and growth. (Sardoni, 2011, p. 42) Empirical evidence of secular trends Table 9.1 displays ten-year averages of U.S. real GDP growth rates as well as profit and accumulation rates in the business and nonfinancial corporate sectors of the U.S. economy, from 1950 to 2020. We interpret the average real GDP growth of 4.53 percent in 1960–1969 falling to 3.24 percent in the 1970–1979 period and then to 1.93 percent in 2000–2009 ending with 1.74 percent in 2010– 2020 as a manifestation of a falling growth trend or secular stagnation, and a reflection of the underlying dynamics in business profitability and capital accumulation rates. Our estimates of average profit rates for the business sector in Table 9.1 followed the same procedure as in NIPA Table 1.14 to calculate profit rates in the nonfinancial corporate sector. NIPA Table 1.14 shows the ‘net operating surplus’ Table 9.1 Ten-year averages in business and nonfinancial corporate profit and accumulation rates plus real GDP growth rates from 1950 to 2020, authors’ calculations. Business Business Sector Sector Accumulation Profit Rates Averages Averages

Nonfinancial Corporate Profit Rates Averages

Nonfinancial Corporate Accumulation Averages

Real GDP Growth Averages

1950–1959 1960–1969 1970–1979 1980–1989 1990–1999 2000–2009 2010–2020

12.42% 12.16% 10.28% 8.52% 8.56% 8.19% 8.65%

2.86% 3.77% 3.61% 3.02% 2.55% 2.14% 1.89%

11.71% 12.53% 9.82% 8.56% 8.90% 8.41% 8.74%

2.87% 3.64% 3.40% 2.67% 2.72% 2.15% 1.82%

4.24% 4.53% 3.24% 3.13% 3.23% 1.93% 1.74%

1949–1979 1980–2020

11.64% 8.48%

3.39% 2.39%

11.34% 8.66%

3.26% 2.33%

3.85% 2.49%

The neo-Keynesian retreat  241 data for the nonfinancial corporate sector calculated by subtracting from nonfinancial corporate net value added employee compensation plus taxes on production and imports less subsidies. Following that procedure, we estimated the net operating surplus in the business sector, defined as a gross measure of business profits inclusive of net interest payments after deducting from net value added in the business sector, Yt, the private sector employee compensation plus the imputed compensation of proprietors, minus taxes on production and imports for corporate and non-corporate businesses. We calculated the average profit rate for the business sector as a whole, rt, as the ratio of net operating surplus in financial and nonfinancial firms over the one-year lagged net fixed capital stock in the business sector, given the data compiled in the BEA Fixed Assets Tables.



Yt Wt Pt æ P öæ Y ö P w 1 Y W Y Yt Y t t rtb = t = t = = t = ç t ÷ç t ÷ = t K t -1 K t -1 K t -1 è Yt ø è K t -1 ø K t -1 K t -1 Yt Yt Yt

The gross profit rate in the business sector, rt, is equal to 1 minus the wage share, W K wt = t , divided by the capital/output ratio, t -1 . NIPA Table 1.14 also provides Yt Yt data for nonfinancial corporate savings, consisting of after-tax ‘undistributed profits,’ that is retained earnings after subtracting net interest and dividend payments from the net operating surplus. These are the funds available to purchase either net fixed capital assets or net new equity shares. Business net investment or capital expenditures are the mainstay behind labor productivity growth and refers to all ‘nonresidential’ expenditures on plant and equipment required to expand the capital stock, since the replacement of plant and equipment used is covered with depreciation funds. We exclude ‘households’ residential investment from our fixed business capital accumulation rate estimates. The procedure used to calculate the accumulation rate in the business sector, actb , shows a trajectory similar to the profit rate in that sector:

actb =

( GIt - Dt ) = K t -1

P It = s b t » s rtb K t -1 K t -1

Despite the decline in average profit rates experienced between the late 1950s and late 1960s, accumulation rates in both sectors, the business as a whole and the nonfinancial corporate sector alone, remained comparatively high through the mid1970s because profitability levels emerging from the Great Depression remained historically high. The overall profile since the late 1970s presents the classic features addressed in standard theories of secular stagnation, namely falling accumulation and real GDP growth trends that after each new recession fail to achieve strong recoveries.

242  The neo-Keynesian retreat In our calculations, average profitability between the period 1949–1979 and the period 1979–2020 fell by 23.7 percent in the U.S. nonfinancial corporate sector and 27.11 percent in the U.S. business sector as a whole. Reflecting that decline, average retained profits in the nonfinancial corporate sector between the two periods contracted by 26.57 percent. Accumulation rates in the same two periods declined by 28.68 percent and 41.8 percent in the nonfinancial corporate and business sectors, respectively. Reports of the “almost complete recovery in the rate of profits since 1980” remain somewhat premature (Bellofiore, 2014, p. 10). Gathering the main points on secular stagnation In this chapter, we deployed consistent evidence to support our claim that falling and low average profit rates exerted downward pressure on accumulation trends and, hence, were the main factors behind the emergence of secular stagnation, as the average real GDP growth rate between the two periods 1949–1979 and 1979– 2020 declined by 54.9 percent. Lower profitability trends throughout the system represent the unintended consequence of rising capital/output ratios, as leading corporations deployed capital-intensive technology to lower unit costs and reduce market prices in order to gain market share. In our view, capital-intensive, laborsaving technical change played the chief role in pushing down the long-run profitability trend, despite rising profit shares. Implementation of austerity regimes that reduced the wage share became increasingly ineffective as the labor share of value added diminished. Since net value added (net output) includes labor compensation and ‘property income,’ approaching zero wages would turn net value added into (maximum) profits. When the compression of wages reaches its maximum point, zero wages, net value added represents maximum profits. After reaching that critical point, the upper notional limit of the profit share, Ω/Y, would equal to 1, and the steadily rising fixed capital would control the movement of the actual average Pt profit rate, . K t -1 Ricardo and Marx clearly understood the central role of fixed capital investment in the dynamics of capital accumulation. In Ricardo’s long-run analysis, the declining fertility in marginal lands under cultivation increased the cost of corn and required subsistence nominal wages to rise and the profits share to fall lowering the profit rate. For Ricardo, capital using technical progress served to counteract declining labor productivity in marginal lands under cultivation, but despite improving labor productivity in agriculture due to lower labor employment, Ricardo feared that in the long run technical change would not prevent the effect of diminishing marginal land fertility from lowering the system’s profitability. Marx updated the Classical argument on the significance of fixed capital as a determinant of profitability trends in chapter 15 of Capital Volume 1. For Marx, mechanization and the growth of fixed capital expressed the progressive adaptation of the labor process to the goal of maximum feasible labor productivity. To that end, the rationalization of the labor process involved the scientifically planned separation

The neo-Keynesian retreat  243 of all intermediate steps in the production process, carried out by individual workers only responsible for each separate motion, in a seamless chain of centrally controlled discreet phases. The routinization of labor activities contributed to the growth of mechanization as the machine’s level of technical efficiency and flawless performance foreshadowed its replacement of real workers and their downgrading as imperfect machines. James Galbraith recently pointed out that the growth of fixed capital in the pursuit of higher efficiency, lower unit costs, and higher profitability underpinned the relentless mechanization process transforming the conditions of capitalist production: Typically, a more efficient system requires a larger investment in fixed costs: to get better you need to be bigger…In times of plenty and stability, natural selection and economic policies generally aim to increase fixed costs by accumulating capital through investment…Stability is important because it is possible to justify high fixed costs only if the system is expected to remain profitable, earning a surplus, for a long time. (Galbraith, 2014, p. 99) All growth theories postulating the existence, and not merely the possibility, of steady-state growth paths, neoclassical and heterodox, proceed from the assumption that in the long run capital/output ratios will remain constant. In Harrod’s and Solow’s growth models, the natural rate of growth, gn, sets the sustainable steadystate growth path of the system. Both posit a constant capital/output ratio and by implication a constant profit rate as characteristic features not only of their theoretical models but of capitalist development in the long run. Goodwin’s models of irregular but sustainable growth take such constancies for granted as well. While such models allow for local deviations from the steady-state growth path, they are set up to ensure its long-run persistence through the intervention of corrective attractors built into their structure. As Kaldor noted, without the stability of capital/ output ratios, the consequences included, a major breakdown in the process of investment and economic growth, such as occurred during the great depressions of the 1880s or the 1930s…For when rising capital/output ratios and falling profit rates cause the rate of investment to shrink at some critical speed (or below some critical level) the fall in income generated in the investment-goods industries will react unfavorably on the level of demand in the consumption-goods industries, causing a cumulative process of contraction in incomes, investment and employment. (Kaldor, 1980, p. 300) Indeed, in any of Goodwin’s models, allowing the capital/output ratio to rise steadily will eventually bring about the decline of the system’s general profit rate, even if profit shares keep steadily rising. As the rise in the profit share approaches its maximum limit of one, it ceases to exert any countervailing effect on the rising capital/output ratio. Since we assumed profitability to drive capital accumulation,

244  The neo-Keynesian retreat falling profit rates will have an impact on employment and output. Goodwin did not question the empirical foundation of his constant capital/output assumption applied to his models of capitalist dynamics. But as we show throughout this book, our findings challenge the canonical view of capitalist technical change being compatible with constant capital/output ratios and trendless profit rates. References Barro, R. 2022. “Understanding Recent US Inflation,” Project Syndicate, August 30, https:// www​.project​-syndicate​.org​/commentary​/us​-inflation​-fiscal​-policy​-likely​-culprit​-by​ -robert​-j​-barro​-2022​-08. Bellofiore, R. and Vertova, G. 2014. The Great Recession and the Contradictions of Contemporary Capitalism, Edward Elgar. Bernanke, B. 2005. “The Global Saving Glut and the U.S. Current Account Deficit,” The Federal Reserve Board, March 10, https://www​.federalreserve​.gov​/boarddocs​/speeches​ /2005​/200503102/. Bernanke, B. 2015. “Why Are Interest Rates So Low?,” Brookings Institute, March 30, March 31, April 1, and April 15, https://www​.brookings​.edu​/blog​/ben​-bernanke​/2015​/03​ /30​/why​-are​-interest​-rates​-so​-low/. Blanchard, O. and Johnson D. R. 2013. Macroeconomics, 6th edition, Pearson. Blanchard, O., Rhee, C. and Summers, L. 1993. “The Stock Market, Profit, and Investment,” The Quarterly Journal of Economics, Volume 108, No. 1, pp. 115–136, Oxford University Press. Boianovsky, M. 2019. “Paul Samuelson's Ways to Macroeconomic Dynamics,” Center for the History of Political Economy (CHOPE), Working Paper, No. 2019-08, pp. 1–47. Duménil, G., Glick, M. and Rangel, J. 1987. “The Rate of Profit in the United States,” Cambridge Journal of Economics, Oxford University Press, Volume 11, No 4, December, pp. 331–359. Eichengreen, B. 2014. “Secular Stagnation: A Review of the Issues,” Secular Stagnation: Facts, Causes and Cures, edited by C. Teulings and R. Baldwin, Centre for Economic Policy Research (CEPR): A VoxEU​.o​rg Book, https://cepr​.org​/voxeu​/columns​/secular​ -stagnation​-review​-issues. Eichengreen, B. 2015. Hall of Mirrors, Oxford University Press. Fazzari, S. 1993. “Investment and U.S. Fiscal Policy in the 1990s,” Working Paper No. 98, pp. 1–55 Levy Economics Institute of Bard College. Federal Reserve, 2020. “Dealing with Unexpected Expenses”, Report on the Economic Well-Being of U.S. Households in 2019, pp. 21–25. Galbraith, J. 2014. The End of Normal, Simon & Schuster. Gillman, J. 1958. The Falling Rate of Profit, Cameron Associates. Gomme, P., Ravikumar, B, and Rupert, P. 2015. “Secular Stagnation and Returns on Capital,” Economic Synopses, Federal Reserve Bank of St. Louis, No. 19, https:// research​.stlouisfed​.org​/publications​/economic​-synopses​/2015​/08​/18​/secular​-stagnation​ -and​-returns​-on​-capital. Gordon, D. 2010. “Putting the Horse (Back) Before the Cart: Disentangling the Macro Relationships between Investment and Saving,” Macroeconomic Policy after the Conservative Era, edited by G. Epstein and H. Gintis, Cambridge University Press. Hansen, A. 1939. “Economic Progress and Declining Population Growth,” American Economic Review, Volume 29, No 1, pp.1–19.

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246  The neo-Keynesian retreat /sir​- john​- and​- maynard​- would​- have​- rejected​- the​- is​- lm​- framework​- for​- conducting​ -macroeconomic​-analysis Shaikh, A. 2009. “Economic Policy in a Growth Context: A Classical Synthesis of Keynes and Harrod,” Metroeconomica, Volume 60, No. 3, pp. 455–494. Shaikh, A. 2011. “The First Great Depression of the 21st Century,” The Crisis this Time, Socialist Register, Volume 47, pp. 44–63. Sharpe, S. and Suarez, G. 2014. “The Insensitivity of Investment to Interest Rates: Evidence From a Survey of CFOs,” Finance and Economic Discussion Series, Federal Reserve Board, pp. 1–40. Steindl, J. 1976. Maturity and Stagnation in American Capitalism, Monthly Review Press. Summers, L. 2013a. Speech at the IMF Economic Forum, 14th Annual IMF Research Conference: Crises Yesterday and Today, Nov. 8: https://www​.facebook​.com​/notes​/ randy​-fellmy​/transcript​-of​-larry​-summers​-speech​-at​-the​-imf​-economic​-forum​-nov​-8​ -2013​/585630634864563. Summers, L. 2013b. “Why Stagnation Might Prove to be the New Normal,” Financial Times, London, December 15. Summers, L. 2014a. “Reflections on the ‘New Secular Stagnation Hypothesis’,” in Teulings, C. and Baldwin, R (eds.), Secular Stagnation: Facts, Causes and Cures, Centre for Economic Policy Research (CEPR): A VoxEU​.o​rg Book. Summers, L. 2014b. “Washington Must Not Settle for Secular Stagnation,” Financial Times, London, January 5. Summers, L. 2014c. “Low Equilibrium Real Rates, Financial Crisis, and Secular Stagnation, Across The Great Divide,” New Perspective on the Financial Crisis, Martin N. Baily and John B. Taylor (ed), Hoover Institution Press. Summers, L. 2015a. “Demand side secular stagnation,” American Economic Review: Papers & Proceedings, Volume 105, No. 5, pp. 60–65. Summers, L. 2015b. My views and the Fed’s views on secular stagnation: http://larrysummers​ .com​/2015​/12​/22​/my​-views​-and​-the​-feds​-views​-on​-secular​-stagnation/ Summers, L. 2016. “Corporate Profits are Near Record Highs. Here’s why that’s a Problem,” Washington Post, March 30. Summers, L. 2016. “Crises in Economic Thought, Secular Stagnation, and Future Economic Research,” NBER, Macroeconomics Annual 2016, Volume 31, Issue 1, pp. 557–577, University of Chicago Press. Tinbergen, J. 1942. “Critical Remarks on Some Business-Cycle Theories,” Econometrica, Volume 10, No. 2, pp. 129–146. Vatter, H., Walker, J., Alperovitz, G. 1995. “The Onset and Persistence of Secular Stagnation in the U.S. Economy: 1910–1990,” Journal of Economic Issues, Volume 29, No. 2, pp. 591–600. Wicksell, K. 1936/1989. Interest and Prices: A Study of the Causes Regulating the Value of Money,. Macmillan & Co.

10 The Classical advance Schumpeter and Grossman

The Classical theory of growth linked the formation of effective demand to the pursuit of profits, the rate of investment to business saving, and employment and wage growth to capital accumulation. It allowed for recurrent phases of growth and stagnation driven by the cyclical dynamics of profitability. In Classical Political Economy, Ricardo, McCulloch, Mill, and Marx highlighted the power of profits to spur capital accumulation (Lowe, 1954; Baumol, 1970; Foley and Michl, 2010) and the evolution of profitability was the decisive force behind capitalism’s expansion and crisis. When realized profits matched expectations, after successfully completing each phase of the capital circuit, the portion of profits allocated to fund new investment was the starting point for a new round of the capital circuit. The new investment expenditures on means of production and labor at the start of that capital circuit provided the funds behind effective demand and supply levels. The scale of the capital circuit depended on the expected profitability that motivated the initial capital spending. In David Ricardo and John Stuart Mill’s analysis of the forces compelling the expansion of the industrial capital circuit, meeting the food needs of a growing labor force employed in industrial activities ran up against the declining fertility of marginal strips of agricultural land. The growing scarcity of fertile land increased the necessary labor time per unit of output and hence raised food costs and prices. Given the working day, additional labor time employed in the production of the workers’ consumption needs (the real wage) would reduce the time allotted to the production of the surplus product accruing to the capitalist farmer. Since wages hovered around the subsistence level, in order to prevent falling consumption to impair the reproduction of the labor force, nominal wages would have to rise, profit margins would be reduced, and the profit rate would fall. As falling profitability sapped the urge to accumulate capital, effective demand fell and growth rates declined. Had the term secular stagnation been in vogue with Ricardo and Mill, it would describe the transition phase from high to low growth before capitalist development reached the stationary state (Durand and Lege, 2013). Unless technical change counteracted the impact of diminishing returns in marginal lands, Classical economists feared that in the long run falling profitability would weaken the lure of accumulation. With rising food costs compressing the surplus that funded accumulation, both the incentive and the wherewithal to sustainable capital accumulation declined and, instead, the stationary state loomed as an unavoidable DOI:  10.4324/9781003413806-10

248  The Classical advance destination. At that distant point, capitalist development entered its terminal phase (Ricardo, 1981, p. 120; Mill, 1987, p. 731). In Ricardo, Mill, and Marx the evolution of profitability regulated short-run as well as secular trends of capital accumulation. Sectoral changes in capital flows reflected short-term profitability differentials responding to changes in the structure of effective demand. Ricardo thought that changes in short-term effective demand would cause profitability differentials and these, in turn, would direct inter-industry investment flows from low to higher profitability sectors, without ever reaching complete profit rate equalization, a change in fashion should increase the demand for silks and lessen that for woolens…the profits of the silk manufacturer would be above, whilst those of the woolen manufacturer would be below, the general and adjusted rate of profits. Not only profits, but the wages of the workmen would be affected in these employments. This increased demand for silks would however soon be supplied, by the transference of capital and labour from the woolen to the silk manufacturer. (Ricardo, 1981, pp. 90–91) For Mill and Marx, capitalist development encountered periods of marked turbulence caused by structural limitations to the expansion of production, the realization of profits, and their reinvestment. For Mill, falling profitability reflected the dynamics of capital growth, the triumph over scarcity. For Classical economists, technical change played a central role in raising labor productivity, profits, and the demand for labor which, in turn, expanded markets. But different views of technical progress’ impact on employment and profitability divided Adam Smith and McCulloch from Ricardo and Marx. Since “The average rate of profit is the real barometer-the true and infallible criterion of national prosperity” (McCulloch, 1870, p. 63), McCulloch was satisfied that “no introduction of machines having a tendency to lower the price and to increase the supply of commodities can possibly diminish the demand for labour, or reduce the rate of wages” (McCulloch, 1870, p. 100). Ricardo agreed that technical change “improvements in machinery connected with the production of necessaries” would temporarily counter diminishing returns in agriculture, lowering the cost of wage goods and postponing the arrival of the stationary state. In the end, however, these technical advances would fail to reverse the central tendency of profit rates to fall and the stationary state to arrive, “Long, indeed, before this period, the very low rate of profits will have arrested all accumulation” (Ricardo, 1981, p. 120). Schumpeter’s Classical roots Schumpeter’s view of capital accumulation was decidedly Classical as he held that the “bulk of accumulation came from profits and hence presupposes profits.” Success in business required preventing lesser competitors from crowding in the markets where capital-intensive techniques allowed the formation of temporary

The Classical advance  249 monopolies. He explicitly criticized economists who thought “new technological processes tend to require less fixed capital…than they used to in the past,” arguing instead that the “statistical evidence up to 1929…point the other way” (Schumpeter, 2017, p. 119). Despite his profound attachment to the values and practices of his idealized capitalist culture, he credited Marx with anticipating the Keynesian-inspired theory of secular stagnation, which he defined as “a stage of permanent crisis, temporarily interrupted by feeble upswings or by favorable chance occurrences” whose content could be summarized as “the theory of vanishing investment opportunities” (Schumpeter, 2008, p. 112). While criticizing Marx’s argument as to why it would happen, Schumpeter did not fail to acknowledge that Marx was right in foreseeing the eventual breakdown of capital accumulation. Similarly, Schumpeter also argued that Keynesian-inspired forecasts of coming secular stagnations were timely and correct but their theoretical foundations were wrong (ibid., p. 112). In Schumpeter’s view, the most challenging aspect of entrepreneurial decision making to overcome was the uncertainty attached to investment planning unless “exceptionally favorable conditions” coalesced in support of high profit expectations due to exceptional price, quality, or economies of scale advantages. In their absence, business enterprise typically languished in activities yielding profits low enough to question the rationale for the original investment and frequently enough allowed “a large section of the capitalist world to work for nothing…in the midst of the prosperous twenties just about half of the business corporations in the United States were run at a loss, at zero profits” (ibid., pp. 89–90). Schumpeter credited Marx for understanding that the recurring periods of crises were not simply the result of accidental shocks external to the process of accumulation, but rather the result of the system’s turbulent dynamics involving the unintended consequences of technical change and creative destruction. He agreed with Marx on the cyclical path of business profitability, but in the 1930s he linked the extended state of stagnation, a protracted state of simple reproduction, to the loss of monopoly profits and the disappearance of the innovators’ initial market advantage once imitators drove prices down. Schumpeter also associated the capitalist ethos with such success in the control of nature, production organization, and technological change that society found it more desirable to promote the expansion of science than to nurture the strong entrepreneurial personality that made it remarkably immune to the fear of risk. He found disturbing the growing weight of expert teams exerting their influence to program all aspects of decision making in capitalist economies as well as rationalizing all aspects of business administration, including product and process innovations. The advance of science, development of systems analysis, and the growing prominence of technocrats, managers, and engineers replaced the role of gifted entrepreneurs and made their creative talents obsolete. For Schumpeter, entrepreneurs, gifted with unique characteristics, built up the capitalist ethos, and spread its creative spirit throughout society having first gained social acceptance for their notion of progress as a process of creative destruction. Unfortunately, capitalist society prospered but grew complacent. Rich and mature, capitalist society increasingly searched for ways to promote creative growth without the pain of destruction, to

250  The Classical advance move forward without facing the threat of collapse. In the course of time, the idea of socialism loomed large at the end of this peaceful transition from the entrepreneurial culture that promoted ‘creative destruction’ to the mediocre certainties of centralized planning. Instead of seeking monopoly profits under socialism, profits would disappear and the managers in charge would receive salaries like all others: If capitalist evolution—either ceases or becomes completely automatic, the economic basis of the industrial bourgeoisie will be reduced eventually to wages…Since capitalist enterprise…tends to automatize progress, we conclude that it tends to make itself superfluous. The perfectly bureaucratized giant industrial unit not only ousts the small or medium-sized firm and ‘expropriates’ its owners, but in the end it also ousts the entrepreneur and expropriates the bourgeoisie as a class. (Schumpeter, 2008, p. 134) Schumpeter on profitability in the early 20th century Schumpeter’s entrepreneurs generated cyclical waves of expanding profits and employment when they introduced innovative forms of technical progress or consumer products that replaced older ones by virtue of their superior power to lower unit costs or deliver higher quality at the going price. After reaching a crest these rising waves would collapse when imitators crowded the market and depressed prices. His vision did not recognize any reason for a conflict of interest between visionary entrepreneurs and compliant workers. With the development of capitalist production, progressive economists like Desai, Goodwin, and Schumpeter shared the conviction that ruling entrepreneurs, and the workers they employed, would learn to recognize the necessity of peaceful coexistence. They would also recognize the benefits of a symbiotic relationship between their class interests, and this awareness ensured the long-run viability of capitalism. For a balanced appreciation of Desai’s, Goodwin’s, and Schumpeter’s grasp of their ability to appreciate the nature of neoliberalism, their failed judgments are as essential as their insights, because they throw light on the limits of their analytical approach. From the vantage point of 21st-century neoliberalism, it is clear, of course, that Schumpeter was utterly mistaken to believe that the dynamics of capitalist accumulation would usher in any form of socialism. His prognosis to that effect fared no better than Keynes’ speculative projection of the “euthanasia of the rentier” opening the way for “the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital” (Keynes, 1977, p. 376). As Heilbroner pointed out, summarizing various aspects of Marx’s work, “one can validly claim that Marx’s analysis points with overwhelming likelihood, although not absolute certainty, toward a climactic failure of the system. But the aftermath of that failure need not be socialism” (Heilbroner, 1987). In his 1939 edition of Business Cycles, Schumpeter noted that the fluctuations of the New York commercial paper in 40 years, from 1875 to 1914, appeared to be trendless. He used this fact ‘in passim’ to dismiss the “theory or fact to justify belief in any tendency in the recurrent waves of profit” and, therefore, to reject

The Classical advance  251 “the so-called Law of the Declining Rate of Interest or, as the classics said, Profits” (Schumpeter, 2017, p. 628). Despite Schumpeter’s hasty dismissal of the Classical law, upheld by Adam Smith, David Ricardo, Karl Marx, and Maynard Keynes, Joseph Schumpeter conceded that “contrary to a prevalent impression 1925 (or 1926) was the most profitable year, though of course, overshadowed by 1919.” In the pre-depression years of 1916–1917, contemporary empirical studies carried out by distinguished academic figures (he mentioned one Professor Crum) reported that, between 1919 and 1928, “a considerable share of the total gross corporate business is done at a loss” (ibid., p. 833). Schumpeter concluded that, generally, “about 50 percent of the corporations in the country lose money,” a striking number that in his view “expresses a very important truth” (ibid., p. 834). In 1942, Schumpeter repeated the dismal statistics concerning large numbers of profitless corporations present in the pre-depression decade in order to emphasize the uncertainty surrounding all entrepreneurial decisions. In addition, elusive visions of profitability could only succeed under “exceptionally favorable situations…by price, quality and quantity manipulation,” even if they were able “to produce profits far above what is necessary in order to induce the corresponding investments.” As Schumpeter pointed out, successful innovations were baits that lure capital to untried trails…Their presence explains in part how it is possible for a large section of the capitalist world to work for nothing: in the midst of the prosperous twenties just about half of the business corporations in the United States were run at a loss, at zero profits. (Schumpeter, 2008, p. 90) By 1946, the weight of accumulated experience forced Schumpeter to reconsider his blanket rejection of the Classical law concerning the tendency of profit rates to fall and to argue that “it should not surprise anyone” that it was necessary to acknowledge “The tendency of profit rates to fall” as the driving force leading to the “events of 1928 and 1929” (Schumpeter, 1946, p. 7). Evidence of falling profitability before the Great Depression We have confirmed Schumpeter’s casual interpretation of falling profitability before the onset of the Great Depression in the 1930s. As we showed in Chapter 3, Figure 3.1, after emerging from the 1930s Depression in the early 1940s, at various times up to 1965 in the postwar ‘glorious’ recovery made possible by the postwar capital-labor accord, business sector profitability reached levels comparable to the best years of the 1920s. Once again, as it happened between 1901 and 1929, in the decades between 1947 and 1982 the tendency for the rate of profit to fall resurfaced, and the profit rate in that interval fell by 47 percent. In Figure 3.1, we showed that after reaching a trough in 1982, the recovery phase underwent three (approximately) decennial cycles, each of which reached a trough lower than its predecessor, while now, the current post–Great Recession cyclical downturn is not yet completed.

252  The Classical advance Extending the time series to the beginning of the 20th century presented serious challenges in reconciling theory and historical facts. The BEA provides comprehensive data tables for new value added in the business sector from 1929 to the present, as well as estimates for private nonresidential fixed assets (the business sector) from 1925 to 2021. It also publishes data tables for full time (equivalent) employee compensation in the private sector as well as the total number of full-time (equivalent) employees and the number of proprietors (self-employed). We calculated the average income of self-employed workers assuming that it was comparable to the average income of business sector employees. Figure 3.1 also provided evidence of the striking parallelism between profitability and fixed capital accumulation trends. While that parallelism is more immediately noticeable in the postwar years due to the availability of more reliable data from the Bureau of Economic Analysis (BEA), the evident co-movement in the two decades before the Great Depression, despite the lower degree of reliability of the sources used, lends support to the longrun relationship between profitability and the accumulation paths. We relied partially on the data provided by Gerard Duménil and Dominique Levy in their pioneering study of U.S. profitability (http://www​.cepremap​.fr​/membres​/dlevy​/biblioa​.htm) to construct our profitability time series between 1901 and 1929. Their data allowed us to extend our calculations of profitability and accumulation paths in the U.S. back to the opening of the 20th century and forward to the latest available data for 2020. In order to splice both sets of data we linked up the Duménil and Levy time series covering the period 1901–1925, with the BEA’s tables for the business sector from 1925 on, mindful of the fact that the weight of government activities in national income determination from the turn of the century through the 1920s was negligible. That fact allowed us to use their wages and capital stocks estimates from their 2013 comprehensive version for our own calculations, but we found in Klein and Kosobud’s authoritative findings of Net Product in their Table 3 estimates from 1900 to 1925 better suited to our purposes (Klein and Kosobud, 1961). We constructed our fixed capital accumulation rate from 1901 to the present seeking the best fit between Duménil and Levy’s version (2013) of their fixed assets estimates for the period not covered by the BEA between 1901 and 1925 and the BEA’s nonresidential investment estimates supplied in its most recent publication. As Schumpeter’s student at Harvard University, Robert Heilbroner understood that capitalism’s growth or stagnation depended on expected profitability and the accumulation of profits. He agreed that the pursuit of profits set off the dynamics of capitalist development and that the system’s potential growth depended on the rate at which the capital circuits expanded. Profit growth regulated both the system’s effective demand and effective supply changes, the fundamental force that drives the system through history is its search for profit…the trajectory of capitalism is immediately recognizable as a movement guided by the imperious need for profit—indeed, as a movement incomprehensible without an awareness of this central element of its nature. (Heilbroner, 1986a, p. 142)

The Classical advance  253 The breakdown of capitalist accumulation A close reading of Joseph Schumpeter’s and Henryk Grossman’s major works shows that despite Schumpeter’s rejection and Grossman’s acceptance of Marx’s theory of value and capital accumulation, their views converged on the direction of change brought about by capitalist dynamics. Specifically, they shared a common perspective on the impact of technical progress on profitability, and the breakdown tendencies of capital accumulation (Schumpeter, 2008; Grossman, 2021; Grossman, 2010). Grossman’s 1941 review of Schumpeter’s book Business Cycles: A Theoretical, Historical and Statistical Analysis of the Capitalist Process acknowledged its value as “an inexhaustible source of information on the economic facts and theories relevant to business cycles, and as such is a meritorious work” (Grossman, 2017, p. 534). But Grossman concluded that Schumpeter remembers…more of Mill’s and Marx’s explanations of the cycle that he would care to admit, that capitalist production is not for use but for profit. When profitability disappears, the capitalist mechanism of production and capital accumulation, come to a standstill, and can be revivified only by a rearrangement of technical and organizational bases. The theory is not made any more original when the name of ‘innovations’ is assigned to what Mill and Marx called countertendencies. (ibid., p. 542) Schumpeter did not reciprocate the attention received and only once described Grossman as “chiefly a Marxist scholar” author of Das Akkumulations und Zusammenbruchsgesets without commenting on the significance of his work (Schumpeter, 1986, p. 881). On the other hand, Schumpeter was keen to set the points of convergence and separation between his own and Marx’s theories of capitalism’s breakdown tendencies, Marx was wrong in his diagnosis of the manner in which capitalist society would breakdown; he was not wrong in the prediction that it would breakdown. The Stagnationists are wrong in the diagnosis of the reasons why the capitalist process should stagnate; they may still turn out to be right in their prognosis that it will stagnate. (Schumpeter, 2008, pp. 424–425) Otto Bauer’s balanced growth model In her Die Akkumulation des Kapitals book, Rosa Luxemburg (2003) sought to answer a question that she feared remained unsolved in Marx’s own schema of expanded reproduction as presented in Capital, Volume 2. Her concern was that while Marx had formulated the

254  The Classical advance conditions…without which there can be no accumulation. There may even be a desire to accumulate, yet the desire plus the technical prerequisites is not enough in a capitalist economy…the effective demand for commodities must also increase…Where is this continually increasing demand to come from? (Luxemburg, 2003, p. 104) For Luxemburg, capital accumulation required a systemic source of effective demand, and such source was missing in Marx’s schema. For Luxemburg, Marx’s conflation of the conditions necessary for capitalist expanded reproduction with their automatic implementation, created the sense that the system’s growth had no limits. Concluding, on the other hand, that the growth of effective demand could not be sustained from within the capitalist system itself, Luxemburg argued that non-capitalist markets provided the missing source exerting the necessary pull on effective demand. In the advanced stages of capitalist accumulation, however, as non-capitalist economic centers diminished and the forces underpinning the growth of final effective demand weakened, Luxemburg argued that capital accumulation would slow down and would eventually reach the breakdown point. In his “Accumulation of Capital” article, Otto Bauer (Bauer, 1978, 1986) sought to answer the analytical questions posed by Rosa Luxemburg as criticism of Marx’s schemes of extended reproduction. Luxemburg had dismissed those schemes as an “arithmetic” exercise merely intended to show “the conditions…without which there can be no accumulation” but failing to identify where in reality was “this continually increasing demand to come from” (Luxemburg, 2003, p. 104) to sustain growth. Arguing that Marx’s reproduction schemes did not pinpoint a valid source for the growth of final demand, she concluded that they were incapable of shedding light on the actual dynamics of capitalist development. In her view, moreover, the composition of the schemes appeared to suggest that capitalist growth faced no breakdown tendencies: “this diagram can be indefinitely extended, it follows that capitalist accumulation can also proceed ad infinitum,” but this is nothing other than an “arithmetical exercise on paper” (ibid., p. 294). Bauer’s own contribution purported to meet head-on Luxemburg’s objections, showing that the prime mover of the growth engine derived from the rising organic composition of capital. In the pursuit of higher profits, capitalists would promote the deployment of capitalintensive techniques that raised the productivity of labor and lowered total unit costs. In Bauer’s numerical model, despite a steadily falling profit rate, the constant fixed capital grew at a steady 10 percent rate per period while variable capital (wages) increased by only 5 percent per period, hence the organic composition of capital, Ω, rose without limit, providing the source for the growing effective demand that sustained capital accumulation. The rate of surplus value, on the other hand, remained constant at 100 percent (St = Vt). According to King, Bauer’s growth model (Bauer, 1986) “presents a sophisticated two-sector Marxian growth model which, by including an increasing organic composition of capital, goes significantly further than Marx’s own treatment” (Bauer, 1986, p. 87, Translator’s introduction). In his model, Bauer proceeded to work out the necessary exchange proportions required between Marx’s

The Classical advance  255 two departments to achieve the balanced expansion of the system. Bauer went beyond Marx in two respects, first adding technical change and a rising organic composition of capital, and second, exploring the conditions necessary to reach the system’s ‘equilibrium’ growth path while maintaining full employment. Contrary to Marx’s assumption of constant technique in his expanded reproduction models, Bauer’s growth scheme assumed that technical progress raised the organic composition of capital (rising capital-labor ratio) but he kept the rate of surplus value constant, and inadvertently set the grounds for the collapse of accumulation beyond a certain point of the expansion due to insufficient surplus value. While Bauer’s introduction of Marxian technical change into his reproduction schemes added a realistic feature to the growth process (bringing the analysis of capitalist growth to a more concrete level), Grossman showed that these two conditions proved disastrous to Bauer’s aim of showing the viability of unlimited growth. Orzech and Groll have pointed out that after the introduction of capital-intensive, labor-displacing technological change, along with a constant rate of surplus value, Bauer’s schemes of expanded reproduction could not remain in their original long-term balanced growth path: The necessary and sufficient condition for balanced, sustained economic growth in a one-sector as well as a two sector economy is the same in both models: equality between the rate of investment and the rate of population growth. (Orzech and Groll, 1983, p. 546) Bauer acknowledged that the central issue in modeling sustainable paths of capitalist development was capital’s inner drive to grow faster than the employed labor power and thus its tendency to press against the limits of surplus value growth, since the slower growth of labor power limited the extraction of surplus value. Formulating equilibrium growth paths should lay bare the adjustments necessary to show how “the accumulation of capital must take place in order that it may remain in equilibrium with population growth.” But he overlooked the unsustainable growth path emerging from a rising organic composition of capital along with a constant rate of surplus value. It appears, moreover, that Bauer discarded the possibility of a rising rate of surplus value (increasing profit share in net value added) on grounds that it would create a crisis of under-accumulation. Anticipating Goodwin’s growth cycles, Bauer outlined the emergence of fluctuations in his reproduction schemes, based on the notion that since “the capacity to consume of capitalist society falls further and further behind the boundlessly developing forces of production” the balanced growth between Marx’s two sectors would unravel, giving rise to persistent cycles. Under-consumption would cause the profit rate on capital to decline, hence weakening both the incentive and the means of sustaining the system’s expansion. Bauer defined the “social rate of accumulation” as the ratio between the accumulated part of surplus value and the total product, including wages plus surplus value. If the rate of accumulation fell below the population growth rate and, consequently, the outlays of variable capital were

256  The Classical advance insufficient to employ the available labor force, under-accumulation would bring about the rise of ‘the industrial reserve army.’ As unemployed workers bid down wages, employment and the rate of surplus value would rise, and the wage share decline. With the new higher rate of surplus value, the initially insufficient rate of accumulation would increase the portion of accumulated surplus value, thus providing additional variable capital to expand employment, and additional workers hired at lower wage rates. After the industrial reserve army disappeared, the growth rate of capital accumulation would necessarily fall in line with the population growth rate. Bauer concluded: Thus the capitalist mode of production contains within itself the mechanism which, when accumulation lags behind population growth, adjusts it to population growth once more. (Orzech and Groll, 1983) Bauer’s grand vision of capitalist dynamics acknowledged the fact that indeed no mechanism existed to sustain the equality between the growth rate of capital and population without systemic readjustments of wage and profit shares. While admitting possible cyclical deviations from the equilibrium growth path due to the anarchy of capitalist production, Bauer posited full employment growth as a possible but not necessary condition of capital accumulation. Stages of over-accumulation would be followed by periods of under-accumulation, giving rise to growth cycles and phases of “prosperity, crisis and depression.” Accumulation would follow countercyclical trends relative to employment: rising when the reserve army of labor increased, and falling when its growth rate exceeded that of the population and labor unemployment declined. Grossman and secular stagnation Until recently, most students of Classical/Marxian Political Economy, with the exception of Paul Mattick, thoroughly rejected Grossman’s interpretation of Marx’s analysis of capitalist production as well as his formulation of the breakdown theory of accumulation. But even Mattick’s interpretation of Grossman’s theoretical model distanced itself from its empirical underpinnings (Mattick, 1981). For unquestionably Grossman expected empirical validation of his breakdown tendency, and Mattick saw no need for it. Perhaps only now that, after Rick Kuhn’s persistent efforts, or “Grossmaniac endeavors,” Grossman’s research papers are available, we can look forward to a more balanced assessment of his work. In a letter dated June 17, 1933 from Paris, Grossman asked Mattick for information on “the results of the latest American census concerning the accumulation of capital per worker” adding that it would be important to establish (from the volume on ‘Manufactures’) the number of workers, total capital, capital per worker. I am convinced that a prodigious per capita increase has taken place…Capital that is superfluous

The Classical advance  257 and does not find sufficient outlets…will flow to the banks and from there, further to the stock exchange…if I am to present reality then the organic composition must also reflect reality. In Bauer’s schema it is 2:1. I believe that in most advanced industries the relationship is 10:1 or even 12:1. That is capital invested per worker is 10 or 12 times greater than the worker’s annual wage. (Grossman, 2018, p. 250) Grossman’s 1929 book Das Akkumulations—und Zusammenbruchsgesets des kapitalistischen Systems, Zugleich eine Krisentheorie sought to link up the emergence of the accumulation crisis with the structural changes brought about by capitalintensive technical change and the growing decline of (living) labor employed relative to the growing mass of machinery and buildings, materialized ‘dead labor.’ Following Marx, Grossman was keen to work out the consequences of introducing capitalist technical change (automation) into Marx’s schemes of expanded reproduction. Grossman wished to derive the “vast implications for the long-run dynamics of Marx’s schema, in so far as the displacement of living labor narrows the base from which surplus value and profit are derived” (Heilbroner, 1987). The rising capital stock/net value added ratio (‘organic composition’), reflecting the increasing capitalization of production characteristic of the advanced stages of capitalist development, including the neoliberal phase, generates the growing discrepancy between the mass of surplus value necessary to sustain the growth rate of the (bloated) capital stock (due to accumulation) and the shrinking source of that surplus value. At some critical point, the mass of surplus value extracted will fail to reach the magnitude necessary to sustain the previous rate of accumulation. At that point, the system’s expanded reproduction will slow down before reaching the crisis stage. As Howard and King pointed out, Grossman’s book elicited successive waves of criticism from the leading economists of German social democracy. The negative appraisals included Sweezy’s comments in his celebrated treatise, The Theory of Capitalist Development (1970, pp. 209–213), effectively sealing its fate. As Kenneth Lapides noted (Lapides, 1994), to this day, critics characterized Grossman’s theory of breakdown as a “mechanistic” extension of the unrealistic trends set up in Otto Bauer’s schemes of expanded reproduction. Howard and King questioned Grossman’s strategy in following Bauer’s assumptions, The analytical weaknesses of Grossmann’s work were mercilessly exposed in the reviews of his book, only one of which (Tazerout, 1930) was at all favorable. Critic after critic objected that Otto Bauer's initial assumptions were too rigid realistically to model an actual capitalist economy. Why, firstly, should constant capital grow continuously at 10, and variable capital at 5% per period, irrespective of the effects of this on the viability of the system? The organic composition of capital is not given by technology, but depends upon the profitability of investment decisions. Faced with the consequences of continuing as Grossman would have them do, capitalists would

258  The Classical advance adapt their behavior to avoid ruination, slowing the overall pace of accumulation and reducing the rate of increase of the organic composition. (Howard and King, 1988, pp. 290–309) Grossman’s modeling strategy Grossman repeatedly pointed out that Bauer’s numerical model was an absurd representation of capitalist dynamics. In a letter to Paul Mattick dated June 21, 1931 (Aufsatze zur Krisentheorie, Frankfurt: Verlag Neue Kritik, 1971), he unequivocally expressed his rejection of Bauer’s assumptions, noting that, I would not like to create the impression that I derive the tendency to collapse from Bauer’s schema. I emphasized in the book that Bauer’s schema is unrealistic…Bauer makes unrealistic, false assumptions, and I just wanted to reduce ad absurdum, his thoughts about his own schema…The outcome was built into his schema since he assumes that capitalists expand their investments by 10% and workers’ wages rise by 5% annually. Such assumptions do not reflect reality…I am not saying that surplus value will decline. It is even possible that it will increase. Nonetheless it will prove to be insufficient since capital accumulation involving an ever rising organic composition) absorbs an increasing share of surplus value…For the organic composition to rise on the basis of an ever larger capital stock, it will be necessary to direct an increasing share of surplus value to that end. The remaining share intended for consumption …will shrink…Obviously I am not at all saying that capitalism is moving towards its own automatic collapse. (Grossman, 2018, p. 229) Grossman went on to link his conception of breakdown with John Stuart Mill’s theory of falling profitability, and the recurrence of breakdowns with the byproduct of accumulation in the advanced stages of capitalist development. It was easy for Grossman to show that with a rising organic composition of capital, and a constant rate of surplus value, as the capital accumulation rate exceeded the growth of labor employment, capital accumulation would cease or stagnate beyond some definite point for lack of a sufficient mass of surplus value. Acknowledging the unreality of such structure, Grossman argued that “if we take into account the rising rate of surplus value (and)…if we look at examples that resemble reality, both in regard to capital and the rate of surplus value…breakdown emerges as a tendency in a foreseeable future” (Grossman, 2018, p. 250). If capital accumulation proceeded faster than the mass of surplus value could be extracted to sustain it, including the expansion of fixed and variable capital, one of the three growing components, either constant (fixed and circulating) capital, variable capital, or capitalist consumption would have to shrink and, hence, give rise to new structural tensions. That prospect would generate rising tensions including the exacerbation of the class struggle as capitalists sought to compress wages and impose new austerity measures on workers.

The Classical advance  259 The last chapter of Grossman’s book on the accumulation of capital, moreover, drew the implications of the argument leading to the unavoidable sharpening of class struggle. As capitalists sought to preserve either capitalist accumulation or their personal consumption unchanged while squeezing labor’s share in new value added, the class struggle would heat up. It is in this final chapter that the preceding analysis of breakdown tendencies, and the countertendencies which they provoke, leads to the decisive outcome of the breakdown process. As Lapides pointed out, we find in “this concluding chapter a vision of political struggle at odds with the purely fatalistic scenario usually attributed to him” (Lapides, 1994). Grossman made it abundantly clear that, speaking about his own contribution, In contrast to all previous breakdown theorists…Grossman seeks to support the theory developed by Marx…already present in John Stuart Mill and Adam Smith in an embryonic form. It holds that once a nation’s capital exceeds a definite scale, its accumulation finds no further profitable opportunities for investment and consequently either lies idle or has to be exported. (Grossman, 2017, p. 128) As translated and abridged by Jairus Banaji, Grossman pointed out that the roots of Ricardo’s theory of breakdown are discernible in the imperfect valorization of capital that defines advanced stages of accumulation. The actual phenomenon, the tendency for the rate of profit to fall, was correctly perceived by Ricard, but he explained it in terms of a natural process rooted in the declining productivity of agriculture. Grossman saw his theory of breakdown as an extension of the work of J. S. Mill, who “viewed the ‘stationary state’ as the general direction of the advance of modern society.” Mill went on to argue that “if capital continued to accumulate at its existing rate and no circumstances intervened to raise its profits, only a short time would be needed for the latter to fall to a minimum” (Grossman, 1992, p. 73; Grossman, 2021, pp. 132–133). Tracing the roots of the breakdown theory in Smith, Ricardo, Mill, and Marx should contribute to clarifying Grossman’s own view of the slowdown in capital accumulation. Following Marx, Schumpeter and Grossman assumed that, in order to raise labor productivity, the characteristic form of capitalist technical change would generally be labor-saving and capital-intensive. In Marx, technical change sought to achieve increasingly higher control over the tempo of production, minimizing the potential mishaps caused by workers’ errors or strike threats. As a result of higher fixed capital per worker-hour, rising labor productivity involved a rising volume of raw and intermediate materials processed into a final product. Grossman’s concept of the breakdown tendency in advanced stages of capitalist accumulation was directly tied with Mill’s view of capitalist development:

260  The Classical advance By the time a few years have passed over without a crisis, so much additional capital has been accumulated that it is no longer possible to invest it at the accustomed profit…(and) the diminished scale of all safe gain inclines persons to give a ready ear to any projects which hold out, though at the risk of loss, the hope of a higher rate of profit; and speculations ensue. (Mill, 1987, p. 734) Grossman agreed with Mill that once business expectations deteriorate and capital accumulation declines because “money capital cannot find profitable investment opportunities in the production sectors,” capital will turn to speculative ventures. In a recession, the rate of interest steadily declines, idle capital abandons the production sectors and turns to the stock market to fish in troubled waters…Stock market activity is closely related to the movement of interest rates in the money market…Stock market speculative activities grow. (Grossman, 2010, pp. 158–159) Inevitably, after a period of unbridled optimism, the inevitable crash destroys large amounts of speculative capital to restore business confidence. Grossman’s analytical strategy Bauer was confident that his model would satisfy Luxemburg’s objections regarding the absence of a built-in source of effective demand and would demonstrate that her solutions were groundless. But he overlooked the unraveling of his reproduction schemes, once the system expanded beyond a certain time period. Grossman’s strategy was simply to use Bauer’s numerical construction, intended to clarify the structural relations that would allow Marx’s reproduction schemes to undergo a more ‘realistic’ path of capitalist development, to show exactly the opposite conclusion. Grossman proved that once you introduce technical change in Marx’s schemes of reproduction, and therefore a rising organic composition of capital (a rising capital/output ratio), breakdown tendencies will emerge to destabilize the reproduction path. Grossman argued that in Bauer’s scheme his fixed accumulation rate was incompatible with a falling rate of profit. For the stock of constant capital to grow at 10 percent annually, while the profit mass rose at only 5 percent annually, an increasing share of profits must be directed to accumulation. At some point, the division of the gross profits (surplus value) between accumulation and capitalist consumption would require adjustments difficult to make without sharpening the class struggle. Under the terms stipulated in Bauer’s model, namely the growth of constant capital, ΔKt/Kt-1 = 10 percent annually, and variable capital, ΔVt/Vt-1 = 5 percent, preserving the division of the profits (surplus value) between accumulation and capitalist consumption would be impossible; instead, it would require a progressively smaller share of capitalist consumption. But at some point (in Grossman’s calculations in the 35th period), capitalist consumption would fall

The Classical advance  261 to zero, and then, Grossman concludes, capitalism as depicted in Bauer’s model would break down: without capitalist consumption, capitalism would cease to exist. This does not mean that Grossman endorsed the silly notion of a mechanical, let alone automatic, collapse of the capitalist system. Not only did Grossman dedicate a substantial portion of his book to discuss and integrate the major countertendencies that would spring up to weaken, if not annul, the system’s tendency to the breakdown of such fictitious model. He explicitly expounded reasons for the unreality of Bauer’s model: Bauer makes unrealistic, false assumptions, and I just wanted to reduce ad absurdum, his thoughts about his own schema. Someone has ironically said, in criticism of me, that in my book capitalism does not break down because of the misery of the workers but rather because of the misery of the capitalists. This objection does not affect me but rather Bauer. It arises from his schema, because he assumes that capitalists accumulate at most by 10% annually, and that workers’ wages increase at most by 5% a year. In reality these assumptions do not apply. (Grossman, 2018, pp. 229) The system’s viability required that the mass of surplus value extracted be large enough to fulfill three requirements: 1) sustain the growth rate of constant capital, ΔC at the required level; 2) preserve the growth rate of variable capital (wages), ΔV, to cover the reproduction needs of the working class; 3) meet the consumption expectations of the capitalist class, ΔK. The system’s ‘breakdown’ will occur when using the available surplus value to maintain the combined expansion of constant and variable capital at the established rates leaves nothing for the consumption needs of capitalists themselves: without capitalist consumption, no capitalist class exists, hence Bauer’s abstract ‘breakdown’ of capitalism (Howard and King, 1988, pp. 290–309). To clarify the rigid requirements imposed upon the extraction of surplus value (gross profits), Grossman highlighted capitalist consumption as one of the essential components of capitalist expanded reproduction (Trottmann, 1956). There would be no capitalist system without capitalists and there would not be capitalists without personal capitalist consumption, Kt. If we write St to represent surplus value (= variable capital). Kt = representing constant capital, Kt = K0 × (1 + gc)t, growing at a constant percentage rate, gc. Vt = Variable capital = Vt = V0 × (1+gV)t, growing also at a constant percent rate, gV. The rate of surplus value, et = St/Vt, remaining constant at 100 percent. Capitalists’ consumption through time will be the difference between surplus value and the needs of capital accumulation, Kt = St − (Ct + Vt) = St − (Ct × gc − Vt × gV). Grossman was able to show that, after extending Bauer’s calculations to 36 periods, the needs of capital reproductions left no surplus for capitalist consumption, Kt = 0. The timing depended on the growth trajectory of the organic composition of capital, Ω = Kt/Vt. Substituting, we have Kt = V0 × (1 + gV)t × (e − gV) = C0 × (1 + gc)t × gC, and therefore,

262  The Classical advance

( 1 + gc ) t (1 + g v ) t

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v0 ( e - g v ) é 1 + gc ù t e - g v so that ê ú = Wg C0 g c 0 c ë1 + g v û

é e - gv ù êW g ú 0 c û so that, dt / dW0 < 0; dt / dg c < 0; dt/de > 0 and finally, dt / dg v > 0 t=ë é 1 + gc ù ê1 + g ú vû ë In Bauer’s model, the decline of capitalist consumption and the specific timing of breakdown t (in the 36th period would depend on the initial value of the organic composition, Ω0, and the growth rates of the two components of capital accumulation, gc, or gv, including the extent to which the rate of surplus value, e, could be increased. With a constant rate of surplus value, it is not difficult to establish the system’s ‘breakdown’ threshold once the model’s assumptions regarding the initial organic composition of capital are set, and the growth rates of constant and variable capital are given. Figure 10.1 shows the simulation of the central variables in the Bauer–Grossman model extended up to 34 periods, beyond which, fulfilling the requirements of accumulation exhaust the available surplus value and capitalist consumption is no longer possible.

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The Classical advance  263 Possible alternatives But we may seek to increase the rate of surplus value in Bauer’s system to avoid the contradiction of a steadily rising capital accumulation being unresponsive to a persistently falling rate of profit. Supposing that, instead of working out the tendencies of a model whose structural characteristics include a rising organic composition of capital and a constant rate of surplus value (hence a falling profit rate), we assume a 3 percent (not a 10 percent as in Bauer’s model) steady growth of fixed constant capital, Ct, along with a 3 percent compression of variable capital (wages). Assume that in each period, a certain amount of necessary value (wages), Vt, is transferred to surplus value, St (hence a rising rate of surplus value), St/Vt or a rising profits share in new value added, St/(Vt + St). As Figure 10.2 shows, in the early stages of such a model, and despite the growing organic and value composition of capital, starting from a relatively low 20 percent gross profit share in new value added, (Vt + St), the system will exhibit a phase of rising profitability, capital accumulation, and capitalist consumption. Despite the declining wage share, moreover, rising labor productivity need not portend falling real wages. From Grossman’s standpoint, breakdown tendencies are absent at this early stage of capitalist development, and, despite accumulation as well as capitalist consumption growing, the class struggle will lack material conditions favoring its resurgence. But even if the breakdown point were pushed forward beyond the 35th period, as capital accumulation progresses, the falling rate of profit and the stagnating mass of profits will prove to be insufficient to maintain both the

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264  The Classical advance established rates of gross investment, ΔCt (3 percent per period), and capitalist consumption, ΔKt. At the advanced phases of capitalist development, the growing gap between the gross investment rate necessary to keep the accumulation rate steady while preventing the share of capitalist consumption from falling, the stagnating profits mass extracted from a shrinking value base will exacerbate the confrontation between capital and workers for the redistribution of the new value added. In Grossman, the breakdown tendency cannot be separated from the measures taken by capitalists to increase their share of the stagnant new value added that lead to the intensification of class struggle. This aspect of Grossman’s theory of the accumulation breakdown was fully developed in the last chapter of his 1929 book The Law of Accumulation and Breakdown of the Capitalist System: Being also a Theory of Crises (Grossman, 2010, 2021), but remained largely unknown, possibly because it was excluded from the abridged English version by Pluto Press in 1992. In our modified model, in addition to a rising rate of surplus value, we maintained the Bauer–Grossman specification of a 3 percent steady increase of the accumulation rate for constant fixed capital, even though the rate of profit associated with that system’s assumptions exhibits a changing trend, first rising and then steadily falling at a declining rate. But in response to criticism of Grossman’s extension of Bauer’s scheme pointing out that in Marxian models the accumulation rate would not remain constant with changing profitability, and particularly so after entering an extended phase of falling profitability, we allowed accumulation to reflect the falling profitability dynamics. Since expected profitability drives the incentive to invest, and future projections are largely shaped by past experience, the objection to a constant rate of accumulation is perfectly understandable. Our next simulation presented in Figure 10.3 shows the alternative outcomes of the model when the accumulation rate consistently reflects the trend variations in profitability. Figure 10.3 displays the structural differences between accumulation rising at a steady 3 percent per period, with the rate of surplus value consistently increasing as in the previous case and the impact of falling profitability on the accumulation rate, first raising it somewhat as the profit rate rises and, then, lowering it in the descending phase of the profit rate. While there will be multiple feedback effects between profitability and the rate of accumulation, in the early stages of capitalist development, the rising profit rate should pull up the accumulation rate above the 3 percent growth trend initially stipulated (10 percent in the Bauer–Grossman version). As we show in Figure 10.4, once the profit share approaches its upper limit of one, and technical progress continues to raise the organic composition of capital, the employed mass of productive labor relative to the value mass of constant capital, the declining growth rate of the mass of surplus value (profits) will impose some changes. At some point, the rise of profits per worker will not compensate for the shrinking mass of employed productive workers and the accumulation rate will have to decline. When the growth of capital accumulation no longer exceeds the rate of decline in the rate of profit, the stagnation in the mass of profits will bring about a ‘breakdown’ of expanded reproduction, and a period of crisis will ensue.

The Classical advance  265

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18000 Alternative Results: Projections of Lower Accumulation & Higher Capitalist Consumption As Capital Accumulation and Capitalist Consumption Adjust to Profitability Trends

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The limits of capital accumulation In more advanced phases of capital accumulation, as the profit share approaches the upper limit of its potential increase and technical progress continues to raise the organic composition of capital, reducing the employed mass of productive labor

266  The Classical advance relative to the value mass of constant capital, the growth rate of the mass of surplus value (profits) will necessarily fall. At some point, the rise of profits per worker cannot compensate for the shrinking mass of employed productive workers. When the decline in the rate of profit cannot be compensated with a rising rate of capital accumulation, the stagnation in the mass of profits signals a ‘breakdown’ of the system’s capacity to grow and a crisis will ensue. For the system to surmount the slump, either a further reduction in the accumulation rate, further compression of the wage rate, or a possible contraction of capitalist consumption will be necessary. Finally, the crucial difference between Grossman’s view of secular stagnation and the various interpretations advanced by Hansen, Summers, Bernanke, and Krugman from the neo-Keynesian perspective is that long periods of low accumulation growth, ceteris paribus, extend in time the viable division of the available surplus value and weaken the ‘breakdown’ tendency without sharpening the class struggle. Examining Figures 1.1 for the U.S. economy and 1.2 for the Japanese economy (Chapter 1), we conclude that the subpar growth rates described in Keynesian terms as ‘secular stagnation’ along with ‘financialization,’ or the growing weight of capital flows seeking financial profits through speculative activities, represent measures to palliate the over-accumulation of capital and weaken the ‘breakdown’ tendency discussed in this chapter. In other words, secular stagnation and financialization are the legacy of neoliberalism for a post-pandemic future signaling the return of stagflation. References Bauer, O. 1978. “La Acumulación del Capital,” El Marxismo y el “Derrumbe” del Capitalismo, Lucio Colletti (editor), Siglo XXI, Mexico. Bauer, O. 1986. “The Accumulation of Capital,” History of Political Economy, translated by King, J. E., Volume 18, No 1. Baumol, W. 1970. Economic Dynamics, The Macmillan Company: London. Durand, C. and Lege, P. 2013. “Over-Accumulation, Rising Costs and “Unproductive” Labor: The Relevance of the Classic Stationary State Issue for Developed Countries,” Review or Radical Political Economics, Volume 20, No 10, pp. 1–19. Foley, D. and Michl, T. 2010. “The Classical Theory of Growth and Distribution,” Chapter 2, Handbook of Alternative Theories of Economic Growth, Setterfield, M. (ed.), Edward Elgar. Grossman, H. 1992. The Law of Accumulation and Breakdown of the Capitalist System, translated and abridged by Banagi, J, Pluto Press. Grossman, H. 2010. La Ley de la Acumulación y del Derrumbe del Sistema Capitalista. Una Teoría de la Crisis, Siglo XXI, Mexico. Grossman, H. 2017. “Fifty Years of Struggle over Marxism, 1883−1932,” Chapter 2, Capitalism’s Contradictions: Studies of Economic Thought Before and After Marx, Haymarket Books. Grossman, H. 2018. “Grossman Letters to Frieda and Paul Mattick,” Chapter 10, Henryk Grossman Works, Volume 1, Essays and Letters on Economic Theory, Brill. Grossman, H. 2021. Henryk Grossman Works, Volume 3, The Law of Accumulation and Breakdown of the Capitalist System: Being also a Theory of Crises, Brill.

The Classical advance  267 Heilbroner, R. 1986. The Nature and Logic of Capitalism, W. W. Norton. Heilbroner, R. 1987. “Economics and Political Economy,” Marx, Schumpeter, Keynes: A Centenary Celebration of Dissent, edited by S. Helburn and D.F. Bramhail, M.E. Sharpe. Howard, M. C. and King, J. E. 1988. “Henry Grossmann and the Breakdown of Capitalism,” Science & Society, 1988, Volume 52, No. 3, pp. 290–309. Keynes, J. M. 1977. The General Theory of Employment, Interest and Money, Royal Economic Society: The Macmillan Press. Klein, L. R. and Kosobud, R. F. 1961 “Some Econometrics of Growth: Great Ratios of Economics,” The Quarterly Journal of Economics, Volume 75, No. 2, pp. 173–198. Lapides, K. 1994. “Henryk Grossmann on Marx’s Wage Theory and the “Increasing Misery” Controversy,” History of Political Economy, Volume 26, No. 2, pp. 239–266. Lowe, A. 1954. “The Classical Theory of Economic Growth,” Social Research, Volume 21, No. 2, pp. 127–158, Johns Hopkins University Press. Luxemburg, R. 2003. The Accumulation of Capital, Routledge. Mattick, P. 1981. Economic Crisis and Crisis Theory, M.E. Sharpe. McCulloch, 1870. The Principles of Political Economy, Kessinger Publishing, LLC. Mill, J. S. 1987. Principles of Political Economy, Augustus M. Kelley Publishers. Orzech, B. and Groll, S. 1983. “Otto Bauer’s Scheme of Expanded Reproduction: An Early Harrodian Growth Model,” History of Political Economy, Volume 15, No. 4, pp. 529–548. Ricardo, D. 1981. On the Principles of Political Economy and Taxation, Cambridge University Press. Schumpeter, J. 1946. “The Decade of the Twenties,” The American Economic Review, Volume 36, No. 2, pp. 1–10. Schumpeter, J. 1986. History of Economic Analysis, Oxford University Press. Schumpeter, J. 2008. Capitalism, Socialism and Democracy, Harper Perennial Modern Thought. Schumpeter, J. 2017. Business Cycles (Volume Two), Martino Fine Books. Sweezy, P. 1970. The Theory of Capitalist Development, Monthly Review Press. Trottmann, M. 1956. Zur Interpretation und Kritik der Zusammenbruchstheorie von Henryk Grossmann, A. Fricker.

11 From secular stagnation to stagflation

In this chapter, we outline our projection for the transition path from a long phase of secular stagnation to a new variance of stagflation based on profitability, employment, GDP, and credit growth experienced from the Great Recession to the ending of COVID-19 lockdowns in 2021. In earlier chapters, we traced the emergence, consolidation, and crisis of neoliberalism to the systemic pressures created by the evolution of business profitability in the U.S. economy from 1947 to 2020. In this chapter, we weigh the prospects for a new stagflation outbreak after the destructive impact of COVID-19–related lockdowns first led to the collapse of effective demand and, then, to the disruption of fragile supply chains, when suppliers themselves defaulted on their financial obligations. Retailers at the high as well as the low ends of the market experienced bankruptcy. In quick succession, as the gathering income losses following the lockdowns lowered effective demand, the supply chains themselves experienced catastrophic debt defaults. In the U.S., huge net new credit expansion and deficit spending pressed against broken supply chains leading to shortages that produced inflationary outbreaks. Profitability and systemic changes We identify the postwar decline of profit rates across the business sector of the U.S. economy as the underlying cause of the structural changes that led to the stagflation crisis of the 1970s and opened the door to the emergence of neoliberalism. We interpret neoliberalism as a new configuration that altered the direction of capital flows in the system after overcoming the deep slump of the early 1980s. Throughout the book, we consistently stressed the role of profitability as the chief driver of capital accumulation. We associated the robust dynamics of Fordist expansion, driven by high levels of fixed capital investments in manufacturing, with historically high profitability levels in the U.S. postwar period from 1945 to 1965. In contrast with that period, we linked the falling accumulation rate since the mid-1970s with the significantly lower level of profitability experienced after 1965 and, particularly, in the neoliberal phase from the early 1980s to the present. Given the outcome of capital-intensive technological change raising capital/output ratios, we stressed the significance of profit shares as determinants of profitability trends, and pointed out that the actual profit share in net value added reached historic lows in the 1970s, as full employment policies strengthened labor’s bargaining DOI:  10.4324/9781003413806-11

From secular stagnation to stagflation  269 position (Glyn and Sutcliffe, 1972). In the 1970s, expansive fiscal policies propped up effective demand, but given the low profit shares and high capital/output ratios of this period, they failed to reverse the declining trend of the average profit rate. Such combination of low profit shares and high capital/output ratios limited the growth capacity of corporate firms, and, consequently, the relatively high levels of investment spending throughout that decade bumped against the reduced growth potential, creating supply bottlenecks that produced inflation outbreaks and growing unemployment. We argued in Chapter 3 that the sharp decline in profitability between 1965 and 1975 provided the rationale for the urgent dismantling of the capital-labor accord and created the sociopolitical environment that paved the way for the transition to neoliberalism. We attributed that structural break to the defensive reaction of managerial elites seeking to stave off the threat of a system-wide breakdown following the vanishing of profitable investment opportunities. In Chapter 3, we applied Shaikh’s classical theory of inflation to show that high corporate investments, in conjunction with falling profitability, caused the stagflation crisis of the 1970s, which in turn served as the catalyst of the deindustrialization measures that ushered in neoliberalism and weakened the labor unions. We specifically argued that, after 1984, secularly falling interest rates expanded the field of speculative finance and laid the grounds for the consolidation of financialization as an open-ended ‘investment’ channel. Then, in the 1990s, geopolitical changes leveled the global barriers blocking the circulation of capital and produced massive flows of offshore investments that undermined the growth potential of the U.S. manufacturing industry. The legacy of neoliberalism From its emergence in the early-1980s to its consolidation in the 1990s, the neoliberal project succeeded in raising the profits share of the financial sector, reducing labor union density, and sharply weakening the bargaining position of labor. The cyclical exuberance of financial assets further contributed to skewing the distribution of income between the upper 10 percent and the rest of households. This happened because the wealthiest 10 percent of the population owned the lion’s share of financial assets, while the income of the majority depended on slow rising compensation. In the case of production and nonsupervisory employees, weekly real earnings did not grow at all after the 1960s. In our view, the experience of secular stagnation in the neoliberal phase generated the financial fragility that underpinned the catastrophe of the COVID-19 pandemic. Privileging investments in financial assets over fixed capital assets did not raise labor productivity growth throughout the system; instead, the neoliberal structure of capital accumulation led to long periods of low growth or secular stagnation. Once revenues linking aggregate demand with their supply sources were cut off, suppliers faced default and the feedback loops that make reproduction possible broke down. In a world drowning in debt, revenue cut-offs are bound to spiral upward and disrupt the balances necessary for the expanded reproduction of the global economy. In the face of massive deficits, the breakdown of supply links

270  From secular stagnation to stagflation created shortages and bottlenecks that led to inflationary pressures as the recovery went on. In contrast with the first stagflation crisis of the 1970s, the new variety is not due to high levels of corporate investments pressing against the low-growth potential associated with declining profitability across the business sector. This time, inflationary pressures surged when breakdowns in supply links caused global shortages of traded goods. As the manufacturing sector’s growth sharply declined, the associated labor unions disappeared. Federal Reserve’s policies sustained the long-term compression of nominal interest rates that brought about the consolidation of banks, replacing large manufacturing corporations with too-large-to-fail banks. In the process, thousands of smaller banks went bankrupt, and the weight of riskier financial institutions expanded. Capital gains and asset inflation increased as sources of effective demand, and offshore investment flows widened in search of higher profitability and escape from domestic union contracts. Domestic non-financial capital accumulation rates declined. Since then, the Federal Reserve’s policy of easy money sought the return of prosperity through the vaunted ‘wealth effect’ that Greenspan attributed to the spending of wealthy investors as their portfolios increased. After the Great Recession, the Federal Reserve’s ‘quantitative easing’ involved buying huge amounts of Treasury bills and ten-year bonds in order “to create a tidal wave of cash and a frantic search for any new place to invest it…The hope was that higher asset prices would create the ‘wealth effect’” (Leonard, 2022, pp.118–119), that would trickle down through the system as a whole. By March 2021 “the Fed was spending $120 billion a month in quantitative easing” (ibid., p. 304). As Leonard concluded his assessment in The Lords of Easy Money, “In many important ways the financial crash of 2008 had never ended…All the Fed’s money only widened the distance between winners and losers…The long crash of 2008 had evolved into the long crash of 2020” (ibid., p. 305). Our argument links the persistent symptoms of secular stagnation with the structural changes derived from the consolidation of neoliberalism, namely deindustrialization, financialization, and globalization. After 1984, moreover, our comprehensive analysis of falling profitability, driving the U.S. long-run decline in real capital accumulation, led us to conclude that neoliberalism did not reverse the postwar profitability decline but just reduced its rate of descent. We, therefore, maintain that once financial markets assumed the decisive role in support of effective demand, rising financial fragility strengthened the prospect of secular stagnation and the outbreak of systemic crises. For the dynamics of accumulation to remain viable and profitability to retain its commanding role over the system’s growth, capital flows had to change since the previous structure of accumulation blocked the recovery path. The Federal Reserve’s recovery strategy In December 2021, after injecting in excess of $4 trillion to stimulate recovery, the Federal Reserve at meetings of the Federal Open Market Committee (FOMC)

From secular stagnation to stagflation  271 decided to reduce its monthly bond purchases from $120 billion to $105 billion. Until then, Federal Reserve’s policy relied on pushing long-term interest rates so low that investors would be driven to seek higher capital gains, encouraging them to keep pushing equity prices to ever higher levels. To the extent that the wealth effect is manifest in bubble-like trends of equity markets, while supply chain disruptions continue unabated, the pressures on the general price level will only mount. It would seem impossible for such public deficits to keep rising without inflation rates rising, as supply channels remain clogged. Increasing the money supply out of line with the existing productive capacity will not induce significant real output growth. As Keynes insisted in the midst of the 1930s slump, the recovery of healthy investment activity required the simultaneous increase in profitability and, given the existing high capital/output ratio of cutting-edge technology, increasing profitability would require raising the profit share. Reports of massive job resignations, declining labor participation rates, and labor shortages, coupled with sporadic reports of nominal wage increases, belie the likelihood of that increase. After the wall of money doled out to businesses and consumers to jumpstart sales, reports of inflation rates increasing to levels unseen since the early 1980s do not bode well for the future trend of inflation. At the same time, a significant number of ‘zombie’ companies, barely surviving on ever-rising debt and low interest rates, would surely collapse if both input prices or interest rates kept going up, affecting their input costs. In a short summary of the main issues involved in the phase change from Fordism to neoliberalism, Kregel argued that a new configuration replaced the Keynesian regime. The stable circuit of high (but falling) profitability that sustained both high rates of capital accumulation and labor productivity growth was replaced with “money manager capitalism,” based on the pursuit of “arbitrage or capital gains” derived from speculation on future asset price inflation (Kregel, 2018; Lapavitsas, 2013a). Under neoliberalism, low profitability, low fixed capital accumulation rates, and low labor productivity growth in the nonfinancial corporate sector caused the growth pattern of secular stagnation and provided the historical context for the system’s reaction to the COVID-19 pandemic. In sharp contrast with the “irrational exuberance” of financial markets that Alan Greenspan detected in 1996, since the beginning of the 21st century, the real growth of the nonfinancial sectors remained tepid. Greenspan could not explain how such financial exuberance could coexist with secular stagnation of the real sectors, and how, finally, the juxtaposition of financial exuberance and nonfinancial corporate low growth would lead to the Great Recession. Within the dominant paradigm, Greenspan admitted, understanding the contradiction would be impossible: “how do we know when irrational exuberance has unduly escalated asset values” (Greenspan, 1996). Fisher and Haberler on profits and depression As Irving Fisher wisely recognized in the early 1930s “A depression is a condition in which business becomes unprofitable. It might well be called The Private

272  From secular stagnation to stagflation Profits disease. Its worst consequences are business failures and wide-spread unemployment” (Fisher, 1932, p. 3). We do not share Haberler’s sense that hiding the centrality of profits in prosperity and depression contributes to a better understanding of business cycles. In the neoliberal phase, the trajectory of the profit rate in the nonfinancial corporate sector clearly anticipated the rate of decline in capital accumulation that followed. Haberler acknowledged that for most economists “Fluctuations in profits (and losses) are frequently regarded as the essential characteristic of the business cycle” but he did not do so because “the term ‘profit’ is vague and misleading” (Haberler, 2014, p. 263). For us, the empirical evidence of the association between falling profits and cutbacks in investment overwhelmingly suggests that it is the decisive factor behind both recession and depression outbreaks. After the nonfinancial corporate profit rate bounced back from its 1982 postwar trough of 7.3 percent to 9.42 percent in 1984 it fell to 6.69 percent in the 2001 recession, and after the Great Recession officially ended, the profit rate declined from 8.74 percent in 2010 to 7.25 percent in 2019. A ‘silent depression’ versus secular stagnation After weighing the prospects for recovery from the effects of the stagflation crisis of the 1970s, followed by the anemic recovery of the 1980s and early 1990s, the Keynesian economist Wallace Peterson examined the analytical relevance of various factors contributing to the low level of capital accumulation. According to Peterson: More important in explaining the overall decline in the rate of growth in private capital per worker are sagging profit rates in the post-1973 period. A major lesson from Keynes’ classic work, The General Theory of Employment, Interest and Money, is that the expectation of profit leads businesspeople to spend for new equipment and structures. (Peterson, 1994, p. 187) In Peterson’s view, because “expected profitability is the key to new investment,” the experience of actually falling profitability brought about deindustrialization, the shrinkage of the manufacturing sector, and the collapse of accumulation; hence, “The economic troubles that began in the early 1970s are deeply rooted…recovery and the economy’s current state of health must be judged against the depression that has silently gripped us for two decades” (ibid., p. 10). In his Keynesian view, public investment should be expanded to restore profitability and to support the introduction of a consistent “industrial policy” (ibid., p. 224). Wallace C. Peterson’s book, the Silent Depression, described the U.S. economy in its transition from Fordism to neoliberalism in terms highly reminiscent of those used by Lawrence Summers more than a decade later to revive the concept of longrun secular stagnation. Peterson sought to explain why since 1973…the American economy has not performed well…two decades of sluggish economic health, a time when, by most of the accepted measuring

From secular stagnation to stagflation  273 rods, the economy’s performance was subnormal…This depression is silent because there is none of the sound and fury that come with a major crash such as the one in 1929. (Peterson, 1994, pp. 9–10) In our projections regarding the prospect of depression after the COVID-19 lockdowns and despite massive injections of public credit into the system, we cannot exclude the possibility of a “silent” depression, a condition somewhat akin to secular stagnation but replete with systemic contradictions. For example, the rise in business bankruptcies side by side with surviving ‘zombie’ companies; increasing use of artificial intelligence technology while unemployment is rising; widening fiscal deficits while financial markets are rising. From the standpoint of overcoming the pandemic in 2021, we share Peterson’s view expressed a decade before the concept of secular stagnation gained recognition. On the other hand, rather than a coming depression, silent or otherwise, in 2021 Wall Street believed that the COVID-19 pandemic of 2020 bore the sole responsibility for the economic crisis and, therefore, once vaccines put an end to the health crisis, the system would revert to the imaginary full employment growth path of neoclassical economics. The recurrent financial crises that followed the emergence of neoliberalism from the mid-1980s to the outbreak of the Financial Crisis in 2007–2009 reflected the weakened foundations of the real economy. Tracing the dismantling of Fordism in the late 1970s to the falling trends of profitability and capital accumulation after the mid-1960s, and noting the low recovery path from the Great Recession to the COVID-19 pandemic shock leads to the question: is secular stagnation a better description than a long ‘silent depression’? As we show in Figure 11.9 from 2012 to 2020, the real mass of profits in the nonfinancial corporate sector stagnated. Clearly, the possibility of depression, albeit of a special kind, is considerable. Outside the neoclassical mainstream, from a Keynesian, Marxian, or Classical economics perspective, that fact would be evidence that the system’s reproduction path was blocked. Figure 11.9 captures our view of the prospects for a “silent” depression based on the fact that the stagnation of the mass of real profits that preceded the COVID-19 collapse from 2012 through 2020 was consistent with the weak recovery from the Great Recession. As a result of the falling nonfinancial corporate average profit rate, the stagnation of the nonfinancial corporate real mass of the net operating surplus (a measure of real gross profits) would suggest the makings of a ‘silent depression’ were in place when the COVID-19 pandemic shock occurred in 2020. The only possible outcome of that stagnation from the standpoint of a profitdriven capital accumulation is the emergence of depression, silent or otherwise. Then, in such conditions of profit mass stagnation, it is clear that the unprecedented growth of debt obligations on the part of business and households since the recovery from the Great Recession rendered them exceptionally vulnerable to the disruption of income flows associated with the COVID-19 pandemic. Figure 11.1 would suggest that the deepening financial fragility of marginal firms caused by the long-run falling average profitability in nonfinancial corporate

274  From secular stagnation to stagflation

17% 16% 15%

20% Nonfinancial corporate average profit rate % zombie companies in nonfinancial corporate sector

18% 16%

14%

14%

13%

13%

12%

11%

11%

9%

10%

7%

9%

5%

8%

4%

7%

2%

6% 0% 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 11.1  U.S. nonfinancial corporate average profit rates as previously sourced and the rise of ‘zombie’ companies, https://www​.isabelnet​.com​/share​-of​-u​-s​-zombie​ -companies/.

sectors gave rise to the increasing number of insolvent ‘zombie’ companies. Low levels of corporate capital expenditures produced declining labor productivity growth and, as Wallace Peterson noted in 1994, the term ‘Silent Depression’ referred to a world in which “recession-like conditions of economic decline have been the norm for at least twenty years” (Peterson, 1994, p. 17). For over four decades, the decline in interest rates alongside the slow falling nonfinancial business profit rate spurred Wall Street banks to launch unprecedented waves of financial innovation intended to meet rentiers’ demand for higher-yield assets. Under neoliberalism, rising debts and stagnant incomes led to financial crises, the spread of bankruptcies, and the rise of ‘zombie’ or insolvent companies. The low growth in the real sectors, financial fragility in the banking scaffold that supports them, and asset bubbles that burst could easily transform secular stagnation into a state of depression, if the old usage of the word replaced the modern one of recession. As Keynes put it, given that secular stagnation is likely to continue as “a chronic condition of subnormal activity for a considerable period without any marked tendency either towards recovery or towards complete collapse” (Keynes, 1977, General Theory, chapter 18, Section 3, p. 249), the length of such “condition” may be one of the characteristic features of a ‘silent depression.’ Wallace C. Peterson applied the concept of a Silent Depression, unrecognized by the mainstream but fitting Keynes’ conceptual framework of the U.S. economy of the 1970s. The concept provided a realistic description of a possible alternative to the term ‘secular stagnation.’

From secular stagnation to stagflation  275 From secular stagnation to stagflation To summarize our argument of the transition from secular stagnation to stagflation, we must connect the historic expansion of the Federal Reserve’s balance sheet with the stagnation of the real mass of nonfinancial corporate profits between 2012 and 2019 in the context of secular stagnation, low profit expectations, and the breakdown of global supply chains. The pandemic lockdowns broke down the links between supply and demand, indebted suppliers defaulted, and bottlenecks appeared. The unprecedented cascade of liquidity met with widespread shortages that produced inflationary pressures, even before the outbreak of the Ukrainian war cut off the global supply of essential foods and energy. It is clear to us that after several decades of secular stagnation, in the wake of the Great Recession, massive lockdowns overwhelmed the structural fragility of neoliberal supply chains, built on just-in-time delivery, and their disruption caused product and input bottlenecks to proliferate. On average, companies outside the small group of superstars did not have sufficient reserves to weather the COVID-19 pandemic unscathed. The collapse in aggregate demand triggered by the COVID-19 lockdowns set off waves of bankruptcy filings that disrupted global supply chains and exacerbated inflationary pressures. While the depth and scope of the unfolding slump could not be anticipated in advance, recession symptoms were detected well ahead of the pandemic outbreak. As early as August 2019, The Business Insider reported that “more than 70% of economists think a U.S. recession will strike by the end of 2021” (Heeb, 2019). Although February 2020 preceded the outbreak of COVID-19 lockdowns, the massive downturns in employment, effective demand, and supply that followed the virus outbreaks clearly amounted to something more than a common recession. As epidemiologists pointed out, the COVID-19 impact on the system’s health, causing either mild discomfort or life-threatening illness, will depend on the underlying conditions of the infected organism. Falling or low profit rate levels behind equally low rates of nonfinancial capital accumulation and depressed labor productivity growth throughout the real sectors of the economy, along with frequent episodes of financial bubbles and crashes, intensified the system’s fragility and left the economy vulnerable to external shocks of all kinds, including the COVID-19 pandemics that threatened everyone. The financial excesses that triggered the Great Recession in 2007–2009 exposed the long-standing weaknesses of the neoliberal regime combining the boundless euphoria of financial markets that led to unsustainable bubbles with the secular stagnation of the real economy. By mid-year 2020, a precise mapping of the depth and duration of the unfolding stagflation is not necessary because the chain of disruption in employment, output, and effective demand will unfold in interconnected stages that are time and path dependent. The process, however, will bring out the underlying conditions that made the system so vulnerable to the pandemic shock, including the sputtering growth engine of the neoliberal period powered by falling average profitability in the nonfinancial corporate sector. On the demand side, the COVID-19 pandemic shattered consumer confidence and, in due course, led to business bankruptcies that in turn produced supply bottlenecks and clogged transportation channels. For laid-off workers, the loss of employment set off a massive exit from the labor market. On the side of aggregate

276  From secular stagnation to stagflation demand, the risk of virus infection prevented social interactions in the consumption of services and, particularly so, for the better-paid upper-middle class comprising the upper 10 percent to 20 percent of employees, perched between the richest 1 percent and the roughly 80 percent classified as ‘production and nonsupervisory employees.’ In July 2020, the Congressional Budget Office Report projected the unemployment rate to rise over 14 percent in the next three months, while recognizing that “Low-income families have borne the brunt of the economic crisis, partly because the hardest-hit industries employ low-wage workers.” Financial assistance to the unemployed undoubtedly made up for wages lost in business shutdowns, and lower-paid workers continued to receive government aid money to cover their basic survival needs. But after the employment losses suffered in the deindustrialization phase of the neoliberal transition and the shift to lower wages in the service sectors, it is discretionary consumer spending by the so-called upper-middle class, the managerial and supervisory segment of the better-paid employees, that suffered most from the lockdowns of the COVID-19 crisis. In order to maintain their living standards, their consumption patterns required social interaction with the lowerpaid employees, that they sought to avoid, in hotels, travelling, conferences, concerts, cruises, and even medical care. As a consequence of plummeting demand, by the time vaccines arrived the cumulative loss in consumption spending had caused a large quantity of service business failures and large increases in unemployment (Goolsbee and Syverson, 2020). In the aftermath of the pandemic shock, the prospective increases in interest rates planned by the Federal Reserve in response to the inflation signs, obviously threatened the survival of a significant number (about 20 percent) of insolvent ‘zombie’ companies kept alive since the Great Recession by the availability of cheap credit and the accumulation of debt. After years of secular stagnation and tepid sales, rising interest rates and higher oil prices would suffice to shrink the number of zombie companies. Indeed, the collapse of hitherto frothy financial markets would herald the end of euphoria and the start of a new phase in the unfolding of a “silent depression,” the next historical manifestation of the stagflation crisis. The profit recovery of 2021 was simply a transitory bonanza allowing corporations to capture a good share of the money injected into the economy free of charge by the Federal Reserve’s various recovery programs. Irrational exuberance and secular stagnation From our Classical perspective, the tension between irrational exuberance and secular stagnation is perfectly understandable as an outgrowth of the relentless search for higher profit opportunities in the speculative financial sector rather than in the nonfinancial corporate sector involving fixed capital accumulation. The ‘investment’ of capital in financial assets depends more on expectations of future capital gains than on the receipt of current dividends from nonfinancial profits on current production. Expectations in financial assets are largely speculative views held by ‘investors’ based on the strength of ‘herd’ sentiment in the direction and extent of future capital gains. Not only low interest rates but also low profitability in the nonfinancial sector is likely to spur ‘irrational exuberance’ and raise asset

From secular stagnation to stagflation  277 prices for long periods of time, as long as comparable profitable opportunities in the real economy are not available. We discussed in Chapter 7 the Federal Reserve policy designed to lower long-term interest rates enacted since the early 1980s, jointly with the legalization of corporate share buybacks by rule 10b-18 in 1982 as crucial factors in the consolidation of financial investment channels. These are viable alternatives to fixed capital investment due to their potentially higher yield. They became attractive because falling interest rates raised the present value of future equity yields and increasing corporate shares’ buybacks raised their market price. Similarly, dividend payouts transfer to shareholders the liquidity necessary to indulge their private inclinations with regard to gains. The persistent decline in the capital accumulation of nonfinancial sectors caused by low or falling profitability, and the associated diversion of funds into financial speculation, stalled labor productivity growth and led to secular stagnation in the real sectors, thus increasing the fragility level of the neoliberal regime. When the COVID-19 pandemic disrupted the balance of the system’s reproduction, reducing employment and breaking down the macroeconomic links between effective demand and supply, many businesses closed or went bankrupt. As the pandemic spread in waves that infected an increasing number of people, the active labor force shrunk and the loss of effective demand soon triggered the related fissuring of supply chains. Under neoliberalism’s rules of optimal business strategy in full measure dictated by the logic of profit maximization in financial markets, consumers as well as producers should increase their liabilities and minimize their reserves or inventories to the utmost, and, consequently, they should always be fully leveraged to attain the best results. The lockdowns and the massive cutoffs in aggregate demand that followed immediately bankrupted the high-end businesses catering to the stay-at-home consumers of the upper-middle class. What was not clearly anticipated in the early days of the COVID-19 lockdowns was that bankrupt companies supplying the better-off consumers of the upper-middle class would not survive the interruption of sales. It should have been expected that their high levels of leverage and failure to meet their debt obligations would force their own wholesale suppliers into default because they also operated on the edge of solvency. Absent timely payments from wholesale vendors, their suppliers were pushed to the brink of solvency and, as should be expected, did not survive unscathed. The recovery strategy acknowledged the interruption of normal transactions as a shock that severed the link between aggregate demand and supply, admitting that the lockdowns separated employees from their work but wrongly assuming that the restoration of income flows would bring back forthwith the desired balance between aggregate demand and supply. Millions of small businesses closed when their better-off customers did not materialize because of infection concerns. Lowerpaid workers could not afford to remain away from their routine activities, they kept working or consuming following their habitual lifestyle. But the discretionary spending of roughly the top 20 percent of households took a long time to recover its normal levels, especially in the consumption of services. Because earlier deindustrialization replaced manufacturing with a large sector that employed almost half the labor force in services that were largely consumed in person, aggregate demand

278  From secular stagnation to stagflation remained lower than it was before 2020. The COVID-19 lockdowns severed the established linkages between aggregate demand and supply and supply chains for goods, transportation systems broke down. The growing intensity of geopolitical conflicts, moreover, shattered the supply channels of international trade, thus expanding the emerging global supply restrictions and bottlenecks. We believe that the cumulative gap between aggregate demand and supply will have long-term consequences: by the time vaccine protection raises hopes that the COVID-19 pandemic has been contained, the mass of business failures worldwide will prevent the early recovery of normal business activity (Goolsbee and Syverson, 2020). For companies catering to the privileged few who retained employment but curtailed their consumption of services, the chain of bankruptcies will extend further, affecting upscale firms more than businesses catering to the mass of ‘production and nonsupervisory’ employees (Kahn, Lange, and Wiezer, 2020). For these workers, their needs, like the services they provide, are essential and not discretionary (Barrero, Bloom, and Davis, 2020). But the experience of lower-paid workers returning to jobs under pressure, fearful that COVID-19 infections continue to spread, will likely feed the reluctance of better-paid workers to join them in offices and workplaces. As a result of lower-paid and higher-paid employees seeking to delay their active participation in the labor force or search for new employment in areas not exposed to infection, labor shortages contributed to temporarily raising nominal wage rates. The rise of ‘zombie’ corporations and stagflation In his magisterial book, Capitalism, Anwar Shaikh demonstrated that real business competition involved firms engaged in open-ended (mainly) price wars with each other taking advantage of the most effective technology to lower unit costs as a preliminary of reducing prices, hence pushing rivals out of business or at least on the margins of solvency. In such a competitive strategy, increasing market share for the leading firm requires the market defeat of rivals in the industry. This concept of competition-as-war is best understood with reference to the laws of war (in war even winners suffer losses) far removed from the rules (choreography) of perfect competition which resemble the contrived movements of a minuet dance. In competitive markets (the theater of war), the heavy deployment of superior capitalintensive technology (the armament deployed) and the conquest of economies of scale allow industry leaders to accomplish their goal, underselling their competitors and driving them out of business. For firms that obtain a higher market share at the conclusion of the competitive battle, it is worth accepting a loss in profitability for two reasons. One, their higher market share makes up for their profit rate decline; and two, while sacrificing some loss in profitability relative to past performance, the leading firm will enjoy the highest average profit rate in the industry, and marginal firms the lowest or none at all. ‘Zombie’ corporations at the margin are profitless companies, nonfinancial businesses that can remain open and avoid default as long as Federal Reserve policy allows them to borrow sufficient funds at interest rates low enough to pay their interest on accumulated debt. They are the losers in

From secular stagnation to stagflation  279 the aftermath of real competitive battles with the ‘superstars’ of the nonfinancial corporate sector because their higher unit costs render them unprofitable with the lower prices set by the leading producer. It is predictable that Schumpeter’s ‘gale of creative destruction’ will gather momentum in the stagflation phase of the crisis, but destruction will precede creation this time. ‘Zombie’ companies will not survive the coming hikes in interest rates as arguments for change in the structure of capital accumulation proliferate. The number of ‘zombie’ companies increased in 2020 and their total debts surpassed the levels achieved in the Great Recession. A “Bloomberg analysis of financial data from 3000 of the country’s larger publicly traded companies” found nearly 20 percent of them qualified as ‘zombies’ and their accumulated debt totaled $1.36 trillion, compared to $300 billion in 2009. The Bloomberg article “looked at the trailing 12-month operating income in the Russel 3000 index relative to their interest expenses over the same period,” and found over “a sixth of the index, or 527 companies” had not “earned enough to meet their interest payments” (Lee and Contillano, 2020). On June 15, 2021, a new report on Bloomberg​.c​om found that while bankruptcies had declined due to the rescue programs enacted, “we’ve moved away from creative destruction and towards an economy with a higher percentage of zombie companies” (Authers, 2021). At the opposite end of the zombies, the leading (‘superstars’) firms in every sector apply the most effective methods of production available, produce at the lowest unit costs within the industry, and deliver their product at the lowest possible price, set to keep their competitors unable to match it. But deploying a superior capital-intensive technology is only possible for top-tier capital because it is the most expensive choice of production methods and harder to afford by lesser rivals. Indeed, the competitive strategy of the leading firm seeks to deprive potential competitors of the ability to challenge its ability to retain the lion’s share of market sales. But maintaining supremacy involves the inevitable cost of underselling competitors while incurring higher fixed costs, that is accepting a lower profit rate for itself, after being satisfied that the lagging firms will either go out of business or operate with a still lower profit rate (since they cannot match the lower unit costs of the leading firm). The risk of losing leadership position and market share is never absent. A comprehensive report entitled Superstars, The Dynamics of Firms, Sectors and Cities Leading the Global Economy, based on a study of companies with revenues above $1 billion annually, concluded that “Superstar firms account for about 13 to 15 percent of global surplus and 22 to 25 percent of corporate earnings.” These are “giant firms that use their size to drive productivity growth, driving down marginal costs of expansion and gaining even more market share in the process.” In the report, profitability is defined as “a firm’s invested capital times the difference between its return on invested capital and its cost of capital. It thus reflects the firm’s net operating profit and its net invested capital.” Competition-aswar relentlessly upsets the given distribution of market power in any given industry, and the McKinsey report also noted that Superstar firms continue to be displaced from the top 10 percent and the top 1 percent. Indeed, some firms have risen from the bottom 10 percent to

280  From secular stagnation to stagflation higher deciles, a few all the way to the top 10 percent. In each of the past two decades (corresponding to a business cycle), nearly half of all superstar firms fell out of the top 10 percent during the business cycle and when they fell, 40 percent fell to the bottom 10 percent. The top one percent is also contestable, with two-thirds being new entrants to this top rank in the last cycle. (Manyika et al., 2018) There is no uniform rate of profits within each industry because firms operating with different technologies or conditions of production that determine their unit costs, while facing a common unit price, deliver a wide spectrum of rates of return. Those firms operating with less-than-optimal technology or conditions of production earn a lower rate of profit than the industry’s leaders operating with the available cutting-edge technology. In the early 1980s, Farjoun and Machover reached a similar conclusion, challenging the neoclassical view of uniform profit rates in a perfectly competitive industry, arguing that under any reasonable theorization of the concept of competition, the competitive forces that tend to scramble rates of profit away from uniformity are at least as real and powerful as those that pull toward uniformity within every industry…Therefore the lack of uniformity of the rates of profit that exists in reality cannot be wholly ascribed to the presence of constraints upon free competition; disparities would necessarily arise even in the absence of all constraints. (Farjoun and Machover, 1983, pp. 34–35) We, therefore, find that attributing differential profit rates to the presence of monopoly in a given industry, on account of the small number of large firms in it, reveals the overarching influence of neoclassical concepts, still shaping the conceptual perspective of neo-Keynesian economics. Shaikh’s development of the Classical theory of real competition is quite capable of accounting for the spectrum of unit costs found in all sectors of the global economy, without resorting to monopoly attribution. In this connection, we accept the general tenor of Joe Kennedy’s empirical findings on nonfinancial corporate profitability, disputing the claim that, since oligopoly characterizes the industrial organization of the corporate sector, the average profit rates have been rising since the 1980s. Kennedy’s findings are exceptionally opportune by virtue of the fact that, although a representative of corporate interests, his calculations show that the average profitability trend in the nonfinancial corporate sector between 1949 and 2019 steadily declined from 9 percent in 1949 to 5 percent in 2019, in parallel with our own calculations (Kennedy, 2020). Since Anwar Shaikh’s analysis of the conceptual structure of real competition first appeared in 1978, (1978, pp. 233–251; 1980, pp. 75–83; 2016, chapter 7), the concept of real competition enriched our understanding of capitalist dynamics beyond the limitations of neoclassical perfect versus imperfect competition. The analysis of real competition based on the relentless pursuit of lower unit costs

From secular stagnation to stagflation  281 leads to a spectrum of profitability levels within each industry that reflects the structure of market shares, with the lowest unit costs enjoying the highest market share and marginal firms on the way out of the industry. Firms with the highest degree of automated technology produce at the lowest unit cost and set the market price low enough to prevent others from encroaching on their market share. Operating with the lowest unit costs, they enjoy the highest profit rate. Marginal firms will, eventually, exit the industry unless they muster the wherewithal to challenge the organizational and technological power of the dominant ‘regulating capitals.’ It cannot be accidental that after 2001 when the average gross profit rate in the nonfinancial corporate sector (net operating surplus over current cost net capital stock in that sector) reached its lowest point since 1948 the number of nonfinancial corporate firms categorized as ‘zombies’ sharply rose. The falling average rate of profit in the nonfinancial corporate sector depicted in Figure 11.1 naturally hides the wide divergence between the sector’s corporate leaders, the ‘superstars,’ and the marginalized corporations, the ‘zombies.’ Competition-as-war would thin out the number of standing firms counted as solvent as the pressure on the least profitable mounted until they left the industry. The Federal Reserve policy of lowering interest rates allowed a growing number of insolvent corporate firms to remain in business. Even though the distance between the few profitable superstars and the rising numbers of ‘zombie’ corporations widened, ‘zombies’ survived because low interest rates allowed them to maintain ever-rising debt levels to meet basic obligations. Thus, the dynamics of the falling rate of profit, together with the monetary policies of the Federal Reserve, consolidated the dual-track economy of the neoliberal phase. A few highly profitable and capital-intensive corporations, employing a relatively small, highly skilled, and well-paid labor force coexisted with the growing number of tottering businesses, the profitless ‘zombies’ employing large numbers of low-wage workers. The rising number of such companies in the nonfinancial corporate sector provided a major source of speculative capital flows into financial markets seeking to exploit the vagaries of financial markets for capital gains. Nonfinancial corporations, both solvent and insolvent, steadily increased their debt levels to finance buybacks, dividends, and interest payments rather than the accumulation of fixed capital. While the accumulation trend in nonfinancial corporate sectors declined and labor productivity growth sagged, the market capitalization of financial assets steadily rose. Such structural changes underpinned the low growth pattern characteristic of the neoliberal regime and its consolidation, reflecting the low profit expectations weighing in investment plans and their implementation as a reflection of actual profitability trends since the mid-1980s (McGowan, Andrews, and Millot, 2017). Early forecasts of the coming recession Premonitions of a new recession gathered momentum in 2018 and continued from 2019 until early 2020, when the official NBER body announced the new recession’s

282  From secular stagnation to stagflation arrival. But considering not only GDP growth rates but also GDP levels as well as employment and income levels, the striking fact is that after every collapse or recession, and certainly after the Great Recession, the lost ground in wealth, employment, and incomes was never recovered. While the depth and scope of the future scarring that may follow the pandemic collapse cannot be fully anticipated, clues are available of the damage inflicted by the COVID-19 pandemic throughout the various sectors of the system. As early as August 2019, The Business Insider reported that “more than 70% of economists think a U.S. recession will strike by the end of 2021” (Heeb, 2019). In September 2019, David Levy of the Jerome Levy Forecasting Center wrote “the present cycle is almost certain to end badly” based on the perception that excessive risk is evident throughout much of the U.S. economy in such quantifiable forms as rising degrees of indebtedness, declining debt quality, inadequate risk spreads, higher asset valuations, and ever greater investor dependence on rising asset prices as a source of income. (Levy, 2019) Finally, on June 8, 2020, The Business Cycle Dating Committee of the National Bureau of Economic Research concluded that the start of a recession period “occurred in the U.S. economy in February 2020. The peak marks the end of the expansion that began in June 2009 and the beginning of a recession” (NBER, 2020). The euphoric moods of equity and bond markets during the darkest periods of the COVID-19 pandemic testify to the disregard for the depressing effect of persistently low accumulation rates in the real economy where real wealth, employment, and incomes are jointly created. In 2021, a period of deepening crisis, ‘investors’ in equity shares, beckoned by expert seers, entered a world of boundless capital gains, casting aside concerns for the average falling profit rate of the nonfinancial corporate sector. As Figure 11.2, shows the collapse of real personal income in 2007 ended in 2009, but the recovery path of the personal income, excluding transfer receipts, remained well below the level achieved in the previous four decades. Moreover, in the post-crisis period, the gap between the pre-crisis long-run growth path and the actual post-crisis recovery path steadily widened before the new COVID-19 pandemic in 2020 pushed its level lower yet. As of April 2022, the new pandemic recovery path for the ‘real personal income excluding transfer receipts’ remained well below, not only of the long-run pre–Great Recession trend path, but of the level achieved in the bounce-back period of 2021. The argument applies here as it did in the case of the lower path of GDP. The recovery measures did not restore the level of personal income gained from employment because the destruction of wealth and employment wreaked by the crisis had so lowered the growing base that it would require higher growth rates than those achieved to re-enter the previous historical level and continue growth from there. The employment path depicted in Figure 11.3 shows the historical break occurring in the 21st century, as the

From secular stagnation to stagflation  283

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initial collapse becomes deeper in every crisis of the 21st century. While GDP at least rose to the level of 2019 by 2021, employment levels did not, remaining far below what it would have been if the employment conditions provided by the long haul between 1950 and 2001 had remained in place. On the contrary, this

284  From secular stagnation to stagflation macroeconomic category was clearly the strongest casualty of the recurring crises of the 21st century. As we show in Figure 11.3, employment grew faster in every decade from 1950 to 2001 than it did after the Great Recession of 2007–2009. From October 2009 through October 2019, and by April 2022, non-farm employment did not regain the levels reached at the end of 2019, which means that the current employment level in 2022 is much lower than it would have been if the new downturn associated with the COVID-19 lockdowns had not taken place. Again, failing to attain the pre-crisis level after each crisis is officially pronounced to be over indicates that despite recovery, the long-term prospects of the system, that is, the long-run dynamism of capital accumulation, weakened enough to prevent full restoration of the macroeconomic expansion. The February 2020 recession alert preceded the COVID-19 pandemic outbreak, and the spread of virus infections led to massive lockdowns and triggered massive losses in employment, the collapse in effective demand, and the breakdown of supply chains. In the event, the destructive power of the crisis brought havoc throughout the world surpassing anything experienced since the 1930s Great Depression. As epidemiologists would point out, the impact of COVID-19 on a person’s chance for survival depended on the underlying conditions of the person’s health, causing either mild discomfort in individuals with a strong immune defense system or life-threatening illness in people with a weak one. Analogously, low rates of nonfinancial capital accumulation and low rates of labor productivity growth caused by falling or low profit rates bode ill for the aftereffects of recurrent financial bubbles and threatened the system’s ability to withstand external shocks. From the standpoint of Classical economics and the central role played by productive labor in the production of wealth, nothing could be more disruptive to the system’s reproduction than the separation of the labor force from employment. The lockdowns that followed the pandemic breakout brought home the meaning of ‘essential workers,’ as their withdrawal from their employment sites precipitated the unprecedented 2020 profitability collapse. According to Harvard University’s Economic Tracker data, as shown in Figures 11.4 and 11.5, almost a quarter of the labor force in the lower-paid sectors of the economy lost employment by April 2021 and, in the same period, businesses, catering to low-income customers lost 35 percent of their revenues (https://github​.com​/OpportunityInsights​/EconomicTracker). The new stagflation As we argued in Chapter 3, the reaction of corporate elites to the sharp decline in corporate profitability experienced from the mid-1960s through the early 1980s kindled the transition from Paul Samuelson’s mixed economy or John Kenneth Galbraith’s New Industrial State to the neoliberal phase of capital accumulation. We explained the stagflation outbreak of the 1970s in the context of Anwar Shaikh’s theory of inflation, noting important differences with the new outbreak of the post-pandemic phase. In the 1970s, deficit-financed corporate investment, exceeding the limits set by falling corporate profitability, caused the inflationary

From secular stagnation to stagflation  285

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Figure 11.5  Evolution of U.S. business revenues in three categories: low, middle, and high revenue businesses, https://tracktherecovery​.org/.

286  From secular stagnation to stagflation outbreak. In 2021, the Federal Reserve’s massive injections of money and credit to shore up effective demand, in conjunction with the breakdown of supply chains, laid the grounds for rising excess demand and simultaneous shortages and transportation bottlenecks that stoked inflationary pressures. When the weight of past profitability exerts undue influence on current corporate investment plans, ignoring the weakening growth potential caused by falling profit expectations, shortages and bottlenecks will appear in the least competitive sectors spreading inflation pressures everywhere. Falling profitability will block output growth and hinder the expansion of more competitive firms. Slowing growth in the system will lead to rising labor unemployment, and the growing shortages will lead to rising prices and higher unit costs; in short, a new bout of stagflation. In the 1970s, despite declining average profitability and loss of growth potential, after more than two decades of historically high levels of profitability and low interest rates, profit expectations remained anchored in the profit experience of the mid-1960s: investment levels remained relatively high as they were in previous decades. The ongoing accumulation trend failed to reflect the extent to which its profit underpinnings had weakened. In the 1970s, inflation reflected the failure of corporate investment to fall in tandem with profitability. The disjunction gave rise to production failures that created bottlenecks and clogged the reproduction potential of growing firms as input prices rose and inflation pressures spread out. In the 1970s stagflation episode, the accumulation share of profitability rose but the system’s potential growth declined and price inflation increased jointly with labor unemployment. The first stagflation crisis in the 1970s exacerbated the tensions that for long periods had built up in the postwar structure of capital accumulation between the maintenance of quasi-full employment and falling profitability. The crisis spurred class confrontations between capital and labor, raising concern among the propertied classes for the integrity of their wealth and the viability of the system’s reproduction. Price inflation lowered the welfare of all classes over and above the plight of unemployed workers, but decisively the crisis strengthened the resolve of influential elites to revitalize the dynamics of the profit system at any cost. Their fundamental strategy sought to reverse the falling profitability trend by means of a radical change in the balance of power underpinning the Fordist structure of capital accumulation. The changes involved weakening the power of industrial labor unions, reducing their footprint in nonfinancial sectors, like manufacturing, and depriving them of the historic platforms where confrontations between labor and capital previously occurred. The successful transformation of the institutional settings surrounding the Fordist phase of high industrial growth rates, now associated with unacceptable bouts of rising wage shares and falling profitability, to a new configuration that downgraded the nonfinancial sectors and opened up new channels for the growth of financial assets, cleared the way for the neoliberal phase. In the U.S., inflation pressures had been absent since the mid-1980s despite failed efforts by the Federal Reserve to raise them above 2 percent in order to lower real interest rates and spur investment. After 2021, taking into consideration

From secular stagnation to stagflation  287 the global footprint of manufacturing activities and the wide spectrum of profitability regimes related to technological differences, the recovery from the demand and supply breakdowns of 2020 slowed down. Major inflationary pressures persisted while supply chains remained broken and normal capacity growth restored. In our view, the recurrence of stagflation upending the economic recovery from the COVID-19 pandemic reflects the breakdown of the precarious balance between effective demand and the global supply chains that replaced the domestic manufacturing sector under neoliberalism. In contrast with the 1970s experience, the post COVID-19 stagflation cannot be attributed to the excessive level of corporate investment relative to profitability because the corporate investment rate has been persistently low and falling since the 21st century started. The COVID-19 employment and supply shock As Figures 11.4 and 11.5 show, inflation pressures are likely to mount because following the pandemic losses in employment and revenues, the supply chains were disrupted. Unprecedented levels of fiscal deficits to pump up effective demand did not succeed in replacing either employment or supply links with viable alternatives. The exacerbation of geopolitical tensions and further supply cutoffs could only serve to intensify the inflationary pressures. The stagnation aspect of the stagflation crisis is likely to persist, lacking any evidence that the conditions leading to ‘secular stagnation,’ as in Larry Summers’ diagnosis, or a ‘silent depression,’ as in Wallace Peterson’s, have disappeared. It is notable that soon after the great wall of money and credit pouring into the economy receded by year-end 2021, GDP growth turned negative in the first quarter of 2022. Figure 11.6 shows the remarkable association between net private and public credit growth and GDP growth under conditions of normal expanded reproduction between the late 1940s and 2019. Evidently, net credit growth provided the additional effective demand-pull that drove GDP growth for more than seven decades. The outbreak of the COVID19 pandemic drastically severed the relationship between effective demand and supply because profitability collapsed when workers were separated from their jobs, and, as Ricardo insisted, profitability regulates the movement of both. The lockdowns of 2020 brought home the decisive role that workers played in the production of profits, as the huge net credit expansion neatly synchronized with the large GDP collapse, something never before experienced. The claim of a ‘roaring’ economy advanced by Larry Summers to advocate higher interest rates and his counsel of fiscal strain overlooks the sobering fact that millions of workers currently out of the labor force left their low-paying jobs because the COVID-19 pandemic continued to threaten their survival. In Figure 11.7, setting lagged net credit growth against the inflation growth rates, it is clear that inflation cycles follow credit growth and, therefore, that the unprecedented credit growth of 2020 jointly with the GDP collapse that followed, would necessarily lead to the inflation growth outbreak reminiscent of the 1970s. Indeed, the inflation outbreak of 2021 reflected the credit explosion of 2020, as

288  From secular stagnation to stagflation

18% 16%

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Figure 11.6  U.S. total net bank credit flow/GDPt-1 and nominal GDP growth, IMF and NIPA Table 1.1.5.

much as the collapse of net credit at year-end led to the first six months of negative GDP growth in 2022. Injecting large quantities of net credit into a no-growth or weakly growing economy in the throes of depression (silent or otherwise) will run against the limits set by structurally low profitability, producing widespread bottlenecks and supply breakdowns that stoke inflationary pressures. The differences and similarities with the first bout of stagflation in the 1970s is that, contrary to Keynesian theories of inflation, the presence of full capacity and full employment is not necessary when effective demand boosts encounter supply constraints. Financially strapped firms tottering on the verge of financial collapse cannot be expected to increase output while burdened with unmanageable debt. Business confidence and depressions We interpret the golden-price Long Waves emerging when we divided producer prices over the price of gold in Chapter 2 as embodying the state of profit expectations and business confidence underpinning the corporate decision to invest. Such interpretation arises from the remarkable correlation between the long-term cyclical path of these Long Waves and the fixed-capital accumulation rate of nonfinancial corporate firms that Figure 11.8 allowed us to make. It seems natural to associate the long-term evolution of business confidence, traced by the golden-price cycles, with the parallel movements of the accumulation rate from 1901 to the 1970s until expectations collapsed. The protracted decline in capital accumulation ever since would reflect the low confidence levels brought on by the underpinning average profit rates.

From secular stagnation to stagflation  289

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Figure 11.7  U.S. total net bank credit flow/GDPt-1 and inflation growth rate, IMF and BLS.

Taking into account that falling profitability, rising debt, and low interest rates in the context of ‘secular stagnation’ caused the proliferation of corporate ‘zombies,’ companies without profits and barely able to make interest payments on their rising debt, Peterson’s observations remain valid. The prospect of depression as previously discussed by Keynes, or the likelihood of an extended period of stagflation after the bounce back from the pandemic, hinges on the extent to which public grants and low interest loans manage to shore up ‘zombie’ companies (around 20 percent of the whole) as Federal Reserve waifs. From our perspective, the prospect of a next depression increases the longer ‘secular stagnation’ spreads financial fragility beyond nonfinancial ‘zombies’ to impecunious households after the pandemic crisis is over. After decades of falling interest rates, asset bubbles, and recurrent financial crises, large fiscal deficits and unsustainable imbalances of income and assets growth led to real economy hollowing of its growth potential. Business reports found that, “one in every five publicly traded U.S. companies” survived as “a zombie,” the name for companies “largely abandoned by investors and able to stay in business only by tapping banks or bond investors for more credit” (Lynch, 2020). Ruchir Sharma, chief global strategist at Morgan Stanley Investment Management, worried that: The level of debt in America’s corporate sector amounts to 75 percent of the country’s gross domestic product, breaking the previous record set in 2008. Among large American companies, debt burdens are precariously high in the auto, hospitality and transportation sectors — industries taking a direct hit from the coronavirus. Hidden within the $16 trillion corporate debt market

290  From secular stagnation to stagflation

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Figure 11.8  Parallelism between golden-price Long Waves and long capital accumulation rate in the U.S., as previously sourced.

are many potential troublemakers including the ‘zombies.’ They are the unintended spawn of a long period of record low interest rates, which has sent investors on a restless hunt for debt products that offer higher reward, with higher risk. Zombies now account for 16 percent of all the publicly traded companies in the United States, and more than 10 percent in Europe, according to the Bank for International Settlements, the bank for central banks. A look at the data reveals that zombies are especially prevalent in commodity industries like mining, coal and oil, which may spell upheavals to come for the shale oil industry, now a critical driver of the American economy. (Sharma, 2020) After the COVID-19 pandemic wanes, if the massive injections of public credit end and if high inflation spurs the Federal Reserve to raise interest rates to check it, the unintended consequences may lead to unprecedented waves of ‘zombie’ bankruptcies and near-insolvent companies crashing. Then, considering the near 20 percent magnitude of the ‘zombie’ presence of small and medium companies, the emergence of a ‘silent depression’ (Wallace Peterson’s concept) would replace Summers’ milder form of ‘secular stagnation.’ Pressures to return to work steadily applied by employers on low-wage workers sustained the fear of infection in the minds of higher-paid employees working from home. For companies catering to the top 20 percent of the labor force, who retained employment but curtailed their consumption of services, the chain of bankruptcies surpassed that of businesses catering to the mass of ‘production and nonsupervisory’ employees (Kahn, Lange, and Wiezer, 2020). For these lower-paid workers

From secular stagnation to stagflation  291 their consumption needs, much like their own service work, are essential and not discretionary (Barrero, Bloom, and Davis, 2020). The total number of employed workers in mid-2022 was lower than in 2019, and labor-saving artificial intelligence technology is set to drive larger numbers of poorly-paid employees into out-of-the labor-force status, while broken supply chains spur inflation and low profitability retards growth. From the standpoint of evaluating the consequences of the pandemic crisis, we cannot share Peterson’s view of the 1990s. He argued then, that the Silent Depression will arrive accompanied with none of the sound and fury that come with a major crash such as the one in 1929, much of the public, the press, and people in the government sense that something has indeed gone wrong, but they are unsure of exactly what it is. (Peterson, 1994, p. 10) On the contrary, in 2021 Wall Street wealth managers were quite vocal blaming the COVID-19 pandemic for the economic crisis of 2020, fully confident that vaccines would restore the pre-pandemic growth. But from year-end 2022’s perspective, as the health crisis abates, it is clear that the system’s profitability and accumulation trends have not been reversed. The accumulation pattern remains as it was since the mid-1980s, as capital experienced the financial excesses that triggered the Great Recession of 2007–2009 and weakened the system’s capacity to overcome the pandemic shock without risking a severe depression aftermath. As the Great Recession of 2007–2009 exposed the long-standing weaknesses of the neoliberal regime, combining the boundless euphoria of financial markets that led to unsustainable bubbles with the secular stagnation of the real economy, Anwar Shaikh found “This crisis is an absolutely normal phase of a long standing recurrent pattern of capitalist accumulation…just as previous shocks triggered general crises in the late 1820s, 1870s, 1930s and 1970s” (Shaikh, 2011, p. 44). The COVID-19 pandemic cut off the inter-sectoral flows that sustained the expanded reproduction of capital accumulation and weakened the system’s resistance to financial shocks. While according to Shaikh the insolvencies of the subprime lending fiasco triggered a Financial Crisis that in 2007 led to the “First Great Depression of the 21st Century” (Shaikh, 2011, pp. 44–63), the health crisis in 2020 drove the wedge that sundered labor from capital, buyers from sellers, and triggered the return of depression forebodings. As the health crisis receded, it is clear that the failure to reverse the system’s profitability and accumulation trends that emerged from the mid-1980s exacerbated the financial excesses that triggered the Great Recession of 2007–2009 and weakened the system’s capacity to overcome severe depression shocks, including pandemics. After decades of falling interest rates, asset bubbles and recurrent financial crises, large fiscal deficits and unsustainable imbalances between income and assets growth, we find that COVID-19 merely triggered the economic collapse of the neoliberal framework that delivered decades of secular stagnation and weakened the

292  From secular stagnation to stagflation system’s resilience leading to the blight of the “First Great Depression of the 21st Century,” popularly known as the Great Recession of 2007–2009. From a Classical standpoint, that crisis precipitated an avalanche of devastating bank failures and market contractions in the real sectors without triggering any strong revival mechanism in profitability or capital accumulation. Stagnation of the profit mass after the Great Recession As Figure 11.9 shows, after the Great Recession’s real GDP emerged from its trough in the first quarter of 2009, the recovery path restored its positive growth rate but did not lift the volume to the level and trajectory attained before the downturn occurred. The reason for that omission is built in the very nature of the slump, consisting in the fact that the crisis associated with the Great Recession led to business failures of marginal firms (the ‘zombies’) that, while allowing surviving businesses to improve their profitability prospects, reduced the productive capacity of the system. Simply put, the level of profitability was not sufficiently high to induce the rise in capital accumulation necessary to recover the volume of output lost. Thus, even though the recovery minus the insolvent businesses restored the growth path, the smaller productive capacity, measured by the paired down fixed capital stock, did not match the pre-crisis compound growth trajectory but, instead, remained growing at a lower level. Clearly, the restoration of the profit rate for the surviving businesses was not sufficiently strong to make up for the smaller aggregate capital value. If the real GDP decline after the Great Recession ended in 2009 had recovered its pre-crisis level and had kept growing at the pre-crisis longterm rate rather than proceeding from a lower capacity base, the counterfactual 4820

21500 20500

Real GDP 1992Q1-2008Q4

4460

19500

Real GDP 2008Q4-2022Q1

4100

Real nonfinancial corporate net operating surplus

18500

3740

Linear real GDP trend 17500

3380

16500

3020

15500

2660

14500

2300

13500

1940

12500

1580

11500

1220

10500

860

9500 Jan-92

500 Jul-94

Jan-97

Jul-99

Jan-02

Jul-04

Jan-07

Jul-09

Jan-12

Jul-14

Jan-17

Jul-19

Jan-22

Figure 11.9  U.S. real GDP 1992Q1–2022Q1 and real nonfinancial corporate operating surplus, NIPA Table 1.1.6, Flow of Funds FA106402101.Q, and FRED A007RD.

From secular stagnation to stagflation  293 real GDP in 2022 would have been around 9 percent higher than it actually was, a non-trivial magnitude. It is our contention that after the long experience of secular stagnation in the neoliberal phase, the Great Recession shattered the profit expectations that underpinned the capital accumulation drive. The slump failed to raise the actual average profit rate in the nonfinancial corporate sector. The Great Recession expanded the number of ‘zombie’ companies and reinforced the Federal Reserve’s determination to continue its monetary policy of driving interest rates closer to the zero bound while increasing credit flows. Quarterly real GDP growth declined between April 2003 and October 2008 before the onset of the 2007–2009 Great Recession. The improvement in business conditions, the rise in profitability, achieved by the crisis was not sufficient to bring about a full recovery of the wealth lost in the slump. The measures taken to expand effective demand obviously did not suffice to assuage the business confidence lost in the slump. As Figure 11.9 shows, after the crisis abated in 2009, the quarterly real net operating surplus of nonfinancial corporations reached a level in April 2012 of $15,534 billion from which it did not significantly deviate until October 2019 before it plunged to $12,827 billion in April 2020. Clearly, in the aftermath of the Great Recession, the real recovery never took place, and we must assume that structural imbalances caused the longest period on record that the real net operating surplus of the nonfinancial corporate sector remained stagnant. The unexpected decline of the average profit rate of nonfinancial corporations, a key Classical/Marxian metric, along with the stagnation of the real nonfinancial corporate net operating surplus, signals the presence of a major blockage to the prospects of the system’s reproduction. Figure 11.10 shows our estimates of the system-wide ratio of the gross mass of profits or ‘net operating surplus,’ including the sum of business profits, interest, and rents across all sectors, relative to a measure of productive labor wages, a notion familiar to Marx’s thinking as the rate of surplus value but totally alien to the neoclassical mainstream. In order to obtain a net domestic product value approximating the Classical concept we took the following steps: starting with GDP excluding non-monetary imputations we subtracted capital consumption excluding imputations; then we calculated the earnings of productive workers as the residual of subtracting the earnings of unproductive labor activities from the total earnings of all employees in the private sector. We considered unproductive activities in the classical tradition as those taking place outside the sphere of production of goods and services for sale, including those labor activities not carried out for profit in private households. In sum, production activities encompass those related to the production of goods or personal services for profit-driven businesses. Unproductive workers include employees in not-for-profit government administration; wholesale and retail sales; legal services; financial, insurance, and real estate activities; and miscellaneous services like accounting or cleaning services for businesses. All unproductive workers are necessary for the system’s reproduction, but they remain out of the production sphere. They add to the cost of doing business, they share a portion of the profits for their services, they are a ‘cost’ that must be subtracted from profits and new value added.

294  From secular stagnation to stagflation

3.70 3.50 3.30 3.10 2.90 2.70 2.50 2.30 2.10 1.90 1.70 1.50

1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Figure 11.10  Data approximation to the U.S. rate of surplus value, NIPA Tables 7.12 and 6.2ABCD.

After subtracting capital consumption net of imputations from GDP also net of imputations, we divided the resulting ‘net operating surplus’ net of imputations over the wages of production workers net of imputations. We calculated the wages of productive workers after subtracting from total compensation the compensation of unproductive labor. Dividing our measure of surplus value (gross profits) over the compensation of productive labor we obtained our rough measure of the ‘rate of surplus value’: the gross profit (new value added minus the compensation of productive workers) divided over the compensation of productive workers. As Figure 11.10 clearly shows, this version of ‘net operating surplus’ to compensation of production workers, a rough approximation equivalent to Marx’s ‘rate of surplus value,’ remained trendless from the late 1940s until 1980, but, thereafter, this ratio rose from 1980 to 2010. Since 2010, the rate first stagnated and then declined, falling for a longer period than at any other time since the neoliberal long climb extending from 1980 to 2010. The decline in the rate of surplus value after 2010 would explain the trendless real mass of profits from 2012 to 2020 calculated in Figure 11.9. The falling ‘rate of surplus value’ is attributable to the fact that the employment of unproductive or nonproduction workers as a share of all employed workers decreased following the Great Recession. Conversely, the rising proportion of workers employed in production sectors, such as warehousing and delivery, increased but labor productivity growth actually declined. It seems likely that Larry Summers’ callings for the Federal Reserve to cool off the ‘overheated economy’ after the massive injections of money that preceded recovery and stoked inflation outbreaks, reflect the mainstream determination to

From secular stagnation to stagflation  295 reverse the falling rate of surplus value. Summers’ argument in favor of raising interest rates, despite negative GDP growth in the first half of 2022, seeks to bring about a further slowdown of economic activity and raise unemployment as a preliminary to lower the real wages of all employees but, in particular, the ‘production and nonsupervisory’ category. The Federal Reserve’s decision to raise interest rates as a means to reduce inflation will not only pave the way for a deeper recession in the short term, but also prepare the ground to reverse the falling ‘rate of surplus value,’ and hence achieve higher profitability levels. While the path involved in that reversal may not be clearly drawn, the coming recession and continuing inflation will combine to translate growing unemployment into a smaller share of labor compensation. References Authers, J. 2021. “Zombies Are on the March in Post-Covid-19 Markets,” Bloomber​.com​, June 15. Barrero, J., Bloom, N., and Davis, S. 2020. “Covid-19 Is Also a Reallocation Shock,” Becker-Friedman Institute, Working Paper No. 2020-59, May. Farjoun, E. and Machover, M. 1983. Laws of Chaos, Verso. Fisher, I. 1932. Booms and Depressions, Adelphi Co. Glyn, A. and Sutcliffe, B. 1972. Capitalism in Crisis, Pantheon Books. Goolsbee, A. and Syverson, C. 2020. “Fear, Lockdown and Diversion: Comparing Drivers of Pandemic Economic Decline 2020,” Becker-Friedman Institute, Working Paper No. 2020-80, June. Greenspan, A. 1996. “The Challenge of Central Banking in a Democratic Society,” The American Enterprise Institute for Public Policy Research. December 5: https://www​ .federalreserve​.gov​/boarddocs​/speeches​/1996​/19961205​.htm. Haberler, G. 2014. Prosperity and Depression. A Theoretical Analysis of Cyclical Movements, Transaction Publishers. Heeb, G. 2019. “More than 70% of Economists Think a U.S. Recession Will Strike by the End of 2021,” The Business Insider, August 19. Kahn, L., Lange, F., and Wiezer, D. 2020. “Labor Demand in the Time of Covid-1919: Evidence from Vacancy Postings and UI Claims,” NBER, Working Paper 27061, April. Kennedy, J. 2020. “Concentration is Not Producing Higher Profits or Markups,” Information Technology and Innovation Foundation (ITIF), 11/22/2020. https://itif​.org​/publications. Keynes, J. M. 1977. The General Theory of Employment, Interest and Money, Royal Economic Society: The Macmillan Press. Kregel, J. 2018. “Minskyan Reflections on the Ides of September,” Working Paper, Levy Institute, September 14. http://multiplier​-effect​.org​/minskyan​-reflections​-on​-the​-ides​-of​ -september/. Lapavitsas, C. 2013. Profiting Without Production, Verso. Lee, L. and Contiliano, T. 2020. “America’s Zombie Companies Have Racked Up $1.4 Trillion of Debt,” Bloomberg, November 17. Leonard, C. 2022. The Lords of Easy Money, Simon & Schuster. Levy, D. 2019. “Bubble or Nothing,” The Jerome Levy Forecasting Center, (iii), https:// www​. levyforecast​. com​/ core​/ wp​- content​/ uploads​/ 2019​/ 09​/ Bubble​- or​- Nothing​. pdf​ ?834430.

296  From secular stagnation to stagflation Lynch, D. 2020. “Here’s One More Economic Problem the Government’s Response to the Virus Has Unleashed: Zombie Firms,” The Washington Post, June 23. Manyika, J., Ramaswamy, S., Bughin, J., Woetzel, J., Birshan, M., and Nagpal, N. 2018. “‘Superstars’: The Dynamics of Firms, Sectors, and Cities Leading the Global Economy,” Discussion Paper, The McKinsey Global Institute, October 24. McGowan, A., Andrews, D., and Millot, V. 2017. “Insolvency Regimes, Zombie Firms and Capital Reallocation,” OECD Economics Department Working Papers, No. 1399, June 30. NBER. 2020. “Determination of the February 2020 Peak in US Economic Activity,” Announcement by the Business Cycle Dating Committee, NBER, June 8. https://www​ .nber​.org​/news​/business​-cycle​-dating​-committee​-announcement​-june​-8​-2020. Peterson, W. C. 1994. Silent Depression: The Fate of the American Dream, W. W. Norton. Shaikh, A. 1978. “Political Economy and Capitalism: Notes on Dobb's Theory of Crisis,” Cambridge Journal of Economics, Volume 2, No. 2, June,  pp. 233–251. Shaikh, A. 1980. “Marxian Competition Versus Perfect Competition: Further Comments on the So-called Choice of Technique,” Cambridge Journal of Economics, Volume 4, No 1, March, pp. 75–83. Shaikh, A. 2011. “The First Great Depression of the 21st Century,” The Crisis this Time, Socialist Register, Volume 47, pp. 44–63. Shaikh, A. 2016. Capitalism: Competition, Conflict, Crises, Oxford University Press. Sharma, R. 2020. “This is How the Coronavirus will Destroy the Economy,” The New York Times, March 16.

Index

automation 10, 76, 122, 188, 201, 257 borrowing 65, 72, 78–79, 96, 99, 149, 172–173, 179, 181, 185, 196, 211, 216, 233 Bureau of Economic Analysis (BEA) 12, 47, 67, 106–107, 204, 252 Bureau of Labor Statistics 2 capacity utilization 18, 55, 63, 66, 75–78, 85, 108, 111, 120, 129, 141, 148, 151, 171, 206, 219, 222, 236, 239 capital 1–12, 14–44, 46–59, 62–93, 93–99, 101–113, 115–117, 120–125, 127–129, 131–133, 135–143, 145–155, 157, 159–163, 166–168, 170–176, 181–189, 194–225, 228–244, 247–277, 279, 281–282, 284, 286, 288, 290–294 capital/output ratio 10, 14, 16–17, 55, 62, 68, 75–76, 88, 95–96, 105–106, 122–123, 127, 129, 145, 151–153, 163, 198, 211, 237, 241–244, 260, 268–269, 271 capital-intensive technology 5, 8, 10, 24, 77, 105, 108, 123, 157, 199, 242, 279 Capitalism triumphant 91, 215 capitalist development 5–7, 23, 31, 33, 39, 43, 45–46, 49, 52–53, 57, 110–111, 141, 168, 200, 219, 243, 247–248, 252, 254–255, 257–260, 263–264 capital-labor accord 20, 23, 25, 65, 67–68, 71, 78, 83, 85, 87, 89–91, 96, 98, 102, 105, 107, 110–111, 113, 120, 145, 161–162, 184, 211, 251, 269 capital stock 3, 5, 12, 21, 30, 33, 40, 47, 58, 65–72, 75–77, 83, 86, 92, 106, 109, 128, 132, 147–150, 152, 155, 182–183, 202–205, 211, 213, 222–223, 234, 241, 252, 257–258, 265, 281, 292

Classical economics 9–10, 22, 24, 30–46, 48–58, 87, 92, 141, 220, 223, 273, 284 Classical Political Economy 2, 6–7, 30, 32, 42–43, 49, 65, 110–111, 138, 142, 168, 213, 220, 247 competition 5, 8–12, 14, 24, 36, 43–44, 49–50, 53, 55–56, 67, 82–84, 88, 91, 100–101, 108, 122, 137, 142, 151–152, 154, 171, 174, 198–199, 206, 215, 220, 225–226, 235, 237–238, 278–281 competition-as-war 8–9, 50, 108, 154, 278, 281 creative destruction 73, 92–93, 97, 138, 249–250, 279 credit 1, 14, 17, 20, 22, 26, 31, 50, 65, 67, 71, 76, 82–83, 92–93, 99, 101–102, 104, 141, 167, 179, 185–186, 188–189, 194–195, 199, 202, 204, 207, 209, 227–229, 231, 234, 268, 273, 276, 286–290, 293 debt 2, 4, 11–14, 17, 25, 65, 72, 78, 92–93, 97, 99, 104, 170–172, 186, 192, 194, 196, 198, 201–202, 207–208, 216, 230, 233, 268–269, 271, 273–274, 276–279, 281–282, 288–290 deindustrialization 1, 3, 11, 17, 21, 62–63, 67–68, 96–98, 102–103, 105, 107, 111, 113–114, 124, 126, 137–164, 171, 174, 176, 179, 194, 198, 269–270, 272, 276–277 economies of scale 9, 11, 39, 53, 122, 152, 181, 200, 249, 278 effective demand 1, 3, 8, 14, 17, 22, 26, 34, 38, 45, 54, 63, 66–67, 70, 74–78, 84, 87, 96–97, 99, 101, 103, 108–109, 111, 117, 123, 141–142, 153, 171, 194–195, 198, 200–201, 212, 219, 221–226, 228–229, 233, 235–236, 238–240, 247–248, 252, 254, 260, 268–270, 275, 277, 284, 286–288, 293

298 Index effective federal funds rate 81, 169, 230 employee compensation 65, 68–69, 77, 84, 112, 114, 116, 127–128, 131, 161–162, 164, 177, 208, 213, 241, 252 Federal Reserve 1–2, 4, 12–14, 17, 20–23, 26–27, 68, 80, 82, 93, 97–98, 111–112, 117–118, 123–124, 166–169, 174–175, 178–179, 182–183, 187–188, 195, 201, 206, 211, 213–215, 223, 226–227, 230, 270–271, 275–278, 281, 286, 289–290, 293–295 finance, insurance, and real estate (FIRE) 21, 116–117, 144, 163–164, 183, 187 financial bubbles 3, 239, 275, 284 financial crisis 1, 3–4, 13, 20, 25, 34, 54, 68, 81, 92, 99, 111, 123, 132, 139, 163, 166–189, 196–197, 201–202, 206, 209–210, 213, 215–216, 219, 226–227, 273–274, 289, 291 financial fragility 1–2, 11, 13, 17, 25–26, 74, 97, 170, 269–270, 273–274, 289 financialization 12, 21, 25, 47, 55, 81, 89, 97–98, 104–105, 110–113, 116, 123–124, 143, 147, 166–167, 170, 172–176, 178, 184, 186–187, 196, 198, 212, 215, 266, 269–270 fixed capital 3, 6, 8, 12, 18, 21, 25, 39–41, 44, 49, 64, 68–69, 71–74, 84, 86, 96, 98–99, 105, 108, 110–113, 120, 123, 127–128, 132, 135, 137–139, 147–151, 153, 159, 161, 166, 168, 172–174, 182, 188–189, 194, 196–200, 202–208, 211, 213–215, 220, 223, 230–231, 234–235, 241–243, 249, 252, 254, 259, 263–264, 268–269, 271, 276–277, 281, 292 Fordism 18, 20, 23–25, 62–93, 111, 174, 271–273 Fordist configuration 3, 23, 26, 62–63, 120, 145, 178, 220 Gibson Paradox 178–179 globalization 17–18, 95, 97, 105, 110, 113, 132, 139, 196, 198, 270 Golden Age 25, 63, 66, 68, 82–83, 85, 87–89, 91, 95–96, 100–101, 112, 193, 207 Great Depression 46, 63, 75, 84, 89, 108, 192, 207, 210, 219, 224, 239, 241, 243, 251–252, 284, 291–292 Great Recession 1–2, 17, 23, 25, 46, 66, 86, 91, 97, 108, 117, 131, 135, 140, 148, 159, 184, 187, 196, 201–203, 206–215,

219–220, 224–228, 234–235, 239, 251, 268, 270–273, 275–276, 279, 282, 284, 291–294 gross investment 76, 78, 80–81, 157–158, 193, 222, 237, 263–264 housing bubble 13, 189, 209, 215, 227 incremental profit rate 64, 66, 69, 155–160, 190 inequality 1, 20, 24, 47, 91, 101, 105, 107, 109, 171, 174, 208, 233 inflation 1–2, 14, 19–20, 22, 24, 26–27, 46, 62, 65, 67, 70–72, 78–81, 83–85, 87–88, 95–96, 98–99, 101–102, 109, 112, 117, 123, 141–143, 166–167, 169–170, 183, 190, 196, 200, 204, 208, 226–227, 231, 269–271, 276, 284, 286–291, 294–295 innovations 93, 98, 153, 233, 237, 249, 251, 253 interest rates 1–4, 7, 11, 13–14, 16–17, 20–21, 25–27, 47–48, 57, 68, 79–82, 93, 97–99, 101, 105, 110, 112, 117, 123–124, 143, 149, 166–189, 193–194, 201, 207, 210, 214, 215, 219, 222–223, 225–232, 234, 238, 240, 260, 269–271, 274, 276–279, 281, 286–287, 289–291, 293, 295 IS-LM model 22, 193, 226–229, 231, 234 Keynesian perspective 142, 195, 200, 221, 224, 266 labor compensation 115, 123, 125–127, 129–130, 242, 295 labor-displacing technology 122 labor share 15, 63, 83, 96, 120, 129–130, 146, 242 labor union density 105, 126, 177, 269 long waves 43–47, 288, 290 manufacturing 12, 16–21, 23–24, 55, 62–63, 67, 70–71, 75, 81, 83–85, 88–89, 95–96, 98, 102, 104–108, 113, 116, 120–121, 123–125, 127, 137–141, 143–152, 154–168, 173, 175, 178–179, 181, 183, 186, 193–194, 197, 208–209, 212, 220, 236, 268–270, 272, 277, 286–287 mixed economy 20, 46, 63, 71, 83, 85, 99, 102, 145, 212, 284 monetary policy 12, 17, 21, 25, 68, 90, 96, 98–99, 101, 105, 112, 167–168, 170, 175, 178, 194, 210, 215, 225–228, 231, 281, 293

Index  299 monopoly 4–5, 8–12, 53–56, 71, 73, 82, 198, 220, 226, 233, 235, 238, 249–250, 280 mortgage-backed securities 1, 13, 167, 185 mortgages 1, 4, 12–13, 113, 168, 170, 180, 184–185, 188, 207, 228, 231, 233 neoclassical synthesis 101, 142 neoliberal financialization 25, 167, 170, 173, 178 neoliberalism 3, 8, 11, 20–26, 46, 54, 56, 62–63, 66–67, 69–71, 74, 81–82, 85, 93–98, 100–102, 104–107, 109–114, 120, 123–124, 127–130, 137–138, 143–145, 148, 160–161, 163–166, 169, 171–172, 174–175, 178, 183–184, 186, 194, 196, 199, 208–209, 211, 223, 228, 250, 266, 268–274, 277, 287 oligopoly 5, 82, 198, 220, 229, 236–238, 280 operating surplus 3, 19, 21, 65, 68–69, 72–74, 80, 115, 139, 149, 172, 182, 188, 199, 202, 205, 212–213, 215, 240–241, 273, 281, 292–294 organic composition of capital 8, 41, 223, 254–255, 257–258, 260–265 output/capital ratio 58, 77, 106–109, 121, 123, 132–133, 141, 147, 153, 161, 223, 237 over-accumulation 32, 212, 256, 266 perfect competition 5, 9–12, 43, 56, 174, 225, 278 production and nonsupervisory employees 105, 114–116, 125–132, 137, 140, 174, 178, 269, 276 productivity 1, 8, 11, 16, 18–21, 25, 30, 35–39, 47, 49, 52–55, 59, 63, 67–68, 71, 75–76, 79, 82–83, 85, 87–92, 95–122, 124, 126–132, 137, 140, 142, 144, 146–147, 153–154, 157, 160–164, 171, 179, 185–186, 194, 197–199, 201, 203, 208–209, 212, 221–224, 228, 233, 236–238, 241–242, 248, 254, 259, 263, 269, 271, 274–275, 277, 279, 281, 284, 294 profitability 1–14, 16–27, 30–35, 37–40, 42–45, 47–50, 53, 55–58, 62–90, 92–113, 115–117, 120–124, 127–133, 135, 137–143, 145–149, 151–155, 157, 159–161, 163–164, 166–167, 169–172, 174, 178–179, 181–189, 194–199,

203–214, 219–220, 222–226, 230–243, 247–253, 257–258, 263–265, 268–273, 275–281, 284, 286–289, 291–293, 295 regulating capital 10, 18, 55, 154–155, 157, 281 reserve army 37, 256 restructuring 20, 85, 97, 105, 107, 143, 155, 161, 184 retained earnings 62, 65, 71–72, 90, 99, 149–150, 168, 170, 172, 198, 204–205, 207, 215, 229, 232–234, 241 saving glut 232 secular stagnation 3–4, 6, 8, 11, 13–15, 17–19, 21–23, 25, 30–34, 38, 42–44, 46–49, 52–55, 63, 68, 74, 80, 82–83, 86, 97, 110–111, 113, 117, 135, 140, 144, 146, 153, 162, 164, 171–172, 184–186, 192–233, 235–242, 247, 249, 256, 266, 268–295 services 16–17, 19–21, 24, 62–63, 67–68, 70, 78, 83–84, 96, 103, 106, 112, 124, 127, 138, 140, 143–144, 146, 159–162, 164, 171, 186, 194, 203–204, 276–278, 290, 293 share buybacks 6, 63, 79, 99, 104, 139, 172–173, 181, 194, 198, 202, 223, 277 slack coefficient 80–81 stagflation 2–3, 8, 10–14, 16–20, 22–23, 25–26, 33, 45, 62–63, 65–67, 70–72, 74, 78–79, 82–86, 88, 95–97, 101–102, 109, 112, 118, 120–121, 124, 141–144, 166, 171, 176, 178, 186, 208, 212, 266, 268–295 stationary state 7–8, 30, 32–33, 38–40, 42, 54, 193, 247–248, 259 supply chains 1, 3, 14, 17, 22, 26, 62, 80, 117, 140, 167, 176, 184, 268, 275, 277–278, 284, 286–287, 291 surplus value 22, 33, 53, 200–201, 223, 254–258, 260–266, 293–295 technical change 8, 37, 39–41, 47, 49, 52, 56–58, 67, 70, 75, 77, 87, 105, 108, 121, 133, 140–141, 147, 152–153, 157, 197, 206, 225, 242, 244, 247–249, 255, 257, 259–260 unemployment 2, 17, 20, 39, 44, 62, 65, 67, 70, 73, 76, 78–79, 84, 87, 90–91, 95, 97–98, 101–102, 109, 123, 142–143, 161, 166–167, 169, 183, 192–193, 195,

300 Index 221, 223, 237, 256, 269, 272–273, 276, 286 unit costs 8–11, 16, 24, 39, 50–53, 56, 66, 73, 75, 84, 92, 95, 122, 141, 152–154, 157, 178, 181, 199, 206, 237, 242–243, 250, 254, 278–281, 286

wage share 8, 22, 40, 47, 51, 67–68, 71, 85, 99, 101, 104–105, 121, 124, 131, 133, 135, 140, 174, 176, 208, 219, 241–242, 256, 263, 286 wealth effect 1–2, 25, 68, 97, 117, 123–124, 194, 270–271

wage repression 12, 62, 95, 106–107, 110, 128

zombie companies 14, 171, 274, 276, 279