Chris Harman

Economics of the Madhouse

Chapter 2
Explaining the crisis

9. Boom and slump

The history of industrial capitalism has been a history of booms and slumps – of what establishment economists call ‘the business cycle’. For nearly 200 years there have been spells of frenetic expansion of production interspersed with sudden collapses, in which whole sections of industry grind to a halt.

We have been through three such recessions in the last 20 years, and each has imposed a heavier burden on those who work than the one before, with people’s lives devastated as they have lost their livelihoods – and sometimes their homes as well. Such periodic crises are built into the way the system runs.

Each firm is out to maximise profits. If profits seem easy to make, then firms right through the system expand their output as rapidly as possible. They open up new factories and offices, buy new machinery and take on employees, believing they will find it easy to sell the goods that are turned out. As they do so, they provide a ready market for other firms, who can easily sell plant and machinery to them, or consumer goods to the workers they’ve employed. The whole economy booms, more goods are produced, unemployment falls.

But this can never last. A ‘free’ market means there is no coordination between the different competing firms. So, for example, the car manufacturers can decide to expand their output, without there being at the same time any necessary expansion by the firms that make steel for car bodies or the plantations in Malaysia that produce rubber for tyres. In the same way, firms can start taking on skilled workers, without any of them agreeing to undertake the necessary training to increase the total number of such workers.

All that matters to any of the firms is to make as much profit as possible as quickly as possible. But the blind rush to do so can easily lead to the using up of existing supplies of raw materials and components, skilled labour, and finance for industry.

In every boom that capitalism has ever experienced, a point has been reached at which shortages of raw materials, components, skilled labour and finance suddenly arise. Prices and interest rates begin to climb – and this in turn encourages workers to take action to protect their living standards.

The boom inevitably results in rising inflation. And, more seriously for the individual capitalists, rising costs quickly destroy the profits of some firms and force them to the edge of bankruptcy. The only way for them to protect themselves is to cut back production, sack workers and shut down plants. But in doing so they destroy the market for the goods of other firms. The boom gives way to a slump.

Suddenly there is ‘overproduction’. Goods pile up in warehouses because people cannot afford to buy them. The workers who have produced them are sacked, since they cannot be sold. This means workers can buy fewer goods and the amount of ‘overproduction’ in the system as a whole actually gets greater.

The car industry cannot sell as many cars as in the past, so it buys less steel. As a result, steel plants are shut down and steel workers sacked. But the sacked steel workers cannot buy cars, and so fewer cars are produced. It is the turn of car workers to be sacked, but then they cannot buy things like washing machines or fridges made of steel, so less steel is required, more steel plants are shut, more steel workers are sacked and fewer cars can be bought. There is a vicious circle in which each firm claims it can only survive by holding down wages, pushing up productivity and sacking workers. But every time it does so, it means fewer markets for other firms, more sackings and wage cuts there and eventually, a smaller market for its own goods.

The turn from boom to slump always takes big business by surprise. All through the late 1980s establishment figures on both sides of the Atlantic proclaimed that their economies were doing miraculously. In 1990 the British Tory prime minister, John Major, and his chancellor of the exchequer, Norman Lamont, proclaimed repeatedly that there would be no recession. Almost all the professional economic forecasters backed them up. ‘The good news in the latest Economic Outlook from the Organisation for Economic Cooperation and Development is that economic activity in the industrialised world has settled to a sustainable 3 percent economic growth rate’, reported Peter Norman in the Financial Times.

Then, as if from nowhere, the slump broke. The same Peter Norman now reported ‘a litany of grim economic news. Practically all the indicators about declining output, falling retail sales and rising unemployment have been worse than expected’. The Financial Times itself was absolutely baffled as to what had happened. ‘We are in the dark,’ admitted one of its regular columnists. Lamont now spoke of recessions as if they were a natural phenomenon like the ebbing and flowing of the tide. His predecessor, Nigel Lawson, who had boasted most about the alleged ‘economic miracle’ of the 1980s now insisted, ‘The economic cycle is a fact of life. There always have been and there always will be these ups and downs.’

As Marx noted, businessmen always think things are going wonderfully until the slump suddenly breaks: ‘Business always appears thoroughly sound until suddenly the debacle takes place.’ But break the slump always does. And it always leads to a massive devastation of people’s lives and a massive waste of resources. Yet the response of employers and governments to the slump is always to tell people that there is ‘not enough to go round’, and that ‘everyone has to make sacrifices’ and ‘tighten their belts’.

In the recession of the early 1990s the British economy produced in each year at least 6 percent less than it could have done – leading to a total loss of up to £36 billion of output each year for nearly three years. To put it another way, the loss each year was nearly as much as the cost of the National Health Service. The recession was less serious in the US than in Britain. Nevertheless, its output loss was more than 50 billion dollars per year. If it had grown modestly, there would have been an extra 150 billion dollars of output a year – a figure equal to that which the whole black population of sub-Saharan Africa have to live on.

And that is by no means an exhaustive account of the total waste involved. For this was not the first, but the third crisis the Western world had gone through in the previous 16 years. If the Western economies had been able to grow through these years at the same average speed as in the 20 years before, then total output would have been more than 40 percent higher than it was.

The waste resulting, worldwide, from economic crises is much greater than that caused by all the natural catastrophes – all the earthquakes, volcanic eruptions, floods and epidemics – combined. But economic crises are not natural disasters.

The means of producing the things people desperately need continue to exist just as much in the midst of an economic crisis as before – on the one side, the factories, mines, dockyards, fields, etc capable of turning out goods, on the other the workers capable of labouring in them.

It is not some natural catastrophe which stops unemployed men and women working in the closed down industries, but the organisation of capitalism.

10. Capitalist economics and the economic crisis

Despite the waste and devastation of people’s lives caused by capitalist crisis, most mainstream economists have tried to pretend that they do not really happen. They have followed a ‘law’ developed by a French economist who lived two centuries ago, Jean Baptiste Say. He said that crisis is impossible, since every time a good is sold by someone it is bought by someone else. This law is built into the ‘marginalist’ or ‘neo-classical’ school of economics today.

It claims ‘the invisible hand’ of the market automatically ensures that any goods produced can be bought, that ‘supply’ equals ‘demand’. The prices of goods, it says, act as signals telling capitalists what to produce. This ‘theory’ underlies all the fashionable praise for markets by politicians throughout the world today. It is their justification for dismantling controls, privatising industries and declaring that socialism is ‘out of date’.

The ‘theory’ is full of holes.

Price ‘signals’ can never relate output and demand, selling and buying, production and consumption, smoothly. Production is always a process taking place in time. ‘Price signals’ do not tell you what will be wanted when production is finished, but what was wanted before it began.

This time factor creates immense problems, even with the simplest forms of commodity production like the growing of grain by a mass of small farmers. If there is bad weather one year and the crop suffers, then prices do indeed rise. This cannot, however, cause more production of grain that year. In the real world (as opposed to the world of the market theorists) the farmers have to wait until the following spring to sow their next crop. They may respond to ‘price signals’ by sowing a bigger area than previously. But unless, by coincidence, one year of bad weather is followed by a second such year, the only result will be to produce more grain than consumers demand.

The best known such problem is called the ‘pig cycle’, because pig farmers repeatedly find that either the demand for pork exceeds the number of pigs they have ready to sell, or the number of pigs on their hands is much greater than the willingness of people to buy pork. But similar ups and downs have always beset every sort of agricultural production.

The cycles do not go away when you move from a world of small farmers to one of giant capitalist firms. In fact they get worse.

Industrial production does not begin just a few months ahead of final consumption. It depends upon making a huge investment in fixed capital, on building factories and installing machinery, over several years. Since there is a ‘free market’ there can be no coordination between rival firms. And so alternations of ‘overproduction’ and ‘excess demand’, of slump and boom, are even more pronounced than in a purely agricultural system.

The only way for the orthodoxy to get round the problem is to ignore it. This was openly recognised by one of the founders of ‘marginalism’, Leon Walras. ‘We shall resolve this difficulty’, he wrote, ‘purely and simply by ignoring the time element at this point’. Roy Radner, an economist who set out in the late 1960s to prove mathematically that the competitive market economy would produce an equilibrium – a stable balance between what was produced and what was required – was forced to conclude that this was impossible. For it assumed that those involved in the system would have to work out, in advance, how they would respond to all the possibilities facing them at any point in the future. The model of a perfect balance, he concluded, ‘breaks down completely’ faced with the impossibility of people doing so.

In fact, in the real world, if an equilibrium is eventually reached between production and consumption, it is not by a smooth, efficient, painless fitting together of supply and demand, but by violent convulsion – the slump.

Two schools of pro-capitalist economists have recognised this.

The great crisis of the 1930s led some economists, most notably John Maynard Keynes, to reject the crude version of Say’s law. Keynes was a supporter of capitalism – he himself made a fortune speculating on the stock exchange – but he wanted to save it from itself. He accepted much of the theoretical framework of the dominant ‘marginalist’ economics. But if the system were left to itself, he argued, slumps would occur in which both the market for goods and the output of them fell, so that ‘supply’ and ‘demand’ were only equal to each other because both were at a very low level. This led him to reject the conventional wisdom of his day – and of our day more than 60 years later – that the economy would automatically blossom if only governments stopped ‘poking their noses’ into the economy. Keynes held, to the contrary, that only government intervention could stop slumps.

In the 1940s, 1950s and 1960s such views were incorporated into an amended version of ‘marginalism’ to become the orthodoxy accepted by governments of all complexions and taught to economics students. John Samuelson, the Nobel prize winner who wrote the best selling economics textbook of the time, boasted in it that slumps would never happen again: ‘The National Bureau of Economic Research has worked itself out of one of its first jobs, namely business cycles.’

Such faith in government intervention in the system did not survive the big recession of 1974-76. Virtually overnight economists and politicians who had preached the Keynesian doctrine for 30 years suddenly changed their minds. As the American economists Mankiw and Romer have pointed out, the ‘Keynesian consensus’ was replaced by a return to the old idea ‘that markets always clear’ and that ‘the invisible hand always guides the economy to the efficient allocation of resources’.

Economists and politicians now embraced, to varying degrees, a doctrine called ‘monetarism’. This held that, far from government intervention being necessary, governments should not intervene, except to keep in check the total amount of money in the economy and to stop ‘unnatural monopolies’, like that which trade unions were said to exert when they defended living standards.

The triumphal return of the old orthodoxy in the late 1970s and 1980s was marked by a return of the assumption that the market always brought supply and demand together perfectly. This confidence was most fully articulated by the Thatcher wing of the Tory Party in Britain and by those who embraced similar ideas in the former Eastern bloc and the Third World. But it was also echoed by many who used to be on the left.

But there was a barely noticed contradiction within the ideas of the Thatcherites themselves. For they were very much under the influence of a second dissident school, the so called ‘Austrian school’ whose best known figure was Friedrich Hayek. He had always opposed Keynesianism and state intervention, on the grounds that this produced ‘tyranny’ and undermined the ‘dynamism’ of the market. But he had never accepted the neo-classical, marginalist scheme, with its denial of crisis. He recognised that the system was inevitably prone to destructive ups and downs, referring to ‘equilibrium’ as ‘a somewhat unfortunate term’.

Hayek also accepted that the market often produces the opposite of what people want. ‘Competition is only valid in so far as its results are unpredictable, and on the whole differ from those which anyone has, or could have, deliberately aimed at.’ ‘Spontaneous order produced by the market does not ensure that what general opinion regards as the most important needs are always met before the less important ones.’

Hayek at his most frank insisted that the market did not lead to a smooth balance between supply and demand, but proceeded through what his fellow ‘Austrian’ Joseph Schumpeter called ‘creative destruction’, resulting not in an economic equilibrium but an economic ‘order’.

This is not, however, a very palatable economic doctrine for politicians seeking votes or ideologists seeking converts. After all, the ‘creative destruction’ is of the livelihoods – and sometimes the lives – of millions of people. So the version of Hayek’s ideas that is usually preached today is a hybrid version, in which the ‘neo-classical’ notion of a smooth equilibrium replaces the idea of ‘creative destruction’.

The image we are presented with is that instant prosperity will follow if only people embrace the market without reservations.

This is what people in the former Eastern bloc were promised after the old Stalinist economies entered into deep crisis in the late 1980s. The market, they were told, would bring about ‘economic miracles’ such as West Germany had allegedly experienced in the 1950s and 1960s – and would do so in ‘400 or 500’ days.

The same message has been handed out by the International Monetary Fund to some 60 or 70 ‘third world’ countries with its ‘structural adjustment programmes’. And the British Tory party’s main message in the 1992 general election was no different. The economic recovery would start, it promised, the moment it was returned to power with its programme of spreading the market still wider.

In each case the reality that followed was not equilibrium, but destruction. In the case of the East European countries it meant destruction of between 20 and 40 percent of industry through the worst slumps history has known. In the countries of Africa there were massive cutbacks in people’s living standards as a continent that had been able to feed all its people 20 years before became home to millions of starving. In the case of Britain, it meant the worst slump since the 1930s.

11. How the crisis breaks

Enthusiasm for the allegedly miraculous powers of the market is usually greatest during booms. As profits grow, capitalists stampede past each other in the rush to produce more and more goods. Some of the wealth the very rich control spills over into the hands of those just below them. Contractors make profits erecting new warehouses, factories and offices. Advertising agencies find an apparently unlimited demand for their services. Estate agents prosper as properties change hands at growing speed. Whole sections of the middle class feel that they only have to set up in business on their own and money will drop into their laps.

All of these groups buy growing numbers of goods themselves, creating a rising demand for luxuries from champagne and caviar to porsches and penthouse suites. They also add to the demand for the labour of the mass of workers, as there are more jobs in building sites and car showrooms, estate agents and travel agents, banks and finance houses, in taking down tele-ads and in printing advertising supplements. These new workers find they can buy things they were not able to afford – and this, in turn, leads to more demand for the things produced by a whole range of other workers, from those in car and textile factories to those in fast food outlets and DIY shops.

Eventually unemployment falls – even if, as today, it is still not as low as it once was. Employers, desperate to employ particular grades of skilled workers, bid against each other for them and push wages up a little. Other workers, less frightened by the threat of redundancy, begin to demand their share of the ‘prosperity’ they hear about from the media and put in wage claims which employers sometimes feel they have to concede.

At the bottom of society very wide numbers of people still do not notice any real improvement in their position. Even workers who get wage increases find these do not compensate for rising prices. But for a brief moment the claim that the market equals prosperity seems, to anyone who does not look beneath the surface of events, to correspond to reality.

All the factors that turn the boom into a slump are already developing when the boom is at its height – rising prices, a growing shortage of finance for new investment, an upward movement of some skilled workers’ wages. But they are concealed by the frenetic character of the boom. Indeed, even as they begin to cut into some profits, they can lead to a rise in speculation, and a feverous race to grab still more profit. Capitalists who believe that there are never ending opportunities for profit switch their money from one sector to another at great speed – buying raw materials on the assumption that they will be able to sell them at a higher price, financing office building in the expectation of ever rising rents, swinging behind the latest advertising venture, pouring huge sums into the stock exchange on the assumption that share prices can never fall. Even workers can get pulled into the speculative orgy, borrowing to the eyeballs to buy houses in the belief that their price will rise.

Crooks and conmen of all sorts prosper in this get rich quick atmosphere. Any small scale crook who hawks an enterprise that promises rapid profit, however disreputable the project, is bound to find some buyers. And the giant capitalist who wants to become even bigger by fiddling the books to finance a takeover bid finds it easy to do so.

In this glistening atmosphere, as money seems to rain down on the champagne drinking classes, any connection between the glorious business of raking in profit and the murky business of exploitation in the workplace seems to be lost. So it was, for instance, in Britain in the late 1980s, as the Murdochs and the Maxwells, the Hansons and the Reichman Brothers reigned supreme. Those who had dedicated their lives to the profit system believed their time had come.

Such was the power of the most recent capitalist boom that even some of those who in the past had opposed the system were won over to it. Marxism was condemned on all sides as irrelevant and even a magazine that called itself Marxism Today revelled in the upper middle class fashion for expensive clothes and the delights of mixing with Tory cabinet ministers. We were, it was said, in a post-Marxist world – post-industrial, post-mass production, post-crisis and postmodern.

Then, quite predictably for those who were not ‘post-Marxists’, the crisis struck. One after another the great names of the 1980s went bust – B and C, Colorol, Canary Wharf, Habitat, Maxwell, eventually the post-Marxist Marxism Today.

The tone of the media suddenly changed. Those who had used the business pages of the posh papers to toast the boom now suddenly announced that the system was on ‘the edge of a precipice’, that it was going down and no-one could see the bottom.

This has always happened when boom has turned to bust. So, for instance, the American steel magnate Andrew Carnegie could write in the 1880s:

Manufacturers... see the savings of many years... becoming less and less, with no hope of change in the situation. It is in a soil thus prepared that anything promising relief is gladly welcomed. The manufacturer is in the position of patients who have tried in vain every doctor for years...

This was once more the tone in the early 1930s, where despair was nearly universal in Germany and the US.

At such times economists and journalists who previously accepted the wonders of the market system embrace all sorts of weird and even mystical explanations as to why slumps occur. In the 19th century one of the founders of ‘marginalist economics’ Jevons, blamed them on sunspots which, he claimed, affected the weather. The crisis of 1973-75 led to a sudden fashion for theories which claimed the world was running out of oil and even facing a new ice age. The crisis of the early 1990s has led to even stranger conclusions, like those of William Huston, who, according to the Financial Times, is ‘one of the world’s most respected cycle analysts’. He holds that ‘cosmic cycles’ – for instance the relative positions of the planets Jupiter and Saturn in relation to Earth – can directly cause economic catastrophes. Meanwhile, Sir Roy Calne, professor of surgery at Cambridge University, believes there are simply too many people in the advanced industrial countries to ‘support full employment’ and that the only answer to this is to limit parenting to those who are over 25 and who can provide proof of ‘sufficient maturity and financial resources to take proper care of the child’.

Alongside such lunatic explanations of what goes wrong in a slump are some which contain at least elements of truth. The most common explanation of this kind is the one that blames everything on speculation and speculators. If only this aspect of capitalism could be avoided, it is claimed, then slumps need never happen.

Speculation certainly does play a role. It allows some capitalists to enrich themselves while ignoring the real processes of wealth creation. Speculators make enormous fortunes with each boom by borrowing in order to push up prices and pushing up prices in order to borrow. The result is growing indebtedness which vastly exaggerates the ‘hangover effect’ when the slump eventually comes. Speculation also increases the difficulties for a capitalist government trying to keep any sort of grip on what is happening to the national economy as billions or even trillions of dollars and yens a day flow from one country to another.

However, speculation and speculators are not the cause of the boom-slump cycle. That lies in the capitalist organisation of production, in the competition between industrial capitalists to make profits. Speculation and speculators serve to intensify booms and slumps which would occur anyway. They are not the main parasites leading the system into crisis, but rather parasites which feed off other parasites.

Some politicians and mainstream commentators claim everything would be alright if only the speculators were eliminated. This has often been the argument of those who want a slightly reformed version of the present capitalist system. In 1964, for instance, the British Labour prime minister, Harold Wilson, claimed it was ‘the gnomes of Zurich’ who forced him to abandon his election promises when, in fact, it was pressure from the main sections of British big business. Today economic writers like Will Hutton put most of the blame for the crisis on the ‘short termism’ of the financial institutions of the City of London, virtually ignoring the role played by the big industrialists. And on the far right, fascists and Nazis have always found it easy to rant about ‘financiers’ – claiming they are ‘alien’, ‘cosmopolitan’ or ‘Jewish’ – as a way of diverting people’s anger away from the big industrial capitalists. In fact, industrial capitalists and financial capitalists are rarely two entirely different groups of people. Industrial capitalists will seek to boost their profits through speculation whenever this seems an easy option – for instance gambling on foreign exchange markets – while financial capitalists often seek to enhance their own fortunes by buying up industrial companies.

One final point. People sometimes confuse slumps with the ‘collapse’ of the capitalist system, or at least claim there can never be any recovery from the slump.

But even in the deepest slump, not all capitalists go bust. There will always be some who see ways of making profits out of other people’s poverty – from opening pawn shops and hawking food that’s past its sell by date to setting up as company liquidators or providing security guards to protect the rich from the poor. And so the system can survive even the worst crash unless successful workers’ struggle replaces it with a better form of society.

This means that, although crises do not end automatically and smoothly as supporters of the system claim, a point is eventually reached at which some capitalists are confident enough of profits to begin investing again. In fact, the slump itself makes it possible for some capitalists to increase their profitability and their output by buying up on the cheap the raw materials and machinery of firms that have gone bust. It usually exerts some downward pressure on labour costs as workers, terrified of losing their jobs, accept worse pay and conditions. And once the slump has been going for a time, rising interest rates are usually followed by falling ones, enabling capitalists to borrow more easily.

So it is that after a period of months or sometimes years there is some revival of production – a few more workers are taken on. There are then more markets for other firms which can themselves increase production, take on more workers and so on. The vicious downward circle of the slump can give way to the rising, ‘virtuous’ circle of ‘recovery’ until a new boom results, and with it a new, shortlived spell of super-optimism among the capitalist class and their intellectual apologists. Once again there is talk of ‘miracles’ just as the ingredients come together for yet another destructive slump.


Last updated on 15 November 2009