Green Shoots, Profits, and Great Depressions (or Recessions)

In the months following the outbreak of the financial crisis in late 2007, the general climate among economists and economic commentators was kind of a stupor.  Mainstream economists and conservative politicians — who had clamored for decades for the government to keep its hands off the economy, for balanced budgets, and for taxes as low as possible — were conspicuously silent, or seemed to have suddenly accepted the Keynesian tenets championed by economists like Paul Krugman and Joseph Stiglitz.  If the issue was to save the financial system — which actually meant the riches of bank owners and millionaire partners of hedge funds — the intervention of the State was welcome.  For several months, governments, elected representatives, and economic commentators agreed on doing “the only thing that could be done,” which was to inject massive quantities of taxpayer funds into the financial system to avoid a massive collapse of banks, insurance companies, investment funds, and all the other institutions that compose the so-called financial sector.  Even for Dough Henwood of the Left Business Observer, there was no alternative to supporting the bailout of the financial system — we were all held hostage by the banks.  Letting banks and financial corporations like AIG go down would have been the demise for the whole society, they said.  However, considering both the short-term and the long-term consequences of some other major financial disruptions, like the ones that occurred in Southeast Asia in the late 1990s, or the Argentinean one in 2001, it seems that the claims about the societal consequences of a financial meltdown were quite exaggerated.  For instance, in terms of social costs — meaning misery, homelessness, disease, and death — the transition of the centrally planned economies of the old Soviet Union and Eastern Europe to free markets in the early 1990s seems to have been incomparably more costly than any of the recessions or financial meltdowns in the market economies during the second half of the twentieth century.  According to UNICEF estimates reported in The Lancet, more than 3 million premature deaths in the countries of Eastern Europe and the old USSR can be attributed to the transition process, led by Boris Yeltsin, Jeffrey Sachs, and other benefactors of humanity.  Contrarily, to the puzzlement of many, in market economies the secular trend to health progress tends to improve during recessions and to deteriorate or even revert during expansions.

During 2008, the disagreements among most economists and between Republican and Democratic politicians on economic policy were mostly in the details and the nuances.  They all basically agreed on cutting taxes — the major thrust and almost sole content of Bush’s economic policy — as proved by the bipartisan economic stimulus of early 2008 that so miserably flopped.  The basic consensus continued, though some cracks began to appear when the financial crisis erupted and Treasury Secretary Paulson started the policy of throwing billions of dollars into the black hole of bank debts generated by the failing worldwide market of derivatives.  During the late months of 2008, however, the bailouts to banks and financial institutions approved by both Democrats and Republicans and acquiesced to by almost all economists created huge popular discontent, an indication of a widening gap between “economic experts” and the people in the street.  It was not surprising, then, that in the last months of 2008, economic commentators linked to unions or liberal think tanks started to affirm that more of the bailout measures must be directed to help the real economy — workers or home-owners at risk of foreclosure.  At the same time, more conservative economists like Gregory Mankiw timidly expressed doubts on the soundness of big government spending because of the unwanted consequence of a too big public debt to be paid by future generations.  Hal Varian, the author of a standard text of microeconomics, joined the chorus approving the bailouts of the financial institutions, but commented rather shyly that promoting private investment would be the best way to stimulate the economy.

The inauguration of Obama’s presidency, the vote in the House for Obama’s stimulus plan, and the fact that major voices joined the group using the term “nationalization” in discussing what had to be done with the failing bank sector in the United States seem to have been the incantations that broke the spell.  On January 28, the same day the Democrats in the House — except a handful — voted the $825 billion stimulus package without even one Republican voting in favor, a full page ad in The New York Times was published, sponsored by the Cato Institute, in which over 200 economists — including major names like Eugene Fama, Deepak Lal, Deirdre McCloskey, and the Nobel laureates James Buchanan, Edward Prescott, and Vernon Smith — rebutted “With all due respect, Mr. President,” Obama’s assertion that there is general agreement that government action is needed for “a recovery plan that will help to jumpstart the economy.”  The short text of the ad states that

Notwithstanding reports that all economists are now Keynesians and that we all support a big increase in the burden of government, we do not believe that more government spending is a way to improve economic performance.  More government spending by Hoover and Roosevelt did not pull the United States economy out of the Great Depression in the 1930s.  More government spending did not solve Japan’s “lost decade” in the 1990s.  As such, it is a triumph of hope over experience to believe that more government spending will help the U.S. today.  To improve the economy, policy makers should focus on reforms that remove impediments to work, saving, investment and production.  Lower tax rates and a reduction in the burden of government are the best ways of using fiscal policy to boost growth.

In recent months, major blows have been exchanged in the intellectual debate on the present crisis.  Arguments have sprung up between Keynesian economists supporting the interventionist actions of the administration and often considering them insufficient and the more conservative economists supporting the criticism of the Republican party, scandalized to the marrow by the increasing level of “socialism.”  Economists like Paul Krugman and Joseph Stiglitz who can be considered to the left of the Obama Administration — to use a conventional terminology — argue that the stimulus is not sufficiently massive and even accuse Director of President Obama’s Economic Council Larry Summers and Treasury Secretary Timothy Geithner of applying an economic policy of socialism for the rich.  Republicans raise their voices arguing unconvincingly that the Obama Administration is pushing America toward socialism or, at least, toward major financial turmoil and inflation.  While Robert Barro defends the orthodoxy of neoclassical economics by labeling as “voodoo economics” the government’s Keynesian policy of fiscal stimulus, Paul Krugman counters with a blunt claim that we’re living in a Dark Age of macroeconomics.  He even asserts that work in macroeconomics in the past thirty years was useless at best and harmful at worst.  At any rate, besides the spectacle of the uproar among academic economists (always a nice one for those who believe that what is today taught as economics is to a large extent useless for understanding economic reality), we have to deal with the real issues of the condition of the world economy, particularly now that for several months “experts” have been appearing in the media arguing that the economy is showing green shoots and that we are now at the beginning of the recovery, in spite of the November news that put the national unemployment rate in double digit levels.

In the modern jargon of politicians and media publicists, our present economic system is called the free enterprise system, the free market system, or the private enterprise system.  When this system began to have a well-defined existence in England in the eighteenth century it was sometimes called “the factory system.”  Adam Smith called it “the commercial society,” Marx “the bourgeois economy,” other authors “capitalism,” and the institutionalist Wesley Mitchell called it “the money economy” or “the profit economy” — a term particularly appropriate, in my view.  From the time that authors began studying the workings of this system, it was observed that a basic component of it was periods in which the economy was seriously disturbed, markets were overflowing with unsold products, many businesses were failing, and workers were being laid off in great numbers.  A controversy developed when the French economist Jean Baptiste Say argued that it was impossible for a “general glut” of the market to occur, though partial gluts might occur if too much of something was produced in a particular sector of the market so that an excess supply appeared in that sector.  But in general, proposed Say, “supply creates its own demand,” and the flows of money created in the production of all goods and services supplied to the market — money paid for wages, for raw materials, for land, etc. — have to be sufficient to buy back, that is, to create effective demand for, all those goods and services.  That is Say’s law, or the law of markets, which has been a permanent theme among economists since the time when it was first stated two centuries ago.

Classical economists followed Say in rejecting the possibility of a general glut.  However, though the concept of profit was a key element for Adam Smith and David Ricardo, the recognized founders of economics, in the controversy on the general glut profits were basically ignored.  When economics was built in the last decades of the nineteenth century and the early twentieth century, two of its most important pillars were Adam Smith’s invisible hand, which “organizes” markets to produce what is needed so that the outcome is the common good, and Say’s law that a general glut, a general situation of total supply exceeding total demand, is not possible.  The general assumption of economists then was that a self-correcting mechanism would lead markets to avoid by themselves any major disruption or, at least, to recover themselves quickly.  Since the general tendency was believed to be toward equilibrium and harmony, absent any planned intervention, when the Great Depression hit the world in the 1930s, major economists like Irving Fisher and Joseph A. Schumpeter followed the basic tenets of their science, and claimed that markets would recover by themselves.  The best thing governments could do was to allow the economy to heal itself.  It was a dangerous prescription, however, when millions and more millions were becoming unemployed and needed income to satisfy their needs.  If markets were going to recover themselves, they were taking a quite long time, because the dreadful decay in economic activity that took place in 1930 continued for three years, until in mid-1933 visible signs of recovery appeared.

In the nineteenth century there had been major critics who rejected Say’s law and the idea that general gluts were impossible.  Three prominent ones among them were Thomas R. Malthus, Simonde de Sismondi, and Karl Marx.  The three of them denied the impossibility of general gluts, arguing that situations of total supply exceeding total demand were common in the history of modern industrial nations.  Nevertheless, while Malthus was a defender of the status quo and believed general gluts were basically short-run problems that could be solved by allowing for increased landlords’ consumption, both Sismondi and Marx considered general gluts — or industrial crises as Marx called them — to be symptoms of the irrationality of the capitalist system.  For Sismondi and Marx, another economic system had to be organized to overcome the recurrent decays of capitalism.  Not surprisingly, Sismondi and Marx were always held under a cloud of unacceptability among academic economists, and when the idea of the general glut came to the fore again in the twentieth century from the work of John Maynard Keynes, its source was Malthusian.

Before the Great Depression hit economies worldwide in the 1930s, major recessions had occurred in the 1920s in several European countries, and governments had started to intervene in the economy to ameliorate persistent unemployment.  In the United States it was President Roosevelt who under the force of circumstances initiated in 1933 the programs to stimulate the economy that were collectively known as the New Deal.  Indeed, the economy started to recover in 1933 and economic growth, which had been negative in the previous three years, turned strongly positive.  The unemployment rate, which had reached a peak of almost 25% in 1933, started to decline, falling to 17% in 1936 and 14% in 1937.

Economists have hotly debated the causes of the Great Depression, the recovery that followed in the mid-1930s, and the subsequent recession in 1938.  Most theories are only tentative and prominent economists often recognize that much is yet unclear and not understood about the Great Depression.  Some facts, however, are not disputed.

Between 1929 and 1993, a quarter million business firms in the United States — among them hundreds of banks — disappeared.  The most dramatic declines in the number of firms were in manufacturing, where the total dropped by 35%, and in construction, where it dropped by 21%.  Millions of workers lost their jobs and wages declined under the pressure of mass unemployment.  By 1933, weekly wages in manufacturing had dropped down to a level about two-thirds of what they were in 1929.  All of this, added to the prescriptions of the National Recovery Administration that permitted businesses operating in the same sector to agree on prices, allowing for a generous margin of profit, made investment again an attractive option for the wealthy, and industrial activity jumpstarted.  Profits that had been negative in 1932 and 1933 became positive in 1934, growing 42% in 1935 and 45% in 1936.  Though the unemployment rate dropped in the mid-1930s, it was still at high levels and to a considerable extent economic activity was dependent on government demand financed with deficit spending.  When Roosevelt tried to reduce government deficits by cutting government spending in 1938, economic activity dropped and the economy again went into recession, with unemployment rising again to almost a fifth of the labor force.

The recovery of 1933 and other historical examples indicate that business profit is the basic drive of the market economy.  As a rule, profits start falling before recessions, drop strongly when the recession opens, and rise again when the economy reaches the bottom.  The recovery of profits leads to the start of a new expansion.

Since profit is the surplus money that is obtained when money is “invested,” a business is simply a pile of money “organized” to get more money.  This is applicable both to big corporations such as Boeing and Microsoft and to tiny “mom and pop” businesses like those that Republicans so proudly tout as a key element of the American economy.  There is no business without profit.  As Wesley Mitchel said, an essential feature of the “money economy,” the ancient institution which “has attained its fullest development in our own day,” is that “economic activity takes the form of making and spending money incomes,” so that “natural resources are not developed, mechanical equipment is not provided, industrial skill is not exercised, unless conditions are such as to promise a money profit to those who direct production.”

Recessions often start with a financial crisis in which banks, insurance companies, and other financial firms go bankrupt.  But below the phenomena in the financial sphere, in the so-called real economy where goods and services are produced, recessions start with a stagnation of sales which reduces profits, which in turn reduces the incentive to keep or build up inventories.  Investment in wages, raw materials, and new machines or production facilities also falls and this in turn reduces the level of business activity, since business failures and reduction of business activity reduce both wages and investment, which are the two basic sources of demand.  This is a vicious cycle that may operate for months, or for years, bringing the economy to a mild recession like that of 2001 or to a severe one like the one we are seeing now, or the Great Depression of 1930-1933.

Marx thought that the crisis itself is the built-in mechanism that brings the economy back to expansion.  In his view, during periods of economic expansion profits grow only to eventually decline, triggering the crisis, but the crisis itself, by eliminating business, putting an enormous downward pressure on wages as a result of massive unemployment, and cutting the cost of raw materials and other elements of capital, eventually creates the conditions for new profitable investment and for new expansion.  In the early 1930s, financial distress in the business sector was very uneven, with aggregate corporate profits before tax going negative in 1931 and 1932, and after-tax retained earnings were negative in each year from 1930 to 1933.  However, as Bernanke explained in a scholarly paper published in 1983 in the American Economic Review, corporations holding more than $50 million in assets maintained positive profits throughout this period, leaving the burden to be borne by smaller companies.  “Mom and pop” businesses were major casualties of the crash of the early 1930s, and that will probably also be the case in the present slump.

What the present recession has proved is the key role of the government in maintaining the economy and the economic and political power of big business.  Since fall of 2008, the U.S. government, under first a Republican administration, and then a Democratic one, pumped billions of taxpayers’ money into the financial system.  President Obama said that this had to be done to avoid the whole system “falling down on our heads.”  The reality is that it is very arguable to what extent the nationalization of several dozen failed banks and insurance companies would have triggered a bigger recession than the one we are in now.  What is not arguable, however, is that, by saving Citibank, Bank of America, AIG, and other major financial corporations, the government of the United States helped to maintain the value of major investments.  Particularly by saving AIG, the insurance company that had insured other financial companies in their stock market ventures, the government’s intervention created the conditions for massive transfers of taxpayer money to the banks, through the conduit of insurance payments from AIG.  At the same time, unemployment continues to grow and even the most optimistic economic forecasters don’t expect any reduction in unemployment until the summer of 2010.  It is hard to know, however, if the so-called green shoots in the economy are real, or just a mirage produced by the wishful thinking of those who never saw a major recession like the present one coming and who cannot conceive of another Great Depression like the one of the 1930s occurring now.

Now that the world economy is to a large extent unified, the fact that almost all countries in the world are in a recession is another factor contributing to make the crisis deeper and longer.  The harder the recession, however, the more failed businesses, the more people unemployed and ready to work for much less than they earned previously, the closer will be a recovery, because the more favorable will be the conditions for successful investment.  Enormous quantities of money, “invested” in Treasury bonds yielding almost nothing, or deposited in bank accounts, or even in safes in private residences (on March 6 the New York Times reported booming sales of safes), now sit waiting for the opportunity for profitable investment.  That will be the flow of demand that will create jobs again and trigger an economic expansion.  Whether that is going to occur during the last quarter of 2009, or much farther in the future, is hard to know.  But by sustaining failing corporations, creating business activity by fiscal policy, and providing some relief to the needy, the government is ameliorating the social impact of the recession and avoiding the mechanism that makes recessions evolve by themselves into expansions.  Unfortunately for the human beings who have to suffer them, the deeper and harder economic recessions are, the more businesses are destroyed, and the more workers are made redundant, the stronger will be the subsequent “prosperity.”

As Lord Keynes saw it, capitalism has suicidal tendencies and the task of economists is to avoid letting those tendencies materialize.  Wouldn’t it be better to say that capitalism, like any other economic system or human institution, has its own historical life and then has to die to allow for human progress?  Just as cannibalism, feudalism, slavery, and the peculiar “state communism” of the old Soviet Union and Maoist China disappeared into history, capitalism will have to disappear to allow for a system more in agreement with the present stage of human civilization.  That stage has led us to form a global society in which national states and governments have become historical relics, increasingly unable to cope with worldwide problems that require worldwide solutions.  When an increasing number of governments in the world have nuclear weapons at their disposal and when in almost every country a large proportion of what is consumed is produced in other countries, does it make any sense that kings exist (not only in Swaziland, but also in Sweden), that enormous armies are maintained by nation states at the ready against one another, and that in many parts of the world people are put in jail just for airing their opinions, while the rest of humanity looks in other direction?

As the first decade of the twenty-first century comes to a close, it is difficult to be optimistic about the future of humanity.  The governments of the most powerful countries are all strongly committed to building military strength.  The United States continues to be involved in two wars and the Obama administration is doing nothing to punish the heinous acts of torture and illegality that were actively promoted by the former administration.  The Russian government, empowered by massive inflows of cash due to high oil prices, has partially recomposed the strength lost when the former Soviet Union broke up in the 1990s, and is now actively involved in reclaiming and reasserting its sphere of influence in Central Asia and the Caucasus, while horrendous political crimes and abuses against political dissidents indicate that respect for civil rights has reached a very low level there (a friend of mine, married to a Russian, says that, according to his wife, in the past it was the Communist Party that was in power, now it is just the KGB).  China continues to reinforce its military forces, demonstrating that Chinese integration into world capitalism does not preclude but, contrarily, promotes the conversion of China into a world military superpower under the most tyrannical absolutism.  Finally, the proliferation of nuclear weaponry in Korea, India, China, Pakistan, Israel, and probably Iran very soon — all of them nations plagued by political, nationalistic, religious, or ethnic strife — only increases the risk of an eventual use of nuclear weapons.  If the potential threat for the future of humanity posed by nuclear war were not sufficient, we have also that of global warming, which will change the global climate in unexpected ways, but with a high degree of certainty will displace hundred of millions from the coastal areas that eventually will be taken by the sea if Greenlandic and Antarctic ice melt into the sea.

The twenty-first century had as its symbolic start the attacks, on September 11, 2001, on the World Trade Center and the Pentagon, two emblematic symbols of American supremacy in the world.  Almost a decade has passed since those events, a decade in which the United States successfully fought a conventional war against Iraq and unsuccessfully fought a low intensity war — mostly in Afghanistan and Iraq — against Islamic fundamentalist organizations.  Though the United States is still the first power in the world, it is clear that its strength is increasingly being challenged not only by other countries, but also by forces steeped in backward ideologies and narrow views of the world.

The present economic crisis, affecting the whole world, indicates how important it is that human beings learn to think in global terms and promote solutions that will be valid only if they are possible for all human beings, and not only for those of this country or that religion or continent.  Only advancing in that way will it be possible to avoid making the twenty-first century the one in which humanity will disappear by its own acts, or be taken back to some form of barbarism.

In the meantime, we will have to wait and see if the present crisis is solved by allowing profits to be made again.  If that occurs, jobs will also come, though later.  Although economists rarely refer to profits when talking about “the business cycle” and recessions, business people and financiers know that profit is what is all about.  Andy Kessler, a former hedge-fund manager, explained it clearly in The Wall Street Journal (May 12): “You can have a jobless recovery, but you can’t have a profitless recovery. . . .  For now, the market appears dependent on a hand cranking out dollars to help fund banks.  I’d rather see rising expectations for corporate profits.”



The social and health disaster in Eastern Europe during the transition of the 1990s is documented by Stillman (“Health and Nutrition in Eastern Europe and the Former Soviet Union during the Decade of Transition,” Economics & Human Biology 2006 4:104-146) and by several authors in the book edited by Cornia and Paniccià (The Mortality Crisis in Transitional Economies, Oxford University Press; 2000).  In Collision and Collusion: The Strange Case of Western Aid to Eastern Europe (Palgrave; 2001), Janine Wedel has documented some political aspects of that transition.

The health aspects of recessions and expansions in market economies have been investigated by Abdala (in the chapter on Argentina in the aforementioned book edited by Cornia), by Ruhm (“Are Recessions Good for Your Health?” Quarterly Journal of Economics 2000; 115:617-650; “Deaths Rise in Good Economic Times: Evidence from the OECD,” Economics and Human Biology 2006; 4:298-316) and by myself (“Life and Death during the Great Depression,” Proceedings of the National Academy of Sciences 2009 Sept 28;  “Macroeconomic Fluctuations and Mortality in Postwar Japan,” Demography, 45: 323–343, 2008).

For views of economists on the recent crisis, see “Paul Krugman’s London Lectures” (The Economist 2009 Jun 11th), Henwood presentation on “The Deepening Economic Disaster” available at nyusocioogy. org/blogs/radical/2008/12/08/the-deepening-economic-disaster/, 2009, Krugman’s “Boiling the Frog” (New York Times 2009 July 13), Barro’s “Demand Side Voodoo Economics” (The Economists’ Voice 2009, 6(2):1-4), Mankiw’s “What Would Keynes Have Done?” (New York Times 2008 Nov. 30). and Thomas Palley’s website (www., Stiglitz’s “America’s Socialism for the Rich” (Guardian 2009 June 12) and “How to Rescue the Bank Bailout” ( 2009 Jan. 26) and Hal Varian’s “Boost Private Investment to Boost the Economy” (Wall Street Journal 2009 Jan 7).

For the views of three key authors (Marx, Mitchell, and Keynes) on the recurrent expansions and contractions in market economies, see William Blake’s An American Looks at Karl Marx: Elements of Marxian Economic Theory (New York, Cordon, 1939), Wesley Mitchell’s Business Cycles and Their Causes (New York, NBER, 1942), Paul Mattick’s Marx and Keynes: The Limits of the Mixed Economy (Sargent, 1969), and Michael Polanyi’s Full Employment and Free Trade (Cambridge University Press, 1945).

Statistics from the Great Depression and views of economists on the economy during the 1930s are taken from Historical Statistics of the United States: Millennial Edition Online (Cambridge University Press; 2006), Lee’s Economic Fluctuations (Irwin, 1955), and two collections of interviews collected by R. Parker: Reflections on the Great Depression (Edward Elgar, 2002) and The Economics of the Great Depression (Edward Elgar,  2007).

José Tapia is a researcher presently at the Institute for Social Research, University of Michigan, Ann Arbor.  He studied medicine in Spain and public health and economics in the United States.  His field of research is the relation between macroeconomic changes and changes in population health.

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