Sunday, September 28, 2014

How Capitalism Works (5) (1979)

From the May 1979 issue of the Socialist Standard

How Capitalism Works (5): Keynes and Capitalism

An enterprise's rate of profit is the ratio of the amount of profits it makes, say in a year, to the money-value of its assets at the beginning of that year. The average rate of profit of the whole economy is the ratio of total profit to total capital. The rate of profit would tend to fall if over time the amount of the total capital tended to increase at a faster rate than the total amount of profits.

This fall tends to happen as a result of the increasing amount of old wealth that must be used as fixed equipment in producing new wealth (or, what amounts to more or less the same thing, to the increasing size of the means of production in relation to the amount of human labour needed to operate them). Because there are so many offsetting factors, this tendency for the average rate of profit to fall only becomes evident in the very long run and so could not explain the onset of a much shorter term occurrence like a slump.

What else, then, could cause the rate of profit to fall? The ratio would also be reduced if for some reason the amount of profits made on the same amount of capital were to fall. Since profits are what is left after part of the newly created wealth has been allocated for consumption by wage-earners, then they would fall if wages were to rise.

The law of wages tends to keep wages down to what the workforce must consume to reproduce itself and keep fit for work, but wages are a price and so subject to the influence of supply and demand. Wages are the price of the skills wage-earners sell to enterprises so the market demand for these skills depends on the amount and kind of work enterprises want done. As the economy expands and as more and more workers are employed, then the level of more or less full employment of the workforce will be reached. At this point the market demand for workers' skills will begin to exceed the market supply: wages will tend to rise, eating into profits. The rate of profit would then tend to fall.

Rising wages eating into profits is only one possible cause. Another would be a miscalculation by a group of enterprises about the size of the market they supplied. The resulting oversupply in that particular market, and the resulting cutback in production for it would have a cumulative effect on the profits of other groups of enterprises and so on the economy as a whole. The particular market oversupply would then, through affecting general profit prospects, have become a general market oversupply and lead to idle productive capacity.

Despite the regular occurrence of slumps the general trend has been for the amount of wealth in the world, especially means of production, to increase. This means that in practice enterprises have been able to find profitable investments. These they have found in two main areas. First, in meeting the market demand for new equipment which is continually being created as the competitive struggle for profits forces enterprises to innovate in order to reduce costs. Second. in meeting the market demand created by the extension of exchange relationships into more and more parts of the world.

Slumps, in this light, appear as temporary setbacks to economic growth from which the system always recovers. Slumps (during which total market demand falls short of existing productive capacity) are the opposite of booms (during which total market demand exceeds existing productive capacity). Booms and slumps are in fact two sides of the same coin: they are complementary phases of the business cycle and the course which long-term growth follows.

But can there not be steady growth? Although the decision-making structure of the exchange economy is chaotic, the structure of production itself is extremely systematic with each workplace being an inter-dependent part of a world-wide system. This is why decisions made by enterprises controlling one part of this system are bound to affect the profit prospects of enterprises controlling other, especially closely related parts. It is also why a miscalculation in one sector can have a cumulative effect on the whole economy.

Leaving aside any instability introduced by changes in the rate of profit, in order to avoid booms and slumps there would have to be balanced growth of all the sectors of the economy. Each sector would have to expand at a given rate determined by its place in the productive system. This would require a degree of central co-ordination quite impossible so long as control over the parts of the system is scattered among thousands and thousands of profit-seeking enterprises. The anarchy which results from this makes balanced growth quite impossible.


The man generally credited with having "saved capitalism" is the English economist John Maynard Keynes whose main work appeared in i936, Writing in the middle of the great slump of that period, he could see that Say's Law, as the dogma that total market demand would always be equal to existing productive capacity, was wrong. He showed how, due to what amounted to hoarding of profits (which he called "liquidity preference"), there could be a lack of market demand. He went on to claim, however, that this could be permanent, that even in the long run existing productive capacity would not necessarily be fully used. This places Keynes in the camp of the lack-of-market-demand school of economists.

Keynes was saying in effect that there was no reason to believe that the system would always recover from a slump: the lack of market demand might be permanent and lead to a permanent slump, to state of stagnation. He believed that the tendency of the economic system was towards such a state of stagnation. As the amount of capital in the world increased, he argued, so the rate of profit would tend to fall, thereby discouraging investment. At the same time people would be choosing to spend a smaller and smaller part of their rising incomes on consumer goods, thereby discouraging consumption. But this would mean, he went on, a falling market demand since market demand is composed of investment (purchase of producer goods) and consumption (purchase of consumer goods).

Keynes' solution was for the State to intervene and take steps to encourage investment and consumption. Investment could be increased by the State increasing its spending, while consumption could be raised by taxing the incomes of the rich and giving some of it to the poor (on the principle that many poor people will spend more on consumer goods than a few rich people).

A theory of permanent slump was obviously attractive in the 1930s. But even then it was wrong. One way or another — by the planned physical destruction of "excess" productive capacity on a massive scale, if need be — capitalism can in time always recover from a slump. It was the war and then repairing the damage the war caused — not Keynesian policies — which ended the slump of the 1930s. Since then the world exchange economy has resumed its growth, still punctuated by booms and slumps, misleadingly called "stop-go" to give the illusion that these fluctuations are the result of deliberate government policies rather than the normal working of the unplannable exchange economy. The Keynesians have the cheek to claim that the very event which proved their stagnation thesis wrong — the post-war re-expansion of capitalism — was the result of the adoption of their policies. Keynes did not "save capitalism" since, in the absence of a successful movement to abolish it, the system was capable of "saving" itself.

That the profit-motivated exchange economy tends towards a permanent slump brought about by a chronic lack of market demand has long been a view popular among reformers of the system. Keynes seemed to have confirmed their views: they in turn, have tacitly accepted his views. For in explaining, as many of them do, capitalism's survival by State spending on armaments they are in effect conceding Keynes' claim that States can engineer the "full employment" of the workforce within their frontiers.

That States do in fact possess such a power is very much open to question. They do not intervene in the capitalist economy from outside but rather are themselves essential parts of it, and have to rely for every item of wealth they consume on what they can obtain from enterprises, non-State as well as State. This means that State spending is ultimately limited by the amount of profits made by enterprises, or rather by the amount of profits it can take from enterprises without thereby reducing their incentive to invest or damaging their competitive standing in the world market. For, as explained in a previous article, State spending is a charge on profits, a cost enterprises have to bear and one which, like all costs, they want kept to a minimum.


It is true that over the years State spending, as a proportion of total market demand, has tended to increase. But this has not been the result of a conscious policy aimed at saving capitalism from collapse. Rather has it been due to enterprises handing over to the State the responsibility for carrying out certain and increasingly costly non-productive services like health and education and to the increasing cost of maintaining and equipping the armed forces (another essential service as far as enterprises are concerned).

A growing number of people directly employed by the State in non-productive work will have some effect on the working of the exchange economy because the kind of work the State employs these people to do is not so dependent on market conditions as work done for enterprises. So will the growing demand of the State for buildings and equipment (schools and hospitals as well as armaments) to carry out this work. But these developments would mean that a slump, insofar as it affects employment, might tend not to spread as far as it would if wage-earners were employed by enterprises rather than the State. On the other hand, States do have to cut their spending when enterprises are suffering from lowered profits and are curtailing production, precisely because profits are the ultimate source of the money which States spend. This happens even though, in Keynesian theory, they should rather be increasing their spending.

The idea behind the State spending during a slump is that the State should take over and spend the profits enterprises are hoarding. If States were to do this, then it is possible they might help to speed recovery by closing the gap between market demand and existing productive capacity. But States do not act in this way because to tax away the hoarded profits of enterprises during a slump would only make matters worse. Enterprises would be discouraged from investing even that part of their profits they had continued to. The increased State spending would then be offset by the decreased investment of enterprises.

States prefer to get the money to spend during a slump by printing it themselves. Actually they do not usually do it as directly as that. What they do is to increase the National Debt by borrowing more and then repaying part of the debt and the interest in newly-printed money (or rather money-tokens). This of course is a policy of currency depreciation or inflation. Keynes believed that the rise in prices caused by depreciating the currency in this way would encourage enterprises to invest rather than hoard their profits. Whether or not he was right, one result of Keynesian doctrines has been permanent inflation, it is no accident that prices have been rising in Britain since 1940, the year of the first Keynesian budget. For, although States have not adjusted their spending in accordance with Keynes' theories, they have chosen to finance some of it by a policy of inflation. This has certain internal political advantages (Keynes himself pointed out that it is easier to keep wage-earners' living standards down by raising prices more than money wages than by reducing money wages in line with falling prices), but has definite external disadvantages. Rising prices at home means increasing costs in relation to the world market, a fact which places another limit on the extent of State spending.

Even if the State were itself to take over direct responsibility for all investment by establishing a state capitalist economy within its frontiers, it could still not escape the dictates of the world market. The State enterprises set up in place of the old non-State ones would still have to take part in the world-wide competitive struggle for profits. State spending would still be limited by how successful these enterprises were in that struggle. And the State would still be compelled to keep the consumption of its wage-earners to a minimum, as the experience of States like Russia which have tried this policy has shown.

Rather than States being able to control the capitalist economy as Keynes taught, it is the other way round. States have to trim their policies to the changing conditions brought about by the world capitalist economy as it expands and contracts.

The world economy needs to keep millions of people, some permanently and some for shortish periods, out of non-productive as well as productive work. A pool of unemployed is needed for two reasons. First, so that competition among wage-earners for jobs will prevent wages from rising and eating into profits. Where unemployment has been relatively low, as it was until recently in some of the industrialised parts of the world, the States there have implicitly recognised this by adopting policies of planned wage restraint as a substitute. Secondly, enterprises need a reserve of unemployed workers they can call on to work for them during the periods when they are expanding production. The bulk (but by no means all of the world's unemployed) are located in the industrially backward parts of the world which have supplied large numbers of extra workers for enterprises in the industrially advanced parts. Hence the migration of the unemployed to Europe and North America.


The full charge sheet against the world exchange economy with regard to the way it forces people to use the world's resources can now be drawn up. It reads:

(1) That, although there has been a long-term expansion of productive capacity and oil output, this has been only a fraction as fast and as extensive and as safe as technology has made possible.
(2) That, although in the long run the existing capacity has been more or less fully used, this has been broken by regular periods of under-use.
(3) That, in agriculture and in industries faced with declining markets, there has been deliberate destruction of productive capacity and regular destruction of wealth.
(4) That millions and millions of human beings who could have contributed to producing useful things have been prevented from working at all.
(5) That millions and millions more human beings have been allowed to work but only to engage in wasteful exchange and coercive activities.
(6) That the existing productive capacity has been used to produce considerable amounts of waste.

These are all serious charges and all of them are proved. They point to the need for the world's people to recover control over the productive system by abolishing the exchange economy altogether and replace it by a society that will allow them to plan the production of wealth in their own interests and to allocate the products for their own individual and collective use.

Adam Buick