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Booms and slumps - what causes them?

"Recessions," "Slumps," or "Crises," as they are variously referred to, are now accepted as a quite regular part of economic life. Politicians now rationalise such crises, describing them as a "necessary pain" to be endured every so often. Ultimately, it is the economy that controls politicians and not the other way around.

What is an Economic Crisis?

Economic crises are periods of low, or even negative, economic growth. This means that production levels are lower and entails increased unemployment. As a result, the bargaining position of workers is weakened and their wages decline.

Shift in Attitudes

It was once thought by many economists that economic crises were avoidable. When Karl Marx argued that capitalism inevitably develops unsteadily with periods of both expansion and contraction, his theory was fiercely resisted by many.

In his principal work, Capital, Marx formulated the basic law of capitalist progression in the following terms:

The factory system's tremendous capacity for expanding with sudden immense leaps, and its dependence on the world market, necessarily give rise to the following cycle: feverish production, a consequent glut on the market, then a contraction of the market, which causes production to be crippled. The life of industry becomes a series of periods of moderate activity, prosperity, over-production, crisis and stagnation.(1)

At that time and for some decades afterwards, capitalist economists claimed that crises and slumps were not integral to capitalism itself but rather brought about by outside interference with the free market. They saw "market irregularities" such as excessive trade union power, restrictions on free trade or incorrect government monetary policy as the cause of economic slumps.

This view that, if the free market was left to its own devices, there would be no slumps of any magnitude was based upon the doctrine propounded by the early nineteenth century French economist J.B.Say, that

every seller brings a buyer to the market.

Of course, if every good that was produced was indeed bought then there would be no economic slumps (this is true by definition). However, such an assumption is based upon faulty reasoning. As Marx put it:

Nothing could be more foolish than the dogma that because every sale is a purchase, and every purchase a sale, the circulation of commodities necessarily implies an equilibrium between sales and purchases… its real intension is to show that every seller brings a buyer to the market with him… but no one directly needs to purchase because they have just sold.(2)

Few today still believe in the picture given by Say. Most now accept that events have proved the free market to be just as incapable of providing lasting growth as restrictive state intervention. Although the Marxist view is now implicitly accepted, relatively few understand why.

Marx vs Keynes

According to Marx, the division in capitalism between the buyers and sellers of commodities raises the possibility of economic crisis and slump, as holders of money do not always find it in their interests to immediately turn money into commodities. Therefore, so long as buying and selling, money, markets and prices exist, so will the trade cycle.

By the time of the Great Depression of the 1930s, most economists had come to agree that slumps were integral to capitalism, having followed the lead in their time provided by John Maynard Keynes. Like Marx before him, Keynes argued that Say's Law was nonsense and that the free market did not naturally lead to an equilibrium point of full employment with sustained growth. Capitalism, he argued, would, if left to its own devices, stagnate as it had after the Wall Street Crash of October 1929. Keynes and his followers took the view that, as capitalism developed, the observable tendency of the system to concentrate wealth into ever fewer hands would lead to excessive saving, hoarding of wealth and a decline in overall demand. This in turn would plunge capitalism into prolonged slump.

Keynes, in elaborating an economic doctrine which was to influence governments all over the world, claimed that government intervention was necessary to prevent future slumps. Governments should increase taxes on those least likely to spend large parts of their income, and direct funds to those who did. Furthermore, governments should take action to ensure an adequate level of demand in the economy, increasing spending and running budget deficits where necessary.

World trade in 1932 was little more than a third of what it had been before the Wall Street Crash. The two worst affected countries were the USA, where unemployment topped thirteen million, and Germany where it stood at six million and helped propel Hitler's rise to power. In Britain, over three million, or twenty percent of the insured workforce, were unemployed by 1932.

Keynes's remedies of increased state expenditure and budget deficits were put into practice from 1933 onwards in the USA by the Democratic administration under Roosevelt. Unemployment fell for a time, but no more so than in Britain, which had not yet gone Keynesian and operated directly opposite policies. 1938 saw the arrival of a brand new slump in the US which was only to abate during the Second World War. The initial prognosis for Keynesian intervention was not therefore good, even if the free market alternative seemed dead and buried.

After the second world war, the various private enterprise-based capitalist countries adopted Keynes's recommendations to varying degrees, being wary of another Great Depression and the social turmoil it would bring, and confident that unfettered free markets were a thing of the past. Despite this, most countries carried on with the trade cycle operating as before, even if there was no big depression. One of the few exceptions was Britain. In the UK growth remained relatively strong throughout the 1950s and 60s and unemployment never rose above 900,000. The supporters of Keynesian policies claimed it was a triumph of government demand management.

The subsequent history of the economy in Britain was to prove how wrong they were. After the war Britain had achieved a relatively advantageous position in world markets for many commodities, with rivals like Germany and France economically devastated. For some time Britain emerged as a major manufacturer of motor vehicles, airplanes, chemicals, electricity and other commodities. By the late 1960s, however, Britain's rivals had caught up, competing on the basis of the new and improved technology which had been introduced in the wake of the wartime devastation. In the late 1960s and early 1970s, the classic trade cycle began to reassert itself with a vengeance on the British economy—eventually promoting a return to free market policies in the 1980s. Unemployment rose, breaking through the 1,000,000 barrier for the first time since 1945 under Prime Minsiter Edward Heath in the early 1970s.

By then, economists had come to agree that slumps were integral to capitalism, having followed the lead in their time provided by John Maynard Keynes. Like Marx before him, Keynes argued that Say's Law was nonsense and that the free market did not naturally lead to an equilibrium point of full employment with sustained growth and that capitalism, if left to its own devices, would stagnate, just as it had after the Wall Street Crash of October 1929. Keynes and his followers took the view that, as capitable to state that as capitalism has developed, crises and slumps have become more integrated with the increasing worldwide concentration of capital, and their effects have become more widespread. What is more, they have been able to demonstrate why neither Keynesian economic policy nor the free market have been capable of preventing them from breaking out.

A Step by Step Guide

In truth, the mere existence of buying and selling always raises the possibility of crisis, but the drive to accumulate capital—the lifeblood of capitalism—ensures that periodically crises become very much a reality, and nothing the politicians do can prevent them. When capitalism is in boom, enterprises are in a position where their profits are rising, capital is accumulating and the market is hungry for more commodities. But this position does not last. Enterprises are in a perpetual struggle for profits—they need profits to be able to accumulate capital and therefore survive against their competitors. During a boom this inevitably leads some enterprises—typically those which have grown most rapidly—to over-extend their operations for the available market.

In capitalism, decisions about investment and production are made by thousands of competing enterprises operating without social control or regulation. The competitive drive to accumulate capital compels enterprises to expand their productive capabilities as if there was no limit to the available market for the commodities they are producing.

Growth is not planned but governed by the anarchy of the market. The growth of one industry is not linked to the growth of other industries but simply to the expectation of profit, and this gives rise to unbalanced accumulation and growth between the various branches of production. The over-accumulation of capital in some sectors of the economy soon appears as an overproduction of commodities. Goods pile up, unable to be sold, and the enterprises that have over-extended their operations have to cut back on production.

As commodities lie unsold revenue and profits fall, making further investment at the same time more difficult and less worthwhile. Accumulation stalls, saving and hoarding increase and the unstable forces of money and credit soon transmit the downturn to other sectors of the economy. The initially over-expanded enterprises cut back on investment and this leads to a fall in demand for their suppliers products, who in turn are forced to cut back, causing difficulty for their suppliers' suppliers and so on. Profits fall, debts mount up and the banks push interest rates up and contract their lending in a vicious downward spiral of economic contraction. In this way, what started as a partial overproduction for particular markets is turned into general overproduction with most sectors of industry affected.

Crises and slumps invariably follow this general pattern. Sometimes the initial overproduction takes place in consumer goods industries, as it did in 1929, and spreads from there. At other times, like in the mid-1970s the initial over-expansion is in the producer goods sector where enterprises produce new means of production like industrial steel or robotics equipment. In the slump of the early 1990s a major factor was the over-extension of the commercial property sector and some of the high-tech 'sunrise' industries. Whatever the cause, the result is always the same—falling production, increased bankruptcies, wage cuts and unemployment, with an attendant growth in poverty.

In a slump there is simultaneously a problem of falling market demand alongside declining profits. Attempting to deal with one problem (say consumer demand) at the expense of the other (profits) as the Keynesians have, will not improve the situation.

A number of quite distinct and separate things need to happen before a slump can run its course. Firstly, capital has to be wiped out if excessive productive capacity is to be tackled with devalued capital being bought cheaply by those enterprises in the best position to survive the slump. Secondly, destocking needs to take place, with overproduced commodities bought up cheaply or written off entirely. Investment will not resume if overproduction still exists. Thirdly, after this has occured there needs to be an increase in the rate of industrial profit helped by both real wage cuts and falling interest rates (which tail off naturally as the demand for more money capital eases off in the slump.) This will help renew investment and increase accumulation. Also, if recovery is to be sustained, a large proportion of the debt built up during the boom years will need to be liquidated if it is not to act as a drag on future accumulation. Through these mechanisms a slump helps build the conditions for future growth, ridding capitalism of inefficient units of production.

Continuous Cycle

When these processes have run their course, accumulation and growth can begin once more with capitalism again creating a boom situation which will be inevitably followed by a crisis and slump. This has been the history of capitalism ever since it first developed. No reform intervention by governments—however sincere—has prevented or can prevent this cycle from operating. The supporters of laissez faire and the free market have failed and so have the Keynesian interventionists. Today, when faced with the trade cycle, supporters of capitalism have nowhere to run.

Indeed, the trade cycle demonstrates the impotence of reformers and politicians, and is a further indictment of the capitalist system as a whole, bringing misery for millions of workers who lose their jobs, become bankrupt or have their wages reduced and have their working conditions worsened. And far from being an aberration, this cycle of misery is the natural cycle of capitalism.