The crisis of 2008:A second look back at the underlying causes and potential cures

The roots of the recent crisis and the path to recovery is still an important debate. A little over four years ago I wrote a piece on this and posted it in my older blog on blogspot. I am reproducing it here for the convenience of readers and my students.

Wednesday, October 27, 2010

The current crisis:Hayekian, Keynesian or Marxian?
Jan 30, 2010

It was minus 23 celsius last night, my intake water pipe appears to have frozen and I am busy trying to unthaw it according to my city’s engineer’s instructions but it seems more appealing to spend a few minutes pondering the state of the global economy and the potential explanations for the crisis we are emerging from. The cure for the crisis so far has been rather Keynesian, a major but not massive injection of state funds into the economy designed to build infrastructure, reverse negative animal spirits and boost aggregate demand. This has been combined with action on the monetary front which most but not all monetarists support, very low interest rates and a good measure of quantitative easing , a policy which I developed in the late 1980s and early 1990s. I called it then temporary monetization of a greater portion of the public debt.
I had presented the idea and the research and articles I had published on the subject to my former L.S.E. supervisor, Meghnad Desai in 1993 in London as a plausible alternative to monetarist strictures on deficit finance but he had dismissed it at the time claiming wrongly that it was both impractical and even illegal and in any case would only spook the financial markets.As he put it to me then,” Harold the financial houses all employ Ph.D. economists who will see this as automatically inflationary and act to counteract it. It won’t work.” Well Desai turned out to be wrong about this as did a number of other economists who had listened to my presentation of the idea at a major conference of business economists in Ottawa in 1994 where I shared a panel with the Canadian associate deputy minister of finance at the time, Don Drummond and who were similarly skeptical. This non inflationary turn around and recovery which has involved significant quantitative easing shows that they were all wrong and that my policy innovation had merit.

But rather than dwell on the difficulties of overcoming conventional wisdom lets explore for a moment the roots of the current crisis. It began in the housing market bubble which rather swiftly drew in the bulk of the financial industry and the major investment banks on Wall Street. If you are a Hayekian you would quickly seize on this and argue with some justification that this is precisely what Hayek predicts. Overinvestment occurs because the interest rate is reduced below the natural rate in a Wicksellian sense. this leads to a bubble which then bursts as the expected investment return does not materialize and the burst bubble creates a depression or deep recession. So far so good.

But , the problem with Hayek’s rather intriguing theory of the cycle is that once the bubble has burst raising interest rates as Hayek appears to propose won’t cure the problem. Nor will discouraging investment or consumption accomplish what we want.Furthermore, the low interest rates were introduced because of the legitimate fear of deflation after the crisis of 9/11. Still Hayek’s ideas are worth exploring.

Hyman Minsky draws upon Keynes and his notion of uncertainty but also has Hayekian elements in his analysis of Ponzi or Madoff finance in his brilliant theorization of speculative bubbles that threaten the entire financial system.

Keynes’ work argues that declining animal spirits wracked by uncertainty and a structural tendency toward underconsumptionism and disproportionality between savings intentions and investment intentions leading to inadequate aggregate demand are responsible for slumps. He also is a sharp and hands on experienced critic of the irrational speculations of the stock markets and unregulated free for all that they tended to become whenever manias affected them.

His cure of greater regulation of the investment process, a strong dose of deficit financed intervention to push an economy out of depression and a modest redistribution of wealth and income to ensure adequate aggregate demand still seems to be the best cure.

Marx was clearly an Hegelian romantic(although he expressly denies this) but nevertheless a powerful critic of the horrors of Dickensian nineteenth century capitalism. He has an analysis of the tendency of the rate of profit to fall because of the growth in the organic composition of capital(that is the ratio of machinery, plant and embodied technology to the wage portion of output)and the need to extract a higher rate of surplus value to counter that but all bound up with the very abstract labour theory of value. The transformation problem still bedevils his analysis. Bohm Bawerk wrote a trenchant critique of Marx’s method which was first published in 1896.Marx drew his analysis of the labour theory of value directly from David Ricardo in his work the principles of Political Economy and Taxation. Ricardo ideas about free trade, the doctrine of comparative advantage and free competion came to dominate the economics profession. But his labour theory of value clearly articulated in the first chapter of his great work was eclipsed by neo classical marginal utility theory developed by Carl Menger, Alfred Marshall, Leon Walras and Stanley Jevons in the late 19th and early twentieth century. Ricardo put the matter boldly drawing from the work of Adam Smith before him:

“The real price of everything” says Adam Smith, “what everything really costs to the man who wants to acquire it, is the toil and trouble of acquiring it…Labour was the first price-the original purchase money that was paid for all things….It is natural that what is usually the produce of two days’ or two hour’s labour should be worth double of what is usually the produce of one day’s or one hour’s labour.” that this is really the foundation of the exchangeable value of all things,excepting those that cannot be increased by human industry is a doctrine of the utmost importance in political economy. ..if the quantity of labour realised in commodities regulate their exchangeable value, every increase of the quantity of labour must augment the value of that commodity on which it is excercised and every diminuation must lower it.” (pp6-7 The Principles of Political Economy and Taxation London, Everyman Library, 1965.)

Ladislaus Von Bortkiewicz sought to show the errors in Marx’s treatment of the transformation problem in 1907.(See Bohm -Bawerk, Karl Marx and the close of his system and Bohm Bawerk’s criticism of Marx, by Rudolf Hilferding with an appendix by Ladislaus von Bortkiewicz, On the correction of Marx’s fundamental theoretical construction in the third volume of capital; edited by Paul Sweezy, 1975, the Merlin Press.) Bohm -Bawerk was an advocate along with Carl Menger of the then new subjective value theory based upon the concept of marginal utility. He was also Austrian finance minister in three different Austrian governments. He finished his career as a chaired professor in political economy at the University of Vienna.He was a founder of the Austrian school to which Hayek belonged.Von Bortkiewicz , on the other hand , was a statistician who spent much of his life working in Germany although he was from a Russified Polish family. He was appointed to the University of Berlin in 1901 and taught there until his death in 1931.

Thomas Sowell( ”Marx’s Capital after 100 years” Canadian Journal of Economics, vol.33, 1967,pp.50-74) and others have argued that Marx understood that capitalism functioned on the basis of exchange prices and not on the basis of value and that his intention was always to show that prices diverged from value and that in so doing periodic crises, disproportionalities and booms and busts and financial bubbles would characterize the system.As Sowell puts it:”When the inherent disproportionalities of capitalism reach sufficient magnitudes, price fluctuations become great enough to precipitate scrambles for liquidity in sectors threatened with bankruptcies; this in turn leads to general monetary contraction and depression. A growing capital:labour ratio in the economy means that the workers’ share of gross output declines over time…”
Desai (Marx’s Revenge, p.64)argues that Anwar Shaikh has demonstrated empirically that although values do not transform precisely into prices there is empirical evidence that suggests despite some discrepancies , if properly calculated for a representative list of products using an input output model there is a rough correlation between the two at least for Italy and the U.S. between 1947 and 1963. But clearly profits come not just from labour but from information technology and other innovations that greatly enhance labour productivity including managerial innovation including self -management.They may themselves have their origin in labour but they present themselves in a different identity in the contemporary production process. Still the issue is complex and subject to considerable debate.

However, Marx did fairly accurately predict globalized capitalism and as Desai points out in his work Marx’s Revenge he rather welcomed it as eventually delivering both higher productivity and material wealth and with the appropriate societal changes a better form of civilization.

If over time globalized corporations under the pressure of requiring higher rates of profit continue to outsource their production to lower wage economies outside of the core countries and thereby undermine the Keynesian prescription which is , after all, based on increased aggregate demand and fuller employment in the core then some serious thought will have to be given to the questions raised by these different theoretical approaches.At the very least the regulatory framework and the design of tax benefits and tax breaks for corporate employers will need to have some employment conditions attached to them. Otherwise , the recovery will be a hollow one.

In the meantime the debate over the causes and solutions to the crisis will continue. It is a debate worth having.


About haroldchorneyeconomist

I am Professor of political economy at Concordia university in Montréal, Québec, Canada. I received my B.A.Hons (econ.&poli sci) from the University of Manitoba. I also completed my M.A. degree in economics there. Went on to spend two years at the London School of Economics as a Ph.D. student in economics and then completed my Ph.D. in political economy at the University of Toronto. Was named a John W.Dafoe fellow, a CMHC fellow and a Canada Council fellow. I also was named a Woodrow Wilson fellow in 1968 after completing my first class honours undergraduate degree. Worked as an economist in the area of education, labour economics and as the senior economist with the Manitoba Housing and Renewal Corporation for the Government of Manitoba from 1972 to 1978. I also have worked as an economic consultant for MDT socio-economic consultants and have been consulted on urban planning, health policy, linguistic duality and public sector finance questions by the governments of Manitoba, Saskatchewan,the cities of Regina and Saskatoon, Ontario and the Federal government of Canada. I have also been consulted by senior leaders of the British Labour party, MPs from the Progressive Conservative party, the Liberal party and the New Democrats on economic policy questions. Members of the Government of France under the Presidency of Francois Mitterand discussed my work on public sector deficits. I have also run for elected office at the municipal level. I first began to write about quantitative easing as a useful policy option during the early 1980s.
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