The Long Term Story
The long term story, as I have already indicated, is a story about the rise and (possible) fall of neoliberalism. The Golden Age of Capitalism – the two and a half decades after the second World War – drew to a close by the late 1960s and global capitalism entered a period of structural crisis. The process of general capital accumulation is largely driven by current and expected trends of profitability of capital (measured by the rate of profit). When the rate of profit declines the process of capital accumulation slows down, heralding a period of crisis of capitalism. The rate of profit had peaked in the early-to-mid 1960s in both Europe and the USA; thereafter, the rate of profit continued to decline for the next decade and a half falling from a high of about 20 percent to a low of around 10 percent.
Structural Crisis of Capitalism
Why did the rate of profit fall during this period? The falling profit rate goes to the heart of capitalism and shows up deep contradictions in the process of economic growth and technical change that accompanies capitalist development. The technological dynamism of capitalism is driven by competition between capitals to increase profits by reducing the cost of production. When the share of wages in national income is high, there is a strong incentive for capitalists to reduce the amount of labour required for production. The Golden Age of Capitalism, being a period of regulated and welfare capitalism, had ensured high and rising real wages and therefore maintained a high and relatively constant share of wages in national income. That provided the incentive for adopting labour saving technical change, i.e., adopting new techniques of production that required less and less labour per unit of output. Labour saving technical change increased the productivity of labour.
But the increasing productivity of labour came at a cost: falling productivity of capital or the output-capital ratio (the ratio of output to capital). Labour saving technical change, which increased labour productivity, was only achieved by replacing labour with capital, i.e., more and more labour was replaced by more and more machines in the process of production. This is one of the characteristic features that we often observe with capitalist development: mechanization and the increasing capital intensity of production. The use of more and more machines that increased labour productivity meant that every unit of output now required less labour but more capital; thus labour productivity increased but capital productivity fell.
This is the pattern of technical change, whereby labour productivity increases but capital productivity falls, that accompanies capitalist development during significant periods of time. This is also the way Marx had described the pattern of technical change under capitalism in his discussion of the process of general capital accumulation in Volume 1 of Capital. That is why economists Gerard Dumenil and Dominique Levy has called this pattern “trajectories a la Marx”, while Duncan Foley and Thomas Michl has called it Marx-biased technical change. But what has this pattern of technical change got to do with the falling rate of profit?
The rate of profit is defined as the ratio of profits to the total stock of capital and can be decomposed as follows:
rate of profit = (profit/capital) = (profit/output)*(output/capital)
Thus we see that the rate of profit is the product of two crucial ratios: (1) the share of profits in output, and (2) the productivity of capital. The share of profits in output, though high, had remained relatively stable through the Golden Age of Capitalism; this is a typical pattern observed under capitalism (other than for the neoliberal period). The productivity of capital, on the other hand, fell because of Marx-biased technical change leading to a sharp fall in the rate of profit, and ushering in a period of crisis for capitalism. The sharp decline in the rate of profit meant a decline in the revenues accruing to all sectors of the capitalist class, especially the top fraction. The neoliberal counterrevolution, the sharp turn in economic and social policy around the mid-1970s, was the response of the upper fraction of the capitalist class to their declining income and power (a more detailed development of this argument can be found in Dumenil and Levy, 2004).
Neoliberal Response as a Prelude to Crisis
The neoliberal turn largely managed to achieve what it had set out to. Profit rates started moving up and the revenue accruing to capital, especially the top fraction of capital associated with the financial sector, increased enormously. But it was a period of unmitigated disaster for the working class. Unemployment rates rose across the capitalist world, wages stopped growing (or slowed down considerably) in real terms, social welfare expenditures were gradually cut down, unions and other working class organizations were “busted”; in short, the social power and revenue accruing to the working class was severely restricted. It was a true counterrevolution which restored the power and privilege of the ruling class.
The two figures below demonstrate this in vivid terms. Between 1950 and 1973, real wages had increased at an annual compound rate of 2.61 percent, closely following the phenomenal growth of labour productivity which grew at an average annual compound rate of 2.70 percent. The next 25 years stand in stark contrast to this. Between 1974 and 1999, labour productivity grew at 1.62 percent per annum while real wages grew at only 0.92 percent per annum. Thus, even though labour productivity growth had slowed down significantly, it was still growing at close to twice rate at which real wages increased. This created a stupendous growth in profit incomes and created the source of finance that was to submerge the US working class in debt for the next four decades.
A crucial aspect of the neoliberal turn was the deregulation of sundry aspects of the economy, including, most importantly, the domain of operation of finance. The last great crisis of capital during the Great Depression had brought forth several important changes and new developments in the regulatory framework of capitalism. One by one, each of these laws relating to the operation of finance, both domestically and internationally, were whittled down or even outright overturned. Thus, the burgeoning profit income and the shredding of all regulation together created the supply of debt finance in the US economy. The demand for debt arose from a working class facing stagnant wage incomes but long used to growing consumption expenditures. The net result was the largest build-up of debt in the US economy since the Great Depression. During the beginning of the Great Depression total debt was about 300 percent of US GDP; in early 2008, total debt in the US economy was touching 350 percent of GDP. It was this huge debt build-up resulting from three decades of neoliberal economic policies that created a systemically fragile financial superstructure which imploded, leading to a credit freeze, when the housing bubble burst (I have borrowed parts of this argument from Wolf, 2008).
Dumenil, G. and D. Levy. 2004. Capital Resurgent: Roots of the Neoliberal Revolution. Harvard University Press.
Wolff. R. 2008. Capitalism Hits the Fan. Available here.