Profitability, Investment, and the Pandemic

[Photo Credit: REUTERS]

By Michael Roberts

Originally published at the author’s blog.

Last week’s speech by US Federal Reserve Chair Jay Powell at the Peterson Institute for International Economics, Washington was truly shocking.  Powell told his audience of economists that “The scope and speed of this downturn are without modern precedent”. One shocking fact that he announced was that, according to a special Fed survey of ‘economic well-being’ among American households, “Among people who were working in February, almost 40% households making less than $40,000 a year had lost a job in March”!!!

Powell went on to warn his well-paid audience sitting at home watching on Zoom that “while the economic response has been both timely and appropriately large, it may not be the final chapter, given that the path ahead is both highly uncertain and subject to significant downside risks”. Indeed, if the continual downgrading of forecasts of global growth are anything to go by, then the number of optimists about a V-shaped recovery are beginning to dwindle to just the leaders of governments and finance.

Another study projects that US GDP will decline by 22% compared to the pre-COVID-19 period and 24% of US jobs are likely to be vulnerable. The adverse effects are further estimated to be strongest for low-wage workers who might face employment reductions of up to 42% while high-wage workers are estimated to experience just a 7% decrease.

And Powell was worried that this collapse could leave lasting damage to the US economy, making any quick or even significant recovery difficult.  “The record shows that deeper and longer recessions can leave behind lasting damage to the productive capacity of the economy.”, said Powell, echoing the arguments presented in my recent post on the ‘scarring’ of the economy.

Powell reckoned the main problem in achieving any recovery once the pandemic was over was that “A prolonged recession and weak recovery could also discourage business investment and expansion, further limiting the resurgence of jobs as well as the growth of capital stock and the pace of technological advancement. The result could be an extended period of low productivity growth and stagnant incomes.”  See here.

And there was a serious risk that the longer the recovery took to emerge, the more likely there would be bankruptcies and the collapse of firms and eve n banks, as “the recovery may take some time to gather momentum, and the passage of time can turn liquidity problems into solvency problems.”

Indeed, last week, the Federal Reserve released its semi-annual Financial Stability Report, in which it concluded that “asset prices remain vulnerable to significant price declines should the pandemic take an unexpected course, the economic fallout prove more adverse, or financial system strains re-emerge.”  The Fed report warned that lenders could face “material losses” from lending to struggling borrowers who are unable to get back on track after the crisis. “The strains on household and business balance sheets from the economic and financial shocks since March will probably create fragilities that last for some time,” the Fed wrote.  “All told, the prospect for losses at financial institutions to create pressures over the medium term appears elevated,” the central bank said.

So the coronavirus slump will be deep and long lasting with a weak recovery to follow and could cause a financial crash.  And working people will suffer severely, especially those at the bottom of the income and skills ladder. That is the message of the head of the world’s most powerful central bank.

But the other message that Jay Powell wanted to emphasise to his economics audience was that this terrifying slump was not the fault of capitalism.  Powell was at pains to claim that the cause of the slump was the virus and lockdowns and not the economy. “The current downturn is unique in that it is attributable to the virus and the steps taken to limit its fallout. This time, high inflation was not a problem. There was no economy-threatening bubble to pop and no unsustainable boom to bust.  The virus is the cause, not the usual suspects—something worth keeping in mind as we respond.”

This statement reminded me of what I said way back in mid-March when the virus was declared a pandemic by the World Health Organisation. “I’m sure when this disaster is over, mainstream economics and the authorities will claim that it was an exogenous crisis nothing to do with any inherent flaws in the capitalist mode of production and the social structure of society.  It was the virus that did it.”  My response then was to remind readers that “Even before the pandemic struck, in most major capitalist economies, whether in the so-called developed world or in the ‘developing’ economies of the ‘Global South’, economic activity was slowing to a stop, with some economies already contracting in national output and investment, and many others on the brink.”

After Powell’s comment, I went back and had a look at the global real GDP growth rate since the end of the Great Recession in 2009.  Based on IMF data, we can see that annual growth was on a downward trend and in 2019 global growth was the slowest since the GR.

And if we compare last year’s 2019 real GDP growth rate with the 10yr average before, then every area of the world showed a significant fall.

The Eurozone growth was 11% below the 10yr average, the G7 and advanced economies even lower, with the emerging markets growth rate 27% lower, so that the overall world growth rate in 2019 was 23% lower than the average since the end of the Great Recession.  I’ve added Latin America to show that this region was right in a slump by 2019.

So the world capitalist economy was already slipping into a recession (long overdue) before the coronavirus pandemic arrived.  Why was this?  Well, as Brian Green explained in the You Tube discussion that I had with him last week, the US economy had been in a credit-fuelled bubble for the last six years that enabled the economy to grow even though profitability has been falling along with investment in the ‘real’ economy.  So, as Brian says, “the underlying health of the global capitalist economy was poor before the plague but was obscured by cheap money driving speculative gains which fed back into the economy”.  (For Brian’s data, see his website here).

In that discussion, I looked at the trajectory of the profitability of capital globally. The Penn World Tables 9.1 provide a new series called the internal rate of return on capital (IRR) for every country in the world starting in 1950 up to 2017. The IRR is a reasonable proxy for a Marxian measure of the rate of profit on capital stock, although of course it is not the same because it excludes variable capital and raw material inventories (circulating capital) from the denominator.  Despite that deficiency, the IRR measure allows us to consider the trends and trajectory of the profitability of capitalist economies and compare them with each other on a similar basis of valuation.

If we look at the IRR for the top seven capitalist economies, the imperialist countries, called the G7, we find that the rate of profit in the major economies peaked at the end of the so-called ‘neoliberal’ era in the late 1990s.  There was a significant decline in profitability after 2005 and then a slump during the Great Recession, matching Brian’s results for the US non-financial sector.  The recovery since the end of the Great Recession has been limited and profitability remains near all-time lows.

The IRR series only goes up to 2017.  It would be possible to extend these results to 2019 using the AMECO database which measures the net return on capital similarly to the Penn IRR.  I have not had time to do this properly, but an eye-ball look suggests that there has been no rise in profitability since 2017 and probably a slight fall up to 2019.  So these results confirm Brian Green’s US data that the major capitalist economies were already significantly weak before the pandemic hit.

Second, we can also gauge this by looking at total corporate profits, not just profitability.  Brian does this too for the US and China.  I have attempted to extend US and China corporate profit movements to a global measure by weighting the corporate profits (released quarterly) for selected major economies: US, UK, China, Canada, Japan and Germany.  These economies constitute more than 50% of world GDP.  What this measure reveals is that global corporate profits had ground to a halt before the pandemic hit.  Marx’s double-edge law of profit was in operation.

The mini-boom for profits that began in early 2016 peaked in mid-2017 and slid back in 2018 to zero by 2019.

That brings me to the causal connection between profits and the health of capitalist economies.  Over the years, I have presented theoretical arguments for what I consider is the Marxian view that profits drive capitalist investment, not ‘confidence’, not sales, not credit, etc.  Moreover, profits lead investment, not vice versa.  It is not only the logic of theory that supports this view; it is also empirical evidence.  And there is a stack of it.

But let me bring to your attention a new paper by Alexiou and Trachanas, Predicting post-war US recessions: a probit modelling approach, April 2020. They investigated the relationship between US recessions and the profitability of capital using multi-variate regression analysis.  They find that the probability of recessions increases with falling profitability and vice versa.  However, changes in private credit, interest rates and Tobin’s Q (stock market values compared with fixed asset values) are not statistically significant and any association with recessions is “rather slim”.

I conclude from this study and the others before it, that, although fictitious capital (credit and stocks) might keep a capitalist economy above water for a while, eventually it will be the profitability of capital in the productive sector that decides the issue. Moreover, cutting interest rates to zero or lower; injecting credit to astronomical levels that boost speculative investment in financial assets (and so raise Tobin’s Q) and more fiscal spending will not enable capitalist economies to recover from this pandemic slump.  That requires a significant rise in the profitability of productive capital.

If we look at investment rates (as measured by total investment to GDP in an economy), we find that in the last ten years, total investment to GDP in the major economies has been weak; indeed in 2019, total investment (government, housing and business) to GDP is still lower than in 2007. In other words, even the low real GDP growth rate in the major economies in the last ten years has not been matched by total investment growth.  And if you strip out government and housing, business investment has performed even worse.

By the way, the argument of the Keynesians that low economic growth in the last ten years is due to ‘secular stagnation’ caused by a ‘savings glut’ is not borne out.  The national savings ratio in the advanced capitalist economies in 2019 is no higher than in 2007, while the investment ratio has fallen 7%.  There has been an investment dearth not a savings glut.  This is the result of low profitability in the major capitalist economies, forcing them to look overseas to invest where profitability is higher (the investment ratio in emerging economies is up 10% – I shall return to this point in a future post).

What matters in restoring economic growth in a capitalist economy is business investment.  And that depends on the profitability of that investment.  And even before the pandemic hit, business investment was falling.  Take Europe. Even before the pandemic hit, business investment in peripheral European countries was still about 20 per cent below pre-crisis levels.

Andrew Kenningham, chief Europe economist at Capital Economics, forecast eurozone business investment would fall 24 per cent year on year in 2020, contributing to an expected 12 per cent contraction in GDP. In the first quarter, France reported its largest contraction in gross fixed capital formation, a measure of private and public investment, on record; Spain’s contraction was also near-record levels, according to preliminary data from their national statistics offices.

In Europe, manufacturers producing investment goods — those used as inputs for the production of other goods and services, such as machinery, lorries and equipment — experienced the biggest hit to activity, according to official data. In Germany, the production of investment goods fell 17 per cent in March compared with the previous month, more than double the fall in the output of consumer goods. France and Spain registered even wider differences

Low profitability and rising debt are the two pillars of the Long Depression (ie low growth in productive investment, real incomes and trade) that the major economies have been locked into for the last decade.  Now in the pandemic, governments and central banks are doubling down on these policies, backed by a chorus of approval from Keynesians of various hues (MMT and all), in the hope and expectation that this will succeed in reviving capitalist economies after the lockdowns are relaxed or ended.

This is unlikely to happen because profitability will remain low and may even be lower, while debts will rise, fuelled by the huge credit expansion.  Capitalist economies will remain depressed, and even eventually be accompanied by rising inflation, so that this new leg of depression will turn into stagflation.  The Keynesian multiplier (government spending) will be found wanting as it was in the 1970s.  The Marxist multiplier (profitability) will prove to be a better guide to the nature of capitalist booms and slumps and show that capitalist crises cannot be ended while preserving the capitalist mode of production.

Engels on Nature and Humanity

(Pictured: A painting by English artist LS Lowry (1887 - 1976) entitled 'Going To Work')

By Michael Roberts

Republished from the author’s blog.

In the light of the current pandemic, here is a rough excerpt from my upcoming short book on Engels’ contribution to Marxian political economy on the 200th anniversary of his birth.

Marx and Engels are often accused of what has been called a Promethean vision of human social organisation, namely that human beings, using their superior brains, knowledge and technical prowess, can and should impose their will on the rest of the planet or what is called ‘nature’ – for better or worse.

The charge is that other living species are merely playthings for the use of human beings.  There are humans and there is nature – in contradiction.  This charge is particularly aimed at Friedrich Engels, who it is claimed, took a bourgeois ‘positivist’ view of science: scientific knowledge was always progressive and neutral in ideology; and so was the relationship between man and nature.

This charge against Marx and Engels was promoted in the post-war period by the so-called Frankfurt School of Marxism, which reckoned that everything went wrong with Marxism after 1844, when Marx and Engels supposedly dumped “humanism”.  Later, followers of the French Marxist Althusser put the blame on Fred himself.  For them, everything went to hell in a hand basket a little later, when Engels dumped ‘historical materialism’ and replaced it with ‘dialectical materialism’, in order to promote Engels’ ‘silly belief’ that Marxism and the physical sciences had some relationship.

Indeed, the ‘green’ critique of Marx and Engels is that they were unaware that homo sapiens were destroying the planet and thus themselves.  Instead, Marx and Engels had a touching Promethean faith in capitalism’s ability to develop the productive forces and technology to overcome any risks to the planet and nature.

That Marx and Engels paid no attention to the impact on nature of human social activity has been debunked recently in particular by the ground-breaking work of Marxist authors like John Bellamy Foster and Paul Burkett.  They have reminded us that throughout Marx’s Capital, Marx was very aware of capitalism’s degrading impact on nature and the resources of the planet.  Marx wrote that 

“the capitalist mode of production collects the population together in great centres and causes the urban population to achieve an ever-growing preponderance…. [It] disturbs the metabolic interaction between man and the earth, i.e., it prevents the return to the soil of its constituent elements consumed by man in the form of food and clothing; hence it hinders the operation of the eternal natural condition for the lasting fertility of the soil. Thus it destroys at the same time the physical health of the urban worker, and the intellectual life of the rural worker.” 

As Paul Burkett says: “it is difficult to argue that there is something fundamentally anti-ecological about Marx’s analysis of capitalism and his projections of communism.”

To back this up, Kohei Saito’s prize-winning book has drawn on Marx’s previously unpublished ‘excerpt’ notebooks from the ongoing MEGA research project to reveal Marx’s extensive study of scientific works of the time on agriculture, soil, forestry, to expand his concept of the connection between capitalism and its destruction of natural resources. (I have a review pending on Saito’s book).

But Engels too must be saved from the same charge.  Actually, Engels was well ahead of Marx (yet again) in connecting the destruction and damage to the environment that industrialisation was causing.  While still living in his home town of Barmen (now Wuppertal), he wrote several diary notes about the inequality of rich and poor, the pious hypocrisy of the church preachers and also the pollution of the rivers.

Just 18 years old, he writes: 

“the two towns of Elberfeld and Barmen, which stretch along the valley for a distance of nearly three hours’ travel. The purple waves of the narrow river flow sometimes swiftly, sometimes sluggishly between smoky factory buildings and yarn-strewn bleaching-yards. Its bright red colour, however, is due not to some bloody battle, for the fighting here is waged only by theological pens and garrulous old women, usually over trifles, nor to shame for men’s actions, although there is indeed enough cause for that, but simply and solely to the numerous dye-works using Turkey red. Coming from Düsseldorf, one enters the sacred region at Sonnborn; the muddy Wupper flows slowly by and, compared with the Rhine just left behind, its miserable appearance is very disappointing.”

He goes on:

“First and foremost, factory work is largely responsible. Work in low rooms where people breathe more coal fumes and dust than oxygen — and in the majority of cases beginning already at the age of six — is bound to deprive them of all strength and joy in life. “

He connected the social degradation of working families with the degradation of nature alongside the hypocritical piety of the manufacturers.

“Terrible poverty prevails among the lower classes, particularly the factory workers in Wuppertal; syphilis and lung diseases are so widespread as to be barely credible; in Elberfeld alone, out of 2,500 children of school age 1,200 are deprived of education and grow up in the factories — merely so that the manufacturer need not pay the adults, whose place they take, twice the wage he pays a child. But the wealthy manufacturers have a flexible conscience and causing the death of one child more or one less does not doom a pietist’s soul to hell, especially if he goes to church twice every Sunday. For it is a fact that the pietists among the factory owners treat their workers worst of all; they use every possible means to reduce the workers’ wages on the pretext of depriving them of the opportunity to get drunk, yet at the election of preachers they are always the first to bribe their people.”

Sure, these observations by Engels are just that, observations, without any theoretical development, but they show the sensitivity that Engels already had to the relationship between industrialisation, the owners and the workers, their poverty and the environmental impact of factory production.

In his first major work, Outlines of a Critique of Political Economy, again well before Marx looked at political economy, Engels notes how the private ownership of the land, the drive for profit and the degradation of nature go hand in hand. 

“To make earth an object of huckstering — the earth which is our one and all, the first condition of our existence — was the last step towards making oneself an object of huckstering. It was and is to this very day an immorality surpassed only by the immorality of self-alienation. And the original appropriation — the monopolization of the earth by a few, the exclusion of the rest from that which is the condition of their life — yields nothing in immorality to the subsequent huckstering of the earth.” 

Once the earth becomes commodified by capital, it is subject to just as much exploitation as labour.

Engels’ major work (written with Marx’s help), The Dialectics of Nature, written in the years up to 1883, just after Marx’s death, is often subject to attack as extending Marx’s materialist conception of history as applied to humans, into nature in a non-Marxist way.  And yet, in his book, Engels could not be clearer on the dialectical relation between humans and nature.

In a famous chapter “The Role of Work in Transforming Ape into Man.”, he writes: 

“Let us not, however, flatter ourselves overmuch on account of our human conquest over nature. For each such conquest takes its revenge on us. Each of them, it is true, has in the first place the consequences on which we counted, but in the second and third places it has quite different, unforeseen effects which only too often cancel out the first. The people who, in Mesopotamia, Greece, Asia Minor, and elsewhere, destroyed the forests to obtain cultivable land, never dreamed that they were laying the basis for the present devastated condition of these countries, by removing along with the forests the collecting centres and reservoirs of moisture. When, on the southern slopes of the mountains, the Italians of the Alps used up the pine forests so carefully cherished on the northern slopes, they had no inkling that by doing so they were … thereby depriving their mountain springs of water for the greater part of the year, with the effect that these would be able to pour still more furious flood torrents on the plains during the rainy seasons. Those who spread the potato in Europe were not aware that they were at the same time spreading the disease of scrofula. Thus at every step we are reminded that we by no means rule over nature like a conqueror over a foreign people, like someone standing outside nature — but that we, with flesh, blood, and brain, belong to nature, and exist in its midst, and that all our mastery of it consists in the fact that we have the advantage over all other beings of being able to know and correctly apply its laws.” (my emphasis)

Engels goes on: 

“in fact, with every day that passes we are learning to understand these laws more correctly and getting to know both the more immediate and the more remote consequences of our interference with the traditional course of nature. … But the more this happens, the more will men not only feel, but also know, their unity with nature, and thus the more impossible will become the senseless and antinatural idea of a contradiction between mind and matter, man and nature, soul and body. …”

Engels explains the social consequences of the drive to expand the productive forces.  

“But if it has already required the labour of thousands of years for us to learn to some extent to calculate the more remote natural consequences of our actions aiming at production, it has been still more difficult in regard to the more remote social consequences of these actions. … When afterwards Columbus discovered America, he did not know that by doing so he was giving new life to slavery, which in Europe had long ago been done away with, and laying the basis for the Negro slave traffic. …”

The people of the Americas were driven into slavery, but also nature was enslaved. As Engels put it:

“What cared the Spanish planters in Cuba, who burned down forests on the slopes of the mountains and obtained from the ashes sufficient fertilizer for one generation of very highly profitable coffee trees–what cared they that the heavy tropical rainfall afterwards washed away the unprotected upper stratum of the soil, leaving behind only bare rock!”

Now we know that it was not just slavery that the Europeans brought to the Americas, but also disease, which in its many forms exterminated 90% of native Americans and was the main reason for their subjugation by colonialism.

As we experience yet another pandemic, we know that it was capitalism’s drive to industrialise agriculture and usurp the remaining wilderness that has led to nature ‘striking back’, as humans come into contact with more pathogens to which they have no immunity, just as the native Americans in the 16th century.

Engels attacked the view that ‘human nature’ is inherently selfish and will just destroy nature.  In his Outline, Engels described that argument as a “repulsive blasphemy against man and nature.”  Humans can work in harmony with and as part of nature.  It requires greater knowledge of the consequences of human action.  Engels said in his Dialectics:

“But even in this sphere, by long and often cruel experience and by collecting and analyzing the historical material, we are gradually learning to get a clear view of the indirect, more remote, social effects of our productive activity, and so the possibility is afforded us of mastering and controlling these effects as well.”

But better knowledge and scientific progress is not enough. For Marx and Engels, the possibility of ending the dialectical contradiction between man and nature and bringing about some level of harmony and ecological balance would only be possible with the abolition of the capitalist mode of production. As Engels said: “To carry out this control requires something more than mere knowledge.”  Science is not enough. “It requires a complete revolution in our hitherto existing mode of production, and with it of our whole contemporary social order.”  The ‘positivist’ Engels, it seems, supported Marx’s materialist conception of history after all.