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Tackling the Current Global Economic and Financial Crisis: Beyond Demand Management

This paper highlights the depth of the crisis confronting the global economy. It presents the various ways of understanding demand deficiency, which was the underlying feature of the earlier downturns in capitalist economies. A resolution of the problems faced then was possible with demand management using Keynesian tools. But the current economic crisis is different from the past ones and the lessons learnt from the past may not be applicable to solving the crisis of 2009. The arguments presented here imply that demand management alone will not work because capitalism faces a basic crisis. One implication is that we need redistribution, but that is not on anyone's agenda today.

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Tackling the Current Global Economic and Financial Crisis: Beyond Demand Management

Arun Kumar

This paper highlights the depth of the crisis confronting the global economy. It presents the various ways of understanding demand deficiency, which was the underlying feature of the earlier downturns in capitalist economies. A resolution of the problems faced then was possible with demand management using Keynesian tools. But the current economic crisis is different from the past ones and the lessons learnt from the past may not be applicable to solving the crisis of 2009. The arguments presented here imply that demand management alone will not work because capitalism faces a basic crisis. One implication is that we need redistribution, but that is not on anyone’s agenda today.

Arun Kumar (arunkumar1000@hotmail.com) is with the Centre for E conomic Studies and Planning at Jawaharlal Nehru University, New Delhi.

A
dverse economic news greets the world almost every day. The US budget deficit in 2009 is set to triple to $1.75 trillion, the largest ever, from last year’s figure of $450 billion. The Bank of England has fixed the lowest interest rates since it came into being in 1634. Toyota has announced its first ever losses. The largest housing mortgage companies, Freddie Mac and Fannie Mae, the largest insurance company, AIG, and banks like Citibank exist because they have been rescued with hundreds of billions of dollars pumped in by the US government.

Major world economies are in recession or their rates of growth have plunged. In the last quarter of 2008, the US economy declined by more than 6% a year, the Euro zone contracted by 1.5% and Japan contracted at an unprecedented 12% a year. Britain, Russia and Canada are in recession while the Chinese, Brazilian, South Korean and Indian economies have slowed down rapidly. Smaller economies like Spain, Mexico, Ireland, Iceland, Singapore, Greece, Ecuador, Hungary, Latvia, Pakistan, and Ukraine are in deep trouble. This is in spite of massive bailout packages put together by various governments. The US alone, according to one estimate, has put together a package of more than $8.8 trillion and already spent $2 trillion (New York Times 2009). The t otal commitment (not all spent) by all governments is in excess of $11 trillion.

Companies like AIG, which received $150 billion, and Citibank, which received $300 billion, in bailouts up to November 2008 are now asking for more funds (Lorr 2009). In spite of the m assive bailout, AIG has posted the largest quarterly loss ever ($62 billion) by any US corporation. These were entities that were considered “too big to fail” up until June 2008 but they are now sinking rapidly. The speed is startling. Companies of their size would have earlier declined over many years but they are now collapsing in months and weeks. Supposedly healthy companies like the Japanese bank Mitsubishi needed more c apital within months of trying to rescue Morgan Stanley. Even before US President Barack Obama’s bailout strategy has got g oing, its assumptions about the extent of collapse are proving to be incorrect (Goodman 2009).

Analysts are stunned by what they are witnessing. Most of them are constantly behind the curve. For a long time, the International Monetary Fund (IMF) did not admit that a recession was around the corner but finally pronounced that was indeed the case in November 2008. After suggesting that things were not too bad, the US Federal Reserve chairman admitted in September 2008 that there was a deep systemic crisis and even then hoped that things would turn around soon. On 23 February 2009, in

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Senate hearings of the Banking Committee, he accepted that 2009 would not see the end of the recession and that a recovery might occur in 2010 – even this is conditional on the assumptions being right (Rampell and Healy 2009).

Even economists like Joseph Stiglitz and Paul Krugman who were sceptical of what was going on in the financial markets did not anticipate the speed of the collapse. In hindsight, it seems obvious that a collapse was inevitable, given the size of the financial bubble, but no one had figured out what needed to be done if the bubble burst. Today, analysts are groping in the dark to work out an explanation and a possible solution to the growing problem. Stiglitz (2009) states,

We are moving in uncharted waters. No one can be sure what will work. But long-standing economic principles can help guide us. Incentives matter. The long-run fiscal position of the US matters.

The main question is whether the ongoing crisis of capitalism is basic and requires a fundamental change in the system or whether it is merely a financial crisis which can be tackled by governments, even if with some difficulty. Most analysts, some of the well-known ones being Stiglitz and Krugman, believe it is the latter. While Stiglitz believes that a better designed package is necessary (Stiglitz 2009), Krugman (2009) argues, it needs to be large enough to have an effect. Both think there will be pain but the US economy will turn around. Bhaduri (2009) argues for a massive Keynesian intervention on employment but is uncertain whether this is going to happen.

Kumar (2009) argues that the crisis is a fundamental one because restoration of faith in a flawed financial system is difficult. Since the financial system is fundamental to the functioning of the capitalist system, the current crisis will bring down the capitalist system as we have known it. In this paper we analyse the fiscal and monetary policies that have been adopted by various governments the world over and why they are not having the e ffect they were expected to have. Governments have exhausted the tools of economic intervention available to them but the situation is worsening rapidly.

Krugman and Stiglitz argue that we learnt how to overcome such downturns during the Great Depression of 1929 and the crisis can therefore be overcome. Stiglitz has said that no one can today afford to not be a Keynesian just as till 2007 no one could afford to be seen to be a Keynesian. Businesses which have been votaries of markets and minimum government intervention till recently are unashamedly demanding massive help from governments and cannot oppose Keynesian policies anymore. However, socialism remains a dirty word and government intervention has therefore tended to be half-hearted (see Krugman 2008). Most policymakers are from the world of finance and for them saving real companies is less important than saving the fi nancial world.

Theoretical Aspects of Demand and Downturn

This is not the first major crisis faced by capitalism and so many believe that just like the earlier crises, capitalism has the resilience to overcome this one too. Capitalism has gone through many business and trade cycles which cause output in the economy to fluctuate, perhaps, not in textbook fashion.

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Economic theory uses the multiplier-accelerator interaction to explain fluctuations. Since there are other accompanying factors/ changes, the cycles are not regular. Since an understanding of Keynesian economics developed in the mid-1930s, the downturns have been moderated with counter-cyclical interventions by governments. Rapid technological changes in the last century led to investment booms and changes in productivity that modified the cycles.

Given the practical difficulties, it is hard to identify a pure recession or a depression in an economy. Ideally, a recession should imply the output level falling below the trend (average) level and a depression when it falls considerably below that level. However, given the difficulty in identifying these clearly, a recession is now defined as two or more consecutive periods of decline of output (negative growth, even if the output is at a high level).

A precise definition of these terms in terms of investment and capital stock in an economy is possible (Kalecki 1971:11). It is pointed out that there is a crucial difference between investment decisions and the delivery of plant and equipment. The latter is what results in a rise in capital stock. Kalecki argues that there is a time lag between the two and this leads to a cycle in a capitalist economy. In the early part of a depression, investment decisions move towards a low while capital stock is falling but is still above its average level (in a cycle). In a recession, the investment decisions fall rapidly but because delivery of equipment is still above the average level, capital stock keeps rising. This depresses investment decisions even faster and slows down the economy rapidly. These changes are reflected in changes in output to produce a cycle. Consequently, in a recession, the level of output is at an average but falling rapidly while in a depression the output level is low but falling or rising gradually.

The functioning of cycles is based on what Domar (1946) described as the “dual nature of investment”. Namely, investment not only raises output through the multiplier, it also lowers potential opportunities for investment by creating additional capacity. As output (O) rises, through the accelerator, investment (I) rises but as capital stock (K) rises, I falls. It may be written as

I = a.O – b.K, where a and b are both positive constants. Different time lags between the three variables lead to different kinds of cycles.

Domar suggested that technological obsolescence leads to demand problems in the steady state path of a capitalist economy and that this makes the path unstable. Kaldor (1960), in a simplified model of cycles, introduced the expectations of capitalists into the analysis. He suggested that an economy goes from a high to a low level of activity due to cumulative changes in expectations. Keynes (1973) suggested that counter-cyclical fiscal intervention would help overcome a downturn. However, Kaldor pointed out that once a downturn begins, government intervention cannot prevent its occurrence. He argued that government intervention is needed in the early part of the cycle but even then the downturn eventually takes place.

In the Keynesian framework, a downturn is the result of shortage of demand. In this context, Rosa Luxemburg argued that the existence of an export market could mitigate the demand shortage in a capitalist economy. Tugan Baranovsky argued that if

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i nvestment takes place for the sake of investment, demand in a capitalist economy can be maintained. Kalecki critiqued these arguments (Kalecki 1971: 146-155). He argued that Luxemburg’s argument is flawed since it is not the export market that causes an expansion of market but the export surplus. As for Baranovsky’s argument, he pointed out that investment is an unstable process and the demand problem cannot be escaped (similar to Domar’s argument). Kalecki suggested that creating a war machine to make machines for the sake of machines was a possibility because they could be periodically destroyed (like, in Orwell 1990). Thus, rising defence expenditures could keep up demand even if it invariably resulted in imperialism and a military industrial complex. This would also overcome the problem raised by Domar (1946) of rising capital stock raising productive capacity which then depresses investment.

Kalecki (1971) argued that it is the budget deficit of a government that adds demand to the economy and not just government expenditure. This was also Keynes’ understanding. A downturn in a capitalist economy may also be formulated in terms of the Marxist notion of overproduction. Namely, a rise in the potential production above what is demanded creates spare capacity. This makes the accelerator stop working and investment declines, pulling down output. This is basic to capitalism and cannot be overcome for all time.

In brief, the various ways of understanding downturns in capitalist economies and their management by creating demand explain some aspects of what happened during earlier downturns. The question is whether they adequately explain what has been going on since 2006.

Lessons from the Depression

The current crisis is different from the Great Depression of 1929-33 (see also Mankiw 2008). Economies then were less integrated than they are today. Mobility was much less and agriculture and primary goods production were the mainstays of most economies in the world. A large part of the workforce was employed in agriculture. Finance was important but to a lesser extent than at present because a substantial amount of production was in the local economies in small or family units. Multinational corporations (MNCs) were growing but had not become the behemoths with global reach that they have become today. Stock markets were important but their reach was much more limited and only a tiny percentage of the population was involved in them.

In the Great Depression, the stock markets, output and employment all collapsed as business confidence declined and investments froze. Banks failed in large numbers when businesses collapsed. That was due to a shortage of demand. The problem was compounded by the conservative monetarist stance of the policymakers. This is a problem today as well because the world of finance has dominated policymaking for the last 30 years.

To meet the challenge, it was considered appropriate that the budget be balanced. So, as the crisis deepened and revenues fell, government expenditure was curtailed rather than raised to counter the fall in demand. As a consequence, demand fell even further and the depression became deeper. Further, investment was considered inadequate because of the lack of profitability and wage cuts were propounded as a measure to boost profitability. This only resulted in a further fall in demand. Investment, which always comes with a time lag, never materialised because of excess capacity. Thus, employment and the wage rate both fell, leading to a further decline in demand (Kalecki 1971: 26-34). It was only the New Deal and the rapid rise in the public expenditure irrespective of the budget deficit that pulled the economy out of the depression.

Downturn in the US Economy in 2008

Rising disparities in a capitalist economy lead to a shortage of demand (overproduction) and a downturn. In the recent past, the tendency towards overproduction has been countered by the wealth effect due to rising asset prices. This has been especially true in the US where savings have dropped sharply since the mid1980s to almost zero in the middle of the present decade (see K umar 2009). The US could do this due to the dollarisation of the world economy which enabled it to export its deficits (in trade and the budget) since the rest of the world was willing to lend to it. It became the largest debtor nation of the world.

While the earlier downturns were the result of a slowdown in demand, the crisis of 2008 has a different basis. It originated not in a slowdown in demand but a financial crisis which triggered a crisis of trust between borrowers and lenders and therefore a fall in asset prices. This led to massive bankruptcies in various financial and production units. Thus, unlike the earlier ones, it is a crisis created on the supply-side. Subsequently, it has also manifested itself as a demand-side problem with unemployment and housing foreclosures rising in the US. Other economies, d ependent on exports to the US, have experienced a fall in d emand. Given this sequence, can the crisis be overcome by boosting demand?

Unlikely, because the supply side collapse is continuing. This downturn is different from the Great Depression and those since it. Boosting demand may not work in countries such as China and Germany which depended to a large extent on exports or countries such as Britain and Iceland which were involved in the same kind of financial leveraging as the US. In a few countries which do not face either of the above two problems, domestic demand may be boosted to partly mitigate the distress. However, today, it is not so easy to quickly boost domestic demand because the structures of most economies are now oriented outward and they c annot be changed overnight.

In 2008, the growth rates of the world economy and of the US were positive till almost the middle of the year and the fall was not as sharp as in 1929. The decline in the stock markets was gradual to begin with and picked up speed later. Unemployment has risen but not so precipitously. Policymakers and analysts have been surprised because they were in a denial mode. This time around, fiscal deficits everywhere have been allowed to soar to unprecedented levels. This may have temporarily slowed down the downturn but the decline is continuing. This is the other surprise. It may be argued that the stimulus is inadequate (Krugman 2008) or that there is a lag effect and that matters will improve. But the signs are that the collapse is deepening. That there is a difference from the earlier downturns and from the Great

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D epression of 1929-33 needs to be understood. For this a better understanding of the current crisis is needed.

Explaining the Origins of the Current Crisis

It is generally argued that the crisis originated in the financial sector due to the failure of sub-prime assets, especially in the housing mortgage market. But the question arises, why were the sub-prime assets created? Further, if capital gains had continued to be positive, these assets would not have collapsed. So why did capital gains start declining? There is also another explanation of the financial crisis which suggests that there was a Ponzi scheme that has now failed (Sen 2008). This implies fraud. While a c ertain amount of fraud is likely (like, in the Madoff affair and the failure of the Stanford Group or closer home, the Satyam a ffair), this cannot be a total explanation for the collapse of the financial system.

Kumar (2009) has shown that the present crisis originated in the interaction between the real and financial sectors and that it is linked to the architecture of the financial sector and the world economy. It is argued that over the last 30 years, disparities in a large number of countries (US, China, India, UK and so on) had risen (George 2008) and led to a tendency for overproduction.

In the US economy, in particular, this was countered by increased demand because of the wealth effect (Bhaduri 2009) created by massive amounts of capital gains in the financial markets. Consequently, the savings rate declined (Economic Report of the President 2008). The US could do this because of the dollarisation of the world economy and the willingness of the world to hold surplus dollars and give loans to it (Kumar 2008).

However, this also set in motion a counter tendency of increasing amounts of surplus generated in the US economy accruing to foreigners who owned progressively more and more of the capital in the country. Further, the huge profits of the owners of financial capital were siphoned off to tax havens (see the recent admissions of the UBS bank on its Swiss connection and the news of MNC banks having a large number of subsidiaries in tax havens). These factors, along with the rising war effort and internal s ecurity expenditures since 2001, led to a reduction in the funds available for generating more and more financial assets in the US.

Growing deregulation of the financial markets resulted in runaway speculation in financial assets and the build-up of a financial bubble through very high degrees of leveraging. As argued elsewhere, the leakage of the surplus of the economy (pointed to above) countered this tendency. Thus, it has been argued that the financial bubble suffered from knife-edge instability. Since the rate of return on financial assets is largely dependent on capital gains (or losses), it can either grow or collapse. It is pointed out that there is an asymmetry in this – the bubble grows slowly but collapses quickly. The reason is that the returns on financial i nstruments are a multiple of the capital gains due to the leveraging. The higher the leveraging, the higher the rates of return. That is why the entire real economy becomes inadequate to pay the profits on the financial assets and the bubble only survives if the profits are reinvested into the financial assets for it to grow.

Further, as capital gains fall, the returns also fall precipitously and funds begin to move out to other assets (like speculation in

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commodities). At this point the bubble starts to collapse and the returns turn negative. A vicious cycle of withdrawal of funds is set in motion and the collapse is rapid. Consequently, investors in these markets (mostly people and companies with surpluses) s uffer large losses.

Capital gains started falling in 2006. Even before that happened, sub-prime assets were created to boost the financial m arkets. They posed no problem as long as capital gains were positive. But as soon as they turned negative, the assets began to collapse and aggravated the decline in capital gains, which then fed back into the loop of decline. This is why it was suggested earlier that the crisis began in 2006.

Leveraged buying also involves borrowing and lending across institutions. Thus, the balance sheets of most institutions get i nterlined and this is referred to the “interlocking of balance sheets”. If one institution suffers losses and is not able to repay its creditor, it adversely affects another and that affects others. A chain of failures is set up. Since the entire financial system ( investment banks, auditors, credit rating agencies and so on)

o perated with the same model and investors (individuals or firms) followed their advice, the collapse has not remained c onfined to a few entities but become systemic.

The problem is compounded by the requirement of “mark to market”. That is, losses have to be brought on to the balance sheets of companies. Since leveraging leads to large amounts of financial exposure, even small losses in capital values lead to large losses in relation to own capital. Hence, the capitals of companies resorting to high leveraging get wiped out and they become bankrupt, requiring a fresh infusion of capital.

In brief, the interlocked balance sheets of companies and the requirement of “mark to market” has turned a large number of companies bankrupt. It is a different matter that the losses may not be recorded all at the same time and the losses keep appearing on balance sheets quarter after quarter. The problem is further aggravated by the decline in stock markets and the decline in the value of stocks of companies. This reduces the capacity to raise fresh capital. All this is visible in the case of the financial institutions and the other companies that have been provided bailout packages in the last year or so. Huge packages given to them have disappeared in weeks and months, into black holes, with no trace at all.

This has worsened the situation for the entire system because no one knows which company will fail next. Consequently, trust has evaporated and financial institutions do not know who to lend to. If they lend to a company which has a lot of toxic assets (assets that have lost value and are continuing to lose value) it may not be able to repay and then the lender will be the next to fail. This lack of trust has also led to a difficulty in raising working capital and therefore to difficulty in paying salaries, and to output and employment running down.

The financial crisis has triggered massive foreclosures in housing and to a decline in the stock markets. This has set the wealth effect boosting demand into reverse gear and it is now driving consumption down, aggravating the demand problem. Thus, the demand problem has come after the financial crisis was triggered of by problems in the real economy in the US. Bhaduri (2009) also argues that the problem is not just demand.

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With the decline in the financial markets leading to a decline in the stock markets, even healthy companies that were not involved in the financial markets have suffered losses in valuation. They also face working capital problems, turning good assets toxic. Further, as US markets decline, it has an effect globally on all financial markets and the problem has become a global one.

Ineffectiveness of Government Policies

Since early 2008, when policymakers perceived the crisis had b egun (for quite some time before that, they were in a state of denial, see NYT Interactive 2008), governments have tried many kinds of measures. They may broadly be classified as monetarist and fiscal. Among the monetarist measures, we have seen cuts in cash reserve ratio, lowering of interest rates, the lending of money by central banks, and providing loan guarantees. Fiscal measures include investments in companies, cutting taxes, giving support to social sectors and increasing expenditure in areas like science (see New York Times, 2009 for a break-up of the proposed interventions in the US amounting to $8.8 trillion).

In spite of cuts in interest rates to unprecedented low rates and massive infusion of liquidity all over the world, the various economies are not showing signs of revival. Instead, the crisis is deepening. Monetary policy cannot do more because interest rates cannot be cut any further. There seems to be a liquidity trap. Since risk is perceived to be very high, lending at almost any reasonable interest rate will perhaps not cover the risk of the lender. Since demand has fallen and profitability has sharply declined, a slight fall in interest rates (which is all that is possible in today’s regime of low interest rates) is inadequate to boost profits for the borrower to a point where investment demand can revive.

Increased liquidity has not been able to get credit flowing b ecause of a lack of trust (as argued above). It is being used by the entities getting the funds to protect their own balance sheets. Hence, there are complaints that credit has frozen (Goodman 2008). In Kumar (2009), this has been represented as a fall in the money multiplier and transactions velocity of money to unity and the economy entering a liquidity trap.

Tax cuts in today’s situation will not lead to increased spending but to increased savings (Domar 1946 argued similarly in the context of his growth model and shortage of demand). To the e xtent the tax cuts go to well-off sections because their savings propensity is high, they will not boost demand much. The underlying idea of tax cuts is that they also provide incentives to invest more. However, since the crisis is in the financial sector and risk and uncertainty are very high, expecting investments to pick up is unrealistic.

The question is whether fiscal policies work in this situation. Kaldor (1960) has argued that government intervention works only if cumulative expectations have not turned negative. Thus, a government can prevent a downturn only if it intervenes early. In the present situation, policymakers awakening from a state of d enial have been behind the curve. They have only intervened timidly and the problem has grown beyond their control.

Today, there is a fall in investment, consumption and exports in most economies. The only boost is through rising fiscal deficit. But this cannot overcome the fall in demand in the private sector. Unfortunately, if the fiscal deficit is a result of transfers to c apitalists, the effect is lowered (Kumar 1999).

Beyond Demand Management

Given that there is a deep crisis in the financial sector, the little boost in demand due to the fiscal deficit cannot overcome rising bankruptcy in major sectors of the economy. Even if demand is created, production may be difficult to revive because many companies are going bankrupt. In this context, it is important to r emember that Kaldor (1960) suggested that eventually, after enough plant and equipment has been depreciated away, cumulative expectations turn again and an upturn does occur. However, in the present circumstances, the implication is that even this may not happen without a major rearchitecturing of the e ntire production and finance system.

CHINA SINCE 1978

December 27, 2008

Inequality and Its Enemies in Revolutionary and Reform China –Ching Kwan Lee, Mark Selden Property Rights and the Social Costs of Transition and Development in China –Carl Riskin Rural Industrialisation and Spatial Inequality in China, 1978-2006 –Chris Bramall Double Movement in China –Shaoguang Wang A House Divided: China after 30 Years of ‘Reforms’ –Robert Weil Light and Shadow of an Inarticulate Age: Reflections on China’s Reform –Pun Ngai Socialism, Capitalism, and Class Struggle: The Political Economy of Modern China –Minqi Li China’s Rural Reform: Crisis and Ongoing Debate –Dale Jiajun Wen Globalisation Meets Its Match: Lessons from China’s Economic Transformation –Dic Lo, Yu Zhang

For copies write to: Circulation Manager, Economic and Political Weekly,

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As pointed out in Kumar (2009), while the asset side of most businesses has collapsed, the liability side remains as it is. The peculiarity is that in a bookkeeping sense, most businesses may be bankrupt while the real asset base of the economy is intact. The issue is who owns these assets? Most of those who owned them are now bankrupt because of their paper losses. Further, these losses are legally covered by contracts with others, hence they are not fictitious. The problem is then systemic and a resolution difficult.

Can some agency retrace each of the steps in the creation of the financial assets and reverse this process so that the debts to each other can be cancelled? As pointed out in Kumar (2009), this is improbable if not impossible due to the process being akin to a random walk where there is not micro reversibility but macro irreversibility. Some fundamental changes in the system would be required, namely, property rights would have to be derecognised. This would be akin to nationalisation of the entire economy. Today, when infusion of simple equity by government in financial institutions is resisted on grounds of “nationalisation”, how much more resistance would there be to elimination of property rights even if it is a one-shot affair. Capitalists would fear that this would become a precedent for all time to come and could happen later also without any benefit to them.

The logic of the argument presented above is that most businesses as we know them will close down as losses come on to their balance sheets. This would occur rapidly in some cases while it may take time in others. A high degree of leveraging and capital losses on assets implies that losses on the books of most businesses are far greater than their owned asset base.

The implication also is that apart from the government, no one else would buy these companies with losses on their balance sheets. Further, as stock markets continue to decline, capital losses will only grow. In the event, at current market prices, b uyers will be few and prices will only fall. So the markets will remain bearish for the foreseeable future.

However, it also needs to be asked, even if the government and central bank guarantee it and bailouts are spread to all companies, will their resources be adequate to the task? Since, the size of the financial collapse is a multiple of the capital base of the real economy, even after nationalising all the assets in the economy, the government cannot put in the resources to take over all b usinesses.

Conclusions

The paper points to the depth of the crisis confronting the global economy. It points to how cycles originate and how recession and depression can be more precisely defined in terms of investment decisions and capital stock rather than the current definitions in terms of output. It also presents the various ways of understanding demand deficiency, which was the underlying feature of the earlier downturns in capitalist economies. A resolution of the problems faced then was possible with demand management u sing Keynesian tools. This paper argues that the current global economic crisis is different from the past crises experienced by capitalism. Hence the lessons learnt from the past may not be a pplicable to solving the current crisis. The arguments presented in the paper imply that demand management alone will not work because capitalism faces a basic crisis. Even more radical solutions, like those proposed by George (2008), based on tackling poverty and environmental degradation will also not work. What we do in the future is not the issue. The question is what do we do now? One implication of this paper is that we need redistribution, but that is not on anyone’s agenda today.

The present problem is a culmination of the trends in the real economy over the last few decades which resulted in the emergence of a financial bubble. This turned into a financial crisis in 2006 and reacted back on the real economy, affecting it more and more since mid-2007. Thus, it is argued here that fiscal p olicies (or monetary policies) would have worked in the present crisis if demand was the problem. But, since that is not the crux of the problem, these policies are not producing the expected r esults and are unlikely to do so.

This is because it is the inter-relationship between real and financial capital which is leading to the bankruptcy of businesses. Real assets exist but their current owners are mostly bankrupt due to paper losses. Further, there is loss of trust in the system and the financial sector has lost its capacity to facilitate production. Productive capacity exists but the arrangements that allow it to function fully are increasingly breaking down. The breakdown in the financial arrangements cannot be reversed in an

o rderly manner. It is suggested that it might require dismantling the entire system of property rights to correct it. But that would pose a fundamental challenge which at present would be unacceptable to capitalists and therefore, the resolution of the present problem seems difficult, if not impossible.

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