How Much Fiscal Stimulus Will It Take?

In view of what was required to get out of the Great Depression, I don’t think there is any way the economy is going to escape stagnation until and unless government intervention on a massive scale occurs. Since this point does not appear to be widely recognized by policymakers or the general public, stagnation will continue until – after 1, 5, 10 or more years – the reality finally registers in the public consciousness, or at least among policymakers, that a massive and sustained intervention is required.

The following figures come from a short paper by Alan Freeman. In 1933, US unemployment was 25% and private investment was at a record low of 2.2% of GDP. The New Deal, which was nowhere near sufficient to enable recovery, increased government spending by 5% of GDP and cut unemployment to 16%. By this stage, the stock market had picked up and the financial sector was demanding cuts to government spending, etc. The inevitable result was a reversion back into recession in 1937-1938. Recovery only came with the war. Freeman writes:

Between 1938 and 1944, government spending trebled, approaching half of GDP – compared with a miserable three per cent from private investors. And when the war was over, state investment stayed at double its pre-war level despite repeated foolish attempts to cut it back. This was what it took, economically, to ‘solve’ the crisis.

It’s common to speak as if the war was ‘economically abnormal’. Well, so is the present situation. So here’s an ‘uncomfortable truth’: before the US economy saw a meaningful recovery, the state took over half its economy, supplanting private investment for three years, and following that, retained both investments and spending which were double their pre-war levels.

And it happened in wartime, when private investors accepted measures they would not tolerate in peacetime. That’s food for thought. It means the way out of the crisis involves something never seen before – wartime state involvement on a peacetime basis.

In this post I want to focus briefly on why such massive government intervention is required before sustainable recovery can occur. The answer, in my view, is linked closely to Marx’s tendency for the rate of profit to fall, and the inability of the private sector to escape this tendency in anything other than a socially disruptive fashion in the absence of a massive government intervention. However, I will view this tendency in terms of realized profit rather than produced surplus value.

At the aggregate level, Marx maintained that total price equals total value, total profit equals total surplus value, and the average rate of profit equals the average rate of surplus value. For this reason, it is legitimate at the macro level to view Marx’s tendency in price (profit) terms rather than value (surplus value) terms. If the additional assumption is made that all produced profit (surplus value) is realized, the tendency can be viewed in terms of Kalecki’s aggregate profit identity. This identity, which I previously discussed here, states that, as a matter of accounting:

P = CP + I + BD + NX – SW

Here, P is realized aggregate profits, CP is capitalist consumption, I is private gross investment, BD is the budget deficit, NX is net exports, and SW is worker saving out of wages. The identity says that realized aggregate profits equal the sum of capitalist expenditures, government net expenditure and the trade surplus minus worker saving.

The average realized rate of profit, r, can be represented as P/K, where K is the amount of private fixed capital investment (in dollar terms) tied up in production:

r = P/K = (CP + I + BD + NX – SW)/K

The question is why the private sector is unlikely to recover on its own any time soon. The answer is that to do so, there would have to be an enormous increase in gross private investment, I, at a time when: (i) the rate of profit has collapsed; (ii) the private sector needs to net save and pay off debt; (iii) there is enormous excess capacity, and hence insufficient demand to ensure high utilization of existing capacity let alone expanded capacity; and (iv) sections of capital, especially financial capital, will resist the necessary devaluation of capital, represented in the profit-rate expression by a collapse in K. Private investment adds not only to P, but also K. It is this factor that causes the realized rate of profit to fall over the expansionary phase preceding the crisis. To restore profitability without government intervention, there would need to be a massive collapse in K, which is the functional role of crises under capitalism. That would mean lenders and creditors (rather than debtors) taking huge losses. The most powerful sections of financial capital strongly resist this process. They want workers and even productive capital to pay for the crisis, not financial capital.

To the extent the present malaise can be addressed within capitalism, it requires government to step in with massive deficit expenditure. This is what occurred before recoveries were possible after the depressions of the 1890s and the 1930s. In addition to war expenditure, which provided an outlet for government investment expenditure, the government also invested in infrastructure, plant, etc., which raised productive capacity at no cost to the private sector (i.e. without adding to K). After the war, this newly created productive capacity was transferred over to the private sector at bargain-basement prices. In other words, the prices of the elements of K were dramatically reduced. A combination of an increase in aggregate profit, P, due both to government consumption and investment expenditure, and a reduction in K, delivered a strong revival in the rate of profit. If the aim of policymakers is to restore profitability, something similar will be required again. Hopefully this time it won’t entail world war.

The problems we face now bear a striking resemblance to the problems faced in the 1930s, and the risk is that we will make the same mistakes and take just as long to learn from those mistakes as policymakers did in the past. Much the same arguments against deficit expenditure, fueled by much the same vested interests, dominated the debate then as now, and emotions ran just as high. That’s why it took two years too long for the initial stimulus in the early 1930s to be applied, why these measures were removed prematurely as soon as Wall Street “recovered”, why it took further recession for stimulus measures to be reapplied, and why after the war there were repeated attempts to cut expenditure only to result in slowdowns and recessions.


4 thoughts on “How Much Fiscal Stimulus Will It Take?

  1. An idiot. (George Costanza has nothing on this idiot.) I just realized, after much consternation, why comments in some threads have “gotten themselves” out of order. Somebody who shall temporarily remain nameless changed the blog’s timezone to “Australia” and created havoc. This caused all his comments — and only his — to jump to earlier positions in threads. This had him replying to people before they even had the chance to leave a comment. Thankfully, the blog has now been put back on “world” time, but I still have to go through and physically re-save any of his (yes, my) comments that got out of order. Hmph.

  2. Lol, Peter. When I first started visiting this blog regularly, I noticed the date/time stamps seemed a little “off”. So I tried to sync the “timing” of your posts/comments here to my own timezone received in my reader. And by my best estimation, you were somewhere in Ghana. Predictably, hilarity ensued when I began to question all things “Australia”.

    And then? Then you started teleporting. Alas, I notice these things. But to this day, my initial findings remain the same:

    1. Worst Comment Moderator Ever.
    2. Worst Communist Ever.
    3. Best Thing Ever on the Internet.
    4. “Australia”

    As I will always say: For the love of everything holy, please don’t ever change.

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