Taking the role of effective demand seriously can sometimes seem to put you between a rock and a hard place in relation to other economists. Here, I want to consider the significance of demand in general as well as in terms of understanding the current crisis, particularly its connections to profitability.
On one side is the neoclassical orthodoxy, with its denial of any impact of demand on output and employment in the long run. In the lead up to the global financial crisis, these economists were even denying any significance in what is now clearly understood to have been an unsustainable build up of private debt. At the time, this was supposedly the rational decision making of intertemporally optimizing individual agents.
On the other side – admittedly a smaller group, but one I have more of an affinity with – are Marxists who consider Marx’s ‘law of the tendential fall in the rate of profit’ to be the fundamental cause of crisis and who tend to be dismissive of explanations that attribute significant roles to demand, credit or government policy.
I share some agreement with those Marxists who see falling profitability as crucial to explaining the crisis, but disagree with the dismissal of demand, credit and policy factors. In particular, I think demand and profitability are really two sides of the same coin.
Demand in General
One reason that I keep harking back to the insights of the capital debates is that this controversy exposed the perils of being too quick to dismiss demand. The Sraffian protagonists in this debate developed a powerful critique of neoclassical theory that holds many ramifications. The significance of the controversy for the present discussion is that it was only really neoclassical economists who had made a serious attempt to establish, theoretically, a supposed (long run) irrelevance of demand to output and growth. Neoclassical general equilibrium theorists ultimately ran up against the same wall exposed by the Sraffians: there is no automatic tendency to full resource utilization (see here and here for further discussion of this implication of the capital debates).
Marxists, in contrast, never really put forward a serious theoretical argument against demand. What instead happened is that Marxists of various stripes (though not Marx) tended to adopt one or other one-sided explanation of crisis to the exclusion of others, usually emphasizing either underconsumptionist or overproduction tendencies. Most relevant, here, is the underconsumptionist claim that the competitive drive to minimize wages will limit demand because workers will not be able to purchase the output produced.
The underconsumptionist argument is a limited view of demand. There is some truth to it, but the argument is incomplete because it fails to recognize that workers are not the only source of demand. If workers’ share in real income falls, that means the real income share of other income groups rises, and these groups are also a possible source of demand. Because of this incompleteness in the argument, it was easy for Marxists who were critical of underconsumptionism to dismiss it.
But in their dismissal, they were led to downplay the significance of demand-side explanations of crisis. This is despite Marx’s analysis in the last parts of volume 2 of Capital and some passages in Theories of Surplus Value having shown a way forward in terms of aggregate analysis and the role of demand. It seems highly likely that Keynes would have been aware of this, and Kalecki developed his work on effective demand starting from Marx’s analysis. As a result, economists influenced by Kalecki or Keynes placed more emphasis on these issues than Marxists. They understood that, yes, all social groups are a potential source of demand, but this does not mean demand is never an issue. It is still necessary to ask if there are mechanisms to ensure that demand deficiency can never be a problem.
This is where the negative critique of the Sraffians is so important. The pre-Keynes neoclassical orthodoxy asserted that there was such a mechanism – the price mechanism – that would ensure demand would always adjust to full-employment output. Keynesians rejected this and it eventually led to the critique of neoclassical theory developed in the capital debates. These debates made clear that there is no basis for supposing the price mechanism can play the role attributed to it in neoclassical theory. This supported the positions of Kalecki and Keynes, but also Marx’s earlier critique of Say’s Law and his analysis of realization problems.
Demand, Profitability, and the Crisis
These theoretical considerations remain relevant to the debate over the current crisis. Some Marxists are critical of Minskian and demand-side explanations of crisis, arguing that they miss the true underlying cause of crisis: Marx’s tendency for the rate of profit to fall.
I have discussed Marx’s falling rate of profit theory previously in Fiscal Policy and the Rate of Profit. Briefly, the argument is a dynamic one. It is contended that during an expansionary phase, capitalists invest proportionately more over time in constant capital (plant, machines, raw materials) and less in variable capital (wages paid to workers). Since, for Marx, labor is the source of all new value, and hence surplus value, this implies the amount of surplus value appropriated by capitalists falls as a proportion of value invested over time. The solution, inherent in the logic of capital, is for a crisis to cause a collapse in the values of the components of constant capital. This boosts the rate of profit and paves the way for recovery, though only after much hardship and mayhem in the interim period.
Personally, I am open to the argument that a falling rate of profit may be central to an understanding of crisis. But even if a falling profit rate is critical to an understanding of crisis, the implementation of fiscal austerity is closely connected to falling profitability. Although value and surplus value are extracted in production, not exchange, fiscal policy through its influence on demand affects both the level of activity (real value production) and the extent to which profit can be realized. It affects realization because, in aggregate, profit is the sum of capitalist expenditures, net exports and the budget deficit, minus saving out of wages. To the extent capitalist investment decisions reflect expected profitability, the prospects for realizing profit will be a critical factor in capitalists’ decisions to invest, and this will be influenced by the government’s fiscal policy.
The U.S. government ran budget surpluses or near balanced budgets in the latter half of the 1990s and very early 2000s. For a trade-deficit nation such as the U.S., that meant, as a matter of accounting, that the domestic private sector had to be spending more than it earned, in aggregate (see Budget Deficits and Net Private Saving). It is not clear whether it was the austerity that caused the private sector to go into deficit or the private sector deficit that caused the budget to go into surplus. Either way, it seems clear that stagnating real wages added to the appetite for private credit and equally clear that deregulatory policies enabled and encouraged the subsequent unsustainable build up of private debt. In this way, the negative impact on profits of insufficient budget deficits (in fact surpluses some years) was partly offset by the reduced saving of households and the extra credit-based autonomous consumption expenditure that this made possible. Household dissaving partly made up for the fiscal drag, and, in the U.S., external demand drain.
Marxists who reject demand-side explanations of crisis are really only countering the underconsumptionist argument. True, that argument is one sided and incomplete. It is correct to say that if workers’ real wages fall, the lost demand could be offset (or even more than offset) by investment or capitalist consumption out of profits. But, equally, it might not be. And, as it happens, over the period leading up to the crisis, it was not. Instead, workers’ supplemented their income with private debt that ultimately proved unsustainable.
The underconsumptionist argument, even though incomplete, actually captured this aspect of the problem. Capitalists did not seek to spend more themselves to an extent that offset the effects of stagnating real wage growth. They could have done, but they didn’t. They preferred instead to encourage workers to keep spending even though they had to go into more and more debt to do so.
It is always demand – more specifically, autonomous demand, including private investment demand but also autonomous private consumption demand, export demand and government expenditure – that determines the level of income (and value) creation that occurs. It is not enough to respond to a fall in one source of demand by saying that some other source will pick up the slack. Nothing in general can be said about aggregate demand and the way it will respond to a fall in real wages. It will depend on concrete social factors. In the neoliberal period leading up to the crisis, it so happened that demand was steered in a particular direction partly by the deregulatory and fiscal policy approach of governments, and in accordance with the spending propensities of capitalists and workers, propensities which themselves are produced socially.
By the same token, the chronic tendency of capitalism toward demand deficiency is really just another expression of Marx’s tendency for the rate of profit to fall. It is viewing the same problem from a different angle. If profitability had no tendency to fall over an expansionary phase as a result of a rising organic composition of capital, there would be less concern of demand deficiency, because capitalist investment would remain strong in response to the strong profitability. In that case, there would be no functional need under capitalism for a collapse in capital values to occur to restore profitability. In other words, there would be no functional need of crisis.
It might be objected that capital is what drives the system, and hence profitability is the root cause of crisis, not demand. That position seems more defensible under a gold standard or commodity-backed monetary system in which there is a strong external pressure on government to behave like capitalists, obeying the imperatives of capital. It is no longer the case – or, at least, need not be the case – in societies with a floating exchange-rate fiat currency system. A sovereign currency issuing government is freed from following the dictates of capital to the extent society deems it appropriate. My view, as I’ve argued previously, is that fiat money opens the way to greater liberty and economic democracy, if we wish to take it. It would technically be possible to eliminate the tendency for the rate of profit to fall (see here), but equally we are free to rid ourselves of capital in its entirety if that is the preferred social course.