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, its connections to profitability, and the implications for capitalism. It is argued that demand considerations, when considered in conjunction with Marx’s ‘law of the tendential fall in the rate of profit’, do not call for the preservation of capitalism but rather suggest a means of transitioning to socialism.
Denial of a real significance for demand comes from two directions. On one side are neoclassical economists, many of whom deny 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 (or profit rate tendency, for short) 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.
Demand in general
The capital debates exposed, among other things, the perils of ignoring 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 himself) tended to adopt one or other one-sided explanation of crisis to the exclusion of others, usually emphasizing either the underconsumptionist or overproductionist tendencies of capitalist economies. 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 prevent demand deficiency from ever being 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 traditionally 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 are relevant to the debate over the current crisis. Some Marxists are critical of 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 profit rate tendency 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 to the logic of capital, is for a crisis to bring about a collapse in the values of the components of constant capital. This boosts the rate of profit.
This revival of profitability is necessary for capitalist recovery, but it is not sufficient. The revived rate of profit will only entice investment to the extent that the resulting output can be realized in exchange. Although value and surplus value are extracted in production, not exchange, demand affects both the level of activity (real value creation) and the extent to which profit can be realized. It affects profit realization because, in aggregate, realized profit is the sum of capitalist expenditures, net exports and the government 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 depend on demand.
So, demand is necessary to entice investment, yet ongoing growth in demand (in the absence of crisis) will tend to depress the rate of profit. For as long as demand growth persists and the rate of profit remains above the minimum rate just sufficient to entice investment, a capitalist economy can continue to expand, for a time.
In the lead up to the global financial crisis, it was households rather than government or capitalists who played the pivotal role in sustaining demand. In the US, the federal government ran fiscal surpluses or near balanced budgets in the latter half of the 1990s and very early 2000s. For a trade-deficit nation such as the US, that meant, as a matter of accounting, that the domestic private sector had to be spending more than its income, in aggregate (see Government Deficits and Net Private Saving). It is not clear whether it was the government’s fiscal stance that caused the private sector to go into deficit or the private sector deficit that caused government to go into surplus. Either way, it was clearly an unsustainable situation, a point that was made repeatedly by economists employing the sectoral balances framework of Wynne Godley. In any case, the negative impact on demand of insufficient fiscal 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 US, external demand drain, but hit its inevitable limit when private debt servicing requirements became excessive relative to income.
Marxists who reject demand-side explanations of crisis are really only countering the underconsumptionist argument. True, that argument is one sided. 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 sluggish 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 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 variations 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.
Implications of an all-sided understanding of crisis
It may seem that to concede a significant role for demand is at the same time to concede that capitalism can be preserved through demand-management policies. Certainly many Keynesians take this view, and it leads them to reformist policy prescriptions aimed at propping up the existing system. But the likelihood of this Keynesian policy prescription actually preserving capitalism rests crucially on Marx’s profit rate tendency being inoperative. If, on the contrary, Marx’s profit rate tendency is binding, then a full consideration of demand factors does not logically lead to the possibility of preserving capitalism but rather to the likelihood that ongoing demand-management policies will push the system toward socialism.
The reasoning leading to this conclusion can be summed up as follows. If Marx’s profit rate tendency holds, the foregoing discussion of demand and profitability implies two necessary conditions for the preservation of capitalism:
1. Periodic revival in the rate of profit. This requires crises to decimate capital values.
2. Ongoing demand. This requires continual injections of demand.
Satisfying one condition without satisfying the other is not enough to sustain capitalism. Although a collapse in capital values brought on by crisis will revive the rate of profit, this higher profitability is only a potential unless there is sufficient demand for it to be made realizable in exchange, which is unlikely in a crisis due to collapsed demand and excess capacity. Conversely, ongoing maintenance of demand without a collapse in capital values will ultimately bring the rate of profit below the minimum required to entice capitalist investment. Beyond this point, the level of activity can be maintained indefinitely, but to do so, production will increasingly need to be situated in the public and/or not-for-profit sectors and underpinned by the spending of currency-issuing government. This would entail a transition to socialism.
In short, if Marx’s profit rate tendency holds, the preservation of capitalism requires periodic crises. The choice confronted by society will be between a crisis-prone capitalism or a transition to socialism.
In this sense, the theoretical status of Marx’s profit rate tendency is of critical importance. This remains so even when we take demand seriously.