Marxian and Post-Keynesian Theories of Finance and the Business Cycle

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Introduction

The end of the economic expansion that began in the us and the other advanced capitalist countries in the early 1990s presents an opportune moment to review Marxian theories of the business cycle. (1) Much of the orthodox discussion about whether the end of the expansion would lead to a recession has been informed by a neo-classical approach to economics, which conceives of recessions as the result of 'shocks' or 'disturbances' which lead an economy to deviate from a normal path of steady growth. In contrast, the Marxian approach sees business cycles as an intrinsic feature of the way that growth occurs in a capitalist economy.

According to this view, economic expansion occurs in protracted spurts, which lead to an accumulation of tensions, and a downturn in the business cycle is seen as the mechanism by which such tensions are eliminated, thereby creating the basis for a new period of growth.

Marx himself was, of course, one of the first people to recognise the existence of business cycles. (2) However, as has often been pointed out, there is no place in which he set out all the different elements of his approach in a consistent form. Since Marx's time, the Marxian theory of the business cycle has generated an enormous body of literature, and this received a fresh impetus in the early 1970s, when the lengthy period of relatively sustained accumulation that had begun after the Second World War came to an end. However, much of this literature is marked by having taken just one aspect of Marx's approach, and presented it as the over-arching explanation for business cycles. Furthermore, relatively little attention has been paid to financial aspects of the business cycle, even though Marx's own approach involved an interaction of real and financial factors. Indeed, because in Marx's time the downturn in a business cycle was usually associated with a dramatic monetary and financial crisis, he sometimes used the term 'crisis cycle', or even just 'crisis', when he was referring to the analysis of the business cycle. (3)

The aim of this paper is, first, to outline the basis of Marx's approach to the business cycle, and then to look at how more recent authors have attempted to use and develop this approach to understanding the modern business cycle. Marx's approach to business cycles can be viewed as consisting of three stages. The first of these is concerned to demonstrate that crises are a possibility in a monetary economy. This is considered in section 2.

The second stage is found in the course of Marx's analysis of production and circulation in a capitalist economy. Having demonstrated that a commodity economy involves the possibility of crises, Marx argues that, in a capitalist commodity economy, periods of profitable accumulation necessarily tend to undermine profitability, and that this blunts both the desire and the ability of capitalist enterprises to promote further accumulation. The different factors that Marx mentions in this connection, together with more recent interpretations by other Marxist writers, are reviewed in section 3.

The third and final stage of Marx's approach is concerned with the question of why a decline in profitability should lead not merely to a slowdown in accumulation, but to a period in which economic activity contracts. The answer has to do with the operation of the capitalist financial system, and the way it interacts with industrial and commercial capital. In order to understand this it is necessary, first, to analyse the credit system and the way the rate of interest is determined, and this is the subject of section 4. It is then necessary to examine how the availability of credit and the rate of interest impinge on the process of accumulation, and this is considered in section 5.

Marx's analysis of the financial system attaches considerable importance to institutional structures, and these have obviously changed considerably since his day. For this reason, the last part also draws on the work of recent post-Keynesian writers, who have developed illuminating insights into the way that contemporary monetary and financial systems function in the advanced capitalist countries. (4) However, as stressed in the conclusion, in explaining business cycles predominantly in terms of financial instability, post-Keynesians imply that, if such instabilities could be eliminated, it would be possible to overcome the cyclical nature of growth. In contrast, the Marxian approach argues that the business cycle is the result of the interaction of real and financial factors, and that while it might be possible to modify or even ameliorate the business cycle, it can never be completely eliminated.

1. Money and the possibility of crisis

The first steps in Marx's analysis of crises and the business cycle are established within the framework of a simple commodity economy,s Marx first argues that a commodity economy is necessarily a monetary economy, and then points out that that after a commodity has been exchanged for money, the money that is received might not be used to purchase another commodity, or at least not immediately. (6) This idea that money might be withdrawn from circulation involves money's function as a store of value. Marx refers to this as the abstract possibility of crisis, and it is the basis of his criticism of Say's Law. (7)

A further element of Marx's theory of the business cycle that is established at this stage concerns transactions in which commodities are exchanged, not for money, but for a promise or contract to pay at a future date. (8) Money comes into play here when the contract comes to be settled, and it involves money's function as a means of payment. The introduction of contractual payments of this type can give rise to two possible consequences. First, if prices or values should decline before a contract has elapsed, the debtor might be unable to raise the amount of money required to settle the contract. Second, where a contract is only one of an interlinked series of contracts, then a failure to pay by one debtor could spread rapidly, and this could give rise to forced sales of commodities, as debtors strive to obtain the money they need to meet their obligations. This is a second form of abstract possibility of crisis, and it introduces the idea that difficulties arising in one set of transactions could rapidly be transmitted to other parts of an economy. (9)

Having established why it is that crises are possible in a monetary economy, Marx then proceeds to show why he considers them to be a necessary result of production and exchange in a capitalist economy.

2. The falling rate of profit

The basis of the Marxian analysis of the business cycle is that periods of capitalist expansion necessarily lead to a fall in the rate of profit, and that this reduces both the desire and the ability of capitalist enterprises to accumulate. There are, however, a number of different explanations of why exactly this occurs, and these can be grouped under three main headings, as follows. (10)

One of the most widely discussed approaches is the one known as the profit squeeze position. This is based on the analysis of accumulation in the first volume of Capital, where Marx argues that capitalist firms are forced by competition to invest at least part of their profits in order to expand the scale of their operations, and so reduce their unit costs of production. (11) To a greater or lesser extent, depending on the degree of mechanisation, however, accumulation involves an increase in the number of workers employed, and therefore a decline in the number who are unemployed. This decline in the number of unemployed strengthens the bargaining position of workers, and makes it more possible for them to push up their wages, thereby reducing the amount of added value going to profits.

The consequence of such a squeeze on profits is to undermine both the eagerness and the ability of firms to accumulate any further, thereby bringing a period of expansion to an end. A corollary of this position is that a recession, by leading to layoffs and closures, increases unemployment, and helps employers to raise profits at the expense of wages, thereby laying the foundation for a new phase of accumulation.

In the literature that has been published since the early 1970s, it is mainly in the more empirically-oriented contributions that the profit-squeeze position has been put forward as the main cause of crises. Some of the earliest of these studies were concerned to establish that corporate profitability had indeed fallen sharply, and the profit-squeeze argument was put forward to explain this, without going into alternative Marxist explanations. (12) There are also some later contributions which consider several of the different Marxist explanations, but which then conclude, on the basis of empirical evidence, that the profit-squeeze version is the most significant in explaining falling profitability. (13)

The profit-squeeze position has, however, been criticised. It is said that while it is couched in terms of class divisions, the analysis is confined to the issue of distribution, and a Marxist analysis should give primacy to contradictions that arise in the sphere of production. (14) The importance of wage pressure in explaining capitalist cycles is also played down by referring to a theoretical argument of Marx to the effect that, in the relation between accumulation and wages, it is accumulation that determines wages, and not the other way round. (15) At the same time, the results of the empirical studies have been challenged with the argument that there are significant differences between the empirical measures employed, and the Marxian concepts they are supposed to represent. (16)

In addition to the basic form of the profit-squeeze position, there are two other lines of argument which have some features in common with it. The most similar of these involves extending the analysis to include the prices of primary commodities, which are one of the main sources of export earnings for many Third World countries.

If the process of accumulation results in the demand for primary commodities increasing more rapidly than their supply, then this will help to raise the price of those commodities, thereby resulting in a distributional shift that benefits Third World producers, but which squeezes the profits of firms in the advanced capitalist countries.

Accumulation can then be seen as giving rise to a squeeze on profits as a result of strengthening the bargaining positions, on the one hand, of the working class in advanced capitalist countries and, on the other hand, of primary-commodity producers in the Third World. (17)

The other position that shows some similarity with the profit-squeeze analysis is also concerned with the way that accumulation strengthens the position of workers, but it focuses on the labour process: that is, on the sphere of production rather than that of distribution. This perspective emphasises the fact that, under capitalist social relations, the immediate process of production is the site of a constant struggle between capital and workers, as management seeks to impose capitalist discipline and to achieve the highest possible intensity of labour.

After a period of accumulation based on a particular type of labour process, workers will feel surer of their position as a result of lower unemployment. They will also have become familiar with the organisation of the labour process, and will therefore be in a position to exploit any points of vulnerability so as to resist the demands of management, which results in a lower intensity of labour. A lower intensity of work means that less value will be produced in a given period of time and that, supposing that wages are given, profits will decline. In this approach, periods of crisis or recession are seen as part of the mechanism by which capital seeks to re-establish its command over labour, an important aspect of which is the restructuring of the labour process and the introduction of forms of new technology that give greater control over the process of production to capitalist management. (18)

A second broad line of argument in the Marxian debate about crises is usually known as the underconsumptionist position. Marx initially analysed capitalist production as if firms will automatically be able both to buy the inputs they require and to sell their finished products. In the second volume of Capital, Marx turned his attention to the complexities of capitalist circulation, a process that involves the intertwining of different capitals through the dual flow of commodities and money.

Marx proceeded by considering the simplest possible framework within which it is possible to pose the issue of circulation: a model with two departments, where the first produced means of production, and the second means of consumption. This is the basis of Marx's famous reproduction schema, and he used these to show how economic reproduction required that certain proportions were maintained between the two departments, both in terms of use values and of money. (19)

The reproduction schema raises the issue of where the demand arises that provides the means of realising the value and surplus value that--potentially--has been created in the process of production. The crux of the underconsumptionist position is that it looks upon reproduction as being limited by the final demand for means of consumption. Workers' wages are considered to provide the purchasing power that realises the value of one part of the total social product, but there then remains the issue of how the remaining part of the value that has been created--that which corresponds to surplus value--is to be realised. Investment in expanding the scale of production is recognised as one means of achieving this but, because of the restricted consumption of the working class, it is argued that this doesn't make much sense beyond a quite limited point. The underconsumptionist position therefore hinges on the impossibility of realising all the surplus value that is produced.

One of the most distinguished proponents of this position is Rosa Luxemburg, who linked the problem of realising surplus value with a vivid analysis of capitalism's rapacious colonial expansion. (20) However, despite the praise that has been accorded to Luxemburg's concrete analysis of imperialism, her theory of underconsumption has been subject to considerable criticism. The most serious point that is made against her is that she confuses levels of analysis, and that while, at the level of a two-sector reproduction scheme, it might appear implausible that different capitals could realise each other's surplus value, this is not the case when one moves to the more concrete level of analysis embodying many individual capitals in competition. (21)

Luxemburg's analysis is primarily concerned with a long-term tendency for capitalism to stagnate, rather than with the shorter-term dynamics of the business cycle. This is also true of more recent writings based on an underconsumptionist perspective, such as the influential analysis of post-war us capitalism developed by Paul Baran and Paul Sweezy in the 1960s. (22) However, perhaps prompted in part by the influence of Keynes's ideas, some Marxian writers have drawn on an underconsumptionist perspective in order to analyse the business cycle. One approach along these lines is based on the claim that, at the beginning of a cyclical upturn, profits rise far more rapidly than wages, and it is argued that this leads to a problem of realisation, since it is wages that are the main source of final demand for consumption goods. A decline in demand, it is said, will result in a decline in capacity utilisation and, given a high level of fixed costs, this will lead to higher unit costs and, consequently, a lower rate of profit. (23)

A short-run version of the underconsumptionist analysis is open to the same basic objection that has already been referred to in relation to the long-term version above. Underlying this objection is the view that capitalism is not driven by the satisfaction of consumer demand, but rather by the constant pressure to accumulate. The importance of Marx's reproduction schema, however, is that they demonstrate that there is no necessary problem of underconsumption and that, at least in theory, the process of accumulation can ensure that all the surplus value that has been produced can be realised. Nevertheless, by introducing the notion of effective demand, the analysis of reproduction highlights the fact that the process of realisation is not assured, and that it is sometimes not possible to realise all the value that has been produced.

Marx raises at least two important reasons why realisation might be a problem. One of these is that capitalism involves a constant tendency to cheapen commodities, and that if values have fallen in the interval between production and realisation, it might not be possible to realise their original value. Indeed, crises are seen as one of the mechanisms by which market prices are adjusted to new, lower values.

The second reason why realisation might be problematic--and something that is related to the first reason--is that the renewal of fixed capital is a discontinuous process. Firms do not usually spend that part of their income which corresponds to depreciation gradually, as it accrues; rather, they build up such funds over a period of time, and then throw them into circulation all at once.

While the credit system socialises this process to some extent, making unspent depreciation funds available to firms that do wish to invest, Marx believed that there is a link between the renewal of fixed capital and the business cycle. Firms are most likely to invest in new fixed capital when the prospects for an upturn appear strong, and least likely to invest at the end of an upturn, when markets appear saturated, or during the downturn that follows. More than this, however, Marx believed that there was a link between the duration of the business cycle and the economic life of fixed capital; that is, the length of time before which it was either physically exhausted or, more significantly, before which technological development and changes in productivity had made it obsolete. (24) Following along this line of argument, crises are seen as a mechanism which forces firms to scrap existing fixed capital, and to adopt new techniques which enable the costs of production to be reduced.

A third broad line of approach in the Marxian debate is that associated with the tendency of the rate of profit to fall. This is presented in the third volume of Capital, which combines the analysis of capitalist production and capitalist circulation, and incorporates the existence of many individual capitals in competition. The basis of this position is that competition forces capitalist firms to invest in plant and equipment so as to raise productivity and reduce their costs of production. This means that as accumulation proceeds, the proportion of capital that is advanced for the elements of constant capital (plant, equipment, raw materials) tends to rise, and the proportion advanced to employ living labour tends to fall. Marx refers to this as a tendency for the organic composition of capital to rise, where organic composition is his term for the ratio of constant capital to variable capital. Since in Marx's theory, it is living labour that produces surplus value--the source of profit--if, as a result of …