Tuesday, 25 November 2008

What happens in a recession?

The government's recovery package has gone in the right direction in the area of seeking to maintain consumption during a recession.
The cut in VAT will concentrate tax relief on the average and lower paid - which is what is required from the point of view of both keeping up consumer demand and social justice. There can be discussion about whether the consumer spending stimulus package should have been larger, and whether the restrictions on government spending are necessarily the best thing in current economic circumstances. But overall the package is a commitment to an unambiguously Keynesian approach and, in the fields of consumer and government spending it can, if necessary, be boosted later in any case.
But it is vital to realise that in a recession what is decisive is neither consumer nor government spending. What, above all, occurs in a recession is that investment declines or, in the most severe cases, collapses.
In order to illustrate this Figure 1 shows the changes in the main domestic components of US GDP in the most classic of all recessions/depressions - that in the US following 1929. [1]

Figure 1

As can be seen the pattern is clear. The economic decline in US was extremely severe - on a far larger scale than anything occurring at present. The fall in US GNP (Gross National Product) was 29.7 per cent between 1929 and 1933.[2] The 1929 US level of GNP was not regained for a decade - until 1939.
Looking at the components of this decline in GDP, however, a clearly differential pattern shows itself.
Government spending increased throughout the recession - not only after Roosevelt became president in 1933 but even under Hoover.
The decline in personal consumption expenditure after 1929 was severe but less than the overall decline in GNP. By 1933 US personal consumption expenditure had fallen by 19.7 per cent compared to the 29.7 per cent drop in GNP. Personal consumption expenditure regained its 1929 level by 1939.
But the collapse in investment was extreme, far exceeding the decline in GNP - explaining the difference between the drop in personal and government consumption expenditure and the drop in overall output
By 1933 US private domestic fixed investment had fallen by 73.9 per cent from its 1929 level. Or, put another way, by 1933, US private domestic fixed investment was only 26.1 per cent of its 1929 level. This was by far and away the most severe element of the depression - which, by multiplier effects, spread its consequences through the rest of the economy.
The reason for this differential decline is that while 'demand' may be spoken of in general, in fact the different components of demand are controlled by quite different mechanisms.
Decisions on the level of government spending are taken directly by the state and can therefore be relatively easily controlled.
Regarding personal consumption, the aim of the mass of the population is to have as good a living standard as possible. The most powerful issue affecting personal consumption is the level of income, not the desire to consume. [3]
However, private investment decisions are not controlled by consumption but by profit. Therefore investment decisions are not controlled by the same mechanisms as personal and government consumption - and can fall to almost any level. It is this decline in investment which is by far the largest in a recession.
Why, therefore, cannot the government intervene directly to stop the decline in investment? The issue here is private property in the means of production. If the government takes decisions on investment out of the hands of the private owners of the means of production it, in fact, limits or abolishes that private ownership of the means of production. Therefore, in such circumstances, if the government continues to accept as private ownership of the means of production as an absolute right if cannot halt the decline in investment. Whereas if, in such circumstances, the government aims to halt the decline in investment it must encroach on private ownership in the means of production.
The practical consequences in terms of economic policy are clear. If a recession is relatively mild, acceptance of private ownership in the means of production, and therefore the inability to control investment, may at worst be wasteful but it will not be fatal. The government still has tools to increase its own, state funded, consumption demand - it can, for example, embark on huge new health or education programmes. In terms of personal consumption there is a very severe issue in terms of maintaining demand which is posed by unemployment - overall consumer spending can fall not only because wages drop but because the number of those in work falls. However the government can still carry out large increases in welfare benefits, cuts in taxation, or public works schemes that can significantly support consumer spending.
But in the area of investment the government has no comparable instruments. Approaching one fifth of the economy is accounted for by investment - and this investment also determines the long term economic growth. Public investment is a tiny fraction of this. While the government has powerful levers in the areas of state and personal consumption it has no comparable ones in investment. Nor can it have them without a encroachments on private ownership of the means of production. [4]
This will, therefore, determine the unfolding of the economic situation. There is going to be a severe recession - in terms of comparison to those since World War II. But a severe recession, in those terms, is naturally relatively mild compared to the type of economic crisis after 1929. While the financial crisis is clearly the largest seen since 1929 the downturn in the real economy does not remotely approach that of the Great Depression. The probability is that the current crisis will remain a very severe recession and but there will not be an economic depression - although this depends on the US adopting policies that avoid the type of disastrous errors that followed 1929.
If the economic downturn remains at the level of a recession then Keynesian measures will succeed, after a period, in bringing about a new economic upturn without any severe incursions into private ownership of the means of production - outside of the financial sector where they have already taken place. That is, put in other terms, the moral case for socialism will remain. But, while the role of the state, in a capitalist economy, will require to be increased in order to overcome the economic crisis - something which is already happening, it will not require a transition to a socialist society to overcome the economic downturn. If, however, the present severe recession were to pass over into an economic depression then another outcome would be posed.
It is at this point that the moral and economic cases for socialism become inseparable. A capitalist economic solution says private property in the means of production must be regarded as absolute, and untouchable, even if that means economic collapse - this answer says the rights of capital are absolute and the rights of society subordinate. A socialist solution says that if, in order to avoid economic collapse, it is necessary to make encroachments into the rights of private property in the means of production then this must be done - it is the rights of society that are absolute and the rights of capital are subordinate to this.
These 'cold' figures on the movement of components of GDP during a recession therefore spell out, in their own way, the structure of society - that one part of the economy is controlled by the desire of people to consume, that is to enjoy a better standard of life. That another part of the economy is controlled by profit. And that the interests of the two may clash.
How far they will clash during this economic downturn, and with what outcome, remains to be seen. But the socialist answer is simple. It is society, that is people, which comes first - not the private ownership of the means of production.

[1] The international source of demand is net exports. There was a drastic contraction of international trade after 1929 which seriously deepened the depression. However this does not affect the argument regarding the components of domestic demand dealt with here. Inventories also declined after 1929, adding to the recessionary effect, however changes in stocks, by their nature, are cyclical and again the concentration here is on the long term elements in economic shift.
[2] Gross National Product (GNP) differs from Gross Domestic Product (GDP) in that is equal to GDP plus net income earned from abroad. Long term US historical economic data is in GNP terms. The size of difference to GDP is, however, small and does not seriously distort comparisons to other countries GDP figures.
[3] In a recession personal consumers may decide to save more - among other reasons to protect themselves from the threat of future economic hardship or unemployment. However there are relatively effective mechanisms to tackle this, and in any case if the extra savings are invested by the government or companies no fall in aggregate demand takes place - the savings by individual are merely spent somewhere else in the economy. The biggest effect is the fall in income due to either declines in real wages or unemployment.
[4] Such encroachments may be through large scale expansion of areas of public investment, taking over areas at present controlled by private investment, or both.

1 comment:

Robert said...

We must close down the tax havens before Cameron gets a chance to get his nose through the door of No. 10

As long as they exist in their current form the financial elite and corporate barons will cheat on their taxes by moving their assets offshore, and the government will not have the revenues to protect ordinary people from the recession.

The Tories will then blame Labour for the dire state of public finances having done everything possible to encourage their City friends and the offshore pirates to undermine HM Revenue.


There is every reason to hope that President Obama will be on our side.