Bubbles, Globalisation and the Worldwide Economic Crisis: Graham Turner: Review

A Keynesian looks at the credit crunch The Credit Crunch: Housing

Over a year has elapsed since the “credit crunch” first hit the headlines. Now as the locus of the economic fallout shifts from the US to Europe, and with the UK particularly vulnerable to recession, Graham Turner, a left-leaning Keynesian economist, has produced a timely summary of the crisis. It is not likely to be the last.

Turner aims to identify the underlying causes of the financial crisis and the seemingly inevitable crisis in the “real” economy. He concentrates on the US and UK, drawing heavily on the experience of Japan the 1990s – the “lost decade” of economic stagnation – using his insider knowledge as a former employee of Japanese banks.

The book is written in an accessible style but is quite technical in places and perhaps assumes too much mainstream and Keynesian economic theory to classify it as a popularisation.

Turner examines a number of themes – over-investment, asset-price bubbles, debt, income inequality and globalisation – and sets himself an enormous challenge in attempting to integrate them.

Unfortunately, the threads are too often loosely drawn, meaning lost in a maze of economic indicators – interest rates, currency movements, trade imbalances, capital flows, inflation (and deflation) and so on. Nevertheless, he is to be commended for not simply blaming governments and their central bankers (although there have been policy errors aplenty) or the self-evident voracity of financiers for the current economic problems.

For Turner, periods of economic crisis can be characterised as ones of high inflation or deflation. The Great Depression of the 1930s was a deflationary spiral; the 1970/80s was an inflationary one and the 1990s to the present day deflation again. Turner attributes inflation or deflation to a mismatch between global supply and demand. The Thatcher/Regan era he calls “over-consumption” when demand exceeded supply, the Great Depression and the current period as “over-investment” when supply is outstripping demand.

The result of over-investment, according to Turner, is that workers’ wages will be too low to absorb the increasing supply of goods and services. His analysis is little more than the familiar idea of “under-consumption”. He is also making a big claim here, that there is a significant degree of symmetry between the world economy in the 1930s and today, something that takes quite a lot of proving, given the crisis-wracked nature of the Great Depression. It is a shame that he did not take a brief look back to before the First World War, as surely the first period of globalisation from the early 1890s to 1914 is more relevant.

A more straightforward example of over-investment that he considers is the east Asian currency crisis of 1997 that occurred after vast inflows of Foreign Direct Investment (FDI) into the growing electronics sector for the export market. This may have led to a glut of goods on the world market in one specific sector but this is not the same as a general glut, and the fall in output probably had more to do with investors ditching the emerging economies of East Asia for the US that was experiencing an IT-led productivity boom.

Big investors will always gravitate towards any money-making venture that promises a profit rate above the average. Sometimes it results in over-investment in particular sectors or locations of production, in other cases it is blatant financial speculation, such as the wildly inflated real estate prices in Japan in the late 1980s and the “irrational exuberance” of the dotcom stockmarket bubble. These are examples of the disproportional allocation of capital that is intrinsic to the unplanned nature of capitalism.

Turner covers familiar ground when discussing the most recent asset-price bubble – the dramatic increase in house prices in the US, UK and other industrialised countries – and its inevitable bursting in the shape of the sub-prime mortgage debacle. It is also generally accepted that the Japanese authorities at the beginning of the 1990s, faced with both stockmarket and land price bubbles, were far too slow in reacting with monetary and fiscal measures to boost the economy and consequently the economic slowdown lumbered on for a decade.

Turner argues that Ben Bernanke at the US Federal Reserve was also too late in slashing interest rates, as the financial turmoil may have started in the summer of 2007 but the housing market had peaked almost two years earlier: the writing was on the wall. He also warns that Keynesian intervention may never be quite sufficient to drag an economy out of stagnation. One can only imagine what he thinks about the pathetic inactivity displayed by Gordon Brown and Alistair Darling!

But why did it happen? Turner’s answer is based on the relationship between personal debt, wages and the effects of globalisation. On debt, he gives the results of a simulation run by Oxford Economic Forecasting, where the rise in personal debt to disposable income is assumed to be at a lower rate than it actually has been since 1997. It predicts that real consumption in the US would be 6% lower after 10 years with this constrained rise in debt – knocking about 0.4% off GDP year-on-year – perhaps less dramatic than implied by Turner’s conclusions of a “compelling demand gap”.

The model also forecasts nominal wages in the US to be a whopping 21% lower after 10 years with almost no inflation. This appears to be more persuasive evidence that rising personal debt and the housing bubble have been filling the demand gap and driving economic growth, but it misses out an important fact; workers spending their wages are not the only consumers. You have to include capitalists (and salaried CEOs, fund managers, etc) spending a portion of their profits on goods and services, and on luxury consumption – and this has grown very rapidly in recent years, as illustrated by rising income inequality. The top 1% of households received 22% of total income in 2005, more than double what it was in the 1970s.

Aggregate demand also includes productive consumption, capitalists buying capital goods – buildings, equipment, IT etc. – something very evident in what The Economist called the greatest period of capital investment in history, most notably the exponential investment of China. However, Turner provides little discussion of investment rates.

Yes, living standards for many workers have stagnated for periods, but Turner wants to use this to assert something more fundamental about capitalism today, that low wages and a demand gap have become the cause of crisis.

While it is true that a shortfall in aggregate demand will precipitate and prolong a crisis, this is not because of a deficit in workers’ consumption but because capitalists will hoard their profits when expected returns on investment are too low. Why the rate of profit has a tendency to fall is another story.

It should be noted however, that while personal debt is obviously a major problem for millions of workers and financial corporations are experiencing massive losses resulting from the securitisation of the mortgage market, non-financial corporations generally have “solid balance sheets”. The impact of the credit crunch on the non-financial sectors of the economy, construction apart, has been smaller to date than in previous recessionary periods. Profit rates are off their peaks but still well above the trough of the 1970s/80s.

Turner describes how multinational corporations have shifted manufacturing to the lower-cost emerging economies with pools of cheap labour in the scramble for greater profits. This has exerted downward pressure on wages in the industrialised west as domestic producers have to contend with cheaper imported goods and can always threaten workers with off-shoring.

This may be a factor, but wages as a proportion of GDP started to fall in the 1970s with the attacks on organised labour, before globalisation and the emergence of China and so forth.

Globalisation can be squarely blamed for the growing global imbalances such as the large US current account deficit and accentuating the disproportional allocations of capital discussed earlier. The US trade balance is now improving as exports surge, probably to the surprise of Turner, but the UK may not be so fortunate after the decimation of manufacturing and an over-reliance on financial services.

Globalisation is certainly the biggest of his themes, but for Turner the historically unprecedented growth of the BRICs (Brazil, Russia, India and China) barely registers; it will just add to capitalism’s problems as wages are even lower and the global demand gap will widen further still.

The Marxist approach to crisis is quite different and rests on the primary importance of the rate of profit and, however uncomfortable it is to admit, global profit rates have been at their highest for decades. You wouldn’t really expect to find such an analysis in this book, but nonetheless it is a thought-provoking read.

Wed 03, December 2008 @ 17:15